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Modelling the economic implications of offshore oil : the case of Hibernia Plourde, André 1985

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MODELLING THE ECONOMIC IMPLICATIONS OF OFFSHORE OIL: THE CASE OF HIBERNIA  by ANDRE ROGER PLOURDE B.A., U n i v e r s i t y M.A.,  o f New Brunswick,  1978  U n i v e r s i t y o f New Brunswick, 1979  A THESIS SUBMITTED  IN PARTIAL FULFILLMENT OF  THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY  in THE FACULTY OF GRADUATE STUDIES Department  We accept t h i s  o f Economics  t h e s i s as conforming  to the r e q u i r e d  standard  THE UNIVERSITY OF BRITISH COLUMBIA April  1985  (S) Andre P l o u r d e , 1985  In p r e s e n t i n g  t h i s t h e s i s i n p a r t i a l f u l f i l m e n t of  requirements f o r an advanced degree a t the  the  University  o f B r i t i s h Columbia, I agree t h a t the L i b r a r y s h a l l make it  f r e e l y a v a i l a b l e f o r reference  and  study.  I  further  agree t h a t p e r m i s s i o n f o r e x t e n s i v e copying of t h i s t h e s i s f o r s c h o l a r l y purposes may department o r by h i s o r her  be granted by the head o f representatives.  my  It i s  understood t h a t copying or p u b l i c a t i o n o f t h i s t h e s i s f o r f i n a n c i a l gain  s h a l l not be  allowed without my  permission.  Department O f  Economics  The U n i v e r s i t y o f B r i t i s h Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 Date  DE-6  (3/81)  May 3, 1985  written  ABSTRACT  The  development and  deposits  production  r a i s e s three key  are questions  relating  d e c i s i o n s , and  the  Other i s s u e s concern the c o n s t r u c t i o n and  impact of r o y a l t i e s  l e v e l and  impacts on  production  d i s t r i b u t i o n of powers and  First  producer  taxation. both  the  set of i s s u e s r e l a t e s to  revenues between f e d e r a l  the  and  l i n k s between p r o v i n c i a l r e s o u r c e  e q u a l i z a t i o n payments.  T h i s t h e s i s develops a n u m e r i c a l l y to examine these i s s u e s . At between development plans exploited  taxes on  e f f i c i e n c y of resource  phases. A t h i r d resource  and  the o v e r a l l economy d u r i n g  p r o v i n c i a l governments, i n c l u d i n g the revenues and  petroleum  s e t s of i s s u e s of i n t e r e s t to economists.  to the  hence on  of Canadian o f f s h o r e  i n simulating  t r a c t a b l e economic model designed  the model's core  and  production  i s a one-to-one r e l a t i o n s h i p  p r o f i l e s . This property  is  the behaviour of a p r i c e - t a k i n g ,  n e t - p r e s e n t - v a l u e - m a x i m i z i n g producer under c o n d i t i o n s of c e r t a i n t y . The model i s l i n k e d with  a macroeconometric model of the  Canadian  economy to study the p o t e n t i a l consequences of H i b e r n i a , a petroleum deposit  l o c a t e d i n the E a s t e r n  Canadian o f f s h o r e r e g i o n . T h i s d e p o s i t  chosen f o r a n a l y s i s because i t s s i z e ,  l o c a t i o n and  low  c u r r e n t world o i l p r i c e s ) combine to r a i s e a l l of the  costs  result present  i n the d i s s i p a t i o n of l e s s than f i v e percent value  to s o c i e t y . Although cases are  (relative  issues l i s t e d  In most cases s t u d i e d , producer responses to government  to  above.  policies  of the d e p o s i t ' s  identified  was  where these  net  responses have more s e r i o u s p o t e n t i a l net  benefits  forms of r o y a l t y and  consequences, the  never exceeds 15 p e r c e n t . The  tax r e l i e f  to the  d i s t o r t i o n a r y e f f e c t s of government The  o t h e r i n d u s t r i e s are  shown to be  relatively  prevalent  construction  period.  The accruing the  r e s u l t s suggest that  the  induces small net  but  sympathetic  small,  and  net  p r o v i n c i a l treasury  equalization  systems m o d e l l e d .  i t s Hibernia  on  to be more  benefits under three  r e v e n u e - s h a r i n g systems modelled. However, Newfoundland and  would l o s e a s u b s t a n t i a l p o r t i o n of  the  crowding-out e f f e c t s  l a r g e r share of the  to governments flows to the  reduces  specific  policies.  changes i n most macroeconomic v a r i a b l e s . The  the  e x t e n s i o n of  producer g e n e r a l l y  s i m u l a t e d e x p l o i t a t i o n of H i b e r n i a  during  r e s u l t i n g d i s s i p a t i o n of  of  Labrador  revenues under a l l of  the  iv  TABLE OF CONTENTS  ABSTRACT  i i  TABLE OF CONTENTS  iv  LIST OF TABLES  vii  LIST OF FIGURES  ix  ACKNOWLEDGEMENT  x  CHAPTER 1  INTRODUCTION  1  CHAPTER 2  THE PRODUCTION AND TAXATION OF OFFSHORE PETROLEUM RESOURCES  5  2.1  Introduction  5  2.2  The Taxation of Extractive Resources  6  2.3  Applied Reservoir Economics: A P a r t i a l Review  11  2.3.1  Petroleum as an Exhaustible Resource  11  2.3.2  The Basic Static Model  14  2.3.3  The MIT Model  17  2.3.4  The Platform Location Model  19  2.3.5  The Odell-Rosing Model  2.3.6  The Lowenstein Model  2.4 CHAPTER 3  Concluding  Remarks  . 23 27 30  THE OFFSHORE DEVEL0PEMENT MODEL: OUTLINE AND APPLICATION.. 36  3.1  Introduction  3.2  A Model of the Development and Production of Offshore  36  O i l Deposits  37  3.2.1  Overview of the Model  37  3.2.2  Model Description  39  3.2.3  On Some Properties of the Model  59  V  CHAPTER 3 3.3  (continued) Applying  3.3.1  The H i b e r n i a D i s c o v e r y  3.3.2  A D i s c u s s i o n o f the P r i n c i p a l Estimates  3.3.4  Regulation  3.3.4  Studies  3.4  64  the Model to the Case of H i b e r n i a  and T a x a t i o n  64 and Assumptions. 67 73  Policies  76  of the Economics o f H i b e r n i a  I n c o r p o r a t i n g an Energy-Producing P r o j e c t i n t o MACE  79  GOVERNMENT POLICIES AND THE DECISION TO DEVELOP  88  4.1  Introduction  88  4.2  The Framework o f A n a l y s i s  89  CHAPTER 4  4.2.1  Assumptions R e l a t i n g to MACE  4.2.2  Assumptions R e l a t i n g to the O f f s h o r e  89 Development Model.. 92  4.3  Development  4.4  Development under A l t e r n a t i v e P o l i c y Regimes  i n the Absence o f Government P o l i c i e s  95 98  4.4.1  Introduction  98  4.4.2  Optimal Development Plans  99  4.5  Summary  105  SENSITIVITY ANALYSIS  119  5.1  Introduction  119  5.2  Changes  120  5.3  Adverse Shocks  5.4  Conclusion  CHAPTER 5  CHAPTER 6  i n the Base Case Assumption  ...126 130  THE INCIDENCE AND DISTRIBUTION OF ECONOMIC RENTS FROM HIBERNIA  140  6.1  Introduction  140  6.2  Base Case Assumptions and Adverse Changes  141  6.3  Conclusion  151  CHAPTER 7  MACROECONOMIC CONSEQUENCES  162  7.1  Introduction  162  7.2  H i b e r n i a and the N a t i o n a l Economy  163  7.3  Resource  173  7.4  Conclusion  CHAPTER 8  Discoveries  HIBERNIA,  and the  'Dutch D i s e a s e '  178 FISCAL EQUALIZATION AND ENERGY RENTS IN CANADA..186  8.1  Introduction  8.2  Alternative  8.3  E q u a l i z a t i o n and the  8.4  H i b e r n i a and the D i s t r i b u t i o n of O i l and Gas Rents in  8.5 CHAPTER 9  186 Approaches  to F i s c a l E q u a l i z a t i o n  Revenues from H i b e r n i a  Canada  187 192  198  Conclusion  203  CONCLUSIONS AND DIRECTIONS  FOR FUTURE RESEARCH  BIBLIOGRAPHY  214 224  APPENDIX 1  ALGEBRAIC REPRESENTATION OF CERTAIN DETERMINISTIC MODELS..233  APPENDIX 2  A STUDY OF THE RESERVOIR PRODUCTION SIMULATION PROCESS  APPENDIX 3  GOVERNMENT POLICIES,  241  PRODUCTION RIGHTS AND REVENUE  SHARING  249  A3.1  Introduction  249  A3.2  J u r i s d i c t i o n a l Rights  A3.3  T a x a t i o n and P a r t i c i p a t i o n  253  A3. 3.1  The F e d e r a l L e g i s l a t i o n  253  A3.3.2  The Newfoundland  258  i n Offshore Areas  and Labrador L e g i s l a t i o n  250  A3.4  J u r i s d i c t i o n and P r o d u c t i o n Rights  260  A3.5  J u r i s d i c t i o n and Revenue  263  A3.6  C o n c l u d i n g Remarks  265  VARIABLE AND COEFFICIENT LISTS AND MODEL TRANSLATION  269  APPENDIX 4  Sharing  vii  LIST OF TABLES  Table  3.1  E s t i m a t e s of P l a t f o r m Costs  and O p e r a t i n g E x p e n d i t u r e s  87  T a b l e 4.1  Some of the Assumptions U n d e r l y i n g Cases 1, 2 and 3  109  T a b l e 4.2  Net Present Value o f A l t e r n a t i v e H i b e r n i a Development Plans i n Absence o f Government P o l i c i e s , b i l l i o n s end-1984 d o l l a r s Case 3. F i x e d and F l o a t i n g P l a t f o r m s  114  Table 4.3  Net Present Value o f A l t e r n a t i v e H i b e r n i a Development P l a n s , b i l l i o n s end-1984 d o l l a r s Federal Regulations Case 2. F i x e d and F l o a t i n g P l a t f o r m s  115  T a b l e 4.4  Net Present Value o f A l t e r n a t i v e H i b e r n i a Development P l a n s , b i l l i o n s end-1984 d o l l a r s Newfoundland and Labrador R e g u l a t i o n s - " c a r r i e d interest" option Case 2. F i x e d and F l o a t i n g P l a t f o r m s  116  T a b l e 4.5  Net Present Value o f A l t e r n a t i v e Development P l a n s , b i l l i o n s end-1984 d o l l a r s Newfoundland and Labrador - "working i n t e r e s t " o p t i o n Case 2. F i x e d and F l o a t i n g P l a t f o r m s  117  Table 4.6  Optimal Producer Alternatives  118  T a b l e 5.1  Changes  T a b l e 5.2  Optimal Producer Choices f o r H i b e r n i a Development Consequences o f Favourable Changes i n Assumptions  136  Table 5.3  Optimal Producer Choices CASE 2 and DELAY  f o r H i b e r n i a Development  137  T a b l e 5.4  Optimal Producer Choices f o r H i b e r n i a Development Consequences o f 02, K2 and LOWER P  138  Table 5.5  Net Present Value o f A l t e r n a t i v e H i b e r n i a Development Plans Consequences o f Adverse Shocks Fixed Platforms  139  T a b l e 6.1  Economic Rents from H i b e r n i a Development Optimal Producer Choices Consequences o f 02 and K2  160  T a b l e 6.2  Economic Rents from H i b e r n i a Development Optimal Producer Choices Consequences o f LOWER P and DELAY  161  Choices Under V a r i o u s P o l i c y  to Base Case Assumptions  135  viii  ix  LIST OF FIGURES  F i g u r e 4.1  Net Present Value of A l t e r n a t i v e H i b e r n i a Development Plans i n Absence of Government P o l i c i e s , b i l l i o n s end-84 $ Case 1. F i x e d P l a t f o r m s  110  F i g u r e 4.2  Net Present Value of A l t e r n a t i v e H i b e r n i a Development Plans i n Absence of Government P o l i c i e s , b i l l i o n s end-84 $ Case 1. F l o a t i n g P l a t f o r m s  111  F i g u r e 4.3  Net Present Value of A l t e r n a t i v e H i b e r n i a Development Plans i n Absence of Government P o l i c i e s , b i l l i o n s end-84 $ Case 2. F i x e d P l a t f o r m s  112  F i g u r e 4.4  Net Present Value of A l t e r n a t i v e H i b e r n i a Development Plans i n Absence of Government P o l i c i e s , b i l l i o n s end-84 $ Case 2. F l o a t i n g P l a t f o r m s  113  F i g u r e 6.1  D i s t r i b u t i o n of Economic Rents from H i b e r n i a under A l t e r n a t i v e R e g u l a t i o n and Revenue-Sharing Systems Base Case with R e l i e f . Optimal Producer Choices  158  F i g u r e 6.2  D i s t r i b u t i o n o f Economic Rents from H i b e r n i a under A l t e r n a t i v e R e g u l a t i o n and Revenue-Sharing Systems Base Case. Optimal Producer Choices  159  F i g u r e 7.1  The Impact of H i b e r n i a on Energy Development, m i l l i o n s 1971 d o l l a r s  182  Figure  7.2  Changes i n Real GNP under A l t e r n a t i v e P r o j e c t S p e c i f i c a t i o n s , b i l l i o n s 1971 d o l l a r s  183  Figure  7.3  Per Cent Changes i n C e r t a i n Key V a r i a b l e s Induced by the Development o f H i b e r n i a  184  Figure  7.4  Per Cent changes i n Real 1971 and Nominal Non-Energy E x p o r t s Induced by the Development of H i b e r n i a  185  X  ACKNOWLEDGEMENT  John H e l l i w e l l this  thesis.  