oil company has located a large oil deposit some 30……..

Question

An oil company has located a large oil deposit some 300 kilometres east of the Shetland islands in the North Sea. The plan is to locate six deep-water rigs over the deposit, but the drilling process will be long and complicated, probably taking five years to complete. In the sixth year the oil should start to flow, and the deposit is estimated to be good for 18 years’ worth of crude, valued at about $280 million per year. Assuming interest rates will average around 6% over time period, what is the present value of the expected revenues?

Answer 1

The answer is $2.265 billion in discounted revenue calculated by applying the discount factor of 1/(1+I)^n times the revenue each year over the 18 year life of the revenue stream. The first year of revenue starts in year 6 and continues until year 23.

Actual oil gas development economics would require discounting the cash flow stream. This would require estimates of the investment to drill, complete and deliver product to market , the production decline and expected price of the products produced and the lifting cost to get the product out of the ground. Oil companies usually use a cost of capital of 10-15 or higher given the cost of their debt and the associated risk,