Month: October 2010

In countries where there is significant production by investors the state can decide whether to allow the investor to offset the cost of incremental exploration and development work against the taxable income being generated by the producing fields. Thus it is very important to establish the entity that is liable to tax and/or other fiscal terms and this is known as the “ring fence”. Most fiscal terms are levied on all activity within a concession or contract area, i.e. all costs incurred in the area may be offset against any income generated in the area.

Some regimes allow investor’s to consolidate all or some of their contract areas so costs incurred in one field may be offset against income generated in another. Others are less benign and impose a ring fence around the producing field so that only costs associated with the field can be deducted from the income generated by the field. When a fiscal ring fence is drawn around each field, new fields start predictably at the bottom of the R Factor scale. The wider the ring fence and the higher the marginal rate of State Take, the higher the share of risk the state will be taking in the project. As this is somewhat contrary to the state’s perceived role, it will normally try and keep tight ring fences around producing fields but in mature areas, where discoveries are getting smaller and the potential rewards lower, investors argue very strongly for ring fences to be broadened so that they can restore positive EMV and continue exploration.

A guide for oil and gas companies as to whether it is worth investing in trying to discover hydrocarbons in a particular regime. The result of dividing ValueSuccess by CostExploration. When exploring in a frontier basin, it is not uncommon to seek exploration cover ratios of 10 and more profit to investment ratio of development – a measure of the capital efficiency and therefore a guide to where a company should direct its capital

One of the commonest ways of measuring the value expected to be created through an exploration program is to calculate the expected monetary value of the exploration prospects covered by the program. In its simplest form, this can be calculated as:

EMV = ValueSuccess x ProbabilitySuccess – CostExploration x ProbabilityFailure

At the exploration stage the investor is interested in its expected value from the project – i.e. the balance between the risk (that it incurs the costs and fails to make a discovery) and reward (the After Take NPV from a successful development).

This is known as Expected Monetary Value (EMV) and a simple example of the calculation is given below:

Probability of success = 20%; NPV @12.5% = 100; Probability of failure = 80%; Cost of failure = (20); EMV = 4

EMV = (Probability of Success x NPV @ 12.5%)-(Probability of Failure x Cost of Failure)