p a t i e n t l y guided me through  I feel privileged  the process o f w r i t i n g  to have been able to b e n e f i t  from h i s  advice and s u g g e s t i o n s , and to have been nurtured by h i s support and encouragement. you,  I have l e a r n e d a l o t from him and I owe him much.  John. P a u l B r a d l e y was v e r y h e l p f u l  shape. Don  Thank  In a d d i t i o n  to him, I would  i n the days when t h i s like  to thank T r a c y Lewis,  P a t e r s o n , B r i a n S c a r f e , Tony S c o t t and Margaret  comments.  My c o l l e a g u e s at the I n s t i t u t e  U n i v e r s i t y of Toronto  t h e s i s was t a k i n g Phil  Neher,  Slade f o r h e l p f u l  f o r P o l i c y A n a l y s i s i n the  were a l s o v e r y s u p p o r t i v e .  I a l s o wish  to express  my g r a t i t u d e to Energy, Mines and Resources Canada f o r funding t h i s work. I want to thank Alan Chung who was extremely  h e l p f u l with the  c o n s t r u c t i o n o f f i g u r e s and t a b l e s as w e l l as i n showing that the p o s t a l s e r v i c e between Vancouver and Toronto  indeed works.  For t h e i r  support and  encouragement, I a l s o wish  to thank my p a r e n t s , Diane Dupont, E r i c and  S y l v i a H e i k k i l a , and David  Ryan.  F i n a l l y , I want to express my g r a t i t u d e to my w i f e and c o l l e a g u e , Mary MacGregor.  Her l o v e , support  the days when the l i g h t  and u n f l i n c h i n g  f a i t h kept me going i n  at the end o f the t u n n e l seemed p a r t i c u l a r l y dim.  1  CHAPTER 1 INTRODUCTION  A f t e r years of disappointment and hundreds of m i l l i o n s of d o l l a r s i n e x p l o r a t i o n expenditures, Canada's offshore regions have yielded a number of important o i l d i s c o v e r i e s . The most notable among these are located under the Beaufort Sea and on the Grand Banks of Newfoundland. To date, none of these deposits has been developed and few studies have examined the economic implications of such projects i n Canada. Studies of s i m i l a r developments i n areas l i k e the North Sea have shown that the development and production of major offshore petroleum deposits r a i s e s three key sets of issues of i n t e r e s t to economists. The f i r s t concerns the l i n k s between the motives of producers, government p o l i c i e s and the r e a l i z e d value of the f i e l d . Do government r e g u l a t i o n and taxation p o l i c i e s a f f e c t producer behaviour and i f so, how important i s the induced d i s s i p a t i o n of p o t e n t i a l net benefits l i k e l y to be? How responsive are these p o l i c i e s to economic conditions and to the p h y s i c a l c h a r a c t e r i s t i c s of i n d i v i d u a l deposits? A d i f f e r e n t set of questions surrounds the macroeconomic consequences of development and production. How do such large c a p i t a l - i n t e n s i v e projects a f f e c t the national economy? Are the e f f e c t s of construction a c t i v i t i e s l i k e l y to d i f f e r from those of the production period? How s i g n i f i c a n t are the crowding-out e f f e c t s on other i n d u s t r i e s l i k e l y to be? Another set of issues i s peculiar to federations, l i k e Canada, with important economic powers divided among or shared by more than one j u r i s d i c t i o n . How i s the government share of revenues to be divided between the federal government and that of the j u r i s d i c t i o n nearest to the  2  field?  Furthermore, s i n c e o i l and  governments are s u b j e c t  to f i s c a l  consequences of development and whole, and  on  gas  revenues a c c r u i n g  production  on  located  affected? fromework to examine  a p p l i e s i t to the case of H i b e r n i a , a l a r g e petroleum i n the E a s t e r n  Canadian o f f s h o r e r e g i o n . H i b e r n i a  chosen f o r a n a l y s i s f o r three main reasons. I t s s i z e , c u r r e n t l y to exceed  1 b i l l i o n b a r r e l s of r e c o v e r a b l e  i n d u s t r y standards.  In a d d i t i o n , H i b e r n i a  Canadian o f f s h o r e o i l f i e l d suggest likely  low  l e s s than 300  recently discovered  kilometres  intend  activities the  productive  c a p i t a l . To  model a l s o allows  developed  i t s location,  i n the c o n s t r u c t i o n and  provide  a more a c c u r a t e  the p r o d u c t i v e  over time as p l a t f o r m s  and  and  since province.  and  and  production revenues  are preceded by i n s t a l l a t i o n of  since  periods the  d e p i c t i o n of r e a l i t y ,  c a p a b i l i t i e s of the  are i n s t a l l e d  to  used i n t h i s  streams of c o s t s and  l i v e s of o f f s h o r e o i l f i e l d s  of s u b s t a n t i a l investment  other  l e v e l s of government  f o l l o w s . Development and  are t r e a t e d as d i s c o u n t e d  are  world o i l p r i c e s and  t r a c t a b l e economic model of the development  c h a r a c t e r i z e d as  long p r o d u c t i v e  estimates  t r a n s p o r t a t i o n costs  two  by  first  s i n c e the a v a i l a b l e  t r a d i t i o n a l l y been a 'have not'  of o f f s h o r e petroleum d e p o s i t s  t h e s i s can be  estimated  of Newfoundland, g i v e s r i s e  i s s u e s s i n c e the  Labrador has  numerically  production  the  to share some of the revenues from H i b e r n i a  Newfoundland and The  and  to be  i n Canada. F i n a l l y ,  o f f the coast  interesting distributional involved  is likely  i n comparison to both c u r r e n t  offshore deposits  was  r e s e r v e s , makes i t a g i a n t  to be developed  that i t s development, p r o d u c t i o n to be  the  the e q u a l i z a t i o n system as a  T h i s t h e s i s develops a c o n s i s t e n t a n a l y t i c a l  deposit  provincial  e q u a l i z a t i o n i n Canada, what are  the p o s i t i o n of the p r o v i n c e most  these i s s u e s and  to  as w e l l s  field  the  to be b u i l t  are d r i l l e d  and made  up  3  available  for production.  A s l i g h t l y modified terize  the time  e x p o n e n t i a l d e c l i n e process  i s used to c h a r a c -  path o f the p r o d u c t i v e c a p a b i l i t i e s o f the f i e l d .  assumptions about a few a t t r i b u t e s o f the d e p o s i t , t h i s allows to  derive estimates  Given  the model  o f the p r o d u c t i o n p r o f i l e which are c o n s i s t e n t with  these a t t r i b u t e s but are r e s p o n s i v e  to changes i n the development p l a n .  T h i s one-to-one r e l a t i o n s h i p between development plans and p r o d u c t i o n profiles  i s e x p l o i t e d to c o n s t r u c t a model o f o p t i m a l producer  development p l a n s . The o p t i m i z a t i o n process present-value-maximizing  behaviour  assumes'price-taking, net-  based on expected  values of future  c o s t s , p r i c e s and tax parameters. In the absence of government the producer to  i s modelled  to manipulate  choice of  policies,  as many as s i x d e c i s i o n v a r i a b l e s  i d e n t i f y the development p l a n and the l e n g t h o f the p r o d u c t i v e  life  which maximize the net present v a l u e o f the f i e l d . - The i n t r o d u c t i o n o f government p o l i c i e s producer's  o p t i m i z a t i o n problem. The taxes and r o y a l t i e s  government p o l i c i e s  o f the  imposed by  are p e r c e i v e d as p o t e n t i a l l y a v o i d a b l e c o s t s o f  p r o d u c t i o n by the producer, his  changes the nature  who seeks to maximize the net present v a l u e o f  a f t e r - t a x r e t u r n s from the p r o j e c t . T h i s means that the model  government p o l i c i e s  to i n f l u e n c e producer  allows  d e c i s i o n s , which may r e s u l t i n  the d i s s i p a t i o n o f a p o r t i o n o f the d e p o s i t ' s p o t e n t i a l net b e n e f i t s to society. Finally,  to overcome some o f the l i m i t a t i o n s  the a n a l y s i s d e a l s with c o n d i t i o n s o f c e r t a i n t y , be e a s i l y s u b j e c t e d  to s e n s i t i v i t y  the model i s designed to  analysis.  T h i s model i s l i n k e d with MACE, a two-sector economy to study  imposed by the f a c t that  model o f the Canadian  the p o t e n t i a l consequences of H i b e r n i a . T h i s  procedure  4  was adopted to avoid equilibrium issues  some o f the problems a s s o c i a t e d  a n a l y s i s , to f a c i l i t a t e  with  partial  the examination o f macroeconomic  and to p r o v i d e a more a c c u r a t e c h a r a c t e r i z a t i o n o f the i m p l i c a t i o n s  of H i b e r n i a The relevant  on f i s c a l  e q u a l i z a t i o n i n Canada.  a n a l y s i s proceeds as f o l l o w s . A f t e r a short  review o f the  literature  the model o f the  i n chapter 2, chapter 3 o u t l i n e s  development and p r o d u c t i o n  of offshore  petroleum d e p o s i t s  used i n t h i s  t h e s i s . D e t a i l s r e l a t i n g to the a p p l i c a t i o n o f the model to the case o f Hibernia  can a l s o be found i n t h i s c h a p t e r .  Chapters 4 and 5 are concerned with microeconomic i s s u e s . In particular, the  the o p t i m i z a t i o n  properties  o f the model are used to examine  p o t e n t i a l f o r d i s t o r t i o n a r y e f f e c t s o f government p o l i c i e s i n a number  of d i f f e r e n t economic  environments.  Chapters 6 and 8 d e a l with d i s t r i b u t i o n a l q u e s t i o n s .  The  implications  o f s e v e r a l r e v e n u e - s h a r i n g p r o p o s a l s f o r the d i s t r i b u t i o n o f the government share o f p o t e n t i a l net b e n e f i t s between Ottawa and the government o f Newfoundland and Labrador are c h a r t e d . revenues on a l t e r n a t i v e f i s c a l Macroeconomic i s s u e s  project  to d e r i v e  of Hibernia  a consistent  f o r the n a t i o n a l  equalization  systems are a l s o examined.  are examined i n chapter 7. By s i m u l a t i n g the  development and p r o d u c t i o n possible  The e f f e c t s o f o f f s h o r e o i l  i n conjunction  representation  with MACE, i t i s  o f the consequences o f the  economy. Issues r e l a t e d to the crowding-out  e f f e c t s on other i n d u s t r i e s are a l s o examined. C o n c l u s i o n s and d i r e c t i o n s f o r f u t u r e  research  can be found i n  c h a p t e r 9. The t h e s i s concludes with a s e r i e s o f appendices which certain specific the  text.  issues  i n greater  detail  discuss  than i s f e a s i b l e i n the body o f  5  CHAPTER 2 THE PRODUCTION AND TAXATION OF OFFSHORE PETROLEUM RESOURCES  2.1 Introduction One  of the main objectives of this thesis is to explore issues  related to the level and efficiency of resource taxation in the context of the development and production of petroleum deposits  located in the  Eastern Canadian offshore region. To do so requires a detailed account of the relevant royalties and taxes as well as information about the costs and  attributes of specific  then be brought together  reservoirs or f i e l d s .  A l l this information must  in an economic model of the development decision  which offers a number of channels through which government p o l i c i e s can affect  the simulated behaviour of the producer.  This chapter outlines  some of the p r i n c i p a l directions which the  l i t e r a t u r e on petroleum economics has explored during the last two decades.  