Directors Meeting

Production Engineering II

Introduction1Learning OutcomesAt the end of this lecture, students should be able to :

To discuss all phases of the E & P Business in general.

To mention and explain different types of licensing agreements. To describe the major features of a Production Sharing Contract.

To discuss the Malaysian models of the PSC Terms.

2OverviewExploration & Production BusinessExploration & Production CostsPetroleum Fiscal RegimesProduction Sharing Contract Terms Malaysian ModelsQ & A

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Exploration & Production BusinessThe E&P business focuses on high-margin projects that deliver significant returns, cash flow and long-term value.

One of E&P's key roles is to provide portfolio diversity with low-cost conventional production, which helps balance against higher cost oil sands production, particularly when crude prices are low. The Exploration & Production (E&P) business is responsible for upstream oil and gas activities that will build a strong, sustainable portfolio of assets to support company growth. 4Video Presentation

5Exploration & Production BusinessPhases of Activities in the Petroleum Industry To obtain permission from government or relevant agency before the drilling of Exploration wells.ACQUISITION OF RIGHTSThese can be done through :

Concession [old style]Production License [new concession]Production Sharing AgreementJoint VentureService Contract

6Exploration & Production BusinessPhases of Activities in the Petroleum Industry To obtain permission from government or relevant agency before the drilling of Exploration wells.EXPLORATIONTo search for oil and gas fieldsThese activities may constitute the following:

Gravity and Magnetic Surveys : Mapping of gravity and/or magnetic anomalies due to the variations of the earths geological structures and magnetic properties of rocks.

Seismic Survey : Seismic lines producing Coarse 2-dimensional seismic grid reflecting the geophysical nature of the rocks etc.

Wildcat : The first exploration well drilled in green field with no offset well information available to obtain data and prove hydrocarbon presence. ACQUISITION OF RIGHTS7Exploration & Production BusinessPhases of Activities in the Petroleum Industry To obtain permission from government or relevant agency before the drilling of Exploration wells.ACQUISITION OF RIGHTSEXPLORATIONTo search for oil and gas fieldsAPPRAISALTo determine the commercial significance of the discovery and to shape the initial development plan for the field.8Exploration & Production BusinessAppraisal Phase EXPLORATIONEXPLORATION DRILLINGQUITAPPRAISALAppraisal drilling to define the extent of discoveryData gathering to aid in the development studiesDevelopment feasibility studiesDEVELOPMENTRESULTSRESULTSDryDISCOVERYInconclusive9Exploration & Production BusinessPhases of Activities in the Petroleum Industry To obtain permission from government or relevant agency before the drilling of Exploration wells.ACQUISITION OF RIGHTSEXPLORATIONTo search for oil and gas fieldsAPPRAISALTo determine the commercial significance of the discovery and to shape the initial development plan for the field.DEVELOPMENTTo formulate the Field Development Plan, install platforms / facilities, drill and complete the development wells.10Exploration & Production BusinessThe DEVELOPMENT of Production Concept and IMPLEMENTATION activities.

The objectives : To gain maximum recovery with minimum cost.

Factors to be considered in the development plan are:

Drilling requirements : Number of wells, well spacing and drainage pattern, drilling program, completion strategy, etc.

Production techniques and policy anticipated : Artificial lift needs, pressure maintenance, etc.

Facilities required : Drilling and Production

Development time and cost expected. Development Phase11Exploration & Production BusinessPhases of Activities in the Petroleum Industry To obtain permission from government or relevant agency before the drilling of Exploration wells.ACQUISITION OF RIGHTSEXPLORATIONTo search for oil and gas fieldsAPPRAISALTo determine the commercial significance of the discovery and to shape the initial development plan for the field.DEVELOPMENTTo formulate the Field Development Plan, install platforms / facilities, drill and complete the development wells.PRODUCTIONTo produce oil/gas from sub-surface to surface and to separate gas/oil/water before oil is stored and gas is processed.12Exploration & Production BusinessPhases of Activities in the Petroleum Industry To obtain permission from government or relevant agency before the drilling of Exploration wells.ACQUISITION OF RIGHTSEXPLORATIONTo search for oil and gas fieldsAPPRAISALTo determine the commercial significance of the discovery and to shape the initial development plan for the field.DEVELOPMENTTo formulate the Field Development Plan, install platforms / facilities, drill and complete the development wells.PRODUCTIONTo bring oil/gas from sub-surface to surface and to separate gas/oil/water before oil is stored and gas is processed.PROCESSING / EXPORTTo condition the gas / oil and sell to customers.13Exploration & Production Costs As with most investments, upstream petroleum projects include the following types of cash flow:

Revenue : Income from sales / services Capex : Project development Opex : Project running costs Taxes : Payments to Government Revenue

The basis of revenue is production.All income from the sale of goods and services is normally lumped together as revenueRate of production is constrained by facilities, reserve volume & geometry and energy of the natural system.

