Economic evaluations project evaluation

We have already described and analyzed all the financial mathematical tools needed for our calculations to fulfill the purpose of the chapter. Using these basic tools, we now introduce two concepts that are important for comparison and decision among alternatives (real-life situations and engineering projects). First, the net present value is one of the most common tools to economically evaluate projects. One of the limitations of NPV is when you are comparing two or more projects with different lifespans. Although this difficulty can be remedied, it could be cumbersome. Second, the annual equivalent benefits/costs has the advantage over NPV that you can compare projects with different lifespans. 

The project cashflow forms the basis of the economic evaluation methods which will be described. From the cashflow a number of economic indicators can be derived and used to judge the attractiveness of the project. Some of the techniques to be introduced allow the economic performance of proposed projects to be tested against investment criteria and also to be compared with alternative investments. 

So far, the economics of developing discovered fields has been discussed, and the sensitivity analysis introduced was concerned with variations in parameters such as reserves, capex, opex, oil price, and project timing. In these cases the risk of there being no hydrocarbon reserves was not mentioned, since it was assumed that a discovery had been made, and that there was at least some minimum amount of recoverable reserves (called proven reserves). This section will briefly consider how exploration prospects are economically evaluated. 

Mark Cook is a Reservoir Engineer and Petroleum Economist. He has worked on international assignments mainly in Tanzania, Oman, the Netherlands and the UK. His main focus is in economic evaluation of field development projects, risk analysis, reservoir management and simulation. After 11 years with a multinational company he co-founded TRACS International of which he is Technical Director. 

Evaluation. The evaluation of each idea should iaclude a technical description as well as its economic impact and technical risk. Ideas should be ranked for implementation. A report should provide a five-year framework for energy projects. 

General References Allen, D. H., Economic Evaluation of Projects, 3d... 

One of the most important activities within a company is project screening. One losing venture can negate the gain of several winners. Therefore, the project evaluators must be careful to obtain the best and most complete information possible so that the economics will accurately model the iiiture real world situation. Possible... 

The goal of all economic evaluations should be to eliminate all unprofitable projects. Some borderline, and perhaps a few good projects, will be killed along with the bad ones. However, it is much better to pass up several good projects than to build one loser. 

Every company should develop a standard form for their economic calculations, with a place for everything and everything in its place. As management becomes familiar with the form, it is easier to evaluate projects and choose among several based on their merits, rather than the presentation. 

In considering the economics of process alternatives, it is important to think about the total life cycle costs. There is an increasing interest in this concept in the environmental area, with a recognition of the need to incorporate waste treatment, waste disposal, regulatory compliance, potential liability for environmental damage, and other long term environmental costs into project economic evaluation. Similarly, we must consider life cycle safety costs. Some examples of factors which should be considered include ... 

A systematic approach for economic evaluation of projects includes the following major steps ... 

An overall economic evaluation must be made to ensure that the contemplated project for petroleum development will recover sufficient capital to pay for the total cost of development, installation and assembly effort of the company. Further, the capital return must yield a financial return consistent with the overall company risk involved. Thus, it is very important that the petroleum engineer designing a recovery system understand the company s evaluation criteria that will be used by management in judging whether a new project is to go forward. Chapter 7 (Petroleum Economics) has detailed discussions of general engineering economics and product (or project) evaluation criteria. 

Allen, D.H. (1990) A Guide to the Economic Evaluation of Projects, 3rd edn. The Institutions Chemical Engineers, Rugby. 

Once values have been assigned for the costs and benefits of each proposed risk-reduction modification, a variety of economic evaluation techniques may be used to choose the most attractive option. These techniques include net present value, discounted cash flow rate of return and cost-benefit ratio analyses. Most companies have a preferred method for evaluating project economics, which can be used with little or no modification. Chapter 8 of... 

As was stated in Section 1.2.1, the project design should start with a clear specification defining the product, capacity, raw materials, process and site location. If the project is based on an established process and product, a full specification can be drawn up at the start of the project. For a new product, the specification will be developed from an economic evaluation of possible processes, based on laboratory research, pilot plant tests and product market research. 

