1059PRELIMINARY EVALUATION ON A PETROLEUM EXPLORATION PROJECT IN UZBEKISTAN

TR NG IH CM TP.HCM UNIVERSITÉ LIBRE DE BRUXELLES HO CHI MINH CITY OPEN UNIVERSITY SOLVAY BRUSSELS SCHOOL MBAVB3 Dang Hong Nhat PRELIMINARY EVALUATION ON A PETROLEUM EXPLORATION PROJECT IN UZBEKISTAN MASTER PROJECT MASTER IN BUSINESS ADMINISTRATION (PART-TIME) Tutor’s Name: Student’s Name: Ho Chi Minh City (2011) Dr Nguyen Kim Thu Dang Hong Nhat i Acknowledgement First, I would like to express my deep gratitude to Dr NGUYEN KIM THU, who is my advisor for this research paper, for her kindness and willingness as well as valuable comments and advice that have enabled this accomplishment Second, I would like to send my thanks to all of our professors who have delivered priceless theoretical and practical lessons which pave the foundation for my final thesis Third, tremendous gratitude is extended to my colleagues who provided me internal data of limited publicity, without which the study shall never be realized and fulfilled Last, without the love and sacrifice of my family (my husband who is also this MBAVB3 classmate and my little daughter), I could not have completed this thesis or the whole course ii Statement of Original Authorship I certify that the substance of this thesis has not been already submitted for any degree and is not currently being submitted for any other degree I also certify that to the best of my knowledge any assistance received in preparing this thesis, and all sources used, have been acknowledged and referenced in this thesis Signed: Date: Hong Nhat iii Contents Acknowledgement i Statement of Original Authorship ii Contents iii Abstract iv Chapter Introduction 1.1 Rationale of the research study 1.2 Problem statement 1.3 Research methodology 1.4 Limitation of the research Chapter Strategy towards Oversea Investment 2.1 About PVEP 2.2 Strategy for investment overseas 2.3 Planning for 2011-2015 Period 2.3.1 Exploration 2.3.2 Field Development and Production 11 2.4 Planning for period 2016-2025 12 2.4.1 Exploration 12 2.4.2 Production 14 Chapter Project Introduction 16 3.1 About Uzbekistan 16 3.2 Project approach 18 Chapter Economics Evaluation Model 19 4.1 Methodology 19 4.2 Input data 19 4.3 Economic Evaluation 24 4.4 Sensitivity analysis 26 4.5 Potential Risks 27 Chapter Conclusion and Recommendation 28 5.1 Strategic review 28 5.2 Conclusion & Recommendation 29 References 31 iv Abstract PetroVietnam Exploration Production Corporation (PVEP) is the main force of the Vietnam Oil and Gas Group (PETROVIETNAM or “PVN”) in the upstream sector – the Group’s core businesses It is set forth in the Corporation’s development Strategies to 2015 and orientation to 2025 that investment abroad shall be reinforced to achieve the objective of reserves and to ensure sustainable development and increased oil and gas production The year 2010 witnessed a breakthrough with several remarkable events: putting into production the D30 field, block SK305 in Malaysia, PVEP’s second producing project internationally; signing the Contract for Incorporation and Administration of the Mixed company PetroMacareo, block Junin 2, Venezuela - the biggest venture ever in terms of investment value that PetroVietnam/PVEP have carried out abroad So far, PVEP has been investing in 56 projects, one third of which is located overseas as highlighted in the following map: v Such study on a potential project in Uzbekistan has been in line with the Corporation’s strategy towards expansion into the world’s oil and gas reserves With information from working trips to Uzbekistan and thanks to year long experience in exploration and exploitation at home and abroad, this thesis shall provide preliminary evaluation on the project and recommend way forward in prudent and cost effective manners The below image is an expression of the corporate pride: first success in discovery overseas (Bock - bis Well, Block 433a&416b, Algeria) Chapter 1.1 Introduction Rationale of the research study In view of the declining oil & gas reserves in Vietnam, PVEP has been expanding its exploration & production abroad Investing in a petroleum field in Uzbekistan is to follow the strategic development of PVEP set for period to 2015 and orientation to 2025 The study aims at analyzing a case study in which preliminary data have been collected regarding an opportunity to invest in Uzbekistan With knowledge gained from MBA and seven year