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Technical Paper
Spatially and temporally dispersed marginal subsea
field valuation. Part I: preliminaries
Sirous Yasseri
Safe Sight Technology UK
171
Yasseri. Spatially and temporally dispersed marginal subsea field valuation. Part I: preliminaries
the detailed valuation using a case study. Results perational flexibility must be built into the design
O
presented in Part II emphasise the need for meth- at the selection phase. It allows operators to react
odologies to support the decision-making process, to the current or near term conditions without the
especially when investing in situations without a need to modify the system. For example, ability to
convincing track record. control production from many wells in response to
demand is an operational flexibility. Active r eservoir
management, such as changing oil or gas produc-
2. Development strategy tion rates and injection rates, are also operational
The primary drivers of the development of m
arginal flexibility.
offshore fields are: Architectural flexibility has long-term impact,
while operational flexibility focuses on near term.
• schedule – earliest possible start-up;
Architectural flexibility sometimes enables opera-
• cost––life cycle cost (capital expenditure (CAPEX)
tional flexibility. For example, in the development of
and operational expenditure (OPEX));
a deep-water field, tieback flexibility enables alloca-
• environment – impact of the development on
tion of production capacity among multiple fields
the environment;
(Lin et al., 2009). Architectural flexibility is built into
• technology – new technology, or improvement
a system at the design stage. It allows the system to be
of the existing technology;
modified, with little or no reconfiguration, in order
• capacity utilisation – use of existing infrastruc-
to accommodate new requirements. A flexible field
ture, facilities upgrading and life extension (if
architecture approach allows a staged deployment
needed);
(Yasseri, 2014) of the entire field in order to maxim-
• facilities integrity – reliability, availability and
ise the investment in the infrastructure. Staged
safety;
deployment means that as the flow in some reser-
• intervention, maintenance and repair (IMR);
voirs decline, the excess processing capacity can be
• government fiscal policy and local content
used to tie-in a new reservoir, leading to a smaller
requirements.
central processing facility. Alternatively, if demand
Table 1 outlines various strategies for the develop- exceeds the current capacity, the central processing
ment of a field. facility can be upgraded, provided that higher struc-
The key parameters for economic viability are: tural strength was built into the substructure during
design for the future expansion. This approach does
• acquisition and field licensing cost;
not design for a target capacity but tries to find an
• hydrocarbon type, quantity in place and recover-
initial architecture that will give system managers the
able reserves;
flexibility to adapt to market and field conditions.
• oil and gas price;
The constraint that this approach can impose is
• development strategy;
the use of the facility as designed and constructed
• enabling technology;
(without considering room for expansion), which
• infrastructure costs – design, procurement, fab-
limits available choices in the later stages. This con-
rication, installation, operation and decommis-
straint can be removed, at a cost, by providing the
sioning costs;
additional space for expansion on the central pro-
• forecasted production and revenue accounting
cessing facility upfront. Another issue is the cost for
for costs;
embedding flexibility into an architecture where its
• fiscal policy, taxation, royalty and other claims
usefulness is uncertain. Uncertainties have to be
on the profit;
modelled and integrated into the design process.
• regulation, regarding the local content and
This marks a distinct departure from the traditional
emission in some parts of the world;
approach because market conditions are not usu-
• the hurdle rate (internal rate of return) – in an
ally taken into account by designers.
unstable environment the payback period may
Building flexibility into a design is an option that
become a primary tool.
gives the right, but not the obligation, to utilise it.
Built-in flexibility enables operators to react appro-
priately and in a timely manner to emerging condi-
3. Architectural and operational flexibilities tions, without starting from scratch. For example, a
There are two types of flexibility over the life cycle host platform may be designed with stronger sub-
of a system: operational and architectural (Lin structure than needed now, with the intention to tie-
et al., 2009). Operational flexibility refers to the back new reservoirs when they are found; and there
ease of modifying the operating strategies without is a good of chance of finding new reserves. Such
changing the system architecture or configuration. extra strength gives flexibility to expand, but it
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Underwater Technology Vol. 33, No. 3, 2016
comes at a price. As finding new oil reserves is uncer- the most cost-efficient way of developing scattered
tain, the question is how much one could reasonably marginal fields is via a subsea development, and
invest to create flexibility under such uncertain tying them to an existing processing facility, if pos-
conditions. This question can be answered by using sible. This puts an emphasis on the order and tim-
the RO method (de Neufville and Scholtes, 2011). ing of the development, as inefficient timing
In this study, it is assumed that flexibility is provided reduces the total value of the oil fields.
