FUNDAMENTALS OF

UPSTREAM PETROLEUM
INDUSTRY
BUSINESS AND TECHNICAL
PERSPECTIVES
FKK, UiTM

Course Objectives

To provide an overview of petroleum industry in

Malaysia
To provide an understanding of upstream
petroleum activities from technical and business
perspectives
To discuss key issues in upstream petroleum
business
To understand petroleum project evaluation
process

Contents
1.
2.
3.
4.

5.
6.
7.
8.
9.

10.

Introduction to petroleum industry

Influencing variables in Petroleum E&P
investment
Petroleum agreements
Political risk
Upstream operations
Petroleum Industry in Malaysia
Malaysian Product sharing contracts
Petroleum field development Plan
Economic Evaluation of E&P Project
Risk Analysis

Systems Context
Political System

Organizational System

Geological &
Geographical system

Economic System

Petroleum / Petrochemical
Industry

Enviromental System

Technological System

Key Players in Petroleum

Industry

Multinational Oil Companies (and Independents),

MNOC/IOC
National Oil Companies (NOC)
Service Companies
Other Supported Companies

Petroleum Company
Objectives

To maximizing and producing return of

investments by finding and producing oil and gas
reserves at the lowest cost possible and highest
possible margin.

Objectives of Petroleum Companies in

Upstream Investments

Replace and/or reserve

Maximize profit
Reduce finding and development cost
Increase production rate capability
Diversify reserve area

Upstream Petroleum Activities

Bidding/Acquisition
Exploration
Appraisal and Planning
Development
Production and (Transportation)
Abandonment

Key Questions Asked in

Petroleum E&D Investment

Where is the open acreage available for

exploration?
What is the best bidding strategy to win the
exploration rights? How much does it cost?
What are the fiscal and non-fiscal terms of the
agreement?
If the exploration is successful, will it be oil, gas
or both be discovered?
What quantities will be found?

Key Questions Asked in

Petroleum E&D Investment

Can the field be developed and brought to market

economically with the existing technology and the
fiscal terms attached to it?
If a new technology is required, will it work and
how much will it cost?
What is the existing infrastructure of the location?
What will be the future market for the oil and gas
found?

Key Questions Asked in

Petroleum E&D Investment

What is the impact of the environmental

regulations on the projects operation and bottom
line?
Is there any threat of political events that could
negatively impact the project throughout its life?
How should the project be financed?
Is the project in line with the companys goals,
objectives and strategies?

Influencing Factors in
Petroleum E&D Investment

Geological potential
Fiscal regimes
Political risk
Oil and gas price forecasts
Technological requirements
Existing infrastructure
Synergy with existing operations

Influencing Factors in
Petroleum Investment

Environmental considerations
Geographical locations
Potential exploration & development cost
The companys short term cash flow
Competitors
Alignments with companys goals, strategies and
objectives

Petroleum Agreements

Roles of Petroleum Agreements

Play a key role in enabling petroleum

companies to conduct E&D activities as
well as governments to profit from their
petroleum resources.
Allocate risks to relevant parties.
Provide incentive for efficient
management.
Introduce contracting risks which are
risks to non-performing by on or both
parties.

Types of Petroleum Agreements

1.
2.
3.

Concession system
Production sharing contract
Service contract (risk and
non-risk)

Concessionary System

The oil company receives the right in exchange

for its payment of all costs and specified taxes
To explore, produce and market petroleum.
The company pays a royalty and income tax.
Bonuses and minor taxes may be levied as well.
E.g : USA, UK, Norway

Contractual System

The government retains ownership of the

petroleum reserves.
Oil companies have the right to receive a share of
production or revenues from the sale of oil and
gas accordance with the production sharing
contract (PSC) or service contract.

Production Sharing Contract

Three basic elements of PSC are cost recovery, a

production split between the government and the
oil company, and income tax.
PSC is carried out with the government, usually
through national oil company (NOC).
Originate in Indonesia where it was first used in
agriculture.
E.g. Malaysia, Indonesia

Service Contract

Risk service contract (e.g. Brazil)

Shares the similar elements such as duration of
work obligation, but usually it pays the oil
company in cash, not crude oil.
Places all risk and investment to the contractor,
who provides capital for exploration and
production. If no discovery is made, the contract
ceases to exist.
If discovery is made the company places the well
on stream. Thereafter it may be operated by the
state or in some cases, by the contractor.
Capital is reimbursed with interest and a risk fee.

