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Saturday, September 17, 2011

Oil & Gas Industry-some interesting finance points

For a business plan competition recently, I chose to read the internal audit guides for both upstream(  and downstream( They are worth reading in their entirety for for their lucidity and glossary, so it would be time well spent. Some observations are below
  • Paying for information:- The owner of a well benefits by greater information when oil reserves are proven in the adjacent field. Hence, there is practice by that owner to pay bottom hole contribution to encourage the drilling of a well to help in evaluation of his own acreage or a payment made to ensure information about the result of a well drilled by another oil company. It is paid on reaching XYZ depth. Dry hole contribution is similar, but paid only when the well is proven to be dry(useless!)
  • Depletion/Depreciation/Amortization(DD&A): Probably the clearest explanation of the difference. Depletion relates to the reservoir, depreciation to the capitalised assets and amortisation to the cost of the license interest. This distinction is important during financial projections. 
  • Impairment testing asset group-field:- Impairment accounting tests often face the difficult question to determine whether assets are truly independent or not. Oil fields may consist of single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. Hence, determining the group of assets of challenging in this case
Other general observations are about the importance of certain key financial management areas. For instance,
  • Refinery output mixes can be infinite, hence a proper LPP design is needed to optimize product mix. Reliance apparently uses 10,000+ variables in its LPP for Jamnagar refinery. 
  • The transport cost can be vital, and lead to savings at the retail level, so managing that is crucial. 
  • Given the large gap between cost incurrence and flow of revenues, the risk of assets turning bad('impairment') is quite high, for both operational and economic reasons(just becoming unviable at present lower oil and gas rates). Hence, one needs an asset level MIS to run that calculation
  • Capital budgeting needs to be top key, because the amount to bid for in a competitive scenario would not only depend on outside rates, but also one's confidence in forecasting abilities, which can only come from an objective record and evaluation of corporate level forecasting records

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