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11

Introduction

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

and Appraisal 5.2. Field Development 5.3. Transportation 5.4. Refining 5.5. Distribution 5.6. Upstream Investment
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LEARNINGOBJECTIVES

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

11

Introduction

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 is made.

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 for background 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 energy products, 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.

10000 Nuclear + Hydro 9000 Natural Gas Crude Oil 8000 Solid Fuel 7000 6000 5000
10000
Nuclear + Hydro
9000
Natural Gas
Crude Oil
8000
Solid Fuel
7000
6000
5000
4000
3000
2000
1000
0
60
80
1900
20
40
60
80
2000

70

60

50

40

30

20

10

0

60 80 1900 20 40 60 80 2000
60
80
1900
20
40
60
80
2000

Figure 1 World energy 1860-2001 million tonnes oil equivalent

Figure 2 Petroleum market share

11

Introduction

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.

Figure 3 World car population

Table 1 Petrol Consumption

1000 100 10 1 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
1000
100
10
1
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
0.1
0.01
millions

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 secondary to oil, has been growing faster. Figure 4 indicates that from 1970 to 2000, gas

This trend reflects

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

increasing awareness of environmental issues. Combustion of gas produces less greenhouse gas emission, than does the combustion of refined products of oil.

2.25 2.00 Gas 1.75 1.50 Oil 1.25 1.00 70 75 80 85 90 95 2000
2.25
2.00
Gas
1.75
1.50
Oil
1.25
1.00
70
75
80
85
90
95
2000
Production relative to 1970

2.2. Oil Supply

Around the

beginning of the 20 th 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

Most of the rest was controlled by six countries, including

65% of world supply.

Venezuela, Russia and Iran.

Supply of oil has grown, both in quantity and geographical diversity.

See Figure 5.

10000 Venezuela 1922 Persia 1908 Mexico 1905 East Indies 1885 1000 Russia 1860 Rumania 1860
10000
Venezuela 1922
Persia 1908
Mexico 1905
East Indies 1885
1000
Russia 1860
Rumania 1860
USA 1859
Others
100
10
1
1865
1875
1885
1895
1905
1915
1925
1935
1945
0.1
Thousand Barrels per day

Figure 4 Growth in petroleum production

Figure 5 World oil production [logarithmic].

11

Introduction

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 the Middle 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].

Figure 6 Regional oil production [million bopd]

75 50 Middle East Asia Pacific Europe Africa 25 Russia / FSU South America North
75
50
Middle East
Asia Pacific
Europe
Africa
25
Russia / FSU
South America
North America
00
1950
1960
1970
1980
1990
2000
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2.3. Oil Price

The average price of oil is plotted in Figure 7. Data is presented, both as
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.
100
Price [$/bb/ mod]
90
Price [$/bbl 2000]
80
70
60
50
40
30
20
10
0
60
80
00
20
40
60
80
00

Figure 7 Crude oil price $/bbl

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. Control

Petroleum 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.

11

Introduction

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.

Table 2

Standard Oil

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 Eureka Pipeline

1905

SW Penn Pipelines Eureka Pipeline

1952

^

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 companies created 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 Armenian entrepreneur, 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 long period 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”.

carve-up, with an American “foot in the door”. Figure 8 San Remo 1920 These companies, with

Figure 8 San Remo 1920

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.

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.

See Figure 9 for

 

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%

Table 3 Turkish [Iraq] Petroleum Company Equity

11

Introduction

Figure 9 Red Line area

1 1 Introduction Figure 9 Red Line area In the meantime, Turkish Petroleum negotiated a concession

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 the Scottish Highlands. They also found time to discuss matters of business and reached

an agreement, known as the “Pool Association”. decided that:-

Under this agreement, the cartel

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 market share. 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].

4 $11.651 Posted 1/1/74 Market 3 2 1 0 50 51 52 53 54 55
4
$11.651
Posted
1/1/74
Market
3
2
1
0
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
Dollars per Barrel

Figure 10 Saudi Arabian light fob Ras Tanura

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 – 50

iv development of downstream industry

11

Introduction

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.

