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Using Analytical Hierarchy Process to Determine Appropriate Minimum Attractive Rate of Return for Oil and Gas Projects in Indonesia

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By Lita Liana 

Jakarta, Indonesia
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Abstract

Under current project guideline, the regulator sets a 10% as single hurdle rate in determining oil and gas project economic for the Production Sharing Contract (PSC) contractor. A hurdle rate should represent project’s Minimum Attractive Rate of Return (MARR) which not only include money available for investment, source and cost of funds but also perceived risks related to the opportunities.

This paper is developed to find whether 10% is an appropriate rate to evaluate contractor’s project economic and seek what is the range of appropriate MARR to be used in different kinds of oil and gas projects in Indonesia.

In this paper the author demonstrates using Analytical Hierarchy Process (AHP) to determine range of project risks covers activity, project location and type of drilling to be included in the MARR.  The paper concludes that a range of 14% to 34% covers most conditions so that the rate of 10% MARR for all projects is too low.

Keywords: Cost of capital, CAPM, WACC, hurdle rate, MARR, AHP, project risk

1.    Introduction

1.1    Oil and Gas Reserves and Investment Opportunity in Indonesia

Statistically in 2011, Indonesia has total proven oil reserves of 7,732.27 Million Stock Tank Barrels (MMSTB) or 8% of Asia Pacific proven oil reserves and proven natural gas reserves of 152.89 Trillion Standardized Cubic Feet (TSCF) or 18% of Asia Pacific proven natural gas reserves. The capital investment to utilize those reserves also has been increased year by year.

Investment realization in 2012 is US$15,57 Billion compare with 2011 of US$14,02 Billion. The higher investment can be seen from the activities in exploration and development drilling. In 2012, there are 113 exploration wells and 809 development wells. SKK Migas (Oil and Gas Special Work Unit) as the Management of Production Sharing Contract (PSC) has approved 47 Plan of Development (PODs) from total proposed of 53 during 2012. Total cumulative production of those approved PODs is 956 Barrel Oil Equivalent (BOE) with total investment required to produce those reserves can achieved up to US$21.3 Billion. That information shows that oil and gas investment Indonesia has big contribution in the economic growth. As management of PSC, SKK Migas plays very important role in approving the oil and gas investment projects based on the proposal of PODs. 

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To read entire paper (click here)

Editor’s note: This paper was prepared as a result of a course delivered by Dr Paul Giammalvo of PT Mitratata Citragraha in Jakarta, Indonesia.  The paper was submitted to the Association for the Advancement of Cost Engineering International (AACEi) in partial fulfillment of the Certified Cost Professional (CCP) requirements. http://www.aacei.org/cert/whatCertOffers.shtml .


 About the Author

flag-indonesiapmwj19-feb2014-liana-AUTHOR PHOTOLita Liana

Jakarta, Indonesia

Lita Liana is an oil and gas professional has worked on many companies with multicultural environment namely Conocophillips Indonesia, Inpex Corporation and Pertamina (Persero). She is currently a commercial advisor at Shell Upstream in Indonesia. Lita has 12 years experiences in petroleum project economics, new business development appraisal, asset commercial and portfolio. She holds a bachelor degree in Business Administration and a master degree in Financial Management both from University of Indonesia (UI). She lives in Jakarta, Indonesia and can be contacted at [email protected].