Petroleum Economics and Engineering, 3rd Ed
Petroleum Economics and Engineering, 3rd Ed
Petroleum Economics and Engineering, 3rd Ed
and Engineering
Third Edition
Edited by
Hussein K. Abdel-Aal
Mohammed A. Alsahlawi
Third Edition
Petroleum Economics
and Engineering
Third Edition
Petroleum Economics
and Engineering
Edited by
Hussein K. Abdel-Aal
Mohammed A. Alsahlawi
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Contents
Preface..................................................................................................................... vii
The Editors...............................................................................................................xi
Contributors.......................................................................................................... xiii
v
vi Contents
Technology and economics are two areas that have the capacity to trans-
form our world. Petroleum technology from the engineering point of view is
subject of this book, along with economic analysis. Technology is the great
enabler that has made exploration for oil more effective, drilling more effi-
cient, and production more prolific, safer, and less intrusive to the environ-
ment than ever.
The application of engineering principles to practical ends such as the
design, manufacture, and operation of efficient and economical plants,
machines, and processes exemplifies the leading role of technology in the
petroleum sector. The largest volume products of the industry are fuel oil
and gasoline. Petroleum is also the raw material for many chemical prod-
ucts, including pharmaceuticals, solvents, fertilizers, pesticides, and plastics.
In oil production, virtually every oil field decision is founded on profitabil-
ity. With no control of oil and gas prices and facing steadily rising costs and
declining reserves, companies’ basic decisions are based on constantly mov-
ing targets. Drilling, completing, and producing oil and gas is an extremely
complex business. One might think that the world’s unshakable thirst for
cheap, abundant energy resources makes profitability a sure thing, but this
might not be so.
Petroleum economics and engineering is the application of economic tech-
niques and analysis to the evaluation of design and engineering alternatives
encountered in the petroleum industry. It includes the systematic evaluation
of the economic merits of proposed solutions to engineering problems. Part
of the role of petroleum economics and engineering is to assess the appropri-
ateness of a given project, estimate its value, and justify it from an engineer-
ing standpoint.
The philosophy in this book is the same as in previous editions in that
the fundamentals of economics as applied to engineering problems in the
petroleum industry are emphasized. The text focuses on the fact that engi-
neers seek solutions to problems; the economic viability of each potential
solution is considered along with its technical merits. This is typically true
for the petroleum sector, which includes the global processes of exploration,
production, refining, and transportation (often by oil tankers and pipelines).
Fully revised and updated to reflect major changes over the past two
decades, this third edition offers thorough coverage of every sector in oil
operations, focusing on engineering problems encountered in the oil indus-
try. Sound economic decision making to solve these problems is the main
target of the book. Section 1 consists of introductory materials. All princi-
ples, methods, and techniques of engineering economics (as applied to the
petroleum industry) are presented in Section 2.
vii
viii Preface
combine principles drawn from the chapters to solve problems and evaluate
oil economic projects of which they are in charge.
The economic principles and techniques covered in Section 2, in combina-
tion with the technological descriptions of different phases encountered in the
oil industry and the illustrative examples and case studies in Section 3, impart
the required skills for effective economic evaluation of most practical oil engi-
neering problems. In addition, concepts and techniques of analysis useful in
evaluating the worth of petroleum systems are considered. The answers to fre-
quently asked questions such as “which petroleum projects are worthwhile?”
and “which project should have a higher priority?” are presented.
This book is invaluable to senior and graduate students majoring in
petroleum engineering, chemical engineering, and economics. It is a help-
ful resource for practicing engineers and production people working in the
petroleum industry who have the responsibility of planning and decision
making in oil or gas field development. It also may be used as a reference
volume for managers, executives, and other personnel engaged in this field.
Although the book is focused on petroleum engineering economics, most
of its contents should be equally applicable to other engineering disciplines.
The text can be adopted, accordingly, as a principal or supplemental resource
book in allied courses such as engineering economics, petroleum economics
and policy, project evaluation, and plant design.
Since all aspects of the field of engineering economy in the petroleum indus-
try cannot be covered in detail in a single book, every effort has been made by
the editors and the authors to expose the readers to the nature of the problems
that are typical of the oil industry. This book by no means presents a complete
description of the design of any part of these processes. Many details have
been omitted in order to summarize a vast subject. Errors of exposition and
inelegances of expression undoubtedly remain. These are our responsibility.
References are grouped together at the end of the book to serve as a sub-
ject bibliography. They do not represent complete citation of the authorities
for all the statements given in the text. Conversion factors are included in
Appendix A, and Appendix B lists the economic factors as a function of the
interest rate and the number of years that are used extensively in Section 2.
We are pleased to acknowledge the help we have received over the years
from colleagues and students, and in particular from established sources
and texts on the same topic. We are greatly indebted to the many firms and
publications that have allowed us to use their materials as references.
The editors are grateful to Taylor & Francis Group for their enthusiasm
in the publication of this new edition of our book. It is our pleasure to
acknowledge the help provided by Allison Shatkin, Jill Jurgensen, and Amy
Rodriguez throughout this task.
Hussein Abdel-Aal
Mohammed Alshlawi
The Editors
xi
Contributors
xiii
Section 1
M.A. Al-Sahlawi
CONTENTS
1.1 Introduction..................................................................................................... 4
1.2 Oil Reserves..................................................................................................... 4
1.3 World Oil Supply............................................................................................6
1.3.1 Crude Oil Production......................................................................... 6
1.3.2 Production of Refined Oil Products................................................. 8
1.4 World Oil Demand....................................................................................... 10
1.4.1 Crude Oil Consumption.................................................................. 10
1.4.2 Consumption of Refined Oil Products.......................................... 12
1.4.3 Natural Gas Reserves, Production and Consumption................ 12
1.5 Summary........................................................................................................ 19
The oil and gas industry has invested billions of dollars in finding, discover-
ing, developing, producing, transporting, and refining hydrocarbons for more
than a century and has long been an enormous source of wealth creation.
In this chapter, world petroleum and gas supply-and-demand patterns are
examined. Current statistics on reserves are also reviewed. It is noted that esti-
mates of proven reserves change from year to year, and high oil prices stimu-
late searching for oil and gas, which tends to increase the amount of proven
reserves around the world. Regarding oil supply and demand, the United States
is still the main oil producer and consumer in the world. It also leads the world
in refining capacity. Oil demand is predicted to continue to increase despite
the high price of oil. There are many sources of demand for oil. As countries
develop and industrialize, their oil consumption grows with their economy.
Today China and India are the big players when it comes to growing
economies. The world has never seen economic growth like it has with these
two countries, and the impact on oil demand has already begun. Developed
countries are also yet to seriously change their oil habits but will likely adapt
at a faster pace if oil prices continue to rise.
3
4 Petroleum Economics and Engineering
1.1 Introduction
This chapter provides a general review of oil and gas reserves and the pat-
terns of production and consumption. Recent statistics on world distribu-
tion of oil proven reserves indicate that oil is found in many regions, but
the Middle East accounts for the highest share of the world total. Proven gas
reserves are distributed around the world with more concentrating in the
Middle East and Eastern Europe including Russia. High oil prices induce
more discoveries which increase the amount of proven reserves.
In 2011, 242 oil and gas discoveries were made globally. This was 45 per-
cent less than global oil and gas discoveries made in 2009. The factors that
led to this decrease include an increase in exploration activities in techni-
cally challenging areas, such as deep offshore and ultra-deep offshore areas
and the Arctic, as well as a lack of required technical equipment, environ-
mental protests, and government restrictions.
As far as oil supply and demand are concerned, the United States has been
the principal oil producer. Over the years different producers have emerged
in Latin America, the Middle East, and North Africa. The Middle East alone
produced more than one-fourth of world oil production in 1960. The trends
continue in recent years with more than 10 mbd from Saudi Arabia alone
in 2010. The production of refined oil products, however, is concentrated
near the consuming areas. The United States has led the world in refining
capacity. Together with Western Europe they produce almost half the world
refined oil products.
On the other hand, world oil demand has increased substantially over the
last three decades. The growth in demand has been noticed in the industri-
alized countries. The demand for oil has increased recently in the develop-
ing countries of the Middle East, South Asia, and China as a result of rapid
economic growth and high population. The gas supply picture shows an
increasing share for Organization of the Petroleum Exporting Countries
(OPEC), mainly Iran and Qatar, while maintaining the position of Russia and
the United States as leading suppliers, with the demand for gas concentrated
in the United States, Russia, and Europe.
1600000
7
1400000 6
Million of Barrels
1200000
1000000
800000 5
600000
400000
200000 4
0 3
1960 1970 1980 1990 2000 2010
FIGURE 1.1
World distribution of oil proven reserves at the end of the year (1960–2010). (From OPEC Annual
Statistical Bulletin, Vienna, 2011. Vienna. With permission.)
Figure 1.1 shows world distribution of oil proven reserves at the end of the
year over the period 1960 to 2010. Until 1950 North America constituted the
largest share of world oil proven reserves, but after 1960 other areas have
emerged, such as the Middle East, which has the highest share. Its share rose
to 65 percent of the world total by 1990 and continues to rise, while Latin
America and Russia have followed, with 13 percent and 9 percent, respec-
tively. The distribution of world oil proven reserves by OPEC nations com-
pared to the rest of the world is presented in Figure 1.2. It shows the proven
Libya
Nigeria
Kuwait Qatar
Iraq
Venezuela 296.50 24.8% Iraq 143.10 12.0% Libya 47.10 3.9% Algeria 12.20 1.0%
Saudi Arabia 264.52 22.2% Kuwait 101.50 8.5% Nigeria 37.20 3.1% Angola 9.50 0.8%
Iron, I.R. 151.17 12.7% United Arab 97.80 8.2% Qatar 25.38 2.1% Ecuador 7.21 0.5%
Emirates
oil reserves for countries at the end of 2010. Venezuela is at the top of the
list, followed by Saudi Arabia, Iran, Iraq, and Kuwait. However, oil proven
reserves for these countries have been revised upward lately. Changes in
these estimates from year to year are due to changes in production levels,
new discoveries, and extensions of the existing fields.
To measure the expected life of oil reserves, a ratio of proven reserves to
annual production is calculated given certain assumptions. These assump-
tions include constant rate of production, stagnant oil demand, and no addi-
tional discoveries. For example, in the Gulf countries such as Saudi Arabia,
the expected life of an oil reserve is around 90 years, where the average for the
world is about 40 years. However, this ratio is changing over time as a result
of changing oil prices and the state of technology. Rising oil prices in the 1970s
and subsequent periods have stimulated more investment in exploration, even
in relatively high-cost areas, which in turn has raised the proven reserves. This
indicates that there is a positive correlation between oil prices and oil reserves.
TABLE 1.1
Share of World Crude Oil Production by Region from (mbd) 1960 to 2010
Year 2010 Share
Region 1960 1970 1980 1990 2000 2010 of Total
North America 9.20 13.26 14.10 13.85 13.90 13.88 16.6%
Latin America 2.90 4.83 3.75 4.51 6.81 6.91 8.9%
Western Europe 0.30 0.46 2.6 3.70 4.10 4.2 21.8%
Eastern Europe 3.20 7.60 12.31 12.4 10.5 13.81 21.8%
Middle East 5.30 13.90 22.02 17.54 23.55 25.18 30.2%
Africa 0.28 6.11 6.79 6.72 7.80 10.10 12.2%
Asia and Pacific 0.60 1.99 5.11 6.73 7.87 8.35 10.2%
Total 21.78 48.09 66.05 65.46 74.89 82.10
oil production by regions for the period 1960 to 2010. Oil production by
Eastern Europe including Russia exceeded America’s in 1990, but the lat-
ter spurted ahead after that, where in 2010 Eastern European production
reached 12.6 mbd compared to 6.7 mbd for North America. Latin American
countries, specifically Mexico, started production in 1920, followed by
Venezuela in 1930, with a production share equal to 16.2 percent of world
production. After World War II, the Middle East emerged as an important
producing region. Middle Eastern oil producers produced more than 25
percent of world output by 1960. Indonesia was the largest oil producer in
the Asia-Pacific area; its production was mainly for export and constituted
around 4.5 percent of world production in 1960 and increased around 10
percent by 2010. African output, starting with very small quantities in 1920,
became significant after the expansion of Algerian production. With the
output of Libya and Nigeria, African production totaled more than 13 per-
cent of world production in 1970 and maintained almost the same percent
in 2010.
As far as oil production compared with production of other forms of
energy is concerned, Table 1.2 shows that between 1960 and 2010 the pattern
of primary energy production changed between different forms of energy.
The share of oil in world energy production reached its maximum in 1970
with more than 60 percent. This was caused by the decrease in coal produc-
tion in major parts of the world. In the 1990s, however, the share of oil pro-
duction declined to less than 40 percent as a result of its replacement by other
forms of energy such as coal.
TABLE 1.2
World Primary Energy Production in Percent Share (Energy Mix in Production),
1960–2010
Year
Energy Source 1960 1970 1980 1990 2000 2010
Oil 54.53 60.19 46.45 39.40 39.00 38.50
Natural gas 22.28 25.62 18.41 20.51 21.50 21.70
Coala 20.36 11.56 26.18 28.07 28.1 28.20
Hydroelectric power 02.82 02.46 06.35 06.58 06.00 06.50
Nuclear power 0.01 00.17 02.60 05.43 05.40 05.10
Total 100 100 100 100 100 100
a Commercial solid fuels only (i.e., bituminous coal and hard coal, lignite and brown coal).
Sources: Annual Energy Review 1988, U.S. Energy Information Administration, Washington,
DC, with permission; Jenkins, Gilbert, Oil Economist’s Handbook, 4th ed., Elsevier
Applied Science, New York, 1986, with permission; Energy Statistics Yearbook, 1982,
UN Statistics Division, New York, with permission; Basic Petroleum Data Book, Vol.
VIII, No. 3, American Petroleum Institute, Washington, DC, September 1988, with
permission; data for 2000 and 2010 are based on author’s estimation.
8 Petroleum Economics and Engineering
90 12
80
10
70
60 8
50 %
6
40
30 4
20
2
10
0 0
1960 1970 1980 1990 2000 2010
Asia Pacific 3600 6588 12,364 13,470 21,478 28,394 2.7% 30.9%
World 34,514 51,344 79,363 74,647 82,473 91,791 0.8% 100.0%
Of which:
OECD 22,852 34,591 49,833 40,542 44,761 45,124 –1.3% 49.2%
Non-OECD 11,662 16,754 29,530 34,105 37,712 46,667 3.0% 50.8%
European Unionb 8413 15,119 20,669 15,239 15,456 15,240 –2.0% 16.6%
Former Soviet Union 4518 6105 10,190 11,217 8574 8033 0.9% 8.8%
a Atmospheric distillation capacity on a calendar-day basis.
b Excludes Lithuania prior to 1985 and Slovenia prior to 1991.
Note: Annual changes and shares of total are calculated using thousand barrels daily figures.
Source: BP Statistical Review of World Energy, London, 2011. With permission.
9
10 Petroleum Economics and Engineering
120
2000 2015
100
2010 2020
80
60
40
20
0
North South Europe and Middle Africa Asia Pacific World
America and Russia East
Central
America
FIGURE 1.4
World oil refining capacity (mbd), 2000–2020. From Alsahlawi M., Global Refining Industry
Outlook, 2nd Annual Global Refining Technology Forum, 19 March 2012, Doha, Qatar.
This trend has continued with a decreasing rate as the refining industry
has been directed toward markets of refined oil products. Supporting this
argument, refining capacity in Western Europe and Asia has increased sub-
stantially, and their shares in world refining capacity have increased to 27
percent and 30 percent in 2010, respectively. Over the last four decades the
world refining capacity rose to reach more than 91 mbd in 2010 from 51 mb/d
in 1970. The major contributors to this rise were Europe and the Far East. The
Middle East as a major crude oil producer has increased its refining capacity
from 1.7 mbd in 1965 to 7.9 mbd in 2010. However, against expectations, its
share in world refining capacity has not increased substantially. As a matter
of fact, it did not exceed 8.6 percent in 2010.
In forecasting refined oil products supply, it is assumed that world eco-
nomic growth rates would be 2 percent per year from 2010 to 2015 and 3
percent from 2015 to 2020. Oil prices, however, would be around $180 over
the period 2010 to 2015 and would be in the range of $100 to $110 during the
years 2015 to 2020. Figure 1.4 shows the future projections of world oil refin-
ing capacity for the years 2000 through 2020.
TABLE 1.4
World Primary Energy Consumption in Percent Share (Energy Mix in
Consumption), 1960–2010
Year
Energy Source 1960 1970 1980 1990 2000 2010
Oil 34.21 46.06 43.55 38.70 39.10 38.00
Natural gas 14.00 20.01 18.95 20.20 21.00 21.90
Coala 49.84 33.79 29.11 29.5 28.60 28.30
Hydroelectric power 01.93 02.08 06.00 06.50 06.20 06.04
Nuclear power 0.006 00.13 02.39 05.10 5.10 5.4
Total 100 100 100 100 100 100
a Commercial solid fuels only (i.e., bituminous coal and hard coal, lignite and brown coal).
Sources: Annual Energy Review 1988, U.S. Energy Information Administration, Washington, DC,
with permission; Jenkins, Gilbert, Oil Economist’s Handbook, 4th ed., Elsevier Applied
Science, New York, 1986, with permission; BP Statistical Review of World Energy, London,
June 1988, with permission; author estimations for 2000 and 2010.
of coal by oil continued, but because of high oil prices and the implementa-
tion of energy conservation and environmental policies in oil-consuming
countries, the share of oil has reduced to 38.7 percent in 1990. Consumption
of other forms of energy has also increased, which enhanced the lower
consumption of oil. Yet compared to other energy sources, oil is still the
most important source for energy consumption, with the highest share.
As shown in Table 1.5, total world oil consumption has increased from 22.9
mb/d in 1960 to 87.4 mb/d in 2010. Percentage-wise, this can be translated to
an average 6 percent increase per year.
TABLE 1.5
Share of World Crude Oil Consumption by Region from 1960 to 2010
Year 2010 Share
Region 1960a 1970 1980 1990 2000 2010 of Total
North America 11.70 16.59 20.00 20.32 23.57 23.45 25.8%
Latin America 1.20 20.87 33.22 36.23 48.55 6.10 7%
Western Europe 4.10 13.20 16.28 16.20 15.50 14.12 18%
Eastern Europe 3.33 5.02 8.62 8.20 4.30 5.40 5%
and Russiab
Middle East 0.70 1.16 2.04 3.60 5.12 7.82 8.9%
Africa 0.30 0.72 1.37 1.94 2.44 3.29 3.9%
Asia and Pacific 2.00 6.65 10.48 13.82 21.13 27.24 31.5%
Total 22.93 45.41 61.12 66.50 76.60 87.38 100%
a Author’s estimation.
b It is calculated by subtracting the consumption of Western European countries from the
available total consumption of Europe.
Source: BP Statistical Review of World Energy, London, 2011. With permission.
12 Petroleum Economics and Engineering
The United States alone had more than 55 percent of world oil consump-
tion in 1960, which means that it was the largest oil consumer in the world.
However, the U.S. share of world oil consumption has been declining over
the years to around 26 percent in 2010 in the face of increasing consumption
from other regions such as Europe and the Far East. The consumption share
of the first group has increased from less than 10 percent to 18 percent, while
the consumption share of the second group, including Japan, has increased
from 7.4 percent to 31.5 percent over the same period. Western Europe’s share
of world oil consumption reached its maximum in the mid-1970s up to 27
percent and started to decrease afterward as a result of substituting oil by
other types of energy and applying oil conservation measures.
Fuel oil 1508 2087 2416 1224 893 547 7.7% 2.9%
Others 2202 2802 3299 3357 4143 3848 2.2% 20.1%
Total United States 11,522 14,710 17,062 16,988 19,701 19,148 2.0% 100.0%
South and Central America
Light distillates 400 566 886 1135 1443 1835 4.9% 30.1%
Middle distillates 418 560 973 1109 1628 2203 7.7% 36.1%
Fuel oil 554 640 875 672 728 757 –1.7% 12.4%
Others 234 316 587 708 1056 1309 3.5% 21.4%
Total South and Central America 1606 2082 3322 3623 4855 6104 4.7% 100.0%
(Continued)
13
TABLE 1.6 (Continued)
14
Europe
Light distillates 1636 2678 3682 4338 4309 3401 –1.3% 22.4%
Middle distillates 2510 4473 5470 5626 6760 7663 1.6% 50.5%
Fuel oil 2951 4458 4223 2456 1843 1230 –9.0% 8.1%
Others 1134 1766 2238 2452 2927 2867 –2.9% 18.9%
Total Europe 8231 13,375 15,612 14,871 15,838 15,161 –0.9% 100.0%
Former Soviet Union
Light distillates 600 872 1634 1639 942 1287 4.3% 29.6%
Middle distillates 1247 1812 3214 2490 1003 1293 6.8% 29.7%
Fuel oil 1026 1491 2511 2662 726 390 –2.3% 9.0%
Others 441 652 979 1584 1072 1379 5.3% 31.7%
Total Former Soviet Union 3314 4826 8338 8376 3743 4349 4.7% 100.0%
Middle East
Light distillates 162 193 354 552 949 1783 5.8% 22.8%
Middle distillates 316 402 786 1235 1640 2387 3.2% 30.5%
Fuel oil 304 369 706 1090 1397 2035 5.3% 26.0%
Others 172 194 199 683 1036 1616 7.7% 20.7%
Total Middle East 954 1158 2044 3559 5021 7821 5.2% 100.0%
Petroleum Economics and Engineering
Africa
Light distillates 118 174 330 478 576 802 3.8% 24.4%
Middle distillates 211 299 576 763 1030 1486 3.8% 45.2%
Fuel oil 144 159 290 376 403 447 4.1% 13.6%
Others 55 87 176 327 430 555 –0.7% 16.9%
Total Africa 527 720 1371 1943 2439 3291 3.0% 100.0%
Asia Pacific
Light distillates 632 1232 1997 3130 5842 8326 5.7% 30.6%
Middle distillates 778 1601 3151 4990 7795 9836 6.2% 36.1%
Fuel oil 1377 2925 3830 3385 3571 3163 2.0% 11.6%
Others 437 894 1504 2310 3927 5912 5.1% 21.7%
Total Asia Pacific 3224 6652 10,482 13,814 21,135 27,237 5.3% 100.0%
World
World Oil and Gas Supply and Demand
Light distillates 8532 11,818 15,397 18,414 24,150 28,383 2.8% 32.5%
Middle distillates 7398 11,434 16,072 19,218 26,665 31,417 4.4% 36.0%
Fuel oil 7103 11,015 12,831 9775 10,159 8849 0.7% 10.1%
Others 4436 6312 8539 10,721 15,631 18,734 2.7% 21.4%
Total World 27,469 40,580 52,839 58,127 76,605 87,382 3.1% 100.0%
Notes: Annual changes and shares of total are calculated using thousand barrels daily figures. Light distillates consist of aviation and motor
gasolines and light distillate feedstock (LDF). Middle distillates consist of jet and heating kerosenes, and gas and diesel oils (including
marine bunkers). Fuel oil includes marine bunkers and crude oil used directly as fuel. Others consist of refinery gas, liquefied petro-
leum gas (LPG), solvents, petroleum coke, lubricants, bitumen, wax, other refined products, and refinery fuel and loss.
Source: BP Statistical Review of World Energy, London, 2011. With permission.
15
16 Petroleum Economics and Engineering
120
2000 2015
100
2010 2020
80
60
40
20
0
North South and Europe Middle Africa Asia World
America Central and Russia East Pacific
America
FIGURE 1.5
World demand for oil products (mbd), 2000–2020. From Alsahlawi M., Global Refining Industry
Outlook, 2nd Annual Global Refining Technology Forum, 19 March 2012, Doha, Qatar.
200 55
180
160 50
140
120 45
100
80 40
60
40 35
20
0 30
1960 1970 1980 1990 2000 2010
TABLE 1.8
Natural Gas: Consumption (billion cm/d)
Year Change 2010 2010 Share of
Region 1965 1970 1980 1990 2000 2010 over 2009 Total
North America 44.9 62.4 61.6 61.7 76.7 81.9 4.7% 26.9%
South and Central America 1.4 1.8 3.4 5.6 9.3 14.3 9.3% 4.7%
Europe and Eurasia 15.1 28.1 61.5 94.3 95.1 110.0 7.2% 35.8%
Africa 0.1 0.2 1.9 3.8 5.6 10.2 6.1% 3.3%
Asia Pacific 0.6 1.4 6.9 15.0 28.1 54.9 12.6% 17.9%
World 63.0 95.5 138.7 189.7 232.7 306.6 7.4% 100.0%
Of which:
OECD 47.4 71.3 87.7 96.8 130.8 149.6 6.4% 48.9%
Non-OECD 15.5 24.2 51.0 92.8 101.9 157.0 8.4% 51.1%
European Uniona 3.8 10.5 26.2 31.6 42.5 47.7 7.4% 15.5%
Former Soviet Union 11.2 17.5 34.8 62.2 50.5 57.7 6.8% 18.8%
a Excludes Estonia, Latvia, and Lithuania prior to 1985 and Slovenia prior to 1991.
Notes: Annual changes and shares of total are calculated in million tonnes of oil equivalent figures. The difference between these world consumption
figures and the world production statistics is due to variations in stocks at storage facilities and liquefaction plants, together with unavoidable
disparities in the definition, measurement, or conversion of gas supply and demand data. As the data above are derived from tonnes oil equiva-
lent using average conversion factors, they do not necessarily equate with gas volumes expressed in specific national terms.
Source: BP Statistical Review of World Energy, London, June 2011. With permission.
Petroleum Economics and Engineering
World Oil and Gas Supply and Demand 19
American production levels by the 1990s. The Middle Eastern and Asia Pacific
countries emerged as important suppliers by the end of the 20th century with
more LNG production capacities from Iran, Qatar, and Indonesia. Recently,
Australia was expected to emerge as the global leader in LNG production by
holding abundant reserves and a significant majority of upcoming projects.
In an overview of gas consumption patterns, Table 1.8 shows daily con-
sumption by region. North America and Europe including Russia are
the main consumers of natural gas worldwide. In 2010, their shares of
total world consumption were 26.9 percent and 35.8 percent, respectively.
However, natural gas consumption in non-OECD countries increased by
8.4 percent in 2010 over 2009 and accounts for 51.1 percent of total world
consumption in 2010.
1.5 Summary
The production and consumption patterns of oil and natural gas over the
past 50 years have been reviewed. In the energy mix, oil and gas will remain
the main forms of energy in the future, despite the economic and techno-
logical factors. Traditionally, the United States has been the major oil and gas
producer and consumer. Oil and gas from the Middle East and the Arabian
Gulf in particular have noticeably increased over the years. From the con-
sumption side, new emerging economies such as China and India show high
oil and gas consumption rates in recent years.
2
Structure of the Oil and Gas Industry
M.A. Al-Sahlawi
CONTENTS
2.1 Petroleum Industry Stages.......................................................................... 21
2.1.1 Exploration and Development........................................................22
2.1.2 Production.......................................................................................... 25
2.1.3 Refining.............................................................................................. 27
2.1.4 Oil Marketing....................................................................................30
2.2 Oil and Gas Market Structures................................................................... 31
2.2.1 Structure of Oil Industry................................................................. 31
2.2.2 Crude Oil Pricing.............................................................................. 33
2.2.3 Oil Products Pricing.........................................................................34
2.2.4 Structure of the Gas Industry......................................................... 36
2.3 Summary and Conclusions......................................................................... 40
In this chapter, the structure of the oil and gas industry is analyzed, showing
the oil and gas industry moving from exploration and development through
production, transportation to crude oil refining and processing, then market-
ing. Historical reviews of the involved market structures and pricing mecha-
nisms are provided to show how prices are arrived at in this complex industry.
21
22 Petroleum Economics and Engineering
Upstream
Petroleum Industry
Downstream
Gas Processing Refining
Petroleum Distribution
-NG -Cracking/Conversion
-LNG -Reformulation
-Distillation/
Fractionation
-Blending
Manufacturing
Utilities Gas Stations
Industry
FIGURE 2.1
Petroleum industry stages from exploration to marketing.
TABLE 2.1
Capital and Exploration Expenditures of the Major Oil Companies (Million U.S.
Dollars), 1980–2010a
Company 1980 1985 1990 1995 2000 2005 2010
BP 7,409 9,617 9,844 8,380 11,171 14,149 23,016
Upstream 5,018 6,656 5,592 5,261 6,853 10,398 17,753
Downstream 1,964 2,079 3,271 2,989 3,959 2,859 4,029
ExxonMobil 11,565 13,525 11,988 12,862 11,168 17,699 32,226
Upstream 6,974 9,167 6,273 6,986 6,973 14,470 27,319
Downstream 2,830 2,924 4,504 4,724 4,086 3,149 4,720
Total n.a. 1,679 3,933 2,544 7,677 13,928 21,573
Upstream n.a. 1,206 1,172 1,294 5,191 10,091 17,510
Downstream n.a. 305 2,470 1,196 2,217 3,600 3,956
Royal Dutch/ 7,959 7,334 9,360 10,965 6,209 15,916 26,940
Shell
Upstream 4,974 5,021 3,736 4,477 2,292 4,770 4,523
Downstream 2,498 2,042 4,875 6,163 2,292 4,770 4,523
Chevron 6,674 6,859 7,679 7,928 9,520 11,063 21,755
Upstream 4,273 4,902 4,243 4,651 6,251 8,301 18,904
Downstream 1,302 1,201 3,097 3,075 2,226 2,301 2,552
Total Majors 33,603 39,014 42,804 42,709 45,745 72,755 125,510
Upstream 21,244 26,952 21,016 22,669 28,559 54,206 103,809
Downstream 8,594 8,551 18,226 18,142 14,855 16,666 19,780
a Capital and exploration expenditures include upstream, downstream, and other business
corporate.
Note: BP and Amoco merged to create BP Amoco in December 1995 (name changed to BP in
2002). Exxon and Mobil merged to create ExxonMobil in November 1999. Total/Fina and
Elf Agvitane merged to TotalFina Elf in February 2000 (name changed to Total in May
2003). Chevron and Texaco merged to Chevron Texaco in October 2001 (name changed to
Chevron in May 2005). Upstream: exploration/production; downstream: refining, mar-
keting, transportation, chemicals, and other downstreams.
Source: OPEC Annual Statistical Bulletin, Vienna, 2012 (based on oil companies’ annual reports).
With permission.
exploration and production (E&P) are 3-D and 4-D seismic imaging, basin
modeling, remote sensing integration, and slim-hole drilling. These techni-
cal improvements are aimed at reducing the costs of E&P and increasing
efficiency with less environmental impact.
Drilling a test well is the necessary next step, to ensure the presence of
oil. Drilling methods vary from one area to another. Rotary drilling is more
popular in the West; triple drilling is generally used in the former Soviet
Union. Drilling is a very expensive operation. Table 2.1 gives the capital and
exploration expenditures by major oil companies in 1980, 1985, 1990, 1995,
2000, 2005, and 2010.
The cost of exploration and production by major oil companies has
increased over the last three decades by more than 400 percent. This is due
mainly to expansion of the oil exploration and production activities beyond
24 Petroleum Economics and Engineering
the traditional areas to new regions such as Africa and Asia Pacific. In addi-
tion to the monopolistic nature of the oil industry, capital and exploration
expenditure has increased as a result of the high price of new technologies
and the shortage of skilled human resources. Given its high production level
and number of wells drilled, the United States accounts for more than 30
percent of world capital and exploratory expenditure. Its cost per well drilled
was estimated to be $2 million in 2006, while the cost in Western Europe is
almost 10 times higher because of offshore drilling.
One of the reasons drilling is expensive is that in addition to drilling a test
well, more confirmation wells have to be drilled near the discovery well to
confirm the amount of oil present. Development comes next, when commercial
discovery is demonstrated. The process of development consists first in iden-
tifying the field based on its geological structure, then drilling development
wells, and then establishing gathering systems and other necessary facilities.
From a market structure point of view, oil prices are directly related to
the cost of exploration and development. However, rising oil prices since the
1970s stimulated more investment in exploration, even in relatively high-cost
areas such as the North Sea and Alaska. This can be seen in Table 2.2, which
shows total world exploratory well completions compared to Organization
of the Petroleum Exporting Countries (OPEC). The number of wells has
TABLE 2.2
Wells Completed in OPEC Member Countries and in the World, 1980–2010a
Country 1980 1985 1990 1995 2000 2005 2010
Algeria 249 40 80 95 137 198 258
Angola 24 59 60 60 40 45 118
Ecuador 29 22 38 72 48 131 176
Iran 25 50 24 67 150 183 186
Iraq 67 60 113 10 14 15 71
Kuwait 36 12 7 45 138 67 185
Libya 192 65 98 88 109 115 200
Nigeria 114 64 80 119 85 95 94
Qatar 57 13 23 30 66 62 35
Saudi 223 96 98 187 257 373 386
Arabia
United 109 208 75 112 87 109 146
Arab
Emirates
Venezuela 819 373 236 550 691 1,281 890
Total 1,998 1,063 932 1,455 1,862 2,690 2,820
OPEC
Worldb 84,192 91,654 50,880 52,242 60,095 97,430 97,140
a Includes development and exploration wells.
b Excluding Eastern Europe.
increased by 30 percent over the period 1980 to 2010. However, as oil prices
decline, the total number of exploratory well completions begins to fall.
2.1.2 Production
It is hard to separate production from exploration and development from the
operating point of view as well as from the point of view of cost structure.
After a field has been tested commercially, oil production begins. Normally
for new fields, oil comes to the surface by natural drilling force as long as the
well’s surface pressure is less than the pressure in the reservoir. The source
of this self-driving force is water or gas that is contained in the reservoir,
or both. However, this natural flow will decline as the well gets older and
cumulative production increases. Thus, secondary recovery methods such as
water and gas injections and late tertiary recovery are applied.
The main objective is to maximize utilization of the oil reservoir. More
advanced techniques have been applied in planning oil extraction, such as
3-D visualization modeling. Enhanced oil recovery (EOR) has become a chal-
lenging task in order to increase oil recovery rate and reduce the trapped
hydrocarbons in the reservoir. Figure 2.2 illustrates the overall oil and gas
production process.
The production process starts from the well head to metering, storage,
and export through gathering, separation, and gas compression, including
several facilities in addition to the utility systems of providing water, air,
Production
Drilling Gathering Station Gas/Oil Separation
Wells
Mud &
Cementing
Injection Wells Instrumentation
Control
Metering
Crude
Pipeline Storage
Tanker Tanks
Loading
Pump
FIGURE 2.2
Typical oil and gas production process.
26 Petroleum Economics and Engineering
MC
Price and Cost ($)
ATC
AVC
D
AFC
Q
Production (bbl)
FIGURE 2.3
A static model of the world oil market.
Structure of the Oil and Gas Industry 27
2.1.3 Refining
Refining is a series of physical and chemical processes that convert crude oil
into many finished oil products. Physical processes are those that depend
on atmospheric and vacuum distillations. For the chemical processes, many
different methods have been used, such as thermal and catalytic cracking,
hydrogen catalytic process, polymerization, alkylation, and isomerization.
After that, blending and treatment processes make oil products ready for use.
Table 2.3 shows historical development of refining processes with its purposes.
The number of operating refineries in different parts of the world has
increased in total from 646 in 1989 to 700 in 2008 refineries located in 120
countries over the last decade. Table 2.4 presents the number of world oil
refineries by region for the years 1984, 1989, 1996, 2003, 2008. Most refineries
are located near oil product markets.
The oil industry, including refining, used to be controlled by the major
oil companies. This structure, however, has changed since the 1970s when
oil-producing countries took over most oil operations except refining, which
is still generally under the oil companies’ control or as joint ventures with
national oil companies. Figure 2.4 shows the distribution capacity by regions
at the end of 2011.
The refining industry is located mostly where oil is consumed. For exam-
ple, the Western Hemisphere and Western Europe have 21.4 and 24.6 percent
of world refining capacity, respectively. The share of Asia and Pacific world
refining capacity is growing, and reached 29.1 percent in 2011.
Most of the world refineries operate on average at about 85 percent of
refined capacity. This may sound high, but in fact indicates a problem of
excess capacity, which has tended to prevent oil producers from increasing
their refining capacities or building new refineries. During the 1980s and
1990s, the excess capacity was clearly high; a result of the drop in world oil
28 Petroleum Economics and Engineering
TABLE 2.3
Type of Petroleum Refining Processes
Year Process Name Purpose By-Products, etc.
1862 Atmospheric distillation Produce kerosene Naphtha, tar, etc.
1870 Vacuum distillation Lubricants (original), Asphalt, residual-coker
cracking feedstocks (1930s) feedstocks
1913 Thermal cracking Increase gasoline Residual bunker fuel
1916 Sweetening Reduces sulfur and odor Sulfur
1930 Thermal refining Improve octane number Residual
1932 Hydrogenations Remove sulfur Sulfur
1932 Coking Produce gasoline base stocks Coke
1933 Solvent extraction Improve lubricant viscosity Aromatics
index
1935 Solvent dewaxing Improve pour point Waxes
1935 Catalytic polymerization Improve gasoline yield and Petrochemical
octane number feedstock
1937 Catalytic cracking Higher octane gasoline Petrochemical
feedstock
1939 Visbreaking Reduce viscosity Increased distillate, tar
1940 Alkylation Increase gasoline octane and High-octane aviation
yield gasoline
1940 Isomerization Produce alkylation feedstock Naphtha
1942 Fluid catalytic cracking Increase gasoline yield and Petrochemical
octane feedstocks
1950 Deasphalting Increase cracking feedstock Asphalt
1952 Catalytic reforming Convert low-quality Aromatics
naphtha
1954 Hydrodesulfurization Remove sulfur Sulfur
1956 Inhibitor sweetening Remove mercaptan Disulfides
1957 Catalytic isomerization Convert to molecules with Alkylation feedstocks
high octane number
1960 Hydro cracking Improve quality and reduce Alkylation feedstocks
sulfur
1974 Catalytic dewaxing Improve pour point Wax
1975 Residual hydro cracking Increase gasoline yield from Heavy residuals
residual
Source: U.S. Department of Labor, Occupational Safety and Health Administration, Chapter 2,
Petroleum Refining Processes. With permission.
demand to less than 55 million barrels per day in the mid-1980s. This caused
some refineries to close, but with recent growth in oil demand, capacity utili-
zation increased and ultimately the refining margin improved.
There are plans to expand refining capacities and build new refineries,
especially in emerging markets. However, recent upgrading activities will be
Structure of the Oil and Gas Industry 29
TABLE 2.4
Number of World Operating Refineries
Country 1984a 1989a 1996b 2003b 2008b
North America 259 241 184 168 164
Western and Central Europe 124 107 147 134 125
Asia and Pacific 109 104 170 188 189
Latin America 79 78 78 75 75
Middle East 46 51 41 44 47
Africa 48 65 45 44 43
Eastern Europe n.a. n.a. 42 46 45
Central Asia n.a. n.a. 11 12 12
World 663 646 718 711 700
a From Shell Briefing Service, N6, 1989. With permission.
b From Ivica Billege, NAFTA 60 (97-8) 401–403, MSc, 2009. With permission.
29.1 93
30
24.6
25 21.4
20
15
10 8
6.6
5 3.3
0
Western & Central
North America
Latin America
Middle East
Africa
Total World
Asia & Pacific
Europe
FIGURE 2.4
Distribution of refining capacity by region (million barrels/day) as of the end of 2011. (From BP
Statistical Review of World Energy, London, 2012. With permission.)
30 Petroleum Economics and Engineering
Heavy fuel oil is mainly used for electric power generation. It is always sold
on a wholesale basis, often under long-term contracts, with prices related to
the prices of coal and natural gas.
Oil product pricing generally depends on crude oil price and the quality of
crude in terms of sulfur content and density. The high quality of crude yields
higher-value products which increases the refinery margins given the refin-
ery process and configuration. However, beyond supply and demand, product
pricing is affected by the degree of market competition, the way oil products
are traded in the financial markets, and the governments’ regulations.
TABLE 2.5
Shares of the Largest International Oil Companies in Oil Industry Activities
(Thousand Barrels per Day), 1990–2010
% of % of % of
Company Activity 1990 World 2000 World 2010 World
BP
Crude oil reservesa 7,313 0.26 6,508 0.20 5,559 0.14
Crude oil product 2,104 3.56 1,928 2.93 2,374 3.40
Crude oil processed 2,783 4.39 2,928 4.04 2,426 2.95
Refined products sold 3,837 5.77 5,859 7.65 5,927 6.82
ExxonMobil
Crude oil reservesa 10,181 0.37 12,171 0.36 11,673 0.29
Crude oil product 2,491 4.22 2,553 3.88 2,422 3.47
Crude oil processed 4,952 7.80 5,692 7.79 5,253 6.38
Refined products sold 7,283 10.94 7,993 10.44 6,414 7.40
Total
Crude oil reservesa 2,731 0.10 6,960 0.21 5,987 0.15
Crude oil product 411 0.69 1,433 2.17 1,340 1.92
Crude oil processed 832 1.31 2,411 3.33 2,009 2.44
Refined products sold 1,487 2.23 3,695 4.83 3,776 4.34
Royal Dutch/Shell
Crude oil reservesa 10,107 0.37 6,907 0.21 5,179 0.13
Crude oil product 1,820 3.10 2,274 3.45 1,619 2.32
Crude oil processed 3,218 5.17 2,923 4.03 3,197 3.88
Refined products sold 4,962 7.46 5,574 7.28 6,460 7.43
Chevron
Crude oil reservesa 5,909 0.21 8,519 0.25 4,270 0.10
Crude oil product 1,745 2.95 1,997 3.03 1,923 2.75
Crude oil processed 3,285 5.19 2,540 3.51 1,894 2.30
Refined products sold 4,680 7.03 5,188 6.78 3,113 3.58
Total Majors
Crude oil reservesa 36,241 1.31 41,065 1.23 32,668 0.80
Crude oil product 8,571 14.51 10,185 15.46 9,678 13.85
Crude oil processed 15,070 23.79 16,494 22.70 14,779 17.96
Refined products sold 21,961 33.00 28,309 40.00 25,690 29.56
Total World
Crude oil reservesa 2,759,106 100.0 3,330,425 100.0 4,076,000 100.0
Crude oil product 59,077 100.0 65,863 100.0 69,840 100.0
Crude oil processed 63,336 100.0 72,439 100.0 82,305 100.0
Refined products sold 66,539 100.0 76,537 100.0 86,900 100.0
a Reserves are one in million barrels as of year-end.
Notes: BP and Amoco merged to BPAmoco in December 1998 (names changed to BP in 2002). Exxon
and Mobil merged to ExxonMobil in November 1999. Total Fina and Elf Aquitaine merged to
TotalFina Elf in February 2000 (name changed to Total in May 2003). Chevron and Texaco
merged to ChevronTexaco in October 2001 (name changed to Chevron in May 2005).
Source: Compiled from OPEC Annual Statistical Bulletin, Vienna, 2012. With permission.
Structure of the Oil and Gas Industry 33
yet they still control around 25 percent of world oil refining and about 35 per-
cent of marketing activity.
