Page 364 - Hydrocarbon Exploration and Production Second Edition

Petroleum Economics 351

30
First oil
20 date

Net Cashflow ($m) 10 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

-10
Economic
Lifetime
-20
Time (years)
-30
Figure 14.9 Indicators from the annual net cash£ow.

The profit-to-investment ratio (PIR) may be defined in many ways, and is most
meaningful when the net cashflow has been discounted (more of this shortly).
On an undiscounted basis, the PIR may be defined as the ratio of the cumulative
net cashflow to the capital investment. This is the first of the indicators of project
efficiency, indicating the return on capital investment of the project. If capital is
constrained, as it often is, then the investor should aim to maximise the return per
unit of capital investment, which PIR measures very well. It is simple to calculate,
but does not reflect the timing of the investment or the income stream.
Caution is required in the use of the simple cashflow indicators, since they fail to
take account of changing general price levels or the cost of capital (discussed in
Section 14.4). It is always recommended that the definition of the indicators is
quoted for clarity of understanding.
Figures 14.9 and 14.10 show the indicators on the net cashflow and cumulative
net cashflow diagrams, while Table 14.7 compares what these indicators tell the
investor about the nature of the project economics.

14.3. Calculating a Discounted Cashflow

The project net cashflow discussed so far follows a pattern typical of E&P
projects; a number of years of expenditure (giving rise to cash deficits) at the
beginning of the project, followed by a series of cash surpluses. The annual net
cashflows now need to incorporate the timing of the cashflows, to account for the
effect of the time value of money. The technique which allows the values of sums of
money spent at different times to be consistently compared is called discounting. This
is particularly necessary for typical E&P projects because they are spread over many
years. For very short projects, discounting would be less relevant.