The Necessity of a Holistic View for Asset Evaluation

The Necessity of a Holistic View for Asset Evaluation

26th October 2016

GCA's Drew Powell had an article on an 'Holistic View for Asset Evaluation' published in the October 2016 SPE Review.  The article is re-produced below, or you can download the original version here.

The petroleum industry is littered with projects that possessed strong Internal Rates of Return (IRR) at the FID (Final Investment Decision) gate but have subsequently failed to meet those capital return targets, often by a significant margin. The primary causes of such value erosion have often been significant CAPEX escalation and schedule deferral rather than uncertainty in subsurface definition. 

One particular recent analysis by EY highlighted 64% of large-capital projects as having overspent with 73% reporting schedule delays. The reasons for such overspend and delay are wide-ranging and numerous but the salient point is that CAPEX overspend and schedule extension are extremely common-place. Consequently, any sensible observer should recognise that a true evaluation of a hydrocarbon asset would need to consider “surface-related” risks and uncertainties to the same degree as the “subsurface-related” risk and uncertainty.

This empirical evidence of widespread value erosion needs to be considered when undertaking asset evaluations for transactional, statutory reporting or stock market purposes.

Unfortunately, over many years of hydrocarbon asset evaluation, GCA has seen a common theme whereby the vast majority of the focus from interested parties, in terms of value assessment, is on the subsurface; there is lesser interest in the surface facilities risks, monetisation options and potential CAPEX uncertainty issues. Such interested parties may demand weeks of petrophysical, geoscience and reservoir engineering due diligence on an asset and typically then augment such a review with only a handful of hours assigned to facilities and CAPEX due diligence.

For example, it is common practice for companies to simply have project CAPEX (and OPEX) assigned by means of analogue, based on a regional $ per Barrel norm, or output from some data-limited software.  There is generally little consideration of any surface facility risk register or narrative of where value could be eroded.

It is important that investors understand that good facility definition and robust CAPEX estimates are often as critical as subsurface effort in asset value derivation. To illustrate this statement, the author took a simple but representative model of a generic shallow water development and ran economic sensitivities. The base model managed a respectable NPV10 (net present value at 10% discount rate) of US$580 MM with an IRR of 14.5%. The author then ran sensitivities to 20% variations in CAPEX, OPEX and Production (same effect as oil price) as well as to a 2 year first oil deferral. The tornado diagram below shows the impact on project economics:

Figure 1: Impact on Project Economics

Needless to say, production (and or oil price) has a significant NPV10 impact, but CAPEX and/or a 2 year deferral also have significant impacts on NPV10 whereas OPEX variations can almost be considered inconsequential (obviously, this would not necessarily be the case in a mature producing asset).  Although production appears to be the key driver, it must be recognised that a corroded compressor or an under-sized oil export pipeline can constrain the production profile as much as lower than expected net pay or permeability.

GCA has seen projects where significant increases in Reserves and NPV have been achieved through simple processes such as installation of wellhead oil-water separation (effectively debottlenecking the  export pipeline), implementation of better well-kill processes (90% reduction in required well count), and oil treatment to remove sulphur (thereby increasing oil value). None of these projects had any change to sub-surface definition but each exhibited significant Reserves growth and NPV increase.

The industry generally suffers under the belief that undertaking complex subsurface assessments through modelling or analytic derivation will mitigate the majority of project risk and uncertainty. Consequentially the wellhead onwards tends to be the poor cousin with less effort, time and investment given to surface facility and operational specification and in particular to development of robust CAPEX derivations.

EY’s future assessments of large-capital projects will likely show no improvement until the inherent sub-surface bias in asset evaluations is rationalised and a more holistic assessment of asset value becomes the norm. 

Authors

The Necessity of a Holistic View for Asset Evaluation

Drew Powell

Global Operations Director - drew.powell@gaffney-cline.com

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