14Exploration & Production Costs

Elements of production profileBuild Up Phase The phase of production from start to peak. It is the time when development wells are being drilled and new wells are coming on stream. Speed of build up is diminished by mechanical drilling problems, or by unforeseen geological problems in the reservoir.Plateau Phase

It can dominate the economic performance of a project must be properly planned. The higher the peak, the sooner average oil is produced. Higher rate means higher system capacity, more wells, larger pipes and vessels, more platforms and more cost. Therefore, a balance between rate and reserves is important to ensure optimal economics.15Exploration & Production Costs

Elements of production profile (cont)Decline Phase It starts once production falls off plateau. The decline rate depends on reservoir architecture and energy.Economic Limit

A condition of production comes to an end. Production is terminated for economic reasons. The operation cost is greater than revenue.16Exploration & Production Costs

For the Project Capital Expenditure, several stages of expenditure are involved: Exploration [pre discovery] geology geophysics drilling Appraisal [ pre commercial decision] geology geophysics drilling well-testing Field Development drilling production wells production facilities export facilities Field Modifications more wells injection facilities artificial lift Abandonment seal off wells removal of facilitiesProject Capex17Exploration & Production CostsProject Opex

It is often called Operating Cost.

Opex may include the following costs : Lease of facilities. Platform operation, maintenance and transportation cost. Workover operations on wells. Insurance and administration; such as salary.

18Exploration & Production CostsPetroleum Taxation

Why ?

The petroleum industry is a popular target for government.

Petroleum industries are subject to a wide range of fiscal systems.

Therefore, it is important to understand the impact of taxation on project economies.

19Petroleum Fiscal RegimesLicensing is the legal process by which the owner (government) of subsurface mineral rights grants permission to a company to explore for and to produce petroleum from a specific area.

There are a number of styles of licensing agreement, which have been applied within the petroleum industry. The most common are as follows:-

Concession [old style]Production License [new concession]Production Sharing AgreementJoint VentureService Contract20Licensing AgreementsConcession [old style]

A concession is an arrangement between a government and a company, whereby the produced oil and gas becomes the property of the company and the government receives various payments, in the form of royalties, taxes, etc.The old style concessions, which predominated in the Middle East until the 1950s were characterized by large areas, long time periods and managerial freedom. This type of agreement was clearly inequitable and conceded excessive control to the company.After World War Two, they were gradually replaced by Production Licenses and by various forms of direct government involvement.21Licensing AgreementsProduction Licenses [new concessions]

Modern production licenses [new concessions] offer much more control to government.Prospective areas are divided into many small blocks to increase competition and to reduce government dependence on any single company. Blocks are subject to relinquishment to encourage development. Licenses relate to shorter time periods.Companies must compete for licenses on financial or technical basis.Development plans are subject to government approval. Revenues are subject to realistic levels of taxation.22Concessionary Regime

Illustration of the Concessionary Regime Flow DiagramTotal net profit for the barrel of oil = USD 65 (100-35)Net Take by Government = USD 38 (20+18)Net Take by Contractor = USD 27 (100-20-35-18)23Licensing AgreementsProduction Sharing Agreement & iv. Joint Venture

A PSA is based on the principle that produced oil is shared, or split between the company and government [or its NOC ] in agreed proportions. Approved expenditure may be reclaimed from part of production, designated as Cost Oil, the remaining part for sharing being called Profit Oil. The company may also be liable for profit tax on its share of Profit Oil .In some cases, the company and the NOC form a separate company for the purpose of development. This arrangement is a form of Joint Venture.24PSC Cash Flow Diagram

Illustration of the PSC Flow DiagramProfit oil is the remaining revenue after cost recovery and royalty.Assume that cost recovery ceiling is set at 50% of gross revenue.

Total Profit = USD 40

Profit Split = 30/70

40% tax rate on taxable income

Contractors Entitlement = USD 62 (50+12)

Contractors Net Profit After Tax = USD 7.2 (0.6*12)

Net Take by Government = USD 42.8 (10+28+4.8)

25Licensing AgreementsService Contract

In a service agreement, the company receives no equity in the project. All components, including produced oil and gas belong to the state [through the NOC ]. The company receives a fee for exploration and production services and may have an opportunity to purchase the production.26Licensing AgreementsKey Differences Transfer of Tittle of Hydrocarbons

With Concessions or Licenses, the title transfers at the wellhead. The IOC is entitled to gross production minus royalty oil.

With PSCs title transfers at the export point or fiscalization point. The IOC is entitled to cost oil and profit oil.

With Service Contract title does not transfer. The Government is entitled to the total hydrocarbon production.27Fiscal System Comparison

Concession/License PSAService Contract28Production Sharing Contract The Malaysian Model Petroleum exploration in Malaysia started at the beginning of the 20th century in Sarawak. Oil was first discovered in 1909 and first produced in 1910. A national oil company, PETRONAS, was incorporated to serve as the Governments instrument to take charge of petroleum matters and to exercise, on behalf of the country, its sovereign rights over its own oil and gas resources. PETRONAS opted to adopt the Production Sharing mechanism to manage the exploration, development and production of the nations petroleum resources. Prior to 1975, petroleum concessions were granted by state governments, where oil companies have exclusive rights to explore and produce resources. The companies then paid royalties and taxes to the government. 29Production Sharing Contract The Malaysian Model

Evolution of PSCs in Malaysia30Production Sharing Contract The Malaysian Model

31THANK YOU

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32Q & A Session

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