SPE Project Economics 2 — Questions and Answers
Question 1: A project has an NPV of $0 at a discount rate of 18%. What does this indicate?
- The project generates no cash flows
- 18% is the project's internal rate of return (Correct answer)
- The project should be rejected
- The discount rate is too high for evaluation
Correct answer: 18% is the project's internal rate of return
When NPV equals zero, the discount rate used equals the IRR of the project.
Question 2: Which of the following best describes a 'sunk cost' in petroleum project economics?
- Future capital expenditure already budgeted
- Costs already incurred that cannot be recovered (Correct answer)
- Variable operating costs tied to production rate
- Royalty payments owed to the government
Correct answer: Costs already incurred that cannot be recovered
Sunk costs are past expenditures that are irrelevant to future economic decisions.
Question 3: A well produces 500 BOPD with a lifting cost of $12/bbl and an oil price of $70/bbl. What is the daily net operating income?
- $35,000
- $29,000 (Correct answer)
- $6,000
- $41,000
Correct answer: $29,000
Net operating income = (70 - 12) × 500 = $58 × 500 = $29,000/day.
Question 4: What is the primary purpose of a sensitivity analysis in project economics?
- To calculate the exact project IRR
- To determine the optimal royalty rate
- To identify which input variables most affect project value (Correct answer)
- To compute decline curve parameters
Correct answer: To identify which input variables most affect project value
Sensitivity analysis measures how changes in individual input variables impact the economic outcome of a project.
Question 5: Under a production sharing contract (PSC), 'cost oil' refers to:
- Oil revenue paid as income tax
- The share of production used to recover capital and operating costs (Correct answer)
- Royalty oil allocated to the host government
- The cost of transporting oil to market
Correct answer: The share of production used to recover capital and operating costs
Cost oil is the portion of production revenue allocated to the contractor to recover allowable expenditures before profit oil is split.
Question 6: Which discount rate is most appropriate when evaluating a petroleum project where the company's cost of financing is well-defined?
- Risk-free rate (e.g., treasury bond rate)
- Weighted average cost of capital (WACC) (Correct answer)
- Inflation-adjusted prime rate
- Commodity price escalation rate
Correct answer: Weighted average cost of capital (WACC)
WACC reflects the blended cost of equity and debt financing and is the standard hurdle rate for project evaluation.
Question 7: A project's profitability index (PI) is calculated as 1.35. This means:
- The project has a 35% IRR
- For every $1 invested, the project returns $1.35 in present value (Correct answer)
- The payback period is 1.35 years
- The project NPV is negative
Correct answer: For every $1 invested, the project returns $1.35 in present value
PI = PV of future cash flows / Initial investment; a PI of 1.35 means each dollar invested generates $1.35 in present value.
SPE Project Economics 2
A project has an NPV of $0 at a discount rate of 18%.
What does this indicate?