by design, thus enabling reconfiguration of the Depending on the location or the number of
architecture after it has been deployed. RO approach reserves, a fixed platform or a floating facility is
allows investors to focus on the value of flexibility required. If an infrastructure does not exist or the
without having any technical knowledge of the way life of the field is not long enough to justify an
to embed it. It is further assumed that it is feasible to export pipeline, an FPSO vessel may present itself
embed flexibility and the cost can be justified. as a viable option, provided the produced gas can
Lin et al. (2013) presents a methodology that be reinjected. FPSOs are best utilised for fields
evaluates three kinds of flexibility: the ability to tie that primarily produce oil (Soeters et al., 2002).
back new fields; the ability to expand the capacity The oil is stored in the FPSO’s hull; the gas can be
of a central processing facility; and the dynamic used for fuel, reservoir support and/or re-injection
allocation of processing capacity to connected of excess gas; and the produced water must be
fields. The methodology uses a mid-fidelity model processed and then disposed of. A FPSO has a
in conjunction with Monte Carlo simulation. An large deck with enough space for multiple pro-
experienced subsea systems architect can narrow cessing packages and which can have equipment
them down to just a few alternatives (Yasseri, 2015). added later, if needed.
FPSOs are the preferred floating production
option for small fields spread over a large area (Xia
4. Processing facilities and D’Souza 2012). Spread-moored vessels are also
The processing facility and means of transporting acceptable for most locations and can accommo-
the product are major cost components. Hence, date a large number of wells, since there is no turret
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Yasseri. Spatially and temporally dispersed marginal subsea field valuation. Part I: preliminaries
to limit swivel paths. For a staged development and fiscal policies. However, cold stocking (also
plan, the FPSO should be designed to allow for known as moth-balling) a facility is costly and only
field expansion. This could include excess process- resorted to when the market recovery is expected to
ing capability, additional riser/umbilical, caissons be long.
and porches, and gas handling (e.g. reinjection Governments around the world introduce or
facilities). withdraw incentives in order to maximise their share
of profits. Thus, investors are exposed not only to
the project risk and the market risk, but also to the
5. Fiscal regimes risk of government policies. In an uncertain market,
Many factors are considered when an oil company investors need to consider strategic options stem-
determines the economics of a discovery, and often ming from operational and management flexibility
fields have to wait for favourable technological or to decide whether to carry out the project, modify it
market conditions. Governments around the globe during development or operation phases, or simply
increasingly are offering incentives to induce oil postpone it and wait for more information.
companies to give their marginal fields another
look. Marginal field legislation and incentives cover 6.1. Traditional methods
a wide spectrum of styles and methods, including To date, the standard DCF model is the benchmark
tax holidays, reinvestment incentives and sliding valuation model, because of its simplicity. The
scale royalties. Every country has a different petro- model calculates the net present value (NPV) of an
leum policy to suit its national needs. Whatever the investment, based on its future cash flow, adjusted
regime, the perceived economic returns under a for the time-value of money and risk. The tradi-
tax and fiscal regime must be higher than the cost tional DCF technique is appropriate in situations
of extraction. with low degrees of economic and technical uncer-
The regulatory framework governing the admin- tainties. The objective of DCF is to sum the net cash
istering of oil leases differs from region to region, flows and discount them at the weighted average
although some basic process, charges and operat- cost of capital (WACC), or other discount rate, giv-
ing agreements are common to all. Government ing a static net present value (NPVstatic). The DCF
levies consist of royalties, corporation taxes, and decision rule states that a business should invest in
special taxes such as petroleum profit tax, which is projects that have a positive NPVstatic.
common in most regions (Kasriel and Wood, 2013). The discount rate in the DCF model addresses
This also is a major factor in tipping the scales the time-value of money and some market risk. The
between marginal and viable fields, in terms of eco- most common way to estimate the cost of equity
nomic considerations. within corporate finance is by use of the capital asset
Various regulatory bodies have tried to improve pricing model (CAPM) (Copeland and Antikarov,
marginal field economics by implementing certain 2000). The CAPM states a linear relationship
incentives. In the UK North Sea, for instance, the between the return on a stock and its beta, the
payment of royalty and petroleum tax has been market risk premium and the risk-free rate. Out of
abolished for the recent oil leases (KPMG, 2012). these, only beta is individually defined for an invest-
Tax breaks and investment tax relief are usually ment. Beta is a measure of the volatility, or system-
given for new developments as well. However, the atic risk, of a security or a portfolio in comparison
use of the ‘ring fence’ approach, in which a pro- to the market as a whole. Beta is the tendency of a
ducing field is subject to certain tax rates and not security’s returns to respond to swings in the market.
eligible for tax breaks, has a detrimental effect on A beta of 1 indicates that the security’s price will
marginal field developments adopting the hub move with the market. A beta of less than 1 means
facility or host platform concepts, as they could that the security will be less volatile than the market
affect the categorisation of the facility. and vice versa (Copeland and Antikarov, 2000).