long experience working in PVEP, I shall perform an independent analysis on whether or not to invest in the project 1.2 Problem statement Sourcing from internal database, petroleum reserve in Vietnam is estimated to be at 2,7 billion barrels With production output of 0.370 million per day, the reserve shall be adequate for consumption for 7,297 days (equal to above 20 years) Therefore, it is imperative that we go out of Vietnam to seek for replacement of reduced reserve for the purpose of long term energy security Middle Asia is one of main areas that PVEP has been targeting Therefore, such investing in Uzbekistan is considered the right way towards solving the described problem 1.3 - Research methodology Input data including financial terms in the Contract and minimum commitments, estimated production quantity, estimated cost for CAPEX, OPEX,… - Economic feasibility shall be evaluated based on main methods: Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period; - Evaluation of sensitivity of factors affecting economic feasibility of the project 1.4 - Limitation of the research All input data are collected by a working team dedicated to the project through business trips to Uzbekistan BUT not verified by another independent entity - There have been no thorough lessons learnt from failed projects of same type - Since this is a capital – intensive project and is located overseas with huge inherent uncertainty, it is critical that a more thorough and systematic risk analysis shall be further deepened Chapter 2.1 Strategy towards Oversea Investment About PVEP PVEP was established on May 4, 2007 in accordance with Decision No 1311/QDDKVN of the Management Board of PetroVietnam on the basis of merging two Members of the Group, PetroVietnam Exploration and Production Company (PVEP old) based in Ho Chi Minh City and PetroVietnam Investment Development Company (PIDC) based in Hanoi Achievements from five year planning (2006-2010) Five year period from 2006 to 2010 records successful accomplishments, namely: - New discoveries of oil and gas: 24 discoveries, in which 14 in the country and 10 abroad - Reserves Increase gained high results: (i) completed targets to increase reserves in the country; (ii) completed in excess of planned increases in oversea reserves With assistance of the Government and PVN, PVEP has been granted for investment of Junin-2 field in Venezuela; - Putting 12 new fileds into production, in which, 09 domestic fields, including: Rong Doi / Rong Doi Tay (block 11-2), Yellow Tuna (block 09-2), Eastern (block 15-2), Golden Lion (block 15-1), Doc Rivers (block 46-02), gas and oil Bunga Orkid (block PM-3 CAA), Nam Rong-renovation (block 09-3 and 09-1 ), Pearl (batch 01-02); and 03 oversea fields, including: Cendor lot PM 304, Dana mine, mine D30 batch SK 305 - Malaysia Deploying field development Northeast Black Lion, White Lion, Topaz, Stage-2 field development Dai Hung, phase-3 filed development Lan Do (block 06-1), White Rhinoceros (block 16-1), BRS Field Block 433a & 416b - Algieria; - The first production of oil and gas in foreign countries from Cendor field, Block PM-304 - Malaysia on September 2006 (to 2010 PVEP will have 03 fields from PM304 and SK 305 to be put into operation) Safe and effective production of existing fields with year production results: crude oil - 40.1 million tons, gas - 33.7 billion m3; - Revenue plan and state budget contribution completed: revenue reached 126,320 billion VND (about 7,560 million USD) Contribution to State budget reached 47,200 billion VND (about 2,840 million USD); - PVEP has been investing actively and strongly in oil and gas exploration and production in and outside the country, rapid growth both in quality (ability to manage and operate oil and gas projects) and on the number and scale of oil and gas projects at home and abroad; PVEP’s Performance Result Period 2006-2010 is generalized as below: Period 2006 – 2010 No Bil VND Description Results Plan (%) Actual Revenue 126.321 108.597 116% Donation to State budget 47.186 40.259 117% After Tax Profit 36.167 24.437 148% Investment and Costs 98.403 111.822 88% Sources: Report on PVEP’s business result of 2006-2010 period in general and of 2010 in particular (December, 2010) Project Portfolio So far, PVEP has been investing in 56 projects in Vietnam and overseas, detailed by category as follows: Categorized by 1- Location Total At home Overseas 