Capital Cost Analysis (4)
James Henderson
November 2022
The Economics of Energy Corporations (2)

Outline of the course
Overall objective – understand how senior management use economic models to make investment
decisions
1.Introduction to key themes in the global energy market
2.Introduction to financial modelling as a management tool
1.Understanding some key concepts
3.Starting two models for an oil and a gas field – revenues and prices
4.Inputting the costs – capital expenditure
5.Operating costs and paying the government
6.A power plant – a buyer and seller of energy
7.Calculating a discounted cashflow
1.Why is it important
2.How is it used to make decisions
8.Testing the investment decisions: running some numbers under different assumptions
9.Answering your questions

Increasing interaction between prices of hydrocarbons

Key Cost Elements
Main assumptions
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•Capital expenditure (initial investment)
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•Operating expenditure (ongoing cost of operations)
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•Transportation (getting the product to market)
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•Taxes (operating taxes and profit tax)
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•CAPEX, OPEX, Transport and Tax

Capital Expenditure - CAPEX
Key parameters
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•Size of asset
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•Location
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•Complexity
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•Competition for contractors / availability of local companies

Complex models are used by engineers
•Cost estimates based on historical precedent and prices of key inputs today
•Steel price a key input, for example

Timing and planning is vital, with any slippage being potentially very expensive
•text


Oil price naturally linked to spending
•Upstream costs fell sharply after oil price collapse in 2015/16
•
•2020 has seen a further cut in spending

2020 saw costs slashed and a re-assessment of future plans overall
•Spending across the value chain has been cut radically
•In addition companies have started to questions which oil projects will be viable in a world of
energy transition
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Companies have been forced to re-think spending plans and to focus on efficiency gains
•As companies cut budgets they also look for efficiency gains which can reduce the impact on
investment plans
•Often low oil prices catalyse technological innovation with long-lasting impacts

Where will breakeven prices be low enough to ensure survival and adequate returns?
•The geography of projects is becoming increasingly important
•How can companies get access to assets in areas where the breakeven cost is low enough to
guarantee profits?

It is not just oil producers who have to worry. Service companies are hit hard too
•Companies like Schlumberger, Halliburton and Baker Hughes are vital for oilfield developments
•They have much of the industry expertise ad equipment to hand
•They tend to suffer first in an oil price downturn as companies force through cuts in budgets

Job losses can cause long-term problems
•Jobs are often cut during a downturn, but now this could have radical consequences
•Will skilled workers return to the oil industry or look for employment elsewhere (e.g. offshore
wind)
•Skills shortage is becoming a major problem for oil and gas sectors

In the US the rig count falls in line with the oil price
•It can also recover quickly, but again only if workers stay in the industry
•Some retired workers are being offered huge pay packages to return to work as there are not enough
young engineers and other scientists interested in the oil and gas sector

Comparison of capex by countries
•Low investment costs in Middle East thanks to huge reserves and easy conditions
•Highest costs offshore, especially in deep water
Source: Rystad Energy

Comparison of field capex
•Specific fields exemplify the country trends
•Offshore fields are more expensive (Lula), as are those with complex geology (Kashagan)
•Onshore conventional fields (Ghawar, Novy Port) are lower cost