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CONTENTS

1. SUMMARY

2. HISTORY:- THE OIL CENTURY

2.1. Oil Demand

2.2. Oil Supply

2.3. Oil Price

2.4. Control

3. COMPANIES

4. BP plc

4.1. BP Upstream

4.2. BP Performance

5. INVESTMENT IN PETROLEUM

5.1. Exploration and Appraisal

5.2. Field Development

5.3. Transportation

5.4. Refining

5.5. Distribution

5.6. Upstream Investment

11Introduction


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LEARNING OBJECTIVES

Having worked through this chapter the Student will be able to:

General

1 Describe general financial aspects of the petroleum industry

History

2. Describe briefly the nature and evolution of demand for oil

3. Describe briefly the evolution of oil supply

4. Describe two situations where an attempt was made to control the market for

petroleum

Companies

5. Explain how the role of the National Oil Company versus the International

Petroleum Company has changed since 1974

BP plc

6. Describe briefly the history of the company

7. Describe briefly the Foinaven project

8. List ten financial parameters or statistics that may be used to explain or to monitor

the performance of a petroleum company

9. Describe five of these statistics or parameters

Investment in Petroleum

10. List and describe the five principal sectors of petroleum activity


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Institute of Petroleum Engineering, Heriot-Watt University 3

11Introduction

1. SUMMARY

This module concerns the economic evaluation of petroleum projects. It does not

prescribe a particular method or process, but rather focuses on ideas and principles,

which may become incorporated into corporate procedure. Petroleum investment is

subject to considerable risk and attracts much attention from government. Some of

these issues are identified and reviewed.

Chapter Two concerns the idea of an “asset”, as something possessing value or

bestowing value on its owner. Methods of quantifying such value are considered.

Chapter Three introduces the concept of the “time value of money”, the idea that

money received or spent at different points in time may have different perceived value.

The process of discounting derives directly from this idea and forms the basis of much

systematic study of investment value.

Chapter Four explains the method of cash flow analysis and identifies a number of

important parameters, which may be derived. These measures of value have

important applications, with respect to property trade and project investment.

Chapter Five reviews the diversity and significance of government involvement in the

petroleum industry.

Chapter Six reviews the risk environment, within which petroleum investment ismade.

Chapter Seven identifies and explains some of the important procedures, which may

be used to reduce or to quantify risk. These form the basis of risk management.

2. HISTORY:- THE OIL CENTURY

Detailed study of the history of petroleum business is beyond the scope of this module.

However, it is important for anyone, who is entering the industry, to take an interest.

It is a fascinating story, with an extensive literature. As an introduction and forbackground information, Appendix Three contains a chronological summary, an

edited account of 4000 years of wealth creation, risk and intrigue. If you require more

detail, find a copy of “The Prize” by Daniel Yergin, it is comprehensive and very

readable. Alternatively, use the Internet, which has become an amazing source of

information. Appendix Four is an introductory list of useful URL’s. You should

quickly compile your own.

Although some of the major petroleum companies originated before 1900, most of the

significant events in the history of petroleum belong to the 20th century. In fact, such

has been the growth and dominance of the industry over the last 100 years, that it is

difficult to argue with the suggestion that the 20th Century was truly the oil century.


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2.1. Oil Demand

In 1900, the world traded around 500 million tonnes of oil equivalent in energyproducts, 95% as solid fuel and 5% as oil. 100 years later, the energy market had

expanded almost twenty fold and petroleum [oil and gas] had acquired more than 60%

of this market. Figure 1 plots the growth in energy commodities and Figure 2 indicates

the market share gained by the petroleum industry.

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

60 80 1900 20 40 60 80 2000

Nuclear + Hydro

Natural Gas

Crude Oil

Solid Fuel

0

10

20

30

40

50

60

70

60 80 1900 20 40 60 80 2000

Figure 1

World energy 1860-2001

million tonnes oil

equivalent

Figure 2 Petroleum market share


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11Introduction

Table 1

Petrol Consumption

Figure 3

World car population

This trend reflected a number of factors:-

(i) The petroleum industry was increasingly successful at finding petroleum and

in manufacturing a wider range of useful refined products.

(ii) Fluids are easier to handle than solids

(iii) Transportation technology was increasingly based on oil products [internal

combustion, jet, marine engines].

(iv) Economies of scale reduced the price of oil in relation to other fuels.

(v) Economic and military systems became progressively dependent.

One of the significant factors has been the growth in use of motor vehicles. Figure

3 is a logarithmic plot of cars in use, versus time. The current population is around

650 million worldwide. The illustrative calculation in Table 1 indicates petrol

consumption of the order of 17 million barrels per day, almost one quarter of total

petroleum production.

0.01

0.1

1

10

100

1000

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

m i l l i o n s

25 average fuel consumption [miles per US gallons]?10,000 average annual distance per vehicle [miles]?400 average annual consumption per vehicle [US gallons]9.52 average annual consumption per vehicle [barrels]

650 m world car population

6188 m annual petrol consumption [barrels]16.95 m daily petrol consumption [barrels]

Note:- data approximate and not confirmed


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Figure 2 reveals that this exponential trend was terminated in the early 1970’s, when

oil price suddenly increased. Since 1975, the market for gas, always seen as secondaryto oil, has been growing faster. Figure 4 indicates that from 1970 to 2000, gas

production increased by a factor of 220%, ahead of oil at 158%. This trend reflects

increasing awareness of environmental issues. Combustion of gas produces less

greenhouse gas emission, than does the combustion of refined products of oil.