Section 2.2 examines some of the key theoretical  developments  concerning the role of taxation in exhaustible resource models. Some implications for applied models of resource extraction are also noted. After setting petroleum within the context of the economic theory of exhaustible resources,  section 2.3 provides a review of a number of  applied studies of reservoir economics.  Special attention is paid to the  way in which the key theoretical concerns are reflected  in models of the  behaviour of profit-maximizing producers operating in the context of a market economy. This includes an examination of the scope for producer responses  to r o y a l t i e s and taxes which is offered by these models. Methods  chosen to r e f l e c t  the special aspects of the development and production of  offshore reservoirs are also discussed in this  section.  6  From a l l t h i s  i n f o r m a t i o n , s e c t i o n 2.4  p r o p e r t i e s of models of the development and petroleum d e p o s i t s  development model used  The T a x a t i o n The  in this  [1914] and  However, i t was  of a formal  d e r i v e d a market  imperfection  few  forms of t a x a t i o n . Both v e r i f i e d  or may  instrument  appropriate  Heal  not  1  Even  forces, including a been reached a  profit-  change h i s c h o i c e of e x t r a c t i o n p r o f i l e  i n the  face of t a x a t i o n , depending on  the  used. [1979, chapters  known stock of an e x t r a c t i v e resource i n producer behaviour induced  economic r e n t s  the  f u n c t i o n which c h a r a c t e r i z e s  the c o n c l u s i o n that had  6 and  c o n d i t i o n s , the c o m p e t i t i v e  intertemporal  the  to set the problem  them: under c o n d i t i o n s of p e r f e c t c o m p e t i t i o n ,  a known stock of r e s o u r c e s  Dasgupta and  first  d i s t o r t i o n s caused by v a r i o u s market  maximizing producer may  of the  the p u b l i c a t i o n of  o p t i m i z a t i o n framework. Sweeney [1977]  intertemporal  nature  the p a t t e r n of e x p l o i t a t i o n  s t a r t e d to develop i n e a r n e s t .  the  by others b e f o r e  H o t e l l i n g [1931] c o n t a i n  not u n t i l  [1976] seems to have been the  w i t h i n the context  for  offshore  [1967] that the economic l i t e r a t u r e on  t a x a t i o n of e x t r a c t i v e r e s o u r c e s  independently  provide  thesis.  to the e f f e c t s of t a x a t i o n on  volume e d i t e d by Gaffney  Burness  of o f f s h o r e  o f E x t r a c t i v e Resources  of e x h a u s t i b l e r e s o u r c e s .  then,  production  3 f o r the c o n s t r u c t i o n of the  p i o n e e r i n g e f f o r t s of Gray  some r e f e r e n c e s  a number of d e s i r a b l e  i n a market economy. These p r o p e r t i e s w i l l  g u i d e l i n e s used i n chapter  2.2  distills  a l l o c a t i o n and  that could otherwise  show t h a t , under  intertemporal  a l l o c a t i o n of a  i s s o c i a l l y o p t i m a l . Hence, changes  by r e s o u r c e result  12]  taxation w i l l distort  this  i n the d i s s i p a t i o n of a p o r t i o n of be  generated by  this given  resource  the  7  stock.  This gives  rise  to a number of i s s u e s r e l a t e d to the  consequences of s p e c i f i c The  key  different  of a g i v e n  representation  stock  of view, the  i n the market  Stiglitz  f o r flows.  chosen i n t e r t e m p o r a l for s t o c k s .  must s a t i s f y  two  the  i s , the  It must r e c o g n i z e  will  seek to r e - a r r a n g e the  that  the  that  the  the resource  i s an asset  i s p o s s i b l e to c o n s o l i d a t e  literature notably,  as  other  asset.  and,  as  If  the  p r e - t a x e q u i l i b r i u m , the  intertemporal  equilibrium conditions  As  of The  a l l o c a t i o n must a l s o b r i n g about e q u i l i b r i u m i n  i n t r o d u c t i o n of t a x a t i o n d i s t u r b s  It  conditions.  same i n a l l time p e r i o d s .  a r a t e of r e t u r n equal to that on any  two  allocation  profitability  y i e l d s a r e t u r n to i t s producer through p r i c e a p p r e c i a t i o n requires  the  [1980], i t must r e s u l t i n an That  e x t r a c t i n g the m a r g i n a l u n i t must be  from  chosen i n t e r t e m p o r a l  of an e x t r a c t i v e resource  argued by Dasgupta, Heal and  market  of the e f f e c t s of  instruments l i e s with the r e c o g n i t i o n t h a t ,  producer's p o i n t  equilibrium  t a x a t i o n measures.  to d e r i v i n g a formal  tax  competitive  resource  efficiency  are the  the  which such,  producer  a l l o c a t i o n of the resource  so  met. r e s u l t s that emerge from  f o l l o w s . In simple models of the c o m p e t i t i v e  the c o s t of e x t r a c t i o n does not  this  f i r m where,  depend on cumulative e x t r a c t i o n , 2  commonly used tax invariant  instruments have the  f o l l o w i n g dynamic e f f e c t s .  tax assessed on each u n i t e x t r a c t e d  increases  e x t r a c t i o n c o s t s . I t s i n t r o d u c t i o n thus c r e a t e s production  from a g i v e n  u n p r o f i t a b l e . I f there cumulative t o t a l subsidy  deposit are  e x t r a c t i o n may  production.  may  be  an i n c e n t i v e to  defer  with d i f f e r e n t c o s t s ,  reduced by  and  per-unit  even render e x p l o i t a t i o n p r i v a t e l y  several deposits  reduces e x t r a c t i o n c o s t s  accelerate  and  An  a per-unit  thus c r e a t e s  Furthermore, i f c o s t s vary  an  tax. A  incentive  across  per-unit to  deposits, i t s  8  i n t r o d u c t i o n may cut-off  increase  cumulative e x t r a c t i o n s i n c e i t lowers  grade.  The  i n t r o d u c t i o n of an ad valorem tax  decreases the u n i t p r i c e r e c e i v e d by production  being  accelerated  (delayed  (often called  or u n a f f e c t e d )  the r a t e of i n t e r e s t . Again, i f c o s t s v a r y e x t r a c t i o n may proportional  be  on each u n i t e x t r a c t e d , on  i n c e n t i v e to a c c e l e r a t e  (to d e l a y or not  i s growing f a s t e r than (slower  of i n t e r e s t . O b v i o u s l y , subsidy  effectively  A pure p r o f i t s affect  production  other  tax  as a f i x e d  cumulative  been i n c r e a s e d .  than or at a r a t e equal increase  A  hand, c r e a t e s  to change) p r o d u c t i o n  i s a tax on economic r e n t s and  d e c i s i o n s . However, the  then i t s e f f e c t s are  hand, the  deposits,  to)  an  i f the u n i t  to) the  since  rate  the  lowers the c u t - o f f grade. as such does  the  this  as a f i x e d nominal amount per  same as a p e r - u n i t  subsidy.  On  i n t r o d u c t i o n of a percentage d e p l e t i o n allowance,  p r o p o r t i o n of c u r r e n t  not  i n t r o d u c t i o n of d e p l e t i o n  s u b s i d i e s to e x t r a c t i o n a l t e r s  I f cost d e p l e t i o n i s d e f i n e d  extracted  in  than or equal  the other  cumulative e x t r a c t i o n may  allowances which are e s s e n t i a l l y result.  than ( l e s s  across  result  depending on whether  reduced s i n c e the c u t - o f f grade has  subsidy  a royalty)  the producer. It w i l l  the market p r i c e i s growing at a r a t e g r e a t e r  price  the  revenue, has  the  unit the defined  same e f f e c t s as a  3 proportional It  should  subsidy. be noted  that income taxes are commonly modelled as  taxes i n s t y l i z e d models of r e s o u r c e jurisdictions,  income taxes and  extraction.  taxes on r e t u r n s  p o t e n t i a l l y d i s t o r t i o n a r y s i n c e they are assessed f a c t o r s of p r o d u c t i o n  and  d i s c u s s i o n of these and  as such d i f f e r  However, i n most to e q u i t y against  from pure p r o f i t s  r e l a t e d i s s u e s , see  profits  i n general the  are  income of  taxes.  For  Church [1981, pp.80-85]  a  and  9  Gaudet and  Lasserre  [1984].  Using these s t y l i z e d models, q u a l i t a t i v e (but characterizations  of the d i s t o r t i o n s induced by  t a x a t i o n have been d e r i v e d .  Unfortunately,  as  not  quantitative)  a number of means of  the  s t r u c t u r e of  t h e o r e t i c a l models becomes r i c h e r , i t becomes i m p o s s i b l e q u a l i t a t i v e p r e d i c t i o n s of the The  depletion the  e f f e c t or m u l t i - i n p u t  intertemporal  t u r n , means that p r i c e of the difficult  r e s o u r c e as w e l l The  less l i k e l y  to y i e l d  kind  of  complicates  costs. This,  in  the  net  p r i c e s over time i s more  c h a r a c t e r i z a t i o n of any  a l l o c a t i o n of a known stock  more complex and  i n t r o d u c t i o n of any  r e f i n i n g process s i g n i f i c a n t l y  as among net  even  instruments.  r e l a t i o n s h i p between the market p r i c e and  to r e p r e s e n t .  equilibrium  the  r e l a t i o n s h i p between e x t r a c t i o n and the  to d e r i v e  e f f e c t s of many of these tax  main reason f o r t h i s r e s u l t i s that  these  intertemporal  of an e x h a u s t i b l e  r e s o u r c e i s thus  unambiguous q u a l i t a t i v e r e s u l t s when 5  subjected that  the  to comparative dynamic a n a l y s i s . i n t r o d u c t i o n of t a x a t i o n w i l l  to choose the  extraction profile  induced d i s t o r t i o n s from the In a d d i t i o n to e n a b l i n g  one  although we  induce a p r o f i t - m a x i m i z i n g  for a given  a f t e r - t a x r e t u r n , numerical methods may the  Therefore,  deposit  o f f e r the o n l y means through which  competitive to d e r i v e  a l l o c a t i o n can be  specific  the  a p p l i c a t i o n of n u m e r i c a l methods to the  a n a l y s i s of the  e x p l o i t a t i o n of g i v e n  nature of the the  of a model which d e p i c t s  taxation,  e f f e c t s of  o f f e r s another  assumptions, e s p e c i a l l y about  e x t r a c t i o n technology, to be  construction  forms of  resource deposits  advantage. It allows c e r t a i n r e s t r i c t i v e  measured.  e s t i m a t e s of both the magnitude  d i r e c t i o n of the d i s t o r t i o n s induced by  the  producer  which maximizes h i s  and  t a x a t i o n on  know  relaxed  thus making  r e a l i t y more c l o s e l y .  possible  the  10  An  important  observe that  question,  however, has  e x t r a c t i v e i n d u s t r i e s are  r e g u l a t i o n and  yet  to be  generally  addressed: why  subject  to  substantial  f o r t h to e x p l a i n  the  existence  government i n t e r v e n t i o n i n markets f o r e x t r a c t i v e r e s o u r c e s . that  associated are  the  there  could  with the  be d i s t o r t i o n s from c o m p e t i t i v e  e x p l o i t a t i o n of these r e s o u r c e s .  p u b l i c - g o o d nature of e x p l o r a t i o n ,  mostly associated existence  with the  the  of non-competitive market  Three common examples  from the  s o l u t i o n is impossible.  include  the  i n markets f o r e x t r a c t i v e  premise that  Given t h a t , one  t a x a t i o n of e x t r a c t i v e and  the  there  i s the b e l i e f that  attainment  of the  tasks  industries.  The  problem of the  second  economic r e n t s belong i n the  domain. In Canada, t h i s b e l i e f i s r e i n f o r c e d by most o i l and  gas  deposits  Crown a l s o a c t s  as  have not  the  best  been a l i e n a t e d .  l a n d l o r d . In a d d i t i o n , the  such r e n t s might e x i s t i s of i t s e l f c o l l e c t o r ' s eye  since  i t usually  sufficient signifies  something f o r n o t h i n g : a tax on economic r e n t s  public  f a c t that r i g h t s In g e n e r a l ,  to  therefore,  e x p l o i t a t i o n of  e x t r a c t i v e r e s o u r c e s u s u a l l y generates economic r e n t s . The  tax  the  t h i s area i n d e t a i l .  Finally,  the  economy.  