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Introduction
Drilling an oil well is a very costly and time consuming operation, but our dependency on hydrocarbons is incontrovertible. One of the most time consuming tasks is planning the costs and operations that will be implemented in the exploration, drilling and production of the well. We will briefly explain the process of drilling to give you an idea about the process for a better understanding of the parameters that we defined in our calculations. Because the economics of an actual oil well would take several months to evaluate, we had to base some assumptions that would aid us in finishing the project on time and in a suitable manner. These assumptions will not cause a drastic difference between our calculations and the reality, but they must be accounted for, because they are different from the real way of calculating. The following assumptions are as follows: The price of the oil barrel has been fixed at $100 per barrel. We estimated that we have 50 million barrels divided on eight wells. We assumed that all the hydrocarbons will be accounted for in twenty years.

Overview about Drilling and Production

The first process that is done in drilling is actually exploring the well that we will drill. The geologists gather information about the site using different methods including seismic, gravity, and magnetic surveying. There is no tool to guarantee that we will find hydrocarbons in the reservoir, so we must resort to drilling even though it costs a lot of money and takes effort and time. In our project, we based our calculations on the assumption that the field we developed contained a reasonable estimated quantity of producible hydrocarbon. Without this assumption it would not have been sensible to take the risks and drill in the first place, and we wouldnt have been able to use the different techniques developed in the course.

After drilling an exploratory well, which is not the actual producing well, if we find that hydrocarbons are present in sufficient quantity, we start planning the drilling process. The drilling process includes getting the rig, by either renting, buying it or resorting to the turnkey alternative. Our three alternatives of choice were either buying the rig new, or buying a used rig or renting a rig per day. The turnkey alternative will be explained briefly in the report, but we will have to neglect mentioning thorough calculations about it, since as we shall see, it rarely brings benefit when used.

The well we chose to drill is an offshore oil well which means that it is not on land. The rig we chose is called a jack-up rig. This rig is not the most sophisticated rig as it can only drill up to 800 foot. The rig stands on four legs and thus has to be in

reasonable depth. The legs are raised up when the rig is being transported. After it reaches the destination required, the legs are lowered and fixed on the sea floor so the rig doesnt move even by wave action. The prices of the three alternatives that we are going to study are: Buying New Rig : Buying Used Rig : Renting Rig per Year: $200M $100M $54.75M

After the rig is brought to the site and fixed to the ground, the mast is raised. The rig in the sea must have all the systems augmented in it. The power is brought to life using the power system. This system uses diesel engines. These engines must provide power to the whole rig and must stay functional all the time because they also power the equipment needed to carry on with the drilling process. The drilling process has a lot of systems including the hoisting system that raises the drill pipes, the rotary system rotates the drill pipes so the drill bit can drill the formation, and the well control system includes the blowout preventing system which acts as a line of defense should anything wrong occur such as a kick.

We assumed that the drilling process goes unhindered by any predicament whatsoever and so we quantified the drilling costs and considered them as constant. The drilling process will take approximately one year to complete. This is mainly because we are drilling eight wells. A reservoir must have several wells because it is very big to be controlled by one well; also because several wells help reduce the

pressure on the reservoir, and provide a decent rate of hydrocarbon production. After the drilling is complete, the drill pipes are raised, and the blowout preventer is removed, and replaced by the Christmas tree.

The Christmas tree is responsible for production. To produce from an offshore well, production pipelines must be extended to the refinery which is on shore. In our project, we assumed that the production pipelines will be extended from the rig a total of one hundred kilometers to the refinery, where the crude oil is processed to be ready to use. Another major drilling parameter that we included in our research is the drill bit. The drill bit is the part connected to the end of the drill string, and is responsible for drilling the formation. There several types of drill bits, but we used the three most common types in our calculations. The three alternatives that we used and their costs are as follows: Roller Cone Bit Tungsten Carbide PDC $52,500 $55,000 $50,000 SV SV SV $0 $7200 $9600

This was an overview about the drilling and production operations, and some of the assumptions that we made, and a justification on why we made these assumptions.