1.00

1.25

1.50

1.75

2.00

2.25

70 75 80 85 90 95 2000

Oil

Gas

P r o d u c t i o n r e l a t i v e t o 1 9 7 0

2.2. Oil SupplySupply of oil has grown, both in quantity and geographical diversity. Around the

beginning of the 20th Century, output was less than half a million barrels per day, with

USA and Russia sharing 95% of the market. By 1945, output had grown to 7 million

barrels per day and USA had become undisputed market leader, producing more than

65% of world supply. Most of the rest was controlled by six countries, including

Venezuela, Russia and Iran. See Figure 5.

0.1

1

10

100

1000

10000

1865 1875 1885 1895 1905 1915 1925 1935 1945

Venezuela 1922

Persia 1908

Mexico 1905

East Indies 1885

Russia 1860

Rumania 1860

USA 1859

Others

T h o u s a n d B a r r e l s p e r d a y

Figure 4

Growth in petroleum

production

Figure 5

World oil production

[logarithmic].


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11Introduction

Figure 6

Regional oil production

[million bopd]

For almost 30 years post World War Two [WW2], oil production increased

exponentially to around 65 million bopd, as a result of prolific discoveries in theMiddle East and elsewhere, stimulated by ever-greater demand for petroleum-based

energy products. The ten-fold price increases between 1973 and 1981 disrupted this

trend and caused the market to hesitate, then slide back, until halted by a price collapse

in 1986. Following these price discontinuities, the upward trend continues. BP now

lists 48 countries with at least 50,000 barrels per day. Figure 6 illustrates this growth

in volume and diversity. [See also Table 3, Chapter 5, for a list of the top forty

petroleum-producing countries].

00

25

50

75

1950 1960 1970 1980 1990 2000

Middle East

Russia / FSU

Asia Pacific

Europe

South America

Africa

North America


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2.3. Oil Price

The average price of oil is plotted in Figure 7. Data is presented, both as dollars spent“money of the day” and as dollars in relation to value in the year 2000, “2000 terms”.

See Chapter 3 Section 9.4 for a full explanation of this terminology.

0

10

20

30

40

50

60

70

80

90

100

Price [$/bb/ mod]

Price [$/bbl 2000]

60 80 00 20 40 60 80 00

Price has shown dramatic fluctuations over time, reflecting changes in the market.

Supply disruption, shortage and uncertainty causes price to increase; exploration

success or economic depression may cause the price to fall. Note the increase

associated with war, or its aftermath and with political discontinuity:- WW1 [1914-

18], WW2 [1939-45], Yom Kippur [1973], Iranian Revolution [1979]. Note the fall

associated with success:- Spindletop [1901], East Texas [1930], Libya etc [1960’s],

North Sea and Mexico [1980’s].

2.4. ControlPetroleum is a unique business:-

The products are singularly useful for modern economic and military systems.

Production and processing is highly capital intensive.

Investment carries considerable risk.

Distribution of resources is uncertain.

Investment may be undermined by exploration success elsewhere.

Competition and profitability are therefore unpredictable.

Various attempts have been made over the years to control elements of the market, in

order to reduce costs, competition and investment risk.

Figure 7

Crude oil price $/bbl


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11Introduction

Table 2

Standard Oil

a) Standard Oil

Standard Oil was established by John D Rockefeller in 1870, as a refining company.

It was a successful business and used aggressive and, sometimes, questionable tactics

to undermine the competition. Growth was accelerated by acquisition and the

company achieved complete domination, particularly of the downstream business in

North-East USA. Headquarters in New Jersey and a new corporate “Trust” structure

were used to circumvent Federal laws relating to inter-State ownership. In 1911, after

years of legal dispute, the Trust structure was finally outlawed and Standard was split

into more than 30 separate companies, three of which became “majors” and several

became leading “independents”. Some of the detail of Standard and its subsidiary

companies is presented in Table 2.

1882 SO New Jersey > SO New Jersey > 1972 Exxon > ExxonMobil

1888 Anglo American > Anglo American 1930 ^ 1951 Esso UK

1882 SO New York > Socony 1966 Mobil 1998

1866 Vacuum Oil 1879 Vacuum Oil 1931 ^

1908 BP

1870 Standard Oil > SO Ohio > Sohio 1987 ^

1885 Solar Refining Solar Refining 1931 ^

1889 SO Indiana > SO Indiana > 1973 Amoco 1998 ^

1906 SO Nebraska > SO Nebraska 1939 ^

1896 SO Kansas > SO Kansas 1950? ^

1866 Atlantic Refining 1874 Atlantic Refining > 1966 Arco 1999 ^

1879 Pacific Coast Oil 1900 Socal > 1984 Chevron 2001 > ChevronTexaco

1886 SO Kentucky > SO Kentucky [1984 Gulf]

1875 Continental Oil 1884 Continental Oil > 1929 Conoco 2002 > ConocoPhillips

1887 Ohio Oil 1889 Ohio Oil Company > 1962 > Marathon

1907 Shell

1889 South Penn Oil > South Penn Oil Pennzoil 2002 ^

1881 National Transit > National Transit 1965

1881 SW Penn Pipelines 1905 SW Penn Pipelines 1952 ^

Eureka Pipeline Eureka Pipeline 1947 ^

1924 Ashland

Cumberland Pipeline Cumberland Pipeline 1931 ^

Southern Pipeline Southern Pipeline 1949 ^

1901 Galena-Signal Oil Galena-Signal Oil 1959 ^

plus 13

The grey column represents Standard Oil. To the left are component parts, date of

origin and date of takeover by Standard. Some of these names are of companiescreated by Standard, sometimes to amalgamate pre-existing business. To the right is

the outcome of the break-up of the Trust. 34 companies were created, 21 are listed.