Oil producers’ participation in the oil industry began in 1960 when OPEC
was established. OPEC was formed by five major oil-exporting countries:
Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Qatar joined in 1961 and
was followed by Indonesia and Libya in 1962. By 1979, the number of OPEC
members totaled 13, including the United Arab Emirates which joined in
1967, Algeria in 1969, Nigeria in 1971, Ecuador in 1973, and Gabon in 1975.
From December 1992 to October 2007, Ecuador suspended its memberships,
while Gabon terminated its membership in 1995. By January 2009, Indonesia
suspended its membership, and Angola joined in the same year. Currently,
OPEC has a total of 12 member countries.
In the 1960s, several national oil companies of the producing nations
were established, although in most cases without significant market power.
However, in the 1970s to 1990s, national oil companies gained more power
over the oil industry and extended even more to refining and marketing.
40° API Arabian Gulf crude increased by 33 ç/bbl plus 2 q/bbl in settlement
of freight disparities.
Until that time, oil prices were posted by the major integrated oil com-
panies. However, these were realized or market selling prices, which were
determined by giving discounts of posted prices. The posted prices, however,
served as a basis for oil-producing governments to calculate their royalty
interests and income taxes from the oil companies operating in their coun-
tries. OPEC was able to seize the initiative, and official OPEC prices emerged.
After October 1973 (34° API)—as a marker crude—Saudi Arabia light
became OPEC’s official reference crude oil. OPEC set a price for Saudi Arabia
light and let member governments set their own prices for the different
crudes reflecting the different locational, physical, and chemical characteris-
tics of each crude.
Supply disruption from the Arabian Gulf because of the Iran Revolution in
1979–1980 caused spot oil prices to jump to over $40/bbl and official prices
of OPEC’s crudes to rise accordingly. In the early 1980s, spot and future
markets were widely used at the same time. In those conditions spot and
official prices declined (Table 2.6). This led OPEC members to follow mar-
ket-based pricing systems. In February 1987, OPEC effectively terminated
market-priced sales, and oil prices tended to stabilize around a target price of
$18/bbl as OPEC’s reference basket price or oil-pricing benchmark.
The current basket is composed of 12 crudes: Algerian Sahara blend,
Angola’s Girassol, Ecuador’s Oriente, Iran’s heavy, Iraq’s Basra light,
Kuwait’s export, Libya’s Essider, Nigeria’s Bonny light, Qatar’s Marine, Saudi
Arabia’s Arab light, United Arab Emirates’ Murban, and Venezuela’s Merey.
Theoretically, this is a return to fixed price system. However, in March 2000,
the reference basket price was set at a range of $22 to $28/bbl to reflect mar-
ket forces. The market-based pricing system was enhanced by the develop-
ment of derivative instruments such as forwards, futures options, and swaps.
Trading oil became either through paper markets, where deals are futures
and swaps ,or physical oil trading through spot market and long-term con-
tracts, where the price of a cargo in long-term contracts is linked to spot price.
Such financial and electronic revolutions caused massive market speculation
and more fluctuation in oil prices. The period from 1990 to 2010 witnessed a
wide variation in the exchange value of the U.S. dollar, which increased the
volatility of oil prices. Beyond oil supply and demand, the effect of the U.S.
dollar as the oil pricing currency and the increased role of paper trading of
oil have substantially changed the structure of the oil market.
1998 12.28 12.06 12.71 12.71 12.08 12.69 14.36 11.79 12.34
1999 17.48 17.27 17.91 17.93 17.29 17.95 19.30 17.27 17.76
2000 27.60 26.50 28.44 28.42 27.80 28.57 30.37 26.58 28.74
2001 23.12 22.75 24.46 24.39 22.22 22.82 26.00 22.97 24.78
2002 24.36 23.94 25.03 24.88 24.12 23.55 26.13 23.80 25.45
2003 28.10 27.14 28.81 28.89 28.25 27.78 31.09 27.02 29.52
2004 36.05 34.35 38.23 38.18 37.01 35.53 91.44 34.47 36.72
2005 50.64 50.48 54.44 54.48 50.35 51.31 56.51 50.79 52.65
2006 61.08 62.59 65.16 65.30 59.87 62.72 66.04 61.37 63.33
2007 69.08 68.86 72.55 73.20 67.55 69.67 72.29 69.55 71.30
2008 94.45 94.51 97.37 99.40 95.22 98.94 100.00 94.87 96.72
2009 66.06 62.06 61.68 62.67 60.85 64.38 61.88 61.22 59.97
2010 77.45 78.34 77.60 80.52 77.86 79.75 79.42 78.39 78.45
2011 105.5 106.63 14.36 112.74 105.64 108.30 41.99 109.19 110.46
Note: Spot crude oil prices are nominal prices.
Source: OPEC Annual Statistical Bulletin (oil prices), Vienna, 2012. (Based on Platt’s, Direct communication, Reuters, and Secretariat’s assessments). With
permission.
35
36 Petroleum Economics and Engineering
For perhaps two decades after World War II, the major refining companies
“posted” prices for the major fuel products at which they were willing to sell
to any wholesaler or distributor. With stable crude prices, the major prod-
uct prices remained stable for long periods of time except for the summer/
winter fluctuations in heating oil and motor gasoline prices.
There have been at least three markets for oil products: spot sales, term
contracts, and wholesale transactions. In oil surplus situations, which char-
acterize the world oil market except for supply crises of 1972–1974 and 1978–
1981, spot sales tend to command the lowest markup over crude oil costs
and wholesale transactions the highest. Term contract sales, however, justify
some discounting for outlet security, and therefore fall between wholesale
and spot sales. Nonetheless, the existence of a spot market generated the
need for some kind of reporting service. Platt’s price assessment service
developed to fill this need. Table 2.7 lists spot prices of oil products in major
markets over the period from 1980 to 2010.
Individual product value-added in refining varies among different prod-
ucts. It also varies among market areas and over time. These variations
require refiners to be competitive even during periods of supply surplus.
More recently, competitive pressures on product prices generated different
kinds of discounts from official crude selling prices.
Government regulations and different oil product pricing schemes in dif-
ferent countries are affecting the oil products market. As far as the market
structure is concerned, spot and futures markets have been widely devel-
oped for oil product trading and transactions.
1995 21.31 19.95 13.77 22.10 21.64 13.99 20.60 20.17 14.14
2000 35.10 34.04 20.77 32.55 32.46 23.04 35.16 33.76 20.47
2005 67.25 70.71 36.42 62.10 68.66 38.38 62.58 70.91 34.59
2010 89.54 89.55 70.45 90.05 90.35 72.28 92.35 90.85 70.55
a From 2005, gas oil with 0.05% sulfur.
b From 2005, unleaded 95 RON 0.05% sulfur.
Note: Prices in case of U.S. Gulf and Singapore apply to cargo lots and in case of Rotterdam to barges. Gasoline specification in Singapore is 97 Research
Octane number with 0.15 gram lead per liter. Fuel oil viscosity is 380 centistokes with 3 to 5 percent sulfur. Gasoline specification for Rotterdam is
97-98 RON with 0.15 gram per liter lead.
Source: OPEC Annual Statistical Bulletin, Vienna, 2012. (Information gathered from Platts Oilgram, and Reuters.) With permission.
37
38 Petroleum Economics and Engineering
TABLE 2.8
Natural Gas and LNG Exports and Imports (Billion cm), 2008
Natural Gas Natural Gas LNG
Country Exports Imports Exports LNG Imports
Natural Gas Producers
Russia 195 — — —
Canada 103 — — —
Norway 96 — — —
Netherlands 62 — — —
Qatar 58 — 39 —
Algeria 57 — 20 —
Turkmenistan 54 — — —
Indonesia 37 — 28 —
Malaysia 28 — 31 —
United States 28 — — —
Natural Gas Consumers
United States — 113 — 10
Japan — 95 — 95
Germany — 92 — —
Italy — 77 — —
Ukraine — 53 — —
France — 48 — 10
Spain — 39 — 28
United Kingdom — 37 — —
Turkey — 37 — 5
Korea — 37 — 37
Source: Natural Gas Information, International Energy Agency (IEA), Paris, 2009.
With permission.
Iran, Nigeria, and Qatar. The excess of natural gas supplies in the world
has led LNG spot prices to hit new lows. The drop in spot LNG prices has
made buyers rethink long-term LNG contracts. Importers can now easily
tap the global market for spot cargoes at lower prices than the long-term
supply agreements.
Table 2.8 shows natural gas and LNG exports and imports by leading nat-
ural gas producers and consumers in 2008. The United States and Russia
are the leading countries in natural gas production and consumption, while
Japan and Korea the major importers of LNG.
In the United States, the gas industry has been regulated since the begin-
ning of gas discovery. From time to time, such regulation created a supply
shortage. However, in competitive markets, the price of natural gas reflects
the interaction between the demand and supply, which are inelastic with
respect to price in the short run. This market structure was enhanced by
Structure of the Oil and Gas Industry 39
14
12
10
USD/MMBtv
8
6
4
2
0
1998 2000 2002 2004 2006 2008 2010 2012
*Prices are based on delivery at the Henry Hub in Louisiana, from the trading floor of
NYMEX, the delivery month is the calendar month following the trade date.
FIGURE 2.5
Henry Hub Gulf Coast natural gas spot prices (dollar/MMBTV), mid-year 1998–2012. (Prices
are based on delivery at the Henry Hub in Louisiana, from the trading floor of NYMEX. The
delivery month is the calendar month following the trade date.) (From Annual Energy Review
(several issues), Energy Information Administration, US Department of Energy, Washington
DC. With permission.)
the drop in natural gas prices because of the decline in demand for natu-
ral gas as a result of the 1970s energy crisis and energy conservation poli-
cies. This allowed for direct deals between suppliers and buyers, which
opened the door for natural gas spot markets. With more fluctuations in
natural gas prices, the futures market for natural gas has developed. The
New York Mercantile Exchange (NYMEX) became the trading floor for
short- and long-term futures contracts. Spot prices reflect market condi-
tions where prices for the contracts are based on delivery at the Henry Hub
in Louisiana. Figure 2.5 presents natural gas spot prices and short-term
futures contracts.
Natural gas prices outside the United States are basically linked to oil prices
through long-term contracts. In the United Kingdom, the market is liberalized
and subject to arbitrage between spot gas traded on the national balancing
point (NBP) and continental European long-term contracts. In the continen-
tal European market, gas contracts are based on oil products prices. For Asia,
natural gas prices are based on government-regulated levels with spot pric-
ing for LNG. There are price differentials between these natural gas markets
attributed to different market conditions and price formation whether spot
prices or long-term gas contracts are related to oil prices. The financial crisis of
2008 caused a fall in spot gas prices as a result of a drop in gas consumption.
The two major spot markets, Henry Hub and NBP, recorded lows at ranges of
$3.5/MBTU and $4/MBTU, respectively, between 2009 and 2012.
40 Petroleum Economics and Engineering
Saad Al-Omani
CONTENTS
3.1 Introduction...................................................................................................42
3.2 Crude Oils and Product Composition....................................................... 45
3.3 Hydrocarbons................................................................................................ 45
3.3.1 Alkanes (Paraffins)........................................................................... 46
3.3.2 Cycloalkanes (Cycloparaffins, Naphthenes)................................. 46
3.3.3 Alkenes (Olefins)............................................................................... 47
3.3.4 Aromatic Compounds...................................................................... 47
3.4 Non-Hydrocarbon Compounds.................................................................. 48
3.5 Metallic Compounds.................................................................................... 49
3.6 Crude Oil Properties.................................................................................... 49
3.6.1 Specific Gravity and API Gravity................................................... 49
3.6.2 Ash Content....................................................................................... 51
3.6.3 Salt Content........................................................................................ 51
3.6.4 Carbon Residue................................................................................. 51
3.6.5 Sulfur Content................................................................................... 51
3.7 Crude Oil Classification............................................................................... 51
3.7.1 Classification Systems...................................................................... 53
3.7.1.1 Classification by Chemical Composition........................ 53
3.7.1.2 Classification by Density................................................... 53
3.8 Crude Oil Products....................................................................................... 56
3.8.1 Refinery Gases................................................................................... 57
3.8.2 Hydrogen........................................................................................... 58
3.8.3 Hydrogen Sulfide.............................................................................. 58
3.8.4 Liquid Products................................................................................. 59
3.8.4.1 Naphtha............................................................................... 59
3.8.4.2 Gasoline............................................................................... 59
3.8.4.3 Benzene, Toluene, and Xylenes (BTX)............................. 61
3.8.4.4 Kerosene.............................................................................. 62
3.8.4.5 Gas Oils (Diesel)................................................................. 62
3.8.4.6 Fuel Oil................................................................................63
3.8.4.7 Lube Oil Base Stocks.........................................................64
41
42 Petroleum Economics and Engineering
The petroleum industry generally classifies crude oil by three criteria: the
geographic location where it is produced (e.g., West Texas Intermediate,
Brent, or Oman), its API gravity (an oil industry measure of density), and
its sulfur content. This classification is important because it affects both the
transportation costs to the refinery and the refining costs to meet sulfur
standards imposed on fuels in the consuming countries. The largest volume
products of the industry, on the other hand, are fuel oil and gasoline.
In this chapter, the composition of crude oils, their qualities, and the major
factors included in determining their values are highlighted. Crude oil clas-
sification systems are covered as well. The major types of refined petro-
leum products produced and utilized and their economic importance are
described.
3.1 Introduction
Petroleum or crude oil is a viscous brown-to-black liquid mixture. Historically,
the word petroleum comes from two Latin words: petra, meaning “stone/
rock,” and oleum, meaning “oil.” In Arabic countries crude oil is called alnaft.
Generally we classify the crudes into three types, or families, based on
their density: light, medium, and heavy. Crude oils with gravity >33 API
are considered light crudes. Heavy crudes, those with gravity <28 API,
tend to have more asphaltenes and are usually rich in aromatics (American
Petroleum Institute, Case No. 800205-9, 2011). Examples of crude classifica-
tions with some crude names in the industry, along with their main charac-
teristics, are presented in Table 3.1.
The quality of the oil is normally presented in a structured format called
crude assay, which gives the various components of the crude along with
the expected percentage of recovered products for each specific type of
crude, which will determine the value of the crude, especially for traders
and refiners. It is based on laboratory testing and experimental plant meth-
ods. It demonstrates the true boiling point (TBP) curve, specific density, API,
sulfur content, sediment water, and other important properties. The price
will be determined according to the crude oil quality, even if it is from the
same crude family, as each formation will have its specific quality (e.g., light
crudes will have different price structure based on the given crude assay).
Characteristics of Crude Oils and Properties of Petroleum Products 43
TABLE 3.1
Classification of Petroleum Crude
Examples
Classification API Range Crude Name, API
Light >33 • Saudi super light, 39.5
• Nigerian light, 36
• North Sea Brent, 37
Medium 28–33 • Kuwait, 31
• Venezuela light, 30
Heavy <28 • Saudi heavy, 28
• Venezuela heavy, 24
Typically, leading producers such as Saudi Arabia, Kuwait, and Iran will
issue one comprehensive crude assay for all the light fields, as it would be
logistically difficult to segregate the crudes from the same family, consider-
ing the required assets and capital investment needs.
The main constituent of crude oils is a hydrocarbon mixture with varying
amounts of non-hydrocarbon compounds. Table 3.2 presents a summary of all
hydrocarbon constituents found in crude oil as well as its associated gas. All
hydrocarbon classes except alkenes are present in crude oils. Alkanes, cyclo-
alkanes, and mono- and polynuclear aromatics have been identified in crude
oils. The ratio of these classes, however, differs appreciably from one type of
crude to another. Light hydrocarbon gases such as methane and ethane may
be present in small amounts dissolved in the crude or in large amounts as in
associated gas. Associated gas is mainly constituted of methane, ethane, and
propane. This gas is a valuable raw material for many petrochemicals.
In addition to the hydrocarbon mixture, crude oils contain variable amounts
of non-hydrocarbon compounds such as sulfur, nitrogen, vanadium, and
oxygen compounds, and sometimes mercury is present. These compounds
are sometimes referred to as impurities; they affect the handling, shipping,
and processing of the crude as well as its market value.
Additional processing schemes may be required to reduce sulfur and
nitrogen compounds in the intermediates and the products. A refiner would
prefer to process a low-sulfur crude since this will reduce the cost of hydro-
gen required for hydrotreatment of the products. Crude oils also contain
trace amounts of heavy metals in the form of organometallic compounds
and some inorganic salts, mainly sodium chloride. Some of these heavy met-
als, such as vanadium and nickel, are poisonous to some processing catalysts
and should be reduced to low levels. Crude oils having a high salt content
should also be desalted before refining to reduce corrosion problems, as dis-
cussed in Chapter 18. The composition of crude oils, by major elements, is
shown in Table 3.3.
At ambient temperatures, crude oil products may be light saturated
hydrocarbon gases, such as methane, or ethane, unsaturated gases, such as
44
TABLE 3.2
Characteristics of Crude Oils
Tests Test Methods Arab Extra Light (BERRI) Arab Light Arab Medium Arab Heavy
Gravity, OAPI ASTM D-287 38 33.8 31.2 28.1
Ash, ppm ASTM D-482 21 43 56 108
Pour Point, OF ASTM D-97 0 5 10 −10
Hydrogen Sulfide, ppm IP 103T 70 36 56 N11
Sediment & Water, Vol % ASTM D-96 Trace 0.1 Trace Trace
Sulfur, wt. % ASTM D-129 1.17 1.75 2.48 2.83
Viscosity, SUS @100OF ASTM D-445 38 50 61.8 108.8
Con. Carbon, Wt% ASTM D-189 3.65 3.83 5.71 7.86
Distillation Yield ASTM D-285
Vol. % @350OF 27.7 23.3 21.7 18
375OF 30.3 26.3 23.7 20
400OF 33.3 29.2 26 22
425OF 36.3 32 28.7 25
450OF 39.3 35 31 26
475OF 42.3 36.7 33.3 28
500OF 45.7 40 36 31
525OF 48.7 42 39 33
Source: Farahat, Mohammad Ali, Ul Hasan, Misbah, and Saleem, Mohamad, Distribution of Sulfur Compounds in Arab Crudes, SPE 9583, 1981.
Petroleum Economics and Engineering
Characteristics of Crude Oils and Properties of Petroleum Products 45
TABLE 3.3
Composition of Petroleum Crude
Element Percent by Weight (%)
Carbon 83–87
Hydrogen 11–14
Sulfur 0.05–2.5a
Nitrogen 0.1–2a
Oxygen 0–2a
Minerals and salts 0–0.1
Source: Farahat, Mohammad Ali, Ul Hasan, Misbah, and Saleem,
Mohamad, Distribution of Sulfur Compounds in Arab
Crudes, SPE 9583, 1981. With permission.
a Regarded as impurities.
3.3 Hydrocarbons
The major constituents of most crude oils and their products are hydro-
carbon compounds made of hydrogen and carbon only. These compounds
belong to one of the following subclasses: alkanes, cycloalkanes, alkenes,
and aromatics.
46 Petroleum Economics and Engineering
Alkanes
Cycloalkanes
Alkenes
Aromatics
TABLE 3.4
Factors Affecting Quality of Crudes
Property Comment Range or Limitation
API gravity °API = 141.5/sp.gravity 131.5 From 20 to 45; for Middle
East oils it is around 35
Sulfur content High-sulfur oils require extensive Maximum of 0.5% by weight
processing
Carbon residue Related to the asphalt content in oil A lower carbon residue
means a higher quality oil
Salt content Severe corrosion takes place if the salt Up to 15 lb/1000 bbl of oil
content is high
Nitrogen content Not desirable if high; it causes Up to 0.25% by weight
poisoning of catalysts
Pour point The temperature in °F at which an oil The lower the pour point, the
will no longer flow from a standard lower the paraffin content
test tube of the oil
would normally mean a lower percentage of the valuable light and mid-
dle fractions.
Specific gravity is also used to calculate the mass or weight of crude oils
and its products. Usually crudes and products are first measured on a vol-
ume basis and then changed to the corresponding masses using the specific
gravity.
Another useful measure to determine the relative weights of crude oils is
the API gravity. The API gravity in degrees can be calculated mathematically
using the following equation:
Higher API gravity indicates a lighter crude or product, while a low API
gravity would mean heavy crude or product.
The following diagram illustrates the relation among the crude quality,
specific gravity, and the API as well as the price fundamentals for light/
heavy crudes.
Lighter
Crudes Higher
Price
High API
Heavier
Lower
Crudes
Price
High S.G.
Characteristics of Crude Oils and Properties of Petroleum Products 51
1.
Paraffinic constituents are predominantly paraffinic hydrocarbons
with a relatively lower percentage of aromatics and naphthenes.
52 Petroleum Economics and Engineering
2.
Naphthenics contain a relatively higher ratio of cycloparaffins and a
higher amount of asphalt than in paraffinic crudes.
3.
Asphaltics contain a relatively large amount of fused aromatic rings
and a high percentage of asphalt.
Another index used to indicate the crude type is the Watson characteriza-
tion (UOP) factor. This also relates the mid-boiling point of the fraction in
Kelvin degrees to the density.
( K 1/3 )
Watson correlation factor =
d
54 Petroleum Economics and Engineering
TABLE 3.5
General Properties of Crude Oils
Property Paraffin Base Asphalt Base
API gravity High Low
Naphtha content High Low
Naphtha octane number Low High
Naphtha odor Sweet Sour
Kerosene smoking tendency Low High
Diesel-fuel knocking tendency Low High
Lube-oil pour point High Low
Lube-oil content High Low
Lube-oil viscosity index High Low
TABLE 3.6
Typical Analysis of Some Crude Oils
Arab Heavy Alamein
(Saudi Arabia) (Egypt)
Specific gravity at 60/60°F API 28.0 33.4
Carbon residue (wt%) 6.8 4.9
Sulfur content (wt%) 2.8 0.86
Nitrogen content (wt%) 0.15 0.12
Pour point (°F) –11.0 35.0
Ash content (ppm) 120.0 40.0
Iron (ppm) 1.0 0.0
Nickel (ppm) 9.0 0.0
Vanadium (ppm) 30.0 15.0
Paraffin wax content (wt%) — 3.3
TABLE 3.7
Chemical Composition of Petroleum Fractions
Boiling Range 50% Paraffin-Base Crude (wt%) Asphaltic-Base Crude (wt%)
Fraction ASTM Distillation °F Paraffin Naphtha Aromatic Paraffin Naphtha Aromatic Unsaturates
Gasoline 280 65 30 5 635 55 10
Kerosene 450 60 30 10 25 50 25
Gas oil 600 35 55 15 — 65 33 2
Heavy distillate 750 20 65 15 — 55 43 2
Characteristics of Crude Oils and Properties of Petroleum Products
55
56 Petroleum Economics and Engineering
LPG
Naphtha
Crude Distillation Unit
Reforming
Units Gasoline
Treating Unit
Desulfurization
Unit Diesel
FCC
Vacuum
Distillation HCK
TABLE 3.8
The Major Refinery Process Units
Process Feed Major Products Catalyst
Crude distillation Raw crude LPG None
Naphtha
Kerosene
Diesel
Fuel oil
Vacuum Fuel oil, distillation VGO None
bottoms Fuels
Platformer/rheniformer Naphtha Platformate Yes
93–95 octane
Continuous catalytic reforming Naphtha Platformate Yes
(CCR) 100+ octane
Fluidized catalytic cracking (FCC) Vacuum gas oil Platformate Yes
(VGO)
Hydrocracker (HCK) Atmospheric residue Naphtha Yes
Diesel
Hydro-de-sulfurization (HDS) High sulfur diesel Low sulfur diesel Yes
Isomerization C4/C5 paraffins Gasoline blending Yes
component
Vis-breaker Vacuum bottoms Fuel oil blends None
Asphalt oxidizer Vacuum bottoms Asphalt None
58 Petroleum Economics and Engineering
3.8.2 Hydrogen
Hydrogen is a valuable coproduct; with reformer gasoline, the main catalytic
reforming reactions are hydrogen producing (dehydrogenation). Product
hydrogen from catalytic reformers is not pure and is always mixed with
methane and ethane. Another source of refinery hydrogen (small amount
with other gases) is the catalytic cracking process. Refinery hydrogen is
mainly utilized in hydrodesulfurization, hydrocracking, hydrodealkylation,
and isomerization processes.
Excess hydrogen after refinery needs may be marketed to fertilizer firms
for the production of ammonia. Chemical hydrogen, however, is produced
from the steam reforming or partial oxidation of any carbonaceous material,
including crude oils and their products. Methane is the preferred feedstock
for the production of synthesis gas (a mixture of H2 and CO). Hydrogen is
a valuable raw material for ammonia and urea synthesis and with carbon
monoxide for the production of methanol.
H 2 S + 3/2 O 2 → SO 2 + H 2 O
SO 2 + 2H 2 S → 2S + 2H 2 O
The main source of hydrogen sulfide is refinery gases, which should be
treated to remove hydrogen sulfide. This may be done through either a
Characteristics of Crude Oils and Properties of Petroleum Products 59
3.8.4.1 Naphtha
Naphtha is the lightest side stream from an atmospheric distillation unit.
Light naphtha (boiling range approximately 36 to 80°C) is added to the refor-
mate to adjust its volatility. Light naphtha is not used as a feed to catalytic
reformers since it has a high percentage of low-molecular-weight hydrocar-
bons that are not suitable for aromatization.
Heavy naphtha contains a heavier mixture of hydrocarbons (boiling range
approximately 70 to 160°C) than light naphtha. Reforming heavy naphtha in
a catalytic reformer is a process to change the molecular structure of C6 –
C8 to aromatic hydrocarbons and to isomerize straight-chain molecules to
the branched isomers. Aromatic hydrocarbons and branched straight-chain
alkanes have high octane ratings. Depending on the crude oil base, naph-
tha rich in cyclohexanes and substituted cyclopentanes and cyclohexanes
would be a more suitable feed to catalytic reformers than naphtha rich in
paraffinic compounds. This is attributed to the ease of dehydrogenation of
naphthenes rather than the dehydrocyclization of paraffins to naphthenes
followed by dehydrogenation.
Heavy naphtha is also the preferred feedstock for olefin production in
Europe. The price of naphtha will always depend on the demand for ethyl-
ene production and the availability of ethane as an alternative feed to cracker
units, as well as the gasoline demand and market supply.
3.8.4.2 Gasoline
Straight-run naphtha is not suitable for direct use in motor gasoline engines
because of its unfavorable knocking characteristics. The addition of anti-
knock additives increases the octane rating of the naphtha. A maximum
limit has been designated for the lead additive due to its toxicity. In many
60 Petroleum Economics and Engineering
parts of the world, the use of lead alkyls has been limited to very low levels
or banned for use in new automobiles. Unleaded or no-lead gasolines are the
major grades now used in the United States and Canada.
Marketable gasoline is usually a blend of light naphtha and a high-octane
hydrocarbon mixture from any of the processes that produce high-octane
hydrocarbons called reformate. The main processes used for this purpose
are platforming, catalytic cracking, hydrocracking, alkylation of olefins,
isomerization of C5/C6 naphtha cut, and polymerization of C3–C4 olefins. A
mixture of one or more of the products in the gasoline range from these
processes plus light naphtha makes the gasoline pool. The vapor pressure
of the mixture is adjusted according to the specifications (summer grade,
intermediate, or winter) by adding natural gasoline or pentanes. The two
most important characteristics for marketable gasoline are the octane rating
and the volatility.
The octane rating of a hydrocarbon is a measure of a property of the hydro-
carbon to produce a knock when used in a gasoline internal combustion
engine. This property depends on the molecular structure of the hydrocar-
bon. Straight-chain hydrocarbons in the gasoline range have a much lower
knock characteristic in comparison to aromatic hydrocarbons. Branched
alkanes have higher octane ratings compared to their straight-chain isomers.
Since gasolines are a mixture of compounds from different hydrocarbon
classes, the octane rating of the mixture is approximately the sum of octane
ratings of the individual components according to their ratios.
Table 3.9 shows the octane ratings of some hydrocarbons and some oxygen-
ated compounds. A substantial amount of research has been invested to use
alcohols either as additives to the gasoline pool or as alternate motor fuels
(Matar, 1982). Methyl and ethyl alcohols have high octane rating. However,
some problems are still associated with the widespread use of alcohols or
their blends as motor fuels. This subject has been reviewed thoroughly by
Keller (1979).
Volatility of gasolines is a property related to cold startability of the
engine in winter and to vapor lock problems generally encountered in
hot driving conditions. Vapor lock is a set of engine operating difficulties
attributable to an excess of extremely volatile constituents in the motor fuel
or to high temperatures in the gasoline engine system. Fuel supply is inter-
rupted by formation of bubbles of vapor in supply lines, pumps, or carbure-
tor passages.
Two tests are generally used to indicate the volatility of gasolines: Reid
vapor pressure and distillation. The Reid vapor pressure test (ASTM D-323)
is the vapor pressure at 100°F of a gasoline sample placed in a bomb in which
the liquid volume is one-fifth of the total volume. Although Reid vapor pres-
sure is not the same as the true vapor pressure, it is a simple test for indi-
cating vapor lock tendencies and the explosion and evaporation hazards.
Normally Reid vapor pressure values are specified for gasolines used during
winter and summer.
Characteristics of Crude Oils and Properties of Petroleum Products 61
TABLE 3.9
Octane Ratings of Hydrocarbons and Some Oxygenated Compounds in the
Gasoline Range
Boiling Research Octane Motor Octane
Compound Point (°C) Number Number
n-Pentane 36.1 61.7 61.9
2-Methylbutane 27.8 92.3 90.3
2,2-Dimethylbutane 50.0 91.8 93.4
2,3-Dimethylbutane 58.3 103.5 94.3
n-Hexane 68.9 24.8 26.0
2-Methylpentane 63.3 73.4 73.5
3-Methylpentane 60.0 74.5 74.3
n-Heptane 97.8 00.0 00.0
n-Octane 125.6 –19.0 –15.0
2,2,4-Trimethylpentane (isooctane) 99.4 100.0 100.0
Benzene 80.0 — 114.8
Toluene 110.6 120.1 103.5
Ethylbenzene 136.7 107.4 97.9
O-Oxylene 144.4 120.0 103.0
m-Xylene 139.4 145.0 124.0
p-Xylene 138.3 146.0 127.0
Reformate gasoline (100 RON) 0.0 100.0 88.
Methyl alcohol 0.0 112.0 92.0
Ethyl alcohol 0.0 110.0 90.0
Methyl-tertiary butyl-ether (MTBE) 0.0 118.0 0.0
Tertiary-amyl-methyl-ether (TAME) 0.0 112.0 0.0
3.8.4.4 Kerosene
Kerosene is the fraction heavier than naphtha (BP range approximately 150
to 290°C). It may be produced from atmospheric distillation or from hydro-
cracking units. Kerosene produced from catalytic cracking and delayed
coking units contains unsaturated hydrocarbons which affect its stability.
Hydrotreatment is used to saturate olefinic compounds and to hydrogenate
sulfur and nitrogen compounds in kerosenes from cracking units.
Kerosenes have been extensively used in heating purposes. However,
most of the kerosene produced in the United States and Europe is used for
the production of jet fuels. Since all the important uses of kerosene involve
burning under specified conditions, its physical and chemical properties
are important. The types of hydrocarbons present, the sulfur content, and
the corrosive sulfur compounds and amount of residue left after burning
can affect the burning quality of kerosene. For example, aromatic hydro-
carbons are known to be more smoke-forming than paraffinic hydrocar-
bons. The smoke point test and the flush point and thermal stability are
normally done for kerosenes and jet fuels.
Kerosene is a clear, almost colorless liquid that does not stop flowing in cold
weather except below –30°C. Its specific gravity ranges between 0.79 and 0.81.
It has been used in the past as a fuel for lamps and is still used for that pur-
pose in remote areas where electricity is expensive. It is also used as a burn-
ing fuel and for heating purposes. n-Paraffins in the range of C12–C14 may be
extracted from kerosenes, especially those from paraffinic base crudes. These
paraffins are used in the production of biodegradable detergents.
Jet fuels or aircraft turbine fuels are hydrocarbon mixtures in the kerosene
range. Due to their use in engines at much lower temperatures, the freezing
point of these fuels is important. The aromatic content of jet fuels is also
important since it affects the burning quality of the fuel. This is indicated by
the smoke point, which is defined as the height of the flame in millimeters
beyond which smoking takes places (ASTM D-1322). Military-type jet fuel
(JP-4) is principally naphtha containing some kerosene. Accordingly, it has a
wider boiling range than commercial jet fuels such as JP-A-1.
TABLE 3.10
Products Made by the U.S. Petroleum Industry
Class Number of Products
Fuel gas 1
Liquefied gases 13
Gasolines 40
Motor 19
Aviation 9
Other (tractor, marine, etc.) 12
Gas turbine (jet) fuels 5
Kerosenes 10
Distillates (diesel fuels and light fuel oils) 27
Residual fuel oils 16
Lubricating oils 1156
White oils 100
Rust preventatives 65
Transformer and cable oils 12
Greases 271
Waxes 113
Asphalts 209
Cokes 4
Carbon blacks 5
Chemicals, solvents, miscellaneous 300
Total number of products 2347
Principle 1: One dollar now is worth more than a dollar at a later time.
This explained by the Time Value of Money (TVM).
Principle 2: Three parameters influence the TVM:
Inflation
Risk
Cost of money (interest)
Of these, the cost of money is the most predictable, and hence it is the
essential component in our economic analysis.
Principle 3: Additional risk is not taken without the expected addi-
tional return.
Basic Concepts
• Cash flow
• Interest rate and time value of money
• Equivalence technique
* Unless otherwise indicated, all such cash flows are considered to occur at
the end of their respective periods.
4
Time Value of Money (TVM)
in Capital Expenditures
M. Bassyouni
CONTENTS
4.1 Basic Definitions........................................................................................... 70
4.1.1 Capital Investment............................................................................ 70
4.1.2 Interest................................................................................................ 70
4.2 Types of Interest............................................................................................ 71
4.3 Interest Calculation...................................................................................... 71
4.4 Effective Interest........................................................................................... 73
4.5 Annuities and Periodic Payments.............................................................. 76
4.5.1 Derivation of the Basic Equation (Sinking Fund Factor).............77
4.5.2 Applications of the Annuity Technique........................................ 78
4.5.2.1 Determining the Annual Depreciation Costs................ 78
4.5.2.2 Determining the Annual Capital Recovery Costs........ 78
4.6 Capitalized Costs.......................................................................................... 81
4.6.1 Calculation of Capitalized Costs of an Asset to Be
Replaced Perpetually....................................................................... 81
4.6.2 Calculation of the Capitalized Costs of a Perpetual
Annual Expense................................................................................ 81
4.7 Equivalence....................................................................................................83
4.8 Formulas and Applications: Summary......................................................84
4.8.1 Formulas.............................................................................................84
4.8.2 Practical Applications and Case Studies....................................... 87
Notation................................................................................................................... 91
69
70 Petroleum Economics and Engineering
P = F/(1 + i)
4.1.2 Interest
Interest may be defined as the compensation paid for the use of borrowed
capital. The recognized standard is the prime interest rate, which is charged by
banks to their customers. This definition is the one adopted by engineers; the
classical definition describes interest as the money returned to the investors
Time Value of Money (TVM) in Capital Expenditures 71
for the use of their capital. This would mean that any profit obtained by
using this capital is considered interest, which is not true. Instead a distinc-
tion is to be made between interest and the rate of return on capital.
Types of Interest
Discrete Continuous
FIGURE 4.1
Mathematical definition and classification of interest.
72 Petroleum Economics and Engineering
Using simple interest: the amount of money to be paid on the borrowed capi-
tal P, is given by: (P) (i) (n).
Hence the sum of capital plus the interest due after n interest periods will
be denoted by:
F = P + Pin = P(1 + in) (4.1)
where F is the future value of the capital P.
Using compound interest: the amount due after any discrete number of inter-
est periods can be calculated as follows:
Example 4.1
A sum of $1,000 is deposited into an account where the interest rate is
10% compounded annually; compare the future values of the deposit for
the two cases of simple and compound interest after 4 years.
1600
1400
1200
Simple Interest ($)
1000
800
600
400
200
0
1st year: 2nd year: 3rd year: 4th year:
F1=Po+Interest F2=F1+Interest F3=F2+Interest F4=F3+Interest
1600
1400
Compound Interest ($)
1200
1000
800
600
400
200
0
1st year: 2nd year: 3rd year: 4th year:
F1=P(1+i)1 F2=P(1+i)2 F3=P(1+i)3 F4=P(1+i)4
The effective interest rate, “ie” is related to the nominal interest rate “ i ” as
follows:
If “ i ” is the nominal interest rate stated under the conditions for “m” com-
pounding time periods per year, then the interest rate for one period is given
by i /m . Hence the future value after 1 year is
F1 = P(1 + ie ) (4.4)
Equating Equations (4.3) and (4.4), the effective interest rate “ie” is related to
i and m as given by Equation (4.5):
m
i
ie = 1 + − 1 (4.5)
m
To find the future worth after n years using the nominal interest rate,
Equation (4.3) takes the following form:
Example 4.2
To illustrate the value of knowledge of the effective interest rate to oil
management, assume that a short-term loan for 1 year only could be
arranged for an oil company in temporary distress. The company needs
$100,000 for immediate working capital at either a nominal rate of 12%
compounded monthly or a nominal rate of 15% compounded semian-
nually. The oil company wants to know which arrangement would
provide the oil company with the lower debt at the end of the short-
term loan period. The use of the effective interest rate formula gives
the answer.
SOLUTION
On a nominal 12% rate compounded monthly, and using Equation (4.5):
12
0.12
Effective interest rate = 1 + −1
12
= (1.01)12 − 1
18000
Interest at the end of one year ($)
16000
14000
12000
10000
8000
6000
4000
2000
0
One year: On nominal 12% rate, One year: On nominal 15% rate,
compounded monthly compounded semiannually
2
0.15
Effective interest rate = 1 + −1
2
= (1.075)2 − 1
The loan at 12% compounded monthly has the lower effective interest rate,
or 12.7% and 15.6% for the loan arrangement using a nominal rate of 15%
compounded semiannually. Thus the oil company will borrow $100,000
for 1 year at 12% interest compounded monthly, paying back the loan at
the end of 1 year with $112,700, which includes $12,700 in interest, instead
of borrowing at 15% compounded semiannually, which would cost
$15,600 in interest as illustrated in Figure 4.3, and a total of $115,600. Thus
the oil company saves $2,900 by borrowing at 12% compounded monthly.
CONTINUOUS INTEREST
The final type of interest to be discussed here is what is known as con-
tinuous compounded interest. So far, we have considered payments to be
charged at periodic and discrete intervals—a year, a month, a week. As
the time interval for this discrete compounding interest is allowed to
become infinitesimally small (i.e., approaches zero), the interest is said to
be compounded continuously.
Equations are derived as follows:
If m approaches infinity, Equation (4.6) is rewritten in the following form:
F = P lim (1 + i /m)mn
m→∞
F = P e in
where mlim(1
→∞
+ i /m) m/ i
= e , the base of the natural system of logarithms.
76 Petroleum Economics and Engineering
Example 4.3
1. What is the accumulated sum after 1 year for a $1,000 principal
compounded daily at a nominal interest rate of 20%?
2. Repeat if compounding is done continuously.
3. Calculate “ie” for both cases.
SOLUTION
1. Using Equation (4.3), where P = $1,000, i = 0.20, m = 365:
365
0.20
F1 = 1, 000 1 + = $1, 221.3
365
2. Using Equation (4.7), where n = 1:
C = (1 + i)n (4.9)
D = (1 + i)− n (4.10)
Time Value of Money (TVM) in Capital Expenditures 77
350
Continuous compound interest
Simple interest
Discrete compound interest
Total amount accumulated of
300
5% annual interest rate, ($)
250
200
150
100
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28
Time in Years
A[(1 + i)n − 1
F= (4.11)
1
The above factor [(1 + i)n – 1]/i is known as the compound amount factor or
sinking fund factor.
i
Ad = Fo (4.12)
(1 + i ) n
− 1
i(1 + i)n
Ar = P (4.15)
(1 + i) − 1
n
where [i(1 + i)n/(1 + i)n – 1] is known as the capital recovery factor.
Time Value of Money (TVM) in Capital Expenditures 79
Example 4.4
The capital cost of a small portable pump is $7,000, with a lifetime of 20
years. If money can be invested at 6% (annual interest rate), calculate the
annual depreciation costs and the annual capital recovery and compare
between the two values.
SOLUTION
In order to protect the original capital (principal), the annual deprecia-
tion costs are calculated using Equation (4.12).
0.06
Ad = 7000 = $190.29
(1.06) − 1
20
In other words, the sum of these Ad ’s plus the interest accumulating in a
sinking-fund annuity will generate exactly the $7,000.
What about the “cost” of using the capital? Provision must be made in
order to create an incentive in using this investment. If this $7,000 had
been deposited in a bank, it would have generated a return or interest
as follows:
F = 7,000(1 + 0.06)20 = $22,450
Since this F is the same future worth of the annuity we are looking for,
and developed above by Equation (4.13), the value of Ar is calculated
directly as given by Equation (4.15):
i(1 + i)n
Ar = P n
(1 + i)
0.06(1.06)20
= 7000 = $610.3
(1.06) − 1
20
It is seen now that the sum of these Ar’s plus the interest accumulating
in a sinking-fund annuity will generate $22,450. Specifically, the annual
capital recovery costs will include the annual depreciation costs plus the
annual interest cost on the principal.
To relate Ad to Ar:
Equation (4.15)
Ar/Ad =
Equation (4.12)
and since Fo in Equation (4.12) is by definition the original principal or
capital investment, P, this gives:
Ar/Ad = (1 + i)m
P F
Ad
$190.29
Equation 4–16
Ar
$ 610.3
FIGURE 4.5
Solution of Example 4.4 to illustrate the concept of capital recovery, where n = 10 years and i
= 0.06.
Time Value of Money (TVM) in Capital Expenditures 81
Annuity → n years
Perpetuity → ∞ years
To establish a perpetuity based on capitalized costs for equipment, we should
have an accumulated amount of money, K, in order to provide funds for:
Hence, K = CV + P (4.17)
C (1 + i)n
K = Vs + R n (4.20)
(1 + i) − 1
where Cv = CR + Vs; that is, the cost of new equipment equals the replacement
cost plus the salvage value (Vs).
Example 4.5
Management of an oil company is considering purchase of a bench-
scale reverse-osmosis desalination unit. The installed cost of the unit is
$12,000, its lifetime is 10 years, and the salvage value is $2,000. You have
been asked to calculate the capitalized cost of the perpetual service of
this unit, assuming that interest is compounded at 6% annually.
SOLUTION
Using Equation (4.20) (since no annual operating expense is involved in
this case), the capitalized cost is calculated directly:
10, 000(1.06)10
K = 2000 +
(1.06) − 1
10
= $24, 650
A detailed illustration of how the perpetual replacement takes place is
given in Figure 4.6.
Steps (1) and (2) are carried out only once at the initiation of the project
(for the first period only, i.e., for the first 10 years). Steps (3) through (7)
are what we call a perpetual loop that goes on and on. One period is made
up of 10 years.