Bit Calculation

The following table will give an overview on the numbers we use to calculate the bits and the bit costs: Bit type Number of Bit Roller Cone
Tungsten Carbide

Cost per Bit $17500 $27500

Cost

Salvage Value

Maintenance

3 2

$52500 $55000

$0 $3000

$6600 $7200

PDC

$50000

$50000

$5000

$9600

We used present worth analysis to calculate the present worth of each bit, and from this we concluded which alternative is the best. The following equations are what we used to reach our conclusion: Roller Cone:

($0 - $6600)(P/F, 12%, 1) - $52500 = $-6600(0.892857143) - $52500 = $-58,392.86

Tungsten Carbide:

($3000 - $7200)(P/F, 12%, 1) - $55000 = $-4200(0.892857143) - $55000= $-58,750

PDC:

($5000- $9600)(P/F, 12%, 1) - $50000 = $-4600(0.892857143) - $50000= $-54,107.14

From these calculations, the best alternative is the PDC bit. You might have found this obvious from the numbers that we had in the table; however, this is not always the case. The number of bits chosen and the type is generally dependent on the formation, because there are some formations that only a certain type of bit can drill. Even though the PDC is the strongest and can drill all formations it is not used all the time. One reason is that the drilling assembly might get stuck underground, which makes it impossible to retrieve the diamond-imbued bit. Another reason is because if you drill a very soft formation with a PDC bit, the formation will be drilled very fast which might cause some problems such as a kick, and in extreme cases, a blowout; which means that the well catches on fire which is catastrophic and might lead to the death of many crew members, similar to the unfortunate incident that happened with BP in the Gulf of Mexico in 2010 which caused the death of several crew members, not to mention billions-worth of repair and compensation costs.

Turnkey Alternative

We will now speak about each alternative, including the turnkey alternative, separately. Each alternative will be accompanied by a flowchart, and some spreadsheets that will be made in Microsoft Excel, excluding the turnkey alternative which will be explained in brief.

The turnkey alternative is rarely ever used because it is literally a complete rip-off. The turnkey method is basically that you ask a company to drill the well and do all the processes needed to produce the hydrocarbons, and in exchange, the company gets almost 150% of the money they were supposed to receive in the normal case. The only benefit of this alternative is that it completely removes all the risk of the whole operation. It is rarely ever used because it costs a lot of money and thus decreases the revenues greatly, which is one of the most important things in the project. The turnkey alternative is used only when the well that is being drilled is very challenging for an inexperienced company to drill, since it is very risky, but because the company explored and found the hydrocarbons, it is unwilling to leave it unproduced, so it resorts to the turnkey alternative where the other company is more advanced, and has a better experienced crew. The reason why we are not including this alternative in our project is that the formation we are drilling is an easy one. Had we done the necessary calculations in the turnkey, it would have turned out to be the worst alternative in our case.

Buying a New Jack-Up Rig

The following is the cash flow diagram for the Alternative mentioned above:

The cash flow above shows the total costs and revenues that were included in our calculation of the Buying a New Rig alternative. The Drilling costs were the costs for drilling the well. Although drilling only took one year, the annuity for drilling continues to the end of the twenty one years because the drilling costs also include the costs for production. Production requires that the power remains on. It also requires that some other parameters in the rig, discussed above, stay active.

We found the amount required for maintenance per year, and we added it as an annuity. Maintenance in the offshore rigs is paramount for the safety of the crew. It is crucial that the rig be painted regularly because of the corrosion effect that acts upon the legs of the rig by the sea water. The service costs include the services provided to the crew on the rig, including the food, rooms, laundry, and their salaries. The 300

million is the cost of the pipelines, which are extended to the refinery. They were placed after the drilling operation was complete. The salvage value, 21.88 million, was calculated using the depreciation rate method. We used a depreciation rate of 10% per year.