Of the remainder, some were taken over and some became bankrupt. Moving to the

right, the columns indicate takeover, merger and change of name, with dates where

possible. Note that, for completeness, BP, Shell and Ashland are included. They

were not part of Standard itself, but now own parts of the outcome.

b) Red Line Agreement

Turkish Petroleum was established in 1912, to seek petroleum concessions in the

Middle East. The company was inspired by Calouste Gulbenkian, an Armenianentrepreneur, who had been convinced for many years of the prospectivity of

Mesopotamia [Iraq]. Ownership became a source of considerable political, as well

as commercial interest and, on the insistence of the British Government, Anglo


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Persian was included in 1914, see Table 3. After WW1, politics changed and German

interests [Deutsch Bank] were replaced by the French [CFP]. There followed a longperiod of international negotiation, culminating in the formal inclusion of an American

syndicate [SO New Jersey, SO New York and others] in 1928. Figure 8 is a cartoon

from this time, indicating a British-French carve-up, with an American “foot in the

door”.

These companies, with the support of government, were signatories to the so-called

“Red Line Agreement”. This related to an area encompassing the Arab Peninsula and

northwards to the Black Sea, the Ottoman Empire as was in 1914. See Figure 9 for

a map of the relevant area. The basis of the agreement was that the signatories would

not compete with each other within this designated area. This agreement, involving

the world’s largest companies of the day, set the pattern for later negotiation.

1912 1914 1928

Gulbenkian 7.5% 5% 5%

Royal Dutch Shell 25% 22.5% 23.75%

Deutsch Bank 25% 22.5%

National Bank of Turkey 42.75%

Anglo Persian 50% 23.75%Compagnie Francaise des Petroles 23.75%

American Syndicate 23.75%

Figure 8

San Remo 1920

Table 3

Turkish [Iraq] Petroleum

Company Equity


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11Introduction

Figure 9

Red Line area

In the meantime, Turkish Petroleum negotiated a concession with the Iraq government

in 1925 and made a huge discovery at Baba Gurgur in 1927. The name of the company

soon changed to Iraq Petroleum [IPC]. Gulbenkian became known as “Mr Five

Percent”.

c) Achnacarry Agreement

The oil industry in 1928 faced a number of serious problems, including overcapacity

and falling prices. In August, the chief executives of Standard New Jersey, Standard

Indiana, Anglo Iranian, Shell and Gulf gathered to shoot grouse at Achnacarry, in theScottish Highlands. They also found time to discuss matters of business and reached

an agreement, known as the “Pool Association”. Under this agreement, the cartel

decided that:-

i Companies would share production and markets on the basis of the balance then

prevailing

ii New facilities would be constructed only as necessary and to supply in the most

efficient manner

iii Price would be on a “Gulf Plus” basis, meaning that price would be based on

USA export price, with transportation charges as if the oil originated from the

Gulf of Mexico

These clauses formed the basis of inter-company agreement in Europe and parts of

Asia for the next twenty years.


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d) Organisation of Petroleum Exporting Countries [OPEC]

During the 1950’s, the market for oil expanded rapidly, with major new discoveries

in the Middle East, North Africa and elsewhere. Most of this production was under

the control of a small number of large, international companies [the “Majors” or

“Seven Sisters”]. The companies had Concessions or production licences which

afforded power and freedom to explore and to develop. Re-entry of the Soviet Union

into this market around 1955 added to the growing problem of over-supply and caused

an inevitable, downward pressure on prices.

Oil price was based on a formal system of “Posted Prices”, from which Royalties and

Taxes were derived. Posted Price had originally matched market price, but in the

market of the late 1950’s, companies had been discounting price to maintain marketshare. With a fixed Posted Price [and taxes] and a falling, selling price [and revenue],

companies found themselves paying a higher proportion to government, [see Figure 10].

0

1

2

3

4

50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74

Posted

Market

$11.6511/1/74

D o l l a r s p e r B a r r e l

Companies had the legal right to change Posted Price, but used this sparingly. In 1959,

BP cut its Posted Price by 18¢ [about 10%]. The producer countries were angry and

the issue was discussed at the Arab Oil Congress, held in Cairo in 1959. The

immediate outcome was an informal, “Gentlemen’s Agreement” concerning the

following issues:-

i defence of the existing price structure

ii formation of national oil companies

iii increase in tax-take beyond 50 – 50iv development of downstream industry

Figure 10

Saudi Arabian light

fob Ras Tanura


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11Introduction

Figure 11

Production ratios

[proportion of 1973]

The following year, after further cuts in Posted Price, representatives of leading oil

producers met in Baghdad and OPEC was formed. The founder members were:-Saudi Arabia, Iran, Iraq, Kuwait and Venezuela. Formation of OPEC was the first

collective act of sovereignty exercised by oil producers, with the following objectives:-

i to restore price to pre-cut levels

ii consultation on pricing issues

iii creation of a mechanism for production regulation

iv solidarity in the face of potential, individual sanctions.