56 38 18 17 Huge reserves of oil are found in Uzbekistan Currently it has around 600 million barrels of oil reserve New oil fields have been explored in south western Uzbekistan in places like Kokdumalak, Shurtan, Olan, Urgin and South-Tandirchi The Ustyurt plateau and the Aral Sea also have substantial oil deposits Uzbekistan natural gas reserves are estimated to be around 66.2 trillion cubic feet The largest oil reserves in Uzbekistan is located in the Ustyurt Region In total there are 52 natural gas fields Gazli, Shurtan, Pamuk, and Khauzak are the major oil fields The government is trying to rope in huge amount of foreign capital to develop these industries This will prove to be a major boost to Uzbekistan economy Joint ventures are being encouraged for setting up of oil and natural gas industry in Uzbekistan Baker and Hughes, a foreign company is investing to increase production in the North Urtabulak field The company is also trying to develop and explore new fields in Adamtash, South Kemachi and Umid fields Uzbekistan is one of the major exporters of oil The three oil refineries in Uzbekistan are located at Fergana, and AltyArik A new and a modern refinery has come up in Bukhara Russia has pumped in a lot of capital in the natural gas industry of Uzbekistan The domestic company Uzbekneflegaz has signed an agreement with Itera, a Russian company for exploration and development of new natural gas reserves Trinity Energy of Britain has invested large amount of capital in increasing production of natural gas in the country Uzbekistan is a major exporter of oil and natural gas to its neighboring countries like Kazakhstan, Kyrgyzstan, Russia, Ukraine and Tajikistan The Mubarak gas processing plant is the largest in the country Economic and political stability in Uzbekistan Despite the declared objective of transition to a market economy, Uzbekistan continues to maintain rigid economic controls, which often repel foreign investors 18 The policy of gradual, strictly controlled transition has nevertheless produced beneficial results in the form of economic recovery after 1995 However, politics in the country is considered stable and diplomatic relationship between Vietnam and Uzbekistan has been fostered which is evidenced by the MOU (Memorandum Of Understanding) signed with regards to oil & gas related investment from Vietnam between the two governments in August, 2008 3.2 - Project approach In 2009, working team of PVEP approached documentation provided by Uzbekistan government (hereinafter referred to as “State”) and has been considering investment into one block named Tossor which has gas potential - In case of making decision on investment, PVEP shall directly negotiate with Uzbekneftegas (“hereinafter referred to as UNG”) (the country’s corporation representing government’s control on oil and gas activities) instead of competitive bidding with other potential investors 19 Chapter 4.1 - Economics Evaluation Model Methodology Input data including financial terms in the Contract and minimum commitments, estimated production quantity, estimated cost for Capex, Opex,… - Economic feasibility shall be evaluated based on main methods: Net Present Value NPV@10%), Internal Return Rate (IRR), Payback Period; 4.2 Input data Details are as per Appendix I attached with the Thesis and summarized below: Capex and Opex: Cost Item Value (million USD) Geology and geophysics (*) 55,00 Development 278,95 Operation 363,00 Abandonment 34,79 Contingency 13,95 Total Cost 745,68 Basis for calculation: technical studies and surveys in surrounding areas and PVEP’s internal confidential database (*) is further detailed by the following: Financial Commitment and Expenses (as per UNG’s request) 20 The Exploration Period, during which the Exploration Works shall be undertaken, shall commence on the Effective Date and shall continue for a period of five (5) years excluding the periods of Force Majeure (“Exploration Period”) The Exploration Period shall consist of the first phase (“First Phase of the Exploration Period”) and the second phase (“Second Phase of the Exploration Period”) Detailed work and financial commitment is as follows: Phase Phase (Minimum) Phase (Additional) N o Description MINIMUM WORK PROGRAM 1 Regional and detailed 2D seismic acquisition + other related works Drilling + other related works Price per unit, USD Volume General Expenses, USD 000 700 km 600 000 000 