Time Value of Money (TVM) in Capital Expenditures 83
Step (1):
K Buy a new machine
V0
Start for $12,000
$12,000
$24,650
Step (6):
Step (7):
Sell after 10 years
Buy a new machine
V8
$2,000
Step (2):
Deposit $12,650 in Sum
the bank 2,000
+
10,000
$ 12,000
CR
$10,000
FIGURE 4.6
Solution of Example 4.5 illustrating the concept of perpetuity and capitalized costs. Steps (1)
and (2) are carried out only once at the initiation of the project (for the first period only, i.e., for
the first 10 years). Steps (3) through (7) are what we call a perpetual loop that goes on and on. One
period is made up of 10 years.
4.7 Equivalence
The knowledge of equivalent values can be of importance to oil companies.
The concept of equivalence is the cornerstone for comparisons of time values of
money comparisons. Incomes and expenditures are identified with time as well
as with amounts. Alternatives with receipts and disbursements can be compared
by use of equivalent results at a given date, thus aiding in decision making.
The concept that payments that differ in total magnitude but that are made
at different dates may be equivalent to one another is important in engineer-
ing economy.
84 Petroleum Economics and Engineering
SOLUTION
As shown in Table 4.1, Plan 1 involves the annual payment of interest only
($600) until the end. Plans 2 and 3 involve systematic reduction of the
principal of the debt ($10,000). For Plan 2 this is done by uniform repay-
ment of principal ($l,000/yr) along with diminishing interest, while for
Plan 3 a scheme is devised to allow for uniform annual payment for both
capital and interest all the way through until the end ($1,359). For Plan 4,
on the other hand, payment is done only once at the end of the 10th year.
The equivalence of the four payments is further illustrated in Figure 4.7.
Example 4.7
Show how $100,000 received by an oil company today can be translated
into equivalent alternatives. Assume money is worth 8%.
SOLUTION
Cash flow is translated to a given point in time by determining the
present value or the future value of the cash flow. Accordingly, $100,000
today is equivalent to $215,900 10 years from now (using the formula
Find F/Given P in the next section or the tables in Appendix A). Also,
$100,000 today is equivalent to $25,046 received at the end of each year
for the next 5 years (using the formula Find Ar/Given P). Many other
options can be selected for different periods of time. Figure 4.8 illus-
trates this concept.
TABLE 4.1
Summary of the Four Plans for Solving Example 4.6
Plan 1 Plan 2 Plan 3 Plan 4
Year Investment ($) ($) ($) ($)
0 $10,000
1 600 1,600 1,359
2 600 1,540 1,359
3 600 1,480 1,359
4 600 1,420 1,359
5 600 1,360 1,359
6 600 1,300 1,359
7 600 1,240 1,369
8 600 1,180 1,359
9 600 1,120 1,359
10 10,600 1,060 1,359 17,910
where
i represents interest rate per interest period
n represents number of periods of interest payments (year, month, etc.)
P represents value of principal, $ (present),
A represents annual payments or receipts, $/yr
F represents future value, $
In Equation (4.25), A can stand for the annual depreciation costs and is des-
ignated as Ad (as given by Equation 4.12) or it can represent the annual capital
recovery costs and is referred to as Ar (as given by Equation 4.13).
86 Petroleum Economics and Engineering
$10,000
Receipts
5 10
$10,000
Receipts
5 10
1,600
1,540
1,480
1,420
1,360
1,300
1,240
1,180
1,120
1,060
Payments
(b)
$10,000
Receipts
5 10
$10,000
Receipts
5 10
Payments
(d)
$17,908
FIGURE 4.7
Solution of Example 4.6.
Time Value of Money (TVM) in Capital Expenditures 87
$ 215,900
n = 10 yrs 0
$ 100,000
5 4 3 2 1 0
$ 100,000
FIGURE 4.8
Solution of Example 4.7.
Example 4.8
In 10 years, it is estimated that $144,860 (future value) will be required
to purchase several cooling towers. Interest available at the bank is 8%
compounded annually. Calculate the annual annuity payment that will
amount to the given fund after 10 years of deposit.
SOLUTION
Using the compound interest tables in Appendix A, and the formula
Find A/Given F (Equation 4.25) for 8% and 10 years, we get:
A = (144, 860)(0.06903)
TABLE 4.2
Tabulation of Results for Example 4.8
Payment
with Interest Amount in
Payment into Compound Compound into Fund Sinking
Year Fund ($) Interest Factor Interest (col.2* 4) ($) Fund ($)
1 10,000 (1 + i)n − 1 (1 + 0.08)9 19,990 19,990
2 10,000 (1 + i)n − 2 (1 + 0.08)8 18,510 38,500
3 10,000 (1 + i)n − 3 (1 + 0.08)7 17,140 55,640
4 10,000 (1 + i)n − 4 (1 + 0.08)6 15,870 71,510
5 10,000 (1 + i)n − 5 (1 + 0.08)5 14,690 86,200
6 10,000 (1 + i)n − 6 (1 + 0.08)4 13,600 99,800
7 10,000 (1 + i)n − 7 (1 + 0.08)3 12,600 112,400
8 10,000 (1 + i)n − 8 (1 + 0.08)2 11,660 124,060
9 10,000 (1 + i)n − 9 (1 + 0.08)1 10,800 134,860
10 10,000 (1 + i)n − 10 (1 + 0.08)0 10,000 144,860
Totals $100,000 $144,860
Thus each year a payment or deposit of $10,000 should be made into the
sinking fund at 8% compounded annually. After 10 years, the fund will
contain $144,860 with which the oil company can purchase cooling towers
as provided for by the fund. Table 4.2 tabulates the future value at the end
of 10 years of $144,860, with total deposits of $100,000. At the end of the sec-
ond year the fund shows a total of $38,500, and at the end of the fifth year
a total of $86,200. Amounts into the fund, including interest, decrease as
each year progresses, with no interest being included in the 10th payment.
Example 4.9
A sinking fund is to be established to cover the capitalized cost of tem-
perature recorders. The recorders cost $2,000 and must be replaced every
5 years. Maintenance and repairs come to $200 a year. At the end of 5
years the accumulated sinking fund deposits are expected to cover the
capitalized cost of continuous expense for these recorders. How much
money must be deposited each year, at an interest rate of, say, 5%, to
cover the capitalized costs at the end of 5 years?
SOLUTION
Two methods are proposed to solve this problem:
1. Using Equation (4.22), where Vs = 0 and CR = $2,000:
(1.05)5 200
K, total capitalized cost = 2000 +
(1.05)5 − 1 0.05
= 9,238.5 + 4,000
= $13,238.5
Time Value of Money (TVM) in Capital Expenditures 89
Example 4.10
In Example 4.9, the annual sum of money of $362 was calculated, which
recovers the principal value of the temperature recorders if deposited
in a sinking fund ($2,000). What about the cost of the capital (interest
on capital)?
Calculate the annual capital recovery costs (Ar) and compare with the
annual depreciation cost (Ad).
SOLUTION
In solving Example 4.9, the annual depreciation cost was calculated by:
0.05
Ad = 2, 000
(1.05) − 1
n
= $362/year
In order to calculate the annual capital recovery costs, use is made of
Equation (4.26) as follows:
0.05(1.05)5
A r = 2, 000 = 2, 000(0.23097)
(1.05) − 1
5
= $462/yr
Now, the difference between Ar and Ad equals 462 – 362 = 100/year.
This $100 accounts for the annual cost (interest) on the capital ($2,000),
which makes:
(100/2000)(100) = 5%
90 Petroleum Economics and Engineering
Also, using Equation (4.28), we can check the value of Ar, given Ad:
Ar = (362)(1.05)5
= $462
Example 4.11
An oil production company wishes to repay in 10 installments a
sum of $100,000 borrowed at 8% annual interest rate. Determine the
amount of each future annuity payment Ar required to accumulate
the given present value (debt) of $100,000 for a number of payments
of 10 years.
SOLUTION
Find Ar/Given P:
Ar = (100, 000)(0.14903)
= $14, 903/year
Thus for 10 years, $149,030 would have been paid: $100,000 as principal
and $49,030 as interest.
The $100,000 is the present value of the 10-year annuity and the $14,903
is the annual payment, or the annual capital recovery by the creditor.
Example 4.12
An oil-exploration company plans to take over offshore operations 7
years from now. It is desired to have $250,000 by that time. If $100,000 is
available for investment at the present time, what is the annual interest
rate the company should require to have that sum of money?
SOLUTION
Using Equation (4.23), where
P = $100,000
F = 25,000
n = 7 years
i = to be found
250,000 = 100,000(1 + i)7
Solving for i: The interest rate = 14%, which is rather high to realize.
Time Value of Money (TVM) in Capital Expenditures 91
Example 4.13
During the treatment of associated natural gas it was decided to install a
knockout drum in the feedline of the plant. This vessel can be purchased
and installed for $40,000 and will last for 10 years. An old vessel is avail-
able and can be used but needs to be repaired. However, the repairing
has to be done every 3 years. If it is assumed that the two vessels (the
new and the old ones) have equal capitalized costs, how much does
the maintenance department have to spend repairing the old knockout
drum? Assume interest is 10%.
SOLUTION
Assuming the salvage value, Vs = 0. Equation (4.20) gives: K = CR.
Comparing the new vessel with the old vessel:
(1.1)10 (1.1)3
10, 000 = C
(1.1) − 1 (1.1)3 − 1
10 R
Solving for CR, it is found that the maximum amount the maintenance
department can spend on repairing the old vessel (perpetual service)
is $4,047.
In concluding this chapter, steps in the use of compound interest fac-
tors or formulas involving F, P, and A for measurement and determina-
tion of time values of money for expansion or replacement of older assets
are given as follows:
1. Determine what is wanted—F, P, or A.
2. Determine what is given—F, P, or A.
3. Then apply the formula as to what is given and what is desired,
or use the appropriate compound factor for the formula (found
in Appendix A) with the desired rate of interest (i).
Notation
A, Annual payment ($/yr)
Ad, Annual payment, sinking fund depreciation ($/yr)
Ar, Annual capital recovery ($/yr)
C, Compound interest factor (1 + i)n
Cv, Original value of equipment ($), also denoted as (Vo)
92 Petroleum Economics and Engineering
Faheem H. Akhtar
CONTENTS
5.1 Introduction and Basic Definitions............................................................ 94
5.2 Valuation of Assets Using Depreciation and Depletion: General
Outlook........................................................................................................... 97
5.3 Methods for Determining Depreciation.................................................... 99
5.3.1 Straight-Line Depreciation (S.L.D.)................................................. 99
5.3.2 Declining Balance Depreciation (D.B.D.)..................................... 101
5.3.3 Sum-of-the-Digits Depreciation (S.D.D.)...................................... 103
5.3.4 Sinking Fund Depreciation (S.F.D.).............................................. 105
5.4 Methods for Determining Depletion....................................................... 111
5.4.1 Background...................................................................................... 111
5.4.2 Methods............................................................................................ 112
5.4.3 Summary and Comparison........................................................... 114
Notation................................................................................................................. 116
93
94 Petroleum Economics and Engineering
TABLE 5.1
Estimated Service Life of Assets
Life (Years)
Group I: General Business Assets
1. Office furniture, fixtures, machines, equipment 10
2. Transportation
a. Aircraft 6
b. Automobile 3
c. Buses 9
d. General-purpose trucks 4–6
e. Railroad cars (except for railroad companies) 15
f. Tractor units 4
g. Trailers 6
h. Water transportation equipment 18
3. Land and site improvements (not otherwise covered) 20
4. Buildings (apartments, banks, factories, hotels, stores, warehouses) 40–60
Group II: Nonmanufacturing Activities (Excluding Transportation, Communications, and
Public Utilities)
1. Agriculture
a. Machinery and equipment 10
b. Animals 3–10
c. Trees and vines Variable
d. Farm buildings 25
2. Contract construction
a. General 5
b. Marine 12
3. Fishing Variable
4. Logging and sawmilling 6–10
5. Mining (excluding petroleum refining and smelting and refining of minerals)
6. Recreation and amusement 10
7. Services to general public 10
8. Wholesale and retail trade 10
Group III: Manufacturing
1. Aerospace industry 8
2. Apparel and textile products 9
3. Cement (excluding concrete products) 20
4. Chemicals and allied products 11
5. Electrical equipment
a. Electrical equipment in general 12
b. Electronic equipment 8
6. Fabricated metal products 12
7. Food products, except grains, sugar, and vegetable oil products 12
8. Glass products 14
(Continued)
96 Petroleum Economics and Engineering
TABLE 5.1 (Continued)
Estimated Service Life of Assets
Life
(Years)
9. Grain and grain-mill products 17
10. Knitwear and knit products 9
11. Leather products 11
12. Lumber, wood products, and furniture 10
13. Machinery not otherwise listed 12
14. Metalworking machinery 12
15. Motor vehicles and parts 12
16. Paper and allied products
a. Pulp and paper 16
b. Paper conversion 12
17. Petroleum and natural gas
a. Contract drilling and field service 6
b. Company exploration, drilling, and production 14
c. Petroleum refining 16
d. Marketing
18. Plastic products 11
19. Primary metals
a. Ferrous metals 18
b. Nonferrous metals 14
20. Printing and publishing 11
21. Scientific instruments, optical, and clock manufacturing 12
22. Railroad transportation equipment 12
23. Rubber products 14
24. Ship and boat building 12
25. Stone and clay products 15
26. Sugar products 18
27. Textile mill products 12–14
28. Tobacco products 15
29. Vegetable oil products 18
30. Other manufacturing in general 12
Group IV: Transportation, Communication, and Public Utilities
1. Air transport 6
2. Central steam production and distribution 28
3. Electric utilities
a. Hydraulic 50
b. Nuclear 20
c. Steam 28
d. Transmission and distribution 30
Depreciation and Depletion in Oil Projects 97
TABLE 5.1 (Continued)
Estimated Service Life of Assets
Life
(Years)
4. Gas utilities
a. Distribution 35
b. Manufacture 30
c. Natural-gas production 14
d. Trunk pipelines and storage 22
5. Motor transport (freight) 8
6. Motor transport (passengers) 8
7. Pipeline transportation 22
8. Radio and television broadcasting 6
9. Railroads
a. Machinery and equipment 14
b. Structures and similar improvements 30
c. Grading and other right-of-way improvements Variable
d. Wharves and docks 20
10. Telephone and telegraph communications Variable
11. Water transportation 20
12. Water utilities 50
Source: Peters, Max, Timmerhaus, Klaus, and West, Ronald, Plant Design and Economics for
Chemical Engineers, 5th Edition, McGraw-Hill, New York, 2003. With permission.
in their own countries. For example, in exploring and developing new leases
in the Arabian Gulf area, which could involve millions of dollars before pro-
duction or perhaps even with little chance of production success, oil compa-
nies could write off these costs against their overall revenues. This would
reduce their taxable income and thereby reduce income taxes they would be
liable to pay in their home countries.
To illustrate how both depreciation and depletion costs are calculated,
several methods of determining depreciation and depletion are given, with
examples of each.
Classification of
Depreciation
Methods
Declining Balance
Double Sum of the
Straight Line (SL) Sinking Fund (SF)
Declining Balance Digits (SD)
(DDB)
FIGURE 5.1
Methods used to calculate depreciation cost.
100 Petroleum Economics and Engineering
depreciation rate, $/year; Vo, Vs = original value and salvage values of asset,
$; and n = service life, years—
depreciable capital
then the annual depreciation cost = , or
n
Vo − Vs
d= (5.1)
n
Va = Vo − ( a)(d) (5.2)
24,000
V0
20,000
Straight line method
Multiple straight line method
Sum of the years, digits method
16,000
Declining balance method
Asset Depreciable Value ($)
12,000
8000
4000
Vs
0
0 2 4 6 8 10
Lift period in use, years
FIGURE 5.2
Comparison of different depreciation methods.
Depreciation and Depletion in Oil Projects 101
Example 5.1
An example of where this method might be used in the oil industry is a
heat exchanger. Suppose that the heat exchanger as shown in Figure 5.3
has a depreciable cost of $60,000 and will last for, say, 20 million bbl.
Calculate the annual depreciation cost of the heat exchanger if it is pro-
cessing 600,000 bbl yearly.
SOLUTION
The depreciation factor = 60,000/20,000,000 = $0.003 per bbl. The annual
depreciation, d = (600,000)(0.003) = $1,800.
Obviously, the amount of depreciation per time period can vary
greatly, depending on the activity level achieved by the oil company in
that period. As demand for oil increases, there is an increase in deprecia-
tion expense resulting from the increased use of the equipment.
FIGURE 5.3
Shell and tube heat exchanger.
102 Petroleum Economics and Engineering
Example 5.2
An example of how the double declining balance method is calculated
is given here. If we assume that an acid injection unit had an original
Depreciation and Depletion in Oil Projects 103
TABLE 5.2
Depreciation Schedule for Example 5.2
Remaining Depreciable
Year Depreciation Expense Book Value Cost
Start $25,000 $22,000 (with $3,000 salvage
value off)
After first year $10,000 (40% of $25,000) $15,000 $12,000 ($22,000–$10,000)
After second year $6,000 (40% of $15,000) $9,000 $6000 ($12,000–$6,000)
After third year $3,600 (40% of $9,000) $5,400 $2,400 ($6,000–$3,600)
After fourth year $2,160 (40% of $5,400) $3,240 $240 ($2,400–$2,160)
After fifth year $240 (depreciation before $3,000 0
salvage value)
SOLUTION
Since n = 5 years, the annual depreciation using S.L.D. will be 20%, and
the allowable fixed percentage to be applied using D.D.B.D. will be (2)
(20%) = 40%. The depreciation schedule would then be as shown in
Table 5.2.
n− a+1
“f”= n . (5.4)
∑
y =1
y
da would be = ( f )(Vo − Vs ).
4.
104 Petroleum Economics and Engineering
Finally,
n − a + 1
n (5.5)
da =
∑
y = 1
y (Vo − Vs )
2(n − a + 1)
= (Vo − Vs ) (5.6)
n(n + 1)
Example 5.3
A flow or recording control valve installed on the feed line of a caustic-
soda treating unit costs $4,000, with a service life of 5 years and scrap
value of $400. Calculate the annual depreciation cost using the S.D.D.
SOLUTION
The sum of arithmetic series of numbers from 1 to 5 = 1 + 2 + 3 + 4 + 5 =
15. Using Equation (5.5) or (5.6), we get:
5
d1 = (4000 − 400) = $1,200
15
4
d2 = (3600) = $960
15
d3 = $720
d4 = $480
d5 = $240
Sum = $3,600
1400
1200
Annual Depreciation $
1000
800
600
400
200
0
1 2 3 4 5
Years
Example 5.4
An automobile part had an original cost of $17,000 and its lifetime is 5
years. Calculate the annual depreciation cost and book value using the
S.D.D. The salvage value is taken to be $2,000.
SOLUTION
Calculations are shown in Table 5.3.
i
Ad = (Vo − Vs ) (5.7)
(1 + i)n − 1
TABLE 5.3
Depreciation Schedule for Example 5.4
Depreciation Expense + Remaining
Year $2,000 for Salvage Book Value Depreciable
Start 0 $17,000 $15,000
After first year $5,000 (5/15 of $15,000) $12,000 $10,000
After second year $4,000 (4/15 of $15,000) $8,000 $6,000
0
After third year $3,000 (3/15 of $15,000) $5,000 $3,000
After fourth year $2,000 (2/15 of $15,000) $3,000 $1,000
After fifth year $1,000 (1/15 of $15,000) $2,000 0
106 Petroleum Economics and Engineering
where (Vo – Vs) is the sum of the annuity accumulated in n years, which rep-
resents the amount of depreciable investment of an asset.
After a years, the total amount of depreciation can be calculated using the
following equation:
(1 + i)n − 1
Vo − Va = Ad = Ad (5.8)
i
Substituting for Ad in Equation (5.8) by its corresponding value given by
Equation (5.7) and solving for Va:
(1 + i)a − 1
Va = Vo − (Vo − Vs ) (5.9)
(1 + i)n − 1
It is to be noted that the book values obtained by S.F.D. are always higher
than the ones calculated using the straight-line method.
As far as the application of this method, the S.F.D. has limited utilization;
however, it is useful for decision making on alternative investments and
replacements.
Example 5.5
Assume a petroleum company investment of $10 million for an expan-
sion to a current refinery, allocated $1,000,000 for land and $7,000,000 for
fixed and other physical properties subject to depreciation. Additional
capital of $2,000,000 is available for operation purposes, but this sum is
not subject to depreciation. Investors want a 15% interest rate (or earn-
ing rate to investors) on their money for a 10-year period. The sinking-
fund method will be used, with depreciation figured at 15% per year. No
income taxes are involved in order to simplify the example.
SOLUTION
First-year profit before deducting the sinking-fund depreciation charge
made at the earning rate of 15% interest, and assuming no salvage value
for the physical properties, is 0.15 × $1,000,000, or $150,000 per year.
But the oil company must earn enough additional money annually to
pay for the depreciation occurring on the depreciable capital of $700,000.
Using sinking-fund depreciation and a 15% interest rate for the sink-
ing fund, the annual deposit in the fund is given by:
0.15(1.15)10
Ar = $700, 000 = $139, 440
(1.15)10 − 1
Example 5.6
Rework Example 5.5 to compare S.L.D. and S.F.D.
SOLUTION
Table 5.4 illustrates depreciation over 10 years for the investment in
Example 5.5 as calculated by both the sinking-fund and straight-line
methods. Figure 5.5 compares the book values obtained by the two
108
TABLE 5.4
Solution of Example 5.4 Using Straight-Line and Sinking-Fund Depreciation Methods
Total in Sinking Fund Annual Interest, Annual Annual Book Value at Annual Book
End of Year Depreciation Reserve 15% of Column 2 Deposit Charge End of Year Charge Value
1 2 3 4 5 6 7 8
Start 0 0 0 0 $700,000 0 $700,000
1 $34,440 0 $34,440 $34,440 665,560 $70,000 630,000
2 74,040 $51,600 (15% of 34,440 39,600 625,960 70,000 560,000
74,040)
3 119,580 11,100 34,440 45,540 580,420 70,000 490,000
4 171,960 17,940 34,440 52,380 528,040 70,000 420,000
5 232,200 25,800 34,440 60,240 467,800 70,000 350,000
6 301,540 34,900 34,440 69,340 398,460 70,000 280,000
7 381,280 45,300 34,440 79,740 318,720 70,000 210,000
8 472,920 57,200 34,440 94,640 227,080 70,000 140,000
9 577,960 70,600 34,440 105,040 122,040 70,000 70,000
10 700,000 86,600 34,440 22,040 0 70,000 0
$355,600 $344,400 $700,000 $700,000 is
a constant
deduction
Note: Conclusions are that the sinking-fund method requires a lesser profit before depreciation in the first year; the straight-line method requires a
higher profit, or $220,000, in the first year.
Petroleum Economics and Engineering
Depreciation and Depletion in Oil Projects 109
700
300
Straight line
method
200
100
0 1 2 3 4 5 6 7 8 9 10
Life Period in use, years
FIGURE 5.5
Comparison of straight-line and sinking-fund methods of calculating depreciation.
4. Choose the one for which the present worth of all depreciation
charges is a maximum.
In the absence of guidelines and for quick results, the following rules
are recommended:
Berg et al. (2001) worked on a model in selecting the best method for
calculation between the straight-line depreciation method and an accel-
erated depreciation method like sum-of-the-digits and double declining
methods. They found that straight-line depreciation can be better than
other depreciation methods, as the other methods are usually consid-
ered in empirical literature on accounting method choice. They also
concluded that while making a selection between straight-line and accel-
erated method, it is necessary to consider the uncertainty in future cash
flows and the structure of the tax system.
Noland (1997) states that the declining balance method is the most
prominent type of accelerated depreciation used in financial reporting.
However, he adds a drawback that at the end of the asset’s useful life this
method depreciates the asset to its salvage value. Different companies
use various ways to adjust this problem.
Depreciation and Depletion in Oil Projects 111
Preliminary Preparation
$
on Site
Depletion
Pre-oil $ Exploration Work
Allowances
Production
Phase
$ Test wells/Development
Production, treatment,
$ gas-oil separation and
other operations
Post-oil
Production Depreciation
Phase Allowances
Storage and
$
Transportation
Finished Products
for sale (Income)
Profit $
Production Costs
FIGURE 5.6
Depletion/depreciation allowances in oil operations.
112 Petroleum Economics and Engineering
5.4.2 Methods
If a depletion allowance is to be used, there are two possible methods of
calculating its value:
For the fixed percentage method, the percentage depletion is usually set by
government ruling (in the United States it has been 22% of net sales), but in
no case can the fixed percentage exceed 50% of net income before deduction
of depletion.
In the cost-per-unit method, the amount of depletion charged to each bar-
rel, or ton, of crude produced is determined by the ratio of intangible devel-
opment cost plus the depletable costs divided by the estimated total units
potentially recoverable. This then gives a cost per unit, which is in either
barrels or tons depending on how the estimated total units potentially recov-
erable are given.
The total units recoverable may be estimated if the number of years of
production and the production rates can be estimated. For oil and gas
wells the calculations vary with the nature of the production curve and
the allowable flow permitted by conservation authorities of the govern-
ment of the oil-producing country. A mathematical analysis is used for
estimating the total barrels of oil potentially recoverable under certain
assumed conditions.
Example 5.7
Given the following:
SOLUTION
The depletion charge is based on a 3-year period.
Cost items for the first year ($):
Thus the maximum allowable depletion will be $67.25 million and not
$41.25 million. The $1,000,000 bonus in this problem is recovered as part
of the depletion charge.
Example 5.8
Solve Example 5.7 using the cost-per-unit method, and then compare the
two methods used in calculating the depletion allowance.
SOLUTION
The depletion charge using cost-per-unit method:
Sum of development and bonus costs
=
recoverable oil reserves
8000000 + 100000 (5.10)
=
720000
= $12.5 /bbl
114 Petroleum Economics and Engineering
One can conclude from the above calculations that the percentage deple-
tion method promotes the recovery of a greater amount of oil-reserve
Depreciation and Depletion in Oil Projects 115
80
60
40
20
0
Depreciation Depletion Net Income
Expenses Expenses
140
Percentage depletion
120 Cost per unit method
80
60
40
20
0
Depreciation Depletion Net Income
Expenses Expenses
Notation
Ad, Ar, Annual depreciation and annual capital recovery defined by
Equations (4.12) and (4.15), respectively
a, A specific year in the useful lifetime (n)
d, Annual depreciation rate ($/yr)
da, Annual depreciation rate for the year (a)
f, Fixed percentage factor defined by Equation (5.3)
f , Accelerated depreciation factor defined by Equation (5.4)
n, Number of useful (service) years of life
Va, Value of an asset at year a
Vo, Original value of an asset ($)
Vs, Salvage value of an asset ($), also referred to as Vn
6
Financial Measures and
Profitability Analysis
CONTENTS
6.1 Introduction................................................................................................. 118
6.2 Mathematical Methods for Evaluating Profitability.............................. 118
6.2.1 Annual Rate of Return (Return on Investment, R.O.I.)............. 119
6.2.2 Payout Period (P.P.), Payback Time, or Cash Recovery Period.....121
6.2.3 Discounted Cash-Flow Rate of Return (D.C.F.R.) and
Present Value Index (P.V.I.)............................................................. 125
6.2.4 Net Present Value (N.P.V.).............................................................. 130
6.3 Comments on the Techniques of Economic Analysis........................... 130
6.4 Model Examples.......................................................................................... 132
Notation and Nomenclature............................................................................... 138
117
118 Petroleum Economics and Engineering
6.1 Introduction
Capital expenditure proposals must be sufficiently specific to permit their
justification for exploration and production operations, surface petroleum
operations, petroleum refining, and expansion purposes or for cost reduc-
tion improvements and necessary replacements. In reality, an evaluation
of capital expenditure proposals is both technical and economic in nature.
First, there are the technical feasibilities and validities associated with a proj-
ect, and next come economic evaluation and viability.
In the economic phase of evaluation, oil management may find that it
has more investment opportunities than capital to invest, or more capital to
invest than investment opportunities. Whichever situation exists, oil man-
agement needs to resort to some economic criteria for selecting or rejecting
investment proposals. Management’s decision in either case is likely to be
based largely on the measures of financial return on the investment.
The most common measures, methods, and economic indicators of eco-
nomically evaluating the return on capital investment discussed in this
chapter are:
Based on this classification, the R.O.I. and P.P. are described as “rough” or
“crude” quick methods, while the D.C.F.R. and N.P.V. are known to be accu-
rate, realistic, and time-demanding indicators.
n
∑ annual profits
1= y
R.O.I. = (capital investment)(100) (6.1b)
n
The main drawback of this method is the fact that money received in the
future (cash flow) is treated as money of present value (which is less, of course).
Example 6.1
It is necessary to calculate the R.O.I. for two projects involving the desalt-
ing of crude oil; each has an initial investment of $1 million. The useful
life of project 1 is 4 years and of project 2 is 5 years. The earnings pattern
is given in Table 6.1.
SOLUTION
The average rate of return is calculated for both projects as shown in
Table 6.1. The final answers are:
TABLE 6.1
Average Return on Investment Crude Oil Desalting (Solution of Example 6.1)
Net Earnings Income Net Earnings
Income before Depreciation after before Depreciation after
Depreciation Allowance Depreciation Depreciation Allowance Depreciation
1 $400,000 $250,000 $150,000 $75,000 $200,000 –$125,000
2 $350,000 $250,000 $100,000 $180,000 $200,000 –$20,000
Year 3 $300,000 $250,000 $50,000 $300,000 $200,000 $100,000
4 $275,000 $250,000 $25,000 $400,000 $200,000 $200,000
5 $600,000 $200,000 $400,000
Sum $325,000 $555,000
Average Investment $500,000 $500,000
Average Earning $81,250 $111,000
Average Rate of Return 16.25% 22.20%
Petroleum Economics and Engineering
Financial Measures and Profitability Analysis 121
$700,000
Net earning after depreciation
$600,000 Income before depreciation
$500,000
$400,000
$300,000
$200,000
$100,000
$0
1 2 3 4 5
–$100,000
Year
–$200,000
FIGURE 6.1
Illustration of payout period (P.P.).
Investment for land (if needed) comes first, followed by investment for
the depreciable asset throughout the construction period (points 1
and 2).
The need for the working capital comes next for startup and actual pro-
duction (points 2 and 3).
Production starts now at point 3 (zero time) and goes all the way profit-
ably to cross the zero cash line at point 4. This point corresponds to
the time spent to recover the cumulative expenditure, which con-
sists of capital of land + capital cost of depreciable assets + working
capital. The payout period will accordingly be defined by point 4—
that is, the time required to recover the depreciable capital only.
Point 4 could be considered an alternative way (but different in value)
to define payout period as the time needed for the cumulative expen-
diture to balance the cumulative cash flow exactly.
Financial Measures and Profitability Analysis 123
Example 6.2
Calculate the payout period for the two alternatives of capital expendi-
tures involving an investment of $2 million each for a sulfur removal
plant, as given in Table 6.2. The life of project 1 and project 2 is 6 and 10
years, respectively.
TABLE 6.2
Cash Flow for the Sulfur Removal Plant (Example 6.2)
Cash Flow (S)
Year Project 1 Project 2
0 2,000,000 2,000,000
1 1,500,000 200,000
2 500,000 300,000
3 400,000 400,000
4 350,000 400,000
5 250,000 400,000
6 200,000 400,000
7 100,000 400,000
8 — 400,000
9 — 400,000
10 — 400,000
Cash flow $3,300,000 $3,700,000
Annual cash flow ($/yr) 471,429 370,000
P.P (yr) 4.24 5.41
124 Petroleum Economics and Engineering
SOLUTION
From the cash flow given in payout Table 6.2, the payout period (P.P.) is
calculated as follows:
$ 2,000,000.00
Project 1
Project 2
$ 1,500,000.00
$ 1,000,000.00
$ 500,000.00
$–
1 2 3 4 5 6 7 8 9 10 11
Year
The pay period index would thus recommend project 1 in favor of proj-
ect 2 (fewer years are required to recover the same initial capital incre-
ment). However, project 1, as shown in Table 6.2, ceases to generate any
cash flow after the sixth year, while project 2 continues, through the added
cash flow, to generate $400,000 each year after the investment has been
paid back in full at the end of the sixth year (P.P. is 7 years). It is pointless
to select project 1 on the ground that over the period from year 7 to year 10,
$1.2 million would be generated by project 2, which makes a total of $0.8
million more by project 2 over project 1 for the 10-year period.
Example 6.3
With reference to the investment made to procure boilers for surface
facilities in an oil field, as shown in Table 6.3, calculate the payback
period for each alternative and give reasons for selecting one and not
the other.
SOLUTION
P.P. is readily calculated using Equation 6.2 as follows:
TABLE 6.3
Comparison of Two Boiler Investment (Solution of Example 6.3)
Cash Flow
Year Boiler 1 Boiler 2
0 50,000 50,000
1 20,000 5,000
2 15,000 10,000
3 10,000 15,000
4 5,000 20,000
Total cash flow 50,000 50,000
Payback period P.P. 1 = 4 Years
P.P. 2 = 4 Years
As far as the P.P. as a criterion for choice, the number of years to recover
the depreciable capital is the same for both types of boilers. However, the
recovery of investment for boiler 1 is faster than for boiler 2 (for example,
compare $20,000 to $5,000 for the first year). Therefore, from the stand-
point of cost of money (time value of money), investment in boiler 1 is
preferable to investment in boiler 2.
Comparison of Two Boiler Investments
$ 60,000.00
Boiler 1
$ 50,000.00
Boiler 2
$ 40,000.00
$ 30,000.00
$ 20,000.00
$ 10,000.00
$–
1 2 3 4 Total Cash
Flow
Year
This example points out that when using the payout period method,
oil management should also observe the rapidity of cash flows between
alternatives. The alternatives may have the same number of years-to-
pay-back as they do here, but one may be more favorable than the other
because the largest amount of cash flow comes in the first few years.
This could be an excellent point in favor of investment in one alternative
over another when both have approximately the same payout periods. It
could be a strong factor in selection of one especially if a greater amount
of cash “back” is needed early in the investment.
lifetime n, then the D.C.F.R. is defined as the rate of return, or interest rate
that can be applied to yearly cash flow, so that the sum of their present value
equals P.
From the computational point of view, D.C.F.R. cannot be expressed by an
equation or formula, similar to the previous methods. A three-step proce-
dure involving trial and error is required to solve such problems. Example
6.4 illustrates the basic concepts.
Cash
Flow
Years
0 1 2 3 4 5
FIGURE 6.2
Cash flow pattern.
Financial Measures and Profitability Analysis 127
$ 28,000.00
$ 26,000.00
$ 24,000.00
$ 22,000.00
$ 20,000.00
$ 18,000.00 i = 15%
$ 16,000.00 i = 20%
$ 14,000.00 i = 25%
$ 12,000.00 i = 20.7%
$ 10,000.00
1 2 3 4 5
Year
FIGURE 6.3
D.C.F.R. for investment in a lease of oil wells.
P= ∑p
y =1
y
128 Petroleum Economics and Engineering
where
y
1
py = (annual cash flow)y dy = (A.C.F.)y
1 + i
for the year y, between 1 and 5.
Another important criterion that can be used in order to arrive at the
correct value of i in the discounting of the cash flow is given by the fol-
lowing relationship: D.C.F.R. is the value that makes P.V.I. = 1, where P.V.I.
stands for the present value index and is defined by:
sum of discounted cash flow (present value)
P.V.I. = (6.4)
initial capital investment
The solution of this example applying the discount factor is illustrated
in Table 6.4.
If the annual cash flow has been constant from year to year, say A $/yr,
then the following can be applied:
1 1 1
A + ++ =P
(1 + i)n
(6.5)
(1 + i) (1 + i)
2
Multiplying both sides of Equation (6.5) by (1 + i)n, we get:
The sum of the geometric series in the left-hand side is given by:
(1 + i)n − 1
i
Hence, Equation (6.6) can be rewritten in the form:
(1 + i)n − 1
P(1 + i)n = A (6.7)
i
It is interesting to point out that this equation is equivalent to Equation
(6.3); that is, the future worth of P, if invested in the bank, is given by:
FB = P(1 + i)n
The future worth of the annual cash flow received from oil investment
(A), if compounded in a sinking-fund deposit, is given by:
(1 + i)n − 1
Fo = A
i
Now, Equation (6.7) can be used to calculate directly the D.C.F.R. by trial
and error knowing the values of A, P, and n.
The D.C.F.R. thus represents the maximum interest rate at which
money could be borrowed to finance an oil project.
TABLE 6.4
D.C.F.R. for Investment in Lease of Oil Wells
i = 15% i = 20% i = 25% i = 20.7%
Present Present Present Present
Year (y) Cash Flow dy Value ($) dy Value ($) dy Value ($) dy Value ($)
0 110,000
1 30,000 0.8696 26,088 0.8333 24,999 0.8000 24,000 0.8290 24,870
2 31,000 0.7561 23,439 0.6944 21,526 0.6400 19,840 0.6870 21,297
Financial Measures and Profitability Analysis
SOLUTION
At i = 0.15, the annual cash flow is discounted. The present value of the
sum of the cash flows = $127,000. The N.P.V. is directly calculated using
Equation (6.8):
N.P.V. = 127, 000 − 110, 000
= $17, 000
That is, the oil lease can generate $17,000 (evaluated at today’s dollar
value) over and above the totally recovered capital investment. The solu-
tion is illustrated in Table 7.5.
on the other hand, ignores the useful life of an asset (later years of
project life) and does not consider the working capital.
2. The D.C.F.R. and N.P.V. are regarded as the most generally accept-
able economic indexes to be used in the oil industry. They take into
account the following factors:
3. Any of the methods described in this chapter and proposed for eco-
nomic evaluation in oil projects should be used with discretion and
with due regard for its merits and demerits. Each index provides lim-
ited knowledge that is helpful in making project decisions. No major
investment decision should be totally based on a single criterion. A
more careful study should be considered for oil projects ending in dif-
ferent conclusions as a result of using different economic indicators.
4. Other important factors to consider in economic evaluation are dis-
cussed next. Every oil company has to consider that certain invest-
ments will not yield a “measurable profit,” because some investments
may be needed to improve employee or community goodwill or to
meet legal requirements of the government under which the oil oper-
ations are located. For example, investments in equipment to reduce
air or water pollutants and investments in the social well-being of
the community may not contribute dollars to equity of a company.
These are examples of those investments that will not yield a mea-
surable profit. And oil companies must face some of these “opportu-
nities,” especially when their operations are in countries other than
that in which their main administrative offices are located.
132 Petroleum Economics and Engineering
SOLUTION
No capital investment is involved here, so the problem is simply a dis-
counting procedure.
The present value of the cash flow
= 800,000(1 + 0.1)–10
= $308,000
Example 6.7
Assume that a distillation unit with an initial cost of $200,000 is expected
to have a useful life of 10 years, with a salvage value of $10,000 at the end
of its life. Also, it is expected to generate a net cash flow above main-
tenance and expenses amounting to $50,000 each year. Assuming a
selected discount rate of 10%, calculate the N.P.V.
SOLUTION
The present value of the annual cash flow can be found using Equation (6.7):
(1 + i)n − 1
P=A
i(1 + i)n
(1.1)10 − 1
= 50, 000
0.1(1.1)10
= 50, 000(6.144) = $307, 25
Financial Measures and Profitability Analysis 133
Example 6.8
A feasibility study carried out for an oil company indicated that it is pos-
sible to invest $1 million in either one of two projects. Anticipated cash
flows generated by the two projects over the useful lifetime are given in
Table 6.5.
SOLUTION
For (1), calculation is done for three different discount interest rates, 8%,
10%, and 12%, as shown in Table 6.6. In addition, a graphic plot is pre-
sented (Figure 6.4) for the change of the discounted value (present value)
of the cash flows for both projects with the discount rate.
In summarizing the results of Table 6.6, if the cash flows of project 1 and
project 2 are discounted at 8%, project 2 is preferable; if the cash flows are
discounted at 10%, project 2 is preferred to project 1 because the present
value of project 2 is almost $14,000 more; and if the cash flows are dis-
counted at 12%, project 1 is slightly preferable to project 2 and will con-
tinue to be preferable to project 2 as discount rates go higher than 12%.
Therefore, as the example shows, the choice between the two projects
depends on the discount rate used. Usually, the oil company’s cost of cap-
ital for investing in the project will determine which project is selected.
Figure 6.4, on the other hand, gives the present value curves for both proj-
ect 1 and project 2 resulting from the three discount rates used. The “point
of indifference” appears to be between 10% and 12%. Before this point,
project 2 has the more favorable present value; after this point, project 1 is
favored. As discount rates become higher past the “point of indifference,”
project 1 will continue to be more desirable for investment purposes. From
134
TABLE 6.5
D.C.F.R. for Investment in a Lease of Oil Wells
i = 5% i = 20% i = 25% i = 20.7%
Present Present Present Value Present Value
Year (y) Cash Flow dy Value ($) dy Value ($) dy ($) dy ($)
0 110,000
1 30,000 0.8696 26,088 0.8333 24,999 0.8000 24,000 0.8290 24,870
2 31,000 0.7561 23,439 0.6944 21,526 0.6400 19,840 0.6870 21,297
3 36,000 0.6575 23,670 0.5787 20,833 0.5120 18,432 0.5700 20,520
4 40,000 0.5718 22,872 0.4823 19,292 0.4096 16,384 0.4720 18,880
5 43,000 0.4971 21,375 0.4019 17,282 0.3277 14,091 0.3910 16,813
20,000
Total 117,444 103,932 92,747 102,380
P.V.I. 1.07 0.94 0.84 0.93
N.P.V. $7,444.40 –$6,067.70 -$17,252.90 -$7,620.00
Petroleum Economics and Engineering
Financial Measures and Profitability Analysis 135
TABLE 6.6
N.P.V. of a Distillation
Distillation unit cost $200,000
Useful life/year 10
Salvage value $10,000
Net cash flow each year $50,000
D.C.F.R. $10
Present value of cash flow of $50,000 annually, $307,250
for 10 years at 10%
Present value of cash flows for 10 years, Minus $107,250
original investment of $200,000
Present value of $10,000 salvage value to be $3,860
received at the end of years at 10%
Total value of net cash receipts plus present $111,110
value
the data in Table 6.7, it can be seen that at a discount of 12%, the present
value of cash flow from project 2 is $1 million; and at a discount of over
12%, the present value of cash flow gives us the discount rated amount of
under $1 million. This analysis of the present value of cash flow gives us
the discount rate at which anticipated cash flow equals the initial invest-
ment, which is the D.C.F.R. For project 2, it is about 12%; for project 1, it
is about 13%.
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
–
1 2 3 4 5
FIGURE 6.4
Chart for Example 6.8.