an o p t i m a l s t r u c t u r e of d i s t o r t i o n a r y  economic l i t e r a t u r e on o p t i m a l t a x a t i o n explores  the  structures.  start  f a c i n g a government i s to d e v i s e  it is  " r u l e of c a p t u r e ' problems  choose to i n t e r v e n e  i n t h i s area t y p i c a l l y  taxes which may  First,  equilibrium  r e s o u r c e s to c o r r e c t d i s t o r t i o n s that occur elsewhere i n the  of a f i r s t - b e s t  of  e x p l o i t a t i o n of petroleum r e s o u r c e s and  Second, governments may  Studies  we  taxation?  Three reasons are u s u a l l y put  argued  do  to c r e a t e the  suggestion  that  a gleam i n every  p o s s i b i l i t y of  getting  is non-distortionary,  at  7 least  i n the  short  run  and  in a partial  equilibrium  framework.  However,  11  the  instruments  of t a x a t i o n r e l i e d  e x c l u s i v e l y tax economic r e n t s . The  upon by governments u s u a l l y do a n a l y s i s of the d i r e c t i o n  magnitude of the r e s u l t i n g d e p a r t u r e s a l l o c a t i o n has  been an important  not  and  from the c o m p e t i t i v e e q u i l i b r i u m  concern  of the economic l i t e r a t u r e on  the  t a x a t i o n of e x t r a c t i v e r e s o u r c e s . T h i s o b s e r v a t i o n suggests  a f o u r t h reason.  revenues of non-renewable i n d u s t r i e s may government because they next  best  are p e r c e i v e d  a l t e r n a t i v e . T h i s broader  advantage of such taxes w i l l However, i t should be kept instruments  designed  development and In t h i s  belong  to be  aspect  not be pursued  Taxes l e v i e d i n the  against  fiscal  less d i s t o r t i o n a r y of the p o t e n t i a l further in this  i n mind when probing  the  package of a than  the  comparative thesis.  the e f f e c t s of the v a r i o u s  to tax the revenues generated  by ventures  such as  the  p r o d u c t i o n of H i b e r n i a .  t h e s i s , resource  t a x a t i o n w i l l be  thought of as a s e r i e s  measures through which governments r a i s e revenues and r i g h t s as l a n d l o r d s . The  next  exercise  s e c t i o n p r o v i d e s a review  of  their  of n u m e r i c a l l y  t r a c t a b l e economic models which have been used to examine the consequences of r e s o u r c e petroleum  2.3  t a x a t i o n on the development and  p r o d u c t i o n of o f f s h o r e  reservoirs.  A p p l i e d R e s e r v o i r Economics: A P a r t i a l Review  2.3.1  Petroleum as an E x h a u s t i b l e Resource From an economic p e r s p e c t i v e , crude o i l i s an e x t r a c t i v e r e s o u r c e  l i k e any  o t h e r . I t i s e x h a u s t i b l e i n the c o n v e n t i o n a l  e x p l o i t a t i o n gives r i s e these  sense and i t s  to problems of i n t e r t e m p o r a l a l l o c a t i o n . To  i n t e r t e m p o r a l a l l o c a t i o n problems, the economic  literature  study  12  represents of three first  the  supply  stages:  yield  of crude o i l as an  e x p l o r a t i o n , development and  the d i s c o v e r y  Development of s p e c i f i c reserves  which can  process as being points  the  process which c o n s i s t s  e x t r a c t i o n . E x p l o r a t i o n must  of o i l - i n - p l a c e i n pools  called reservoirs.  r e s e r v o i r s transforms the o i l - i n - p l a c e i n t o  then be  extracted.  the r e s u l t of two  It i s u s e f u l to t h i n k of  decisions  taken by  i t s expectations  l o c a t i o n , timing  Upon the d i s c o v e r y  production  and  about  firms at d i f f e r e n t  future b e n e f i t s , a firm f i r s t  profile.  In doing so,  the  f i r m uses the  i t s associated  information  t r e a t s e x p e n d i t u r e s on e x p l o r a t i o n as  and  examines the economics of development  and  b e n e f i t s of d i f f e r e n t development p l a n s . Under s p e c i f i c  in light  assumptions, the most d e s i r a b l e development plan view can be ensue o n l y  i d e n t i f i e d . Development and i f the  p r i v a t e l y optimal  a n t i c i p a t e d net  from the  production  and  can be to the  costs  behavioural  f i r m ' s point expected  of  to  f i r m under  onshore r e s e r v o i r s are  which bear petroleum. There are  convenient ways of d i s t i n g u i s h i n g between the  The  sunk c o s t s  the  p l a n are p o s i t i v e .  s e t s of g e o l o g i c a l c o n d i t i o n s  which govern p r o d u c t i o n  l o c a t e d under the  obtained  of the expected  benefits accruing  To a r e s e r v o i r engineer, o f f s h o r e  conditions  effort.  f i r m must d e c i d e whether to proceed  i f so, choose a development p l a n and  through e x p l o r a t i o n but  decides  l e v e l of i n t e n s i t y of i t s e x p l o r a t i o n  of a r e s e r v o i r , the  w i t h development and,  are  Canadian p r a i r i e s or  production  the  two  both  no  types s i n c e the  physical  same whether a r e s e r v o i r i s  i n the c o n t i n e n t a l  economics, however, d i f f e r  the r i c h e s of an o f f s h o r e and  this  i n time.  Based on on  integrated  shelf.  s u b s t a n t i a l l y . To  extract  r e s e r v o i r , a d i f f e r e n t technology must be  i t s investment requirements dwarf those necessary to develop  and  used  13  produce a comparable onshore r e s e r v o i r . For example, p r o d u c t i o n must be b u i l t  and  installed  which w i l l  affect  platforms  the number, t i m i n g  and  l o c a t i o n of w e l l s . T h i s i m p l i e s that the d e c i s i o n to develop an  offshore  reservoir  In  is crucially  a f f e c t e d by  a d d i t i o n , the lumpiness of the be  i n a p p r o p r i a t e to r e p r e s e n t  differentiable production the  intermediate  royalties  is likely  points w i l l  suggested  and  taxes  investment requirements.  investment program suggests that i t would development c o s t s with a  function. Therefore,  surface  As was  the  the a t t a i n a b l e p o r t i o n of  to be a f i n i t e simply  not  i n the p r e v i o u s  and  will  of the producer's o p t i m i z a t i o n  net  field  present  present  value  c o s t s of  i s the case,  of the d e p o s i t  concentrated  value  a p o r t i o n of the p o t e n t i a l  to s o c i e t y w i l l have been d i s s i p a t e d  on the development and  production  p r e v i o u s l y occurred  g i v e n r e s e r v o i r . In t h i s of the development and  activities  present  behaviour.  s t u d i e s of o f f s h o r e r e s e r v o i r economics have g e n e r a l l y  that e x p l o r a t i o n had  been proposed  production  optimal  because of the e f f e c t s of government p o l i c i e s on producer Empirical  will  of h i s a f t e r - t a x r e t u r n .  from that which maximizes the net  to s o c i e t y . I f t h i s value  maximizing producer  i t i s p o s s i b l e f o r the p r i v a t e l y  development plan to d i f f e r of the  feasible.  as p o t e n t i a l l y a v o i d a b l e  seek to maximize the net  In such c i r c u m s t a n c e s ,  set of p o i n t s s i n c e many o f  be  problem. For example, a n e t - p r e s e n t - v a l u e taxes  the  s e c t i o n , the i n t r o d u c t i o n of  changes the nature  p e r c e i v e r o y a l t i e s and  continuously  tradition,  production  and  long p e r i o d s of e x t r a c t i o n and  thus assumed  t r a c t a b l e models  of o f f s h o r e petroleum r e s e r v o i r s have  initial are  and  y i e l d e d the d i s c o v e r y of a  several numerically  i n the economic l i t e r a t u r e .  are c h a r a c t e r i z e d by  stages,  In these models, o i l p r o d u c t i o n  capital  thus analysed  expenditures  followed  as d i s c o u n t e d  by  streams of  14  revenues and  expenditures.  A p a r t i a l e q u i l i b r i u m framework i s g e n e r a l l y used and f a c t o r s are assumed to be completely  d e s c r i b e d by a set of tax parameters,  a number of other parameters i n c l u d i n g p r o f i l e s of two price  v a r i a b l e s (wellhead  i n f l a t i o n ) . Within  this  net-present-value-maximizing  exogenous  the d i s c o u n t r a t e , and  p r i c e of crude  o i l and  framework, the behaviour producer  can be  the  time  general r a t e of  of a p r i c e - t a k i n g ,  s i m u l a t e d , as can  the  consequences of the i n t r o d u c t i o n of (or changes i n ) government t a x a t i o n p o l i c y and  of changes i n the g e n e r a l economic environment. q  The  f i v e models reviewed  i n the next  subsection  v a l u e s of c o s t s , p r i c e s , tax parameters and reservoirs  to d e r i v e p o i n t estimates  a l l use  the  expected  c h a r a c t e r i s t i c s of g i v e n  of t h e i r net  present v a l u e s and  the e f f e c t s of r e s o u r c e  t a x a t i o n . A f t e r Van Meurs [1971, chapter 4 ] ,  models w i l l be r e f e r r e d  to as  scope of t h i s  become apparent  2.3.2  The The  i n the next  d i s c o v e r y and Sea has  subsequent e x p l o i t a t i o n of petroleum given r i s e 1  the work of Robinson and  will  to a number of s t u d i e s i n t o  Morgan [1976;1977;1978]. i n the UK  employ an approach which w i l l  T h i s model s i m u l a t e s  resources the  R e p r e s e n t a t i v e of a c l a s s of these s t u d i e s  of the development of o i l f i e l d s  producer  to i n c l u d e o n l y d e t e r m i n i s t i c models  chapter.  economics of such ventures. *^  authors  the  B a s i c S t a t i c Model  under the North  is  these  ' d e t e r m i n i s t i c ' . Reasons f o r l i m i t i n g  l i t e r a t u r e review  of  the behaviour  and  be c a l l e d  of a  1 1  In t h e i r a n a l y s i s  Norwegian s e c t o r s , these the b a s i c s t a t i c model.  net-present-value-maximizing  under the assumption that h i s c h o i c e of development plans  production p r o f i l e s  for s p e c i f i c  reservoirs  i s largely unaffected  and by  15  royalties  and  taxes. Hence, a development p l a n and  are exogenously s p e c i f i e d i  a production  f o r each r e s e r v o i r under  •  study.  •  The model s u n i t of a n a l y s i s i s the r e s e r v o i r . as the number, l o c a t i o n and important  so f a r as t h e i r  requirements  t i m i n g of w e l l s and  implied l e v e l  are known. The  and  profile  12  Considerations  p l a t f o r m s are thus  d i s t r i b u t i o n of  approach a l s o t r e a t s  the  such  only  investment  l e v e l of r e c o v e r a b l e  r e s e r v e s as a known c h a r a c t e r i s t i c of the r e s e r v o i r . Even though four of the f i v e models reviewed  in this  s e c t i o n approach the d e t e r m i n a t i o n of  l e v e l of r e c o v e r a b l e r e s e r v e s i n t h i s manner, the process by which measure i s d e r i v e d remains l a r g e l y u n d e f i n e d . o u t l i n e s an attempt resource The  at r a t i o n a l i z i n g  The  following  the  the  paragraph  the c h o i c e of such a measure of  stock. g e o l o g i c a l c o n d i t i o n s which c h a r a c t e r i z e a g i v e n r e s e r v o i r  assumed known. One  of the elements of the set of f e a s i b l e e x t r a c t i o n  technologies (usually secondary  recovery)  f i x e d p r o d u c t i o n p l a t f o r m s with the p o t e n t i a l f o r  i s assumed to be used to produce the r e s e r v o i r .  