Petroleum economics is a part of back bone of Oil and Gas industry. This encompasses all aspects of industry like Exploration, Subsurface, Production, Process Engineering, which are translated into financial numbers and analysed through statistical tools.
Considering WACC (Weighted Average Cost of Capital) as the benchmark, oil companies’ management make decisions to develop/undeveloped the projects with a critical review of company's MARR (Minimum Accepted ROR). A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company to determine the economic feasibility of expansionary opportunities, divestments, acquisitions, farm-in, farm-out and mergers etc.
WACC/MARR is a weighted average cost of capital of two financial components which are Equity and Debt calculated by using CAPM (capital asset pricing model) method and corporate tax considerations respectively.
The cost of debt (effective rate) that a company pays on its current debt is determined on Btax and Atax basis. Whilst CAPM model is used to calculate cost of equity i.e. Risk Free Rate + Beta × Market Risk Premium
This phenomenon relates to all industries. However, in oil industry the Reserves Risk Premium is an important factor for economic evaluation of the matured projects under the guidelines of SPE-PRMS.
This paper is an effort to seek validity and effect of Reserves Risk Premium quantified from P90, P50 and P10 cumulative reserves estimated cases and added to CAPM model to calculate cost of equity of project.
Economic Evaluation of a project is undertaken based on 1P, 2P and 3P reserves categories after finding their conventional WACC with addition to Reserves Risk Premium. WACC of corporate level and project level (based on 1P, 2P and 3P) was compared and impact of Reserves Risk Premium was determined.