136
TABLE 6.7
Statement of Example 6.8
Year Project 1 Project 2
1 400,000 100,000
2 320,000 200,000
3 200,000 300,000
4 300,000 400,000
5 100,000 500,000
Total anticipated cash flow 1,320,000 1,500,000
At 8% Discount
Year Project 1 Project 2
Discount Factor for Discounted Value Discounted Value
8% Cash Flow (col. 1 * col. 2) Cash Flow (col. 1 * col. 4)
1 2 3 4 5
1 0.926 400,000 370,000 100,000 92,600
2 0.856 320,000 273,920 200,000 171,200
3 0.794 200,000 158,800 300,000 238,200
4 0.735 300,000 220,500 400,000 294,000
5 0.681 100,000 68,100 500,000 340,500
$1,091,723 $1,136,505
(Continued)
Petroleum Economics and Engineering
At 10% Discount
Year Project 1 Project 2
Discount Factor for Discounted Value Discounted Value
10% Cash Flow (col. 1 * col. 2) Cash Flow (col. 1 * col. 4)
1 2 3 4 5
1 0.909 400,000 363,600 100,000 90,900
2 0.826 320,000 264,320 200,000 165,200
3 0.751 200,000 150,200 300,000 225,300
4 0.683 300,000 204,900 400,000 273,200
5 0.621 100,000 62,100 500,000 310,500
$1,045,123 $1,065,105
At 12% Discount
Year Project 1 Project 2
Discount Factor for Discounted Value Discounted Value
Financial Measures and Profitability Analysis
Khaled Zohdy
CONTENTS
7.1 Introduction................................................................................................. 139
7.2 Differential Approach (Δ Approach), or Return on Extra
Investment (R.O.E.I.)................................................................................... 141
7.3 Total Equivalent Annual Cost (T.E.A.C.)/Present Value Method........ 146
7.4 Total Capitalized Costs (T.C.C.)................................................................ 153
7.5 Replacement Analysis................................................................................ 156
7.1 Introduction
Decisions involve a choice among a number of possible courses of action.
Making a decision should be a simple matter, provided that the problem is
clearly stated and (in the field we are addressing) the economic approach is
well defined. Many examples can be cited in the oil industry where man-
agement, engineers, geologists, and others have to make a choice among
139
140 Petroleum Economics and Engineering
alternative projects. The choice can assume many different aspects, for
example, the choice among alternative processes proposed for enhanced oil
recovery in oil fields, among alternative methods of cooling process streams
in gas plants, or among alternative designs of heat exchangers, waste-heat
boilers, pumps, or any piece of equipment.
As an example, an oil company is offered a lease of a group of oil wells in
which primary production is nearing completion, and the major condition
of this offer is to undertake a secondary recovery project (water injection) by
the end of the fifth year. The capital investment of this project is estimated
to be $650,000. In return, the revenue in the form of cash flow realized from
this lease is as follows:
Analysis of Economic
Alternatives
Category I Category II
FIGURE 7.1
Categories and domain of economic alternatives.
Analysis of Alternative Selections and Replacements 141
1.
Profit or income expansion: where revenues (cash flows) are generated,
and maximization of the profit is required
2.
Cost reduction: where no cash flows are given; instead expenses are
known and reduction in costs is the criterion
1. Select the minimum capital investment (C.I.) as our base plan, com-
pute ΔC.I. (difference in capital investment) for the alternatives.
2. Compute Δprofit (difference in cash income) for the alternatives, for
the income-expansion problem, and Δsaving (difference in annual
costs) for the alternatives, for the cost-reduction problem.
142 Petroleum Economics and Engineering
∆profit
∆C.I. → profit; R.O.E.I. = 100
∆C.I.
(7.1)
∆saving
∆C.I. → saving; R.O.E.I. = 100
∆C.I.
4. Check to see that the preferred choice has an R.O.E.I. greater than a
minimum value prescribed by management.
Example 7.1
In the alkanolamine sweetening process of natural gas, two types of cool-
ers have been suggested for the amine solvent: type A and type B. Using
the data given next, recommend which alternative should be used if both
types are acceptable technically. The minimum rate of return on money
invested is 15% and the economic lifetime is 10 years for the coolers.
SOLUTION
Consider straight-line depreciation of 10% of C.I.
The problem is a cost-reduction type.
Type A Type B
Capital investment (CI) 10,000 15,000
n, years 10 10
Average depreciation = CI/n 1000 1500
Average operational cost 3000 1500
Total annual cost = Average depreciation 4000 3000
+ Average operational cost
Average rate of return (given) 0.15 0.15
Difference in CI 5000
Difference in annual cost (saving) 1000
Annual percentage saving = difference 20%
in annual cost (saving)/difference in CI
40
%, Annual Saving 30
20
10
0
–10
–20
0 5 10 15 20
Life Time, n
FIGURE 7.2
Change of A% saving versus lifetime of type B.
Example 7.2
Instead of flaring the associated natural gas separated along with crude
oil, it was decided to recover the lost heat by using the waste-heat recovery
system (W.H.R.S.). For pilot test runs, four designs were offered; each has
a lifetime of 5 years. The savings and costs associated with each are as
follows:
Type 1 Type 2 Type 3 Type 4
Capital investment(CI) 10,000 16,000 20,000 26,000
n, years 5 5 5 5
Average depreciation = CI/n 2000 3200 4000 5200
Average operational cost 100 100 100 100
Total annual cost = average 2100 3300 4100 5300
depreciation + average
operational cost
Revenue (income) $/yr 4100 6000 6900 8850
Annual profit 2000 2700 2800 3550
R.O.I. 20.0% 16.9% 14.0% 13.7%
SOLUTION
Using incremental comparison:
1 2 3 4
First comparing 1 to 2 Acceptable as a basis 11.7% — —
Second comparing 2 to 3 — Basis 2.5% —
Third comparing 2 to 4 — Basis — 8.5%
Conclusion
Design 2 is recommended; it gives more profit than design 1 while return
on extra investment (R.O.E.I.) is 11.7%, which is >10% (minimum).
Figures 7.3 and 7.4 are bar charts to illustrate the solution of the problem.
144 Petroleum Economics and Engineering
25.0%
20.0%
15.0%
%, R.O.I
10.0%
5.0%
0.0%
Type I Type II Type III Type IV
FIGURE 7.3
Change of ROI% savings versus different types.
Example 7.3
Insulation thickness is important for heat exchangers in the oil industry.
One situation was encountered in the sulfur recovery plant from hydro-
gen sulfide gas (H2S) (which has to be removed from natural gas). A heat
exchanger was designed and recommendation was made for four possi-
ble thicknesses of insulation. The costs and savings related to these cases
are as follows. Which one is recommended for 15% minimum R.O.I.?
SOLUTION
For 15% minimum R.O.I., calculations indicate that all four proposals are
acceptable, since they generate R.O.I greater than 15%, each. Now, we can
apply the differential approach as indicated above. However, let us use
the graphic analysis technique, since the problem involves small-invest-
ment increments. Referring to Figure 7.5, the annual savings/C.I. curve
is drawn as shown using the above data. As can be seen, by increas-
ing the C.I., the annual savings are increased until we hit the optimum
point, M, which represents the maximum savings. Then, by drawing our
tangent line at P, we can achieve an R.O.E.I. of about 17% when using C.I.
of nearly $1,600, or an insulation of 2-inch thickness.
16.0%
12.0%
%, R.O.I
8.0%
4.0%
0.0%
1st comparing 2nd comparing 3rd comparing
1 to 2 2 to 3 2 to 4
FIGURE 7.4
Incremental comparison versus different types.
Analysis of Alternative Selections and Replacements 145
P a
Capital Investment
FIGURE 7.5
Differential solution.
1 2 3 4
First comparing 1 to 2 Acceptable 17.0% — —
as a basis
Second comparing 2 to 3 — Basis 11.5% —
Third comparing 2 to 4 — Basis — 14.1%
146 Petroleum Economics and Engineering
50.0%
40.0%
30.0%
%, R.O.I
20.0%
10.0%
0.0%
1 inch 2 inch 3 inch 4 inch
insulation insulation insulation insulation
FIGURE 7.6
Change of ROI% savings versus different types.
Conclusion
Design 2 is recommended; it gives more profit than design 1 while return
on extra investment (R.O.E.I.) is 17%, which is greater than 15% (minimum).
Figures 7.6 and 7.7 are graphical plots to illustrate the results obtained
in solving this example.
10,000
9,200
8,400
7,600
6,800
6,000
A pump with control A pump with a variable
discharge valve (I) speed drive (II)
FIGURE 7.7
Change of T.E.A.C. versus different types of pumps.
Analysis of Alternative Selections and Replacements 147
Specifically, the T.E.A.C. is the sum of the annual cost of capital recov-
ery (initial capital plus interest on it) and other annual operating costs.
(Remember that depreciation costs cannot be included with the annual oper-
ating costs. They are taken care of in the cost of capital recovery.)
where
i(1 + i)n
Ar = P (4.26)
(1 + i)n − 1
Example 7.4
Recommend which arrangement to select out of the following two cases,
where energy saving is required by using higher capital investment.
SOLUTION
0.1(1.1)10
For system I: Ar = 13, 000
(1.1) − 1)
10
= $2, 116
0.1(1.1)10
For system II: Ar = 17, 000 10
(1.1) − 1)
= $2, 767
= 9, 616
= 8, 567
148 Petroleum Economics and Engineering
Example 7.5
GIVEN
Consider two possibilities relative to the purchase of a heat exchanger
for an oil refinery to replace an older model for which annual costs are
running around $20,950. Other details are as follows:
15,000
14,000
13,000
12,000
11,000
10,000
9,000
8,000
7,000
6,000
A: (steel and copper) B: stainless steel
heat exchanger heat exchanger
FIGURE 7.8
Change of T.E.A.C. versus different types of heat exchangers.
Analysis of Alternative Selections and Replacements 149
FIND
Using the annual cost method, determine which purchase possibility
would be more economical with respect to annual costs.
SOLUTION
Purchase Possibility A with Capital Purchase Possibility B with Capital
Recovery, Formula “Find A, Given P” Recovery, Formula “Find A, Given P”
(Original cost – salvage value) (Original cost – salvage value)
(recovery factor) + (salvage value) (recovery factor) + (salvage value)
(interest rate) (interest rate)
($15,000 – $500)(0.1490) + ($500)(0.08) ($40,000 – $1,000)(0.1490) + ($1,000)
= 2,201 capital recovery of original (0.08) = $5,891 capital recovery of
cost and salvage value original cost and salvage value
Summary of annual costs Summary of annual costs with
with capital recovery capital recovery
Recovery of capital $ 2,201 Recovery of capital $ 5,891
Annual costs, 11,500 Annual costs, 4,000
maintenance, repairs maintenance, repairs
Annual costs, optimum 600 Annual costs, optimum 2,800
conditions conditions
Total annual costs $14,301 Total annual costs $12,691
Whereas the annual cost method does not give the relative amounts
of capital, the present value method does. The present value method
reduces all costs to equivalent capital at a given date.
SUMMARY
Example 7.6
GIVEN
Assume the same two heat exchangers given in Example 7.5, with the
same annual costs, economic lives, salvage values, and investments, and
with the cost of capital once again 8%.
WANTED
Compare the two alternatives using the present worth values for each of
the possibilities, as well as total equivalent capital at the “present” time
of consideration of purchase of heat exchangers.
SOLUTION
Using the present value method, a series of known uniform annual costs
are reduced to an equivalent present value. This allows one to estimate the
dollar value at the present time that is equivalent to the amount of annual
costs for some fixed years of service by two alternatives. But uniform annual
costs must first be determined, and this is what the present value method
does. (The annual cost method does not determine uniform annual costs.)
Now, for each of the possibilities, the present values of installations
and the salvage values must be added and deducted, respectively, to
Analysis of Alternative Selections and Replacements 151
current value of annual costs for 10 years in order to get total equivalent
capital requirements.
The following calculations are carried out to find the equivalent capi-
tal at 8%.
Purchase Purchase
Possibility A Possibility B
1. Present value of original (initial) $15,000 $40,000
costs
2. Present value of salvage value; $500 × 0.4632 $1,000 × 0.4632
formula “Find P, Given F,” or factor = 232 = 463
3. Present value of annual costs: (total $12,100 × $6,800 × 6.710
costs) × factor of formula “Find P, 6.710 = = $45,628
Given A” $81,191
4. (1) – (2) + (3) $95,959 $85,165
Summary
100,000
95,000
90,000
85,000
80,000
75,000
A: (steel and copper) B: Stainless steel
heat exchanger heat exchanger
FIGURE 7.9
Change of total annual costs for different types of H.E.
Example 7.7
Compare the relative annual costs and current present values of the two
alternatives in Examples 7.5 and 7.6 for 10 years of service if money is
worth 5% instead of 8%.
SOLUTION
(a) For the annual cost method at 5%:
Purchase Purchase
Possibility A Possibility B
Annual Costs
Capital recovery = $14,500 × 0.1295 $ 1,903 $39,000 × 0.1295
(“Find A, Given P”) + (0.05)($500) = + (0.05)($ 1,000)
= 5,101
Labor, maintenance, etc. 11,500 4,000
Other direct costs 600 2,800
Total annual costs $13,903 $11,901
Purchase Purchase
Possibility A Possibility B
Present worth of original (initial) costs $15,000 $40,000
Present worth of salvage value $500 × 0.6139 $1,000 × 0.6139
(“Find P, Given F”) = 307 = 614
Present worth of annual costs $12,100 × 7.722 $6,800 × 7.722
(“Find P, Given A”) = 93,436 = 52,509
Total “present” equivalent capital $108,129 $91,895
at 5%
Analysis of Alternative Selections and Replacements 153
Example 7.8
The overhead condenser in a stabilization unit of a natural gasoline plant
has to be made of corrosion-resistant material. Two types are offered;
both have the same capacity (surface area); however, the costs are differ-
ent because of different alloying materials:
Condenser A Condenser B
C.I. ($) 23,000 39,000
n (years) 4 7
SOLUTION
(1.08)4
K A = 23, 000
(1.08)4 − 1
= $86, 000
(1.08)7
K B = 39, 000
(1.08)7 − 1
= $93, 000
Example 7.9
Solve Example 7.5 using the capitalized cost technique for 8% and 5%
annual interest rates.
SOLUTION
Two methods are presented:
Purchase Purchase
Possibility A Possibility B
n (year) 10 10
CR ($) 14,500 39,000
Vs ($) 500 1,000
Total operating cost ($/yr) 12,100 6,800
12, 100 6800
K A ($) = 500 + 14, 500(1.8629) + K B ($) = 1000 + 39, 000(1.8629) +
0.08 0.08
= $178, 762 = $158, 653
Purchase Purchase
Possibility A Possibility B
Total annual costs:
Purchase Purchase
Possibility A Possibility B
Total annual costs:
It is clear that both the direct and detailed methods give the same final
answer; however, one would be reluctant to use the latter approach.
At the lower interest rate of 5%, the capitalized cost is $42,060 less for
possibility B ($280,060 – $238,000). The results illustrate the peculiar
effect of the interest rate and emphasize the potential difficulties in com-
paring alternates on either a present value or a capitalized cost basis.
When cost of capital is high, total capitalized costs become lower, but
differences between capitalized costs of higher and lower investment
amounts favor higher investments more when cost of capital (interest
rate) is lower.
156 Petroleum Economics and Engineering
The interest rate is the determining factor, although the relative size of
such individual items as initial costs, annual labor costs, annual material,
repairs, maintenance, and other costs, when compared to capital recov-
ery costs, can affect total equivalent capital involved.
The important point is that the interest based on the going value of
money is always lower than the rate for a venture involving a risk. The
engineer using the going rate for interest will bias his comparisons in
favor of the alternative equivalent to oil capital requirements. Because
of this, the annual cost method is preferred, but the service lives of the
alternatives should be equal, and annual costs of alternatives should be
uniform. When different service lives are involved, or where non-uni-
form annual expenditures must be compared for alternatives, it is better
to use the present value method and put all costs on a comparable basis
in order to get accurate results and avoid “distortions” of costs.
FIGURE 7.10
Replacement analysis.
Analysis of Alternative Selections and Replacements 157
Example 7.10
A tank farm is receiving crude oil through a pipeline. Periodic mea-
surements of the crude oil level are made. The annual labor cost for the
manual operation is estimated to be $50,000. However, if an automated
level-measuring system is installed, it will cost $150,000. Maintenance
and operating expenses of the system are $15,000 and $5,000, respec-
tively. The system will be operated for 5 years.
Should the automated level-measuring system be installed? Assume
that the interest rate is 10%.
SOLUTION
Two alternatives must be compared:
0.1(1.1)5
= 150,000 5
+ 15,000 + 5,000
(1.1)
Example 7.11
An oil company has an existing steam-generation unit. Its cost when
new is $30,000, its lifetime is 10 years, and it has a salvage value of zero.
158 Petroleum Economics and Engineering
The annual operating cost is $22,000. After it has been in use for 5 years,
the estimated book value of the unit is found to be $6,000. The remaining
lifetime now is only 3 years.
It has been proposed to replace this unit by another new one. Its cost
is $40,000, lifetime 10 years, operating costs $15,000/yr, and zero salvage
value. Should we continue using this unit or go for the replacement?
The company requires 10% R.O.I.
SOLUTION
Example 7.12
Consider a control valve that becomes obsolete 3 years before it has been
fully depreciated. When fully depreciated, the valve will have a salvage
value of $400, but at this time (3 years before), it has a trade-in (or resale)
value of $1,000. If the book value (original cost – total depreciation to date)
is $760, there is a favorable “bonus” to management of $240 in trade-in.
But the bonus of $240 is irrelevant as a sunk cost. If a minimum rate
of return is assumed as 10% before taxes, the question is whether the
obsolete control valve with 3 years to go before being fully depreciated
should be replaced now by a new valve. Calculations are needed to com-
pare the old valve with a new valve, which would cost $5,000 and have
an eventual salvage value of $500 and a service life of 10 years.
Analysis of Alternative Selections and Replacements 159
SOLUTION
By comparing the old control valve with the new valve, we can see that
purchasing the new valve now would mean an annual savings of $384 or
($2,166 – $1,782). If the old valve is depreciated out, only the salvage value
of $400 could be allowed on capital recovery.
8
Risk, Uncertainty, and Decision Analysis
Jamal A. Al-Zayer
Taqi N. Al-Faraj
Mohamed H. Abdel-Aal
CONTENTS
8.1 Introduction................................................................................................. 162
8.2 Decision Analysis....................................................................................... 162
8.2.1 Decision Analysis Using Decision Tables................................... 163
8.2.2 Classification of Decision Situations............................................ 163
8.3 Decision Making under Certainty........................................................... 164
8.3.1 Complete Enumeration.................................................................. 164
8.3.2 Computation with Analytical Models......................................... 165
8.4 Decision under Risk................................................................................... 165
8.4.1 Expected Value Criterion............................................................... 166
8.4.2 Expected Value-Variance Criterion.............................................. 166
8.5 Decision Making under Uncertainty....................................................... 168
8.5.1 Laplace Criterion............................................................................. 170
8.5.2 Maximin and Minimax Criteria................................................... 171
8.5.3 Maximax and Minimin Criterion................................................. 171
8.5.4 Minimax Regret Criterion............................................................. 172
8.5.5 Hurwicz Criterion........................................................................... 172
8.5.6 Summary of Criteria Results......................................................... 173
8.6 Sequential Decisions.................................................................................. 174
8.6.1 Decision Trees................................................................................. 174
8.6.2 The Value of Perfect Information................................................. 176
8.6.3 The Value of Imperfect Information............................................ 179
161
162 Petroleum Economics and Engineering
decision strategy. This applies to many oil engineering operations. The sys-
tematic use of information to determine how often specified events may occur
and the magnitude of their likely consequences is detailed as well.
8.1 Introduction
The oil and gas industry epitomizes investment decision making under
conditions of risk and uncertainty, and hence was one of the first industries
to apply decision analysis. Decision analysis provides a framework for ana-
lyzing a wide variety of problems encountered in engineering and man-
agement. It is a methodology used to determine optimal strategies when a
decision maker is faced with uncertain decision alternatives. However, risk
analysis will not eliminate risk in the decision-making process.
Some important applications involving risk and economic analysis in oil
operations may include:
• Reserve quantification
• Reservoir characteristics
• Recovery factors
• Expected production
• Operations schedule
In the study of risk and economic analysis, the following tools are normally used:
second step is to identify future events that might occur. These future events,
which are not under the control of the decision maker, are referred to as the
states of nature. The payoff, which is the outcome resulting from making a cer-
tain decision, and the probability of occurrence of a particular state of nature
should be estimated. This information is organized in what is called a payoff
or a decision table. Decision analysis using decision tables is discussed here,
followed by classification of decision situations.
Identification of the decision alternatives Ai, state of nature Sj, and determi-
nation of the payoff values Vtj associated with each decision alternative i and
state of nature j with probability Pj are organized in a decision table. Table 8.1
represents the general structure for a payoff or a decision table.
TABLE 8.1
General Structure of a Decision Table
Alternative Courses
of Action States of Nature
P1 P2 … Pn
S1 S2 … Sn
A1 V11 V12 … V1n
A2 V21 V22 … V2n
. . . … .
. . . … .
. . . … .
Am Vm1 Vm2 … Vmn
164 Petroleum Economics and Engineering
nature is relevant. In this case, this single state of nature will occur with
certainty (i.e., with probability = 1). This kind of situation is termed a deci-
sion under assumed certainty. A decision situation is called a decision under
risk when the decision maker considers several states of nature, and the
probabilities of their occurrence are explicitly stated. A decision situation
where several states are possible and sufficient information is not avail-
able to assign probability values to their occurrence is termed a decision
under uncertainty.
In summary, decision situations can be classified as follows (Ben-Haim, 2001):
Example 8.1
Suppose an oil company would like to assign three drilling rigs to drill
oil wells at three different stratigraphic locations in a manner that will
Risk, Uncertainty, and Decision Analysis 165
TABLE 8.2
Drilling Times in Days for Three Different Oil Wells
Well Number 1 2 3
Rig Number
A 30 70 40
B 40 60 60
C 30 80 50
minimize total drilling time. The drilling times in days are presented
in Table 8.2.
SOLUTION
By complete enumeration as shown in the solution given in Table 8.3, all
the alternatives are listed. It is clear that alternative number 5 is the best
choice since the total drilling time is the minimum.
TABLE 8.3
Complete Enumeration Solution
Alternative Assignment Total Drilling Time
1 A-1, B-2, C-3 30 + 60 + 50 = 140
2 A-1, B-3, C-2 30 + 60 + 80 = 170
3 A-2, B-1, C-3 70 + 40 + 50 = 160
4 A-2, B-3, C-1 70 + 60 + 30 = 160
5 A-3, B-2, C-1 40 + 60 + 30 = 130 ←
6 A-3, B-1, C-2 40 + 40 + 80 = 160
166 Petroleum Economics and Engineering
EV (di ) = Σ PjVij
j
(8.1)
where
Example 8.2
Consider an investment of a company, engaged in oil field services, of
$10,000 over a 4-year period that returns Rt at the end of year t, with Rt
being a statistically independent random variable. The following prob-
ability distribution is assumed for Rt.
Rt Probability
$2,000 0.10
$3,000 0.20
$4,000 0.30
$5,000 0.40
SOLUTION
The expected value of the return in a given year is given by:
= 4000
= 1, 000, 000
It is to the advantage of the decision maker to use both the expected value
and the variance to develop a criterion that maximizes the expected
profit and at the same time minimizes the variance of the profit. The
criterion is as follows:
Example 8.3
An oil firm has four alternatives from which one is to be selected. The
probability distributions describing the likelihood of occurrence of the
present worth of cash flow amounts, expected values, and variance for
each alternative are given in Table 8.4.
168 Petroleum Economics and Engineering
TABLE 8.4
Probability Distributions, Expected Values, and Variances of Present Worth
Amounts for Four Alternatives
Present Worth of Cash Flow ($1,000)
Alternatives –$40 10 60 110 160 EV Var
A1 0.2 0.2 0.2 0.2 0.2 60 5 * 109
A2 0.1 0.2 0.4 0.2 0.1 60 3 * 109
A3 0.0 0.4 0.3 0.2 0.1 60 2.5 * 109 ←
A4 0.1 0.2 0.3 0.3 0.1 65 3.85 * 109
SOLUTION
For any given alternative, the decision maker wishes to maximize the
expected value and at the same time to minimize the variance of the pres-
ent worth of the cash flow. If equal weights to the expected value and vari-
ance are given, then the values of the expected value-variance criterion
will be as computed in the last column of Table 8.5.
Based on the expected value-variance criterion, alternative A3 should
be selected.
1. Laplace
2. Maximin and Minimax
TABLE 8.5
Values of the Expected Value-Variance Criterion for Four
Alternatives
Alternatives EV Var EV(x) – W * Var(x)
A1 60,000 5 * 109 –4.999 * 109
A2 60,000 3 * 109 –2.999 * 109
A3 60,000 2.5 * 109 –2.499 * 109
A4 65,000 3.85 * 109 –3.849 * 109
Risk, Uncertainty, and Decision Analysis 169
TABLE 8.6
Available Alternatives to the ABC Company
Alternatives Description
A1 ABC Company will serve as a project manager, with all the work to be
subcontracted
A2 ABC Company is to subcontract the design but to do the construction
A3 ABC Company is to subcontract the construction but to do the design
A4 ABC Company is to do both the design and the construction
A5 ABC Company is to bid jointly with another company that has more capability
and experience
Example 8.4
The ABC Engineering and Construction Company has the opportunity
to bid on two contracts from an oil company. The first contract, X, is to
design and construct a deethanizer unit at the oil company’s refinery.
The second contract, Y, is to design and construct a liquified petroleum
gas (LPG) plant. The ABC company may be awarded either contract X
or contract Y or both. Thus, there are three possible outcomes or states
of nature.
The ABC Company has five alternatives to consider for these contracts,
as presented in Table 8.6.
Suppose the present values in thousands of dollars for all the alterna-
tives are as exhibited in the payoff matrix of Table 8.7.
Before proceeding, the payoff matrix should be examined for domi-
nance. The dominance principle is described as follows. Given sev-
eral alternatives, if one is always preferred, no matter which state
occurs, the preferred alternative is said to dominate the others, and
the dominated alternative (or alternatives) can be deleted from fur-
ther consideration.
TABLE 8.7
Payoff Matrix for Profit in Thousands of Dollars for the ABC Company
State of Nature
Alternatives X Y X and Y
A1 –4,000 1,000 2,000
A2 1,000 1,000 4,000
A3 –2,000 1,500 6,000
A4 0 2,000 5,000
A5 1,000 3,000 2,000
170 Petroleum Economics and Engineering
TABLE 8.8
Reduced Payoff Matrix for Profit in Thousands of Dollars for the
ABC Company
Alternatives X Y X and Y
A2 1,000 1,000 4,000
A3 –2,000 1,500 6,000
A4 0 2,000 5,000
A5 1,000 3,000 2,000
TABLE 8.9
Computation of Expected Payoff for the ABC Company
Alternative Average Payoff
A2 (1,000 + 1,000 + 4,000)/3 = 2,000
A3 (–2,000 + 1,500 + 6,000)/3 = 1,833
A4 (0 + 2,000 + 5,000)/3 = 2,333
A5 (1,000 + 3,000 + 2,000)/3 = 2,000
Risk, Uncertainty, and Decision Analysis 171
TABLE 8.10
Payoff Matrix for Profit in Thousands of Dollars for the ABC Company by the
Maximin Criterion
Maximum of
Alternatives X Y X and Y Minj Pjj Minimum
A2 1,000 1,000 4,000 1,000 ←
A3 –2,000 1,500 6,000 –2,000
A4 0 2,000 5,000 0
A5 1,000 3,000 2,000 1,000 ←
172 Petroleum Economics and Engineering
TABLE 8.11
Payoff Matrix for Profit in Thousands of Dollars for the ABC Company by
the Maximax Criterion
State of Nature Maximum of
Alternatives X Y X and Y maxj Pij Maximum
TABLE 8.12
Payoff Regret Matrix in Millions of Dollars for the ABC Company
State of Nature
Alternatives X Y X and Y Largest Regret
A2 1–1=0 3–1=2 6–4=2 2
A3 1 – (–2) = 3 3 – 1.5 = 1.5 6–6=2 3
A4 1–0=1 3–2=1 6–5=1 1←
A5 1–1=0 3–3=0 6–2=4 4
The decision criteria often can result in a mix of decisions, with no one
decision being selected more than the others. The criterion or collection of cri-
teria used and the resulting decision depend on the characteristics and phi-
losophy of the decision maker. For example, if the decision maker for the ABC
Company is extremely optimistic, he or she may choose alternative A3 even
though this alternative has been selected only once by the different criteria.
1.
Decision nodes and alternatives: At a decision point or node, the decision
maker must select one alternative course of action from a finite number
of available ones. A decision node is usually designated by a square.
Decision alternatives are represented by branches or arcs originating
out of the right side of the decision node. If a cost is associated with the
alternative, it is written along the branch. An alternative not selected is
pruned, and designated by the symbol //. Each alternative branch may
result in a payoff, in other decision nodes, or in a chance node.
2.
Chance nodes and states of nature: A chance node indicates that a chance
event is expected at this point in the decision-making process; that
is, one of a finite number of states of nature is expected to occur.
A chance node is designated by a circle. The states of nature are
shown on the tree as branches originating from the chance nodes.
Since decision trees depict decision making under risk, the assumed
probabilities of the states of nature are written above the branches.
Each state of nature may be followed by a payoff, a decision node, or
another chance node.
After the decision tree is constructed, the decision about which alternative
should be undertaken can be made. The solution process starts with seg-
ments ending in the final payoffs, at the right side of the tree, and continues
to the left, segment by segment in the reverse order from which the tree was
drawn. This technique is known as the rollback procedure. The technique can
be summarized by the following two rules:
1. If the node is a chance node, calculate the expected value of all the
states of nature emerging from the chance node (multiply the payoff
values by their corresponding probabilities and sum up the results).
The expected values are then written above the chance node inside
rectangles. These expected values are considered as payoffs for the
next branch to the left.
2. If the node is a decision node, the payoffs computed for each alterna-
tive are compared, and the best one is selected.
The decision maker must select one alternative at each decision node and
discard (prune) all other alternatives. The computation process continues
from the right to the left. Eliminating some alternatives slowly reduces the
size of the decision tree until only one alternative remains at the last decision
node on the left side of the tree.
Example 8.5
An oil drilling company is considering bidding on a $110 million contract
for drilling oil wells. The company estimates that it has a 60% chance of
winning the contract at this bid. If the company wins the contract, it
will have three alternatives: (1) to drill the oil wells using the company’s
existing facilities, (2) to drill the oil wells using new facilities, and (3) to
subcontract the drilling to a number of smaller companies. The results
from these alternatives are given as follows:
Menu is invoked
by selecting Tools/
Decision Tree.
Default titles
FIGURE 8.1
The general structure of a decision tree.
SOLUTION
The oil company should make the bid because this will result in an
expected payoff value of $143.2 million. The problem is solved using an
academic version of Microsoft Excel Add-in, TreePlan Software. To con-
struct a decision tree with TreePlan, go to the Tools menu and choose
Decision Tree, which brings up the TreePlan as shown in Figure 8.1
The dialogue boxes used by TreePlan for constructing a decision
tree are shown in Figure 8.2. The dialogue boxes enable us to add deci-
sion nodes, state of nature nodes, decision alternative branches, state of
nature branches, probabilities, payoffs, and all other tree parameters.
Example 8.6
An investment company is considering three different investment alter-
natives: (a) investing in bonds, (b) investing in stocks, or (c) investing
in certificates of deposit, CDs. There are three states of nature for the
economy: (a) growth, with 50% probability; (b) depression, with 30%
Risk, Uncertainty, and Decision Analysis 177
Click to get
(a) menu (c).
Click number of
branches desired
at node.
(b)
(c)
FIGURE 8.2
TreePlan dialogue boxes.
probability; and (c) inflation, with 20% probability. The rate of return on
the three investment alternatives under the three states of the economy
is given in Table 8.13.
SOLUTION
The expected value for each decision alternative is computed in the last col-
umn of Table 8.13. The decision maker who considers the expected value as
his or her criterion will select alternative D1, to invest in bonds, as the best
decision. If the decision maker decides on obtaining information concern-
ing the future state of the economy from a research firm, the decision maker
can select an investment alternative based on complete information. If the
research firm predicts growth, then the best investment alternative is D2,
investment in stocks. If depression is predicted by the research firm, D3,
investment in CDs will be the best decision investment alternative. If the
research firm predicts inflation, then the best decision alternative will be
D3, investment in CDs. Thus, the expected rate of return will be:
TABLE 8.13
Rate of Return on the Three Investments
Probability 0.5 0.3 0.2
States of Nature Growth Depression Inflation Expected Value
Alternatives
D1 Bonds 12 6 3 8.4
D2 Stocks 15 3 –2 8.0
D3 CDs 6.5 6.5 6.5 6.5
EVPI = ∑P V j ij
where Pj is the probability of state of nature j, and Vij is the payoff when
action dj is taken and state of nature j occurs.
In the case of minimizing:
The EVPI is the maximum amount that would be paid to gain informa-
tion that would result in a better decision than the decision made with-
out perfect information.
In summary, in order to determine whether or not to purchase perfect
information, one should:
Taqi N. Al-Faraj
Jamal A. Al-Zayer
CONTENTS
9.1 Introduction................................................................................................. 181
9.2 Linear Break-Even Analysis...................................................................... 182
9.2.1 Components of Break-Even Analysis........................................... 182
9.2.2 Mathematical Solution................................................................... 183
9.3 Extended Break-Even Analysis................................................................. 186
9.3.1 Using Two Alternatives.................................................................. 186
9.3.2 Using Multiple Alternatives.......................................................... 187
9.3.3 Graphic Solution............................................................................. 190
9.4 Nonlinear Break-Even Analysis................................................................ 190
9.1 Introduction
Break-even analysis is a means of identifying the value of a particular proj-
ect variable that causes the project to exactly break even. In other words, the
purpose of break-even analysis is to determine the number of units of a prod-
uct to produce that will equate total revenue with total cost. At this point,
referred to as the break-even point (BEP), profit is zero. It is also defined
in terms of finding the values of particular variables that give the project a
break-even net present value (NPV) of zero (Cafferky and Wentworth, 2010).
181
182 Petroleum Economics and Engineering
1. Volume
2. Costs
Costs are usually divided into two components: fixed and vari-
able. Fixed costs are generally independent of the volume of units
produced. Some individual costs that might be incorporated into
Break-Even and Sensitivity Analysis 183
3. Profit
Profit is the difference between total revenue and total costs. Total
revenue is the volume multiplied by the price per unit.
TR = (P)(Q) (9.1)
FC = fixed cost
Q = (FC)/(P – VC) (9.3)
TC = total cost
PR = TR – TC (9.4)
Using Equations (9.1), (9.2), and (9.3) and the above result given by Equation
(9.5), the following relationship is obtained:
In other words, the break-even quantity can be obtained by dividing the total
fixed cost by the difference between the unit price and the unit variable cost.
Example 9.1
A refiner determines that the total cost of producing Q barrels of gaso-
line per day is given by
TQ = 4,000 + 2Q
The revenue (in thousands of dollars) from selling Q barrels of gasoline
per day is
TR = 4Q
SOLUTION
1. The break-even point occurs when total revenue equals total cost.
TC = TR
4000 + 2Q = 4Q
2Q = 4, 000
Q = 2, 000
TC = 4, 000 + 2Q
or TR = 4Q
Revenue Total
Cost Revenue
t
l Cos
Tota
t
Profi
8,000.0
Loss
4,000.0 Fixed Cost
Quantity
Breakeven
Point Q = 2,000
FIGURE 9.1
Break-even point (BEP) graph.
3. Since both the total cost and total revenue equations are lin-
ear equations, they can be represented by two straight lines, as
shown in Figure 9.1.
PR = TR − TC
PR = 4Q − (4000 + 2Q)
2Q = 104, 000
TC1 = f1(x)
and
TC2 = f2(x)
where
Example 9.2
Using a special type of machine, a company produces a high-pressure
oil valve to be used in the hydrocarbon industry. The company’s fixed
cost on the valve is $20,000 per month. The variable cost of production
per valve is $900.
The company is considering replacing the old machine with a new
one. The new machine costs $1,200,000. Assuming a 10-year straight-line
depreciation period, the monthly depreciation cost of the new machine
will be $10,000. Other fixed cost allocated to this product is $18,000.
However, because this machine will result in less scrappage and waste of
Break-Even and Sensitivity Analysis 187
raw materials and will require less operator time to produce a valve, it will
reduce the variable cost of the valve to $500 per valve. Above what vol-
ume of production will the new machine be better than the old machine?
SOLUTION
At the break-even point the total costs, TC, of the two machines should
be equal. Thus:
TC1 = TC 2
400Q = 8, 000
Q = 20 units
Cost
TC1
TC2
Breakeven Quantity
Point
Q = 20
FIGURE 9.2
Break-even analysis for Example 9.2.
188 Petroleum Economics and Engineering
Example 9.3
Three different 15-horsepower electric motors are being considered for
purchase by an oil company. Motor X sells for $6,000 and has an effi-
ciency rating of 90% (alternative A); motor Y sells for $4,000 and has a
rating of 85% (alternative B); and motor Z sells for $3,000 and is rated to
be 80% efficient (alternative C). The cost of electricity is $0.20/kilowatt.
An 8-year planning horizon is used (n = 8), and zero salvage values are
assumed for all three motors. An annual rate of return, i, of 25% is to be
used. Determine the range of values for annual usage of the motor (in
hours) that will lead to the preference of each motor. (Note that 0.746
kilowatts = 1 horsepower.)
SOLUTION
First, it is necessary to define the common variable between the alter-
natives and state its dimensional unit. Second, the equivalent uniform
annual cost (EUAC) or the present worth (PW) analysis should be used
to express the total cost of each alternative as a function of the defined
variable. Then, equate the cost equation of each of the two alternatives
and solve for the break-even value of the variable.
Let x be annual usage in hours and CRF be the capital recovery factor
given by
The annual electricity cost for 100% efficient motor = ((15 HP)(0.746
kw/hp)($0.20/kw hr)(x hr/year))/efficiency = (2.238)(x)/year.
= 6, 000(0.3004) + 2.487( x)
= 1, 802.40 + 2.487( x)
= 4, 000(0.3004) + 2.633( x)
= 1, 201.6 + 2.633( x)
= 3, 000(0.3004) + 2.798( x)
= 901.20 + 2.798( x)
Break-Even and Sensitivity Analysis 189
Let
EUAC for alternative A = EUAC for alternative B
x = 2, 898
Let
EUAC for alternative B = EUAC for alternative C
x = 1,821
Figure 9.3 illustrates the graphic solution for the break-even analysis for
the three alternatives. If the anticipated annual usage is below the break-
even value of x = 1,821, select alternative C. If 1,821 ≤ x ≤ 4,115, then select
alternative B, and if x ≥ 4,115, then select alternative A.
(Alternative C)
EUAC = Equipment Uniform
Annual Cost, in Dollars
+ 2.653
1201.6 native
Alter
1802.40°
+2.487)
182.40 Alternative –A
01.40
901.20
1821 2898 4115
X = Annual Usage in Hours
FIGURE 9.3
Break-even analysis for Example 9.3.
190 Petroleum Economics and Engineering
Example 9.4
Two packaging methods A and B for automotive lubricants are under
consideration by an oil company. Method A uses a special carton, while
method B uses regular materials. Figure 9.4 shows the package cost for
the two methods as a function of the volume of the merchandise. By
examining the graph, it is apparent that a relationship between volume
and cost is not a simple one. Method A should be used for the ship-
ment whose volume is less than 3,500 cubic inches, while shipments with
larger volume should use method B.
B
thod
Me
Cost, in Dollars
3500
Volume of Merchandise
FIGURE 9.4
Package cost of automotive lubricants as a function of the volume of merchandise.
Break-Even and Sensitivity Analysis 191
with higher volume as the market becomes saturated. Variable costs may
also fluctuate continuously with increasing volume. There are unlim-
ited variations in the ways revenue and cost can behave in a nonlinear
setting (Lapašinskaitė and Boguslauskas, 2006). In summary, nonlinear
break-even analysis is appealing for two reasons: (1) it seems reasonable
to expect that in many cases increased sales can be achieved only if prices
are reduced; and (2) the cost function of the average variable cost falls over
some range of output and then begins to rise. The situation where variable
cost decreases as economies of scale are realized and then increases as pro-
duction capacity approaches the maximum, while total revenue increases
at a decreasing rate as price is lowered in order for the sale to reach the
market potential is illustrated in Figure 9.5. Solved Example 9.5 is an appli-
cation for the method.
Example 9.5
The oil refining company sells its product for a fixed price of $359 per box.
Total cost (TC) of production varies according to the following equation:
TC = 2Q 2 − Q + 6, 400
Revenue
Cost
Total
Cost
Total
Revenue
Profit
Loss Fixed
Cost
Quantity
Breakeven Breakeven
Point Point
FIGURE 9.5
The case of break-even with nonlinear revenues and cost.
192 Petroleum Economics and Engineering
SOLUTION
Figure 9.6 shows the curves of the total cost and the total revenue (TR),
where TR is a straight line given by the following equation:
TR = 359Q
and the TC is the curve given by the TC equation.
As shown in Figure 9.6, there are two break-even points. Because the
nature of the revenue and cost curves is not very complex, it is possible
to calculate these two points exactly rather than estimate them from
the graph.
At the two break-even points, total revenue must be equal to total cost:
TR = TC
359Q = 2Q 2 − Q + 6, 400
2Q 2 − 360 + 6, 400 = 0
Q = 20 or Q = 160
Therefore, the company will make a profit if it produces between 20
and 160 units. The largest profit will occur halfway between the two
break-even points (i.e., Q = 90 units). This will not always be true. The
Revenue
Cost
ue
ven
Total Cost Re
t al
To
FIGURE 9.6
Nonlinear break-even analysis.
Break-Even and Sensitivity Analysis 193
Sensitivity Analysis
In many cases simple break-even analysis is not feasible because several
factors may vary simultaneously as the single variable is varied. In such
instances, it is helpful to determine how sensitive the situation is to several
variables so that proper weight may be assigned to them (Jovanovic, 1999).
In general, sensitivity analysis is used to analyze the effects of changes
or making errors in estimating parameter values. Sometimes sensitivity
analysis is more specifically defined to mean the relative magnitude of the
change in one or more coefficients of the variables that will reverse a deci-
sion among alternatives. Sensitivity analysis permits a determination of
how sensitive the final results are to changes in the values of the estimates.
Example 9.6
Let us consider the refiner who wants to determine the total cost of pro-
ducing Q barrels of gasoline per day, which is given by:
TC = 4,000 + 2Q
and the total revenue (in thousands of dollars) from selling Q barrels of
gasoline per day is expressed by:
TR = 4Q
The value of $4 in the TR equation is the price of selling a barrel of gas-
oline. In most instances the price is not known with certainty. Let us
assume that $4 is the most likely price, and there is a pessimistic price of
$3 and another price of $5, which is considered to be optimistic.
SOLUTION
The break-even quantities under the pessimistic, the most likely, and
the optimistic prices are shown in Table 9.1. The use of the three price
estimates results in providing three different estimates for the break-
even quantities. Three estimates for parameters other than the price
could also be considered to provide sensitivity analysis for the quantity
or other parameters such as total cost or total revenue.
Example 9.7
Consider a pipe manufacturer who produces various types of pipes, oil,
water, and gas. Pertinent data about selling price, variable cost, and fixed
cost for the next planning period are given in Table 9.2.
