May 10, 2011
To: Wildcat Oil in Kasakstan
About: Cost Estimate of a facility to produce oil
1. Larger facility is a wise investment and therefore recommended
Wildcat Oil has recently discovered a 500 million barrel crude oil reservoir in Kasakstan, and the firm needs a preliminary cost estimate for a feasibility study for a facility to produce the oil and for transporting this oil. Wildcat Oil has already paid the Kasakstan govt. $400M in up-front lease costs for this reservoir. Engineers predict recovery of about 300 million barrels with current technology, however the oil facilities and the remaining oil will belong to the Kasakstan govt. after 100 million barrels of oil is extracted by Wildcat Oil. Kasakstan govt. is also entitled to 10% of the net revenues (net revenue is, selling price of per barrel of oil minus operating and transportation costs).
Major cost items for a basic 36,000 bbl/day facility are identified in below in Table 1. The table below includes the item name, cost, and factor estimate (for each item) which includes equipment, piping, and controls. Total cost for each item and the faciltiy is identified in the extreme right column in Table 1 show below.
Table 1 - Cost Estimation Basis|
| | | |
Cost Item| Cost (in Million $)| Factor Estimates| Total Cost (in Million $)| | | | |
Turbines| 33.2| 2.5| 83.00|
Compressors| 24.8| 2.8| 69.44|
Vessels & tanks| 25.6| 2.7| 69.12|
Valves| 7.2| 3.8| 27.36|
Switchgear| 4.8| 2.4| 11.52|
Total (Cost)| | | 260.44|
The selling price of the oil is valued at $19.50/bbl and the operating cost is determined at $4.50/bbl while the transportation cost amounts to $1.25/bbl. Although the production of oil follows a decline curve, the facility is sized such that the production of oil through Wildcat’s ownership will remain constant. For estimating the cost of different size facilities, the facility can be assumed to have a power sizing of .67. The facility can also be resized to increase oil production by 5000 bbl/day.
First, lets analyze total net revenue during the Wildcat’s ownership of the reservoir i.e. for the first 100M bbl of oil when the oil production is 36,000 bbl/day.
Wildcat’s Profit when Oil Production is 36,000 bbl/day
Since selling price of oil is $19.50, operating cost is $4.50, transportation cost is $1.25, the net profit for 100M bbl of oil is:
$19.50 - $4.50 - $1.25 = $13.75 * 100M = $1.375 Billion
Since the Kasakstan govt. is slated to receive 10% of this profit (i.e. net revenue) the amount in Wildcat’s coffers (over the years) is $1.375B – 10% ($1.375Billion) which equates to $1.2375B.
Lets now compute the number of years it will take Wildcat Oil to extract 100M bbl of oil so that we can determine the present worth of $1.2375B to better determine if this investment is worth the MARR of 15%.
Number of years to extract 100M bbl given that production stays at 36,000 bbl/day
Number of years = 100M/(36000 * 365) = 7.6 years
We will assume that the number of years to extract 100M bbl of oil at 36,000 bbl/day is 8 years.
Let’s now calculate the total cost associated with this project.
Wildcat’s Cost when Oil Production is 36,000 bbl/day
Cost is calculated as $260.4M.
The amount of $400M, which Wildcat Oil paid to the Kasakstan govt. as part of up-front lease costs represents opportunity costs i.e. sunk cost and therefore will be ignored in the analysis.
We will now draw a cash flow diagram from the point of view of Wildcat Oil.
Cash Flow diagram over the 8 year period for 36,000 bbl/day
1 2 3 4 5 6 7 8