The market risk premium and the risk-free rate
should be the same for all stocks. Historically, the
6. Valuation methods anticipated internal rate of return (IRR) for mar-
Investments in the marginal offshore oil and gas fields ginal fields is only between 8% and 18%, whereas
are irreversible and costly, and their profitability is for large projects IRR is between about 20% and
uncertain. These characteristics cause complexity in 30%. IRR is a primary measure for investment
the decision-making process. Some projects count on decision for oil and gas companies, where cost of
strategic flexibility to enable the optimum moment of capital is typically used as a decision basis. Large oil
completion, expansion, contraction, interruption or companies require larger IRR as they are very
abandonment, depending on the market conditions exposed, i.e. their risk expenditure is higher.
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Underwater Technology Vol. 33, No. 3, 2016
Alternatively, DTA, which is a version of DCF and option gives the holder the right, but not the obli-
was developed in the 1950s (Brach, 2003), is more gation, to buy a security at a specified price in the
suitable for the valuation of projects that have a future. The buyer of the call option is taking an
high degree of technical (technological) uncer- optimistic view of the stocks underlying the call
tainty and a low degree of economic uncertainty. option. Similarly, a capital investment today that
DTA is where discrete probabilities are assigned to gives the investor the future right, but not the obli-
potential outcomes at each stage of the valuation. It gation, to make a further investment is a RO. A vari-
happens that projects have a symmetric pay-off ety of factors can influence the value of the option.
structure. As a result, it is possible to assign discrete For example, as the value of the stock (or the pre-
probabilities to various outcomes, making DTA a sent value of the expected cash flows) increases, so
good valuation technique. The difficulty with DTA does the value of the call option.
lies in obtaining reliable probabilities of success for Another critical difference between NPV and
each stage of development. ROs is the effect of uncertainty (or risk) on value.
Some firms’ capital-budgeting decisions are Uncertainty typically is considered bad for the valu-
based on the expected net present value (ENPV) ation of traditional cash flows. In contrast, uncer-
model, which is a variation of DTA models. It was tainty increases the value of ROs. So, in today’s
specially developed to capture the effect of techni- uncertain environment, the value of options actually
cal uncertainty (represented by probabilities to suc- increases. After an investment is made, time passes,
ceed for each phase) on the value of projects. If the uncertainty is resolved and the present value of
prediction of the future cash flows of the project is cash flows (analogous to the future value of a stock)
uncertain, the DTA models are supplemented with can be calculated more accurately. If the environ-
sensitivity and scenario analyses. ment is volatile, then the chance that the value of
Sensitivity analysis ranks input variables of the the project in the future will exceed the necessary
future cash flows (amount of extractable hydrocar- investment (or, in other words, that the NPV will be
bon, unit price, unit costs, etc.) according to their positive) is higher.
contribution to the risk of the project present value. Table 2 gives definitions of variables for three
Analysts attribute, to the most risky input parame- types of options: financial, real asset (e.g. real
ters, their possible minimum and maximum values estate, airport, etc.) and oil and gas asset. Due to
and compute the ENPVs of the project that corre- these similarities, the financial option pricing meth-
spond to these extremes. However, the calculated set ods are used for valuation of real assets (Copeland
of mutually exclusive outcomes of the project value and Antikarov, 2000).
does not facilitate the undertaking of the right The following six categories of ROs are men-
investment decision because the true probability of tioned in the literature:
each outcome is unknown. For this reason, Monte
Carlo simulation (Motta el al., 2000; Adamu et al., • option to postpone/defer;
2013) is used to gain more insight into uncertainties. • option to change the scale (expand or contract);
• option to abandon;
6.2. Real option method • option to switch;
Another approach is the real option (RO) method, • compound option;
which is suitable for proven undeveloped reserves • option to grow.
because the owner has the right, but not the obliga-
tion, to develop such reserves, before the expiry of 6.3. Binomial real option model
the lease. Hence, the total value includes the DCF The binomial approach is one of several methods of
value plus some additional value of a timing option, solving the RO equation (Copeland and Antikarov,
particularly regarding the volatility of unit prices. 2000). The binomial model is more widely used,
For example, if the DCF of a marginal field is $1000 due to its versatility and ease of use. The binomial
MM and it costs $1000 MM to develop it, then the model (Fig 1) represents the price evolution of the
NPV is zero. Development of this reserve has not option’s underlying asset as the binomial tree of all
much benefit according to the traditional decision possible prices at equally-spaced time-steps from
criteria, but the economic value of the field is not today.
really zero. The concessioner may have years before It assumes that at each step, the price can only
losing the right. The lower bound of NPV may be move up and down at fixed rates and with respec-
zero, but there is no inherent upper bound (de tive pseudo-probabilities (Ρu and Ρd ). In other
Neufville, 2003). words, the root node is today’s price, each column
The theory of ROs is an extension of financial of the tree represents all the possible prices at a
option (Copeland and Antikarov, 2000). A call given time, and each node of value S has two child
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Yasseri. Spatially and temporally dispersed marginal subsea field valuation. Part I: preliminaries
Fig 1: Binomial tree showing up and down movement of the underlying value.