In the early years of the organisation, market over-supply limited its powers.

However, in 1960, its market share of world-traded oil was 80% and rising. When

the market tightened in the early 1970’s, OPEC was in a position to exploit the

situation, to increase price. See Appendix 3 and Chapter 6, Section 5.4. OPEC has

survived for more than 40 years and still carries considerable influence. All cartels,

however, face problems both within and without. Controlling production requires

discipline on the part of its members; increasing the price creates extra profits for all

market participants and inevitably encourages expansion of production outside the

control of the cartel. Figure 11 indicates how regional production evolved after the

1973 price increases. Note that Middle East production fell by 50% by 1985, in the

face of mounting competition from Russian, Mexican and North Sea production.

0.5

1

1.5

2

2.5

1973 1978 1983 1988 1993 1998

North America

South America

EuropeFormer Soviet UnionMiddle EastAfrica

Asia Pacific

3. COMPANIES

In 1973, seven large companies, the “Seven Sisters” controlled more than sixty

percent of world oil production. Today, these four [amalgamated] organisations have

little more than ten percent of the market. Table 4 indicates how the market has

changed. The OPEC inspired intervention, which took place in the mid-1970’s,resulted in a massive transfer of control, from international to national oil companies

[NOC’s]. Of the top twenty producers, listed in Table 4, half are NOC’s. The top

four are all NOC’s and are responsible for about 25% of the market. Limited access


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to foreign companies is available in some of the countries, where the resource in

controlled by an NOC. In UAE for example, ADNOC has a 60% interest in key joint

venture companies.

Current 2000 1973 Origin

Saudi Aramco 9.1 1974 NOC:- Saudi ArabiaNIOC 3.8 1953 NOC:- IranPemex 3.5 1938 NOC:- MexicoPDVSA 2.8 1975 NOC:- VenezuelaExxonMobil 2.5 7.9 1882 Merger in 1999RD Shell 2.3 4.5 1892 Merger in 1907

KPC 2.2 1974 NOC:-Kuwait, merged 1980Petrochina 2.1 1988 Privatised by CNPC in 1999ChevronTexaco * 2.0 10. 1902 Includes Gulf; merger 2001BP 1.9 4.6 1908 Includes Amoco, Arco, SohioADNOC 1.5 1971 NOC:- UAE [60%]TotalFinaElf * 1.5 1920 Final merger 1999Lukoil 1.5 1991 Privatised in 1993Sonatrach 1.4 1963 NOC:- AlgeriaYukosSibneft * 1.3 1993 Privatised in 1994Petrobras 1.3 1953 NOC:- BrazilPDO 0.8 1967 part nationalised 1974ConocoPhillips * 0.8 1875 Merger 2002ENI 0.8 1953 NOC:- Italy; privatised 1995 >Statoil 0.7 1972 NOC:- Norway; p priv 2001

Repsol-YPF 0.6 1986 Acquisition in 1999 World Total 74.5 44.0Seven Sisters 11.7% 62.7%

* These companies merged after 2000; the data reflect separate companiesin 2000

The Seven Sisters had to re-invent themselves. BP, in 1972, sourced 99% of its oil

supplies from the Middle East and North Africa. Today these countries contribute

very little [to BP]. Loss of oil supply and dramatically increased oil price provided

the incentive and a favourable economic environment for exploration and developmentof new areas, some of which were considerably more expensive than the lost

productive capacity in the Middle East. The North Sea and Alaska, for example, have

both been developed since 1973 and both represent order of magnitude increases in

cost. Companies have also evolved by merger and acquisition, “drilling on Wall

Street” as they say. Appendix Three lists some of this activity under “1980’s” and

“1999”. Merger also creates opportunity for economies of scale and other cost savings.

Table 4

Oil production by company

[million bopd}


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11Introduction

Table 5

Petroleum in reserve

[end 2000]

Oil Gas O + G world cum

bbls 10^9 boe 10^9 boe 10^9 %

Saudi Aramco * 261.8 38.1 299.9 15.1 15.1

NIOC * 89.7 144.9 234.6 11.8 26.8

UAE * 97.8 37.9 135.7 6.8 33.7

Iraq * 112.5 19.6 132.1 6.6 40.3

Gazprom 122.0 122.0 6.1 46.4

KPC * 96.5 9.4 105.9 5.3 51.7

PDVSA 77.7 26.2 103.9 5.2 57.0

Sonatrach * 9.2 28.5 37.7 1.9 58.9

Pemex * 26.9 5.4 32.3 1.6 60.5

ExxonMobil 11.6 9.3 20.9 1.0 61.5

RD Shell 9.7 9.4 19.1 1.0 62.5

BP 7.6 7.4 15.0 0.8 63.2

Lukoil 14.2 0.7 14.9 0.7 64.0

Yukos 11.8 0.5 12.3 0.6 64.6

ChevronTexaco 8.5 3.0 11.5 0.6 65.2

TotalFinaElf 7 3.8 10.8 0.5 65.7

PDO * 5.5 5.2 10.7 0.5 66.3

Petrobras * 8.5 1.4 9.9 0.5 66.8

ConocoPhillips 5 2.7 7.7 0.4 67.2

ENI 4 2.6 6.6 0.3 67.5

Repsol-YPF 2.4 2.4 4.8 0.2 67.7

Statoil 2 2.3 4.3 0.2 67.9

* national reserves

Table 5 presents reserve data and another challenge. The top ten international

companies report oil and gas reserves, which represent about 6 percent of the world

total. At current rates of production, these companies would be depleted in fewer than

15 years. Half the recorded world reserve is under the control of the six largest NOC’s.

