True Economic Impact of Project Decisions

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True Economic Impact of Project Decisions Peter Kirkham and Tom Mead

Fact Or Fiction? “Upstream Developments - Speed is of the essence. The time it takes to bring a newly discovered oil or gas field into production is critical in ensuring that the project is profitable for the company. Long lead times lead to capex creep, written off over the life of the well making every barrel produced less profitable, while free cashflow is negatively impacted for longer than necessary during the development phase.” Recent E&P Financial Analyst Report

• The ‘wisdom’ that fast project schedules deliver better returns is accepted almost without question by financial analysts and business executives … but is it true? CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Measuring Change in NPV Definition of New Economic Metric Economic Gain/(Loss) : (Actual NPV – Expected NPV)

(Facilities + Drilling CAPEX)

• Metric measures change in NPV relative to total capital expenditure • Metric can be calculated for many closeout projects in current database using an economic simulator

• Provides a single metric to measure complete asset performance

NPV is “Net Present Value” and is an economic measure of a project’s value. It is calculated as the sum of discounted net cash flows over the life of a project. CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Projects With Planned Aggressive Schedules Value Appears To Be Lost, Not Gained Economic Gain/(Loss) (% of CAPEX)

50% Pr < 0.02

25%

2 * Pr < 0.02

0% (25%) (50%) (75%) (100%)

+1 Std. Dev. MEAN

(125%)

-1 Std. Dev.

(150%)

Not Schedule Aggressive

Aggressive Schedule Target

Projects with an execution schedule duration target of less than 0.85 are classified as “Aggressive Schedule Target” CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Distribution of Actual NPV Gain/(Loss) Average Project Loses Value Economic Gain/(Loss) Distribution 30% Mean = −41% Median = −31% Std. Dev. = 63%

Percentage of Projects

25%

20%

15%

10%

5%

0% (200%)

CONFIDENTIAL – UIBC 2012

(150%)

(100%)

(50%)

5

0%

50%

INDEPENDENT PROJECT ANALYSIS

Outline • The Case for Improving Decision Making •

Economic Folly of Schedule Aggression

•

Conclusions and Path Forward

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Asset Outcomes Are Interrelated To Maximize NPV, We Must Ensure No Aspect Is Sacrificed Cost

Schedule

• Lean cost-driven development may experience quality and operability issues

• Focus on schedule leads to cost growth and poor production as corners are cut to meet startup date

Quality (Operational Performance)

• Cautious approach to asset development increases overall cost and schedule CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Ranked Drivers of NPV Gain/(Loss) Ironically the Least Important Contribution Is Schedule (40%)

(30%)

(20%)

(10%)

0%

10%

20%

30%

Initial Production

Pr > |t| 0.001

RPE Volatility

Pr > |t| 0.001

Asset Cost Growth

Pr > |t| 0.001

Execution Schedule Slip

Pr > |t| 0.005

Range reflects contribution to NPV Gain/(Loss) from P90 to P10 distribution for each outcome component CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Breakdown of Projects by Objectives Drive for Schedule Is Common 70%

60%

Percentage of Projects

50%

40%

30%

20%

10%

0% Schedule Driven Schedule Driven

CONFIDENTIAL – UIBC 2012

Cost Driven Driven Cost

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Other Other

INDEPENDENT PROJECT ANALYSIS

Perception of Value Via Accelerated Schedule (1) Revenue

Start With an Ordinary Schedule

Baseline NPV FEL Investment FID

Capital Expenditure Time Net Revenue

Cost

Cumulative Discounted Cash Flow

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Perception of Value Via Accelerated Schedule (2) Accelerate Time to First Oil Through Fast-Track to FID

To achieve a faster schedule, it is easier to accelerate the decision to FID than it is to accelerate execution – the “fast-track” project

Perceived NPV Gain

FID

Expectation is that capital costs and net revenue are simply shifted “to the left” and on a discounted basis, this leads to a higher NPV CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Typical Fast-Track Project Generalized Anonymous Real-Life Example • Development of fast-track offshore oil field “Rapide” • Example is intentionally obfuscated, but similar to several projects in IPA database

Facilities CAPEX Drilling CAPEX Facilities Schedule Drilling Schedule Resource Promise Estimate (MMBOE) Planned Production Plateau (KBOEPD) CONFIDENTIAL – UIBC 2012

