Simplified Methods for Investment Analysis in the Petroleum Production Industry

This paper presents a number of abbreviated methods for determining the investment merit of projects in the petroleum production industry. The use of these simplified methods facilitates the analysis of investments without sacrificing essential accuracy. The valuator is not restricted to a single valuation of an investment but may easily determine a range of values corresponding to the probable range of the principal risks, and this may be done with a minimum of time and effort. The projected schedules of income of many investments in the petroleum production industry lend themselves admirably to the use of the time-saving methods that are outlined. Several methods of calculating rate of return are rigorously defined, and the results of the calculation are compared with an example. Standard methods for performing rate-of-return calculations are suggested. The merit of rate of return as a "single number" index for investment valuation is challenged. Multiple analysis of the range of variables and profitability profiles are used to assist in the understanding of risk and are recommended to supplement rate-of-return calculations. Charts and tables of relationships derived in the Appendix are presented to facilitate use of the methods. Introduction Plagued by shrinking margins and diminishing returns from exploration, the oil industry must seek new approaches for maintenance of profit. A greater emphasis on economics has resulted from the present economic climate of the industry. Fewer opportunities for highly profitable investment mean that a more careful analysis of those investments available must be made to maintain a reasonable rate of return. A satisfactory approach to investment analysis can be one of the key factors for success in an industry with narrowing profit margins. Recent publications have developed the technical and economic theory which is the basis for this paper. Many investments in the petroleum production industry result in a schedule of future income which may be considered either constant, declining according to one of the hyperbolic decline equations, or a combination of constant and declining income. The primary purpose of this paper is to present several methods of investment analysis which are easily computed and have an accuracy commensurate with the data employed for analysis.