Service Contract

Non-Risk Service Contract.

A simple agreement where the contractor is paid a
flat fee for its services.
E.g. Saudi Arabia, Kuwait, Qatar

Ideal Objectives of a Host Government

in Designing the Contract

To ensure that the state maintains the major

share of revenues from highly profitable projects
during periods of high prices or from highly
productive new discoveries that can be developed
cheaply.
To provide incentives for company to explore and
develop small, high cost fields during period of
weak product prices.

Host Government Key

objectives

To maximize economic and non-economic benefits

from petroleum E&P activities.
To attract E&P investments MNOCs.

Elements Petroleum Company

needs in Petroleum Agreements

Profit in event of success

A secured early cash flow
A balance between risk and reward
Freedom to repatriate profits
Minimum risk
Clear fiscal terms for future developments
Flexible development options
Access to available data

Petroleum Agreement

Contractual terms
- terms deal with the non-fiscal aspect of the

agreement, for example, the length of the period

allowed for exploration, development and
exploration phases, and work obligations.

Fiscal terms

- deal with timing and distribution of revenue

generated by the project between the government
and the oil company.

Fiscal Terms

They are the terms that are stipulated in the

petroleum agreement contract between the oil
company and the host government that directly
influence the cash flow of the project.
Among them are royalty, the split of production
sharing, signature bonus, production bonus, state
participation and research contribution
requirements.

Political Risk

Political Risk

The probability that the goals of a project will be

affected by changes in the political environment. It
is the likelihood that political changes will prompt
a change in the investment climate regulating a
project

Political Risks Events

(Petroleum Specific)

Price increase
Income tax change
Production restriction
Export restriction
Remittance restriction
Foreign exchange control
Currency devaluation
Embargos and boycotts
Reinvestment requirements

Political Risks Events

(Petroleum Specific)

Domestic refining and shipping demand

Government to government sales policies
Ancillary demand
Ideological change

Upstream Operations

Three basic elements necessary

for a successful prospect

Rocks are capable of being a reservoir.

A structure or trap with a cap rock to form a seal ;
and
A source rock which has generated oil or gas to fill
trap.

Exploration

Exploration is the process of exploring for potential

petroleum reservoirs and the proving of the
reserves.
No reserve of petroleum can be accepted or
proven until penetrated by an exploration well and
fully sampled and tested.

Surveys for Exploration

Seismic surveys

- The most usual and informative ways of

defining structure in the subsurface and rely in
making shockwaves at the surface and
measuring the time taken for these waves to be
reflected back from the rock layers below.

Gravity and magnetic surveys

- are often run in conjunction with seismic

profiling using the difference in density between
the sedimentary sequence and the basement
below to assist with defining subsurface
structure.

Exploration

The information obtained by the surveys is

converted to depth maps which provide the
geoscientists with a three-dimensional
understanding of the prospectivity of the area, but
drilling a well is the only way to determine
whether oil and gas are present.

Appraisal Phase

Once an oil discovery has been made, a program

of drilling and testing will be pursued, designed to
establish the distribution and continuity of
productive zones within the general confines of
the reservoir structure, to estimate volume of

reserves and to predict reservoir performances.

The objective of the appraisal phase is too acquire

at minimum cost enough information to make an
informed decision on whether a field development
is economically justified.

Types of Information Required

to Make a Decision

The volume and nature of hydrocarbons on place

i.e. whether gas or oil.
The structure and physical characteristics of the
hydrocarbon reservoirs i.e. anticlinal or fault
bounded, porous sandstone or fractured
limestone, porosity and permeability etc.
The possible range of recovery factors which will
lead to an estimate of the recoverable reserves.
The likely producing rate of development wells.

Conceptual Development Proposals

During the appraisal stage, conceptual development

proposals are formulated in very broad terms, to be
refined later and cast formally into firm development
plans.
The conceptual development proposals are
concerned with questions such as the number and type
of platforms or whether to build a pipeline or load
offshore and the shape of the total proposed
production system.
Thorough evaluation of the proposals will eliminate a
large number as being technically unfeasible, others
may be rejected for non-technical reasons, so reducing
the possibilities to a small number to be examined in
more detail as development plans

Development Plans

When the plan have been examined from all point

of view, only few will remain.
These are the technically feasible plan which will
now have to stand up to economic evaluation. For
this purpose the elements of the plan must be
costed and the phasing of expenditure and income
determined.
Costs must be broken into capital and revenue
items and factors such as taxes and royalties
taken into account.

