Theoilsector
Theoilsector
Theoilsector
find
extract
refine and
sell
o oil and gas,
o refined products
o and related products.
QUESTION
What area of operation are you involved in and what
are the major features of your activity ?
Major Features of the Oil & Gas sector
the
the risks
o Exploration is costly yet not always certain to produce results
o Environmental conditions are hazardous for those involved
and the environment with large penalties for damaged
caused (ask BP)
o Business - competition etc
o Financial – CAPEX (NPV) is difficult to assess given the
uncertainty, technical feasibility, capital involved and long
lead times not to mention the ever-changing macro-
economic factors (discussed below)
QUESTION
What are the macro-economic factors ?
The Macroeconomic Factors
Commodity Prices
Growth/Recession - Demand
Currency Fluctuations
Inflation
QUESTION
What are the current prices/rates and how exposed
and your companies to these risks ?
Commodity Prices www.ft.com/commodities
1 Year
Time period
Commodity performance
Brent Crude Oil
View
FTSE 100
Compare to
5 days
Time period
The Oil/Sale price required per barrel to cover Total Costs and
The Oil/Sale price per barrel required to balance the Fiscal Budget
of the country
Margin of Safety =
According to Carnegie many countries in the Middle East have used oil
profits to ease “Arab Spring” tensions by financing public programs.
QUESTION
Which are your major markets and what risks do
they involve?
Currency Fluctuations
ACTIVITY
If Today a barrel of oil costs $100 and the
exchange rate is £1 = $1.50 calculate the impact of
the following possible future scenarios:
The increased cost of oil has been offset by the appreciation of the
£/depreciation of the $ v £.
The reduced cost of oil has been lost due to the depreciation of the
£/appreciation of the $ v £
QUESTION
What should UK Oil Companies do and what do your
company do to overcome Exchange Rate and Oil Price
Risk ?
Managing Exchange Rate and Oil Price Risk
This typically see the most dramatic fluctuations due to the spot price of
the commodities.
Hedge
UK Base Rate
QUESTION
What are the Interest Rates in your country and
given the significant capital required in the sector
what risks do you face if you borrow on a Floating
Rate ?
Inflation
The cost of living in Britain has jumped by the biggest amount in three years, figures have
showed, as the CPI rate of inflation soared above forecasts to 5.2%.
Hefty rises in gas and electricity bills last month drove the inflation increase, the Office for
National Statistics said.
The CPI rate of 5.2% now equals the high reached in September 2008, and was a large jump
from August's rate of 4.5%.
Meanwhile, annual RPI inflation, which also includes housing costs, reached 5.6% last month
- the highest it has been since June 1991.
It adds further pressure to Britons' living standards, as wage rises fail to keep pace with
higher basic living costs.
However, it is better news for those on state benefits, as September's CPI rate is used to
determine next April's rise in payments.
Next year's benefit rates are not formally unveiled until later this year, but the basic single
state pension is set to increase by £5.31 to £107.46 a week, while the joint state pension will
increase by £8.49 to £171.84.
Jobseeker's allowance is set to increase by £3.51 to £71.01 a week based on the 5.2% rise.
Although the CPI rate has now never been higher since the measure began in 1997, it was
expected by the Bank of England.
It had forecast inflation to rise to 5% this year, before falling back below its target of 2% next
year.
As he gives a keynote speech in Liverpool tonight, the bank's governor Sir Mervyn King is
expected to defend the BoE's decision to leave the interest rate at 0.5% and pump more cash
into the economy at a time when inflation is so high.
1.2 Costs in Acquisition, Exploration, Development and
Production of new oil or natural gas reserves
Acquisition
o costs are incurred in the course of acquiring the rights to
explore, develop and produce oil or natural gas.
Development
Production
ACTIVITY
Make a list of the major costs incurred at each
stage
Acquisition Costs
Drilling Costs
Intangible Costs - those incurred to make the site ready prior to the
installation of the drilling equipment
Defines it as:
Exploration for and evaluation of mineral resources mean the search for
mineral resources, including minerals, oil, natural gas and similar non-
regenerative resources after the entity has obtained legal rights to explore in a
specific area, as well as the determination of the technical feasibility and
commercial viability of extracting the mineral resource. [IFRS 6.Appendix A]
Exploration and evaluation expenditures are expenditures incurred in
connection with the exploration and evaluation of mineral resources before
the technical feasibility and commercial viability of extracting a mineral
resource is demonstrable. [IFRS 6.Appendix A]
Development Costs
Production Costs
The costs incurred in extracting oil or natural gas from the reserves are
considered production costs.
Exploration Costs
SE Method:
All intangible costs will be charged to the Income Statement as
part of that period's operating expenses for a company.
All tangible drilling costs associated with the successful
discovery of new reserves will be capitalized
All tangible drilling costs incurred in an unsuccessful effort are
added to operating expenses for that period.
Full Cost
All exploration costs - including both tangible and intangible
drilling costs - are capitalized by being added to the balance
sheet as part of long-term assets.
This is because like the lathes, presses and other machinery used by a
manufacturing concern, oil and natural gas reserves are considered
productive assets for an oil and gas company; Generally Accepted
Accounting Principles (GAAP) require that the costs to acquire those
assets be charged against revenues as the assets are used.
Development Costs
Production Costs
Acquisition – capitalise
Exploration
o SE capitalise successful ONLY;
o FC capitalise ALL
Development - capitalise
Production - expense
1.4 An Introduction/Overview of IFRS in relation to the Oil &
Gas Sector, with particular reference to:
Introduction
In late August 2008, the Securities and Exchange Commission (SEC)
announced that it would issue a proposed IFRS roadmap” that would
include a timetable and appropriate milestones for mandatory transition
to IFRS starting for the years ending on or after December 15 th, 2014.
QUESTION
Where are your company on the Roadmap for
conversion/introduction of IFRS ?
ACTIVITY
In groups select one of the above IFRS and present
an outline of the major features and how impact on
your company.