nodes of values S.u and S.d, where u and d are the from which it can be deduced:
factors of upward and downward movements for a
e rdt − d
single time-step (dt). Variables u and d are derived Pu = (4)
from volatility (s): u −d
From the binomial tree representation, the
u = e −σ dt
(1) option price can then be sequentially derived for
each node of the tree, starting at the leaves. At each
and timeline (i.e. at option expiry) calculation of call
option (Vcall) and put option (Vput) prices are
d =eσ dt
(2) straightforward:
Ρd is simply equal to 1– Ρu, and Ρu is derived Value of call
from the assumption that over a period of dt the option = Vcall = Maximum of (S – X, 0) (5)
underlying asset yields the same profit as a riskless
If market price (S) at expiry date is greater than
investment on average. Therefore, if it is worth S at
strike price (X), a call option has a value of (S – X)
time t, then it is worth S·e rdt at time t + dt. This leads
or zero, and:
to the following equation:
Value of put
S·e rdt = (Ρu·u·S + (1–Ρu)·d·S )(3) option = Vput = Maximum of (X – S, 0) (6)
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Underwater Technology Vol. 33, No. 3, 2016
R13
Vt = (Ρu·Vu,t+1 + Ρd·Vd,t+1)·e–rdt (7)
R4
75 KM
where Vt is the option price for one of the nodes at
Hub
time (t), and Vu,t+1 and Vd,t+1 are the prices of its two R3
R7
child nodes. This formula is derived from the 70 m
R16
observation that an option that is worth Vt at time (t) R5
R2
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Yasseri. Spatially and temporally dispersed marginal subsea field valuation. Part I: preliminaries
16
14
12
10
8
6
4
2
0
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Year
procurement and installation. Consequently, oil Subsea development is the most appropriate
and gas investment can be modelled as a com- choice for this field, as the development can be
pound option: each stage provides a decision point phased. However, since the location is far from
to move on to the next stage. The data collection shore and flow assurance is a major concern, then
and appraisal stage requires consideration of cash a gathering hub is also needed. It is decided to
flows which are needed for periods 2 to 5 (Fig 1). tie-back R4~R5 to a fixed platform in shallow
Government incentives can be seen as options waters. The flowlines can be used for tying the
occurring to the prospective owner. The investor must rest of reservoir later on. The first phase is to
decide whether to spend on knowledge-gathering tie-in R1~R3.
regarding the price movement, consumers’ demand
and government policies. This helps to decide if it
is worthwhile to install adequate capacity to pro- 8. Conclusion
duce now, to stage the production or to delay the Fig 4 shows a flow chart of valuation methods dis-
investment. cussed in this paper. It should be noted that there
Concept selection typically involves relatively are many variations on these themes.
small expenditures. Also, the decision to invest can There is a great potential for using financial
be influenced by the state of the firm’s other assets. asset pricing theories for the evaluation of real
Delaying investment and beginning development assets, as well as for capital allocation decisions,
is not always straightforward, as assumed by the RO businesses valuation and assess performance. Part I
models. has briefly discussed DCF, ENPV and the binomial
approach to RO, which is designed to provide a
7.3. Concept selection better understanding of strategic values of real
Subsea production systems allow production from assets.
multiple drilling centres, and single wells are also Reservoirs are too small to warrant an inde-
easily accommodated. Tie-back distances of over pendent production unit, however, they can be
15 km are feasible from a flow assurance stand- developed by a central production unit as a hub/
point. The type of well installation (platform or host, fixed or floating. The operator also has to
subsea) is often determined by water depth, as decide when to abandon the field and decommis-
well as reservoir size and density. Fixed platforms sion the installation, by taking into account
are often used in shallower water depths that con- future production as well as equipment life and
tain concentrated accumulations, which can be operational cost. The problem of optimal invest-
reached from a single location. Subsea production ment timing interests practitioners who are assess-
can be used in any water depth, but they are nor- ing investment in petroleum production. The
mally used in deeper water, where fixed platforms main decision in a petroleum production project
become more expensive, or there is insufficient is if and when the field should be developed.
resource density. Depending on the field and the technology used
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Underwater Technology Vol. 33, No. 3, 2016
Data gathering
Hydrocarbon
Prices CAPEX Taxation
type
Licence expiry
Demand OPEX Fiscal policy
date
Cost of capital
Extractable Time to first Regulations &
and the
reserves oil or gas policies
hurdle rate
Conventional methods
More data
Dynamic
Simulation programming Binomial method
Available actions
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Yasseri. Spatially and temporally dispersed marginal subsea field valuation. Part I: preliminaries
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