Development Plans

The plans must then be evaluated according to

some common yardstick for the purpose of
comparison such as Net Present Value and
Internal Rate of Return.
Once the economic evaluation have been
completed, it is possible to rank the plans in order
of economic merit. The final ranking, however
may not be the same because of non-quantifiable
factor which may be political or environmental, or
even technical risk, The ranking may well be
subjective and calls for sound judgment and
experience.

Development Phase

Development phase is when the project are found

to be economically viable to be development and
management agrees in principle to proceed.
It includes sufficient technical evaluation and
examination of alternatives to propose the
engineering design basis for further work.

Development Phase

Once a field is found to be economically viable to

develop, a detail Field Development Plan is
prepared. The development phase ies usually
divided intio following steps:

Engineering/Design Phase
Construction Phases
Offshore-Installation
Production Phase

Stage 1

Stage 2

Development Phase

Engineering/Design Phase
- The process of system design involves the
application of specialized knowledge of structures,
petroleum engineering, chemical engineering and
costs data which is project specific.

Development Phase

Construction Phase
- Steel Jackets
-Concrete Gravity Structures
- Decks and Modules
An offshore platform is equivalent to a drilling rig,
petrochemical processing plant and small town all
concentrated to an area the size of a football field.

Development Phase

Offshore Installation Phase

-The load out transportation, erection, hookup,
and commissioning are carried out.
- At the offshore site the equipments are set
according to developed procedures and
specifications. The hookup and commissioning is
done and all systems are checked and proven. A
safety inspections is carried out before any system
is started up.

Devlopment Drilling
The drilling and production phase cannot start
until the construction of the facility is completed.
If separate drilling platform are used the drilling
may commence as soon as construction is
completed.
Drilling rigs are expensive to operate and a typical
4000 meter offshore well in the North Sea may
cost 1015 million compared to
1-2 million for a typical onshore well.

Production Phase

Provides the revenue to turn the huge debts built

up prior to the start of production of oil and gas
into a profit.
The fluid flowing from a well is nearly always a
mixture; either oil with varying amounts of gas; or
oil, gas and water ; or gas and water vapor.
The well fluids first flows to one or more
separators that allow the components to separate.
The gas flows out of the top of the separator to be
flared or treated further for sale; the water flows
from the bottom and the oil passes to further
treatment and storage.

Abandonement

The end of a fields life is reached, not when the

oil or gas stops flowing, but when the revenue
received from produced hydrocarbon is not
sufficient to cover the operating costs.

Malaysian
Petroleum Industry

Historical Facts

Petroleum Development Act (PDA) in 1974

transfers the entire ownership in, and the
exclusive rights, powers, liberties and privilege of
exploring, exploiting whether onshore and
offshore Malaysia, to PETRONAS.
PETRONAS, Malaysias National oil company was
formed on 17th August, 1974.

National Petroleum Policy

To put good use the petroleum resources of the

country.
To enhance the favourable investment climate.
To take advantage of the option increasing
revenues by exporting oil and gas.
To ensure Malaysians are adequately represented
in the industry.
To effect an optimal social economic pace of
exploration of exhaustible petroleum resources
and environmental protection.

National Energy Policy

Emphasize the need to provide the nation with

adequate and secured energy supplies, towards
reducing the dependence on oil, and by
developing and alternative source of energy.

National Depletion Policy

To plan for optimal development of major oil fields

in order to prolong the production life of nations
oil resources.
To avoid excessive pre-investment

Exploration Successes

As 1.1.1998, a total 122 oil fields and 208 gas

fields have been discovered including 40 oil fields
having estimated recovery of less than 8MMSTB
Peninsular Malaysia (64 oil) and (95 gas)
Sarawak (39 oil) and (86 gas)
Sabah (19 oil) and (27 gas)
Mainly in < 200 meters water depth.

Exploration Successes

Success ratio one oil discovery for every 4.5

exploration wildcat wells drilled (1990-1997)
If gas discoveries included, the success ratio in
one in 2.6
Average finding cost is about USD 0.25/Bbl Oil
Equivalent (BOE). Relatively low exploration cost.

