Main Factors Impacting Oil Projects Return: A Sensitivity Analysis

Performing robust economic valuation is critical to ensure success on oil development projects. In a dynamic market with ever changing variables, risks and uncertainties must be well analyzed and mitigated to prevent less than expected economic returns in mega-projects such as an offshore deep-water oil field development. This study aims to evaluate what are the most important factors that should be considered when assessing risks in a project economic valuation, using Brazil’s Production Sharing Contract (PSC) fiscal system as an example. A sensitivity analysis was performed in a standard offshore oil production project using the discounted cash flow method. First, a base scenario was calculated, and then, four key assumptions were chosen to be tested – oil prices, capital expenses (capex), operational expenses (opex) and recoverable reserves - and changes of + and - 20% in each, one at a time, were applied to the base scenario, and their impact on the internal rate of return and government take were measured. Findings indicate that, at least in the Brazilian PSC case, oil price is the most influential parameter in the project profitability, presenting an almost perfect positive correlation with the rate of return. Oil price is also the most difficult assumption to project and the one that is completely out of companies’ control, which poses them a significant challenge, to be able to keep its projects economical under volatile prices. Main investment decision gates happen years before first oil is produced, so the level of uncertainty on this parameter is very high. This study reinforces the concept that a good oil price forecast is paramount in projects valuation. Additionally, companies should always make investment decisions based on multiple oil price scenarios to determine the project’s financial risk.