TABLE 9.1
Sensitivity Analysis Table
Pessimistic Most Likely Optimistic
Break-even quantity 4,000 2,000 1,333
194 Petroleum Economics and Engineering
TABLE 9.2
Data for Pipe Manufacturing
Selling Price Variable Cost
Per Meter Per Meter Fixed Cost
Product (pipes) ($100s) ($100s) ($100s)
Oil 10 5 30000
Gas 7.5 3.6 50000
Water 5 2 20000
SOLUTION
This problem has three products as well as previous commitments and
restrictions. To obtain an expression of the break-even in terms of the
production quantities, the following decision variables are defined:
Minimize 5 X1 + 3.6 X2 + 2 X3
subject to:
5 X1 + 3.9 X2 + 3 X3 = 100000
X1 ≥ 700
X2 ≥ 400
X3 ≤ 300
X1, X2, X3 ≥ 0
Break-Even and Sensitivity Analysis 195
The setup of the Microsoft Excel® Solver for the pipe manufacturing
example is shown in Figure 9.7. The final answer as reported by the
Solver is presented in Figure 9.8. The solution procedure for the above
example is further discussed in Chapter 10.
10
Optimization Techniques
Jamal A. Al-Zayer
Taqi N. Al-Faraj
Mohamed H. Abdel-Aal
CONTENTS
10.1 Introduction................................................................................................. 198
10.2 Differential Calculus.................................................................................. 198
10.2.1 Differentiation Rules...................................................................... 200
10.2.2 Application of Differentiation to Optimization......................... 202
10.3 Linear Programming (LP)......................................................................... 205
10.3.1 Assumptions of Linearity.............................................................. 207
10.3.2 Formulation and Solution of LP Models..................................... 207
10.3.3 Applications of Linear Programming.......................................... 210
10.3.3.1 The Transportation Model.............................................. 210
10.3.3.2 The Assignment Model................................................... 213
10.3.3.3 The Network Models....................................................... 216
10.4 Nonlinear Programming........................................................................... 217
10.4.1 Constrained and Unconstrained Optimization......................... 218
10.4.2 The Substitution Method............................................................... 218
10.4.3 The Method of Lagrangian Multipliers....................................... 219
197
198 Petroleum Economics and Engineering
10.1 Introduction
The general scope of an optimization problem is to determine values of
the independent variables which give the greatest possible numerical
value (maximization) or least possible value (minimization) of a math-
ematical function.
Process optimization, on the other hand, is the discipline of adjusting
a process so as to optimize some specified set of parameters without vio-
lating some constraint. The most common goals are minimizing cost and
maximizing throughput and efficiency. Process optimization finds many
technical applications in the oil sector. This may include equipment siz-
ing, operating procedure, or control optimization. Examples are cited in
the chapter.
Classical optimization methods based on differential calculus are sur-
veyed first and demonstrated by empirical examples. The general strategy
followed in this method is to establish a partial derivative of the dependent
variable from which the absolute conditions are determined. However,
many real problems may involve optimum conditions that exist at bound-
ary conditions rather than a true maximum or minimum (to allow for the
partial derivative to be equal to zero). This is the case covered using linear
programming. It is considered to be the most widely used optimization
technique for modeling physical, economic, engineering, and business
problems. Linear programming is further explained by surveying some of
its basic models. Since not all optimization problems are linear, the tech-
niques of nonlinear programming are presented and discussed in the last
section.
slope = m = ∆y/∆x
= ( y 2 − y 1 ) /(Y2 − y 1 )
With nonlinear functions the rate of change in the value of y with respect
to a change in x is not constant. However, one way of describing nonlinear
functions is by the average rate of change over some interval. Graphically
the average rate of change of a nonlinear function is represented by a secant
line. This is illustrated in Figure 10.1. The instantaneous rate of change of a
smooth continuous function can be represented geometrically by the slope of
the tangent line drawn at the point of interest. The exact tangent line can be
F(x)
B
F(x + ∆x)
Secant
∆y
Line
A
F(x)
Average Rate ∆y F(x + ∆x) – F(x)
= =
of change ∆x ∆x
∆x
x
x x + ∆x
FIGURE 10.1
Average rate of change for a nonlinear function.
200 Petroleum Economics and Engineering
If f ( x) = −3/x = −3 x −1
If f ( x) = ( x 2 − 5)( x − x 3 )
Let f ′ ( x) = u′ ( x) ⋅ v( x) + v ′ ( x) ⋅ u( x)
= (2 x)( x − x 3 ) + (1 − 3 x 2 )( x 2 − 5)
= 2 x 2 − 2 x 4 + x 2 − 5 − 3 x 4 + 15 x 2
= −5 x 4 + 18 x 2 − 5
Optimization Techniques 201
If f ( x) = 3 x 2 − 5 / 1 − 33
= 6 x − 6 x 4 + 9 x 4 − 15 x 2 /(1 − x 3 )2
= 3 x 4 − 15 x 2 + 6 x /(1 − x 3 )2
If f ( x) = 7 x 4 − 5 x − 9
= (7 x 4 − 5 x − 9)1/2
If f ( x) = (3 x/(1 − x 2 ))5
If f ( x) = e x
then f ′( x) = 1 ⋅ e x = e x
Note that the function and its derivative are exactly the same.
f ( x) = f ′ ( x) = e x
If f ( x) = In x
then f ′ ( x) = 1/x
202 Petroleum Economics and Engineering
If f ( x) = ln(5 x 2 − 2 x + 1)
Let u( x) = 5 x 2 − 2 x + 1
Example 10.1
The management of an oil company wants to fence in a rectangular
shape a gas oil separation plant located on the seashore but will not fence
the seashore side. If there are 10,000 m of fence to work with, what is the
maximum area that can be enclosed?
SOLUTION
Let the lengths of the sides of the rectangular area be x and y. And let the
area be A. Therefore:
A = xy(10.1)
Since there are 10,000 m of fence to work with, the following relation-
ship exists:
10, 000 = 2 x + y or
(10.2)
y = 10, 000 − 2 x
A = − x(10, 000 − 2 x)
(10.3)
= 10, 000 x − 2 x 2
2x ≤ 10, 000 or
x ≤ 5, 000
Optimization Techniques 203
A = 10, 000 x − 2 x 2 ,
where 0 ≤ x ≤ 5,000.
Taking the first derivative of Equation (10.3) yields
Setting the derivative (Equation 10.4) equal to zero gives the value of x
that maximizes the area.
10,000 − 4 x = 0
10, 000 = 4 x
x = 2 , 500
y = 5, 000
Therefore, the length of the fenced area should be 5,000 meters and the
two sides should be 2,500 meters each.
Example 10.2
The marketing manager of an oil company knows that the demand for
the oil varies with its charged price. The company has determined that
annual total revenue R (in thousands of dollars) is a function of the price
p (in dollars). Specifically,
R = f ( p) = −50 p 2 + 500 p
SOLUTION
The revenue function is quadratic and its graph is a parabola that is con-
cave downward as shown in Figure 10.2.
204 Petroleum Economics and Engineering
1500
(5,1250)
Revenue Maximization Point
1250
Revenue, in 1,000s of Dollars
1000
R = –50 P2 + 500P
500
0
5 10 15 P
Price in Dollars
Quadratic Revenue Function
FIGURE 10.2
Quadratic revenue function.
As shown in the figure, the maximum value of R will occur at the ver-
tex. The first derivative of the revenue function is:
by setting f ′(p) = 0,
–100p = –500
p=5
There is one critical point on the graph of f(p) and it occurs when p = 5.
Therefore, a relative maximum occurs when the company charges $5
per unit.
Example 10.3
Automobile hydrocarbon emission rate R(x) in milligrams per minute is
found to be related to the speed x in kilometers per hour by
R( x) = xe − x/50
Optimization Techniques 205
Concerned drivers would like to avoid driving at the speed that gives
the maximum emission rate. Find that speed.
SOLUTION
The maximum speed will occur when the derivative is set equal to zero.
= e − x/50 [1 − (1/30)x]
1 − (1/50)x = 0
min/max Z = C1X 1 + C2 X 2 + + CN X N
Subject to:
≤
A11X 1 + A12 X 2 + + A1N X N ( =)B1
≥
≤
A21X 1 + A22 X 2 + A2 N X N ( =)B2
≥
≤
A31X 1 + A32 X 2 + + A3 N X N ( =)B3
≥
≤
AM 1X 1 + AM 2 X 2 + + AMN X N ( =)BN
≥
All X IJ nonnegative
max or min Z = ∑C Xj =1
j j
Subject to:
N ≤
∑
j =1
Aij X j ( =) Bi (i = 1, … , m)
≥
x j ≥ 0 ( j = 1, … , N )
Optimization Techniques 207
Example 10.4
The production manager of an oil refinery must decide on the optimal
mix of two blending processes, of which the inputs and outputs per pro-
duction run are as follows:
208 Petroleum Economics and Engineering
The maximum amounts available of light crude and heavy crude are
20,000 and 15,000 barrels, respectively. Market requirements show at
least 10,000 barrels of regular gasoline and at least 8,000 barrels of pre-
mium gasoline must be produced. The profits per production run from
process 1 and process 2 are $3 and $4, respectively.
SOLUTION
Maximize Z = 3 x1 + 4 x2
c. Nonnegativity constraints:
x1 ≥ 0
x2 ≥ 0
Optimization Techniques 209
SOLUTION
Linear programming problems with only two decision variables can be
solved graphically. Plotting the linear equations of the constraints will
form a convex hull or a solution space, which is called in LP terminology
the feasible region. The optimal solution, if there is one, will occur on an
extreme point or points of the convex hull, and it can be found by plot-
ting isoquant lines of the objective function. The graphic solution of the
problem is given in Figure 10.3.
This linear programming problem can also be solved algebraically
using the simplex method, which is usually tedious, time consuming,
and needs many pivoting iterations. For this reason, especially if the
problem has more than two variables and many constraints, computer
programs are preferred to be used for solving such problems. Due to
the popularity of using linear programming and other optimization
techniques in decision-making analysis, many commercial and educa-
tional mathematical programming computer packages are available and
used extensively to solve large-scale linear programming problems as
well as small ones. Among these packages are Linear and Interactive
Discrete Optimizer (LINDO), Quantitative Systems for Business (QSB),
and Statistical Analysis System/Operations Research (SAS/OR).
The algebraic solution of the above linear programming problem
using the QSB computer package is presented in Table 10.1. Additionally,
the LP problem can easily be solved using the Microsoft® Excel® Solver.
The setup of the LP problem along with the Solver reports are given in
Tables 10.1A and 10.1B.
x2
50
Feasible region
50
0x
1
+
40
z=
0x
30 13
2
8.4
=
20
6
25
00
0
20 Optimal Solution
50 800 x 1 8000
30
0x
+4
1 +
00
50
=
0x
x2
+4
2 =
=1
15
00
00
00
0
x2
10 20 30 40 50 x1
z=0
FIGURE 10.3
Graphic solution of the oil refinery problem.
210 Petroleum Economics and Engineering
TABLE 10.1
Computer Solution Use for the Oil Refinery Problem Using QSB
Variables Variables
Opportunity Opportunity
Number Names Solution Cost Number Names Solution Cost
1 X1 +30.769230 0 5 S3 +10,000.000 0
2 X2 +11.538464 0 6 A3 0 0
3 S1 0 +0.00230769 7 S4 +21,230.763 0
4 S2 0 +0.00616385 8 A4 0 0
TABLE 10.A
Microsoft Excel Solver Solution for the Oil Refinery Problem
Decision variables X1 X2
Solution 30.76923 11.53846 Value
Objective function 3 4 138.4615385 Slack/
coefficients surplus
Constraint-1 500 400 20000 ≤ 20000 0
Constraint-2 300 500 15000 ≤ 15000 0
Constraint-3 500 400 20000 ≥ 10000 10000
Constraint-4 800 400 29230.76923 ≥ 8000 21230.76923
Optimization Techniques 211
TABLE 10.1B
Microsoft Excel Solver Answer Report for Example 10.8
Microsoft Excel 12.0 Answer Report
Worksheet: [Book1]Sheet1
Report Created: 4/15/2012 11:58:51 AM
Target Cell (Max)
Original
Cell Name Value Final Value
$D$3 Objective 0 138.4615385
function
coefficients
value
Adjustable
Cells
$B$2 Solution X1 0 30.76923077
$C$2 Solution X2 0 11.53846154
Constraints
Cell Name Cell Value Formula Status Slack
$D$4 Constralnt-1 20000 $D$4< = $F$4 Binding 0
value
$D$5 Constraint-2 15000 $D$5< = $F$5 Binding 0
value
$D$6 Constraint-3 20000 $D$6> = $F$6 Not 10000
value binding
$D$7 Constraint-4 29230.76923 $D$7> = $F$7 Not 21230.76923
value binding
and n destinations, D1, D2, …, Dn for the commodity, with a demand bj at Dj.
If Cij is the unit cost of transporting from 0i to Dj, find the optimal solution
that will minimize the total transportation cost. The problem can be stated
mathematically as follows:
Minimize ∑C X
i ∈I
ij ij
j ∈j
subject to:
∑X
j∈j
ij = ai , i ∈T = {1, 2 , … , m}
X ij = b j , j ∈ J = {1, 2 , … , n}
X i ≥ o, i ∈ I , j ∈ J
212 Petroleum Economics and Engineering
where Xij represents the amount shipped from 0i to Dj. The assumptions
that total supply is equal to demand and each amount of supply and
demand is nonnegative are necessary conditions for the existence of a fea-
sible solution.
Example 10.5
A contractor must assign workers in an oil field to four work sites each
day. The travel time in minutes between each dispatch location and work
site is shown on the directed areas of the network diagram. In order to
maximize the number of productive work hours per day of each worker,
the contractor wishes to minimize the total worker travel time. Travel
time is considered to be unproductive work time. The number of work-
ers dispatched from locations 1 and 2 is 30 and 50 workers, s1 = 30, and
s2 = 50, respectively. The numbers of workers required at each work site
3, 4, 5, and 6 are 20, 20, 30, and 10, respectively. They are shown on the
network diagram (Figure 10.4) as d3 = 20, d4 = 20, d5 = 30, and d6 = 10.
Formulate a mathematical model to minimize total travel time.
+ 60X 26
Work Site
Dispatch 40 3 d3 = 20
Location
x13 20
S1 = 30 1 x14
x15 20
x16 4 d4 = 20
50
20
x23
x29 10 5 d5 = 30
x25
50
S2 = 50 2 x26
60
6 d6 = 10
FIGURE 10.4
Network diagram for the transportation problem.
Optimization Techniques 213
X 13 + X 14 + X 15 + X 16 = 30
X 23 + X 24 + X 25 + X 26 = 50
X 13 + X 23 = 20
X 14 + X 24 = 20
X 15 + X 25 = 30
X 16 + X 26 = 10
X i ≥ 0 wherre i = 1, 2
j = 3, 4, 5, 6
n n
Minimize Z = ∑∑c x
i =1 j =1
ij ij
Subject to
∑x
j =1
ij =1 i = 1, 2 , … , n (10.6)
214 Petroleum Economics and Engineering
∑x ij =1 j = 1, 2 , … , n (10.7)
i =1
where cij is the cost of assigning the ith individual to the jth job.
Constraint (2) ensures that each individual is assigned to exactly one job,
while constraint (3) ensures that each job is covered by one individual. The
problem as stated above is an integer linear programming problem. However,
if constraint (1) is replaced with the set of nonnegativity restriction:
xij ≥ 0 i = 1, 2 , … , n
j = 1, 1, … , n
Example 10.6
To expand on the linear programming approach in solving assignment
problems, let us consider the following example:
Client
A B C
Project Leader (Estimated Completion Time, Days)
Tom 10 15 9
Mary 9 18 5
Jack 6 14 3
We would like to assign project leaders such that the total number of
days required to complete all three projects is minimized. Let us begin
by defining the following decision variables:
Using the above decision variables, the objective function calling for
the minimization of total days of labor can be written as:
Min 10 x11 + 15 x12 + 9 x13 + 9 x21 + 18 x22 + 5 x23 + 6 x31 + 14 x32 + 3 x33
The constraints affecting this problem are that all clients must receive
exactly one project leader and that the project leaders cannot be assigned
Optimization Techniques 215
to more than one client. The first condition is satisfied by the following
linear constraints:
xij = 0 or 1
The above 0–1 linear programming problem can be solved using any
linear programming software or the Microsoft Excel Solver.
The solution of the assignment problem is given by Excel Solver in
Figure 10.5. Tom is assigned to client B while Mary and Jack are assigned
to clients C and A, respectively. The total completion time is 26 days.
FIGURE 10.5
Setup and solution for the assignment Example 10.6.
216 Petroleum Economics and Engineering
Example 10.7
Determine the capacity of the pipeline network system shown in
Figure 10.6. The flow capacity in million gallons per day is indicated on
each directed arc. The objective is to maximize the flow that enters the
source and exits the sink node. Formulate this maximal flow problem as
a linear programming model.
FIGURE 10.6
A setup and optimal solution for the pipeline system flow, Example 10.7.
Optimization Techniques 217
PROBLEM FORMULATION
Let Xj represent the amount of flow on arc j. f represents the amount of
flow entering and leaving the pipeline network system.
The objective function and constraints are as follows:
Maximize x1 + x2 + x3
x1 + x2 + x3 = f
− x1 − x5 + x6 = 0
− x2 − x4 + x5 + x7 = 0
− x3 + x 4 + x8 = 0
− x6 − x7 − x8 = − f
0 ≤ x1 ≤ 5
0 ≤ x2 ≤ 2
0 ≤ x3 ≤ 4
0 ≤ x4 ≤ 4
0 ≤ x5 ≤ 3
0 ≤ x6 ≤ 6
0 ≤ x7 ≤ 2
0 ≤ x8 ≤ 3
The above problem can be solved using Microsoft Excel Solver. The
setup and the optimal solution of the pipeline flow system are shown in
Figure 10.6A. The maximum flow capacity in the pipeline system is 11
million gallons per day.
f (x) = Z = px = FC−VC(x)
x = 2,000 − 50p
By substituting the demand function into the profit equation, the following
nonlinear function is obtained:
When fixed cost (FC) equal to $3,000 and variable cost (VC) equal to $20 are
substituted into the above profit function:
Setting the derivative of the above profit function equal to zero, the price that
gives the maximum profit can be found. For this particular profit function a
price of $30 gives the maximum profit of $2,000.
This type of nonlinear programming model is referred to as an uncon-
strained optimization. It consists of a single nonlinear objective function and
no constraints. If, however, one or more linear or nonlinear constraints are
added to the nonlinear objective function, the model is referred to as a con-
strained nonlinear optimization model.
Constrained optimization problems can be handled in several ways.
The substitution method and the Lagrangian are two of the most com-
monly used solution techniques for solving simple nonlinear optimiza-
tion problems.
Example 10.8
Consider the following constrained nonlinear optimization problem:
Determine the values of x and y which will result in the least cost.
SOLUTION
From the constrained equation
x = 20 − y
TC = 3(20 − y )2 + 6 y 2 − (20 − y )y
TC = 3( 400 − 40 y + y 2 ) + 6 y 2 − 20 y + y 2
TC = 1, 200 − 140 y + 10 y 2
Setting the derivative of the above total cost function equal to zero and
solving for the value of y will give the following result:
dTC/dy = −140 + 20 y = 0
20 y = 140
y=7
Substituting the value of y into the constraint equation will give the
value of x:
x = 20 − 7
x = 13
Substituting the values of x and y in the objective function will yield the
least total cost, which is $710.
Rearranging the constraint to bring all the terms to the left of the equal sign,
the following is obtained:
x + y − 20 = 0
L = 3 x 2 + 6 y 2 − xy + λ( x + y − 20)
∂LTC/∂X = 6 y − Y + λ
∂LTC/∂Y = 12Y − X + λ
∂LTC/∂λ = X + Y − 20
Setting the above equations equal to zero will result in a system of three
equations and three unknowns:
6x − y + λ = 0 (10.8)
−x + 12 Y + λ = 0 (10.9)
x + Y − 20 = 0 (10.10)
x = 13
y=7
λ = −71
Optimization Techniques 221
A B C D E F G H I
X X-SQR Y Y-SQR XY
Decisions 13 169 7 49 91 Value
OFC 3 6 –1 710
C-1 1 1 20 = 20
FIGURE 10.7
Solver Example 10.8, Setup.
FIGURE 10.8
Solver parameters and solution for the nonlinear Example 10.8.
Section 3
Applications and
Case Studies
Section 3 represents a major change in this revised edition. It includes ten
chapters covering the three main operations in the oil and associated gas
industry from prospects to finished products. It covers:
• Upstream operations: Sub-Subsurface (Chapter 11, Exploration and
Drilling; Chapter 12, Reserves and Reserve Estimate; and Chapter
13, Production).
• Middle stream operations: Surface (Chapter 14, Gas-Oil Separation;
Chapter 15, Crude Oil Treatment; and Chapter 16, Gas Treatment
and Conditioning).
• Downstream operations: Refining/Processing (Chapter 17, Crude
Oil Refining: Physical Separation; Chapter 18, Crude Oil Refining:
Chemical Conversion; Chapter 19, Natural Gas Processing; and
Chapter 20, Oil and Gas Transportation).
The chapters on middle stream operations, known as surface petroleum
operations (SPO) and natural gas processing and fractionation, are new to
this edition.
As in the second edition, the primary aim of Section 3 is to illustrate how
economic analysis is applied to solve engineering problems in different facets
of the oil industry. Addressing relevant problems involving oil-engineering
decisions is our main focus. Case histories and actual calculations for oil
operations and gas processing plants are presented. Many real-world exam-
ples are documented specially for Middle East operations and others.
For each chapter in Section 3, the technical aspects are described first, fol-
lowed by case studies and applications relevant to specific problems.
11
Exploration and Drilling
Hussein K. Abdel-Aal
CONTENTS
11.1 Technology Aspects.................................................................................... 226
11.1.1 Introduction..................................................................................... 226
11.1.2 The Search for Oil: Exploration.................................................... 226
11.1.3 Oil Reservoirs and Classification................................................. 227
11.1.3.1 Definitions......................................................................... 228
11.1.4 The Role of Drilled Wells in Development................................. 229
11.1.5 Number of Wells and Well Spacing............................................. 230
11.1.6 Drilling Operations........................................................................ 230
11.1.7 Factors Affecting Penetration in Drilling.................................... 231
11.1.8 Costs of Drilling.............................................................................. 231
11.2 Economic Evaluation and Application.................................................... 233
11.2.1 Economic Balance in Oil Fields (Optimization)......................... 233
11.3 Conclusions.................................................................................................. 240
11.4 Glossary........................................................................................................ 241
225
226 Petroleum Economics and Engineering
The net result of these studies is the preparation of different kinds of geo-
logical maps that show the changes in the shape of subsurface structures
with depth.
Exploration and Drilling 227
1. Seismic
2. Magnetic
3. Gravitational
Each of these techniques utilizes the principles of physical forces and the
properties of the earth. For example, in the seismic method, creation of artifi-
cial earthquake waves is established by firing explosives into holes. The rates
of travel of these waves are analyzed by echo sounding techniques. The most
recently invented instruments are reflection seismographs, gravimeters, and
airborne magneto-meters. Such devices enable geophysicists to explore not
only the surface and the subsurface conditions of the earth searching for oil,
but the lunar surface and depths as well. These sophisticated lunar experi-
ments monitor the earth’s magnetic and gravitational properties from space.
Stratigraphy, on the other hand, involves drilling a well to obtain strati-
graphic correlation and information. Complete sections of the well forma-
tions are exposed and rock samples are taken while the drilling operation
is in progress. Success in finding oil will depend to a large degree on the
accuracy of well logging. Several kinds of well logs exist. The most commonly
used are:
1. Drillers logs
2. Sample logs
3. Electric logs
4. Radioactivity logs
5. Acoustic logs
Once the data are collected using core samples and wire-line logs of vari-
ous kinds, contour maps are prepared. A contour map consists of a number of
contours, or lines, on which every point of a given area is at the same eleva-
tion above or below sea level. These lines must be at regular depth intervals
to enable geologists to depict three-dimensional shapes.
Other means of exploring for oil include detailed ground geological
surveys aided by preliminary results of aerial photography and photo-
geological work.
11.1.3.1 Definitions
A reservoir may be defined as any body of underground rocks with a con-
tinuously connected system of void spaces filled with hydrocarbon fluids
which can move toward wells—drilled into the rocks—under the influence
of either natural or artificial driving forces. If the volume of the hydrocar-
bons produced by the wells is sufficient to permit an economic recovery, then
the accumulation is known as a commercial reservoir and is usually referred
to as a proven reserve.
Reservoirs, on the other hand, could be described as a “resource base,”
which is the sum total of crude oil, natural gas, and natural gas liquids in
the ground within an identified geographic area. The reservoir thus includes
all stocks, including some stocks that are unrecoverable and therefore not
included in “proven reserves.”
Proven reserves refer to the reserve stocks of immediate or short-term
economic feasibility of extraction; therefore, stocks that are known to exist
but cannot profitably be extracted are excluded from reserves. The cost
limits, or as far as one can go on profitably employing these reserves, are
those costs consistent with the taking of “normal” risk and commercial
production.
The void spaces of proven reservoirs normally contain some interstitial
water (or connate water) along with the hydrocarbons. Since most of this
water is held in space by some sort of capillary forces, reservoir rocks turn
out to be saturated with the three reservoir fluids: oil (liquid), gas, and
water.
Exploration and Drilling 229
Drilling Wildcat
Geo-physical
Wells, Exploratory Dry Wells
Exploration
Search Wells, or Test Wells
for oil
Successful
Discovery
Wells
Development
Wells
Commercial Production
FIGURE 11.1
Different stages in well drilling.
Second, the characteristics of the oil itself and the nature and amount of
oil in the reservoir should be determined from the samples of the reservoir.
The raising of oil to the ground surface and then the handling of the oil at
ground surface will depend to a great extent on the nature of the oil itself
and its associated gas. Crude oil can range from very heavy viscous oil,
almost a tar, with little or no gas dissolved in it and under very low pres-
sure, to an extremely light, straw-colored oil with a considerable volume of
gas, known as a condensate-type crude. The condensate-type crude is more
likely to be found at great depths. Under conditions of high pressure and
temperature that exist at deep levels, the crude is usually in the gaseous
stage. Between the extremes of a heavy viscous oil and a very light oil, there
is an infinite variety of crude oil. The manner of producing these crudes is
decided only after examining samples that show their characteristics and
physical attributes.
Intelligent wells are increasing in popularity. These contain permanent
monitoring sensors that measure pressure, temperature, and flow and
telemeter these data to the surface. More importantly, these wells contain
surface-adjustable downhole flow-control devices, so, based on the dynamic
production information from all the wells in the reservoir, flow rates can be
optimized without having to perform a costly intervention.
drill pipe becomes almost as flexible as a thin steel rod. Controlling the drill
pipe under such conditions and keeping the hole straight at the same time is
difficult and requires great skill in drilling.
During the drilling, a mixture of water, special clays, and chemicals,
known as drilling mud, is pumped down through the hollow drill pipe
and circulated back to the surface in the space between the outside of the
pipe and the walls of the pipe. This drilling mud serves several purposes,
including lubricating and cooling the bit and flushing rock cuttings to
the surface.
As the drilling hole is deepened, it is lined with successive lengths of steel
pipe, called casings. Each string of casing slides down inside the previous
one and extends all the way to the surface. Cement is pumped between these
successive strings of casing and seals against any leakage of oil, gas, or water.
To achieve large annual additions to reserves and to output, the rate of
drilling must be stepped up sharply. Barrels added per foot drilled are one
of the best indicators of the results of drilling effort. This measure should not
show a decline. A projection of the trend of barrels added per foot of drilling
should be established for oil companies engaged in production.
cannot flow unaided, or when the pressure in the reservoir has decreased to
a pressure that is too low to be economical, costly mechanisms that lift oil
to the ground surface must be employed. Low pressure in the reservoir and
low gas content generally go together. This kind of crude, therefore, must be
handled in a different manner.
The daily rates of offshore drilling rigs vary by their capability and mar-
ket availability. With deep-water, drilling rig rates of around $420,000/day
were reported in 2010. A high-pressure, high-temperature well of duration
100 days can cost about $30 million.
Onshore wells can be considerably cheaper, particularly if the field is at a
shallow depth, where costs range from less than $1 million to $15 million for
deep and difficult wells.
Statistical information for the period 2002 to 2007 on the costs of crude
oil and natural gas well drills are reported by U.S. Energy Information as
follows:
View
GraphClear 2002 2003 2004 2005 2006 2007 History
Thousand
Dollars
per Well
All (real*) ◻ 1,011.9 1,127.4 1,528.5 1,522.3 1,801.3 3,481.8 1960–2007
All ◻ 1,054.2 1,199.5 1,673.1 1,720.7 2,101.7 4,171.7 1960–2007
(nominal)
Crude oil ◻ 882.8 1,037.3 1,441.8 1,920.4 2,238.6 4,000.4 1960–2007
(nominal)
Natural ◻ 991.9 1,106.0 1,716.4 1,497.6 1,936.2 3,906.9 1960–2007
gas
(nominal)
Dry holes ◻ 1,673.4 2,065.1 1,977.3 2,392.9 2,664.6 6,131.2 1960–2007
(nominal)
Dollars per
Foot
All (real*) ◻ 187.46 203.25 267.28 271.16 324.00 574.46 1960–2007
All ◻ 195.31 216.27 292.57 306.50 378.03 688.30 1960–2007
(nominal)
Crude oil ◻ 194.55 221.13 298.45 314.36 402.45 717.13 1960–2007
(nominal)
Natural ◻ 175.78 189.95 284.78 280.03 348.36 604.06 1960–2007
gas
(nominal)
Dry holes ◻ 284.17 345.94 327.91 429.92 479.33 1,132.09 1960–2007
(nominal)
Source: U.S. EIA: Annual Energy Outlook 2013, Release Dates: April 15, May 2, 2013.
Exploration and Drilling 233
on estimated ultimate recovery, in barrels of oil, from each well. Since depth
is the principal factor governing drilling costs, depth has a bearing on the
problem of well spacing.
There is no hard and fast rule on spacing of wells; the technical and
nontechnical factors relative to the oil reservoir must be considered sepa-
rately. Oil wells drilled in the United States are widely spaced and located
at the centers of 40-acre tracts or at like ends of 80-acre tracts. For gas
wells, on the other hand, spacing ranges between 160 and 640 acres per
well. The acreage assigned to each development well is known as a drill-
ing unit prior to completion of the well and as a production unit upon suc-
cessful completion.
Usually, the greater the depth to reach productive zones of oil, the wider
the spacing of wells. Since viscous oils do not possess the mobility of ready
passage through reservoirs, as lighter, less viscous oils do, closer spacing of
wells is usually needed with oils of heavy viscosity properties in order to
effect maximum efficient drainage. In the case of gravity, the lighter-gravity
oils (with the higher API) contain more dissolved gases, have more mobil-
ity, and are less viscous than the lower-gravity oils, and so will require
fewer wells and wider spacing to effect maximum efficient drainage.
Reservoirs with high pressures, particularly if pressures are maintained
by some recycling operations such as use of water, gas, or air, offer higher
recovery per well. Thus wider spacing can be employed in reservoirs with
high pressures.
Such reservoir properties as porosity, the ability to contain fluids, and
permeability influence well spacing. Porous and permeable reservoirs that
allow fluids such as oil to flow through the reservoir to the well bore, mean
that reservoirs can be effectively drained, so fewer wells with wide spac-
ing are suitable under such conditions. Closer spacing of wells is necessary
when “tight” reservoirs, with low porosity and permeability, are involved.
Some nontechnical factors also affect well spacing. These include, for
instance, the rate of production desired because of terms of the oil lease,
market price of crude, market demand, etc. Also, proration laws of a gov-
ernment can dictate the amount of oil or gas an oil company can produce.
When this is the case, the number of wells drilled and the spacing may be
affected. Where the rate of payout desired is lengthened and deferment of
income over a wide period because of income tax problems is the objective,
the number of wells drilled may be cut back. Thus spacing will tend to be
wider under such conditions. Conversely, where the rate of payout desired is
for a short period, more wells should be drilled with closer spacing.
Example 11.1
The following simple example offers two alternatives relative to the
number of wells to be drilled and spaced in a reservoir involving the
following information:
Exploration and Drilling 235
REQUIRED
(a) Let us establish the following table using some common basis:
Alternative 1 Alternative 2
1. Capital investment/well ($) 1,900,000 1,400,000
2. Annual operating cost/well ($) 280,000 300,000
3. Capitalized cost of item (2) using interest 2,800,000 3,000,000
rate of 10%
4. Sum of items (1) + (3) 4,700,000 4,400,000
5. Production bbl/(day)(well) 10,000 16,667
Example 11.2
Explorers for crude oil try to determine how often success will be gained
from a given program of N well (wells drilled). “What are the odds of suc-
cess?” a company might ask. A company drilling, say, 20 or 30 wells per year
might want to know the odds of making one, two, three, or five discoveries,
with discovery meaning simply a producing well and not profitability of
the well. How much oil there is, is not part of discovery but comes under
field size distribution. To find these odds of success to total wells drilled, a
mathematical technique called binomial (two numbers) expansion is used.
For simplicity, assume that each well in the program has the same
chance of success with an assumed 10% success rate. Oil explorers know
that some prospects have better “odds” or chances of success than oth-
ers. For most exploration programs, we can assume an “average success”
rate with reasonable safety.
F indicates probability of failure (a dry hole), and S indicates probabil-
ity of success.
For one well (one outcome) F + S = 1.00, or we can write F + S (F + S)1.
For two wells, there are four possible outcomes, FF + FS + SF + SS = 1.00;
and, of course, FS + SF can be written 2FS. Then F2 + 2FS = S2 = 1.00.
Now, if you remember your algebra, F2 + 2FS + S2 is the product of (F +
S)(F + S) and can be written as (F + S)2. So F2 + 2FS + S2 = (F + S)2. The left
half of this equation is the expansion of the binomial (F + S) to (F + S)2.
Now we can set up a cumulative binomial probability table, as shown
next, with an assumed 10% success rate, for any larger number of wells
to be drilled, and we will get some probabilities of success in number of
discoveries to total number of wells drilled.
From Table 11.1, a graph can be drawn, as shown in Figure 11.2, to illus-
trate tables of cumulative binomial probabilities. This graph provides
the following information:
1. At least one discovery or more is 88% (or 88 chances of success
in a total of 100 chances), or with 4.4 chances of S in five chances.
2. At least two discoveries is 60% (or 60 chances of success in 100
total chances), or 3 in 5 chances.
3. At least three discoveries is 30% (30 chances of success in 100
chances), or about 1.5 in 5 chances.
4. At least four discoveries is 13% (13 chances of success in 100
chances), or about 1 in 8 chances.
Exploration and Drilling 237
TABLE 11.1
Cumulative Binomial Probability (Using a 10% Success Rate)
Number of Number of Probability Success in Number of Odds of
Wells Drilled Discoveries Discoveries (%) Success
10 1 60 1 in 10
10 2 26 1 in 5
10 3 15 3 in 10
20 1 80 1 in 20
20 2 61 1 in 10
20 3 50 3 in 20
20 4 25 1 in 5
20 5 10 1 in 4
30 1 90 1 in 30
30 2 73 1 in 15
30 3 70 1 in 10
The chance of drilling any number of dry holes in succession, like the
chance of one dry hole “in succession,” is 1.00 – 0.10, or 0.90 (90%). For
additional wells, the probabilities are as follows:
on = 12%, or 1 in 8 chances
20 dry holes in successio
100
y
er
ov
80
d isc
≥1
Probability, %
60
≥2
≥3
≥4
40
≥5
≥7
≥6
20
≥8 9
≥ 10
≥
0 10 20 30 40 50 60 70
Number of Wells
FIGURE 11.2
Cumulative binomial probability, assuming 10% success.
238 Petroleum Economics and Engineering
Thus, even with a 10% success rate, even in drilling 20 holes, we still
face a 12% chance that all holes will be dry.
The employment of such a table and graph is a possibility for explorers
for crude oil in their efforts to predict success and failure, or discoveries
to dry holes. It can also be useful to oil engineers in estimating prob-
abilities, or odds of success.
Using the binomial distribution to find the probability of an exact
number of successes (discovery wells) in several trials (number of wells
to be drilled), the following relation could be applied:
N
p( x) = p N q N − x (11.2)
x
= CxN p N q N − x (11.3)
where
p(x) = probability of obtaining exactly x successes in N trials
N = size of the sample, or number of trials of an event
x = number of successes, or favorable outcomes within the N trials
p = probability of success
q = 1 – p = probability of failure
( )
N
x CxN = number of combinations in which N objects can be displayed
=
m = NP
σ 2 = Npq
σ = ( Npq)1/2
Example 11.3
As an example, the probability of obtaining zero heads when a coin is
tossed five times is calculated as follows, using Equations (11.2) and (11.3):
p( x) = ( )p q
N
x
x N −x
p(0) = ( )(0.5) (1 − 0.5)
5
0
o 5− 0
= (1)(1)(0.5)5
Roughly, the probability is 3 of 100 times. That is, where successive tosses
were gathered into groups of five tosses in each group, out of 100 such
groups, about three would contain no heads.
Exploration and Drilling 239
Example 11.4
Ten wells are to be drilled. The probability of success is taken to be 0.15.
What is the probability of there being more than two successful wells?
SOLUTION
The answer to this can be found in one of two ways: (1) the individual
probabilities of 3, 4, 5, 6, 7, 8, 9, and 10 successes can be calculated and
added together, or (2) the individual probabilities of 0, 1, and 2 successes
can be added together and then subtracted from 1 to obtain the same
answer. The second method is shorter and is given as follows:
p( x) =( N
x )p q
x N −x
p(0) = ( 10
0 )(0.15) (0.85) = 0.1969
o 10
p(1) = ( 10
1 )(0.15) (0.85) = 0.3474
1 9
p(2) = ( 10
2 )(0.15) (0.85) = 0.2759
2 8
0.8202
Most oil companies are not concerned with how far down drilling pro-
ceeds, but with how high the cost will be to get that deep and what the cost
will be to go, say, another 100 ft or more. Marginal costs are some direct
function of depth. If, then, we let Y be those costs that vary with depth, but
no overhead costs, and let X be depth itself, a formula can then be written as
dY
= C(X ), the cost per foot (11.4)
dX
Thus, depth affects marginal costs. For example, the rise of temperature with
depth, among other things, increases the probability that a drilling bit will
have to be replaced an additional time in a well drilled an additional 100 ft,
because mechanical energy is lost as the drilling process continues. But also,
some costs, such as the costs of additional “mud materials,” needed to drill
a deeper well may actually increase rather slowly in relation to increase in
depth, thus giving a decreasing marginal cost in relation to depth.
The one factor that may most affect the costs of drilling is the average footage
drilled per hookup. As more information on drilling tendencies in any one oil
field becomes available, the number of changes in drilling hookup is reduced,
and the speed of the drilling operation is increased. Also, feet per hour at the
240 Petroleum Economics and Engineering
bottom of the well, combined with the amount of time spent at the bottom,
is perhaps the best measure of the relative efficiency and speed of a drilling
operation in a particular oil well and for a given amount of controlled footage.
In sum, costs of drilling increase because of the following, usually in
some combination:
Once the oil has been explored, developed, and produced, all costs
involved in getting the oil to the surface, where it becomes a commodity as
it is piped in gathering lines to central points for gas separation, are called
the cost of oil field operation. The basic question, “What does oil cost to find,
to develop, and to ready for commercial production?” would be comparably
simple to answer if, during a short period of time—say 1 to 3 years—an oil
company could start in the oil-producing business, discover say 10 million
bbl of oil, develop that 10 million bbl, and finally produce the 10 million bbl
of crude. The cost of drilling, developing, and producing could then simply
be found by dividing the total amount spent for exploratory, developing,
and producing effort by 10 million bbl, which would give a cost per barrel
of crude.
But this is just “grocery store accounting.” Actual accounting for costs in
the oil-producing industry is not that simple. When a company searches for
oil, it may spend several years and millions of dollars on exploration and
development before any substantial, and commercially feasible, amount of
oil is located. In development alone, a company may work for several years
and spend many dollars developing the oil reservoir which it is to produce
over an even greater number of years; and also, all this time, the process is
constantly repeating itself as more oil is being discovered, more oil is being
developed, and more oil is being produced.
11.3 Conclusions
An oil company’s success is measured by its ability to discover reserves. In
its search for oil, it spends substantial amounts of money in many differ-
ent ventures in widely scattered areas. The oil company does this knowing
that many of these ventures will be nonproductive and will eventually be
abandoned.
Exploration and Drilling 241
On the other hand, the oil company recognizes that successes in other
areas must be large enough to recoup all money spent in order to break even
or to provide a profit. Thus, the true assets are the oil reserves, and these
costs are capitalized, but the costs of nonproductive exploration activities
and of dry holes are also a necessary part of the full cost of finding and
developing these oil reserves.
11.4 Glossary
The following are some expressions and definitions used in cost terminol-
ogy and reserves reporting, which are used here as well as in the following
chapters.
CONTENTS
12.1 Technology Aspects.................................................................................... 244
12.1.1 Introduction..................................................................................... 244
12.1.2 Volumetric Methods....................................................................... 244
12.1.3 Material Balance Equation............................................................. 245
12.1.4 Material Balance Equation for Gas Reservoir............................. 247
12.1.5 Material Balance Equation, Straight-Line Concept.................... 248
12.1.6 Decline Curve Methods................................................................. 250
12.1.6.1 Constant Percentage Decline.......................................... 250
12.1.6.2 Harmonic Decline............................................................ 253
12.1.7 Comparison of the Methods..........................................................254
12.2 Economic Evaluation and Application....................................................254
* This chapter was originally written by K.A. al-Fusail in the second edition of this book, and
has been updated and revised for this edition by Hussein Abdel-Aal.
243
244 Petroleum Economics and Engineering
1. Volumetric
2. Material balance
3. Decline curve
where
N = bbls of initial oil in place at surface temperature and pressure condi-
tion, which is called stock tank
Boj = initial oil formation volume factor, which is defined as bbl at reservoir
condition (rb), divided by bbl at surface condition (STB)
Once the recovery factor is known, then the amount of recoverable oil can
be figured out. The bulk volume of the reservoir can be calculated using
subsurface and isopachous maps. The isopachous map consists of isopach
lines that connect points of formations having equal thickness. The areas
Reserves and Reserve Estimate 245
lying between the isopach lines of the entire reservoir under consideration
are used to calculate the volume contained in it.
Simpson’s rule, trapezoidal rule, and pyramidal rule are normally used to
determine the reservoir bulk volume (VB). Simpson’s rule provides the fol-
lowing equation:
where
h = interval between the isopach lines in ft
Bo = area in acres enclosed by successive isopach lines in acres
A1, A2, A3, An = areas enclosed by successive isopach lines in acres
tn = average thickness above the top
Trapezoidal rule provides the following equation:
VB = h/2 ( Ao + 2 A1 + 2 A2 + 2 An−1 + An ) + Tn An (12.3)
Pyramidal rule has the form:
This equation calculates the reservoir bulk volume between any two succes-
sive areas (ΔVB), and the total reservoir bulk volume is the summation of all
the calculated bulk volumes.