Reserve

As 1.1.1998 7.7 billion STB and 98.7 trillion SCF

of recoverable oil and gas, have been discovered
in Malaysia.
Malaysia Reserve (1998)
- 3.9 BSTB (oil), (67% from 35 fields)
- 87 TSCF (gas) (4.6 times larger relative oil in
energy terms)
Asia Pacific Reserve
- 42 BSTB (oil), 321 TSCF (gas)
World Oil Reserve
- 1020 BSTB (oil), 5,086 TSCF (gas)

Malaysia Petroleum Facts (2001)

Oil Reserve : 3.4 billion barrels

- World ranking : 27th
Gas reserve : 82.5 trillion cu. ft.
-World ranking : 12th
Average oil production : 600,000 bpd
Average gas production : 5.7 billion cu. ft. per
day
In the last 5 years, oil reserves have fallen about
15%.
According to PETRONAS, up to 45 exploration
wells are expected to be drilled offshore
Malaysia from April 2002 to march 2003 (largely
unchanged from previous year)

Downstream

Petrochemical related investments to date (2002),

RM 69.1 billion where about RM 39.7 billion
foreign investments.
Kerteh is the largest concentration of foreign
investment in Malaysia.
The Kerteh integrated petrochemical complex
covers more than 4000 ha and provides
employment to 5700 people.

Downstream

Kerteh facility has the capability to process 2

billion scf of gas per day, where 70% is used to
fuel power generation plant.
The gas is then transported through 1700km long
Peninsular gas utilization (PGU) pipeline to
Singapore, Lumut, Meru, Gurun and Kangar.
The PGU pipeline were built at the cost of RM3
billion.

Concession Agreement
(Malaysia)

Between petroleum companies and state

governments.
Petroleum companies had exclusive right to
explore and produce.
They paid royalty and taxes to government. Profit
estimated about 40% of gross revenue.
The concession ceased on April 1, 1975 as a result
of Petroleum Development Act.

Petroleum Development Act

(PDA), 1974

PETRONAS is the owner of all petroleum

resources in Malaysia.
PETRONAS has the right to explore and exploit
petroleum in Malaysia.
PETRONAS also controls the carrying on of
downstream activities.
The PDA would enable the government, through
PETRONAS to ensure the development of
petroleum industry inline with the nations
interests.

MALAYSIAN PRODUCTION
SHARING CONCEPT

PETRONAS has the exclusive rights to explore

and produce petroleum.
PETRONAS is responsible for management of the
petroleum operations and the petroleum
company is responsible to PETRONAS for these
operations as contractor.
The ownership of oil and gas shall vest in
Malaysian government or PETRONAS.
Contractors shall furnish the, necessary risk
capital and provide all technical assistance for
exploration and production of oil and gas. Such
expenditure is recoverable through cost recovery.

MALAYSIAN PRODUCTION
SHARING CONCEPT

The remaining production, after deducing cost

recovered and royalty, is shared between
PETRONAS and contractor.
The ownership of all project-related assets
acquired by the Contractor shall pass to
PETRONAS.
The laws of Malaysia shall apply to production
sharing contract.

Elements Controlled by
PETRONAS on PSC

Control of Development and Production Operations

Annual Work Program and Budget and Revisions
Tender and Contract procedures
PSC Account and Audit
Employment and training of Malaysians

Control of Development and

Production Operations

Field Development Plan

Notice of operation for drilling and workover
activities.
Oil production and gas flaring/venting levels
Surveillance of reservoir and well productions
performance.
PETRONAS safety and environmental inspections.

Objectives of Malaysian PSC

To encourage investment in the petroleum

industry
To ensure meaningful Malaysian participation in
the ownership, management and control in all
phases of the petroleum operations.
To secure additional petroleum reserve.
To encourage MNOC to invest in the petroleum
industry to support its continued growth.

Major PSC Provisions (1976)

Exploration Period
Development Period
Production Period
Production Sharing of Oil and Gas
Management of Operations
Consultation and Approval
Technology transfer

1976 PSC

Primarily to convert the then existing concession

between oil companies and state governments
into PSCs.
Concession system was converted to PSC a more
equitable partnership.
Exploration period 5 years
Development period 4 years
Production period 15 years

1976 PSC

Non-associated gas, PSC provides a HOLDING period of up

to 5 years after the discovery of a GAS field. Within this 5
year period, Contractor has to prepare and agree a
development plan with PETRONAS. Production period is 15
years.
Contractors pays all the expenditure required for petroleum
operations. The costs can be recovered from oil or gas
production.
Production sharing mechanism
- 10% as royalty to Government (State and Federal)
- Up to 20% is available to contractor to recover its costs
(costs oil) and 25% for gas.
- Remaining is split 70:30 between PERRONAS and
contractor.

