Investment Appraisal Methods in Oil Companies
Original post by Michael Wolfe of Demand Media
Many oil companies, particularly larger oil companies, will find themselves presented with a number of investment opportunities. For example, a company may be asked whether it would like to put up money to help with exploration costs of a unexplored region, in exchange for any profits reaped from discovered reserves. When appraising these investment opportunities, the company will have to take into account a number of variables.
Perhaps the main factor that an oil company will need to take into account is the predicted reserves within a particular region. If there has been little exploration of a region and little geologic data exists, then this guess can be exceedingly speculative. Therefore, when appraising the investment, the company will need to weigh its appetite for risk against the likelihood that a particular area will produce a well.
In addition, when appraising an investment, a company should need to look at the current oil price. This is because the amount of money that a company will able to receive from the investment will be directly tied to how much money it can receive through the sale of the oil. As initial investments usually take several years to bear fruit, the company will also have to make projections of the oil price several years out.
Additionally, a company should look at other costs that it will face in developing the project. These include taxes and other fees that the government of the region will assign, as well as technological and logistical expenses. When oil is located in a region with poor transportation, a company wishing to bring the oil to market may also have to invest in transportation infrastructure, too, which can cut steeply into profits.
One of the best shortcuts for appraising an investment opportunity is to offer part of it to other investors on the open market. By bringing in other investors, a company not only saves itself from having to bear the total financial burden of a new exploration, but it can also have several other sets of eyes come and offer an appraisal of the project's worth, perhaps using information unavailable to them.
- "International Oil Company Financial Management in Nontechical Language"; James Bush and Daniel Johnston; 2003
About the Author
Michael Wolfe has been writing and editing since 2005, with a background including both business and creative writing. He has worked as a reporter for a community newspaper in New York City and a federal policy newsletter in Washington, D.C. Wolfe holds a B.A. in art history and is a resident of Brooklyn, N.Y.