The accuracy of trapezoidal rule and pyramidal rule depends on the ratio
of the successive areas. If the ratio of the areas is smaller than 0.5, the pyra-
midal rule is used; otherwise the trapezoidal rule is used.
The formula as provided in Equation (12.1) can be applied to calculate free
gas in a gas reservoir as given below:
the assumption that the oil is produced by the fluid expansion only and the
reservoir is constant, is derived below:
Assume that the initial production, Pi, dropped to P due to Np STB pro-
duced. Then,
Initial volume = NBoi bbl at the reservoir condition, rb
Final volume = (N – Np)Bo bbl at the reservoir condition, rb
Since the reservoir volume is constant, then:
N = N p Bo/(Bo − Boi )
A reservoir with pressure lower than the bubble point pressure will cause
gas to form, resulting in a free gas phase. Such a reservoir is called a saturated
reservoir. The derivation of material balance equation for this case is given
next:
= ( N − N p )Bo + G f Bg
= NRsi − ( N − N p )R
Rs − N p R p
= N (Bo + Bg (Rsi − Rs ) − N p Rp )B
Bp
(12.7)
= N (Bo + Bg (Rsi − Rs ) − N p (Bo + Bg (Rp − Rs ))
where
N = oil in place, rb
NP = oil produced, STB
Bo = formation volume factor, rb/STB
Boi = initial formation volume factor, rb/STB
Bg = gas formation volume factor, rb/STB
RSi = initial gas in solution, SCF/STB
Rs = gas in solution at a pressure lower than Pi
Rp = cumulative gas-oil ratio
If the reservoir has a gas cap at the time of discovery, then the material bal-
ance equation will have the form:
where
m = volume of free gas/oil volume
= Gf Bgi/NBoi
If the reservoir is under water drive, the water influx as well as the water
production needs to be added to the material balance. Then, Equations (12.7)
and (12.8) become:
All these terms, except Np, Rp, We, Wp, are functions of pressure and also are
properties of the fluids. These data should be measured in the laboratory. Rp
depends on the production history. It is the quotient of both the gas produced
(Gp) and the oil produced (Np). A water influx can be calculated by using different
methods depending on the flowing conditions. The boundary pressure as well
as the time are used to calculate the water influx. The value of m is determined
from the log data which provide the gas-oil and oil-water contacts and also from
the core data. Therefore, the accuracy of the calculated oil in place depends upon
how accurately we take these measurements for such calculations.
GBgi = Bg (G − Gp )
= Bg g − G g Gp (12.11)
Gp Bg = G(Bg − Bgi )
G = Gp Bg/Bg − Bgi
F = N p (Bo + Bg (Rp − Rs )) + Wp + Ww , rb
Wc = O and m = O
(12.14)
F = NEo
Reserves and Reserve Estimate 249
F = N (Eo + mEg )
(12.15)
(c) No water drive and m is not known. Equation (12.15) can be written
differently:
F/Eo = N + mNEg/Eo (12.16)
A plot of F/Eo versus Eg/Eo should result in a straight line with the
intercept of N with Y-axis. The value of m can be known from the slope.
(d) For water drive reservoir, m = 0, Equation (12.13) will have the form:
F = NEo + We
Divide by Eo:
Gp Bg = GEg
(12.18)
where Eg = Bg − Bgi
Plotting GpBg versus Eg should give a straight line with G being the
slope. If the reservoir is under water drive, Equation (12.12) can be
written as:
GEg = Gp Bg − We + Wp
GEg = Gp Bg + Wp − We
We + GEg = Gp Bg + Wp
250 Petroleum Economics and Engineering
Divide by Eg:
D = −Δq/(q/Δt) (12.20)
Reserves and Reserve Estimate 251
where
D = decline rate
Δq = qi – q; qi is initial production rate, and q is production at a time (t)
Δt = time t required for qi to decline to q
Integrating Equation (12.20) to get rate-time relation:
t q
dq
−
∫ 0
Ddt =
∫ qi q
(12.21)
q = qi e − Dt
t t
−
∫0
qdt = qi
∫e
o
− Dt
or
N p = − qi/D(1 − e − Dt ) (12.22)
q/qi = e − Dt
N p = qi − q / D (12.23)
q = qi − N p D (12.24)
A plot of q versus Np will result in a straight line. The slope of the line is
D, and qi is the intercept of the Y-axis. Equation (12.21) also yields a straight
line if q is plotted against t on semilog paper. The slope of such a plot is D,
and the intercept is qi. The Np is the cumulative production between any two
production rates.
q = qi e − Dt
− ln q/qi = Dt
252 Petroleum Economics and Engineering
When the decline rate is not constant, then the hyperbolic decline can be
assumed, and the decline rate varies according to the following equation:
D = Di (q/qi )n (12.25)
where
n = decline constant between zero and 1
Di = initial decline rate
The general equation for hyperbolic rate decline can be obtained by substi-
tuting Equation (12.17) into Equation (12.21) and then integrating the result-
ing equation. The equation thus finally derived will have the form:
qi
q= (12.26)
(1 + Dnt)1/n
The cumulative production rate obtained from the hyperbolic decline can
be derived as follows:
Np =
∫ qdt
0
dq
q
D=−
dt
Substitute D value from Equation (12.25) in the above equation, and then
substitute q value in the equation to calculate Np:
q2
dq
Np =
∫q1 q
n
Di
q i
qin q2
dq (12.27)
=
Di ∫
q1 qn
qin
= (q11− n − q21− n )
Di (1 − n)
Reserves and Reserve Estimate 253
The values of qi, Di, and n are assumed to be known and are constant, and
thereafter Equation (12.27) can be used without any difficulty. The values
of qi, Di, and n can be obtained by comparing the actual decline data with a
series of curves of hyperbolic type. A plot of q/qi versus time may fit in one of
the curves which gives the values of qi, Di, and n.
This type of decline may take place in reservoirs where gravity drainage
controls the production. Gravity drainage exists in tilted reservoirs where oil
production is affected by drainage of oil from upstructure to downstructure
which causes segregation of gas and oil in the reservoir. Cumulative produc-
tion can be obtained by integrating Equation (12.24) with respect to time:
t
Np =
∫ qdt
0
t
dt
N p = qi
∫ 0 1 + ai t
(12.29)
= qi/ai ln(1 + ai t)
(1 + ai t) = q/qi
1/qi (1 + ai t) = 1/q
(12.31)
1/qi + ( ai t)1/qi = 1/q
254 Petroleum Economics and Engineering
N p = qi/ai (ln q − ln qi )
( ai/qi )N p = ln q − ln qi (12.32)
ln qi + ( ai/qi )N p = ln q
Example 12.1
Given the following data:
Area = 1,200 acres
Formation thickness = 20 ft
Average porosity = 20%
Reserves and Reserve Estimate 255
SOLUTION
Part (a):
N = 7758 Ahφ(1–S w)Boi
= 7758 × 1200 × 20 × .2(1–.25)/1.2
= 24,274,000 STB
Part (b)
Total gas in solution: = (oil in-place)(initial gas in solution)
= (N)(Rsi)
= 24,274,000 × 650
= 15.78 × 109 SCF
Example 12.2
An oil reservoir has a gas cap at the time of discovery. The size of this gas
cap is not known. The production data and the fluid properties are given
as a function of pressure in Table 12.1.
(a) Calculate the oil in place using the material balance equation as
a straight line.
(b) Use the material balance equation itself.
SOLUTION
Since the production was due to gas cap expansion and the gas cap size
is not known, the following equation can be used:
TABLE 12.1
Data for Example 12.2
P, psi Np, STB Bo, rb/STB Rs, SCF/STB Bg, rb/SCF Rp, SCF/STB
3200 0 1.35 520 0.000932 0
2950 2.50 × 108 1.345 444 0.00095 950
1800 3.37 × 108 1.34 435 0.000995 1,000
2765 4.95 × 108 1.32 410 0.0011 1,150
2500 6.62 × 108 1.308 395 0.00123 1,280
256 Petroleum Economics and Engineering
TABLE 12.2
Solution for Example 12.2
P, psi F Eo Eg F/Eo Eg/Eo
2950 4.57 × 108 0.0672 0.0255 6.8 × 109 0.379
2800 6 407 × 108 0.0745 0.09125 8 6 × 109 1.22
2650 10.56 × 108 0.091 0.238 11.6 × 109 2.615
2500 15.87 × 108 0.1118 0.4182 14.1 × 109 3.743
From Equation (12.20), the Y intercept is N and the slope is mN, then:
Year B/day
1 9,600
2 7,200
3 6,700
4 5,700
5 5,200
6 4,650
7 4,300
8 3,800
(a) Estimate the remaining life of this field if the economic limit is
800 B/D.
(b) What is the recoverable oil as of year 8?
(c) What is the net income if the price of oil is assumed to be $85/bbl?
Reserves and Reserve Estimate 257
10×109
S = 2.2093×109
F/E0
1.0 2.0 Eg/E0
FIGURE 12.1
Solution of Example 12.2.
SOLUTION
Since the decline rate follows the constant percentage decline, then a plot
of q versus time on semi-log is recommended and gives a straight line.
The slope of the line represents the decline rate, D.
(a) Using Equation (12.21), the revising number of years can be cal-
culated as follows:
q = qi e − Dt
− ln q / qi = Dt
or
= 6.225 year
TABLE 12.3
Data to Determine Oil in Place, N
P F Eo + Eg
2950 4.57 × 108 0.07675
2800 6.407 × 108 0.1087
2650 10.56 × 108 0.180
2500 15.87 × 108 0.2684
258 Petroleum Economics and Engineering
(b)
Recoverable oil = q1 − q2/D
3, 800 – 800
=
0.02086
Example 12.4
Use the calculated oil in place in Example 12.1 assuming the f ollowing
values:
Example 12.5
A similar calculation can be done for Example 12.2 assuming the oil
price, operating cost, and production taxes are the same as used in the
previous calculations.
SOLUTION
Gross income = oil in place x price
= 5.9 × 109 × 85
= $500 × 109
Production taxes = $500 × 109 × 0.046
= $23 × 109
Reserves and Reserve Estimate 259
Again, this net income excludes any capital expenditures that may be
needed in the future. Other taxes that may be applicable are not combined.
13
Production Operations
Mohamed A. Aggour
Hussein K. Abdel-Aal
CONTENTS
13.1 Technology Aspects.................................................................................... 261
13.1.1 Introduction..................................................................................... 261
13.1.2 Well Completions............................................................................ 262
13.1.2.1 Factors Influencing Well Completion Design.............. 262
13.1.3 Tubing and Packers......................................................................... 263
13.1.4 Sizing Production Tubing.............................................................. 263
13.1.5 Workover Operations..................................................................... 264
13.1.6 Production Methods....................................................................... 264
13.1.6.1 Natural Flow..................................................................... 265
13.1.6.2 Artificial Lift..................................................................... 265
13.2 Economic Evaluation and Application.................................................... 266
Oil exploration, drilling, and property evaluation have been treated in pre-
vious chapters. In this chapter, the various operations associated with the
production of oil and natural gas are presented. Production is the operation
that brings hydrocarbons to the surface and prepares them for processing.
As part of subsurface operations, this chapter covers completion and work-
over operations and production methods (natural flow and artificial lift).
Surface petroleum operations including gas-oil separation, crude oil treatment
(dehydration, desalting, and stabilization), and gas treatment and condition-
ing are treated in consecutive separate chapters. Following the introduction
of each major production operation, economic-based decisions are presented.
Examples (case studies) illustrating the economic analysis in this strategic
phase of the oil operations are presented at the end of the chapter.
261
262 Petroleum Economics and Engineering
fluids (i.e., oil and natural gas) to the customer. Between the two ends lie
a large number of engineering activities and operations. For example, the
design and installation of the well tubing and surface flowline, the workover
operations that keep the well at its best producing conditions, the selection
and design of the oil/gas production method, and the design, installation,
and operation of the surface separation and treatment facilities are all the
responsibility of the petroleum production engineer.
The economics of most of the above-mentioned operations have to be
evaluated before they are executed. In some cases, several technically viable
alternatives exist for executing a particular operation. In such cases, the deci-
sion to select one alternative over the others would be based entirely on eco-
nomic evaluation of the various alternatives.
In the following sections, brief descriptions of the various major produc-
tion operations are presented along with examples of the economic evalua-
tion of some operations.
• The first relationship describes the flow of fluids from the forma-
tion into the wellbore; it is called the inflow performance relation (IPR).
The IPR is represented, normally, as the relationship between the
bottom-hole flowing pressure (Pwf) and the flow (production) rate (q).
Depending on the type of reservoir and the driving mechanism, the
IPR may be linear or nonlinear, as illustrated in Figure 13.1. When
Bottom-hole Flowing Pressure (Pwf )
Lin
ear
No
nli
ne
ar
FIGURE 13.1
Inflow performance relation (IPR).
264 Petroleum Economics and Engineering
FIGURE 13.2
Outflow (vertical flow) performance.
the IPR is linear, it can be represented with what is called the produc-
tivity index (PI), which is the inverse of the slope of the IPR.
• The second relationship describes the relation between the flow rate
of fluids and the pressure drop in the production tubing. It is called
the outflow performance or the tubing multiphase flow performance.
Several multiphase flow correlations exist for determining the rela-
tionship between flow rate and pressure drop in a well tubing. For
a fixed wellhead pressure, the relationship between Pwf and q is as
illustrated in Figure 13.2.
gI
II
b ing
Tu
I
in g II
Tub
q1 q2 q3
FIGURE 13.3
IPR and outflow performances for different performances.
surface with a wellhead pressure sufficient to force the fluid flow through
all surface facilities. There are two ways a well may be produced; these are
described below.
TECHNICAL DATA
Well location: offshore
Depth: 8000 ft
Wellhead pressure: 80 psi
Initial reservoir pressure: 3,000 psi
Expected pressure decline: 250 psi drop every year until it reaches
2000 psi, at which time a water injection operation will main-
tain a constant pressure
Productivity index = 10 BPD/psi (assumed constant)
Production: all oil
Produced gas/oil ratio: 600 scf/bbl
ECONOMIC DATA
Average price of oil: $80.0/bbl
Average operating cost: $35/bbl
Difference in costs of drilling and completing with 4 in. and 3 in.
tubings = $6,520,000
Annual discount rate of money is 14%
SOLUTION
For the purpose of illustration, we will perform the analysis over a
period of 5 years only. The same procedure is used for a detailed analy-
sis over the life of the well
We first determine the IPR curves for reservoir pressures of 3,000,
2,750, 2,500, 2,250, and 2,000 psi, and productivity index of 10 BPD/psi.
This produces the linear IPR shown by the five parallel straight lines in
Figure 13.4.
Production Operations 267
3000 IPR
For
P
R =3
000
PR = psi
275
2500 0 ps
PR = i
Bottom-hole Flowing Pressure (psi)
250
PR = 0 p si
225
0 ps
2000 PR = i
200
0 ps
i
1500
ing
ub
.T
ing
in
. Tub
3
1000 4 in
500
0
1 2 3 4 5 6 7 8
Production Rate (1000 BPD)
FIGURE 13.4
Flowing bottom-hole pressure versus production.
268 Petroleum Economics and Engineering
TABLE 13.1
Comparison of Rates and Income for 3 in. and 4 in. Completions
ProductionRate, BPD
Average Rate
Year 3 in. 4 in. Increase, BPD Net Income, $106
1 5,750 9,250 3,500 47.25
2 5,200 8,650 3,450 46.57
3 4,600 7,720 3,120 42.12
4 4,000 6,700 2,700 36.45
5 3,350 5,600 2,250 31.72
where the capital of $6.5 × 106 is depreciated over the lifetime of 5 years.
P.O.P = Depreciable capital investment/average annual cash flow
= 6.5 × 106/39.2 × 106
= 0.165 year
= 2 month
CONCLUSIONS
For our present example, a payout period of 2 months is found, indicat-
ing that the choice of the 4 in. completion is economically attractive.
SOLUTION
Based on the data given in Table 13.2, calculations are carried out as pre-
sented in Table 13.3.
The payout period, POP is calculated using the average annual cash
flow over the 5-year period:
P.O.P = Depreciable Capital Investment/Average Annual Cash Flow
= 1.095 x 106 ($)/5.54 x 106 ($ per year)
= 0.1977 years
= 2.37 month
Production Operations 269
TABLE 13.2
Comparison of Natural Flow and Gas Lift Wells
Average Rate, BPD Increased Production
Average Rate, Injection Gas,
Year Natural Flow Gas Lift BPD Yearly bbl MMSCF/Year
0–1 1,450 1,600 150 54,750 666
1–2 1,100 1,320 220 80,300 622
2–3 850 1,080 230 83,950 578
3–4 675 880 205 74,825 538
4–5 540 700 160 58,400 490
TABLE 13.3
Results of Calculations for Placing the Wells on Gas Lift
Annual Gross Injection (Prod. + Maint. Annual Net
Year Revenue × 106 Costs × 102 Costs) × 106 Revenue × 106 Net Cash × 106
0 — — — — –1.095
1 4.38 333 0.137 4.24 4.24
2 6.42 311 0.200 6.22 6.22
3 6.71 289 0.209 6.50 6.50
4 5.98 259 0.187 5.79 5.79
5 4.67 245 0.146 4.52 4.52
TABLE 13.4
Data for Example 13.3
Year
0 1 2
Install new (larger pump) –15,000 19,000 0
Operate existing (old pump) 0 95,000 95,000
270 Petroleum Economics and Engineering
TABLE 13.5
Data for Example 13.5
Year Net Present Worth @ 10%
0 1–4 5 6–20
0 $50,000 –$650,000 $100,000 $ 227,000
SOLUTION
The present worth method is applied in solving this problem (see chapter 6).
Calculate the present worth for both alternatives, where:
Present worth = Present values of cash flows, discounted at 10% − Initial
capital Investment
Based on the above results, keep the old pump. It gives higher present value.
SOLUTION
The fact that the proposal at hand gives a positive present worth, makes
it a viable one. The project should be undertaken.
Next, calculation is carried out to check the present worth reported
above in the table.
The cash flows are discounted to present values, at 10%. Using the
compound interest factors listed in Appendix B, the following results
are obtained:
The discounted values = 50,000 (3.1698) – 650,000 (0.5645) + 100,000 (4.7227)
= 158,490 − 403,585 + 472,270
= $ 227,175
14
Gas-Oil Separation
Hussein K. Abdel-Aal
CONTENTS
14.1 Technology Aspects.................................................................................... 272
14.1.1 The Separation Process.................................................................. 272
14.1.1.1 Flash Separation............................................................... 272
14.1.1.2 Oil Recovery..................................................................... 274
14.1.2 Functional Components of a Gas-Oil Separator
and Control Devices....................................................................... 274
14.1.3 Methods and Equipment Used in Separation............................ 275
14.1.4 Design Equations for Sizing Gas-Oil Separators....................... 276
14.2 Economic Evaluation and Application.................................................... 278
14.2.1 Process Economics and Design Parameters................................ 278
271
272 Petroleum Economics and Engineering
Two case studies are presented at the end of the chapter: “Optimum
Separating Pressure for Three-Stage Separators” and “Causes of Tight
Emulsions in Gas Oil Separation Plants.”
(a) To remove oil from gas: Here we are primarily concerned with recov-
ering as much oil as we can from the gas stream. Density differ-
ence or gravity differential between oil and gas is the first means
to accomplish separation at this stage. At the separator’s operating
condition of high pressure, this difference in density becomes large
(gas law); and the oil is about eight times as dense as the gas. This
could be a sufficient driving force for the oil particles to settle down
and separate. This is true for large size separator, with a diameter
of 100 microns or more. For separators with smaller diameters, mist
extractors are needed.
Other means of separation include change of velocity of incoming
flow, impingement, and the action of centrifugal force. These meth-
ods would imply the addition of some specific designs for the sepa-
rator to provide the desired method for achieving separation.
(b) To remove gas from “locked” oil: The objective here is to recover and
collect any non-solution gas that may be entrained or “locked” in the
oil. The recommended methods are settling, agitation, and applying
heat chemicals.
Section A: Initial separation takes place in this section at the inlet of the
separator. It is used to collect the entering fluid.
Section B: This is designated as the gravity settling section through
which the gas velocity is substantially reduced allowing for the oil
droplets to fall and separate.
Section C: This is known as the mist extraction section. It contains
woven-wire mesh pad, which is capable of removing many fine
droplets from the gas stream.
Section D: This is the final component in a gas-oil separator. Its main
function is to collect the liquid recovered from the gas before it is
discharged from the separator.
Gathering
System
Oil Well
Ga
st
o
S tage a ge
First nd St
Seco
Third Stage
Cru
de t
oP Gas
ipel Crude
ine
Ship
ping
Pum
p
FIGURE 14.1
Flow of crude oil from oil well through GOSP.
276 Petroleum Economics and Engineering
Fundamentals:
• The difference in densities between the liquid and gas is taken as a
basis for calculating the gas capacity.
• In the gravity settling section, liquid drops will settle at a velocity
determined by equating the gravity force acting on the drop with
the drag force caused by its motion relative to the gas phase.
• A normal retention time to allow for the gases to separate from oil is
considered to be between 30 seconds and 3 minutes. Normally reten-
tion time is defined as the residence time or the time for a molecule
of liquid to be retained in the vessel.
Input Outputs
GOSP Process Operations
Three-Phase Gas/Oil
Water Separation Off-Gas
Three-Phase Gas/Oil
Separation
Desalting
Demulsification
Dry Crude Oil
Washing
Electrostatic Coalescence
FIGURE 14.2
Functions of modern GOSP.
Gas-Oil Separation 277
Assumptions:
The equations needed to calculate the oil capacity and gas capacity are as follows:
Rated oil capacity, q = [50.54 d2 L]/t bbl/day (14.1)
where d is inside diameter of the vessel in ft, L is the shell height in ft, and t
is the retention time in minutes.
Gas capacity, Q = 86400[C1C2C3/z]. A SCF/day (14.2)
where C1 = [Pf/Tf] . [520/14.7]; C2 is the difference in densities of oil and gas/
density of gas; C3 is the separation coefficient of the vessel with typical values
of 0.167 and 0.5 for vertical and horizontal separators, respectively; z is the
gas compressibility factor; Pf and Tf designate the flowing pressure and flow-
ing temperature, respectively.
Equation (14.1) is applicable for horizontal separators, while Equation (14.2)
applies for both horizontal and vertical separators, depending on the value
of A. For horizontal, A = ½ the cross section area, while for vertical, A = the
entire cross section = ∏/4D2.
278 Petroleum Economics and Engineering
Equation (14.2) relates the gas capacity of gas-oil separator, Q, to the cor-
responding cross-sectional area, A. This enables finding the diameter of a
separator needed to handle a given input of a gas flow rate.
OBJECTIVE
Optimizing the gas-oil separation facility in order to find the optimal
conditions of pressure and temperature under which we would get the
most economical profit from the operation.
PROCESS
In the case at hand, it is assumed that we have three separators: high-,
intermediate-, and low-pressure separators. It is the pressure of the sec-
ond stage (intermediate) that could freely be changed and optimized.
The pressure in the first separator (high pressure), on the other hand, is
usually kept fixed either to match the requirement of a certain pressure
gas injection facility or to meet a sales obligation through a pipeline, or
it is the flow conditions of the incoming feed line. Similarly, the pressure
in the third separator (low pressure) is fixed; usually it is the last stage
functioning as the storage tank.
The optimum pressure is defined as the one that gives the desired
separation of gases from crude oil, with the maximum recovery of oil in
the stock tank. Under these conditions, we should have minimum gas/
oil ratio.
If R designates the recovery of the oil and is defined as R = O/G
of oil per SCF gas, then the optimum operating pressure in the sec-
ond stage (P2)O should be the value that makes R maximum; or 1/R is
minimum.
APPROACH
The method depends on using a pilot unit to do experimental runs, in
which the pressure in the second stage is to be changed from run to
run. A sample of the gases leaving the three separators is to be ana-
lyzed for the content of some key component, say C 5+. It is established,
therefore, to minimize the loss of C 5+ in the gas stream separated from
the crude oil.
The experimental runs will look as follows:
Run Number P2 [psi] (G/O)2 [scf/bbl] (G/O)3 [scf/bbl]
1 — — —
2 — — —
(G/O)T
(G/O)2 (G/O)3
G(CF)
O(bbl)
(P2)O
P2, psia
FIGURE 14.3
Variation of (G/O) with P (G, gas quantity; CF, O oil quantity, bbl).
CONCLUSION
OBJECTIVE
To evaluate the relative performance of de-emulsifiers and to optimize
their usage in GOSPs while meeting crude and water specifications.
PROCESS
Formation of emulsions during oil production is a costly problem, both
in terms of production losses and chemical costs. In these days of high
oil prices and the need to reduce production costs, there is an economic
Gas-Oil Separation 281
APPROACH
In this case study of tight emulsions, once you have collected all the posi-
tive and negative factors and have quantified them, you can put them
together into an accurate cost-benefit analysis.
On the cost side, one can envisage the following:
• Cost of de-emulsifier
• Addition of asphaltenes dispersants, and surfactants to the
crude oil.
• Using elaborate techniques to quantify the oil-water separation
process, such as ESI, Emulsion Separation Index (method devel-
oped by Saudi Aramco).
Hussein K. Abdel-Aal
Halim H. Redhwi
CONTENTS
15.1 Technology Aspects....................................................................................284
15.1.1 Dehydration of Crude Oil..............................................................284
15.1.1.1 Emulsion Formation........................................................284
15.1.1.2 Emulsion Treatment.........................................................284
15.1.1.3 Heating.............................................................................. 285
15.1.1.4 Chemical Treating............................................................ 286
15.1.2 Desalting of Crude Oil................................................................... 287
15.1.2.1 Introduction...................................................................... 287
15.1.2.2 Description of Desalting Process................................... 287
15.1.3 Stabilization and Sweetening of Sour Crude Oil....................... 289
15.1.3.1 Introduction...................................................................... 289
15.1.3.2 Process Description......................................................... 290
15.2 Economic Evaluation and Application.................................................... 290
Oil leaving the gas-oil separators may or may not meet the purchaser’s speci-
fications. As presented in Chapter 14, associated gas and most of the free
water in the well stream are removed in the separators. The free water sepa-
rated is normally limited to water droplets of 500 μm and larger. Oil stream
leaving the separators would normally contain water droplets of smaller
size along with water emulsified in the crude oil. This chapter deals first
with the dehydration stage of crude oil to free it from the emulsified water.
Depending on the original water content of the oil as well as its salinity, oil
field treatment could produce oil with a remnant water content of 0.2 to 0.5
of 1%.
The next stage in the treatment process of crude oil is desalting. The
removal of salts found in the form of what is termed remnant brine is carried
out in the desalting process. This reduces the salt content in the crude oil
283
284 Petroleum Economics and Engineering
15 µm
• Heating
• Chemical treatment
• Electrical field
Some emulsions can be broken with either chemical and time or heat and
time. Time is the one indispensible variable or element. It is the element that
determines the size of the equipment, which in turn determines its cost.
15.1.1.3 Heating
The most pronounced effect is the reduction of oil viscosity. Other advan-
tages are also contributed to heat, including:
(a) An increase in the difference in specific gravity between oil and water
(b) An increase in the droplet size as demonstrated by its molecular
movement which enhances coalescence
(c) Help in de-stabilization of the emulsifying film
286 Petroleum Economics and Engineering
Emulsion
Direct Heating
Emulsion
Indirect Heating
FIGURE 15.2
Methods of heating oil emulsions.
Crude Oil Treatment: Dehydration, Desalting, and Stabilization 287
the choke. Dosage is estimated to be about 1 quart of the chemical for each
100 barrels of oil.
The principle of breaking oil-water emulsions using electric current, which
is known as electro-static separation, is discussed in the following section.
The quantity of remnant water that is left in oil after normal dehydration
The salinity or the initial concentration of salt in the source of this water
Salt content in oil is a function of both the quantity of remnant water found
in oil and the concentration of salt in it. One has to make the economic com-
promise of using both approaches for reducing the salt content of crude oil.
Economically, there is a limit on reducing the salinity by lowering the quan-
tity of remnant water, by dehydration only. The other alternative is to sub-
stantially decrease the salt content of the remnant water by mixing it with
water with a much lower concentration of salts in it. This is what we accom-
plish in the desalting of crude oil.
Salty
Crude
Oil
Separation Step
Desalted
Crude Oil
FIGURE 15.3
The basic concept of the desalting operation of crude oil.
Acid Gas
Reflux Pump
Sweet Gas
Iean DGA cooler
Acid gas cooler
Make-up Water
Precoat Filter
Contacter
Side
Stripper
Cooler Comp.
Return
Reboiler
Flash Drum Circulator
Pump
Filter
Separation
375 psig
Reclaimer
Steam
Sour Gas
FIGURE 15.4
Typical trayed stabilizer.
* From Chemical Online Newsletter, October 13, 2000, and Linga, H., Al-Qahtani, F.A., and
Al-Qahtani, S.N., New Mixer Optimizes Crude Desalting Plant, SPE 124823, paper presented
at the 2009 SPE Annual Technical Conference and Exhibition in New Orleans, LA, 2009.
Crude Oil Treatment: Dehydration, Desalting, and Stabilization 291
APPROACH
The case could be handled using the method presented in Chapter 7. In
this method, all costs incurred in buying, installing, operating, and main-
taining an asset are put on an annual basis. Selection is then based on what
we call the “differential approach,” or the return on extra investment.
PROCESS DESCRIPTION
The mixer was installed at a 150,000 bbl/d crude distillation unit’s
desalter. Crude at this refinery is a mixture of local production and
imports from Indonesia and Alaska. The crude oil and water are then
simultaneously mixed though two-by-two division, cross-current mix-
ing, and back-mixing, which improves turbulence and increases mixing
efficiency without requiring high fluid shear velocities.
Desalter Performancea
Salt Inb Salt Outb % Removal
Mix Valve (Globe Valve)
90,000 b/d 22º API Crude 42 4.4 89%
14º API Crude § — — —
Static Mixer (New Mixer)
90,000 b/d 22º API Crude 41 1.6 96%
45,000 b/d 14º Crude 43 ¼ 97%
a Desalter mix valve and static mixer are designed for full design crude unit
feed rate of 150 MBPD.
b PTB.
CONCLUSIONS
The modified desalter system has operated well on 14° and 22° API naph-
thenic crudes, with less than 5% oil in the effluent water. At the same
time, the mixer has helped reduce emulsions formed by too much pres-
sure drop created by the mix valve. With less oil carry under, less fuel
is consumed from having to reheat recycled oil up to 300°F before it re-
enters the crude unit. Salt removal also increased as a result of using the
static mixer (see table). Depending on the type of crude oil, the refiner
has been able to remove between 5% and 10% more salt than by the mix
valve method. With less salt carried over out of desalter, less corrosive
HCI will be generated in the crude unit furnaces. This will require less
ammonia to neutralize the atmospheric column overhead stream. Also,
pressure drop due to the mixing device was decreased from 10 psi to 1.5
psi.
The payout period of the new mixer was calculated and found to be
1 year. In other words, the mixer will pay for itself in its first year of
292 Petroleum Economics and Engineering
Case 15.2: Upgrading the Quality of Crude Oil by Using a Desalting Unit
OBJECTIVE
Evaluation of the economic feasibility of a desalting unit.
APPROACH
Calculation of the return on investment (ROI) and pay-out period (POP).
PROCESS DESCRIPTION
The following results were obtained from field desalting of a crude oil in
the Middle East using one stage (Abdel-Aal, 1998):
GIVEN
• The upgrading of crude oil to an acceptable PTB could realize a
savings of 0.1 $/bbl in the shipping costs of the oil.
• The crude oil desalting unit has a design capacity of 120,000
bbl/day.
• The capital investment is estimated to be $5 million, service life
is 10 years, and operating factor is 0.95.
• The total annual operating expenses are $10/1000 bbl, and the
annual maintenance expenses are 10% of the capital investment.
FIND
(a) The return on investment, ROI
(b) The payout period, POP
Crude Oil Treatment: Dehydration, Desalting, and Stabilization 293
SOLUTION
Annual savings in shipping costs of upgraded crude oil = $4.1610
× 106
Total annual expenses incurred by installing the desalting unit =
$1.4161 × 106
Net savings = $2.7449 × 106
ROI = net savings/capital investment = 55%
POP (number of years to recover the capital investment) = 1.8 years
16
Gas Treatment and Conditioning
Hussein K. Abdel-Aal
H.H. Redhwi
CONTENTS
16.1 Technology Aspects.................................................................................... 296
16.1.1 Overview of Gas Field Processing................................................ 296
16.1.2 Effect of Impurities (Water Vapor, H2S/CO2) and Liquid
Hydrocarbons Found in Natural Gas.......................................... 297
16.1.3 Sour Gas Treating........................................................................... 297
16.1.3.1 Selection of Gas-Sweetening Process............................ 297
16.1.3.2 Amine Processes............................................................... 298
16.1.4 Gas Dehydration............................................................................. 299
16.1.4.1 Introduction...................................................................... 299
16.1.4.2 Prediction of Hydrate Formation...................................300
16.1.4.3 Methods Used to Inhibit Hydrate Formation.............. 301
16.1.4.4 Dehydration Methods..................................................... 301
16.1.4.5 Dehydration Using Absorption System........................ 301
16.1.4.6 Dehydration Using Adsorption (Solid-Bed
Dehydration)..................................................................... 303
16.2 Economic Evaluation and Application.................................................... 303
295
296 Petroleum Economics and Engineering
The gas treatment operations carried out in stage I involve the removal of
gas contaminants (acidic gases), followed by the separation of water vapor
(dehydration). Gas processing, stage II, comprises two operations: NGL
recovery and separation from the bulk of gas and its subsequent fraction-
ation into desired product.
Gas field processing in general is carried out for two main objectives:
Natural gas field processing and the removal of various components from
it tend to involve the most complex and expensive processes. A sour gas leav-
ing a gas-oil separation plant (GOSP) might require first the use of an amine
Gas Treatment and Conditioning 297
unit (MEA) to remove the acidic gases, a glycol unit (TEG) to dehydrate it,
and a gas compressor to compress it before it can be sold.
Generic and specialty solvents are divided into three different categories
to achieve sales gas specifications:
1. Chemical solvents
2. Physical solvents
3. Physical-chemical (hybrid) solvents
298 Petroleum Economics and Engineering
100%
Membranes followed by Amines, etc. Membranes
Physical Membranes
Physical Solvents, Mixed Solutions,
Solvents Physical
Amine
Potassium Solvents
10% Carbonate
Acid-Gas Concentration in Feed
Physical Solvents,
Mixed Solutions, Amines, Mixed Solutions
Amine Physical Solvents
s n
Potassium Carbonate
tio
tra
1%
en
nc
1000
Amines, Direct Oxidation
In
ppm
l
FIGURE 16.1
Selection of gas-sweetening processes.
Gas Treatment and Conditioning 299
FIGURE 16.2
Classification of gas-sweetening processes.
A typical amine process is shown in Figure 16.3. The acid gas is fed into a
scrubber to remove entrained water and liquid hydrocarbons. The gas then
enters the bottom of the absorption tower, which is either a tray (for high
flow rates) or packed (for lower flow rate). The sweet gas exits at the top of
tower. The regenerated amine (lean amine) enters at the top of this tower,
and the two streams are contacted countercurrently. In this tower, CO2 and
H2S are absorbed with the chemical reaction into the amine phase. The exit
amine solution, loaded with CO2 and H2S, is called rich amine. This stream
is flashed, filtered, and then fed to the top of a stripper to recover the amine,
and acid gases (CO2 and H2S) are stripped and exit at the top of the tower. The
refluxed water helps in steam stripping the rich amine solution. The regener-
ated amine (lean amine) is recycled back to the top of the absorption tower.
Sour Gas
??
Stabilizer
??
Hot Oil Return
Sour Crude
Inlet Stream ?? Reboiler
??
Hot Oil Supply
First Stage ??
CW Return
Crude Cooler
CW Supply
Sweet Crude
to Stock Tank
FIGURE 16.3
Flowsheet for the amine process.
(Control)
FIGURE 16.4
Gas dehydration methods.
(Dry Gas)
Lean Glycol
(TEG)
Glycol
Contactor
Glycol
Regenerator Water
Feed Gas
(Wet)
Rich Glycol
FIGURE 16.5
Glycol dehydration unit.
Gas Treatment and Conditioning 303
Unheated Gas
for Cooling
Dry Gas
Supply
Heated Gas for
Regeneration
Regeneration
Adsorption Gas Product (Dry)
FIGURE 16.6
A solid desiccant unit for natural gas dehydration.
cools down the lean glycol to the desired temperature and saves the energy
required for heating the rich glycol in the reboiler.
OBJECTIVE
To investigate the economics of utilizing natural gas as a fuel for heating
crude oil.
304 Petroleum Economics and Engineering
PROCESS
Natural gas is recovered from GOSP using an absorber de-ethanizer sys-
tem, along with an amine treating unit and a gas dryer to have available
desulfurized gas that can be used or sold as a fuel gas.
GIVEN
The total cost for the recovery of this gas is estimated to be $0.75/MCF.
It has been suggested to use this gas as a fuel for heating 5000 bbl/day of
40° API crude oil from 80°F to 250°F.
FIND
1. The cost of heating the crude oil using this gas.
2. Compare it with the cost of heating fuel oil at $2.2/MM Btu.
3. Do you recommend change in operation to use the fuel gas as a
heating fuel instead of using the fuel oil?
SOLUTION
The heat duty required is calculated using the well-known equation: Q =
mcpΔT = 127.7 MM Btu/day.
Assuming the heating value of the gas is 960 Btu/ft3 and the heat effi-
ciency is 60%; then the fuel gas consumption will be 221700 ft3/day.
The cost of using this fuel gas for heating = 2217000 ft3/day × $0.75/
MCF = $166.28/day
The cost of using the fuel oil for heating = [127.7 MM Btu × $2.2/MM
Btu]/0.6 = $468.23/day
A daily savings in the cost of fuel of about $300 is realized if the change
to fuel gas takes place. One has to consider other economic factors in
making this analysis. The capital cost involved in changing the burner
system has to be considered.
Case 16.2: How to Control the CO2 Specs in Sweet Gas (Discussion)
Methyl diethanolamine (MDEA) has become the amine molecule cho-
sen to remove hydrogen sulfide, carbon dioxide, and other contami-
nants from hydrocarbon streams. Amine formulations based on MDEA
can significantly reduce the costs of acid gas treating. Under the right
circumstances, MDEA-based solutions can boost plant capacity, lower
energy requirements, or reduce the capital required.
The ultimate goal of amine sweetening is to produce specification
quality product as economically as possible. Amine technology has pro-
duced selective absorbents that remove H2S in the presence of CO2. The
use of selective amines results in:
Synthesis Gas
Sour
Partial Oxidation Scrubbers Shift
Natural
Non-Catalytic Using Water Conversion H2, N2, CO2
Gas
H2
EMF Scrubbers
0.17 V Using Water H2SO4
FIGURE 16.7
Non-catalytic partial oxidation of sour natural gas.
306 Petroleum Economics and Engineering
Loss of H2 as H2O
In the combustion of:
H2S + 3/2 O2 → H2O +SO2
FIGURE 16.8
Current technology to produce synthesis gas from sour natural gas.
amine solvents. The chemisorption of acidic gas into the solvents is fol-
lowed by regeneration of these solvents. Although the bulk production
of synthesis gas is done via catalyzed steam reforming of sweet natural
gas, non-catalyzed partial oxidation of sour natural gas with appropriate
conditions may prove to be more attractive.
17
Crude Oil Refining: Physical Separation
Hussein K. Abdel-Aal
Gasim Al-Shaikh
CONTENTS
17.1 Technology Aspects....................................................................................308
17.1.1 Introduction.....................................................................................308
17.1.2 Distillation of Crude Oil: Overview.............................................309
17.1.2.1 Fractional Distillation: Pillar 1.......................................309
17.1.2.2 Operating Pressure.......................................................... 310
17.1.3 Crude Oil Desalting....................................................................... 310
17.1.4 Separation of Crude Oil: Heavy on the Bottom, Light on
the Top.............................................................................................. 312
17.1.5 Distillation Schemes....................................................................... 312
17.2 Economic Evaluation and Application.................................................... 314
17.2.1 Types of Refineries and Economic Analysis............................... 314
17.2.2 Economic Balance........................................................................... 316
17.2.2.1 Economic Balance in Design.......................................... 317
17.2.2.2 Economic Balance in Yield and Recovery.................... 319
17.3 Conclusions.................................................................................................. 321
17.3.1 Refining Costs................................................................................. 321
17.3.2 Profitability Analysis...................................................................... 322
17.3.3 Cost and Economic Analysis of Refining Operations............... 322
307
308 Petroleum Economics and Engineering
FIGURE 17.1
Flow diagram of the physical and chemical processes of crude oil refining.
TABLE 17.1
Types and Features of Distillation Operations
Atmospheric
Operation Features Distillation Vacuum Distillation Pressure Distillation
Application Fractionation of Fractionation of Fractionation and/or
crude oils heavy residues separation of light
(fuel oil) hydrocarbons
Justification Always, work near To avoid thermal To allow condensation
atmospheric decomposition of the overhead
pressure stream using cooling
water
Extra equipment (as Steam jet ejectors Stronger thickness for
compared with and condensers to the vessel shell
atmospheric produce and
distillation) maintain vacuum
Extra design features Larger diameter Increased number of
(as compared with because of higher trays (N) because
atmospheric vapor flow rate separation becomes
distillation) more difficult;
increased reflux ratio
Crude oil
mixture
To Refining
and Processing
or to shipping
Gas Oil & Dehydration Desalting Physical
Separation Properties
Oil well
GOR 8.5 & W P.T.B A.P.I; Sulfur
GOR : Gas oil ratio, SCF/bbl
B.S. & W : Bottom Sediments, & Water, Volume %
P.T.B : Lb/1000 Barrel of Oil
A.P.I : API, Gravity
Sulfur : Sulfur Content in Crude Oil, W1 %
FIGURE 17.2
Outline of the operations carried out to treat crude oil before distillation.
312 Petroleum Economics and Engineering
17.1.4 Separation of Crude Oil: Heavy on the Bottom, Light on the Top
Once crude oil is heated in the furnace, the resulting liquids and vapors
are discharged into the distillation towers, where they separate into com-
ponents or fractions according to weight and boiling point. The lightest
fractions, including gasoline and liquid petroleum gas (LPG), vaporize and
rise to the top of the tower, where they condense back to liquids. Medium-
weight liquids, including kerosene and diesel oil distillates, stay in the mid-
dle. Heavier liquids, called gas oils, separate lower down, while the heaviest
fractions with the highest boiling points settle at the bottom. These tarlike
fractions, called residuum, are literally the “bottom of the barrel.” This nor-
mally takes place in what is named a topping plant, shown in Figure 17.3. A
schematic presentation of the distillation process of crude oil is shown in
Figure 17.4.
LPG
Naphtha
Distillation Gasoline
column
Jet
Crude Oil Kerosene
Gas
oil/Diesel
S R Fuel Oil
FIGURE 17.3
A flow diagram for a topping plant.
