Investment Decision Making in the Upstream Oil Industry: An Analysis

Surbhi Arora
Assistant Professor, College of Management & Economic Studies, University of Petroleum & Energy Studies

Investment Decision Making in the Upstream Oil Industry: An Analysis

Introduction
Current Capabilities in Upstream Oil & Gas Industry: Current Practice Techniques in Upstream Oil & Gas Industry:

Conclusion

Investment Decision Making in the Upstream Oil Industry: An Analysis

Introduction
The allocation of funds and capital to the various projects is the most important aspect of the investment decision of a firm. Criteria for investment:

type of the projects requirements of the projects return that is promised by the project life time of a project duration of the return value of the project etc.

Investment Decision Making in the Upstream Oil Industry: An Analysis

World oil supply depends upon:
investment decisions by individual companies political decisions of countries with regard to licensing

degree of foreign investment market psychology OPEC Policy unexpected events

resource availability, etc.

Investment Decision Making in the Upstream Oil Industry: An Analysis

The opportunities available for investment would depend:

investment regime, and

the risk involved.

The incentives would be in the form of: oil prices, and the rate of return

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Capabilities in Upstream Oil & Gas Industry:

The costs of this industry remain huge, regardless of whether earnings are high or low as was the case throughout most of the 1990s Refiners need to continually invest, and do so even when earnings are lower

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

Despite its importance to economic growth and market structure, the investment behavior of firms, industries, and countries remains poorly understood. Economic models have had limited success in explaining and predicting changes in investment spending Pindyck, 1991

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

The International Energy Agency estimates that through 2030 investments in oil and gas exploration and production, refining, transportation, and infrastructure, will require $9.6 trillion, averaging over $380 billion annually.

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

As existing and future supply facilities become obsolete or resources are depleted, new exploration and development will need to replace existing oil reserves, plus add significant new oil reserves.

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

A firm should seek to maximize profits, but financial forces and shareholders (banks, fund managers, etc.) may require a firm to pursue growth (reserves volume) or diversify its operations.

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

Typically, a planning horizon for oil prices is assumed and projects are evaluated on a common and consistent basis, where judgments on the risks and rewards of the projects under a variety of price scenarios and geologic, technical production, government, tax, and legal factors are considered (Seba, 2000).

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

If the capital employed in a company does not generate an adequate return, the company will have limited access to new capital because investors and lenders seek more profitable opportunities elsewhere.

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

Capital requirements in E&P compete with other segments in the petroleum industry as well as the capital needs of other industries. Uncertainty about the future price of oil and gas and global conditions impacts allocation decisions and external evaluations by bond raters and capital markets (Pirog, 2005b).

Investment Decision Making in the Upstream Oil Industry: An Analysis

Current Practice Techniques in Upstream Oil & Gas Industry:

Governments might defer investment to preserve hydrocarbon resources and revenues for future generations (Reynolds, 2005). If governments increase taxes and royalties on production, or otherwise change the terms and conditions of the fiscal regime, lower profitability of upstream projects might deter investment.

Investment Decision Making in the Upstream Oil Industry: An Analysis

Some of the current techniques used by upstream oil and gas industry are:
Decision Tree Analysis and Expected Monetary Value
Payback Period Sensitivity Analysis Discounted Cash flows Preference Theory Simulation Portfolio Theory Option Theory

Investment Decision Making in the Upstream Oil Industry: An Analysis

Conclusion
The factors which are vital for investment decision making for specifically the oil and gas industry may be summarized as below:

The Price expectations of the firm from the industry

The amount of annual cash flows expected to be

received on the investment.

The borrowing capacity which the annual cash flows can

support.

Investment Decision Making in the Upstream Oil Industry: An Analysis

Conclusion
Portfolio of opportunities The acceptable risk associated with the investment
decisions.

Other factors - supply factors, market demand,

availability and access to resources etc.