a p p l i c a t i o n of t h i s technology q u a n t i t y of crude  r e c o v e r a b l e r e s e r v e s and  The  i s then assumed to d e f i n e a maximum  o i l which, g i v e n enough time,  r e s e r v o i r under study. That  r e s e r v o i r . As  are  can be recovered  q u a n t i t y i s then c a l l e d  i s assigned  the l e v e l  as a c h a r a c t e r i s t i c  of  from  the  of  the  a r e s u l t , r e c o v e r a b l e r e s e r v e s d e f i n e d i n t h i s manner can  c o n s i d e r e d a p h y s i c a l measure of r e s o u r c e  stock s i n c e they are  be  not  i n f l u e n c e d by changes i n p r i c e s or c o s t s . A set of exogenous weights d e f i n e s each year's p r o d u c t i o n as a p r o p o r t i o n of r e c o v e r a b l e r e s e r v e s . The determines all  both  the  first-  other models reviewed  and  assumed time p r o f i l e o f weights  l a s t - p o s s i b l e e x t r a c t i o n p e r i o d s . As  in this  fixed  s e c t i o n , the stream  of annual  with  production  16  revenues i s o b t a i n e d by the p r o d u c t i o n  requirements  expenditures,  are s p e c i f i e d both  the l i f e  in their  are s p e c i f i e d  of the  and  c a t e g o r i e s whose l e v e l and  revenues a c c r u i n g to the producer  As  t i m i n g . Annual  are e x p l i c i t l y modelled.  in real  Development  c o n t i n u i n g as long as  are at l e a s t  a v o i d a b l e c o s t s . T h i s i m p l i e s that although  the  as l a r g e as the a s s o c i a t e d  recoverable reserves  as a c h a r a c t e r i s t i c of the r e s e r v o i r ,  p r i c e - and  expenditure  assumed to s t a y c o n s t a n t ,  p r o d u c t i o n are then s i m u l a t e d , the l a t t e r  defined  o i l on  reservoir.  Government t a x a t i o n p o l i c i e s and  f o r crude  assumed to be e n t i r e l y e q u i t y - f i n a n c e d ,  from a s e r i e s of a c t i v i t y  operating expenditures terms, over  an exogenous p r i c e path  profile.  Total capital are aggregated  imposing  actual recovery  are  i s both  cost-sensitive.  should have been gathered  from these  few paragraphs and  the  a l g e b r a i c r e p r e s e n t a t i o n of appendix I, the s t r u c t u r e of t h i s approach i s very r i g i d ;  the o n l y two  parameters over which the model can search  1 the  first  and  last  are  3  p e r i o d s of p r o d u c t i o n .  Kemp [1975] and Morgan and  Robinson  [1976a] are examples of s t u d i e s  which have used the b a s i c s t a t i c model to examine the e f f e c t s of r o y a l t i e s and  taxes on the ( p r i v a t e ) p r o f i t a b i l i t y  located  i n the B r i t i s h  and  of  deposits  Sea. The  main  s t u d i e s are that the i n t r o d u c t i o n of  taxation policies  net revenues much more than t h e i r  d e c i s i o n to develop  petroleum  Norwegian s e c t o r s of the North  c o n c l u s i o n s which emerge from these or changes i n r e s o u r c e  of d e v e l o p i n g  typically  level  and  affect  that the  a g i v e n d e p o s i t i s r e l a t i v e l y robust  i n t r o d u c t i o n of v a r i o u s types of r o y a l t i e s  and  taxes.  the  distribution  producer's to the  17  The of  s t r u c t u r e of the model at l e a s t  distributional  affect  i s s u e s . In t h i s  the simulated behaviour  royalties  and  i n part e x p l a i n s t h i s dominance  framework, government p o l i c i e s  of the producer  taxes can r e v e r s e the producer's  making an otherwise  p r o f i t a b l e venture  under s u i t a b l e assumptions about p e r i o d of p r o d u c t i o n , r e s o u r c e  i n o n l y two  t a x a t i o n p o l i c i e s may  p e r i o d of p r o d u c t i o n c l o s e r  would have been the case  i n an u n r e g u l a t e d  taxes on the producer's  hence, of a p r o d u c t i o n p r o f i l e . o f f s h o r e o i l tend  impact  and  than  of  and  c a p i t a l c o s t s , any  taxes on producer  on the investment  2.3.3  Model  A s e r i e s of papers f i r s t  to the present  environment.  the f i x e d  the magnitude of the induced  MIT  cut-off  c h o i c e of a development p l a n  underestimate  The  r a i s e the  first  of c a p t u r i n g the dynamic e f f e c t s  to be much s m a l l e r than  emphasize t h e i r  given a  Since the v a r i a b l e c o s t s of p r o d u c t i o n of  a n a l y s i s of the e f f e c t s of r o y a l t i e s does not  by  p r i v a t e l y u n p r o f i t a b l e . Second,  grade by moving the l a s t  r o y a l t i e s and  ways. F i r s t ,  d e c i s i o n to develop  f u t u r e o i l p r i c e s and  However, t h i s model o f f e r s no way  can  behaviour  decision will  tend  that to  d i s s i p a t i o n of net b e n e f i t s .  p r e s e n t , then r e f i n e an i n t e g r a t e d process  model of the three stages of the supply of crude  o i l from o f f s h o r e b a s i n s  1h like  the North  which can be  Sea.  thought  The model i n c l u d e s a r e s e r v o i r development submodel of as an e x t e n s i o n of the b a s i c s t a t i c  Since the submodel i s part of an i n t e g r a t e d process development and  p r o d u c t i o n are e x p l i c i t l y  model.  approach,  c o n d i t i o n a l on e x p l o r a t i o n and  the subsequent d i s c o v e r y of a r e s e r v o i r which, i n each case, i s c h a r a c t e r i z e d by a g i v e n l e v e l of r e c o v e r a b l e r e s e r v e s . As with the b a s i c s t a t i c model, the u n i t of a n a l y s i s i s the r e s e r v o i r  and  the  production  18  profile  i s d e f i n e d by a s e r i e s o f exogenous weights which  determine the f i r s t Using data capital  and l a s t - p o s s i b l e p r o d u c t i o n p e r i o d s .  from producing  expenditure  implicitly  equations  North  Sea f i e l d s ,  the authors  f o r a s e r i e s of a c t i v i t y  are then used to f o r e c a s t r e a l  c a p i t a l expenditures  estimate  real  c a t e g o r i e s . These  f o r each a c t i v i t y  as a  f u n c t i o n o f the l e v e l o f r e c o v e r a b l e r e s e r v e s c h a r a c t e r i z i n g the r e s e r v o i r under s t u d y .  1 5  are aggregated  These e x p e n d i t u r e s ,  assumed to be e n t i r e l y e q u i t y - f i n a n c e d ,  across c a t e g o r i e s and d i s t r i b u t e d  over  time  a c c o r d i n g to an  16  exogenous set o f weights. similar being over  to that o f c a p i t a l  that r e a l annual time,  The treatment expenditures;  of operating expenditures i s the o n l y important d i f f e r e n c e  operating expenditures,  assumed to remain  are f o r e c a s t with an e q u a t i o n estimated  constant  as a f u n c t i o n o f  recoverable reserves. The  submodel a l s o i n c o r p o r a t e s a d e t a i l e d  t a x a t i o n and r e g u l a t i o n p o l i c i e s . A cash calculate its  flow approach i s then used to  the net present v a l u e o f each r e s e r v o i r d i s c o v e r e d as w e l l as  d i s t r i b u t i o n between producer  production of a given r e s e r v o i r present v a l u e to i t s producer joins  and government. The development and  are assumed to ensue o n l y i f the net  i s positive. If i t isn't,  the r e s e r v o i r  the queue o f d i s c o v e r i e s whose development and p r o d u c t i o n await  more f a v o u r a b l e economic c l i m a t e . As with  periods of p r o d u c t i o n . Even i f c a p i t a l  a  the b a s i c s t a t i c model, the o n l y  two parameters over which the model searches  of  d e s c r i p t i o n of the r e l e v a n t  are the f i r s t  and l a s t  1 7  and o p e r a t i n g e x p e n d i t u r e s  depend o n l y on the l e v e l  r e c o v e r a b l e r e s e r v e s , i t can be argued that the r e s u l t i n g  endogenous  d e t e r m i n a t i o n of the development p l a n imbues t h i s model with a g r e a t e r degree o f f l e x i b i l i t y  than  that o f the b a s i c s t a t i c model. An i n t e r e s t i n g  19  feature  of  different  the model i s reservoir  extension,  it  is  taxation  identical of  increased  s t a t e s of  to d e f i n e  flexibility:  handled endogenously.  the minimum economic  the w o r l d . Otherwise,  to  those of  i n Adelman et  the b a s i c  static  c o n c e r n i n g the consequences of r e s o u r c e al.  [1976] and Eckbo [1979b] which use  those to be found i n s t u d i e s r e l y on the b a s i c  static  effects  environment  model. T h i s e x p l a i n s  By  reservoir  the p o t e n t i a l  and r e g u l a t i o n and of changes i n the economic  the r e s u l t s  2.3.4  to t h i s  s i z e s can now be c o n s i s t e n t l y  now p o s s i b l e  size in alternative of  attributable  the  are  similarity  taxation  obtained  the MIT model w i t h  such as Morgan and Robinson [1976a] which  model.  The P l a t f o r m L o c a t i o n Model Drawing from the o p e r a t i o n s  research l i t e r a t u r e ,  [1969;1972] have proposed a c o s t - m i n i m i z i n g model of offshore Devine profits  oil  fields  that  excludes  [1975] l a t e r  cast  the  over a p r e - s p e c i f i e d  field-to-shore  field-to-shore  pipeline  problem as a m a x i m i z a t i o n of  assigned  a key r o l e  transportation  targets  of  F r a i r and  after-tax  p l a n n i n g h o r i z o n . Dogru, Lesso and Brons model which,  to the  selection  while of a  system.  Given the p h y s i c a l c h a r a c t e r i s t i c s and l o c a t i o n of  the development  transportation.  [1977] suggested a n e t - p r e s e n t - v a l u e - m a x i m i z a t i o n excluding taxation p o l i c y ,  Devine and Lesso  of  the r e s e r v o i r and the number  to be reached by p r o d u c t i o n w e l l s ,  the  following  18  problem i s  solved by Devine and Lesso  f u n c t i o n which depends platforms depends total  and t a r g e t s  [1969;1972].  A well d r i l l i n g  on the h o r i z o n t a l and v e r t i c a l d i s t a n c e s is  on the number of  specified,  as  is  a p l a t f o r m cost  separating  f u n c t i o n which  t a r g e t s produced from each p l a t f o r m . Since  c o s t of an i n d i v i d u a l p l a t f o r m , i n c l u d i n g d r i l l i n g  cost  costs,  the  rises  20  p r o p o r t i o n a t e l y more s l o w l y than the number o f w e l l s contained there e x i s t s a t r a d e o f f between the s i z e o f p l a t f o r m s  in i t ,  and the p r o x i m i t y o f  t a r g e t s to p l a t f o r m s . Given a number o f p l a t f o r m s , their  the problem i s then to choose  s i z e and l o c a t i o n as w e l l as the a l l o c a t i o n of w e l l s to p l a t f o r m s 19  which minimizes the cost of development. authors  To o b t a i n a s o l u t i o n , the  r e l y on the a l l o c a t i o n - l o c a t i o n a l g o r i t h m which proceeds i n the  f o l l o w i n g manner. Given an a r b i t r a r y assignment o f t a r g e t s to p l a t f o r m s , the a l g o r i t h m  f i n d s the p l a t f o r m l o c a t i o n s which minimize d r i l l i n g  Then, the t a r g e t s are r e a l l o c a t e d among the p l a t f o r m s and  platform costs given  the c o s t - m i n i m i z i n g  platform  As  such numerical  that o f  o p t i m i z a t i o n techniques, the  s o l u t i o n i s dependent on the i n i t i a l v a l u e s  over which the a l g o r i t h m  searches.  In l i g h t  authors  recommend that the problem be solved  initial  platform l o c a t i o n s .  The  with  occurs  subproblem.  i s common with  'optimal'  locations w i l l  of the new t a r g e t a l l o c a t i o n s . Convergence  when the s o l u t i o n o f the l o c a t i o n subproblem i s compatible the a l l o c a t i o n  drilling  the l o c a t i o n s . T h i s y i e l d s yet another l o c a t i o n  subproblem s i n c e , i n g e n e r a l , have changed i n l i g h t  to minimize  costs.  