000 well 000 0000 Subtotal OPTIONAL PROGRAM WORK Regional and detailed 2D seismic acquisition + other related works 10 600 000 000 300 km Subtotal 400 000 Total - Minimum Period (1-3 years) 13 000 000 MINIMUM WORK PROGRAM Regional and detailed 2D seismic acquisition + other related works Drilling + other related works 000 800 km 400 000 000 000 well 000 000 Subtotal OPTIONAL PROGRAM WORK Drilling + other related works 11 400 000 000 000 well 000 0000 Subtotal 000 000 Total - Additional Period (5 Years) 16 400 000 Total of the General Exploration Program Revenue Assumption: 400 000 29 400 000 21  Production Quantity: Item Applicable Volume Total Production Quantity of the project 1,329.84(Bcf) Maximum Production Quantity 200,00(MMscf/day) First year of production 140 MMscf/day Next 14 years of production 200 MMscf/day Annual th From 15 years onwards end of project production quantity shall be lowered by rate ranged from 10% or 14% per year It is estimated that there are only 350 days per year for production The remaining time is for normal maintenance of production facility (1000 MMscf = Bcf)  Gas Price: USD/MMscf It was recorded by the working team of PVEP that under all contracts in Uzbekistan gas is sold to Gazprom at 5,95 USD/ MMscf Therefore, to be on the safe side, it is priced at USD/MMscf for computation of economic feasibility Depreciation: Capex shall be depreciated at ratio of 15% annually Cost Recovery Mechanism: The procedure of approval of Recoverable Costs, adjustment of volume of Compensation Product, the amount of Hydrocarbons to be used for production, profit product sharing, adjustment in allocation of profit sharing, transfer of ownership, deduction of the Recoverable Costs shall be determined by the Product Sharing Agreement proposed by UNG 22 Cost Recovery Description Max Cost Recovery = (Revenue- Royalty Tax) x Max Cost Max Cost Recovery Recovery Ratio (65%) Cost To Be Cost To Be Recovered = Cost incurred+ Cost Un- Recovered recovered x Interest rate applied (6%) Cost Recovered = Min (Max Cost Recovery & Cost To Be Cost Recovered Recovered) Cost Not Yet Cost Not Yet Recovered= Cost To be Recovered – Cost Recovered Recovered Basis for assumption: technical studies and surveys in surrounding areas Terms and conditions in the Product Sharing Contract proposed by UNG: Item Applicable Rates Royalty Tax Rate: 30% imposed on total revenue Corporate Income Tax: 10% imposed on taxable profit Imposed on earnings to be remitted to Remittance Tax Rate: 15% home country Interest Rate: 6% to be credited to Cost- Unrecovered 65% of total revenue 50% for each party (Uzbekistan & PVEP) Maximum Cost Recovery Ratio: Sharing Ratio between State and PVEP: 0.002615 Tax on Land Use: 198 USD Per year 13 UZS/ha 0.01 USD/ha (1466 UZS= USD) 297,200 (Block Area) 23 The above is summarized as below table: Total Production Quantity Royalty Tax Cost Recovery Profit Contractor (50%) State Sharing Ratio (50%) (+) Corporate Income Tax 10% (+) (-) (-) Remittance Tax 15% Contractor State From the above (i) total cost; (ii) assumed revenue and (iii) contract terms and conditions, estimated return for the whole project is as below (detailed in Appendix II): No Item Value (million USD) Total Revenue 6,649.20 Royalty Tax 1,994.76 Total Cost 745.68 3.1 CAPEX 347.90 3.2 OPEX 363.00 3.3 Field Abandonment Cost Actual Cost Recovery Profit 34.79 827.46 3,826.98 24 5.1 PVEP share 1,913.49 5.2 State Share 1,913.49 Tax 6.1 Tax on Land Use 6.2 Corporate Income Tax 201.32 6.3 Remittance Tax 271.78 State Earnings 4,381.43 4.3 0.08 Economic Evaluation Details are as per Appendix II attached to the thesis From the above mentioned input data, the economic model using stated methodology produced below result for the project (30 years): Economic Evaluation Result NPV @ 16% (million USD) 69.16 IRR (%) 22.96% Pay Back Period (year) 9.90 NPV = Present Value (PV) of the Cash Flows discounted at IRRmin The following formula is set by PetroVietnam’s Decision No 4028/Q -DKVN dated May 12, 2010 on regulations on appraisal of oil and gas projects: (*) IRRmin = WACC +I + Re +Ro = Wd*Kd*(1-T) +We*Ke+ I + Re +Ro Item Description 2.5% (Average inflation rate through 10 past years is 2.38%) I: Inflation rate (I) 2000: 3.4 2001: 2.8 2002: 1.6 2003: 2.3 2004: 2.7 2005: 3.4 25 2006: 3.2 2007: 2.8 2009: - 0.4 2010: 1.6 2008: 3.8 (Source: www.usinflationcalculator.com/inflation/historical-inflation-rates) Re: