Petroleum Economics, Risk and Project Management
Petroleum Economics, Risk and Project Management tests cash-flow valuation, fiscal terms, uncertainty, and decision quality. Expect NPV, IRR, payback, expected monetary value, sensitivity, and project risk.
Core rules
- NPV discounts cash flow at the WACC or hurdle rate. Accept positive-NPV projects and rank mutually exclusive projects by NPV.
- IRR is the discount rate that makes NPV zero. It can mislead with nonconventional cash flows or projects of different scale.
- EMV = sum of probability × outcome. It is a risked value, not a guarantee.
- Fiscal regimes include royalty, tax, production sharing, and cost recovery. Cash-flow timing changes value.
- Sensitivity or tornado analysis shows which variable drives NPV. Project management uses stage gates and contingency.
Worked example
A project has capex 100 MM at t0 and net cash flow 30 MM/yr for five years at a 10% discount rate. The annuity factor is (1 - 1.1^-5)/0.1 = 3.7908. PV of cash flow is 30 × 3.7908 = 113.72 MM, so NPV = 113.72 - 100 = 13.72 MM. Capex is not discounted because it occurs at t0; if it were spread over time, each year would be discounted separately.
Traps
Discounting t0, mixing nominal cash flow with a real discount rate, or including sunk costs will misstate NPV. Do not rank projects by IRR when scale differs. EMV does not capture risk tolerance, and a positive EMV can still be a poor decision if downside risk is unacceptable.
Key points
- NPV uses discounted cash flow at the hurdle rate.
- IRR can mislead for nonconventional or different-scale projects.
- EMV = probability × outcome summed over cases.
- Fiscal terms and timing affect project value.
- Sensitivity identifies the dominant value driver.