of t h i s  o f the parameters  shortcoming, the  f o r a number of d i f f e r e n t  m o d i f i c a t i o n s to the b a s i c approach suggested by F r a i r and Devine  [1975] and Dogru, Lesso and Brons [1977] transform  the p l a t f o r m l o c a t i o n  model i n t o something much more a k i n to a model of the development and production  o f o f f s h o r e o i l r e s e r v o i r s . While r e t a i n i n g the assumptions o f  exogenously g i v e n number and l o c a t i o n o f t a r g e t s , both papers approach the problem as a m a x i m i z a t i o n o f the present over a g i v e n p e r i o d of time.  value  o f a net revenue stream  21  As with the b a s i c s t a t i c model and o b t a i n e d by  imposing  an exogenous p r i c e path  reservoir production p r o f i l e . D r i l l i n g with  the use of equations  [1972].  Operating  p l a t f o r m and  similar  expenditures,  f o r each  the MIT  and  model, annual  f o r crude  o i l on  p l a t f o r m c o s t s are  revenues are the determined  to those d e v i s e d by Devine and  Lesso  on the other hand, are s p e c i f e d by  year.  Both approaches t r e a t r e c o v e r a b l e r e s e r v e s as a known c h a r a c t e r i s t i c of  the r e s e r v o i r .  I t i s a l s o assumed that a l l w e l l s i n a r e s e r v o i r have  the same p r o p e r t i e s i n terms of t h e i r p r o d u c t i v e c a p a b i l i t i e s . Given  an  assumed i n i t i a l  which  w e l l p r o d u c t i o n r a t e , an e x p o n e n t i a l d e c l i n e process  r e l a t e s c u r r e n t r e s e r v o i r output  to cumulative  p r o d u c t i o n i s then  20 specified  to simulate p r o d u c t i o n .  r e s e r v e s , the number of w e l l s and  Since the l e v e l of r e c o v e r a b l e the i n i t i a l  well production rate  u n i q u e l y determine the r e s e r v o i r d e c l i n e r a t e , once the v a l u e of parameters i s s p e c i f i e d , Dogru, Lesso  and  the p r o d u c t i o n p r o f i l e  Brons  o p t i m i z a t i o n techniques  the development which now system. Given inherent  the h i g h e s t pre-tax net present v a l u e of  the number of p l a t f o r m s , the model e x p l o i t s the t r a d e o f f s and  p l a t f o r m cost f u n c t i o n s and  p i p e l i n e cost f u n c t i o n which depends on ' o p t i m a l ' s o l u t i o n depends on and  field-to-shore  Devine  l e n g t h and  the i n i t i a l  platform  diameter.  introduces a Again,  the  locations.  [1975], on the other hand, ignore the q u e s t i o n of  t r a n s p o r t a t i o n but  income which i s assumed to capture They a l s o modify s l i g h t l y specified  numerical  includes a field-to-shore transportation  i n the w e l l d r i l l i n g  Frair  is fully characterized.  [1977, pp.5-6] use a number of  to f i n d  these  i n t r o d u c e an e f f e c t i v e  tax r a t e on net  a l l the e f f e c t s of t a x a t i o n p o l i c y .  the p r o d u c t i o n process by assuming that f o r a  number of years at the b e g i n n i n g  of i t s p r o d u c t i v e  life,  22  r e s e r v o i r production  w i l l be  c a p a b i l i t y . A f t e r that govern r e s e r v o i r Since before  at a r a t e l e s s than i t s  time, an e x p o n e n t i a l  d e c l i n e process i s assumed  need not  be  installed  few  programming a l g o r i t h m  to o b t a i n  problem. U n f o r t u n a t e l y ,  this  authors use  a l l wells  drilled  i n Devine and  Lesso  problem. A f t e r making a  'good' s o l u t i o n s to the  solution s t i l l  parts:  depends on  second p a r t of the  the  initial  locations.  r e s u l t s seem o b v i o u s . For example, an  of d r i l l i n g  a w e l l , c e t e r i s paribus,  (fewer) p r o d u c t i o n  platforms  models are d e f i n e d  over a s p e c i f i c  hhe  to  a l i n e a r mixed-integer  Although n e i t h e r model i s ever subjected few  as  a platform-installation/well-drilling  s i m p l i f y i n g assumptions, the  platform  nor  s t a r t s , the problem can be broken down i n t o two  an a l l o c a t i o n - l o c a t i o n problem which i s solved [1972] and  productive  production.  a l l platforms  production  constant  and  will  avoidable  increase create  vice versa. planning  absence of a shut-down r u l e e n s u r i n g  to s e n s i t i v i t y  (decrease) i n the  an  cost  i n c e n t i v e to use more  However, the horizon,  fact  that  these  i n conjunction  that p r o d u c t i o n  c o s t s exceed expected revenues, c u r t a i l s  analysis, a  with  i s stopped when  the p o t e n t i a l e f f e c t s  of changes i n the economic environment, i n c l u d i n g t a x a t i o n p o l i c y . Even i f it two  were p o s s i b l e to change the properties  relevant  and  to i n c o r p o r a t e  taxation p o l i c i e s ,  specified  implies  s t r u c t u r e of the model to e l i m i n a t e  that  the  a more d e t a i l e d d e s c r i p t i o n of  fact  the p r o d u c t i o n  T h i s , i n t u r n , suggests that  the  the number of t a r g e t s  profile  is effectively  scope o f f e r e d by  endogenous producer responses to the and  that  these  the i s pre-  exogenous.  such a model f o r  i n t r o d u c t i o n of r o y a l t i e s and  taxes,  to changes i n the economic environment would be no wider than that  o f f e r e d by  the b a s i c  s t a t i c model.  23  2.3.5  The O d e l l - R o s i n g Model O d e l l and  situated  Rosing  [1977a] have examined the economics of three  i n the B r i t i s h  s e c t o r of the North  Sea  that were e i t h e r  fields  producing  21  or scheduled  f o r development  The  devices w i l l  authors h y p o t h e s i z e  that  producers  left  different  from that which would maximize government revenues from  given f i e l d .  to t h e i r own  i n 1976.  choose a development s t r a t e g y  T h e i r model i s thus designed  any  to e v a l u a t e the e f f e c t s of  the  number and  l o c a t i o n s of p r o d u c t i o n p l a t f o r m s on the net present v a l u e  each f i e l d  and  i t s d i s t r i b u t i o n between producer  and  government over  of an  22  economically  r e l e v a n t time p e r i o d .  development and  p r o d u c t i o n i s thus  A two-dimensional divided  The  b a s i c u n i t of a n a l y s i s f o r both  the p l a t f o r m .  r e p r e s e n t a t i o n of each f i e l d  is specified  and  i n t o a number of e q u a l - s i z e d hexagons, the c e n t e r of each hexagon  being a p o s s i b l e p l a t f o r m l o c a t i o n . T h i s r e p r e s e n t a t i o n i s then used i n c o n j u n c t i o n with contour  i n f o r m a t i o n to g i v e a measure of the  under each hexagon. Under s p e c i f i c e x t r a c t i o n technology,  oil-in-place  assumptions about the nature of  the  the model d e r i v e s a measure of the volume of  p r o d u c i b l e r e s e r v e s i n each hexagonal column. I t i s then assumed that each f i x e d p l a t f o r m equipped sweep and  f o r p r o d u c t i o n and  i n j e c t i o n has  a limited  areal  can d r a i n a g i v e n maximum number of columns i n accordance  with  •  23  an exogenous p r o d u c t i o n schedule. T h i s c r e a t e s a r e l a t i o n s h i p between the f i e l d ' s p r o d u c t i v e c a p a b i l i t i e s and i t s p r o d u c t i o n p r o f i l e , on the one hand, and  the i n t e n s i t y of development, on  platforms  i n c r e a s e s , so do  field's  output  the o t h e r . As  the number of  the l e v e l of r e c o v e r a b l e r e s e r v e s and  the  at each p o i n t i n time. However, i f p l a t f o r m s are l o c a t e d  too c l o s e to one  another,  reduction in their  t h e i r drainage  t o t a l recovery  areas o v e r l a p thus c a u s i n g a  potential.  24  The  level  and  d i s t r i b u t i o n of c a p i t a l  the c o n s t r u c t i o n and  expenditures  associated  i n s t a l l a t i o n of a p l a t f o r m of known s i z e  determined exogenously. S i m i l a r l y , o p e r a t i n g expenditures over  p l a t f o r m u n i t s . T h i s i m p l i e s that each f i e l d ' s  supported  by  a unique development p l a n and  are  are  specified  production  introduces  with  profile is  some scope f o r 2 4-  o p t i m i z a t i o n over compared with that  the number and  l o c a t i o n of p r o d u c t i o n p l a t f o r m s .  the three approaches p r e v i o u s l y reviewed, i t becomes evident  the O d e l l - R o s i n g model p r o v i d e s a broader  to a f f e c t  the simulated  Since the authors c h o i c e s and  behaviour are  of the  i n t e r e s t e d i n the d i v e r g e n c e  undertaken. O d e l l and  that a l l investment  Rosing  i s debt-financed.  l o c a t i o n , a cash  v a l u e of any  given  government. The  producer  in effect  will  at the  then assume that the  Given  time  field  authors  f o r p r i v a t e producers  a number of p l a t f o r m s  and  and  present  as w e l l as i t s d i s t r i b u t i o n between producer using d i f f e r e n t  and  numbers and l o c a t i o n s  show t h a t , g i v e n government p o l i c i e s , a p r i v a t e  choose a development s t r a t e g y that i s l e s s  i n t e n s i v e than  t h a t which maximizes government revenues f o r each of the three s t u d i e d . They then v e r i f y  the  opportunity  flow approach i s used to measure the net  e x e r c i s e i s repeated  of p l a t f o r m s . The producer  between  government i n t e r e s t s , the model i n c l u d e s a d e t a i l e d  cost of money i s lower f o r the government than  their  scope f o r t a x a t i o n p o l i c i e s  producer.  d e s c r i p t i o n of the r e l e v a n t B r i t i s h p o l i c i e s study was  When  the robustness  same c o n c l u s i o n with d i f f e r e n t  fields  of t h e i r r e s u l t s by r e a c h i n g  assumptions about a number of  the  key  parameters. In l i g h t  of the assumed d i f f e r e n t i a l between p r i v a t e and  o p p o r t u n i t y c o s t s of money, a means of r e c o n c i l i n g two  p a r t i e s i s suggested.  public  the i n t e r e s t s of  I t c o n s i s t s of the government u n d e r t a k i n g  the to  25  finance  the c a p i t a l  additional  expenditures  production  platforms  p r o j e c t . The p o t e n t i a l gains  required while  and i n s t a l l the  not a c q u i r i n g an e q u i t y  share i n the  i n tax revenues due to the more i n t e n s i v e  development are shown to be great The authors do not d i s c u s s  to b u i l d  enough to warrant t h i s kind of p o l i c y .  the l i k e l y b e h a v i o u r a l  responses of p r i v a t e  firms to such an i n c e n t i v e system. A rather  s c a t h i n g c r i t i q u e o f the approach  1977] along with  a response from the authors  [Wall, Wilson and Jones  [ O d e l l and Rosing  appeared l e s s than a year a f t e r the p u b l i c a t i o n o f t h e i r dust  had s e t t l e d ,  productive  i s s u e . Wall et a l . claimed  assumption i s indeed  horizon  [1977b, p.301]. Although Wall et a l .  to the a n a l y s i s and c e n t r a l to t h e i r  O d e l l and Rosing.  e x t r a c t i o n and u l t i m a t e l e n g t h of the p r o d u c t i o n  the p o s s i b l e c o n f u s i o n  recovery.  By r e l y i n g  on an exogenously  limits,  from a g i v e n  specified  indeed  that p e r i o d . For short  enough  expect cumulative e x t r a c t i o n to i n c r e a s e  the number of w e l l s used to produce a g i v e n  certain  of cumulative  p e r i o d , O d e l l and Rosing's a n a l y s i s concerns  cumulative e x t r a c t i o n d u r i n g  time p e r i o d s , one should with  that the  on t h i s p o i n t , the assumption of a p r e - s p e c i f i e d  The problem r e s t s with  i t s e l f with  of such a  f o r an a n a l y s i s of the problem i n an  time p e r i o d "  is crucial  disagreement with  contentious  that the assumption of the e x i s t e n c e  warranted  relevant  chose not to dwell planning  as the most  i s unwarranted. O d e l l and Rosing countered  "economically  study. Once the  the r e l a t i o n s h i p between s p a t i a l coverage and the  c a p a b i l i t i e s of a r e s e r v o i r surfaced  relationship  1977b]  f i e l d . However,  within  the q u a n t i t y of crude o i l that can u l t i m a t e l y be  field  will  g e n e r a l l y tend  number of w e l l s used to produce i t .  