For small projects, and for simple choices between alternative processing schemes and equipment, the decisions can usually be made by comparing the capital and operating costs. More sophisticated evaluation techniques and economic criteria are needed when decisions have to be made between large, complex projects, particularly when the projects differ widely in scope, time scale and type of product. Some of the more commonly used techniques of economic evaluation and the criteria used to judge economic performance are outlined in this section. For a full discussion of the subject one of the many specialist texts that have been published should be consulted Brennan (1998), Chauvel et al. (2003) and Vale-Riestra (1983). The booklet published by the Institution of Chemical Engineers, Allen (1991), is particularly recommended to students. 

Most proprietary spreadsheets have procedures for calculating the cumulative NPW from a listing of the yearly net annual revenue (profit). Spreadsheets are useful tools for economic analysis and project evaluation. 

There is no one best criterion on which to judge an investment opportunity. A company will develop its own methods of economic evaluation, using the techniques discussed in this section, and will have a target figure of what to expect for the criterion used, based on their experience with previous successful, and unsuccessful, projects. 

As well as economic performance, many other factors have to be considered when evaluating projects such as those listed below ... 

Ulrich, G. D. (1984) A Guide to Chemical Engineering Process Design and Economics (Wiley). Valle-Riestra, J. F. (1983) Project Evaluation in the Chemical Process Industries (McGraw-Hill). 

Overall, there are always considerable uncertainties associated with an economic evaluation. In addition to the errors associated with the estimation of capital and operating costs, the project life or interest rates are not known with any certainty. The important thing is that different projects, and options within projects, are compared on the basis of consistent assumptions. Thus, even though the evaluation will be uncertain in an absolute sense, it will still be meaningful in a relative sense for choosing between options. 

One advantage of the three estimates is that it allows an economic evaluation to be made for each. This will then show the effect the capital investment has on the project. 

These and other such items are generally ignored when an engineer runs an economic evaluation to determine the merits of a given project. 

In the first case, the minimum values for the economic yardsticks were evaluated assuming that a conservative 7300 bbl (= 8150 bbl -850 bbl 1160 m3 = 1295 m3 - 135 m3) of incremental oil had been produced by the end of the project. Maximum values for the economic data were calculated by assuming that 9000 bbl (= 8150 bbl + 850 bbl 1430 m3 = 1295 m3 + 135 m3) of incremental oil were produced by only 61.6 % of the TFSA which had been injected into Well TU-120 this assumption is based on the results of the tracer study which showed that as much as 38.4 % of the injected fluids flowed out of the pilot pattern. In the final case, the most probable values for the economic yardsticks were calculated assuming the 8150 bbl (1295 m3> of incremental oil were produced by 90 % of the TFSA. 

Palarski J. and Lutynski M. Capacity of an abandoned coal mibe converted into high pressure C02 reserovir. Economic evaluation and risk analysis of mineral projects, London, UK. 2008 Taylor Francis. 

This disjunctive between costs and benefits resulting from the regulation of the pharmaceutical approval process can be dealt with by means of economic evaluation. The various projects can be represented using a decision tree as shown in simplified form in Figure 8.1. 

So far we have explained how to estimate capital and operating costs. In Example 3.3, we formulated an objective function for economic evaluation and discovered that although the revenues and operating costs occur in the future, most capital costs are incurred at the beginning of a project. How can these two classes of costs be evaluated fairly The economic analysis of projects that incur income and expense over time should include the concept of the time value of money. This concept means that a unit of money (dollar, yen, euro, etc.) on hand now is worth more than the same unit of money in the future. Why Because 1000 invested today can earn additional dollars in other words, the value of 1000 received in the future will be less than the present value of 1000. 

In Chapter 3 we discussed the formulation of objective functions without going into much detail about how the terms in an objective function are obtained in practice. The purpose of this appendix is to provide some brief information that can be used to obtain the coefficients in objective functions in economic optimization problems. Various methods and sources of information are outlined that help establish values for the revenues and costs involved in practical problems in design and operations. After we describe ways of estimating capital costs, operating costs, and revenues, we look at the matter of project evaluation and discuss the many contributions that make up the net income from a project, including interest, depreciation, and taxes. Cash flow is distinguished from income. Finally, some examples illustrate the application of the basic principles. 

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