Assignment Task:

Report
This component requires the financial analysis and development of suitable models to address specific tasks highlighted for an oil and gas investment case (see Appendix 1). Write a single report, together with any accompanying spreadsheet models or supporting information. Reports should be around 3,000 words (+/- 10%). The group report should show all workings, including assumptions, methodology, and discussion of results and conclusions. Where assumptions or discussions draw on concepts in the literature, empirical evidence or other materials, proper citation and references to sources used should be provided. Report marks for each task include consideration for style, presentation, structure and appropriate use of sources and references. 
APPENDIX 1: OIL AND GAS PROJECT EVALUATION 
Case Description 
Groeder Oil and Gas Plc (GOGP) is a listed company operating in the United Kingdom Continental Shelf (UKCS). Due to dwindling fortunes in the UKCS, GOGP has decided to seek new prospects and opportunities in Venezuela. Following protracted political and economic upheaval, Venezuela is keen to create the right environment to attract foreign investment to help exploit its vast mineral resources, including oil and gas. Consequently, mandated by the government under new enabling laws, the Venezuelan national oil company, Petro?leos de Venezuela, S.A. (PDVSA), has undertaken a review of the country’s fiscal regime and has divided the country’s previously unexploited offshore prospects in the East Venezuelan Basin Province into several oil blocks/properties and sold rights to them to prospective investors. It is believed that these properties are of lesser prospectivity than the onshore Orinoco Oil Belt, but the revised fiscal regime provides suitable incentives to attract investors. However, investors must develop acquired blocks within 5 years or risk forfeiting their license. 
GOGP has acquired the license relating to Block-66a, which is an oilfield situated in the central belt of the total offshore area, where commercial reserves have been discovered in the past. Following exploration and appraisal, GOGP’s and PDVSA’s technical departments have confirmed reserves (proven) of about 72 million barrels of recoverable oil, with a gas-oil ratio (GOR) of 2000 cubic feet of gas per barrel (i.e., 2 Kcf/barrel). So far, GOGP and PDVSA have jointly spent $18 million (borne equally) in exploring and appraising the Block-66a property. In addition, GOGP had paid PDVSA a signature bonus of $25 million when the license was granted. 
A decision has been taken to develop Block-66a. The arrangement between GOGP and PDVSA is for GOGP to be responsible for all the development costs. The reserves are expected to be produced over 11 years. All associated gases are to be flared in the selected development design.

Requirements 
Prepare a detailed group report that addresses the following tasks:
 
Task 1 
Model GOGP’s all-equity net cash flows based on Table 1 and the additional information provided above.
Using the Capital Asset Pricing Model (CAPM), the above information in relation to the project funding structure and any other data you can access (e.g., risk-free rate, published betas, market risk premium, country risk adjustments for investments in Venezuela, etc.), determine the project’s real weighted average cost of capital (WACC). Since the capital structure of GOGP is not given, assume the company has the same gearing as the UK oil and gas industry. You will need to obtain or derive the unleveraged equity beta for the industry and use it as a basis for computing the asset/project beta based on the proposed funding structure for the project. You should make your assumptions and calculations clear and easy to follow and you should cite any data sources and reference materials used, especially to underpin your assumptions
Using the discounted cash flow (DCF) method and the cost of capital calculated above, compute relevant capital budgeting metrics for evaluating the project.

Task 2  
You are provided with the following additional information: 
i)  The CAPEX gave in Table 1 already has a 10% contingency built-in, and this is assumed to be enough to cover the risk of cost escalation. 
ii)  The current forward contango1 for crude oil is 2.5% nominal per annum over the estimated production profile in Table 1. GOGP believes that it can secure these forward prices for its production. 
iii)  GOGP can enter into specific performance contracts that will keep Block-66a’s operating cost at 75% of revenues. 
iv)  By offering a 1% discount, the working capital requirement can be fully eliminated. 
Based on the above and making any additional assumptions as necessary, set out relevant adjustments to appraise the project using the Modern Asset Pricing Method (MAPM). 
Compare the DCF/CAPM and the MAPM results and explain your decision under each method. By reviewing the relevant assumptions of each, a state which of the two approaches is more appropriate for deciding whether to undertake the development project in line with GOGP’s objective of wealth maximization. [20%] 
A contango relates the forward price in the futures market to the current spot price. In this instance, a 2.5% nominal contango implies an annual 2.5% increase in the forward price over the current spot price. 

Task 3  
Working with the DCF/CAPM model from Task 1, prepare a sensitivity analysis/Monte Carlo simulation addressing the key sensitivities, including changes in the price of crude, production profile, CAPEX, OPEX, discount rates, and other pertinent variables. For the Monte Carlo simulation, you can assume that variables are characterized by the probability distributions given in Table 2 below. [20%] 
Based on your analysis, should the company undertake this project? What value should the company put on this property? (Make an argument for each of the valuation methods – DCF/CAPM, MAPM, and DCF/CAPM with sensitivity analysis).
Are there relevant issues or factors which you think have not been considered in the evaluation? 

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  • Posted on : March 01st, 2019

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