Abstract

Economics performed by projected cost per unit analysis will give better insight into the merits of an oil production project than conventional measurements. This alternative economic metric can easily be used to determine if the project meets the objectives of a particular oil company. The proposed method will give pertinent values to see if return on investment, return on capital employed, operating expense, and cash flow goals will be met. As an additional benefit, cost per unit analysis also incorporates all the accounting pseudo charges. The inclusion of all actual and financial impacts will give a clearer picture as to the outcome a project will achieve. The calculations are not dependent upon predicting future oil prices or assigning a time value to money. Conventional economic measurements (net present value (NPV), internal rate of return (IRR), profitability indexes) can be misleading as to the actual benefit the project has for an oil company. They require that you predict oil prices and, in the case of NPV, assign a time value to money. These typical economic measures were designed to compare one project against another. High IRRs for capital investments can be due to initially high oil production and/or high tax regimes that allow for accelerated depreciation. A good NPV is sometimes achieved just by the large size of a project. Examples will be shown how projects with excellent NPVs and IRRs turned into disastrous economic failures despite performing close to prediction. Using the alternative method described in this paper would assist in avoiding costly mistakes and will help achieve the financial goals a company aspires.

Introduction

Economic metrics have been used for decades to evaluate the merits of a particular project and to compare a range of projects to each other. Certain metrics have gained wide acceptance among all industries. These generally accepted measures (specifically NPV and IRR) have made it easy to present potential projects to groups of various backgrounds and from different organizations. Most people are comfortable with the standard metrics whether or not they truly understand them. There is not an apparent need to explain the calculations because whether a person's educational background is finance, engineering, or geology, he or she knows the terminology and has some background in the subject. It is curious that if the results from the most complicated decision analysis models are presented in the form of NPVs and IRRs, most individuals will give creditability to the outcomes. Presented in any alternative format, economic results will be given extreme scrutiny. The bottom line is that people are always more at ease with things they are familiar with.

It is for the aforementioned reasons that when proposing an alternative economic analysis method, one must be cautious. Any new method must not be complicated or have any vagueness. More importantly a new economic measurement must be in some way clearly superior to those that already exist. Without meeting these two criteria, any new method will be dismissed out of hand.

Cost per unit economics meets these criteria. The basics of cost per unit economics are straightforward. The calculations are not at all complicated. The analysis of the results will be only as involved, as the analyzer wants to make them. The results of the analysis will provide clear indication whether or not a project will help achieve the objectives of a company.

Method of Calculation

Quite simply, cost per unit economics (CPUE) has as its basis the unit cost of producing a barrel of oil or a MCF of gas. The elements necessary to do the analysis are the development costs, expected marketable hydrocarbons that the well or project will produce, the relevant actual operating expenses, and any accounting expenses. Knowledge of these values alone is enough to do the basic calculations. The analysis, not the calculations, thus becomes the more important criteria. As will be seen in the "Analysis of Results" and "Sample Analysis" sections, the analysis does not have to be complicated either.

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