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Buying a Used Jack-Up Rig

The following is the cash flow diagram for the Alternative mentioned above:

The Buying Used Rig alternative method is the same as the method above in almost all of the numbers except the maintenance cost which is higher, and the initial cost which is lower. This is normal because the used rig will be in a worse condition than the new one. This will, however, affect the salvage value of the rig at the end of the period.

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Renting an Oil Rig

The following is the cash flow diagram for the alternative mentioned above:

In this option we shall examine drilling without purchasing a rig. Instead, we rent a rig from a contractor and use it in our drilling operation. In this case, unlike the previous two cases there are no maintenance costs, since they are covered by the contractor from which we rent the rig. The daily rig renting cost is $100,000. Just like

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the previous two alternatives the 300M cost of pipelines is still occurring. Unlike the previous two alternatives, there is no initial cost (we dont buy a rig) and subsequently there is no associated salvage value.

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Comparing Alternatives
In this project, we performed the IRR comparison for mutually exclusive projects. 1- Ranking: Consider the Renting a Rig alternative alone

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AW: $162500000 $98550000 - $398550000(A/P, i*, 20) = 0 AW: $63950000 = $398550000(A/P, i*, 20) (A/P, i*, 20) = 0.16046 After comparing the value calculated above for the (A/P, i*, 20) with the values of the factor in the tables, 15% < i*< 20% which is greater than the MARR. Using linear interpolation: (A/P, i, 20) = 0.15976 . for i = 15% (A/P, I, N) = 0.20536 .. For i = 20% (0.20536 0.16046)/ (20 - i*) = (0.20536 0.15976)/ (20-15). Therefore, i* = 15.07675% > MARR. Hence this alternative is acceptable and we should consider this alternative.

2- Challenge the previous alternative with the second alternative which is Buying a used rig: $-100M (A/P, i*, 21) ($44.04M $98.55M) + $10.94M (A/F, i*, 21) = 0 $54.15M = $100M (A/P, i*, 21) - $10.94M (A/F, i*, 21) If we substitute with i* = 12% in the right hand side of the equation, the left hand side will yield a value of $13.224M and if we substituted with i* = 15% in the right hand side of the equation, the left hand side will yield a value of $15.75M. This means that if we substitute with a higher value for i*, we will approach the

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($54.15M). Therefore, the incremental investment has IRR > MARR. Thus, the second alternative is considered the current best.

(P/A,i*,N) i 0.11562439 0.12383793 0.132240092 0.140814328 0.149544861 0.158416791 0.167416169 0.176530035 0.185746433 0.195054399 0.204443939 0.213905981 0.223432334 0.233015628 0.242649254 0.252327309 0.262044531 0.271796244 0.281578301 0.291387031 0.301219192 0.311071923 0.320942703 0.330829315 0.340729809 0.350642474 0.360565806 0.370498488 0.380439364 0.390387423 0.400341776

N 0.1 0.11 0.12 0.13 0.14 0.15 0.16 0.17 0.18 0.19 0.2 0.21 0.22 0.23 0.24 0.25 0.26 0.27 0.28 0.29 0.3 0.31 0.32 0.33 0.34 0.35 0.36 0.37 0.38 0.39 0.4 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21

(A/F,i*,N) 0.01562439 0.01383793 0.012240092 0.010814328 0.009544861 0.008416791 0.007416169 0.006530035 0.005746433 0.005054399 0.004443939 0.003905981 0.003432334 0.003015628 0.002649254 0.002327309 0.002044531 0.001796244 0.001578301 0.001387031 0.001219192 0.001071923 0.000942703 0.000829315 0.000729809 0.000642474 0.000565806 0.000498488 0.000439364 0.000387423 0.000341776