Crude Oil Refining: Physical Separation 313
Petroleum gas
Crude Oil < 40 °C
C1 and C3
Distillation Tower
Gasoline
40–200 °C
C4 and C12
Kerosene, jet fuel
200–250 °C
C12 and C16
Heating Oil
250–300 °C
C15 and C18
Crude Oil
Lubricating Oil
300–370 °C
C19 and up
Residue, asphalt
C25 and up
Heating Burner
C. Ophardt c. 1998
FIGURE 17.4
The distillation process of crude oil.
Figure 17.5 illustrates a distillation scheme for crude oil that involves all
types of distillation operations: atmospheric, under vacuum and under pres-
sure, and the stripping operations that take place inside the side strippers
and at the bottoms of the atmospheric column and the vacuum tower.
314 Petroleum Economics and Engineering
To
Side-Stream
Strippers
Crude Stripping
Oil Operations
Steam
Steam
Vacuum
Distillation
FIGURE 17.5
Different modes of distillation plus stripping.
Types of Refineries
Fuel
Chemical Refinery
Conventional Refinery
FIGURE 17.6
Classifications of refineries.
and others. The fully integrated refinery will provide other processes and
operations necessary to produce practically all types of petroleum products,
including lubrication oils, waxes, asphalts, and many others.
A chemical refinery, on the other hand, is a special case of the conven-
tional oil refinery in which the emphasis is on manufacture of olefins and
aromatics from crude oil. A chemical refinery can be defined as one that
includes an olefin complex for the pyrolysis of petroleum fractions (for
example C2H6 to C2H4). It must not produce motor gasolines; that is, it is
a non-fuel-producing refinery. In other words, the purpose of chemical
refining is to convert the whole crude oil directly into chemical feedstocks.
An example is the heavy oil cracking (HOC) process, in which the atmo-
spheric residuum is catalytically cracked directly into lighter products.
Chemical refining is an economically attractive venture for large chemi-
cal companies that can penetrate the market by selling large quantities of
olefins and aromatics.
Economic analysis is used in refining to determine the most economical
refining operations, to determine whether to use new or existing equipment,
etc. Economic analysis, including cost analysis, is complicated in a refinery
because an operation in a refinery with lower operating costs is not necessar-
ily the most desirable procedure, and similarly, an operation giving higher
yields, or production rates, is not necessarily a more economical one. A high-
est yield with lowest cost is what the refiner would like to achieve.
Economic analysis is further complicated by the fact that several hundred
different products may be produced from one basic raw material, crude oil.
There are also other complications. The basic crude may consist of a num-
ber of different crudes that have considerably different characteristics and
different selling prices (to independent refiners only). Furthermore, it is
316 Petroleum Economics and Engineering
desired separation. This means lower fixed costs for the column. The
other extreme limit for the reflux could be reached by further increase
in R with corresponding decrease in the number of trays until the total
reflux, Rt, is reached (case of minimum number of trays, Nm). Attention
is now directed to the effect on the diameter of the column of increasing
the reflux ratio, that is, increasing vapor load
As R increases, the vapor load inside the column increases; conse-
quently, the diameter of the column must be increased to attain the same
vapor velocity. A point is reached where the increase in column diameter
is more rapid than the decrease in the number of trays. Hence the only
way to determine the optimum conditions of reflux ratio that will result
in the right number of trays for the corresponding column diameter is
to use economic balance. For different variable reflux ratios, the corre-
sponding annual fixed costs and operating costs must be combined and
plotted versus the reflux ratio.
Annual fixed costs are defined as the annual depreciation costs for
the column, the reboiler, and the condenser, where the cost of a column
for a given diameter equals the cost per plate of this particular diameter
times the number of plates. Therefore, the operating cost equals the cost
of the steam plus the cost of cooling water. Figure 17.7 illustrates how we
obtain the optimum reflux ratio (a design parameter) by minimizing the
total annual costs of the distillation column.
150
90
FIGURE 17.7
A plot of the total annual costs versus the reflux ratio. (From Peters, Max, and Timmerhaus,
Klaus, Plant Design and Economics for Chemical Engineers, McGraw-Hill, New York, 1981. With
permission.)
Crude Oil Refining: Physical Separation 319
or Y = output/input
or recovery in percent form. Also, if fixed costs are constant for a given pro-
cess, then fixed costs will be constant for a given value of F or total feed
(crude). However, as is usually the case, equipment costs will be higher for
a higher-grade product, with the result that the annual fixed cost per unit of
refined product increases.
For a given crude feed rate, raw material costs are constant but refinery
processing costs usually increase for a higher-grade product to give a vari-
able cost curve that also increases. The value of the finished product, like
that of fixed costs and variable costs per unit of refined oil, will vary with the
grade of product.
Figure 17.8 is a typical economic chart with curves illustrating economic bal-
ance curves in a refinery. Recovery, or ratio of output to input, in the oil refin-
ery is greater than recovery in the oil fields. To make a profit the refiner must
stick to the product grades marked between A and B, shown in Figure 17.8.
320 Petroleum Economics and Engineering
Sales Dollars
Total Costs
Dollars per Unit of Feed
t
ofi
Variable Costs
Pr
Fixed Costs
Raw Materials Cost (Crude)
A Product Grade B
FIGURE 17.8
Economic level of refined oil production from a given feed of crude oil.
SOLUTION
The total annual cost is the sum of the annual operating expenses plus
annual depreciation costs. Assuming straight-line depreciation:
d, the annual depreciation cost = 5 × 106/10 = 0.5 × 106 $/year (17.1)
The annual operating expenses = (10/1,000)(120,000)(365)(0.95)
= 0.416 × 106 $/year (17.2)
Crude Oil Refining: Physical Separation 321
17.3 Conclusions
17.3.1 Refining Costs
Refining costs include variable and direct refining costs, fixed charges, over-
head expenses, and general expenses:
How much fuel does a refinery use? It is estimated that the amount of heat
needed in the processing of oil varies between 555,000 and 700,000 Btu/bbl
of crude.
If crude oil has a heating value of 6 million Btu/bbl, the above figures indi-
cate the equivalent of 9.2% to 11.7% of the crude oil. The heat requirements
322 Petroleum Economics and Engineering
include the burning of coke from catalyst as well as such common fuels as
refinery gas, natural gas, residual fuel oil (pitch), and acid sludge and coal.
Total 100%
Not more than 65% of the heat, or about 4,500,000 Btu, actually enters the
barrel of oil, the remaining 35%, or about 1,575,000 Btu, of heat goes up the
stack and out or remains as chemical energy in carbon monoxide (in regen-
erator flue gas).
Costs over and above fixed costs represent additional costs, incidental to
the production of each additional barrel of refined oil products (marginal
costs), assuming the oil refinery is in operation. The addition to total costs
arising from the production of each additional barrel of refined oil prod-
ucts is the same regardless of the operating rate at which the additional
output is obtained, as long as the other factors affecting costs remain
constant. This phenomenon of constant additional costs covers a range of
output from 20% of capacity to about 90% of physical limit of output. As
the physical limit of capacity, or 100%, is reached, the equipment becomes
overtaxed and for various reasons operates less efficiently and at greater
cost. In such cases, additional costs incidental to production (marginal
costs) of an additional unit of output cease to be constant and probably rise
sharply, so the basic economic law of diminishing returns makes further
production uneconomical.
18
Crude Oil Refining: Chemical Conversion
Abdullah M. Aitani
CONTENTS
18.1 Technology Aspects.................................................................................... 326
18.1.1 Introduction..................................................................................... 326
18.1.1.1 Overview........................................................................... 326
18.1.1.2 Refinery Configuration................................................... 327
18.1.2 Crude Oil and Refined Products.................................................. 329
18.1.2.1 Type and Composition of Crude Oils........................... 329
18.1.2.2 Refined Products.............................................................. 330
18.1.3 Light Oil Processing....................................................................... 330
18.1.3.1 Catalytic Hydrotreating.................................................. 330
18.1.3.2 Catalytic Naphtha Reforming........................................ 332
18.1.3.3 Isomerization.................................................................... 333
18.1.3.4 Alkylation.......................................................................... 333
18.1.3.5 Etherification..................................................................... 333
18.1.3.6 Polymerization and Dimerization.................................334
18.1.4 Heavy Distillate Processing..........................................................334
18.1.4.1 Fluid Catalytic Cracking (FCC)......................................334
18.1.4.2 Catalytic Hydrocracking................................................. 335
18.1.5 Residual Oil Processing................................................................. 335
18.1.5.1 Coking............................................................................... 335
18.1.5.2 Visbreaking....................................................................... 335
18.1.5.3 Residue Hydrotreating and RFCC................................. 336
18.1.6 Auxiliary and Treating Processes................................................ 336
18.1.6.1 Hydrogen Production...................................................... 336
18.1.6.2 Residue Gasification........................................................ 337
18.1.6.3 Aromatics Extraction....................................................... 337
18.1.6.4 Sulfur Recovery................................................................ 337
18.2 Economic Evaluation and Application.................................................... 338
18.3 Concluding Remarks..................................................................................343
This chapter discusses the various aspects of crude oil refining as a primary
source of fuel and as a feedstock for petrochemicals. The main objective of
chemical conversion in oil refining is to convert crude oils of various ori-
gins into valuable products having the qualities and quantities demanded by
325
326 Petroleum Economics and Engineering
TABLE 18.1
Regional Outlook of World Refining Operations
Region Number Million b/d Coke,
of
Crude Catalytic Catalytic Catalytic Catalytic 1000
Refineries
Distillation Reforming Cracking Hydrocracking Hydrotreating tons/d
North 148 21.3 4.1 6.5 1.9 16.4 134.7
America
South 66 6.6 0.5 1.3 0.2 1.9 24.6
America
Western 99 14.4 2.1 2.2 1.2 10.1 12.6
Europe
Eastern 89 10.4 1.5 0.9 0.3 4.3 12.5
Europe
Asia 164 24.9 2.3 3.2 1.3 10.2 20.3
Mideast 44 7.3 0.8 0.4 0.5 2.0 3.3
Africa 45 3.2 0.5 0.2 0.06 0.8 1.8
Total 655 88.1 11.5 14.7 5.5 45.7 209.8
Source: True, W.R., and Koottungal, L., Global Capacity Growth Reverses; Asian, Mideast
Refineries Progress, Oil Gas Journal, December 5, 2011. With permission.
89 800
88
Capacity
87
86 750
Capacity, million b/d
85
Refineries
84
700
83
82
81 650
Number of refineries
80
79
78 600
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
FIGURE 18.1
Worldwide refining: capacity and number of refineries. (From True, W.R., and Koottungal,
L., Global Capacity Growth Reverses; Asian, Mideast Refineries Progress, Oil Gas Journal,
December 5, 2011. With permission.)
328 Petroleum Economics and Engineering
LPG
Gas Plant
Polymerization
Gas Olefins
Hydrotreater Aromatics
Kerosine Kerosene
Crude
Desalter Hydrotreater
Crude Oil Atm gas oil Fuel oils
Hydrotreater
Coke
Coker
FIGURE 18.2
A typical high-conversion refinery. (From Aitani, A., Oil Refining and Products, In: Encyclopedia
of Energy, C.J. Cleveland, Ed., Elsevier, Amsterdam, New York, vol. 4, pp. 715–729, 2004. With
permission.)
have become larger, more selective, more integrated, and more energy-efficient.
Thereby, refining costs have decreased, and consequently world consumption
of refined products has increased drastically, mainly in Asian countries. In gen-
eral, the refining industry has been characterized as a high-volume, low-profit
margin industry. However, despite all technological improvements the refining
industry is still looking for more efficient processes and catalysts.
Figure 18.2 presents a schematic diagram of a typical high-conversion
refinery, showing various processing units. These units range from relatively
simple crude oil distillation to the more complex ones: vacuum distillation,
hydrotreating, catalytic reforming, catalytic cracking, hydrocracking, alkyla-
tion, and isomerization. In 2011, with respect to crude distillation, catalytic
hydrotreating represented 52% followed by vacuum distillation capacity at
Crude Oil Refining: Chemical Conversion 329
33%, catalytic cracking at 17% and catalytic reforming at 13%. In general, the
chemical conversion and treatment processes in a modern refinery can be
grouped as follows (Aitani, 2004):
TABLE 18.2
Typical Yields (%) of Refineries Processing Selected Crude Oils—U.S. Gulf Coast
Major Refined Boiling West Texas Arabian Arabian Nigerian
Product Point,°C Intermediate Light Heavy Bonny Light
Gasoline 10–200 48.1 38.9 36.8 44.9
Kerosene/jet 200–260 8.1 8.2 6.7 7.8
Diesel 260–345 30.9 24.7 9.7 39.6
Fuel oil 345+ 9.8 23.7 41.6 4.5
330 Petroleum Economics and Engineering
produced by OPEC countries. The demand for crude oil is projected to reach
110 million b/d with major increase in Asian countries for transportation
fuels, mainly diesel (OPEC, 2011).
TABLE 18.3
Properties and Uses of Refined Products
Refined Product Source, Properties, and Uses
LPG Liquefied petroleum gas (LPG) consists of propane and butanes. It
is used as fuel and in the manufacture of olefins. Butanes are also
used in the manufacture of ethers and to adjust the vapor pressure
of gasoline. LPG is also used in transportation and domestic and
household applications.
Naphtha BTX aromatics from naphtha reforming are the main petrochemical
feedstocks derived from refinery. These products are the basis for
integrating refining and petrochemical operations. Benzene and
xylenes are precursors for many valuable chemicals and
intermediates such as styrene and polyesters.
Gasoline Mixture of hydrocarbons made up of different refinery streams
mainly straight-run naphtha, isomerized C5/C6 paraffins,
reformate, hydrocracking, FCC gasoline, oligomerate, alkylate,
and ethers. The important qualities for gasoline are octane number,
volatility, vapor pressure, and sulfur content.
Kerosene/jet Middle-distillate product used for jets and in cooking and heating
(kerosene). When used as a jet fuel, some of the critical qualities
are freeze point, flash point, and smoke point. Kerosene is also
used for lighting, heating, solvents, blending into diesel fuel, and
paraffins dehydrogenated for use in detergents.
Diesel/heating oil A blend from atmospheric distillation, hydrocracking, FCC light
cycle oil, and some products obtained from visbreaking and
coking. Its main property for automotive engine combustion is
cetane number. Sulfur reduction and cetane improvement are
heavily investigated to produce a clean diesel.
Residual fuel/bunkers The least valuable refined product, selling at a price below that of
crude oil. Many marine vessels, power plants, commercial
buildings, and industrial facilities use residual fuels or
combinations with distillate fuels for heating. Two most critical
properties are viscosity and low sulfur content.
Lubes/wax Vacuum distillation is the main source for lubes. Antioxidants and
viscosity improvers are added to provide properties required for
motor oils, industrial greases, lubricants, and cutting oils. The
most critical quality is a high viscosity index.
Petcoke/asphalt Petcoke (petroleum coke) has a variety of uses from electrodes to
charcoal briquettes. Bitumen or asphalt is a semisolid material
produced from vacuum distillation. It is classified into various
commercial grades and is mainly used for paving roads and
roofing materials.
contaminants can have detrimental effects on the equipment and the qual-
ity of the finished product. Hydrotreating for sulfur or nitrogen removal is
called hydrodesulfurization (HDS) or hydrodenitrogenation (HDN), respec-
tively. World capacity for all types of hydrotreating currently stands at about
45.7 million b/d % (True and Koottungal, 2011). Hydrotreating is used to
332 Petroleum Economics and Engineering
40
2010 2035
30
20
10
0
Ethane/ Naphtha Gasoline Jet/ Diesel/ Residual Other
LPG Kerosene Gas/Oil fuel** products**
total capacity of about 11.5 million b/d % (True and Koottungal, 2011). About
40% of this capacity is located in North America, followed by 20% each in
Western Europe and the Asia-Pacific regions. Reforming processes are
generally classified into semi-regenerative, cyclic, and continuous catalyst
regenerative (CCR). Most grassroots reformers are designed with continu-
ous catalyst regeneration. CCR is characterized by high catalyst activity with
reduced catalyst requirements, more uniform reformate of higher aromatic
content, and high hydrogen purity.
18.1.3.3 Isomerization
Isomerization is an intermediate feed preparation-type process. There are
more than 230 units worldwide with a processing capacity of 1.7 million
b/d of light paraffins. Two types of units exist: C4 isomerization and C5/C6
isomerization. A C4 unit converts normal butane into isobutane, to provide
additional feedstock for alkylation units, whereas a C5/C6 unit will isomer-
ize mixtures of C5/C6 paraffins, saturate benzene, and remove naphthenes.
Isomerization is similar to catalytic reforming in that the hydrocarbon mol-
ecules are re-arranged, but unlike catalytic reforming, isomerization just
converts normal paraffins to isoparaffins. The greater value of branched par-
affins over straight paraffins is a result of their higher octane contribution.
The extent of paraffin isomerization is limited by a temperature-dependent
thermodynamic equilibrium. For these reactions a more active catalyst per-
mits a lower reaction temperature and that leads to higher equilibrium lev-
els. Isomerization of paraffins takes place under medium pressure (typically
30 bar) in a hydrogen atmosphere.
18.1.3.4 Alkylation
Alkylation is the process that produces gasoline-range compounds from
the combination of light C3-C5 olefins (mainly a mixture of propylene and
butylene) with isobutene. The highly exothermic reaction is carried out
in the presence of a strong acid catalyst, either sulfuric acid or hydroflu-
oric acid. World alkylation capacity is currently 2.1 million b/d (True and
Koottungal, 2011). The alkylate product is composed of a mixture of high-
octane, branched-chain paraffinic hydrocarbons. Alkylate is a premium
clean gasoline blending with octane number depending upon the type of
feedstocks and operating conditions. Research efforts are directed toward
the development of environmentally acceptable solid superacids capable of
replacing HF and H2SO4.
18.1.3.5 Etherification
Etherification results from the selective reaction of methanol or ethanol to
isobutene. The ether products such methyl tertiary butyl ether (MTBE) or
334 Petroleum Economics and Engineering
18.1.5.2 Visbreaking
Visbreaking is a non-catalytic residue mild-conversion process with a world
capacity of 3.8 million b/d (True and Koottungal, 2011). The process is
designed to reduce the viscosity of atmospheric or vacuum residues by ther-
mal cracking. It produces 15−20% of atmospheric distillates with proportion-
ate reduction in the production of residual fuel oil. Visbreaking reduces the
quantity of cutter stock required to meet fuel oil specifications and, depend-
ing upon fuel oil sulfur specs, typically reduces the overall quantity of fuel
oil produced by 20%. In general, visbreakers are typically used to process to
336 Petroleum Economics and Engineering
vacuum residues. The process is available in two schemes: coil cracker and
soaker cracker. The coil cracker operates at high temperatures during a short
residence time of about 1 minute. The soaker scheme uses a soaking drum at
30−40°C at about 10−20 residence time.
and beyond. Catalytic naphtha reforming alone is not able to meet refinery
hydrogen requirements. A recent survey on world refining indicated that
the capacity of supplementary refinery hydrogen, produced mainly by steam
reforming process reached 14,160 MMcfd (True and Koottungal, 2011). There
is a growing recognition that there will be a significant future shortage of
refinery hydrogen supply. Specific hydrogen production units such as steam
methane reformers or partial oxidation of heavy residues will have to be
built. The refining industry will require a substantial amount of on-purpose
hydrogen to meet processing requirements with Asia Pacific and the Middle
East representing nearly 40% of global requirements. About two-thirds of
incremental refinery hydrogen demand will be for expanding hydrocrack-
ing operations.
TABLE 18.4
Complexity Factors of Refinery Processes
Processing Unit Complexity Factor
Atmospheric distillation 1.0
Vacuum distillation 2.0
Thermal cracking 3.0
Delayed/fluid coking 6.0
Visbreaking 2.5
Catalytic cracking (FCC) 6.0
Catalytic reforming 5.0
Catalytic hydrocracking 6.0
Catalytic hydrorefining 3.0
Catalytic hydrotreating 2.0
Alkylation 10.0
Aromatics, BTX 15.0
Isomerization 15.0
Polymerization 10.0
Lubes 6.0
Asphalt 1.5
Hydrogen manufacturing, MMscfd 1.0
Oxygenates 10.0
Source: Kaiser, M.J., Gary, J.H., Study Updates Refinery Investment Cost Curves, Oil & Gas
Journal, April 23, 2007. With permission.
Crude Oil Refining: Chemical Conversion 339
TABLE 18.5
Complexity Index of Various Refineries
Refinery Type Process Complexity
Coking Coking/resid upgrading to process medium/sour crude oil 9
Cracking Vacuum distillation and catalytic cracking to process light 5
sour crude oil to produce light and middle distillates
Hydroskimming Atmospheric distillation, naphtha reforming, and 2
desulfurization to process light sweet crude oil to
produce gasoline
Topping Separate crude oil into refined products by atmospheric 1
distillation, produce naphtha but no gasoline
340 Petroleum Economics and Engineering
25
USGC heavy sour coking
NWE light sweet cracking
Singapore medium sour hydrocracking 20
15
10
–5
01 02 03 04 05 06 07 08 09 10 11
TABLE 18.6
Refinery Integration Interface with Aromatics Complex and Steam Cracker
Source: Leighton, P., Potential of Integrated Facilities—Finding Value Addition, World Refining
Association: Petchem Arabia, 4th Annual Meeting, Abu Dhabi, October 2009. With
permission.
342 Petroleum Economics and Engineering
It has been stated that part of the success of the revamp in this case
study was due to a focused team accountable for the goals and execution
of the project.
Mazyad Al Khaldi
CONTENTS
19.1 Technology Aspects....................................................................................345
19.1.1 Introduction.....................................................................................345
19.1.2 Why Field Processing?...................................................................346
19.1.3 Recovery and Separation of NGL.................................................346
19.1.3.1 Options of Phase Change...............................................346
19.1.4 Parameters Controlling NGL Separation....................................348
19.1.5 Fractionation of NGL...................................................................... 349
19.1.6 Shale Gas.......................................................................................... 350
19.2 Economic Evaluation of Selected Problems............................................ 352
Gas field processing is generally is carried out for two main objectives:
1. The necessity of removing impurities from gas (the topic of Chapter 16)
2. The desirability of increasing liquid recovery above that obtained by
conventional separation
Natural gas processing, the topic of this chapter, comprises two consecu-
tive operations: NGL recovery (extraction) and separation from the bulk of
gas followed by subsequent fractionation into desired products. The purpose
of a fractionator’s facility is simply to produce individual finished streams
needed for market sales. Fractionation facilities play a significant role in gas
plants. A case study involving the optimum recovery of butane using lean
oil extraction is presented.
345
346 Petroleum Economics and Engineering
will require removal before the gas can be sold to a pipeline gas transmission
company. All of the H2S and most of the water vapor, CO2, and N2 must be
removed from the gas. Gas compression is often required during these vari-
ous processing steps.
The condensable hydrocarbons heavier than methane which are recovered
from natural gas are called (NGL). Associated gas usually produces a higher
percentage of natural gas liquids. It is generally desirable to recover NGL pres-
ent in gas in appreciable quantities. This normally includes the hydrocarbons
known as C3+. In some cases, ethane C2 can be separated and sold as a petro-
chemical feed stock. NGL recovery is the first operation in gas processing, as
explained in Chapter 16. To recover and separate NGL from a bulk of a gas
stream would require a change in phase; that is, a new phase has to be devel-
oped for separation to take place by using one of the following:
Legend:
Located at gas wells Located in gas processing plant
Red Indicates final sales products Blue Indicates optional unit processes available
Condensate is also called natural gasoline or casinghead gasoline
Pentanes + are pentanes plus heavier hydrocarbons and also called natural gasoline
Acid gases are hydrogen sulfide and carbon dioxide
Sweetening processes remove mercaptans from the NGL products
PSA is Pressure Swing Adsorption
NGL is Natural Gas Liquids
FIGURE 19.1
347
• Operating pressure, P
• Operating temperature, T
• System composition or concentration, x and y
Second
For separation using MSA, a control in the composition or the con-
centration of the hydrocarbons to be recovered (NGL); y and x
are obtained by using adsorption or absorption methods.
Adsorption provides a new surface area, through the solid
material, which entrains or adsorbs the components to be recov-
ered and separated as NGL. Thus, the components desired as
liquid are deposited on the surface of the selected solid and then
regenerated off in a high concentration; hence, their condensation
efficiency is enhanced. About 10% to 15% of the feed is recovered
as liquid. Adsorption is defined as a concentration (or compo-
sition) control process that precedes condensation. Therefore,
refrigeration methods may be coupled with adsorption to bring
in condensation and liquid recovery.
Absorption, on the other hand, presents a similar function of
providing a surface or contact area of the liquid-gas interface.
The efficiency of condensation, and hence NGL recovery, is a
function of P, T, gas and oil flow rates, and contact time. Again,
absorption could be coupled with refrigeration to enhance
condensation.
In the lean oil extraction method, the treated gas is cooled by heat
exchange with liquid propane and then washed with a cold hydro-
carbon liquid, which dissolves most of the condensable hydrocar-
bons. The uncondensed gas is dry natural gas and contains mainly
methane with small amounts of ethane and other heavier hydro-
carbons. The condensed hydrocarbons or natural gas liquids (NGL)
are stripped from the rich solvent, which is recycled back to the
process.
The goals for the tasks for system design of a fractionating facility are
as follows:
Shale gas reserves have been known for a long time, but natural fracture
technology used earlier was uneconomical to produce shale gas. Recent
developments in horizontal drilling and hydraulic fracturing (called frack-
ing) made it viable. Mitchell energy, a Texas gas company, first achieved eco-
nomical shale gas fracture in 1998. Shale gas is currently in an evolutionary
stage and so far is largely confined to North America. The complete technol-
ogy and economic factors are yet to mature. Several high-profile shale gas
drilling efforts in Europe have already failed.
Shale gas costs more to produce than NG from conventional wells. The
high cost is mainly due to the expense of massive hydraulic fracturing treat-
ments required to produce shale gas and horizontal drilling. Drilling a ver-
tical and horizontal well cost about $1 million and $4 million, respectively.
The huge requirement of water for hydraulic fracking and then the waste-
water treatment are major cost inhibitors. Overall, addressing environmen-
tal concerns associated with shale gas hugely adds to its cost. Shale gas
production may be feasible only in those regions where energy/NG prices
are high. The shale gas production cost in the United States is estimated to
be between $4 and $7 per MMBTU, but it is termed as “foggy economics”
since all factors were not considered. Earlier it was thought that shale gas
will produce less greenhouse gases, but scientists have recently concluded
otherwise and opine that it will accelerate global warming. Shale gas pro-
duction requires large amounts of water and chemicals added to it to facili-
tate an underground fracturing process that releases gas. A maximum of
70% of used water is recovered and the rest remains underground which
can lead to contamination. Significant use of water for shale gas production
may affect the availability of water for other uses and can affect aquatic
habitat. The treatment of a large amount of recovered wastewater before
re-use or disposal is an important and challenging issue. There is some
evidence of groundwater contamination in areas of fracking. The environ-
mental impacts of shale gas production are therefore challenging but still
considered to be manageable.
So far shale gas is confined mostly to North America. There is little drill-
ing progress in China, Australia, and Poland. In other countries, it is still
in the pilot stages. Canada has huge shale gas reserves but exploration is
restricted due to strict environmental regulations and related issues. In
the United States, BP predicted NG self-sufficiency and NG share of total
energy consumption to double to 40% with 4% anticipated annual growth
in shale gas production by 2030. EIA, however, slashed BP shale gas fore-
cast reserves by 41% in January 2012. The energy demand (dominated by
oil) will still grow in the next two decades by 39%, but most of the growth
in demand will be from Asian countries, especially China and India. In
Saudi Arabia, evaluation of shale gas reserves is in progress and produc-
tion may start in 2020 but low NG price remains a major issue in develop-
ing the prospects.
352 Petroleum Economics and Engineering
SOLUTION
Profit = Income – Expenses
CONCLUSION
Some balance must be reached between the pumping costs and the con-
struction costs in order to lower the total costs of operation. Also, it is
not practical to construct a tower of extremely large diameter because of
liquid distribution problems.
Apparently, there are constraints on the tower diameter. Solution is
reached by optimization technique in order to minimize the total annual
costs of operating the tower as a function of the tower diameter.
M.A. Al-Sahlawi
CONTENTS
20.1 Introduction................................................................................................. 355
20.2 The Tanker Market..................................................................................... 356
20.3 Tanker Planning and Scheduling.............................................................364
20.4 Pipelines....................................................................................................... 373
20.4.1 General Review............................................................................... 373
20.4.2 Pipeline Economics......................................................................... 376
20.4.3 Piping and the Oil Fields............................................................... 380
20.5 Economic Balance in Piping and Optimum Pipe Diameter................. 383
20.6 Railroad Tank Cars..................................................................................... 387
20.7 Tank Trucks................................................................................................. 388
20.8 Environment Impacts................................................................................. 389
20.9 Summary...................................................................................................... 390
20.1 Introduction
Oil and natural gas are only rarely found near the points at which they are
consumed. The main oil and gas deposits are located in emerging or devel-
oping countries. Once domestic demand is met, these countries export most
of their hydrocarbon production to industrialized regions. Europe, North
355
356 Petroleum Economics and Engineering
America, and East Asia have strict energy requirements but are not self-suf-
ficient enough in terms of oil and gas supplies. As a result, transportation of
crude oil and its products as well as natural gas is a significant part of the
cost buildup from initial exploration and discovery through to the final user.
For the world oil industry, there are four basic kinds of transportation. In
rough order of importance, they are:
• Tankers
• Pipelines
• Railroads
• Tank cars and tank trucks
Oil tankers are by a fairly wide margin the cheapest form of transporta-
tion on a barrels-per-kilometer basis, with pipelines second, railroad tank
cars third, and tank trucks fourth. But which form of transport is technically
or economically feasible depends mainly on geographic factors, such as the
location of the markets to be served, the size of the market, and what kind of
road or railroad facilities are available.
The choice of transportation facilities also depends partly on whether crude
oil, natural gas, or oil products are involved. In general, it does not make much
difference what kind of crude oil is put into a tanker or a pipeline, since the
mixing of one type or another does not significantly affect the refining pattern
to which the oil is subjected, but it can make a great deal of difference if oil
products, which are often subject to very tight specifications, are mixed a great
deal in their transportation systems. This means that product transportation
systems have to be segregated to avoid contamination among the various
products, which significantly affects the economics involved. With respect to
natural gas, it is difficult to transport by tank trucks because of its low density,
and it is expensive to transport by pipelines across oceans.
TABLE 20.1
Distribution of World Oil Tanker Fleet by Region: Million DWT, 1970–2007
% of % of % of % of % of
Region 1970a World 1980a World 1988a World 2003b World 2007b World
United 09.3 06.13 16.16 4.97 16.53 06.79 18.35 5.30 25.80 7.50
States
Europe 52.10 34.20 86.56 26.60 48.41 19.90 55.10 15.30 47.90 12.80
Asia 15.20 10.10 30.05 09.25 14.68 06.03 51.39 13.90 63.70 16.40
(Japan)
Africa 37.40 24.65 100.27 30.87 56.12 23.10 42.30 11.44 46.40 12.20
(Liberia)
Panama 5.50 03.63 12.17 03.75 20.70 08.50 37.80 10.12 52.80 13.10
World 151.72 100 324.80 100 243.72 100 367.85 100 429.50 100
a Champness, M., and Jenkins, G., Oil Tanker Databook, Elsevier Applied Science, New York, 1985;
World Tanker Fleet Review, John I. Jacobs, London, July–December 1988. WIth permission.
b Compiled from UNCTAD Statistics (Trade), Geneva; Lloyds Register, Fairplay (Fleet owner-
ship), London; U.S. Central Intelligence Agency and U.S. Maritime Administration Statistics;
and R.S. Platou Economic Research, Oslo, Norway. With permission.
Over the past 50 years, tanker technology has experienced many changes.
During World War II and for some years thereafter, the standard oceangoing
tanker was the T-2, with a capacity of some 26,000 deadweight tons (DWT),
in this case about 150,000 barrels. Because of the economies of scale and
the very large increases in world oil demand between 1945 and 1975, the
maximum size of tankers grew from 26,000 to over half a million DWT, a
more than 20-fold increase.
Within this size category, there are five main size classes: Panamax, with up
to 70 thousand DWT and 0 to 5 million barrels capacity; Aframax ranging from
70 to 120 thousand DWT with 0.750 million barrels capacity; Suezmax ranging
600
Fairplay Forecast
Oil Tanker Fleet, Million dwt, 1976–
500
400
300
200
100
0
1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
2011–01 A 200.000+dwt B 120–199.999 dwt C 60–119.999 dwt D 10–59.999 dwt E–9.999 dwt
FIGURE 20.1
Oil tanker fleet, million DWT, 1976–2012.
358 Petroleum Economics and Engineering
PANAMAX ULCC
PANAMAX 2%
5% SUEZMAX 1%
SUEZMAX ULCC 20% AFRAMAX
23% 1% 23%
AFRAMAX
40%
VLCC
31% VLCC
54%
Number of Ships: 777
Capacity (Million DWT)136.5
FIGURE 20.2
Composition of the World Long Haul Tanker Fleet.
between 120 and 200 thousand DWT with a capacity of one million barrels;
very large crude carrier (VLCC) ranging from 200 to 325 thousand DWT with
2 million barrels capacity; and finally (ULCC) ranging between 320 and 550
thousand DWT and four million barrels capacity. The composition of these ves-
sels in terms of number of ships and capacity is presented in Figure 20.2.
More detailed features of VLCC and ULCC are shown in Table 20.2, while
Table 20.3 shows the world oil tanker fleet tonnage of year 2010, by size cate-
gories. The noted 30-year increase from 1945 to 1975 in tanker size has appar-
ently about run its course, at least for the medium-term future. There are two
basic reasons for this. One is that the economies of scale increase only very
slowly above the half-million DWT level. The other is that limitations on
harbor depths and port facilities in many areas tend to make inconvenient or
impossible the use of even the current large tankers.
A tanker market can be considered a competitive market where the tanker rate
is determined by the interaction of supply and demand. The demand for tanker
services is inelastic with respect to spot rate (price) and depends on the degree
TABLE 20.2
Comparison between VLCC and ULCC
Features VLCC ULCC
MDWT 160–320 320–550
Draft, ft 65 75
Length, ft 1,145 1,240
Beam, ft 170 225
Cost $ million
Single-hutted 100 n/a
Double-hutted 120 n/a
Charter rates, $ thousand/d 30–40 35–45
Source: Saudi Aramco, Engineering Services, Oil Pipelines: Spreading the Network,
AramcoExpats, Dhahran, Saudi Arabia, http://www.aramcoexpats.com/articles/2006/10/
oil-pipelines-spreading-the-network/, October 7, 2006. With permission.
Oil and Gas Transportation 359
TABLE 20.3
Existing Commercial Tanker Fleet, 2010
Group Size, DWT Number of Vessels Percent
1,000–2,000 278 14%
2,000–3,000 398 19%
3,000–5,000 677 33%
5,000–8,000 432 21%
8,000 and over 266 13%
Total 2051 100%
Source: United Nations Conference for Trading and Development, UNCTAD, Geneva, 2010.
With permission.
S
Rates S
Tanker Services
FIGURE 20.3
Demand-and-supply relationship for tankers.
360 Petroleum Economics and Engineering
TABLE 20.4
Freight Rates for Different Types and Sizes of Cargo between the Source and
Discharge, February 2009
Source Discharging Cargo Size World- Freight
(Leading) (Unloads) Cargo 1000 Barrels Scale Rates Cost, $/b
Caribbean New York Distillate 200 215 2.48
Northern New York Distillate 200 158 2.91
Europe
Northern Houston Crude oil 400 82 2.22
Europe
West Africa Northern Crude oil 910 71 1.6
Europe
West Africa Houston Crude oil 910 74 2.27
Arabian Gulf Houston Crude oil 1,900 36 2.08
Arabian Gulf Japan Crude oil 1,750 48 1.61
Arabian Gulf Northern Crude oil 1,900 36 1.51
Europe
Source: Average data for February 2009 as published in Oil & Gas Journal from Drewery
Shipping Consultant Ltd., www.petrostrategies.org. With permission.
and size of cargo with different distance will determine freight rates. The
freight rates for most tanker sizes in 2010 performed on average 30 percent
higher than in 2009, as shown in Table 20.5. It is noted that freight rates for all
vessel types in the first quarter of 2011 have decreased by about 15 percent
compared to the same period of 2010 but remained more than 20 percent
higher than in first-quarter 2009.
The main loading points are Arabian Gulf, West Africa, the Mediterranean,
the Caribbean, and Singapore, while the main discharging points are
East of Asia, Southern Africa, North-West Europe, the Mediterranean, the
Caribbean, and the East Coast of North America. However, new routes and
variations in freight rates have emerged because of political and financial
critical events that have affected the tanker market. For example, the current
global economic crisis has been reflected in the supply and demand for tank-
ers and has changed the freight rates.
The main reason this variation in tanker rates can be sustained in competi-
tive markets is that many seaports are not deep enough to handle the very
large tankers with their scale economies. The largest tankers in the fleet have
drafts (the depth of their hulls fully loaded) of as much as 30 m. Dredging
many harbors to those depths would be uneconomical, and in some cases
the lengths of the ships involved are too great to give them room to maneu-
ver in any but the largest harbors.
There is another important reason for the observed variation in tanker
sizes and therefore in their basic costs. Some ships are used only for light oil
product movements; these are called “clean” tankers, because it is possible
without extensive cleaning to carry motor gasoline on one trip and heating
TABLE 20.5
Clean and Dirty Spot Rates on Major Tanker Routes for Various Sizes of Vessels
Vessel Type 2009 2010 2011
VLCC/ULCC % Change
(200,000 dwt+) Route Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009/2010 Jan Feb Mar Apr May Jun
Arabian 56 104 71 84 90 72 95 58 51 48 47 75 61 8.9 48 74 63 50 51 54
Gulf-Japan
Arabian 53 88 76 76 91 68 81 55 50 46 56 67 56 5.7 50 55 60 49 49 54
Gulf-Republic
of Korea
Oil and Gas Transportation
Arabian 34 70 – 57 66 52 58 42 42 40 34 42 57 6.8 34 37 – 38 38 43
Gulf-Europe
Arabian 35 65 52 56 58 53 63 48 39 35 30 44 36 2.9 32 37 42 38 37 39
Gulf-
Caribbean/
East Coast of
North America
Arabian 0 0 89 80 66 52
Gulf-South
Africa
Suannu (l00,000–160,000 dwt)
West 77 127 100 104 114 125 110 85 78 64 80 96 118 53.2 63 75 107 83 84 –
Africa-North-
West Europe
Weal 73 114 97 98 112 118 103 73 74 65 78 81 103 41.1 60 72 101 79 81 66
Africa-
Caribbean/
East Coast of
North America
Mediterranean- 63 127 103 115 110 129 102 96 84 72 97 101 113 36.1 71 82 130 86 80 74
Mediterranean
(Continued)
361
TABLE 20.5
362
Clean and Dirty Spot Rates on Major Tanker Routes for Various Sizes of Vessels (Continued)
Vessel Type 2009 2010 2011
VLCC/ULCC % Change
(200,000 dwt+) Route Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009/2010 Jan Feb Mar Apr May Jun
Aframax (70,000–100,0(X) dwt)
North-West 115 137 113 126 116 141 100 108 107 90 103 94 162 40.9 88 97 122 95 99 94
Europe-North-
West Europe
North-West 100 135 117 110 — 153 104 103 115 — — 85 120 20.0 131 90 135 85 90 84
Europe-
Caribbean/
East Coast of
North America
Caribbean- 112 173 146 127 123 167 131 137 115 99 98 127 146 30.4 125 98 125 123 104 98
Caribbean/
East Coast of
North America
Mediterranean- 117 124 95 135 114 160 110 108 107 87 112 92 138 17.9 75 97 122 95 99 94
Mediterranean
Mediterranean- 108 121 92 119 110 151 102 91 102 111 16.8 86 87 110 115 99 98
North-West
Europe
Indonesia-East 95 136 118 116 99 127 114 111 98 92 91 102 111 16.8 88 87 110 115 99 96
Asia
Handy Size (less than 50,000 dwt)
Mediterranean- 120 — 164 130 158 173 — 146 139 129 132 126 168 40.0 140 116 134 155 138 130
Mediterranean
Petroleum Economics and Engineering
Mediterranean- 111 171 183 139 145 161 145 138 131 119 118 121 146 31.5 134 111 147 139 133 116
Caribbean/
East Coast of
North America
Caribbean-East 116 176 181 151 146 163 129 142 138 112 117 119 200 72.4 155 105 174 155 139 126
Coast of North
America/Gulf
of Mexico
All Clean Tanker
70,000–80,000 Arabian 111 140 123 118 106 124 112 124 144 130 101 99 125 12.6 107 98 105 123 129 111
dwt Gulf-Japan
Oil and Gas Transportation
50,000–60,000 Arabian 121 151 139 124 126 143 123 128 161 141 110 120 126 5.8 119 111 122 142 145 124
dwt Gulf-Japan
35,000–60,000 Caribbean/East 99 149 139 159 137 119 127 169 135 129 135 133 158 59.6 133 120 190 191 171 152
dwt Coast of North
America/Gulf
of Mexico
25,000–35,000 Singapore-East 158 145 156 144 143 215 240 161 155 — 183 165 193 22.2 139 135 159 185 — 177
dwt Asia
Source: UN Conference for Trading and Development, UNCTAD, Review of Maritime Transport, Geneva, 2011. With permission.
363
364 Petroleum Economics and Engineering
oil or diesel fuel on the next. This gives such ships considerable flexibility to
react to market forces in particular areas, such as the shift in the U.S. market
from high motor gasoline demand in the summer to high heating oil demand
in the winter. By contrast, crude oil carriers are described as “dirty” ships
because of the extensive and expensive scrubbing of their tanks that would
be necessary if the vessel were to be cleaned up to carry light oil products.
The distinction between clean and dirty tankers is an important one. Not
only does it determine to a large extent the size of ships that can be economi-
cally used in particular markets; it also affects the ability of source-oriented
refineries to compete with consuming area refineries in the selling of light
products. If the latter can use dirty carriers in their cost buildup, and the
former are burdened with clean ship costs to move their products to market,
the differential freights can have a very important impact on profitability of
refinery operations.
Some oil producers, such as Kuwait, achieve some light product trans-
portation cost savings by shipping both crude and light products to such
major consuming countries as Japan in the same tanker. Since large ships are
divided into several compartments, partly for safety in the event of an acci-
dent, and partly to lend stability from sloshing in heavy waves, it is some-
times feasible to permanently commit some of the compartments to clean
products and thus to take advantage of the overall large tanker’s economics
of scale. This is not, however, normal shipping practice.
In addition to ocean-going tankers, there is a substantial waterborne traf-
fic in barges, particularly on the major rivers in industrial countries. Some
barges carry crude oil from ocean ports such as Rotterdam up the Rhine
River and New Orleans up the Mississippi to inland refineries, but most
of such traffic is involved with oil product movements to bulk terminals
upstream. Barges offer more flexibility than do pipelines and are less costly
where rivers are deep enough to handle them, though on a ton/kilometer
basis their generally smaller sizes make them less economical than oceango-
ing tankers. Some consideration has been given to building very large barges
for ocean traffic, but control problems in bad weather have presented enough
danger to discourage such a development.