1976 PSC

PETRONAS lifts and sells the royalty oil and its

profit oil.
Contractor lifts and sells its cost oil and profit oil.
For gas, contractor and PETRONAS sell their
shares of gas on a joint basis to a common outlet.

1976 PSC

Out of its profit oil or gas, contractor has to make the following
payments :
a. Petroleum income tax to Malaysian government 45% of
the taxable income.
b. Export duty to Malaysian Government 20% Profit Oil
portion exported,
c. Research Cess to PETRONAS 0.5 % cost oil plus profit oil
d. Export Duty to Malaysian Government 20% profit oil,
portions exported.
e. Discovery Bonus to PETRONAS RM2.5 million before first
production.
f. Production Bonus RM 5.0 million when production reached
50 Kb/d (or, each multiple).per quarter
g. Supplemental payment to PETRONAS 70% of incremental
Profit Oil revenue when Oil base price ( Which escalates 5%
per year from 1975 Base Price of USD 12.71/bbl)

Management of Operations

PETRONAS is responsible for the overall

management of the petroleum resources of
Malaysia.
Contractor is responsible for the necessary
exploration, development and production
activities, as an independent contractor to
PETRONAS.

Consultation and Approvals

In the course of implementing the PSC, numerous

meetings, discussions and communications take
place at the various levels between PETRONAS
and Contractor.
Each year Contractor is required to prepare a work
program and budget describing all aspects of the
proposed operations in the following year.

Transfer of Technology

Malaysian staff.
Provide development and training programs for its
Malaysian staff.
Training programs for PETRONAS staffs.

1985 PSC

To attract more E&D investments during early

1980s.
Offered better terms to contractors.
Specified minimum participations of Carigali.
Cost oil ceiling increase from 20% to 50%.
Cost gas ceiling increase from 25% to 60%
Sliding scale on profit split for both oil and gas.
- First 10,000 bbl/d 50:50, from 10,001 to 20,000 bbl/d

60:40, above 20,000 bbl/d 70:30 all in favor of PETRONAS.

1985 PSC

Profit oil split 70:30 beyond 50 million bbls

cumulative production.
Profit gas split 50:50 up to 2 trillion cu. ft. of gas
production. Beyond this the split is 70:30 in favor
of PETRONAS.
Carigali to have minimum of 15% carried interest,
with participation option on commercial
discoveries.
PSC BASE price USD 25/bbl in 1988.
Export duty is 25% of profit oil barrels.

1985 PSC

28 PSCs signed.
Minimum investment commitment of USD 368
million
125 exploratory wells.

Deepwater PSCs

Introduced in 1993
Based on 1985 PSC
Improvement on cost recovery, profit split and the
exploration, development and production periods
to reflect the higher costs, higher risks and
technology required in the deepwater operations.

Deepwater PSCs

Lead time
- Exploration Period 7 years
- Development Period 6 years
- Production Period 25 years
Cost oil ceiling 75%
Cost gas ceiling 60%

Deepwater PSCs

Two type of deepwater contracts :

- 200 to 1000 meter water depths.
- more than 1000 meter water depths
As Oct. 1999, 5 blocks taken by Esso, Shell (3),
and Murphy
Additional players, Conoco and Amerada Hess
(Block F, offshore Sarawak).

Revenue Over Cost PSCs

Introduced in 1997.
Profitability based fiscal regime.
To further stimulate exploration activities.
To provide incentives to develop smaller
discoveries.
To promote use of cost effective new technology
in E&D.
To balance the softening oil price and increasing
operating costs.

Revenue Over Cost PSCs

Built in self adjustment mechanism for the

changing price and costs environments.
Allows contractors to have a larger share of
revenue of a project.
Gives contractor a quicker cashflow at the
beginning of the period and increase the economic
feasibility of developing marginal/small fields of
30-50 million barrels of reserve.

Key items in PSC fiscal terms

Royalty
Cost Recovery
Profit Oil and Gas
Export Duty
Payment for PETRONAS