W3.1_AEP_Applying economic evaluation and decision tree analysis to complete the workover job


Problem identification

In order to fulfill gas supply commitment in accordance to sales agreement with PT PLN, a suspended gas exploration well was proposed to be put on production. With a gas price plot in the sales agreement at $6 per MBTU, the gas at amount of 1500 mmscf was expected to be produced in 3 years. Presume an investment cost at $750 thousands and annual operation cost at $700 thousands give the contractor’s take an IRR of 142% and NPV $1.5 million. (PSC gas share for government/contractor is 70/30 from net revenue, while the MARR for oil and gas investment is set 20%).

From the previous measurement, the potential zone called X255 was identified as damaged. Another potential layers were proposed to be perforated. Workover job has brought the new layers as water producing with a very small gas show. As alternative to the bad result, the contractor proposes additional effort to reopen the X255 zone with the probability of 0.6. The cost has already run at S1 million (over 33% from its original AFE $750 thousands) and additional efforts will require another $500-$700 thousands to the budget. Termination of the job will cost a penalty at $500 thousands.

The feasible alternatives

Technical evaluation using activity based cost to reopen X255 zone estimates an additional budget at $500 thousands. Other $200 thousands is considered to put on the budget as a contingency which probability is 0.3. Completion will also bear the risk of fail at the probability of 0.4.

Based on this information, an alternative is to terminate the job to avoid bigger lost than the investment cost plus penalty to the buyer. Another alternative is to continue the completion job since the expected gross revenue can recover all the investment costs within the first year. This alternative consists of three considering: succeed as plan, succeed with contingency, and the worst is fail to deliver. These considering can be calculate using probabilistic method.

Development of the prospective outcomes

The net cash flow approach is used to develop outcomes from each alternative. Economical evaluation will be determining the new IRR and new NPV. The difference between IRR and the MARR is the measurement of investment safety. At the end a decision tree is combined with the method to help us recommend either to continue with the proposal or to terminate the job.

Selection of Decision Criterion

IRR Decision Rule: If IRR ≥ MARR, the project is economically justified.

Decision tree analysis uses the present worth or NPV approach and probability in which calculation with the highest result as the preferred alternative.

Analysis and comparison of alternatives

The cash flow, NPV and IRR evaluation comes with the result as the table below:

w3_1

The tables below summarized the economical evaluation using NPV and IRR.

w3_2

Continuing the job will be preferred as the IRR is still above the MARR and the lost is lesser than if the job is terminated.

Since continuing the job still bear the risk of fail at the probability of 0.4, we use decision tree to support the preferred alternative. Decision tree analysis uses the present worth or NPV approach as shown as below.

w3_3

Selection of the preferred alternative

The expected PW (EPW) of completion which is negative but bigger than the EPW of termination shows that to complete the job also minimize the lost of the overall project. The analysis indicates that continue to complete the workover job is economically preferable to the termination.

Postevaluation

The risk of fail in completing the job recommends the contractor to apply best engineering practices. Close supervision is required to have the job deliver on schedule and safe.

References

Decision Tree Analysis – Decision Skills from MindTools.com. Retrieved September 16, 2013, from http://www.mindtools.com/dectree.html

Lubiantara, B. (2012). Ekonomi migas: Tinjauan aspek komersial kontrak migas. A. F. Susanto (Ed.). Jakarta: Gramedia Widiasarana Indonesia (Grasindo).

Middleton, M. (2008). TreePlan for Decision Trees, SensIt for Sensitivity Analysis, and RiskSim for Monte Carlo Simulation. Retrieved from http://www.treeplan.com/

Partowidagdo, W. (2009). Migas dan energi di Indonesia: Permasalahan dan analisis kebijakan. Bandung: Development Studies Foundation.

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). Chapter 5 / Evaluating a single project. In Engineering economy (15th ed., pp. 194-205). Boston, MA: Prentice Hall.

Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012). Chapter 12 / Probabilistic risk analysis. In Engineering economy (15th ed., pp. 506-511). Boston, MA: Prentice Hall.

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4 Comments

Filed under Afriandi EP, Week 03

4 responses to “W3.1_AEP_Applying economic evaluation and decision tree analysis to complete the workover job

  1. Ahhhh…….!!!! That’s more like it, Pak Andi!!!! Don’t make this same mistake again!!! At least for the next 10 – 12 weeks, follow this step by step process…….

    After I am comfortable that everyone has mastered it, THEN I will open it up to “free style” or other outline models.

    Keep up the good work and leadership from the front!!!

    BR,
    Dr. PDG, Jakarta

    • Grazie mille, Signore!
      can i claim this blog for methods to solve problems in chapter 5 and chapter 12 engineering economy?

      andi

      • Yes, IF you have listed them specifically in your citations then you can claim one problem for each tool and technique you use. So if you use two tools/techniques in one blog posting, it is possible to claim your two problems in one blog posting.

        Make sense?

      • grazie signore!
        it makes sense ت

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