Impact of Financial Assumptions on Economic Viability of Incremental Projects

Abstract

Commerciality assessment and reserves booking is an important task, routinely performed by every oil and gas company. The task is performed based on the guidelines presented in the Petroleum Resources Management System (PRMS). The PRMS, revised in 2018, is a system developed for consistent and reliable definition, classification, and estimation of hydrocarbon resources. The document was prepared by the Oil and Gas Reserves Committee under the auspices of the Society of Petroleum Engineers. The PRMS has been broadly adopted by the oil and gas industry as an international standard reference for the classification and categorization of oil and gas reserves and resources. The objective of this paper is to reiterate the well-known knowledge regarding the economic viability, economic limit, sunk cost, depreciation, incremental project vs. entity’s economics, economic contingency, and technical contingency in a simple, unambiguous, and concise manner. The paper emphasizes using only discounted cash flows in all economic evaluations whether it is for reserves booking or investment decision-making. It is unfortunate that this well-known knowledge is incorrectly described and used in the industry for commerciality assessment of oil and gas resources and investment decision-making. The paper also shows that some of the financial assumptions and definitions such as financing at the incremental project level, properly accounting for sunk cost, and treatment of income tax when an entity has positive taxable income, if applied correctly, can greatly and legally enhance the chances of commerciality and reserves booking.