Page 28 - Introduction to Petroleum Engineering

12 INTRODUCTION

Production volume is predicted using engineering calculations, while fluid price
estimates are obtained using economic models. The calculation of cash flow for
different scenarios can be used to compare the economic value of competing reser-
voir development concepts.
Cash flow is an example of an economic measure of investment worth. Economic
measures have several characteristics. An economic measure should be consistent
with the goals of the organization. It should be easy to understand and apply so that
it can be used for cost‐effective decision making. Economic measures that can be
quantified permit alternatives to be compared and ranked.
Net present value (NPV) is an economic measure that is typically used to evaluate
cash flow associated with reservoir performance. NPV is the difference between the
present value of revenue R and the present value of expenses E:
NPV RE (1.12)

The time value of money is incorporated into NPV using discount rate r.
The value of money is adjusted to the value associated with a base year using dis-
count rate. Cash flow calculated using a discount rate is called discounted cash
flow. As an example, NPV for an oil and/or gas reservoir may be calculated for a
specified discount rate by taking the difference between revenue and expenses
(Fanchi, 2010):

N Pq Pq N CAPEX OPEX TAX
NPV on on gn gn n n n n
n
n 1 1 r n 1 1 r
(1.13)
N Pq n o Pq n g CAPEX n OPEX n TAX n
n g
n o
n
n n 1 1 r
where N is the number of years, P is oil price during year n, q is oil production
on
on
during year n, P is gas price during year n, q is gas production during year n,
gn
gn
CAPEX is capital expenses during year n, OPEX is operating expenses during year
n
n
n, TAX is taxes during year n, and r is discount rate.
n
The NPV for a particular case is the value of the cash flow at a specified discount
rate. The discount rate at which the maximum NPV is zero is called the discounted
cash flow return on investment (DCFROI) or internal rate of return (IRR). DCFROI
is useful for comparing different projects.
Figure 1.4 shows a typical plot of NPV as a function of time. The early time part
of the figure shows a negative NPV and indicates that the project is operating at a
loss. The loss is usually associated with initial capital investments and operating
expenses that are incurred before the project begins to generate revenue. The
reduction in loss and eventual growth in positive NPV are due to the generation of
revenue in excess of expenses. The point in time on the graph where the NPV is zero
after the project has begun is the discounted payout time. Discounted payout time on
Figure 1.4 is approximately 2.5 years.