Example 20.1
Matching Terminal Facilities to Liftings
Assume the following facts relative to the programming of ships through
basic terminal facilities for a 160,000-dwt maximum at the terminal:
With the above facts in mind, assume the following steps on arrival and
departure from the terminal. (In actual practice, this computation can
undoubtedly be performed with the aid of a computer, with which a
more precise program could be put together.) Also, assume these steps
with “times” in hours for each ship to be loaded.
Queue awaiting cargo Tankage → Lost production when tanks are full
↓ Production
Queue awaiting (one berth) 4.5 hr estimated
↓
Mooring 1.0 hr estimated
↓
Deballasting 3.5 hr estimated
↓
Minimum loading average 10.0 hr estimated
↓
Documenting, tests 1.5 hr estimated
↓
Unmooring 0.5 hr estimated
TABLE 20.6
Programming Tanker Distribution at Terminal
Date Time, hr Ship Size, dwt Liftings, Tons
Jan. 1 4.5
10.0 105,000 100,000
2.0
4.5
Jan. 2 3 hr 105,000 33,333
10.0
7 hr 70,000
2.0
4.5
10.0 65,000 63,333
Jan. 3 0.5 hr
2.0
1.5 hr
4.5
10.0 125,000 123,333
2.0
4.5
Jan. 4 1.5 hr 70,000 10,000
10.0
8.5 hr 56,667
2.0
4.5
Jan. 5 9.0 hr 85,000 76,667
10.0
1.0 hr 7,667
2.0
4.5
10.0 130,000 125,667
2.0
4.5
Jan. 6 10.0 90,000 88,333
2.0
4.5
Jan. 7 65,000 45,000
7.5 hr
10.0
2.5 hr 15,000
2.0
4.5
10.0 120,000 118,333
2.0
Oil and Gas Transportation 367
TABLE 20.6 (Continued)
Programming Tanker Distribution at Terminal
Date Time, hr Ship Size, dwt Liftings, Tons
Jan. 8
3.0 hr
4.5
1.5 hr
10.0 58,000 55,333
2.0
4.5
Jan. 9 130,000 78,000
6.0 hr
10.0
4.0 hr 50,000
2.0
4.5
10.0 85,000 81,333
2.0
Jan. 10 1.5 hr
4.5
3.0 hr
10.0 65,000 61,333
2.0
4.5 155,000 72,000
Jan. 11 4.5 hr
10.0
5.5 hr 80,000
2.0
4.5
10.0 55,000 53,333
Jan. 12 2.0
4.5
10.0 115,000 114,000
2.0
4.5
Jan. 13 3 hr 70,000 19,333
10.0
7 hr 46,667
2.0
4.5
10.0 90,000 87,000
(Continued)
368 Petroleum Economics and Engineering
TABLE 20.6 (Continued)
Programming Tanker Distribution at Terminal
Date Time, hr Ship Size, dwt Liftings, Tons
Jan. 14
0.5 hr
2.0
1.5 hr
10.0 120,000 118,333
2.0
4.5
Jan. 15 1.5 hr 100,000 15,000
10.0
8.5 hr 85,000
2.0
4.5
Jan. 16 9 hr 55,000 46,000
10.0
1 hr 5,333
2.0
4.5
10.0 130,000 128,000
2.0
Jan. 17 4.5
10.0 60,000 58,333
2.0
4.5
Jan. 18 7.5 hr 100,000 75,000
10.0
2.5 hr 25,000
2.0
4.5
10.0 110,000 108,333
2.0
Jan. 19 3.0 hr
4.5
1.5 hr
10.0 105,000 100,000
2.0
4.5 60,000 33,333
Jan. 20
6.0 hr
10.0
4.0 hr 22,000
Oil and Gas Transportation 369
TABLE 20.6 (Continued)
Programming Tanker Distribution at Terminal
Date Time, hr Ship Size, dwt Liftings, Tons
2.0
4.5
10.0 115,000 111,333
2.0
Jan. 21
1.5 hr
4.5
3.0 hr 80,000 76,000
10.0
2.0
4.5
Jan. 22 4.5 hr 130,000 57,333
10.0
5.5 hr 76,000
2.0
4.5
10.0 60,000 57,333
Jan. 23 2.0
4.5
10.0 80,000 76,000
2.0
4.5
Jan. 24 3.0 hr 100,000 57,333
10.0
7.0 hr 40,000
2.0
4.5
10.0 95,000 93,333
Jan. 25
0.5 hr
2.0
1.5 hr
4.5
10.0 110,000 105,333
2.0
4.5
Jan. 26 1.5 hr 100,000 28,000
10.0
8.5 hr 68,333
2.0
4.5
(Continued)
370 Petroleum Economics and Engineering
TABLE 20.6 (Continued)
Programming Tanker Distribution at Terminal
Date Time, hr Ship Size, dwt Liftings, Tons
Jan. 27 75,000 65,000
9.0 hr
10.0
1.0 hr 7,333
2.0
4.5
10.0 130,000 126,000
2.0
Jan. 28 4.5
10.0 80,000 76,300
2.0
4.5
Jan. 29 75,000 57,033
7.5 hr
10.0
2.5 hr 15,900
2.0
4.5
10.0 120,000 117,433
2.0
Jan. 30 3.0 hr
4.5
1.5 hr
10.0 70,000 67,250
2.0
4.5 115,000 66,083
Jan. 31 6.0 hr
10.0
4.0 hr 45,920
2.0
4.5
10.0 90,000 87,413
2.0
Feb. 1 1.5 hr
4.5
3.0 hr
Oil and Gas Transportation 371
TABLE 20.7
Programming Result for the Month of January
Total hours in a 31-day month 744
Total pre- and postloading time (30 × 6.5 hr) 195
Total loading time (30 × 10 hr) 300
Total waiting time (30 × 4 hr) 120
Total hours accounted for on 45 ships (16.5 hr × 45 ships) 732.5
372 Petroleum Economics and Engineering
TABLE 20.8
Breakdown by Size of Ships Loaded in January
Ship Size, dwt Number Loaded
40,000–50,000 0
50,000–60,000 3
60,000–75,000 10
75,000–100,000 10
100,000–150,000 21
150,000–200,000 1
where
and
Ton-days per year per tanker = running time per year for a tanker ×
Example 20.2
Assume a refinery required 20 million tons of crude oil a year. The
tanker used is 270,000 dwt with net weight of 234,375 tons and 320 days
running time per year. The travel time (round trip) from the source of
supply of crude to the refinery is 30 days. The number of 270,000-dwt
tankers needed per year can be found as follows:
Total no. of ton-days needed = 20, 000, 000 tons × 30 days
= 600,000,000 ton-days
Ton-days per year per each 270, 000 -dwt tanker = 320 days × 234, 375
tons
= 75, 000, 000 ton-days
= 8 tankers
20.4 Pipelines
20.4.1 General Review
Pipelines are the second most important form of oil and gas transportation.
Their uses are more complex than the uses of tankers, which by their nature
only move crude oil or products and gas from or to a rather limited number
of points on the oceans or navigable rivers. Pipelines, however, are used for
gathering systems in oil fields, for moving the crude oil thus collected to
refineries or marine terminals, and often for moving refined products from
refineries to local distribution points. They may also be used, like the old
Trans-Arabian Pipeline (Tapline), to avoid long ocean voyages, or as in the
374 Petroleum Economics and Engineering
Saudi lines to Yanbu on the Red Sea to avoid the possible strategic danger of
closing the Straits of Hormuz.
Pipelines often cross national borders, and this can pose strategic and politi-
cal problems. Saudi Arabia’s Tapline has been closed for many years on political
grounds, as have the Iraqi pipelines to Banias and Tripoli on the Mediterranean.
In Western Europe there has been a persistent fear that the large natural gas
pipelines from Russia may be used as a bargaining device in Russia-EU rela-
tions. For example, in 2009 Russian state-owned gas company Gaspron cut off
gas supplies to Ukraine, the supplying point to Europe, in an attempt to propose
a new pricing system that affected the supply to Europe. Transit fees, that is the
charges that are levied by countries through which a pipeline passes, may be
increased arbitrarily, thus altering the pipeline’s economics substantially. Such
factors as these must be taken very carefully into account when planning major
pipeline investments. The within and between-countries pipelines in the world
are shown in Figure 20.4. The United States presents 40 percent of the world’s
pipeline network, followed by Russia with 12 percent.
A word about natural gas pipelines may be appropriate here. In general,
because of its chemical and physical properties and its low energy content
per unit volume, natural gas can only be shipped by tanker or other surface
transportation at very high cost because of the need to compress it at very
high pressures or to cool it until it becomes a liquid as in liquefied natural
gas (LNG). This means that almost all natural gas moves by pipelines, which
generally confines such movements to contiguous land masses. (As in most
rules, there are exceptions. Natural gas is delivered to Southern Europe by
undersea pipelines from North Africa.) Within the industrialized nations
of North America and Western Europe, natural gas pipelines move much
larger quantities of energy than do oil pipelines. The main gas pipeline from
Russia to Western Europe is 2 m in diameter, by far the largest size of any
pipeline that has ever been built. Table 20.9 lists examples of recently con-
structed pipelines in different parts of the world.
FIGURE 20.4
World pipeline network.
Oil and Gas Transportation 375
TABLE 20.9
Example of Recent Pipelines in the World
Name Length Cost Completion Capacity Remarks
Oil (O) or Gas(G) Kms US$bn Est. Year
West to East G 4200 16.9 2004 18 bcm/y Tarim-Shanghai
Siberia-Pacific O 4200 18 Plan[i] 80 mtpy Taishet to
Nakhodha
Siberia-Korea G 4000 12 Plan 1.91 tcm Kovykta via
PRC
Sakhlain I O+G 220 12 2005 10 mbpd
Sakhalin II O+G 1670 10 2007 12 mtpy
Asian Gas Grid 5000 6 2008 ? Indonesia-China
G[ii]
Kazakhstan O 3000 9.5 2011 25 Mt/y to Xinjiang
TransSahara G 6000 7.5 Feas. 500 MMscfd Spain, WB
TransAsean G 4500 7 2020 ? Thailand,
Philippines
Iran-India G 2660 6 2010? 180 Mcm/d Via Kashmir
Yamal-Nenets G 4000 6 2004 1 tcmy Siberia, Belarus,
Poland,
Germany
Chad-Cameroon O 1070 4.2 2003 225 Kb/d
Tangguh BP, G — 5 2008 7 Mt/y Bintuni[iii] W.
Papua LNG
Blue Stream G 1220 3.4 2002 16 b.cu.m/ Russia, under
yr Black Sea/
Ankara
BTC O+G 1760 3 2005? 1 mbpd
PNG/Australia G 3600 3 Plan 600 mcm/y Highlands’
Katubu
Kazakhstan O Chev 1400 2.7 2001 600 Kb/d Black Sea
Bolivia-Brazil G 3150 2.1 1999 30 Mcum.d
Peru: Camisea G 715 2 2004 450 mcfd
TransAfghan G 1800 2 Plan l.2 md ADB, WB?
Ex-Unocal
Tsaidam G 950 1.9? 1999? — To Gansu
Xinjiang p 1.2 2006? 10 Mtpy To Lanzhou
Sudan O 1600 1.0? 1999 0.240 mbpd
Ecuador OCP O 503 1.5 2003 850 kbpd
Mozambique O 665 1.3 2004
Burma Yadana G 560 1.2 1998 525 mcfpd
WAGP G 1033 0.6 2006 200+ mcfpd
Iran/TurkeyG 2530 0.1 2001 1.5 Mcm/d
Tanzama O 1710 0.1 1995? 8 Mb/d Imports from
Dares-Salaam
Source: U.S. Department of Energy, International Energy Outlook, 2005, Oil & Gas Journal. With
permission.
376 Petroleum Economics and Engineering
Pipelines used for oil can be converted to natural gas, and vice versa, if the
basic economic or strategic considerations make it appropriate. Similarly, if
supply/demand conditions change, the direction of flow through pipelines
can be reversed simply by turning around the pumping stations along the
pipeline routes.
Unlike tankers, oil pipelines in the industrial world tend to be devoted
to oil product movements, particularly for the light ends of the oil barrel.
(Heavy fuel oil, in most climates, needs to be heated to flow efficiently, and
consequently is not put into oil product pipelines.) The light ends of the bar-
rel include motor gasoline, airline jet fuel, diesel fuel, home heating oil, and
such blending components as gas oil and naphtha. They move through the
pipes in batches, that is, blocs of a given volume, that are diverted into stor-
age at various delivery points along the line. Given the current sophistica-
tion of pipeline technology, mixing of the products during transportation
is minimal, so that even the tight product specifications that are required of
airline jet fuel and motor gasoline are not compromised in the delivery of
such products to their ultimate users.
Pipeline sizes (the inside diameter of the pipe) as well as the lengths
involved are determined by market economics. Depending on what products
are being delivered, and the market volumes demanded, pipelines vary in
size from less than 10 cm to about 2 m. Again for reasons of economies of
scale, pipeline systems tend to be overbuilt relative to current demand levels.
Saudi Arabia, for example, has export capability through its pipelines and the
ocean terminals with which they connect of some 15 million barrels per day
of crude oil, even through the country’s maximum historical production was
about 12 million barrels in early 1980s during the Iraq/Iran War.
Market demand growth can, of course, outstrip a pipeline’s basic ability
to handle the demanded volumes. The first way to solve this problem is to
increase the speed with which the oil passes along the line by adding pump-
ing stations. But since pipeline friction increases geometrically with the
speed of flow, at some point it becomes economical to add more pipes. This
process is called “looping,” and it consists of laying another pipeline along-
side the existing one. Doing so involves several economic advantages: ease of
access via existing roads, the ability to perform regular pipeline inspections
of all the pipelines simultaneously, added flexibility if one of the pipelines is
damaged, and the common use of pumping stations, to mention only a few.
In summary, pipelines serve a vital function in the transportation of both
oil and natural gas. How pipelines fit into the world energy system is primar-
ily a function of technical economics but also involves strategic and political
considerations that go beyond simple pipeline economies.
D2
D3
C1
C4 D4
C2
C3
Q1 Q3 Q2 Q4 = Q1 + Q3
Throughput MCF/D
FIGURE 20.5
Cost throughput curves for different diameter pipes (after Stephenson).
3000
2500
$ 1,000 per Mile
2000
1500
1000
500
0
8 10 12 14 16 18 20 22 24 26 28 30 32 34 36
Pipelines Size in Inches
FIGURE 20.6
Total average construction costs (2005). (From Oil & Gas Journal, Databook).
378 Petroleum Economics and Engineering
ranging from 8 to 36 in. These costs vary among diameter classifications and
are affected by geographic location, terrain, and pipe length. It has been noted
that the cost per mile for a given diameter is lower where the pipeline is longer.
The major cost components of pipeline construction are material, labor,
right-of-way (ROW) damages, and miscellaneous. In most cases, mate-
rial and labor account for more than 65% of construction cost as shown in
Figure 20.7. The investment distribution of constructing pipelines for both
crude and oil product are similar.
Table 20.10 lists the various cost items that make up the total capital invest-
ment for crude oil and oil products investment distribution pipelines as gath-
ered from U.S. major oil pipeline companies in 2005. Capital cost investment
totaled $2.62 billion for pipelines with 30 in. diameter while 12 in. pipelines
total investment is the lowest with 0.32 billion.
As to the pipeline operating costs, they seem to vary among different sizes,
uses, and locations. For example, total operating costs for the U.S. interstate nat-
ural gas pipelines were estimated by natural gas companies to be $3.41 billion in
1985. A major part of operating costs is the cost of pipeline power consumption.
Pipelines
Land and ROW,
4.90% Misc., 10.46%
Pipeline
construction,
33.95%
Pipelines
Linepipe and
fillings Pump station
21% and
equipment
29%
Pipeline
construction
38%
FIGURE 20.7
Oil pipeline investment distribution.
Oil and Gas Transportation 379
TABLE 20.10
Total Capital Investment in Liquid Pipelines, per Mile, 2000–2005
Size Year ROW Material Labor Misc. Total
8 in. 2004 239,860 84,651 599,280 591,276 1,515,065
2000 20,099 51,065 385.845 137,789 594,479
12 in. 2004 595,684 212,495 1,740,0003 691,419 320,361
2000 30,721 83,069 264,461 163,663 541,849
16 in. 2005 88,312 144,768 238,056 181,419 652,555
2000 132,500 121,675 442,903 259,815 988,143
20 in. 2005 28,799 191,553 385,889 187,486 793,927
2000 175,788 227,202 506,423 318,035 1,227,447
24 in. 2005 99,492 324,099 553,603 289,991 1,267,185
2000 119,147 238,555 461,141 327,696 1,146,538
30 in. 2005 108,418 580,031 1,296,165 639,103 2,623,718
2000 138,324 389,249 639,270 463,670 1,630,514
36 in. 2005 161,665 819,178 929,436 633,630 2,543,909
2000 195,848 454,764 779,527 442,122 1,874,260
Source: Oil & Gas Journal, Databook, 2006. With permission.
Figure 20.8 explains the relationship between relative fuel cost and pipe
diameter for different horsepowers where throughput and length of pipe are
given. It is noted that the power cost per extra unit of throughput decreases
as pipeline diameter increases.
Costs-per-mile figures may reveal more about cost trends of pipelines
than aggregate costs. For gas projects in the United States the average land
50,000 5
Through put 300,000 BPD
Length of Line 500 Miles
Fuel Cost–$1.00 Per MMBTU
B.H.P 4
40,000 Fuel Cost
(in millions & annualy)
Relative Fuel Cost
Brake Horse Power
30,000
20,000
1
10,000
24 26 28 30
FIGURE 20.8
Horsepower and fuel cost versus pipe diameter.
380 Petroleum Economics and Engineering
1. Those that run from the oil field to loading ports and are complemen-
tary to ocean transport. Without these, there would be no transport by
tankers at all, so they are not competitive with transport by tankers.
2. Those long-distance pipelines that naturally shorten the alternative
sea route. They can be competitive with ocean transport tankers if
tanker rates are high. But in times of low tanker rates, such pipe-
lines are not competitive with transport by tankers. A good example
of this type of pipeline is Tapline, the 1,100-mile pipeline from Ras
TABLE 20.11
Estimated Pipeline Construction per Mile (Onshore)
1995–1996 2000–2001 % Change
Land
Material $274,210 (31%) $279,565 (21%) 2%
Labor $422,610 (47%) $571,719 (44%) 35%
Miscellaneous $154,012 (17%) $344,273 (26%) 124%
ROW and damages $48,075 (5%) $120,607 (9%) 151%
Total $898,907 $1,316,164 38%
Offshore
Material $684,604 (42%) $413,995 (16%) –40%
Labor $527,619 (33%) $1,537,249 (60%) 191%
Miscellaneous $396,394 (25%) $510,271 (20%) 29%
ROW and damages $3,201 (0%) $116,898 (4%) 3552%
Total $1,611,818 $2,578,413 60%
Source: Oil & Gas Journal, Pipeline Economics Survey, various issues. With permission.
Oil and Gas Transportation 381
Oil Well
Refinery
Gathering Collecting
Oil center
Well Pipeline with gas
separator
Pu ouse
H
mp
Oil Well
Tank Farm
Pump
House
Trunk Line
Oil Well
Ho ump
e
us
P
FIGURE 20.9
Transport of oil by pipelines.
382 Petroleum Economics and Engineering
HA’IL
DHAHRAN
BURAYDAH ABQAIQ
1
2
3
4 AL
MEDINA 6 5 MUBARRAZ
8 7 KHURAIS
YANBU 9 Riyadh
11 10
AD DAWADIN
ZURB SALAMIYAH QATAR
RED SEA
Legend
MECCA
Pipeline route
JIDDAH Pump Station
FIGURE 20.10
East-West of Saudi Aramco.
Oil and Gas Transportation 383
TABLE 20.12
Crude Oil Pipeline Capacities
Diameter, in. Useful Range, Million Tons/Yeara Usual Pump Station Spacing, Miles
6 0.4–0.7 30–80
8 0.7–1.3
10 1.3–2.5 40–100
12 2.0–4.1
16 4.1–8.0
20 7.0–13.0
24 12.0–18.0 60–200
30 15.0–25.0
36 20.0–40.0
a Forty million tons or 300 million bbl.
As far as the crude oil pipeline capacities are concerned, each pipeline
must be considered an individual problem. Generally speaking, the eco-
nomic capacity of each of the various diameters of pipelines as well as
the usual spacing between pump stations (booster pumps) lies between
the limits given in Table 20.12.
When moving oil and oil products, such operating costs as the follow-
ing, based on a per-ton mile basis, will be important:
Finally, these large sizes of pipe are costly to ship because the space they
occupy relative to their weight is high, and therefore freight costs are
increased. To reduce freight costs, it has become the practice today to
design these large pipelines for equal quantities of two slightly different
sizes of pipe, so that they can be “nested” for shipment; for example, one
length of 20″ pipe is placed inside each length of 22″ pipe.
Unfortunately, there are no hard and fast rules or formulas to use; every
case is different. Costs of actual pumping equipment undoubtedly must be
considered, but the area in which the pipes will “run” is also important. For
instance, to obtain the same pumping effort in the desert as opposed to a
populated area could involve much higher costs in the form of providing out-
side services and even creating a small, self-contained township. In the flow
of oil in pipes, the fixed charges are the cost of the pipe, all fittings, and instal-
lation. All these fixed costs can be related to pipe size to give an approximate
mathematical expression for the sum of the fixed charges.
In the same way, direct costs, or variable costs, comprising mostly the costs
of power for pressure drop plus costs of minor items such as repairs and main-
tenance, can be related to pipe size. For a given flow, the power cost decreases
as the pipe size increases. Thus direct costs decrease with pipe size. And total
costs, which include fixed charges, reach a minimum at some optimum pipe
size. This factor can be expressed roughly in a series of simplified equations that
express relations in terms of weight rate of flow and fluid density, then weight
(or mass) rate of flow and annual cost per foot for most cases of turbulent flow.
To summarize, in choosing the inside diameter of pipe to be used, either
in the oil field or in a refinery, selection should generally be based on costs
of piping versus costs of pumping. Small-diameter pipe, which usually
involves quicker drops in pressure than large-diameter pipe and therefore
must be supplemented with more pumping equipment when laid for long
distances, costs less than large-diameter pipe, but cost of pumping can add
considerably to total cost of transferring a given amount of oil. Conversely,
large-diameter pipe will have a fixed capital charge, even though pumping
costs are minimized since natural pressure drops are less than with small-
diameter pipe. Thus, an economic balance is desirable.
Example 20.4
This is an example of the principle of economic balance as applied to
piping involving two alternatives. One alternative is the use of a large-
diameter pipe with a small pressure drop; the other alternative is a
small-diameter pipe with a greater pressure drop and more pumps.
Pumps and pump room installation are considered part of the invest-
ment in pipelines.
Assume that the requirement is to transfer 100,000 bbl/day of crude oil
for a distance of 200 miles by pipe. In order to arrive at the optimum con-
ditions where total annual costs will be minimized; the fixed costs, or
installation costs, and corresponding operating costs for the pipeline for
different diameters must be determined and the optimization technique
then applied. This is illustrated as follows:
Example 20.5
This example illustrates determination of the optimum pipe (Dopt) through
optimization of the total annual cost. Assume the following formulas:
Annual operating cost = F1 (1/Dpipe )
where F1 and F2 are some defined functions of the diameter D of the pipe.
The total annual costs for transferring oil will be equal to F1 1/Dpipe + F2 Dpipe .
Total Costs
Annual Cost, Dollars/(Year)
Annual Fixed
Charges
Annual Variable
Optimum Economic Cost for Pumping
Pipe Diameter
Pipe Diameter
FIGURE 20.11
Optimum pipe diameter.
386 Petroleum Economics and Engineering
and letting this product equal zero, solving for the value of D = Dopt.
To illustrate the principle of D = Dopt in a simplified manner, take F1
and F2 as linear functions of some constants:
F1 (1/d) = a/D + b and F2 (D) = cD + d
This gives
a/D2 = c
Hence,
Dopt = ( a/c)1/2
The exact equation for predicting Dopt for turbulent flow for incompress-
ible fluids inside steel pipes of constant diameter is given by the equation:
D opt = 2.2 W0.45/ℓ0.32
where D > 1″; W are thousands of pounds mass flowing per hour; and ℓ
is density, or lb-mass/ft3.
Then, to calculate Dopt, if we are considering the transfer of 500,000 bbl/
day of oil of an average API of 33° (with ℓ = 53.70 lb/ft3) across a distance
of 1,000 miles, we have:
= $ 900 million for the pipe plus $48 million for 6 stations
= $ 948 million
= $ 950 million approximately
perhaps U.S. 2 cents per gallon, or 85 cents per barrel. (Final delivery for
the last few hundred meters, however, is by tank truck into the aircraft
fuel tanks.)
Thousand Tonnes
500
Largest spills since the 1990s
Largest spills Year Tanker Spill (ts)
All other spills 1991 ABT Summer 260,000
400 1991 Haven 144,000
1991 Kirki 17,700
1992 Agean Sea 74,000
1992 Katina P 72,000
1993 Braer 85,000
300
1996 Sea Empress 72,000
1997 Nakhodka 14,000
1999 Erika 20,000
2002 Prestige 62,657
200 2003 Tasman Spirit 30,000
2004 Al Samidoon* 9,000
2005 DBL 152* 9,465
*Largest spills in 2004/05
100
0
1990 91 92 93 94 95 96 97 98 99 00 01 02 03 04 2005
FIGURE 20.12
Accidental oil spills from tankers.
390 Petroleum Economics and Engineering
ballast tanks that separate oil from water. The environmental impacts are
not restricted to marine settings but also occur on land when it comes to
pipeline transportation of oil and gas. Petroleum industry damages to the
environment occur at different stages from production to distribution includ-
ing processing and refining. The effects of the damage are social and eco-
nomic in terms of cleanup, prevention, and financial compensation in case
of social harms.
The oil industry has developed information and techniques for precau-
tions to avoid and manage the consequences of oil spills. As a precaution
measure in transporting oil and gas by tankers, the oil industry performs
a necessary ship vetting process. Such vetting arrangements will ensure
that the tanker is meeting the necessary requirements of safe berthing and
loading operation. However, in the event of an oil spill, a series of planned
actions will be implemented. These actions start from spill collection and
monitoring to cleanup of the sea and shoreline.
20.9 Summary
Moving oil from the wellhead, through the refining process, to the ultimate
user of oil products involves a complex blend of oceangoing tankers, river
barges, pipelines, and rail and road tank cars. Which form the mix takes in
any particular case is a function of both geography and economics, with occa-
sional political and strategic factors thrown in. Economics of scale are often
important in determining which set of transport modes will be used. And all
require a complex system of infrastructure: terminals, storage tanks, good
roads, and railroad tracks and rolling stock. They also need to be flexible to
accommodate both market growth and shifting relative product demand.
Above all, basic economics are the primary shaper of the way transport sys-
tems develop. This is applicable to natural gas transportation from the gath-
ering pipelines system to distribution through pipelines or LNG tankers.
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Appendix A: Conversion Factors
TABLE A.1
Alphabetical Conversion Tables
To Convert From Do This
399
400 Appendix A
TABLE A.2
Metric Tons to Barrels (Crude Oil)
Abu Dhabi 7.624 Albania 6.672
Algeria 7.661 Angola 7.206
Argentina 7.196 Australia 7.775
Austria 6.974 Bahrain 7.335
Bolivia 8.086 Brazil 7.315
Brunei 7.334 Bulgaria 7.300
Burma 7.464 Canada 7.428
Chile 7.802 China 7.300
Colombia 7.054 Congo 7.478
Cuba 6.652 Czechoslovakia 6.782
Denmark 7.650 Dubai 7.295
Ecuador 7.580 Egypt 7.240
France 7.287 Gabon 7.245
Germany, West 7.223 Hungary 7.630
India 7.441 Indonesia 7.348
Iran 7.370 Iraq 7.453
Japan 7.352 Italy 6.813
Libya 7.615 Kuwait 7.281
Mexico 7.104 Malaysia 7.709
Morocco 7.602 Mongolia 7.300
Neutral Zone 6.825 Netherlands 6.816
New Zealand 8.043 New Guinea 7.468
Norway 7.444 Nigeria 7.410
Pakistan 7.308 Oman 7.390
Poland 7.419 Peru 7.517
Romania 7.453 Qatar 7.573
Senegal 7.535 Saudi Arabia 7.338
Spain 7.287 Sharjah 7.650
Taiwan 7.419 Syria 6.940
Tunisia 7.709 Trinidad 6.989
United Arab Emirates 7.522 Turkey 7.161
United States 7.418 United Kingdom 7.279
Zaire 7.206 U.S.S.R. 7.350
Venezuela 7.005 Yugoslavia 7.407
404 Appendix A
TABLE A.3
Metric Tons to Barrels (Products)
Refined Products Other Products
Aviation gasoline 8.90 Grease 6.30
Motor gasoline 8.50 Paraffin oil, pure 7.14
White spirits 8.50 Paraffin wax 7.87
Kerosene 7.75 Petrolatum 7.87
Jet fuel 8.00 Asphalt and road oil 6.06
Distillate gas and diesel oil 7.46 Petroleum coke 5.50
Residual fuel oil 6.66 Bitumen 6.06
Lubricating oil 7.00 LPG 11.60
Miscellaneous products 7.00
TABLE A.4
Crude Oil Measurea
To
Gallons Gallons Tons/
From Tons Long Tons Barrels (Imperial) (U.S.) Year
Multiply by
Tons 1 0.984 7.33 256 308
(metric)
Long tons 1.016 1 7.45 261 313
Barrels 0.136 0.134 1 35 42
Gallons 0.00391 0.0383 0.0286 1 1.201
(Imperial)
Gallons 0.00325 0.00319 0.0238 0.833 1
(U.S.)
Barrels/day 49.8
a Based on average Arabian light (33.5 API gravity).
TABLE A.5
Refined Product Measures
Barrels Tons
to to Barrels/Day Tons/Year to
To Convert: Tons Barrels to Tons/Year Barrels/Day
Multiply by
Motor spirit 0.118 8.45 43.2 0.0232
Kerosene 0.128 7.80 46.8 0.0214
Gas oil/diesel 0.133 7.50 48.7 0.0205
Fuel oil 0.149 6.70 54.5 0.0184
Appendix A 405
TABLE A.6
Calorific Equivalent
One Million Tonnes of
Oil Approximately Equals
Heat Units
In Btu’s 40 × 1012
In therms 397 × 106
In teracalories 10,000
Solid Fuelsa
In tonnes of coal 1.5 × 106
In tonnes of lignite 3 × 106
Natural Gasb
In cubic meters 1.111 × 109
In cubic feet 39.2 × 109
a Calorific values of coal and lignite, as produced.
b 1 cubic foot = 1,000 Btu; 1 cubic meter = 9,000 Kcal.
TABLE A.7
Natural Gas/LNG/LPG
Natural Gas LNG LPG
(One billion cubic meters (One million tonnes (One million tonnes equals
equals approximately equals approximately approximately 11.8 × 106
35.3 × 109 cubic feet) 0.05 TCF [gas]) barrels of LPG)
0.89 × 106 tonnes of crude 1.23 × 106 tonnes of crude 1.1 × 106 tonnes of crude oil
oil oil
0.8 × 106 tonnes of LPG 1.1 × 106 tonnes of LPG 1.25 × 109 cubic meters (gas)
0.725 × 106 tonnes of LNG 1.4 × 109 cubic meters 0.91 × 106 tonnes of LNG
(gas)
1.35 × 106 tonnes of coal 1.9 × 106 tonnes of coal 1.7 × 106 tonnes of coal
36 × 1012 British Thermal 52 × 1012 Btu 47 × 1012 Btu
Units (Btu)
38 × 1015 joules (38 PJ) 55 PJ 50 PJ
Notes: Tonnes, metric tons; TCF, trillion cubic feet; Mtoe, million tonnes crude oil equiva-
lent; Mtpa, million tonnes per annum; 1 trillion, 1 million million (1012); 1 billion, 1
thousand million (109); mmscfd, million cubic feet per day; mmbtu, million British
Thermal Units; PJ, petajoules (1015 joules).
Appendix B: Compound Interest Factors
10.00% 10.00%
407
408 Appendix B
10.00% 10.00%
4%
To find F, To find P, To find A, To find A, To find F, To find P,
given P: (1 + i)n given F: given F: given P: given A: given A:
1 i i(1 + i)n (1 + i)n − 1 (1 + i)n − 1
(1 + i)n (1 + i)n − 1 (1 + i)n − 1 i i(1 + i)n
n ( f /p)10
n ( p /f )10
n (a /f )10
n (a /p)10
n ( f /a)10
n ( p /a)10
n n
1 1.100 0.9091 1.00000 1.10000 1.000 0.909 1
2 1.210 0.8264 0.47619 0.57619 2.100 1.736 2
3 1.331 0.7513 0.30211 0.40211 3.310 2.487 3
4 1.464 0.6830 0.21547 0.31547 4.641 3.170 4
5 1.611 0.6209 0.16380 0.26380 6.105 3.791 5
6 1.772 0.5645 0.12961 0.22961 7.716 4.355 6
7 1.949 0.5132 0.10541 0.20541 9.487 4.868 7
8 2.144 0.4665 0.08744 0.18744 11.436 5.335 8
9 2.358 0.4241 0.07364 0.17364 13.579 5.759 9
10 2.594 0.3855 0.06275 0.16275 15.937 6.144 10
11 2.853 0.3505 0.05396 0.15396 18.531 6.495 11
12 3.138 0.3186 0.04676 0.14676 21.384 6.814 12
13 3.452 0.2897 0.04078 0.14078 24.523 7.103 13
14 3.797 0.2633 0.03575 0.13575 27.975 7.367 14
15 4.177 0.2394 0.03147 0.13147 31.772 7.606 15
16 4.595 0.2176 0.02782 0.12782 35.950 7.824 16
17 5.054 0.1978 0.02466 0.12466 40.545 8.022 17
18 5.560 0.1799 0.02193 0.12193 45.599 8.201 18
19 6.116 0.1635 0.01955 0.11955 51.159 8.363 19
20 6.727 0.1486 0.01746 0.11746 57.275 8.514 20
21 7.400 0.1351 0.01562 0.11562 64.002 8.649 21
Appendix B
22 8.140 0.1228 0.01401 0.11401 71.403 8.772 22
23 8.954 0.1117 0.01257 0.11257 79.543 8.883 23
24 9.850 0.1015 0.01130 0.11130 88.497 8.985 24
25 10.835 0.0923 0.01017 0.11017 98.347 9.077 25
Appendix B
n ( f /p)12
n ( p /f )12
n (a /f )12
n (a /p)12
n ( f /a)12
n ( p /a)12
n n
1 1.120 0.8929 1.00000 1.12000 1.000 0.893 1
2 1.254 0.7972 0.47170 0.59170 2.120 1.690 2
3 1.405 0.7118 0.29635 0.41635 3.374 2.402 3
4 1.574 0.6355 0.20923 0.32923 4.779 3.037 4
5 1.762 0.5674 0.15741 0.27741 6.353 3.605 5
6 1.974 0.5066 0.12323 0.24323 8.115 4.111 6
7 2.211 0.4523 0.09912 0.21912 10.089 4.564 7
8 2.476 0.4039 0.08130 0.20130 12.300 4.968 8
9 2.773 0.3606 0.06768 0.18768 14.776 5.328 9
10 3.106 0.3220 0.05698 0.17698 17.549 5.650 10
11 3.479 0.2875 0.04842 0.16842 20.655 5.938 11
12 3.896 0.2567 0.04144 0.16144 24.133 6.194 12
13 4.363 0.2292 0.03568 0.15568 28.029 6.424 13
14 4.887 0.2046 0.03087 0.15087 32.393 6.628 14
15 5.474 0.1827 0.02682 0.14682 37.280 6.811 15
16 6.130 0.1631 0.02339 0.14339 42.753 6.974 16
17 6.866 0.1456 0.02046 0.14046 48.884 7.120 17
18 7.690 0.1300 0.01794 0.13794 55.750 7.250 18
19 8.613 0.1161 0.01576 0.13576 63.440 7.366 19
20 9.646 0.1037 0.01388 0.13388 72.052 7.469 20
21 10.804 0.0926 0.01224 0.13224 81.699 7.562 21
Appendix B
22 12.100 0.0826 0.01081 0.13081 92.503 7.645 22
23 13.552 0.0738 0.00956 0.12956 104.603 7.718 23
24 15.179 0.0659 0.00846 0.12846 118.155 7.784 24
25 17.000 0.0588 0.00750 0.12750 133.334 7.843 25
Appendix B
n ( f /p)15
n ( p /f )15
n (a /f )15
n (a /p)15
n ( f /a)15
n ( p /a)15
n n
1 1.150 0.8696 1.00000 1.15000 1.000 0.870 1
2 1.322 0.7561 0.46512 0.61512 2.150 1.626 2
3 1.521 0.6575 0.28798 0.43798 3.472 2.283 3
4 1.749 0.5718 0.20027 0.35027 4.993 2.855 4
5 2.011 0.4972 0.14832 0.29832 6.742 3.352 5
6 2.313 0.4323 0.11424 0.26424 8.754 3.784 6
7 2.660 0.3759 0.09036 0.24036 11.067 4.160 7
8 3.059 0.3269 0.07285 0.22285 13.727 4.487 8
9 3.518 0.2843 0.05957 0.20957 16.786 4.772 9
10 4.046 0.2472 0.04925 0.19925 20.304 5.019 10
11 4.652 0.2149 0.04107 0.19107 24.349 5.234 11
12 5.350 0.1869 0.03448 0.18448 29.002 5.421 12
13 6.153 0.1625 0.02911 0.17911 34.352 5.583 13
14 7.076 0.1413 0.02469 0.17469 40.505 5.724 14
15 8.137 0.1229 0.02102 0.17102 47.580 5.847 15
16 9.358 0.1069 0.01795 0.16795 55.717 5.954 16
17 10.761 0.0929 0.01537 0.16537 65.075 6.047 17
18 12.375 0.0808 0.01319 0.16319 75.836 6.128 18
19 14.232 0.0703 0.01134 0.16134 88.212 6.198 19
20 16.367 0.0611 0.00976 0.15976 102.444 6.259 20
21 18.821 0.0531 0.00842 0.15842 118.810 6.312 21
Appendix B
22 21.645 0.0462 0.00727 0.15727 137.631 6.359 22
23 24.891 0.0402 0.00628 0.15628 159.276 6.399 23
24 28.625 0.0349 0.00543 0.15543 184.168 6.434 24
25 32.919 0.0304 0.00470 0.15470 212.793 6.464 25
Appendix B
n ( f /p)20
n ( p /f )20
n (a /f )20
n (a /p)20
n ( f /a)20
n ( p /a)20
n n
1 1.200 0.8333 1.00000 1.20000 1.000 0.833 1
2 1.440 0.6944 0.45455 0.65455 2.200 1.528 2
3 1.728 0.5787 0.27473 0.47473 3.640 2.106 3
4 2.074 0.4823 0.18629 0.38629 5.368 2.598 4
5 2.488 0.4019 0.13438 0.33438 7.442 2.991 5
6 2.986 0.3349 0.10071 0.30071 9.930 3.326 6
7 3.583 0.2791 0.07742 0.27742 12.916 3.605 7
8 4.300 0.2326 0.06061 0.26061 16.499 3.837 8
9 5.100 0.1938 0.04808 0.24808 20.799 4.031 9
10 6.192 0.1615 0.03852 0.23852 25.959 4.192 10
11 7.430 0.1346 0.03110 0.23110 32.150 4.327 11
12 8.916 0.1122 0.02526 0.22526 39.581 4.439 12
13 10.699 0.0935 0.02062 0.22062 48.497 4.533 13
14 12.839 0.0779 0.01689 0.21689 59.196 4.611 14
15 15.407 0.0649 0.01388 0.21388 72.035 4.675 15
16 18.488 0.0541 0.01144 0.21144 87.442 4.730 16
17 22.186 0.0451 0.00944 0.20944 105.931 4.775 17
18 26.623 0.0376 0.00781 0.20781 128.117 4.812 18
19 31.948 0.0313 0.00646 0.20646 154.740 4.843 19
20 38.338 0.0261 0.00536 0.20536 186.688 4.870 20
Appendix B
21 46.005 0.0217 0.00444 0.20444 225.025 4.891 21
22 55.206 0.0181 0.00369 0.20369 271.031 4.909 22
23 66.247 0.0151 0.00307 0.20307 326.237 4.925 23
24 79.497 0.0126 0.00255 0.20255 392.484 4.937 24
Appendix B
Kuwait Qatar
Iraq
Venezuela 296.50 24.8% Iraq 143.10 12.0% Libya 47.10 3.9% Algeria 12.20 1.0%
Saudi Arabia 264.52 22.2% Kuwait 101.50 8.5% Nigeria 37.20 3.1% Angola 9.50 0.8%
Iron, I.R. 151.17 12.7% United Arab 97.80 8.2% Qatar 25.38 2.1% Ecuador 7.21 0.5%
Emirates
90 12
80
10
70
60 8
50 %
6
40
30 4
20
2
10
0 0
1960 1970 1980 1990 2000 2010
LPG
Naphtha
Crude Distillation Unit
Reforming
Units Gasoline
Treating Unit
Desulfurization
Unit Diesel
FCC
Vacuum
Distillation HCK
1000
800
600
400
200
0
1st year: 2nd year: 3rd year: 4th year:
F1=Po+Interest F2=F1+Interest F3=F2+Interest F4=F3+Interest
1600
1400
Compound Interest ($)
1200
1000
800
600
400
200
0
1st year: 2nd year: 3rd year: 4th year:
F1=P(1+i)1 F2=P(1+i)2 F3=P(1+i)3 F4=P(1+i)4
18000
Interest at the end of one year ($)
16000
14000
12000
10000
8000
6000
4000
2000
0
One year: On nominal 12% rate, One year: On nominal 15% rate,
compounded monthly compounded semiannually
300
5% annual interest rate, ($)
250
200
150
100
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28
Time in Years
1400
1200
Annual Depreciation $
1000
800
600
400
200
0
1 2 3 4 5
Years
Amount in Million $
80
60
40
20
0
Depreciation Depletion Net Income
Expenses Expenses
140
Percentage depletion
120 Cost per unit method
100
Amount Million $
80
60
40
20
0
Depreciation Depletion Net Income
Expenses Expenses
40
2010 2035
30
20
10
0
Ethane/ Naphtha Gasoline Jet/ Diesel/ Residual Other
LPG Kerosene Gas/Oil fuel** products**
15
10
–5
01 02 03 04 05 06 07 08 09 10 11
600
Fairplay Forecast
Oil Tanker Fleet, Million dwt, 1976–
500
400
300
200
100
0
1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
2011–01 A 200.000+dwt B 120–199.999 dwt C 60–119.999 dwt D 10–59.999 dwt E–9.999 dwt
The fully revised third edition is updated to reflect key advancements in petroleum technology and
expanded to include chapters on middle stream operations, known as surface petroleum operations
(SPO), and natural gas processing and fractionation. By looking globally at the hydrocarbon industry,
the improved text offers the reader a more complete picture of the petroleum sector, which includes
the global processes of exploration, production, refining, and transportation.
K14628