Risk in petroleum 3% exploration and (Article 8– Risk in petroleum exploration and exploitation exploitation activities activities undertaken in favorable areas) Ro: Risk in investment environment 2% (Article 10- Applicable for areas like Uzbekistan (2%) Wd, Kd, We, Ke - Wd: Percentage of debt over total investment capital: 0% (Reason: Exploration projects are not entitled to enjoy loans) WACC= Wd*Kd(1- - Kd: Cost of Debt (Not Applicable) - We: Percentage of equity over total investment capital: 100% T)+We*Ke (Weighted Average - Ke: Cost of Equity: 8.5% (as per Financing Agreement between PVN and PVEP and Cost of Capital) PetroVietnam Financial Corporation (PVFC): PVEP’s equity shall be financed to exploration project at cost of 8.5% - T: Corporate Tax Rate (Not Applicable)  WACC= 100% x 8.5% = 8.5% IRRmin = WACC+I+Re+Ro IRRmin = 8.5% + 2.5% + 3% + 2% = 16% Conclusion: with preliminary data, the result showed that the project is economically feasible with NPV@16% valued at USD 69.16 million and IRR at 22,96% 26 4.4 Sensitivity analysis Below tables show that gas price (uncontrollable factor) puts greatest influence on project’s economic feasibility (NPV and IRR) Capex is ranked second in the influence Therefore, efforts to reduce Capex shall bring out higher returns to the project Influences of Capex-Opex-Gas Price over NPV 140.00 120.00 100.00 NPV (Million USD) 80.00 60.00 40.00 20.00 - 70% 90% Opex Capex 110% 130% Gas Price Influences of Capex-Opex-Gas Price over IRR 30.00% 25.00% 20.00% IRR (%) 15.00% 10.00% 5.00% 0.00% 70% 90% Capex Opex 110% Gas Price 130% 27 4.5 Potential Risks Projects in hydrocarbon exploration phase are highly risky From a forward-looking point of view, some risks in this project are identified as follows: - Geological uncertainty with respect to structure, reservoir seal…: technical study both through documentations and fieldwork provided gas output figures of the project which enormously affect economic feasibility The geological conclusions are normally made by rule of thumb of highly experienced specialists Financially, as per minimum work to be committed with the State, PVEP shall carry out first exploration phase with total cost from USD 13 million to USD 29,4 million Therefore, in worst scenario that the exploration phase fails, the loss shall be in that range - The economic evaluations contain so many uncertainties related to Capex and Opex, probability of finding and producing economically viable reservoirs The costs (Capex and Opex) are variables depending on Uzbekistan’s service market (the market with restricted entry of service provider shall cause higher costs for the project) - Political and legal risks in terms of changing regulations are also areas of concerns which shall be lessened to the maximum during negotiation of the PSC Recently, accompanied with other economic reasons, PVEP’s project in Tunisia is going to be closed down, partly due to chaos The project in Algeria is always in threat from bombing activities in the country - If the exploration phase is successful, the development and production stages embody a high level of uncertainties in relation to their critical variables (infrastructure, production schedule, quality of oil, operational costs, reservoir characteristics, etc.) These uncertainties originated from geological models and coupled with economic and engineering models involve high-risk decision scenarios, with no guarantee of successfully discovering and developing hydrocarbons 28 Chapter 5.1 Conclusion and Recommendation Strategic review It is evident that that oil and gas investment overseas is a prominent trend in the world today For example, Chinese National Oil Companies (NOC) have been exploring the possibility of acquiring foreign assets since 1993 and has been more and more aggressive, either through corporate acquisitions or bidding rounds China is a success story with overseas production volume accounted for 25% of China's total crude oil imports and net oil production abroad is expected to reach 1.2 million b/d in 2010 The Chinese government’s resource diplomacy drive is helping its NOCs to acquire high-potential assets, particular in Africa, where the need for development is most urgent The Chinese government is also promoting measures to ensure energy security without necessarily involving the NOCs, for instance through the China Petroleum Investment Fund, which was