25 Core Principles of Petroleum Economics

 

1. Petroleum projects are capital intensive and high risk

Large upfront investments with long payout periods define the industry.

2. Cash flow is the central decision variable

Project evaluation is based on projected cash inflows and outflows over time.

3. Time value of money is fundamental

Money today is worth more than money in the future.

4. Discounting converts future cash flows into present value

Future revenues and costs must be discounted to a common base year.

5. Net Present Value (NPV) is the primary decision criterion

Projects are acceptable if NPV > 0 at the required discount rate.

6. Internal Rate of Return (IRR) measures project yield

IRR is compared to the hurdle rate to determine viability.

7. Payback period ignores time value beyond recovery

Useful but limited indicator of capital recovery speed.

8. Nominal vs real cash flows must be treated consistently

Inflation handling must match discount rate basis.

9. Fiscal regimes determine government take

Taxation structure significantly affects project value.

10. Royalty systems deduct revenue before profit

Royalty reduces gross revenue regardless of profitability.

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11. Production Sharing Contracts (PSC) allocate cost recovery and profit oil

Economic rent distribution depends on contract structure.

12. Ring fencing limits cost offset between projects

Taxable income may be restricted within project boundaries.

13. Depreciation affects taxable income

Capital recovery mechanisms influence project cash flow timing.

14. Economic limit defines field abandonment timing

Production stops when operating revenue equals operating cost.

15. Reserves classification affects economic assessment

Different reserve categories carry different uncertainty levels.

16. Risk arises from geological, technical, economic, and fiscal uncertainty

Petroleum economics integrates multiple uncertainty dimensions.

17. Expected value combines probability and outcome

Used in exploration and decision tree analysis.

18. Decision trees structure sequential decisions

They model uncertainty and alternative pathways.

19. Portfolio effects reduce overall risk

Combining prospects alters expected value and variance.

20. Sensitivity analysis identifies key value drivers

Examines impact of single-variable changes on NPV.

21. Break-even analysis identifies critical thresholds

Determines minimum price or production for viability.

22. Cost estimation accuracy affects economic reliability

Early-stage projects carry greater uncertainty.

23. Abandonment liabilities must be included in evaluation

Late-life costs affect overall project value.

24. Economic rent is the surplus after required return

Fiscal systems aim to capture part of this surplus.

25. Investment decisions require integration of technical and financial analysis

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Petroleum economics bridges engineering and finance.