Figure 11 Production ratios [proportion of 1973]

2.5 North America South America Europe Former Soviet Union Middle East Africa 2 Asia Pacific
2.5
North America
South America
Europe
Former Soviet Union
Middle East
Africa
2
Asia Pacific
1.5
1
0.5

1973

1978

1983

1988

1993

1998

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 Arabia

NIOC

3.8

 

1953

NOC:- Iran

Pemex

3.5

 

1938

NOC:- Mexico

PDVSA

2.8

 

1975

NOC:- Venezuela

ExxonMobil

2.5

7.9

1882

Merger in 1999

RD Shell

2.3

4.5

1892

Merger in 1907

KPC

2.2

 

1974

NOC:-Kuwait, merged 1980

Petrochina

2.1

 

1988

Privatised by CNPC in 1999

ChevronTexaco *

2.0

10.

1902

Includes Gulf; merger 2001

BP

1.9

4.6

1908

Includes Amoco, Arco, Sohio

ADNOC

1.5

 

1971

NOC:- UAE [60%]

TotalFinaElf *

1.5

 

1920

Final merger 1999

Lukoil

1.5

 

1991

Privatised in 1993

Sonatrach

1.4

 

1963

NOC:- Algeria

Yu kosSibneft *

1.3

 

1993

Privatised in 1994

Petrobras

1.3

 

1953

NOC:- Brazil

PDO

0.8

 

1967

part nationalised 1974

ConocoPhillips *

0.8

 

1875

Merger 2002

ENI

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

44.0

   

Seven Sisters

11.7%

62.7%

   

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

Table 4 Oil production by company [million bopd}

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 development of 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.

11

Introduction

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 Fortune Magazine. 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

162.4

Enron

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

Table 6 Fortune 500 [2001] Top Earning Companies

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- Ceyhan Pipeline will create a valuable, alternative route for export from the Caspian Basin. Downstream [refining, manufacturing and marketing], BP has 24 refineries, 38

11

Introduction

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 Upstream

Table 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 may therefore 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 discovery

1909

Anglo Persian Ltd

Formation of new company, by Burmah

1909

Abadan, Persia

New refinery [to become world’s largest]

1914

UK Government

Purchase majority shareholding

1914

Iraq Petroleum Company

Joint Venture company

1920

Scottish Oils [shale oil]

Acquisition

1924

Grangemouth

New refinery

1928

Baba Gurgur, Iraq

Oil discovery [Iraq Petroleum Joint Venture]

1931

Shell Mex & BP

Joint Venture company

1935

Anglo Iranian Ltd

Name change

1938

Burgan, Kuwait

Oil discovery [Gulf JV] [50000 million bbls]

1951

Iran

Nationalisation of petroleum assets

1954

British Petroleum Ltd

Name change

1954

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 shares

1977

Alaska

Completion of Trans-Alaskan Pipeline System.

1987

Sohio

Acquisition of remaining shares

1987

UK Government

Share disposal

1988

Britoil

Acquisition

1991

Cusiana, Colombia

Oil discovery [1600 million bbls]

1996

Mobil

Downstream Joint Venture

1998

Amoco

Merger [60:40]

1998

BPAmoco plc

Name change

1999

Arco

Acquisition

2000

Trinidad

Gas discoveries

2000

Burmah

Castrol Acquisition

2001

BP plc

Name change

2002

Veba Oil

Acquisition

2002

Caucasus

Agreement to build Baku-Tblisi-Ceyhan Pipeline

2003

Sidanko,

TNK Russia Joint Venture company

Table 7 BP plc Time Line

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 flow data from Foinaven are introduced in Chapter Two, Section 6, and then used to demonstrate evaluation methodology throughout Chapter Four.

11

Introduction

Table 8 BP Oil Production 2002

Table 9 BP Gas Production 2002

Oil Production

10^3 bopd

Angola Argentina Australia Azerbaijan Canada Colombia Egypt Norway Russia Trinidad UAE UK USA Alaska USA GOM USA Lower 48 Venezuela Other

Σ

29

53

43

38

16

46

85

84

73

67

113

461

309

264

192

51

94

2018

UK Field

BP Interest

BP Share

Names

%

10^3 bopd

Andrew

62.8

23

Bruce

37.0

17

Foinaven

72.0

72

Forties

96.1

50

Harding

70.0

42

Loyal

50.0

10

Machar

100.0

16

Magnus

85.0

31

Marnock

62.1

7

Miller

52.0

11

Monan

69.9

1

Mungo

69.9

37

Schiehallion

33.4

33

Wytch Farm

67.8

32

Other

various

79

US Fields

BP Interest

BP Share

 