Project Estimate at FID US$2,500 million US$1,000 million 30 months 1,000 days

Benchmark Index at FID 1.05 1.05 0.80 0.95

250

100 percent

100

100 percent

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INDEPENDENT PROJECT ANALYSIS

Pathways To Success Appraisal and Reservoir FEL Are Reflected In All Outcomes

Facilities FEL

Appraisal

Reservoir FEL

Facilities Outcomes

Asset Outcomes

Not Integrated Asset Team

Wells FEL

Wells Outcomes

ASSET NPV CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Appraisal Affects All Subsequent Drivers Fast-Track Has Implications for All Outcomes Appraisal Effectiveness Index

Reservoir FEL

Facilities FEL

Conservative

4.00

Fair

Best Pr < 0.001

4.50

Poor

5.00

Moderate

Good

5.50 Pr < 0.001

Wells FEL

6.00 Fair

Good

Aggressive

6.50

CONFIDENTIAL – UIBC 2012

7.00

Pr < 0.001

Fair

Poor

7.50

Poor

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INDEPENDENT PROJECT ANALYSIS

Project Definition Drives Outcomes Subsurface Definition Indicates Risk to Project Appraisal: Moderate/ Aggressive

Facilities FEL

Facilities Outcomes Facilities CI = 1.01 SI = 0.83 Outcomes Growth: −4% Slip: 3%

CA = 1.05 SA = 0.80

Reservoir FEL Fair or worse

Asset Asset Outcomes Outcomes PDA = 65%

CA = 1.05 SA = 0.95

Wells FEL

Wells Outcomes Wells CI = 2.10 SI = 1.90 Outcomes

ΔRPE = −20%

Growth: 100% Slip: 100%

Target Setting Risk

<<< Less

-----

More >>>

Results

<<< Better

-----

Worse >>>

Low

Medium

High

CA/CI = Cost Aggressiveness/Index SA/SI = Schedule Aggressiveness/Index CONFIDENTIAL – UIBC 2012

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PDA = Production Attainment ΔRPE = Change in RPE

INDEPENDENT PROJECT ANALYSIS

Illustrated Economic Erosion (1) ‘Industry Average’ Cash Flow Stream

Industry NPV10 = US$1,991 million

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Illustrated Economic Erosion (2) Project Initial Expected Cash Flow Stream

NPV10 = US$2,111 million

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Illustrated Economic Erosion (3) Effect of Facilities Cost Growth and Schedule Slip

NPV10 = US$2,145 million

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Illustrated Economic Erosion (4) Additional Effect of Production Attainment

NPV10 = US$1,059 million

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Illustrated Economic Erosion (5) Additional Effect of Resource Promise Estimate Deviation

NPV10 = US$683 million

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Illustrated Economic Erosion (6) Additional Effect of Wells Cost Growth and Schedule Slip

NPV10 = US$381 million

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Misguided Tradeoffs NPV Impact From Sacrifice Outweighs Perceived Gain Common Problem: When one or more of the targets is set so aggressively that the project is likely destined to be a major disappointment

Quality is sacrificed for low cost

Safety is sacrificed for speed

Cost is sacrificed for fast schedules

Quality is sacrificed for fast schedules

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Outline •

The Case for Improving Decision Making

• Economic Folly of Schedule Aggression •

Conclusions and Path Forward

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Alternative Hypothesis Obsession With Schedule Erodes NPV • Roughly half of E&P projects are schedule driven and this focus is established very early in the planning phase • The emphasis on schedule limits FEL, which then has a cascading effect across all subsequent project phases • The problem is failing to recognize the magnitude of the cascading effect that these early decisions have on outcomes – Project framing does not properly account for trade-offs between cost, schedule, and operability – Leads to suboptimal NPV outcomes CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

ABC of Schedule-Driven NPV Loss Schedule Focus Adversely Affects All Outcomes Antecedent

Behaviors

Consequences

Compress Definition Phase

All Outcomes Affected By Poor Definition

Schedule

Less Complete Reservoir Evaluation

Driven

Parallel Subsurface and Project Planning Poor Planning and FEL

Aggressive Schedule Targets Unrealistic Estimates

CONFIDENTIAL – UIBC 2012

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Production Shortfall Reserve Downgrade

Cost Growth Schedule Slip

Significant Destruction of Planned NPV INDEPENDENT PROJECT ANALYSIS

Compression of FEL Driven by Business Target Date for Startup Is Often to Blame • Project teams get cornered into compressing FEL to meet business objective of early first hydrocarbons FEL Duration

