1.Investment Decisions

8/3/2019 1.Investment Decisions

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Investment Decision Making in theUpstream Oil Industry: An Analysis

Surbhi AroraAssistant Professor,College of Management & Economic Studies,University of Petroleum & Energy Studies


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Investment Decision Making in the Upstream OilIndustry: An Analysis

IntroductionCurrent Capabilities in Upstream Oil & Gas

Industry:Current Practice Techniques in Upstream Oil &

Gas Industry:Conclusion


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The allocation of funds and capital to the various

projects is the most important aspect of theinvestment decision of a firm. Criteria forinvestment:

type of the projects

requirements of the projectsreturn that is promised by the project

life time of a project

duration of the return value of the project etc.

Introduction


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investment decisions by individual companies

political decisions of countries with regard to licensing

degree of foreign investment

market psychology

OPEC Policy

unexpected events

resource availability, etc.


World oil supply depends upon:


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The opportunities available for investment woulddepend:

investment regime, and

the risk involved.

The incentiveswould be in the form of:oil prices, andthe rate of return



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The costsof this industry remain huge, regardlessof whether earnings are high or low as was thecase throughout most of the 1990s

Refiners need to continually invest, and do soeven when earnings are lower

Current Capabilities in Upstream Oil & GasIndustry:



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Current Practice Techniques in Upstream Oil& Gas Industry:

Despite its importance to economic growth and

market structure, the investment behavior of firms,

industries, and countries remains poorly understood.

Economic models have had limited success inexplaining and predicting changes in investment

spendingPindyck, 1991



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The International Energy Agency estimates thatthrough 2030 investments in oil and gas

exploration and production, refining,transportation, and infrastructure, will require$9.6 trillion, averaging over $380 billion annually.




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As existing and future supply facilities becomeobsolete or resources are depleted, newexploration and development will need to replace

existing oil reserves, plus add significant new oilreserves.




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A firm should seek to maximize profits, but financialforces and shareholders (banks, fund managers,etc.) may require a firm to pursue growth

(reserves volume) or diversify its operations.




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Typically, a planning horizon for oil prices isassumed and projects are evaluated on acommon and consistent basis, where judgments

on the risks and rewards of the projects under avariety of price scenarios and geologic, technicalproduction, government, tax, and legal factors areconsidered (Seba, 2000).




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If the capital employed in a company does notgenerate an adequate return, the company willhave limited access to new capital because

investors and lenders seek more profitableopportunities elsewhere.




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Capital requirements in E&P compete with othersegments in the petroleum industry as well as thecapital needs of other industries.

Uncertainty about the future price of oil and gas andglobal conditions impacts allocation decisions andexternal evaluations by bond raters and capital markets(Pirog, 2005b).




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Governments might defer investment to preservehydrocarbon resources and revenues for futuregenerations (Reynolds, 2005).

If governments increase taxes and royalties onproduction, or otherwise change the terms andconditions of the fiscal regime, lower profitability ofupstream projects might deter investment.




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Some of the current techniques used byupstream oil and gas industry are:

Decision Tree Analysis and Expected Monetary Value

Payback Period

Sensitivity Analysis

Discounted Cash flows

Preference Theory

Simulation

Portfolio Theory

Option Theory


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ConclusionThe factors which are vital for investment decision making for

specifically the oil and gas industry may be summarized asbelow:

The Price expectationsof the firm from the industry

The amount of annual cash flows expected to be

received on the investment.

The borrowing capacitywhich the annual cash flows can

support.


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Portfolio of opportunities

The acceptable risk associated with the investment

decisions.

Other factors - supply factors, market demand,

availabilityand access to resources etc.

Conclusion


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1.Investment Decisions

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