Access to this will depend on how the politics of world oil evolves, but at present

equity access is limited. One anomaly in this equation is Gazprom, a private

company, [Russian Government owns 38% of shares], with control over most of

Russia’s gas resource. It is clearly one of the largest, both in terms of reserves and

production.


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If size equates with success, petroleum is a successful business. Table 6 lists the

fifteen largest companies worldwide, ranked by sales in 2001, according to FortuneMagazine. Five of these are oil companies, including ExxonMobil and BP in the top

four. Furthermore, four other companies in the list specialise in motor vehicle

manufacture, one of the most important markets for oil products.

Company $ Billions

Walmart Stores 219.8

ExxonMobil 191.6

General Motors 177.3

BP 174.2

Ford Motor 162.4Enron 138.7

Daimler Chrysler 136.9

Royal Dutch Shell 135.2

General Electric 125.8

Toyota Motor 120.8

Citigroup 112.0

Mitsubishi 105.8

Mitsui 101.2

ChevronTexaco 99.7

TotalFinaElf 94.3

4. BP plc

BP is one of the former Seven Sisters and one of top three international petroleum

companies. Like most of the large petroleum companies, it has a century of history

and has grown both by successful investment in upstream and downstream facilities

and by acquiring or merging with other companies. See Table 7 for a simplified time-

line, summarising BP historical evolution. Since 1974, the larger companies have

found it easier to grow by merger and acquisition, than by exploration and development.

[See Section 3 above, Chapter Seven, Section 3.2 and Appendix 3 for further

information.]

BP is a vertically integrated petroleum company, meaning that it is involved in the

whole process, from exploration, through to marketing of refined and manufactured

products.

BP has upstream [exploration and production] interests in more than twenty countries,

most of which are listed in Tables 8 and 9. The UK and USA dominate, with sixty

percent of current production. In the midstream [transportation] business, BP has a

significant interest in three world-class, million-barrel-per-day pipeline systems. The

Forties Pipeline in the North Sea carries production from more than forty fields and

generates tariff income of some $350 million per year. The Alaska pipeline was vital

to the successful development of the North Slope and the new Baku-Tblisi- CeyhanPipeline will create a valuable, alternative route for export from the Caspian Basin.

Downstream [refining, manufacturing and marketing], BP has 24 refineries, 38

Table 6

Fortune 500 [2001]

Top Earning Companies


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11Introduction

chemical sites and almost 30,000 service stations. It sells 6.6 million barrels of

petroleum products and 100,000 tonnes of chemicals every day.

4.1. BP UpstreamTable 8 is a breakdown of BP oil production in 2002 with a more detailed listing of

oilfields in the UK. Oilfields commonly produce economic volumes of gas and some

of these named oilfields also contribute to the natural gas production recorded in Table

9. Bruce, for example is a complex field with reserves of oil, condensate and gas. In

2002, Bruce produced 45,000 barrels of oil and 450 million cubic feet of gas per day.

Many petroleum development projects are owned by a group, rather than by a single

company. Bruce, for example, has four participants, as follows:-

43.25% TotalFinaElf

37.00% BP

16.00% BHP Billiton

3.75% Marubeni

Joint ownership reflects the strategy of spreading risk, particularly at the time of

exploration [see Chapter Seven, Section 3.1]. BP’s percentage interest is noted for

each of the named fields. As fields mature, investment risk diminishes and companies

may seek to rationalise their interests. Having a larger, percentage share of a smaller

number of projects is probably more efficient use of resources. Furthermore, larger

companies may be more suited to the development of new opportunities and maytherefore wish to transfer mature assets to smaller organisations, which specialise in

such projects. In the UK, in recent years, BP has disposed of ten fields, which are

approaching abandonment. Forties, for example, has been sold to Apache in 2003.


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1901 Persia D’Arcy Concession, funded by Burmah

1908 Masjid-i-Suleiman, Persia Oil discovery1909 Anglo Persian Ltd Formation of new company, by Burmah1909 Abadan, Persia New refinery [to become world’s largest]1914 UK Government Purchase majority shareholding1914 Iraq Petroleum Company Joint Venture company1920 Scottish Oils [shale oil] Acquisition1924 Grangemouth New refinery1928 Baba Gurgur, Iraq Oil discovery [Iraq Petroleum Joint Venture]1931 Shell Mex & BP Joint Venture company1935 Anglo Iranian Ltd Name change1938 Burgan, Kuwait Oil discovery [Gulf JV] [50000 million bbls]1951 Iran Nationalisation of petroleum assets1954 British Petroleum Ltd Name change1954 Iran New Concession, includes British Petroleum