Subsurface definition FEL Facilities FEL

Start FEL 2

Project execution

Target Startup

Sequential

Phased

Overlapped

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

The Economic Folly of Chasing Schedule • Chasing schedule is commonly done under the impression that NPV is enhanced

• Implicit assumption is that any negative outcomes that result from shorter appraisal and FEL duration are outweighed by the accelerated first oil date – Potential cost growth and schedule slip will have much smaller effect on NPV compared to gain from schedule – Disappointment in RPE and production attainment is rarely (if ever) considered

• Combined effect of actual cost, schedule, and production outcomes on NPV is more devastating than commonly believed – This is a non-obvious conclusion CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

How to Avoid the Schedule Trap Can We Go Fast Without Eroding NPV? • Schedule itself is not the culprit for the poor economic results; practices are to blame • Schedule aggressiveness can lead to a cascading series of events that ultimately destroys NPV

Aggressive ScheduleDriven Project

CONFIDENTIAL – UIBC 2012

Compressed FEL Phase & Aggressive Appraisal

Reservoir Uncertainty & Unclear Trade-offs

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Poor Outcomes Lead To NPV Erosion

INDEPENDENT PROJECT ANALYSIS

Breakdown of Outcomes …But Trades Fast FEL for Poor Outcomes PRODUCTION ATTAINMENT

Overlapped Schedule-Driven Sequential or Phased

0.60 0.70

FACILITY COST GROWTH

0.80 0.90

20% 15%

15%

10% 5% 0% 0.50

5%

10%

0%

0.60

5%

0.70

10%

0.80

15%

0.90

20%

FEL DURATION INDEX CONFIDENTIAL – UIBC 2012

1.00 0%

WELLS COST GROWTH 20%

SCHEDULE SLIP 33

INDEPENDENT PROJECT ANALYSIS

Recipe for Value Preservation Go Slow to Go Fast • A solid foundation of basic data and clear project objectives are the necessary starting point • Good project definition leads to a cascading series of events that ultimately preserves NPV

Completed Subsurface Definition & Clear Trade-offs

CONFIDENTIAL – UIBC 2012

Set Realistic Cost & Schedule Targets Based On Project Definition

Mitigation Of Risks During FEL Phase

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Stable Project During Execution Preserves NPV

INDEPENDENT PROJECT ANALYSIS

Outline •

The Case for Improving Decision Making

•

Economic Folly of Schedule Aggression

• Conclusions and Path Forward

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Fact or Fiction? “Upstream Developments - Speed is of the essence.”

Fact

Fiction

• Some projects have delivered fast schedules with no loss of NPV • A fast schedule is the result of good project definition • Faster time to first oil leads to an increase in NPV

• Chasing a fast project schedule can lead to unintended consequences • A significant proportion of NPV is eroded if the project does not meet all targets • Poorly defined projects with aggressive schedule targets have highly unpredictable NPV outcomes

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Emphasise FEL, Not Schedule The Tail Cannot Wag the Dog • Good practices lead to successful economic outcomes irrespective of whether or not a project is schedule driven • The prize for well-defined projects is competitive targets and preservation of expected NPV • Achieving Best Practical project definition requires both time and effort; neither are made reliably available to schedule-driven projects by business

The most challenging aspect of delivering a successful schedule-driven project is NOT focusing on the schedule CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Good FEL Preserves Economic Value • It is possible to achieve a successful schedule-driven project with an aggressive schedule target • Well-defined projects with good integrated schedule and comprehensive project execution planning are the differentiator for success • Poorly planned projects suffer larger NPV loss on average, but are also more unpredictable

Without Good or better FEL, a project is potentially giving up over half of its NPV

CONFIDENTIAL – UIBC 2012

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INDEPENDENT PROJECT ANALYSIS

Making Good Decisions Is a Complex Optimisation Problem • There is a complex relationship between project outcomes and project drivers • An economic simulator backed by strong data relating drivers to outcomes is needed to reveal to true effect of project decisions – Provides insight into the most appropriate balance between cost, schedule, and production attainment – Indicates the possible unintended consequences of any particular decision

The true economic impact of a project decision is non-obvious and can lead to unintended consequences CONFIDENTIAL – UIBC 2012

43

INDEPENDENT PROJECT ANALYSIS

Thank You!