petroleum economics experts

petroleum economics experts

The Economics of Petroleum: Key Concepts and Analysis

1. Introduction to Petroleum Economics

The economic analysis utilized in the field of petroleum production is under the conditions of uncertainty or risk. Various methods are used to estimate the profitability of costly oil investment projects, such as the internal rate of return and net present value calculations. The methods used to reduce income tax liabilities, account for escalating project costs, and account for the time value of money are also described.

In simple terms, it refers to the utilization of economic analysis methods applied to petroleum production problems. For example, a particularly important problem facing a petroleum company is the investment decision of choosing whether or not to explore for, develop, and produce oil from a particular area in the world. The practices of petroleum economics are particularly important in this example because the decision facing the firm is physically large, time-consuming, and extremely complicated. Also, the size of the expenditures for exploring, developing, and producing oil is typically in the millions or tens of millions of dollars. In other cases not particularly concerned with investment decisions, the long-range plans of the petroleum company concerning their overall mix of oil-drilling activities and expenditures should also be welcomed.

2. Key Factors Affecting Petroleum Prices

The primary economic factor affecting the demand for petroleum products at any time is the level of real income. The level of commercial activity or real gross national product is highly correlated with the demand for all goods and services in general, and the demand for particular products such as gasoline, diesel fuel, and aviation fuel. In the United States, the demand for gasoline has increased at a compound annual rate of 2.0% per year from 1964 to 1979. The demand for diesel and aviation fuels is very closely tied to the level of general economic activity and is one of the most cyclical components of the petroleum products demand.

The use of energy is said to be “post-cyclical,” which simply means that it lags the condition of the economy – it does not fluctuate in concert with the level of economic activity. Thus, as the economic level has bounced back, so too has the demand for energy, specifically in the form of crude oil and petroleum products. This effect has been studied, particularly in the United States. As one might expect, the demand for petroleum products is highly correlated with changes in price. The demand for gasoline, and to a lesser extent diesel and aviation fuel, has been extremely price sensitive. When the price of gasoline is decreased, the demand for gasoline increases rapidly. The motorist opts for optional trips and increases his total mileage until the previous pattern of consumption is resumed. The ratio of the percentage change in quantity consumed to the percentage change in the price is called the price statistics.

3. Economic Analysis of Petroleum Production and Exploration

This chapter considers the production and exploration aspects of the petroleum industry. The early sections describe the geological structure of petroleum deposits and the methods for transforming the petroleum deposits into income streams, and then show how the nature of the geological endowment determines the cost structure of the industry. The measurement of production performance is then considered.

After setting the stage with a description of the geological environment in which petroleum is found, we discuss the general characteristics of oil and gas development, and the cost structures of these businesses. The nature of profitability in a depleting resource industry is then considered. With this background knowledge, we review the systems in use in various countries for allocating rights to explore for, and produce, petroleum, and the ways in which institutions form, over time, due to political economy pressures on the resource, and design choices made by the owners. Finally, the nature and general performance of petroleum cartels are discussed. While the OPEC cartel has provided substantial profits for its members at times, modifications in the demand for and supply of petroleum have resulted in aggressive and ultimately unsuccessful price wars for global market share.

4. Government Policies and Regulations in the Petroleum Industry

The petroleum industry is characterized by complex government regulations and policies at all stages of production, transportation, distribution, and consumption. The purpose and extent of government intervention in the industry continue to be a central issue among political leaders, industry officials, consumers, and students of the industry. These policies and regulations can range from an attempt to influence production or consumption, to a concern with the flow of direct and indirect benefits of the industry. Policymaking is complicated by the fact that what is good for the industry overall is not necessarily consistent with national economic goals such as efficiency, growth, and distribution, nor social or other political goals. Furthermore, different countries have different policy objectives and use widely differing policies to try to reach their objectives.

All of this government regulation affects the behavior of individual firms within the industry and therefore has important incidence and distributional effects. These effects are influenced not only by the policy tools employed, but also by the specific institutions of government that enact and execute industry policy.

5. Case Studies and Future Trends in Petroleum Economics

In this final section, we discuss various case studies concerning petroleum investment, development, and operations that are typical of the economics encountered by the petroleum industry in Canada. We have also included various future trends in petroleum economics and the associated challenges that may be encountered in Canadian petroleum developments.

In general, feasibility work for any petroleum project forms an industry segment adhering to project finance principles. For the strict project financing case, analysis is undertaken to determine project asset and revenue risks in addition to operating risks. The conclusion of these analyses passes through to the location of the investment on the industry scale of risk rates.

Because of the specific features of petroleum properties as lease-lend operations, the emphasis in financial matters with them shifts. True project financing requires a PUD class of operation and has not been the associated flow-cost determination. The major economic decision to be made is over the timing of development. If the development plan is postponed, it has the effect of managing operating costs, but it holds out for a higher oil price. The decision point is made to render an after-corporation regularized rate of return below the expectations in current high-interest markets. This phenomenon in the past led to the rapid development of “marginal” wells when tax policy would become current through secure cash actions taken place.