25  to be r e l a t i v e l y u n a f f e c t e d  recovered by the  26  T h i s i s not a f i e l d may  be  to deny t h a t , i n some cases,  the g e o l o g i c a l p r o p e r t i e s  such that some r e s e r v e s might never be  produced  of  i f a more  26  i n t e n s i v e p a t t e r n of development were not to suggest that production end  of the p e r i o d  and  i n t e n s i v e development  ultimate  Stiglitz  recovery  ignored  tend  by  the c r i t i c s ,  that r e s e r v o i r development  e a s i l y be r e v e r s e d  i f different  i s reminded of a r e s u l t  to favour more  a l s o seems to  i s not  few  t a x a t i o n p o l i c i e s had  obtained  change i f a more c o n v e n t i o n a l Odell-Rosing  problems caused by  as two  resource  i n t e r e s t i n g to f i n d out  by Dasgupta, Heal  whether O d e l l and  and  r e p r e s e n t a t i o n of the  Rosing's r e s u l t s would  the p l a t f o r m  l o c a t i o n model  the  h o r i z o n . Even i f i t were p o s s i b l e  to c o n s t r u c t  a  the  three-dimensional  under study removes any  comparative  that t h i s approach might have except i n cases where these data available.  any  It would  change the o p t i m i z a t i o n c r i t e r i o n ,  required field  the  o b j e c t i v e were adopted.  an exogenous p l a n n i n g  information  as  been  p o l i c y instruments to make  a l l o c a t i o n p r i v a t e l y optimal.  model shares with  to r e l a x t h i s c o n s t r a i n t and geological  be  intensive  [1980, pp.170-171] showing t h a t , under c e r t a i n c o n d i t i o n s ,  p a t t e r n of i n t e r t e m p o r a l  The  which w i l l  the  the model uses the m a x i m i z a t i o n of government revenues  government can manipulate as  a l s o be  the  patterns.  an o b j e c t i v e , the c o n c l u s i o n  m o d e l l e d . One  l e n g t h of  d r i v e a wedge between cumulative e x t r a c t i o n at  Another p o i n t , completely  enough c o u l d  Rather, i t i s meant  the exogenous s p e c i f i c a t i o n of the  p e r i o d may  important. Since  adopted.  advantage are r e a d i l y  27  2.3.6 The Lowenstein Model 1  The basic  t h r u s t of L o w e n s t e i n s paper i s c l e a r l y  intent  process"  i s to add f l e x i b i l i t y  [Lowenstein  1977, p.10].  s t a t e d : " [ t ] h e model's  to the c h o i c e o f the p r o d u c t i o n By a l l o w i n g the model to simulate the  c h o i c e o f a p r o d u c t i o n p r o f i l e , Lowenstein hopes to c r e a t e a r i c h e r framework o f a n a l y s i s which would p r o v i d e a more complete r e p r e s e n t a t i o n of  the o p t i o n s a v a i l a b l e to a n e t - p r e s e n t - v a l u e - m a x i m i z i n g  particular  interest  to the author  producer. Of  are the e f f e c t s o f government  policies  on producer d e c i s i o n s . In t h i s model, the w e l l emerges as the b a s i c u n i t o f p r o d u c t i o n . In c o n j u n c t i o n with t r e a t i n g characteristic  the l e v e l o f r e c o v e r a b l e r e s e r v e s as a known  o f the r e s e r v o i r , Lowenstein makes two assumptions t h a t  enable  him to d e s c r i b e the p r o d u c t i v e c a p a b i l i t i e s o f a g i v e n  First,  as was the case with  reservoir  reservoir.  the p l a t f o r m l o c a t i o n model, a l l w e l l s i n a  are assumed to have the same p r o p e r t i e s i n terms o f t h e i r  productive c a p a b i l i t i e s .  Second, the l e v e l o f r e c o v e r a b l e r e s e r v e s i s 27  assumed not to be a f f e c t e d by the speed o f r e c o v e r y .  Given  an assumed  i n i t i a l w e l l p r o d u c t i o n r a t e , an e x p o n e n t i a l d e c l i n e process which r e l a t e s current  to cumulative  reservoir The  extraction i s specified  and assumed to c h a r a c t e r i z e  production. capital  expenditures  undertaken i n any g i v e n year are d e f i n e d  across a number o f c a t e g o r i e s and depend on the l e v e l o f a c t i v i t y . Operating  expenditures  are s p e c i f i e d by p l a t f o r m and f o r each year o f  o p e r a t i o n . Each p o s s i b l e p r o d u c t i o n p r o f i l e unique development s t r a t e g y which c a r r i e s expenditures,  operating expenditures  and  i s t h e r e f o r e a s s o c i a t e d with a  i m p l i e d streams o f c a p i t a l revenues.  28  T h i s degree of f l e x i b i l i t y i n the model's r e p r e s e n t a t i o n of c h o i c e of a p r o d u c t i o n p r o f i l e  and  the l i n k a g e s between development  p r o d u c t i o n are e x p l o i t e d i n the f o l l o w i n g manner. Given for  the  a starting  and time  p r o d u c t i o n , i t i s p o s s i b l e f o r the model to choose a r e s e r v o i r d e c l i n e  r a t e and  the a s s o c i a t e d development p l a n which support  production p r o f i l e  the i m p l i e d  that maximizes the net present v a l u e of  the  28 reservoir. may  However, the r e s u l t i n g  steadily declining  r e q u i r e the i n s t a l l a t i o n of l a r g e q u a n t i t i e s of p r o d u c t i v e  more and more of which w i l l Such circumstances e a r l y years  be  i d l e as r e s e r v o i r  foregone  output-cumulative  i s s u e s i n the f o l l o w i n g way.  than the peaked p r o f i l e  annual  f o r some years which, with i t s i n a h i g h e r net present v a l u e of the  and  a s s o c i a t e d development  with the same r e s e r v o i r d e c l i n e r a t e . The  still  current  p r o d u c t i o n r e l a t i o n s h i p of the e x p o n e n t i a l d e c l i n e  a s s o c i a t e d development p l a n , r e s u l t s  compatible  present  The  i s used to i d e n t i f y a d e p l e t i o n p r o f i l e with a l e v e l of  reservoir  falls.  revenues.  p r o d u c t i o n that c o u l d be maintained  profile  production  would c r e a t e i n c e n t i v e s to reduce e x t r a c t i o n i n the  The model d e a l s with these  process  lying  profile  capital,  i f the present v a l u e of the cost savings exceeds the  v a l u e of the  embodies the u n r e a l i s t i c  of the r e s e r v o i r . A more r e a l i s t i c  year of the  treatment  plan  resulting depletion  assumption that the  p r o d u c t i o n i s at i t s h i g h e s t p o i n t i n the f i r s t life  production  would be  flow of productive to a l l o w f o r a  g r a d u a l b u i l d - u p of the r e s e r v o i r ' s p r o d u c t i v e c a p a b i l i t i e s as more w e l l s are assumed to be d r i l l e d  into  the s t r u c t u r e . U n f o r t u n a t e l y , the approach  adopted by Lowenstein can not r e a d i l y be m o d i f i e d feature.  to i n c o r p o r a t e such  a  29  The the  model has  f i v e c h o i c e v a r i a b l e s : the  r e s e r v o i r d e c l i n e r a t e , the  period  of p r o d u c t i o n ,  d e c l i n e r a t e need not of w e l l s d r i l l e d once d e c i s i o n s  and,  initial  before  a f t e r production  has  p e r i o d of development,  l e v e l of p r o d u c t i o n ,  since a l l wells  be d r i l l e d  first  implied  by  production  the  the r e s e r v o i r  can b e g i n ,  s t a r t e d . The  the c h o i c e  secondary importance. No  of an optimal  r e s u l t s are r e p o r t e d  the  timing  author r e p o r t s  are made about the r e s e r v o i r d e c l i n e r a t e and  l e v e l of p r o d u c t i o n ,  last  drilling  that  the  initial  schedule i s of  f o r the other  two  decision  variables. The should  p o t e n t i a l e f f e c t s of government p o l i c i e s  now  be  i n f l u e n c e d by  the e f f e c t s of t a x a t i o n and  assumption that  the  hence, p r o d u c t i o n  i s s o c i a l l y optimal,  economic l o s s e s a s s o c i a t e d  profile.  addresses t h i s problem f o r three North Sea  .  B r i t i s h government.  29  The  p o s s i b i l i t y of d e v e l o p i n g  further It simulate  of  Furthermore, under  the  problem unconstrained  i t i s p o s s i b l e to measure  with government  s u b s t a n t i a l economic l o s s e s can be  be  r e g u l a t i o n i n his choice  s o l u t i o n to the o p t i m i z a t i o n  government p o l i c i e s  producers and  approach  c l e a r . A n e t - p r e s e n t - v a l u e - m a x i m i z i n g producer may  development p l a n and,  .  i n such an  by  the  i n t e r v e n t i o n . Lowenstein r e s e r v o i r s and  a t t r i b u t e d to the  author mentions that  this  finds  that  tax p o l i c i e s of suggests  the  the  p o l i c i e s which would leave both p r i v a t e  s o c i e t y i n b e t t e r p o s i t i o n s . However, t h i s r e s u l t i s not  exploited. should  a l s o be mentioned that  the paper does not  the e f f e c t s of d i f f e r e n t assumptions about the  environment on by e x t e n s i o n , government  the on  s o c i a l l y and  p r i v a t e l y optimal  the magnitude of the  policies.  attempt  to  economic  development plans  economic l o s s e s  induced  by  and,  30  2.4  Concluding  Remarks  T h i s review  of f i v e d e t e r m i n i s t i c models of the development  p r o d u c t i o n of o f f s h o r e r e s e r v o i r s has  served  to h i g h l i g h t  of d e s i r a b l e p r o p e r t i e s of such models. F i r s t , investment and  p l a n , the time  net-present-value expenditures  an equal  the lumpiness  of  l a g between between development and  the time-consuming nature  of the process  imply  and number  the  production  that a  approach which d i s c o u n t s streams of revenues  at an a p p r o p r i a t e r a t e should be used to study  and  the economics  of o f f s h o r e r e s e r v o i r s . Furthermore, i f the model i s to have anything say about the impact should  of r o y a l t i e s  include a detailed  and  taxes on producer  behaviour, i t  d e s c r i p t i o n of the r e l e v a n t t a x a t i o n systems.  Second, s i n c e the model seeks to s i m u l a t e  the behaviour  economic agents i n a l t e r n a t i v e s t a t e s of the world,  endogenous d e t e r m i n a t i o n of the p r o d u c t i v e l i f e  rational  of each  a l l o w f o r the reservoir.  T h i r d , at the core of the model should be a systematic which each exogenously s p e c i f i e d  of  i t should be c a s t i n  an o p t i m i z a t i o n framework. For example, the model should  through  to  relationship  development p l a n c o u l d  be  a s s o c i a t e d with a unique e x t r a c t i o n p r o f i l e which would be c o n s i s t e n t w i t h the u n d e r l y i n g c h a r a c t e r i s t i c s or a t t r i b u t e s of each r e s e r v o i r . T h i s would widen the scope f o r o p t i m i z a t i o n o f f e r e d by s p e c i f i c a l l y , would a l l o w i t to r e f l e c t taxes  and  the model and, more  the dynamic e f f e c t s of  the economic environment i n g e n e r a l on the producer's  a development p l a n . However, s i n c e the p h y s i c a l p r o p e r t i e s of reservoirs generally influence their producibility, f l e x i b i l i t y which the model makes a v a i l a b l e overstated.  