1956 Niger Delta, Nigeria Oil discovery [Shell Mex Joint Venture]1969 Forties, UK Oil discovery [2750 million bbls]1970 Sohio Acquisition of shares1977 Alaska Completion of Trans-Alaskan Pipeline System.1987 Sohio Acquisition of remaining shares1987 UK Government Share disposal1988 Britoil Acquisition1991 Cusiana, Colombia Oil discovery [1600 million bbls]1996 Mobil Downstream Joint Venture1998 Amoco Merger [60:40]1998 BPAmoco plc Name change1999 Arco Acquisition2000 Trinidad Gas discoveries2000 Burmah Castrol Acquisition

2001 BP plc Name change2002 Veba Oil Acquisition2002 Caucasus Agreement to build Baku-Tblisi-Ceyhan Pipeline2003 Sidanko, TNK Russia Joint Venture company

The fields, which are named in Table 8, are all BP-operated, meaning that BP is the

group member with responsibility for field planning, construction and operation. See

Chapter Five, Section 3.7 for information about the role of the Operator. One of these

BP-operated fields is Foinaven, which was the first to receive development consent

in deep water on the UK Atlantic margin. Summary technical details of this project

are listed in Table 10 and the field development is illustrated in Figure 12. Cash flowdata from Foinaven are introduced in Chapter Two, Section 6, and then used to

demonstrate evaluation methodology throughout Chapter Four.

Table 7

BP plc Time Line


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11Introduction

Oil Production

10^3 bopd

Angola 29

Argentina 53 BP Interest BP Share

Australia 43 % 10^3 bopd

Azerbaijan 38

Canada 16 62.8 23

Colombia 46 37.0 17

Egypt 85 72.0 72

Norway 84 96.1 50

Russia 73 70.0 42

Trinidad 67 50.0 10

UAE 113 100.0 16

UK 461 85.0 31

USA Alaska 309 62.1 7

USA GOM 264 52.0 11

USA Lower 48 192 69.9 1

Venezuela 51 69.9 37

Other 94 33.4 33

67.8 32

Σ 2018 Other various 79

UK Field

Names

Andrew

Bruce

Foinaven

Forties

Harding

Loyal

Machar

Magnus

Marnock

Miller

Monan

Mungo

Schiehallion

Wytch Farm

Gas Production

10^6 scfd

Argentina

Australia

Canada

China

Egypt

Indonesia BP Interest BP ShareNetherlands % 10^6 scfd

Norway

Trinidad various 28

UAE various 169

UK 75.2 113

USA Alaska 100.0 106

USA GOM 82.3 47

USA Lower 48 43.5 48

Other 41.0 54

73.7 63

Σ various 601

70.5 108

various 2094

3431

US Fields

BP Operated

Anscutz Ranch East

Hugoton

Jonah

Marlin

Matagorda Island 519

Matagorda Island 623

Moxa Arch

Pompano

San Juan Coal

Wamsutter

Non-operated

251

295

514

102

256

45787

60

1238

134

1550

52

1185

2246

280

8707

Table 8

BP Oil Production 2002

Table 9

BP Gas Production 2002


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Location Atlantic Margin, Faroes Basin 160 Km West of the Shetland Islands Water depth 500 metres

Ownership 72% BP28% Marathon

Licence 1985 Concession

Discovery 1992Consent 1994Onstream 1997

Reservoir Palaeocene sandsOil gravity 25-26 APIºReserves 323 million barrels of oil

221 billion cubic feet of gas

Production Two sub-sea production manifoldsSub-sea water and gas injection

FPSO.Export Shuttle tankers Gas pipeline to Magnus

4.2. BP PerformanceBP is a “large” and “successful” company, operating in a large and dynamic market.

There are many parameters, which may be used to describe corporate activity and to

measure corporate performance. The following notes refer to data in Table 11, which

are extracted from BP Annual Accounts, 1997-2002.

Table 10

Foinaven Summary

Figure 12

Foinaven Field

Development


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11Introduction

Section “a” indicates key elements of the economic environment, within which

BP operates, with weak prices in 1998 and strong prices in 2000. As

an international company, BP trades in many currencies and is

inevitably affected by exchange rates. Refinery margin [surplus of

revenue over operating costs] reflects supply and demand interaction

in that market.

Section “b” highlights operational details. Reserves replacement is a measure of

exploration success; greater than 100% means discoveries exceed

production. Finding and development cost records the unit cost of

new fields and reflects geographical location, technological advance

and corporate efficiency. Production of oil was uniform over this

period, whereas gas production increased significantly from 1999.

Section “c” includes measures of financial activity. Turnover is a measure of

company sales revenue; it reflects variation in prices and in rates of

production. Capital investment is money spent on new projects. It

fell in 1999, in response to lower prices and revenues in the previous

year. $36 billion was spent in acquiring Arco in 2000. Finance Debt

is money borrowed from banks and financial institutions and for BP

represents about 25% of its available capital. Increased borrowing

increases corporate risk [see Chapter Six, Section 5.7].

Section “d” relates to performance. Measures of profitability, as published incorporate accounts, must conform to recognised accounting standards.

