W3_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 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. Economical evaluation will be determining the new IRR and NPV. A decision tree will help us recommend either to continue with the proposal or to terminate the job.

Economic evaluation

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

With “IRR Decision Rule: If IRR ≥ MARR, the project is economically justified”, continue the job will be preferred as the IRR is still above the MARR and the lost is lesser than if the job is terminated.

Decision Tree Analysis

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 (PW) or NPV approach as shown as below.

w3_3

Conclusion

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.

Pay for attention

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

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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3 Comments

Filed under Afriandi EP, Week 03

3 responses to “W3_AEP_Applying economic evaluation and decision tree analysis to complete the workover job

  1. Sorry Pak Andi, but although your case study is a very good one and you did a great job on your citations, unfortunately you did not follow the 7 step process, so I have no choice but to REJECT this weeks posting.

    IF you want to PASS the very difficult “Part 2” (case study narrative answer) on your AACE exams you MUST master the use of this 7 step process. If you DON’T master it, then you risk FAILING this part of your exam.

    So I really hate to have you do this over, but until you demonstrate to me that you have mastered this approach, I expect you to follow it EXACTLY as shown on page 7, Figure 1-1 from Engineering Economy.

    BR,
    Dr. PDG, Jakarta

  2. PS Please REPOST as W3.1…..

  3. done it, sir!
    thank you for the correction 🙂

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