Modified Straight-Line Depreciation Model for Upstream Petroleum Investment

Abstract

Abstract Depreciation is a method used to recover the cost of an asset or facility used to develop and produce petroleum from any oil and gas field. The challenge with the straight-line depreciation method used to depreciate an asset was, it does not take into consideration the time value of money. Over time, the value of money changes. The amount recovered after the depreciation period is usually less than the future value of the asset. This is because the value of money today is not the same as the value of money tomorrow. Hence, there was the need to incorporate the time value of money into the straight-line depreciation model. This research considered the incorporation of the time value of money into the depreciation equation. The conventional straight-line depreciation equation was modified by incorporating the time value concept of money into the equation. A petroleum economic model was developed using a spreadsheet approach. The model was used to evaluate the impact of the modified straight-line depreciation model on the profitability of petroleum investments. Two petroleum investment scenarios were considered. Scenario 1 had the conventional depreciation model. Scenario 2 had the modified depreciation model for comparative analysis. The effect of the conventional and modified depreciation model on the profitability of the investment was evaluated. The NCF of the contractor for Scenarios 1 and 2 when the oil price was $50/bbl was $214 MM and $317 MM respectively. While the NCF of the host government for Scenarios 1 and 2 when the oil price was $50/bbl were $627 MM and $524 MM respectively. It was observed that the incorporation of the time value of money into the depreciation equation increased the NCF of the contractor. This allowed the contractor to mitigate the effect of risk associated with the value of the asset over time due to inflation. The modified depreciation model made the petroleum fiscal arrangement more attractive.