established to pursue an "Equity for Oil” initiative The concept is that foreign enterprises holding foreign oil resources or oil field owners may launch equity-bound JVs with oil shares due to Chinese enterprises and a certain amount of cash PETRONAS (National Oil Company of Petronas) tends to share investment risks and therefore favors partnerships Its choice of partners demonstrates a preference for major IOCs although it has a decade long experience of working with Chinese companies and is now increasingly partnering with NOCs from the producing countries in which it is operating for investment in third countries Out of its total 62 ventures, PETRONAS is the operator in 30 of these, joint operator in 13 and active partner in the remaining 23 Vietnam’s strategy for the “go-out” tends to favour operatorship Particularly, out of 18 projects overseas, nine (09) projects are wholly operated by PVEP; four (04) projects are jointly operated and five (05) projects are financially funded only (not directly participating in the project 29 operation) Moreover, PVEP tends to invest in exploration phased project Such strategy is therefore, characterized by capital- intensive requirements and incurs extremely high risks due to the nature of exploration with huge unknown uncertainty Consequently, according to source from Dau Tu Newspaper, it was admitted by the Vietnam Oil and Gas Group (PVN) that revenues and profits of the overseas investment projects are not commensurate with the invested capital PVN has invested $1.056 billion into overseas projects and over $31 million have been repatriated Actually, of the 18 ongoing oversea projects, PVEP is in progress to stop and end some projects (for example in Tunisia, Cuba, ) Despite the fact that investing in oil and gas field takes long time from exploration to exploitation for investment return but under the context of stressful financial pressure and tougher external investment environment, the “go-out” strategy is to be further considered towards either concentrating on domestic market or diversifying investment portfolio overseas (i.e to increase number of development and production phased and field purchase projects which are less risky than exploration – phased projects) 5.2 Conclusion & Recommendation From the above analysis in Charter 4, with preliminary data, it can be preliminarily concluded that the project is economically feasible However, it is recommended that further in-depth steps should be taken before final decision to be made: Setting up an internal appraisal committee or external international consultancy to verify all input data and to advise on final decision to be made by PVEP Negotiation with UNG for more favorable terms and conditions of the Petroleum Sharing Contract, for example oil profit sharing ratio, preferential taxation regime for PVEP 30 Negotiation with Gazprom on gas sales contract in order to reach gas price higher than 5USD/mcf because gas price is evaluated as the most sensitive factor that affects Net Present Value of the project Technical study on several more scenarios of other reserves in the field in order to analyze economical feasibility of the project on larger scale Calling for partnership with other foreign oil companies to ease the burden of financing and for experience sharing purpose Final decision making should be made in consideration of the Corporation’s financial and human resources and in comparison with economic effectiveness of other projects, particularly those at home Last but not least, study and acquaintance with culture of Uzbekistan shall make the project smoother and more effective 31 References  National energy strategy of Vietnam to 2025 implementation plan, vision to 2050" by PVN (August/2008);  Report on PVEP’s business result of 2006-2010 period in general and of 2010 in particular (December, 2010);  Report on working results in Uzbekistan;  PetroVietnam’s Decision No 4028/Q -DKVN dated May 12, 2010 on regulations on appraisal of oil and gas projects;  Internal confidential database; Websites:  http://vietnambusiness.asia/vietnam%E2%80%99s-overseas-investmentsreach-nearly-1b/  http://vietnambusiness.asia/overseas-investment-efficiency-is-not-assatisfactory-as-expected/  http://www.nbr.org/publications/asia_policy/Preview/AP5_ChinaOil_preview pdf  http://www.ciooe.com.cn/en/html/content_194.html  http://www.ca-c.org/journal/eng-03-2000/20.khafizL.shtml