Energy Project Investment and Finance

Coursework

The aim of this assignment is to assess the student on different concepts and practices in oil and energy project valuation, investment and finance. In particular, the tasks are designed to examine student’s understanding of how

●   oil and gas projects are designed and evaluated,

●   simulation techniques can be used to assess the uncertainty around oil, gas and energy projects

●   to use energy derivatives in project valuation

●   real option valuation is applied to energy projects valuation and investment analysis

●   This coursework carries  100% of the overall mark for the Module and should be completed strictly in groups of two (not 1, 3, or 4). You are free to choose your partner.

●   The only acceptable work is a typed report in word or pdf format and all the calculations should be done in Excel. Both files should be submitted.

●   The deadline for the coursework is 24.00 on Sunday 14th  July 2024.

●   Make necessary assumptions where required.

●   Any attempt of plagiarism, outsourcing, copying other groups work, will result in failure of any group involved and possible further actions.

Task 1: Estimation of Cost of Equity, WACC and Project Evaluation

You are working for a small oil & gas E&P company, which is considering an oilfield development project to extract crude oil. The company would like to assess the viability of the project using the DCF approach. The total investment of the project is $4.0bn, which is scheduled through $1.0bn initial investment, $1.5bn in the first year, $1.0bn in the second year, and $500m as working capital and cash reserves ($300m WC and $200m CR). The project is expected to be financed with 60% debt and 40% equity. The debt, which will be drawn over two years (0.4bn initially, 1.0bn in first year and 1.0bn in second year), is scheduled to be fully amortized over 10 years with equal repayments at 6.0% interest. The production will start from the end of the 1st  year (i.e. 15m bbl from beginning to the end of year 2), increase to 25m bbl in the following year and 35m bbl the year after. The production is expected to decline from year 10 at a rate of 12% to the end of the project. The operating cost is estimated to be initially $20/bbl per year and increase with inflation (3%pa). The project which is a PSC is planned for 25 years and as an IOC you are required to pay royalty of 10% and share the profit 50-50. The oil revenue will be taxed at 25%; while there will be a 50% limit on cost recovery and depreciation rate is 15%pa.

1-   Assuming current price of oil is $75/bbl, prepare a spreadsheet to calculate the projected CADS of the project.

2-   Construct the debt repayment installments and calculate the equity cash flow.

3-   Collect information on the beta of a sample of oil and gas exploration and production companies (e.g. 10 or 15 small to mid-size companies), market risk premium, risk free rate, as well as debt and equity of the sample companies. Estimate the asset and equity betas, and calculate the cost of equity and WACC of the project.

4-   Use the WACC and Cost of equity to estimate theNPV of the project.

5-   Use the book value of equity and debt to calculate the cost of equity every year and the new NPV of the project.

[30 marks]

6-   Optional with no marks: Estimate the NPV of the project using multiple discount rate and QMV method.

Task 2: Oil and Gas Project Evaluation under Uncertainty

In some E&P projects oil and gas are found together and in the same reservoir, which means for every barrel of oil produced, there will be some associated gas. The expected gas production from the field is expressed in Gas-to-Oil Ratio (GOR); i.e. the number of cubic feet of natural gas produced with a barrel of oil. A high gas-to-oil ratio is extremely undesirable because the pressure in a reservoir, the propulsive force to move the oil in the formation to the boreholes, can be depleted as gas is recovered. And with the reservoir pressure gone, a great percentage of the oil may not be recoverable, except by a costly secondary recovery program. Therefore, when evaluating an E&P project we should consider the production and sale of both oil and gas. In this exercise, you are required to produce a spreadsheet for evaluation of an E&P project using simulation techniques.

The oilfield under investigation is estimated to contain enough oil to yield a production rate of 15m barrels in the first production year (year 2), 20m bbl in the second production year, 30m bbl from third production year for 7 years, and decline at a rate of 20% per year thereafter until year 20. It is also expected that the field will have a Gas-to-Oil Ratio of 80cf/bbl, which means that for every 1000 barrels of oil extracted, 80kcf of gas is produced. The total investment for this project is estimated to be $5000m which spreads over two year development period ($2000m initially, $1500m a year for year 1 and 2), and operating cost at $35/bbl which is expected to escalate at 3% per year (rate of inflation) during the production period. The production is planned to start from the beginning of the second year and areinjection process is planned to be introduced from year 11 at a cost of $50m per year to boost production by 3%.

1-   Assuming a cost of capital of 12.0% (discount rate), oil price of $75/bbl, and gas price of ct0.5/cf (approximately $5/MMbtu), estimated the NPV and IRR of the project.

2-   Assuming oil and gas prices are random and follow the given lognormal distributions, prepare a spreadsheet to simulate the project NPV and find the probability that the NPV project to be negative. Oil Price ~ LN(75,30) and Gas price ~ LN(ct0.5/cf, 0.15)

3-   Try to incorporate other possible uncertain variables in the simulation model, assuming appropriate distributions and analyze the NPV of the project, and present/discuss your results

4-   Let us now assume that we hedge the oil and gas for the first 5 years of production through a 5- year forward swap contract at a fixed price of $70/bbl and gas for ct0.45/cf, and sell oil and gas at market price thereafter. Simulate theNPV of the project and find the probability of theNPV of the project being negative P(NPV<0).

5-   Optional with no marks: You can define stochastic processes for oil and gas prices and run your simulation with projected price paths for oil and gas.

[30 marks]

Task 3: Intrinsic Value of Gas Storage Contract

You are working for a small investment group which is considering renting a gas storage facility for the next year as there seem to be a good opportunity to make some profit due to shape of the Gas forward curve. The facility has a  capacity of 50,000,000mmbtu with a maximum injection and withdrawal rates of 1,400,000mmbtu per day and 1, 100,000mmbtu/d, respectively. The cost of injection is $0.07mmbtu and cost of withdrawal is $0.05mmbtu. Under the contract the storage will betaken over half full and should be given back at the end of the period half full.

1.   Collect recent forward curve for natural gas (e.g. Henry Hub or ICE for July 2024 to June 2025).

2.   Assuming a flat interest rate curve of 4%, build a model that computes intrinsic value of a storage contract and estimate intrinsic values of the storage contract in Excel using Excel solver.

3.   Perform. some sensitivity analysis around the assumed injection/withdrawal rates.

4.   Discuss the results and any deficiencies that this valuation method may have as well as how such shortcomings maybe resolved.

[20 marks]

Task 4: Real Option Valuation

The Green LNG plant is planned to construct and operate 3 LNG trains with a total production capacity of 10mt of LNG per year. The NPV of this 30 year project is estimated to be $500m. Given the volatility of the NG prices and the LNG market, it is estimated that NPV of the project to have a volatility of 35%. However, the company has the option to increase production by 25% for an additional cost of $400m if LNG demand and prices increase. In addition, the company has the operational flexibility to reduce production by 40% and make a cost saving of $150m, should LNG prices fall.

1-   Given the above information, assuming an interest rate of 4%, construct a 60-step binomial tree to estimate the value of these options (expansion and contraction) and the expanded NPV of the project.

2-   Comment on your results and discuss any other operational optionality that you maybe able to use in this project.

[20 marks]