%

10^6 scfd

BP Operated

Anscutz Ranch East

various

28

Hugoton

various

169

Jonah

75.2

113

Marlin

100.0

106

Matagorda Island 519

82.3

47

Matagorda Island 623

43.5

48

Moxa Arch

41.0

54

Pompano

73.7

63

San Juan Coal

various

601

Wamsutter

70.5

108

Non-operated

various

2094

 

3431

Gas Production

10^6 scfd

251

295

514

102

256

457

87

60

1238

134

1550

52

1185

2246

280

Argentina Australia Canada China Egypt Indonesia Netherlands Norway Trinidad UAE UK USA Alaska USA GOM USA Lower 48 Other

Σ 8707

1
1
1 Location Atlantic Margin, Faroes Basin 160 Km West of the Shetland Islands Water depth 500

Location

Atlantic Margin, Faroes Basin

160

Km West of the Shetland Islands

Water depth 500 metres

Ownership

72% BP

28% Marathon

Licence

1985 Concession

Discovery

1992

Consent

1994

Onstream

1997

Reservoir

Palaeocene sands

Oil gravity

25-26 APIº

Reserves

323

million barrels of oil

221

billion cubic feet of gas

Production

Two sub-sea production manifolds Sub-sea water and gas injection FPSO. Shuttle tankers Gas pipeline to Magnus

Export

Figure 12

Foinaven Field

Development

Table 10 Foinaven Summary

4.2. BP Performance

BP 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.

11

Introduction

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 in corporate 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.

1
1
 

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

Table 11

BP Statistics

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

62

RD Shell

191.5

9.6

57

ChevronTexaco

117.0

9.5

66

BP

168.7

11.0

60

TotalFinaElf

105.4

7.7

69

Lukoil

13.4

1.6

68

Yukos

9.8

1.4

 

ConocoPhillips

66.2

4.8

77

ENI

48.8

5.0

62

Repsol-YPF

43.2

6.1

 

Σ

996.7

67.9

 

Table 12 Sales and investment [2000}

11

Introduction

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 is divided into two categories, namely Capital and Operating.

Table 13 Investment in oil

 

Capital

Operating

     

Expenditure

Expenditure

Taxation

Profit

Price per Barrel

f)

       

$90 - $190 Gasoline selling price

Excise Duty & Sales Tax

none

none

Excise Duty & Sales Tax

none

         

$50

e)

Storage facilities

Gasoline

Distribution &

Transportation fleet

System operation

selling price

Marketing

Service station

Sales

Corporate Taxes

Downstream Profit

pre-duty

         

$44

d)

Gasoline market

Refining

Refinery

Refinery operation

Corporate Taxes

Downstream Profit

price ex-refinery

 

Pipeline system

Tariff payments

     

c)

Tanker fleet

Pipeline operation

$27

Transportation

Terminals

Tanker operation

Corporate Taxes

Midstream Profit

Market price cif

b)

Production platform

       

Field

Production wells

Production Taxes

Development &

Control equipment

Royalties

$25

Operation

Export system

Field operation

Corporate Taxes

Upstream Profit

Market price fob

 

Successful Wells

       

a)

Seismic surveys

Exploration &

Exploration wells

Signature Bonus

$2

Appraisal

Logging/ testing

Unsuccessful Wells

Allowances

none

Finding 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

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.

and equates with “invests” above.

5.1. Exploration and Appraisal

Exploration 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.

1
1

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 [See Chapter 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 Development

Once 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

Opex per barrel is sometimes called “Lifting Cost”; this

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

to produce petroleum.

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 on board”. The transportation phase between upstream and downstream may be called “midstream”.

5.3. Transportation

Transfer 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].

11

Introduction

Transportation from wellhead to point of sale [or valuation], may fall within the boundary [ring fence] of upstream or production taxes, whereas transportation beyond that 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. Refining

Refineries 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. Distribution

Refinery 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.

called duty, excise duty, sales tax or value added 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.

It is a proportion of pre-tax

This may be

5.6. Upstream Investment

Large, 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 to more 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.