Oil Project Selection by Metrics

Abstract

The recent fall in oil prices has led to extensive capital rationing, and thereby given rise to a renewed focus on parameters for project selection which supplement net present value. While the financial crisis was creating capital constraints, the oil industry seemed to be paying great attention to the net present value index. The metric most often referred to at present, given the prevailing uncertainty over the direction of future oil prices, seems to be the breakeven price of a project. Management and professionals in the oil and gas sector, as well as industry analysts, appear to be very concerned about which criteria in addition to net present value other companies are applying in their decision-making. Our findings indicate that they can be more relaxed here, since the various supplementary criteria provide very similar rankings. We examine the different investment metrics of a portfolio of oil projects. The analysis of project metrics shows that the overall grouping of projects is the same with the three supplementary metrics. The concentration by the companies on robustness related to oil prices means that particular attention is paid to the breakeven price and cost optimisation. Projects which are optimised and sanctioned may have a very high return with the realisation of an expected price scenario. We introduce a new metric, referred to as the complete net present value index, which improves the traditional net present value index by including operating expenditure and by treating taxes in a consistent manner.

Keywords: project metrics, project valuation, oil projects

JEL Classification: Q400, G120, G310