In the UK, for example, procedures are contained in Financial

Reporting Standards [FRS’s] and Statements of Recommended

Practice [SORP’S]; in the USA, Generally Accepted Accounting

Principles [GAAP’s]. Historical Cost Profit is the standard,

accountants’ measure of performance [see Chapter Two, Section 2];

here, it correlates strongly with prices. Return on Average Capital

Employed [ROACE] is profit, as a proportion of capital employed [a

measure of total corporate funding]. Dividend is the annual distribution

of profit to shareholders; note that Dividend distribution was preserved

in 1998, despite lack of profit, a measure of the influence of the large,institutional investors, which hold most of the BP shares. Share price

reflects market perception of the performance and potential of the

company. It also reflects attitude to the stock market in general and

to other forms of investment.


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Table 11

BP Statistics

1997 1998 1999 2000 2001 2002

a) BP average oil price $/bbl 18.30 12.10 16.74 26.63 22.50 22.69

BP average oil price £/bbl 11.16 7.29 10.33 17.64 15.63 15.13

BP average gas price $/mcf 2.50 1.93 1.92 2.91 3.30 2.46

BP Refinery Margin $/bbl 2.50 2.10 1.24 4.22 4.06 2.11

Exchange Rate $/£ 1.64 1.66 1.62 1.51 1.44 1.50

b) Reserves replacement % 160.00 132.00 112.00 163.00 191.00 175.00

Find / Dev Cost $ / bbl 4.22 4.70 3.21 3.29 3.68 4.14

Oil production bopd 10^6 1.93 2.05 2.06 1.93 1.93 2.02

Gas production boepd 10^6 1.03 1.00 1.04 1.31 1.48 1.49

Employees 100,800 96,650 80,400 107,200 110,150 115,250

c) Turnover $ 10^9 108.60 83.70 101.20 161.80 175.40 180.19

Capital Investment $ 10^9 9.70 9.00 6.40 11.00 13.20 14.07

Acquisitions $ 10^9 1.00 0.70 0.30 36.40 0.90 5.04

Finance Debt $ 10^9 12.87 13.76 14.54 21.19 21.42 22.01

Taxation $ 10^9 4.00 2.69 3.34 8.71 8.06 5.62

d) Historical Cost Profit $ 10^9 5.30 2.70 4.60 10.10 6.60 6.85

Ave. Capital Employed $ 10^9 50.67 51.30 52.04 78.84 87.26 89.62

ROACE % 0.10 0.05 0.09 0.13 0.08 0.08

Net Income per boe $ 4.25 2.08 4.17 8.61 7.51 6.04

Dividend $ 10^9 3.50 4.10 3.90 4.60 4.90 5.38

Share Price 31/12 £ 4.00 4.49 6.22 5.40 5.34 4.27

Dividend per Share £ 0.11 0.12 0.12 0.14 0.15 0.16

5. INVESTMENT IN PETROLEUM

BP currently produces 2 million barrels of crude oil and sells more than 6 million

barrels of refined products every day. In order to maintain productivity and operating

efficiency, the company invests, annually more than $10 billion in new field

development, downstream facilities and infrastructure. The world petroleum

industry invests in excess of $100 billion per year. See Table 12 for data on ten large

international companies.

Turnover Capex Upstream$ 10^9 $ 10^9 %

ExxonMobil 232.7 11.2 62RD Shell 191.5 9.6 57ChevronTexaco 117.0 9.5 66BP 168.7 11.0 60TotalFinaElf 105.4 7.7 69Lukoil 13.4 1.6 68Yukos 9.8 1.4ConocoPhillips 66.2 4.8 77

ENI 48.8 5.0 62Repsol-YPF 43.2 6.1

Σ 996.7 67.9

Table 12

Sales and investment [2000}


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11Introduction

From exploration, through to selling a gallon of gasoline, the petroleum industry

consists of a number of business layers, as illustrated in Table 13. Expenditure isdivided into two categories, namely Capital and Operating.

Capital

Expenditure

Operating

Expenditure Taxation Profit Price per Barrel

f)

Excise Duty &Sales Tax none none

Excise Duty &Sales Tax none

$90 - $190

Gasolineselling price

e)

Distribution &Marketing

Storage facilities

Transportation fleetService station

System operationSales Corporate Taxes Downstream Profit

$50

Gasoline

selling pricepre-duty

d)Refining Refinery Refinery operation Corporate Taxes Downstream Profit

$44

Gasoline marketprice ex-refinery

c)Transportation

Pipeline system

Tanker fleetTerminals

Tariff payments

Pipeline operationTanker operation Corporate Taxes Midstream Profit

$27Market price cif

b)

Field

Development &Operation

Production platform

Production wells

Control equipmentExport system Field operation

Production Taxes

RoyaltiesCorporate Taxes Upstream Profit

$25Market price fob

a)

Exploration &Appraisal

Successful Wells

Seismic surveys

Exploration wellsLogging/ test ing Unsuccessful Wells

Signature BonusAllowances none

$2Finding Cost

(a) Exploration and appraisal

(b) Field development and operation

(c) Transportation

(d) Refining

(e) Distribution and marketing

Capital Expenditure [Capex] relates to the creation of a useful or productive system

and equates with “invests” above. Operating Expenditure [Opex]is that required to

operate and to maintain these productive systems. See Chapter Two, Section 4.1 for

a more detailed explanation.

5.1. Exploration and AppraisalExploration is the first stage in the process of producing oil. Money is spent on seismic

surveys and drilling of exploratory wells. Discoveries are made, tested and eventually

added to reserves. Many unsuccessful wells are drilled. Standard practice is to

consider the cost of successful wells as Capex and the cost of unsuccessful wells as

Opex. This is known as “successful efforts” accounting. It is, however, permissable

to record all exploration expenditure as Capex [full cost accounting]. This is

explained more fully in Chapter Two, Section 2.2.

