Critically evaluate the viability of the OCTP project using the after-tax Net Cash Flow model

Background The first oil from the Offshore Cape Three Points Integrated Oil and Gas Project (OCTP) at Sanzule in the Ellembelle district of the Western Region is expected in August next year as the project’s first phase. The second phase is also expected to deliver gas in February 2018. The project will produce almost 180 million standard cubic feet of gas (MMscf) daily. The peak production will be 45,000 barrel of oil per day and 171 MMScfd for 20 years, for an overall production equal to approximately 80,000 boed. The STOIIP is evaluated to be 481 MMbbls, 383 MMbbls of which in the Cenomanian and 98 MMbbls in the Campanian discoveries. Oil reserves are estimated to be around 330 MMbbls (197 in the Cenomanian and 133 in the Campanian). Phase 2 (NAG): gas production through Campanian gas bearing levels; NAG raw reserves 1.75 tcf, sales gas reserves ~1.096 tcf, 54 mmbbls of condensates. The $7 billion project, being undertaken by Italy's largest oil company, Eni Spa, in collaboration with Vitol Energy, will see the development of the Sankofa and Gye Nyame fields that will provide substantial gas to operate Ghana’s thermal power plants for 20 years. OCTP is a deep offshore development project located approximately 60 kilometres south of Sanzule and in a water depth ranging between 500m to 1000m. The development consists of one double-hull FPSO located within the OCTP licence, 19 wells, subsea production systems (130 km of risers & flowlines and 45 kilometres of umbilicals); and an offshore gas export sealine of 63 km connecting the FPSO to an Onshore Receiving Facilities (ORF) located in Sanzule. The crude oil, after treatment and stabilisation on the FPSO, will be exported by means of tankers while the associated gas (separated from the oil in the stabilisation process) and formation water will be re-injected into the reservoir for pressure maintenance. The OCTP project meets or exceeds the highest Health Safety and Environmental standard with minimal impact - zero-flaring and zero discharge project (all associated gas and water will be-injected into the reservoirs) while FPSO will be a new conversion/double hull unit. The OCTP project is joint venture partnership undertaken by ENI S.p.A., an Italian multinational oil and gas company with 44.444% shares; the Ghana National Petroleum Company (GNPC) also has 20% shares, representing the interest of Ghana; as well as 35.5565 for Vitol Group, a global energy and commodity trading company. Mr. Umberto Carrara, Executive Vice-President for the sub-Saharan Africa Region and Chairman of ENI Ghana, explained that the OCTP fields will continuously supply Ghana’s thermal power system from 2018 to 2036. The non-associated gas will provide environmental benefits, supplying gas from 2018 and on for many years at a constant plateau of 171 MMSfcd to existing and new thermal power plants, replacing light crude oil and enabling expansion of the country’s power generation capacity. This volume, he explained is adequate to generate up to 1,000MW of power, or more than 80% of the thermal power generation capacity installed in Ghana today. “The supply of gas will be on firm delivery basis as it is non-associated, with GNPC as the offtaker -- besides, the country will also benefit from additional oil production starting from 2017 through GNPC’s participation in the project, and royalties and taxes generated by the production, together with employment and further development of local content,” he said. He added that the OCTP Project has awarded contracts to Ghanaian Joint Ventures and Indigenous Ghanaian Companies valued at US$1.5 billion within the spirit of Local Content Regulations – LI2204. http://thebftonline.com/commodities/oil-gas/18791/first-oil-from-octp-expected-in-aug-next-year.html#sthash.2ClgwAJ5.dpuf, fiscal terms and figures modified. Additional information: Royalties 5% of the annual gross production of Natural Gas and for Oil 10% of gross production if water depth < 400 m and 7.5% of gross production if water depth >400m. Income Tax and Additional Oil Entitlement (AOE) A general income tax rate of 35% is to be applied on the project. The State shall however be entitled to a portion of Contractor’s share of Crude oil (AOE), calculated on the basis of the rate of return (ROR) of the Contractor’s Net cash flow after-tax. ROR AOE 12.5% -10% 17.5% -12.5% 22.5% -16% 27.5% -20% Phase 1 Oil Project Phase 2 NAG Project Exploration Cost US$355M US$75M SPS Capex: US$375M US$163M R&F Capex: US$540M US$298M Rig Rate: US$1.2M/day US$1.1M/day FPSO: Cost US$4.5B FPSO Retrofit-Compression: - US$116M Sealine: US$414M US$164M Prices: Oil/Gas US$75/barrel US$8.90/MMBtu Start Up-1st oil/gas 2016 2018 Down Time: 5% Other Fiscal Terms: • Per the Petroleum Agreement, the project is expected to be ring-fenced at the block/license level first and at the Plan of Development (PoD) level after production commences. • Under the new Income Tax Act 2015, Act 896, companies can carry their losses forward for only five years whilst capital expenditures are provided for 5 years to enable companies recover their capital investment. Aspects of the Petroleum Income Tax Law, PNDCL 188, 1987 referenced in the Petroleum Agreement are shall remain in force due to stabilization clauses. Additional Information Eni’s opex normally calculated as cost per barrel in other regions has been US$12 per barrels but this is expected to be about US$17 per barrel due to peculiar challenges and risk in the West African sub-region. Traditionally the company uses 8% internal rate of return (IRR) is clearing/hurdle rate for projects in OECD countries but applies 12% to the country due to the country profile and rating by Moody’s and Standards & Poor. Question: 1. Critically evaluate the viability of the OCTP project using the after-tax Net Cash Flow (NCF) model, i.e. the NPV. You will expected to establish the project’s IRR and compare to the compare hurdle rate, this should enable the company make a decision regarding the overall economics of the project. - 40 Marks 2. Due to the recent oil price volatility and high producer price index (PPI) which has affected prices of steel and other inputs, the company has decided to conduct sensitivity analysis on the key variables such as the oil prices, major capital expenditure as listed above in order to critically evaluate their impact and develop a clear strategy to overcome them. You may depict using Tornado chart or spider web illustrate the project sensitivity that you have calculated and discuss strategies to minimise their impact. - 20 Marks