AW 11391508.16 12232406.05 13090102.55 13963124.04 14850065.34 15749599.44 16660484.02 17581564.92 18511777.3 19450144.81 20395777.19 21347866.69 22305683.69 23268571.79 24235942.55 25207270.11 26182085.91 27159973.48 28140563.48 29123529.02 30108581.27 31095465.47 32083957.14 33073858.79 34064996.81 35057218.71 36050390.67 37044395.32 38039129.77 39034503.86 40030438.61

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3- Challenge the second alternative Buy a used rig with the third alternative Buy a new rig AW: (-($200M - $100M)(A/P,i*,21)) ($44.04M - $44.4M) + (($21.88M $10.94M))(A/F,i*,21)) = 0 $100M(A/P,i*,21) - $10.94M(A/F,i*,21) = $0.36M If we substitute i* with 0.12 in the left hand side of the above equation, the right hand side will yield a value of $13.09M and if we substitute i* with 0.15 the right hand side will yield $11.56M which means that while we are reducing the value of i* in the above equation, we are approaching the right hand side. Thus, i* is less than the MARR.
(P/A,i*,N) i 0.11562439 0.12383793 0.132240092 0.140814328 0.149544861 0.158416791 0.167416169 0.176530035 0.185746433 0.195054399 0.204443939 0.213905981 0.223432334 0.233015628 0.242649254 0.252327309 0.262044531 0.271796244 0.281578301 0.291387031 N 0.1 0.11 0.12 0.13 0.14 0.15 0.16 0.17 0.18 0.19 0.2 0.21 0.22 0.23 0.24 0.25 0.26 0.27 0.28 0.29 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 21 (A/F,i*,N) AW 1 0.01562439 0.01383793 0.012240092 0.010814328 0.009544861 0.008416791 0.007416169 0.006530035 0.005746433 0.005054399 0.004443939 0.003905981 0.003432334 0.003015628 0.002649254 0.002327309 0.002044531 0.001796244 0.001578301 0.001387031 AW 2 11391508.16 12232406.05 13090102.55 13963124.04 14850065.34 15749599.44 16660484.02 17581564.92 18511777.3 19450144.81 20395777.19 21347866.69 22305683.69 23268571.79 24235942.55 25207270.11 26182085.91 27159973.48 28140563.48 29123529.02

11391508.16 12232406.05 13090102.55 13963124.04 14850065.34 15749599.44 16660484.02 17581564.92 18511777.3 19450144.81 20395777.19 21347866.69 22305683.69 23268571.79 24235942.55 25207270.11 26182085.91 27159973.48 28140563.48 29123529.02

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The incremental investment has IRR<MARR Thus, the third alternative Buy a new rig loses the challenge and the second alternative Buy a used rig is the current best.

We should choose the second project.

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Equivalent Annual Costs (EAC) Analysis for a New Rig

25

New Rig Equivalent Annual Costs

20

15 $MILLIONS 10

EAC Capital Costs (M) Operation and maintenace cost(M) EAC TOTAL COSTS(M)

0 1 3 5 7 9 11 13 15 17 19 21 YEARS

According to the annual cost analysis for a new rig, the economic life is around 13 years. We used declining balance depreciation (d=10%) to calculate the salvage values of the new rig each successive year. From this we managed to calculate the equivalent annual capital costs using the capital recovery formula. We also set some reasonable values for operation and maintenance costs from which we managed to calculate equivalent operation and maintenance costs. Adding both costs together, we realized that the economic life of a new rig in our case was thirteen years.

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Break-Even Analysis
In this section, we will perform some Break-Even analyses for the previous alternatives.

Break-Even Analysis for Pipelines cost

30 25 20 15 10 Annual worth 5 0 -5 0 -10 -15 -20 Pipeline cost (M) 200 400 600 800 Break-Even Analysis for Pipelines cost

For the first alternative Renting a rig, we found that, according to the figure shown, that the project is viable as long as the Pipelines cost is below $480M. Above this value for Pipelines costs, the present worth of the project will give a negative value.