Table 13

Investment in oil


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Taxation is limited at this stage, since revenue is not generated. Lump sum payments

[Bonus Bid or Signature Bonus] may be required by the Licence agreement [SeeChapter Five, Section 3.3]. Expenditure gives rise to tax allowances, which may be

carried forward, until revenue is available.

Finding Cost relates exploration expenditure to barrels discovered. This depends on

a wide range of factors, such as geological complexity, well location and technology.

Time is a particular problem in compiling any average relationship between reserve

barrels and cost of discovery, since commercial status may not be confirmed for five

or ten or twenty years. Because of varying calculation procedure, it is difficult to use

such a parameter to make meaningful comparison between companies.

5.2. Field DevelopmentOnce a commercial decision is taken, investment [Capex] is required in wells,structures, production facilities and export. The cost of development varies dramatically

from one environment to another [onshore – deep offshore] and technology evolves

over time. Order of magnitude differences are possible. Development cost per barrel

is influenced by many factors [see Chapter Two, Section 5.3] and may be calculated

in a variety of ways [see Chapter Four, Section 4.2]. and so caution is required with

interpretation and comparison.

When production starts, expenditure [Opex] is required to operate the system, in order

to produce petroleum. Opex per barrel is sometimes called “Lifting Cost”; this

benefits from economies of scale and increases over time as rate of production

diminishes.

Taxation varies from country to country and many regimes include specific field-

related, or upstream or production taxes. The basis of these taxes is normally the

market price for crude oil. If a field or petroleum project can be delineated, it is

possible to define profit, relating to it. Profit is generally based on the residual of crude

oil selling price less exploration, development and lifting costs, and taxes.

“Upstream” relates to the discovery and the production of oil and gas. “Downstream”

relates to refining and manufacture of chemical products. The transition is some

convenient point of sale, which may be the wellhead, an offshore loading buoy or an

export terminal. The price at this point is identified as “fob” meaning “free onboard”. The transportation phase between upstream and downstream may be called

“midstream”.

5.3. TransportationTransfer from oilfield to refinery may be direct, by pipeline, or by a series of stages

and owners involving pipeline, storage and tanker. The Forties Pipeline System, for

example, runs directly to the Grangemouth Refinery in Central Scotland. It also links

to an export terminal, which allows part of the stream to be exported to Europe and

North America, by tanker Transportation infrastructure may be owned by the user [oil

producer], or leased on a per- journey, per-year or per-barrel basis. Ownership implies

that the company has invested [Capex], whereas leasing implies payment of tariffs[Opex].


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11Introduction

Transportation from wellhead to point of sale [or valuation], may fall within the

boundary [ring fence] of upstream or production taxes, whereas transportation beyondthat point does not. The cost of the midstream journey is reflected in the difference

between the delivered price [cif meaning carriage insurance and freight] and the fob

price. This midstream transportation activity is subject to general corporate taxes

[wherever the company is based] and contributes to general corporate profits.

5.4. RefiningRefineries buy crude oil at market [cif] price; [if the refinery is owned by the oil

producer, this “transfer” price may differ from market price]. Refineries are designed

to produce a range of refined products and therefore generate revenue reflecting the

weighted-average, market price of these products. The difference between unit

selling and unit purchase price is sometimes called the gross refining margin. This

is the revenue available, per barrel, to meet refinery operating costs and also give a

return on the capital investment . [Net] refinery margin is gross margin minus refinery

operating cost [energy plus materials plus labour etc]. Detailed analysis of refinery

economics is beyond the scope of this module. Refinery activity gives rise to general

corporate taxes and profits.

5.5. DistributionRefinery output may be feedstock for other downstream processes, or may be

transferred directly into a distribution system for sale to consumers. All the large oil

companies have access to service stations selling gasoline [petrol, benzene], their

most important product. Service stations may be owned by an oil producer and refiner,

by a refiner or by a retail organisation. If the retailer is independent of the refiner, the

product is purchased on a wholesale market.

Sales Tax; Tax is commonly charged on gasoline at the point of sale. This may be

called duty, excise duty, sales tax or value added tax. It is a proportion of pre-tax

selling price. In the USA, these taxes amount to some $20 per barrel, whereas in the

UK, $140 per barrel, bringing the selling price of gasoline close to $200 per barrel.

5.6. Upstream InvestmentLarge, integrated petroleum companies invest predominantly in the upstream sector

of the business. It is expensive, it is long term and it is risky, but it may be very

profitable. A single exploration well can cost anything from less than $1 million tomore than $100 million, with perhaps a 75% chance of failure; an oilfield development

can cost from a few to a few thousands of millions of dollars and may then generate

revenues for half a century. Financial performance of a company is derived directly

from its investments, the larger the project and the longer its life expectancy, the more

important the decision.

Decisions to make these investments are always taken in an environment of uncertainty.

Recoverable reserves are only confirmed, when they have been recovered and

technology often has to survive in extreme conditions. Tomorrow, the price of oil will

be different and somewhere government policy will have changed.

Chapters, which follow, consider the principles of investment in general, and review

the specific issues of upstream petroleum investment, in an environment of uncertainty.


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