Changes

Prices and costs can be significant, especially wellhead prices, operating costs, inflation rates, and interest rates. Although many companies routinely project future increases in prices and costs in their economic analyses, the historical record indicates this practice may be misleading and unreliable. It is misleading because some marginal drilling ventures may become "commercial" only through such price escalation forecasts, and it is unreliable because the practice requires ''two'' forecasts to be made (price and cost escalation plus inflation rates), and the industry record at predicting either is demonstrably abysmal.

Prices and costs can be significant, especially wellhead prices, operating costs, inflation rates, and interest rates. Although many companies routinely project future increases in prices and costs in their economic analyses, the historical record indicates this practice may be misleading and unreliable. It is misleading because some marginal drilling ventures may become "commercial" only through such price escalation forecasts, and it is unreliable because the practice requires ''two'' forecasts to be made (price and cost escalation plus inflation rates), and the industry record at predicting either is demonstrably abysmal.

One procedure is to hold all wellhead prices and operating costs constant, assuming that they will rise or fall together. In addition, many firms now recognize that, by present standards, the historical price of oil has oscillated since 1880 between about $11 and $22 per barrel, (except for the 1978-1984 and 1990-1991 spikes), and they set their price predictions in that range. However, and

One procedure is to hold all wellhead prices and operating costs constant, assuming that they will rise or fall together. In addition, many firms now recognize that, by present standards, the historical price of oil has oscillated since 1880 between about $11 and $22 per barrel, (except for the 1978-1984 and 1990-1991 spikes), and they set their price predictions in that range. However, and costs are assumed and the inflation component of the discount rate is omitted (leaving a discount rate of approximately 3-4%), the project analyst is assuming that any price or cost changes that do occur will exactly offset any inflation or loss of purchasing power. If all the assumptions are correct, the result would be a constant purchasing power net present value.

 

 

 

costs are assumed and the inflation component of the discount rate is omitted (leaving a discount rate of approximately 3-4%), the project analyst is assuming that any price or cost changes that do occur will exactly offset any inflation or loss of purchasing power. If all the assumptions are correct, the result would be a constant purchasing power net present value.

Variations in oil prices would be expected to follow a lognormal statistical distribution, given a free world market—many small price fluctuations and only a few very large ones. However, predicting ''variations'' tends to be a near-term preoccupation, which is of limited value in a business that is as long-term as the oil business. Predicting ''trends'' would indeed be useful if we could do it—but the historical evidence says we cannot.

Variations in oil prices would be expected to follow a lognormal statistical distribution, given a free world market—many small price fluctuations and only a few very large ones. However, predicting ''variations'' tends to be a near-term preoccupation, which is of limited value in a business that is as long-term as the oil business. Predicting ''trends'' would indeed be useful if we could do it—but the historical evidence says we cannot.