Petroleum Economics and Commerce
Commerce in GATE PE covers petroleum economics: cash-flow analysis, project valuation, and risk. The exam tests net present value (NPV), internal rate of return (IRR), payback, and basic fiscal regimes.
Core rules and concepts
- NPV = (\sum \frac{CF_t}{(1+r)^t} - I_0), where (CF_t) is net cash flow in year t, r is discount rate, and (I_0) is initial investment at t = 0.
- IRR is the discount rate that makes NPV = 0; accept projects with IRR > hurdle rate.
- Payback period uses undiscounted cash flows to find the time to recover (I_0).
- Depreciation methods: straight-line, declining balance, and MACRS (modified accelerated cost recovery system).
- Fiscal terms: royalty, corporate tax, and production-sharing contracts (PSC) affect net cash flow.
Worked example
A project requires $50 million initial investment and generates $15 million per year for 5 years. Discount rate is 12%. NPV = -50 + 15 × [(1 - (1.12)^-5) / 0.12]. Compute (1.12)^5 = 1.7623; 1/1.7623 = 0.5674; (1 - 0.5674) = 0.4326; /0.12 = 3.605; ×15 = 54.08. NPV = -50 + 54.08 = +$4.08 million. Since NPV > 0, accept the project.
Traps that cost marks
- Discounting the initial investment (it occurs at t = 0 and is not discounted).
- Mixing nominal and real cash flows with an inconsistent discount rate.
- Ignoring salvage value or working-capital recovery at the end of project life.
- Using undiscounted payback when the question asks for discounted payback.