Assignment Requirements
5 Questions, to involve: Projection evaluation, Tanker Freight Calculation, Hedging Prices and Real Option Valuation (Monte Carlo). Please see attached brief.
Executive MBA: Energy Stream
Oil and Energy Trading, Transport & Risk Management
Coursework
The aim of this assignment is to assess the studenton different concepts and practices in oil and energy trading and finance. In particular the tasks are designed to examine student’s understanding of how
- different crude assays are evaluated and netback price is calculated,
- oil and gas projects are evaluated,
- transportation costs are assessed,
- price risk is managed,
- and real option valuation is applied to energy industry investment projects.
- This coursework carries 100% of the overall mark for the Module and should be completed in groups of two. You are free to choose your partner.
- The only acceptable work is a typed report in word or pdf format and all the calculations should be done in Excel. Both files should be submitted.
- The deadline for the coursework is 12.00 midnight on Sunday 8nd June 2014.
Task 1: GPW and Margin Calculation
Your company has a refinery at Syracuse (Sicily), which can use different types of crude. As an employee in charge of crude purchasing, you are asked to evaluate Arab Light and Bonny Light for this refinery and see which crude yields a more profitable margin for the refinery.
The following information on yield data for these crude oils as well as current regional market prices for each product is available to you.
Conversion factors: 1 tonne of Bonny Light = 7.40 barrels
1 tonne of Arab Light = 7.30 barrels
| Mediterranean Prices | Arab Light | W-African Bonny | ||
| Yield | Yield | |||
| Wt% | Wt% | |||
| LPG/Naphtha | 948 | $/tonne | 5 | 6 |
| Gasoline | 1059 | $/tonne | 38 | 39.5 |
| Jet/kerosine | 866 | $/tonne | 8 | 7 |
| Gasoil | 885 | $/tonne | 26 | 23 |
| LSFO | 658 | $/tonne | 0 | 22 |
| HSFO | 636 | $/tonne | 20 | 0 |
| Losses | 3 | 2.5 | ||
| $/bbl | $/bbl | |||
| Marginal Refining Cost | 0.2 | 0.22 | ||
| Freight cost | 0.53 | 0.34 | ||
| Current Oil Price | 107.5 | 111.8 | ||
1- Evaluate the GPWs for the two crudes
2- Given current prices for each crude, estimate the refinery’s profit margin in each case,
3- What other important factors should the refinery consider in order to complete the evaluation?
[10 marks]
Task 2: Oil and Gas Project Evaluation
We know that in most E&P cases oil and gas are found together and in the same reservoir, which means for every barrel of oil produced, there will be some associated gas. The expected gas production from the field is expressed in Gas-to-Oil Ratio (GOR); i.e. the number of cubic feet of natural gas produced with a barrel of oil. A high gas-to-oil ratio is extremely undesirable because the pressure in a reservoir, the propulsive force to move the oil in the formation to the boreholes, is being depleted. And with the reservoir pressure gone, a great percentage of the oil may not be recoverable, except by a costly secondary recovery program. Therefore, when evaluating an E&P project we should consider the production and sale of both oil and gas. In this exercise, you are asked to produce a spreadsheet for evaluation of an E&P project using simulation techniques.
The oil field under investigation is estimated to contain enough oil to yield a production rate of 10m barrels in the first production year, 15m bbl in the second production year, 20m bbl in the 3rd production year, and decline at a rate of 8% per year thereafter until year 20 years. It is also expected that the field will have a Gas-to-Oil Ratio of 500cf/bbl, which means that for every 1000 barrels of oil extracted, 0.5mcf of gas is produced. The total investment for this project is estimated to be $3500m which spreads over two year development period ($1500m initially, $1000m a year for year 1 and 2), and operating cost at $200m which is expected to escalate at 3% per year (rate of inflation). The production is planned to start from the beginning of the second year and a reinjection process is planned to be introduced from year 10 at a cost of $2m per year to boost production by 10%.
1- Assuming a cost of capital of 17.5% (discount rate), oil price of $80/bbl, and gas price of ct0.4/cf (approximately $4/MMbtu), estimated the NPV and IRR of the project.
2- Assuming oil and gas prices are random and follow the given lognormal distributions, prepare a spreadsheet to simulate the project NPV and find the probability that the NPV project to be negative. Oil Price ~ LN(80,30) and Gas price ~ LN(0.04/cf,0.01)
3- Let us now assume that we hedge the oil and gas for the first 5 years of production through a 5 year forward swap contract at a fixed price of $80/bbl and gas for ct0.4/cf, and sell oil and gas at market price thereafter, simulate the NPV of the project and find the probability of the NPV of the project being negative P(NPV<0).
[30 marks]
Task 3: Tanker Freight Calculation
It is 20 July 2010 and you have sold two cargoes of crude oil (1,000,000 bbl = 130,000mt each) on CIF basis to buyers who would like to take delivery in Rotterdam (The Netherlands) and Algeciras (Spain). Both cargoes must be lifted from Min Al Ahmadi (Kuwait) between 16 and 19 August 2010. The plan is to hire one VLCC (Kensington) to combine the two cargoes to be lifted from Mina Al Ahmadi as one shipment (260,000mt crude oil) to Ain Sukhna for WS 60. Then use the Sumed pipeline to transfer the cargo to Sidi Kerir where the cargo can be loaded into two Suezmax vessels (Front Brabant and Front Ardenne), each to be hired for WS115, for discharge in Rotterdam and Algeciras. Assuming the cost of transferring the cargo through Sumed line is 3.25$/mt:
a) Calculate the total freight and $/mt freight for each cargo/destination.
b) Discuss what other factors you may consider when negotiating and hiring vessels,
c) Discuss what technical factors you would consider when hiring vessels for this trade and why?
[20 Marks]
Task 4: Hedging petroleum product prices
On 20 November 2009 Petrofine refinery in US Gulf is reviewing its product price revenue for the first quarter of 2010 (Jan 2010 to March 2010). The refinery gets its supply of sour heavy crude from its parent company under a long term contract at $70/bbl. Petrofine can operate at 100,000bbl/day and yield 45% gasoline (Reformulated Gasoline Blendstock for Oxygen Blending)and 22.5% gasoil (Heating oil number 2). The products will be sold FOB price in the US gulf. Given the information in spreadsheet task 4 prices,
1- advise how the refinery can set up a hedging strategy using Gasoline and Heating oil futures in NYMEX,
2- given the same prices work out how the hedge performed over the three month period,
3- discuss any other method which the refinery could use to protect the selling price of its products,
4- discuss any other issue that the refinery may need to consider when setting up a hedging strategy.
[20 marks]
Task 5: Real Option Valuation
The Green LNG plant is planned to construct and operate 2 LNG trains with a total production capacity of 10mt of LNG per year. The NPV of the project is estimated to be $500m. Given the volatility of the LNG and NG market, it is estimated that NPV of the project to have a volatility of 20%, while the project is estimated to have a 20 year life. However, the company has the option to increase production by 30% by building a third LNG train for additional $1000m. In addition, the company has the operational flexibility to reduce production by 50% and make a cost saving of $200m per year, should LNG prices fall.
1- Given the above information, assuming an interest rate of 5%, construct a 20 step binomial tree to estimate the value of these options (expansion and contraction) and the expanded NPV of the project.
2- Comment on your results and discuss any other operational optionality that you may be able to use in this project.
[20 marks]
Good Luck!
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