royalties, choice of individual  the degree of  to the producer  should not  be  31  Fourth,  i n a p p l i e d economic  s t u d i e s of  this  b u i l d models which i n c o r p o r a t e the key f e a t u r e s which r e s e r v o i r s  are developed  reservoirs fields  and f i e l d s  which c o n s i s t  Finally, its of  it  sensitivity  same v e i n , thus  wells d r i l l e d  of more than one  should be p o s s i b l e  the  the model should of i n d i v i d u a l  and made  study of the  to  through  available  the model should d i f f e r e n t i a t e  facilitating  between  economics  of  reservoir.  to submit the model to an a n a l y s i s  to changes i n c e r t a i n key parameters.  a d e t e r m i n i s t i c model, t h i s  effects  the processes  the p r o d u c t i v e c a p a b i l i t i e s  as p l a t f o r m s are i n s t a l l e d ,  for p r o d u c t i o n . In the  of  one should seek  and produced. For example,  a l l o w for a g r a d u a l b u i l d - u p of reservoirs  kind,  W i t h i n the  of  context  would a l l o w for a l i m i t e d study of  the  of u n c e r t a i n t y and t h e i r d i s t r i b u t i o n between government and  producer. Another aspect of of  attention:  a l l of  the d e t e r m i n i s t i c models  them cast  the development  reviewed  above  and p r o d u c t i o n of  reservoirs  i n a p a r t i a l e q u i l i b r i u m framework. Two reasons  using this  type of approach to analyse  project  such as the development  an incomplete  picture.  First,  the  of a g i a n t  is  oil  offshore  suggest  i m p l i c a t i o n s of a offshore  worthy  that  'large'  field will  the p r o j e c t may have r e p e r c u s s i o n s  produce  that  cannot be captured or adequately measured by a c e t e r i s p a r i b u s approach. Second, a p a r t i a l e q u i l i b r i u m approach does not economic  environment  the economics  induced by the p r o j e c t  of the p r o j e c t  to  a l l o w changes i n filter  the  through and  affect  itself.  Robinson and Morgan [1977;1978, chapter 8]  offer  a l i m i t e d assessment 30  of use  the macroeconomic the b a s i c  likely  static  s c a l e of  implications  of the North Sea developments.  model i n c o n j u n c t i o n with assumptions  f u t u r e developments  about  and f o r e c a s t s of a few key  They the  32  macroeconomic v a r i a b l e s to estimate  the e f f e c t s of North Sea  economy. Although t h i s approach p r o v i d e s  o i l on  a l i m i t e d means of c a p t u r i n g  e f f e c t s of o f f s h o r e development on an open economy, i t does not project-induced on  the  to i n c o r p o r a t e  the  allow  macroeconomic e f f e c t s and next chapter  problem  the p r o j e c t i n t o a macroeconomic model of a  n a t i o n a l economy. T h i s would p r o v i d e  The  UK  changes i n the economic environment to be brought to bear  a n a l y s i s . A more c o n s i s t e n t method of approaching t h i s  would be  the  both a method of c a p t u r i n g  the  a feedback mechanism.  o u t l i n e s an approach that t r i e s  to i n c o r p o r a t e a l l  these elements i n t o a s i m u l a t i o n model of the development and o f o f f s h o r e petroleum r e s e r v o i r s .  production  33  FOOTNOTES T h i s i s not to say that the i n t e r v e n i n g p e r i o d witnessed no c o n t r i b u t i o n s to t h i s l i t e r a t u r e ( s e e , f o r example, McDonald [1961]) but r a t h e r that the papers i n Gaffney [1967] c o n s o l i d a t e d the work done i n t h i s f i e l d and opened new avenues o f r e s e a r c h . For example, Dasgupta and Heal [1979, chapter 12] assume that the m a r g i n a l cost of e x t r a c t i o n i s c o n s t a n t . Conrad and Hool [1980;1981] assume that the m a r g i n a l cost of e x t r a c t i o n i s e i t h e r constant or growing with the l e v e l of e x t r a c t i o n i n each p e r i o d . The above d i s c u s s i o n was l a r g e l y based on r e s u l t s presented i n Conrad and Hool [1980, chapter 3] and Lewis and Slade [1983]. See, f o r example, p.30] . For  example,  Sweeney [1977, p.129] and Conrad and Hool  see Lewis and  Slade [1983,  pp.25-34].  See, f o r example, Dasgupta and Heal [1979, pp.361-363], [1983, p . l ] and Slade [1983, pp.1-2]. See Dasgupta  [1981,  and Heal [1979, chapter 12] and Church  Lewis and Slade  [1981, chapter 3 ] .  Although s i m i l a r s t u d i e s have been done f o r a number of e x t r a c t i v e i n d u s t r i e s , I have chosen to review o n l y those c o n t r i b u t i o n s which examine the e f f e c t s of t a x a t i o n on o f f s h o r e o i l e x p l o i t a t i o n . B r a d l e y , H e l l i w e l l and L i v e r n o i s [1981], F o l e y and C l a r k [1982], H e l l i w e l l [1978] and Slade [1983] are examples of s t u d i e s examining the e f f e c t s of r e s o u r c e t a x a t i o n i n other e x t r a c t i v e i n d u s t r i e s . 9 10  11 12  1 3  1 4  Appendix  1 c o n t a i n s a l g e b r a i c r e p r e s e n t a t i o n s of most of these models.  See, f o r example, [1975] .  Davis [1981], Kemp [1975] and MacKay and Mackay  See a l s o Morgan and Robinson  [1976a;1976b] .  T h i s approach o f f e r s no convenient way of d i f f e r e n t i a t i n g between r e s e r v o i r s and f i e l d s . T h e r e f o r e , to s i m p l i f y the e x p o s i t i o n , i t w i l l be assumed that each f i e l d c o n s i s t s of a s i n g l e r e s e r v o i r . As w i t h a l l the models reviewed i n t h i s c h a p t e r , the p o t e n t i a l f o r choosing the f i r s t p e r i o d of p r o d u c t i o n remains l a r g e l y u n e x p l o r e d . With the e x c e p t i o n of the MIT model ( t o be reviewed n e x t ) , i t i s s p e c i f i e d exogenously. See Adelman et a l . [1976], Adelman and Jacoby [1977], B e a l l [1976], Eckbo [1977;1979a;1979b] and Eckbo, Jacoby and Smith [1978].  34 \  15  16  17  18  19  20  21 22  23  The p o t e n t i a l f o r expanding the s e t o f independent v a r i a b l e s was r e c o g n i z e d e a r l y on (see Adelman e t a l . [1976, pp.15-19]) but never acted upon (see Eckbo, Jacoby and Smith [1978, pp.222- 223] and Eckbo [1979a, p . 4 1 ] ) . S u f f i c e i t so say that the e x t e n s i o n r e q u i r e d to c o n s i d e r a d i f f e r e n t d e b t - e q u i t y f i n a n c i n g r a t i o i s s t r a i g h t f o r w a r d and can e a s i l y be i n c o r p o r a t e d i n t o the a n a l y s i s as shown i n Eckbo, Jacoby and Smith [1978, pp.222-224]. A g i v e n r e s e r v o i r sees i t s development and p r o d u c t i o n simulated as soon as the net present v a l u e to i t s producer i s p o s i t i v e . Other than t h a t , no e f f o r t i s made to examine the economics o f postponement. Since i t i s assumed that each w e l l reaches o n l y one t a r g e t , the number of w e l l s must equal the number o f t a r g e t s . T h e r e f o r e , assuming that the number and l o c a t i o n o f t a r g e t s are exogenously determined i m p l i e s that the number and l o c a t i o n o f w e l l s are a l s o exogenous. It i s , o f c o u r s e , p o s s i b l e to repeat the e x e r c i s e u s i n g a d i f f e r e n t number of p l a t f o r m s and thus o b t a i n a s o l u t i o n which i s 'optimal' along yet another dimension. T h i s method i s used e x t e n s i v e l y throughout the petroleum i n d u s t r y ( s e e , f o r example, Campbell [1959, c h a p t e r 9] and Nind [1981, chapter 2 ] ) . The  fields  i n q u e s t i o n are F o r t i e s , Montrose  and P i p e r .  Although n o t h i n g i n the l o g i c o f the approach r e q u i r e s t h i s assumption, the f i r s t p e r i o d o f p r o d u c t i o n i s not t r e a t e d as a c h o i c e v a r i a b l e . I n s t e a d , the authors use e i t h e r the a c t u a l p r o d u c t i o n s t a r t - u p date (as i n the case of F o r t i e s ) or that i m p l i e d by the a c t u a l development p l a n s . I t should be noted that a l l three f i e l d s were under p r o d u c t i o n by the time the study was completed. T h i s makes any d i s t i n c t i o n between ' f i e l d ' and ' r e s e r v o i r ' l a r g e l y i r r e l e v a n t f o r the purposes o f s i m u l a t i n g development and p r o d u c t i o n u s i n g t h i s model.  2h Although t h i s d e s c r i p t i o n conveys the essence o f the approach used by O d e l l and Rosing, the s o l u t i o n procedure i s i n f a c t s l i g h t l y more complex than suggested. The authors assume that a hexagonal column can o n l y be produced i f i t i s reached by a w e l l . Given the number and s i z e of p l a t f o r m s , the a l l o c a t i o n - l o c a t i o n a l g o r i t h m ( d i s c u s s e d i n s u b s e c t i o n 2.3.4 above) i s used to determine the maximum q u a n t i t y of o i l that can be r e c o v e r e d from a g i v e n r e s e r v o i r . T h i s o p t i m i z a t i o n procedure i s then repeated f o r a d i f f e r e n t number (and, by e x t e n s i o n , d i f f e r e n t locations) of platforms. 25  26  See B r a d l e y [1967, chapter 4 and e s p e c i a l l y pp.43-48] and the references given therein. Montrose, f o r example, [1977a, pp.107-114].  appears to be such a c a s e . See O d e l l and Rosing  35  These assumptions are f r e q u e n t l y encountered i n d i s c u s s i o n s of simple techniques designed to represent r e s e r v o i r p r o d u c t i o n p r o c e s s e s . For example, see Nind [1981, pp.361 and 377]. Bradley [1967, chapter 4] a l s o dwells on t h i s t o p i c . In the context of t h i s model, choosing a r e s e r v o i r d e c l i n e r a t e amounts to choosing the number of p r o d u c t i o n w e l l s . The r e s e r v o i r s s t u d i e d are Cormorant (which i n a l l l i k e l i h o o d r e f e r s o n l y to South Cormorant), F o r t i e s and E k o f i s k . The author assumed that a l l three were s i n g l e - r e s e r v o i r f i e l d s . It should a l s o be noted that E k o f i s k , although s i t u a t e d under Norwegian waters, saw i t s development and p r o d u c t i o n simulated as i f i t were s u b j e c t to B r i t i s h p o l i c i e s . Other s t u d i e s of the macroeconomic i m p l i c a t i o n s of North Sea o i l and n a t u r a l gas i n c l u d e MacKay and Mackay [1975], Gaskin and Chipman [1978] and Lewis and M c N i c o l l [1978].  36  CHAPTER 3 THE OFFSHORE DEVELOPMENT MODEL: OUTLINE AND APPLICATION  3.1 I n t r o d u c t i o n As i t s t i t l e outlines  i n d i c a t e s , t h i s chapter performs  the o f f s h o r e development model developed  two main f u n c t i o n s . I t and used  in this  thesis,  and d e s c r i b e s i t s a p p l i c a t i o n to the case o f H i b e r n i a . Thus, s e c t i o n  3.2  develops an economic model of the development and p r o d u c t i o n of o f f s h o r e oil  d e p o s i t s that  i s based  on the f e a t u r e s suggested  i n the l a s t  section  of chapter 2 above. Emphasis i s p l a c e d on d e v e l o p i n g a n u m e r i c a l l y t r a c t a b l e model which o f f e r s a number of channels through which government p o l i c i e s and  the g e n e r a l economic environment  can a f f e c t  the s i m u l a t e d  behaviour of a n e t - p r e s e n t - v a l u e - m a x i m i z i n g producer. Some of the p r o p e r t i e s and  shortcomings  of the model are a l s o d i s c u s s e d i n t h i s  section. S e c t i o n 3.3  d e s c r i b e s how  t h i s model i s a p p l i e d  H i b e r n i a . A b r i e f d e s c r i p t i o n of the f i e l d ' s d i s c u s s i o n of the problems  likely  to the case o f  characteristics  to be a s s o c i a t e d with  prefaces a  petroleum  development and p r o d u c t i o n i n t h i s area of the North A t l a n t i c , and of their  i m p l i c a t i o n s of consequence to t h i s  model i s then t a i l o r e d  to r e f l e c t  study. The o f f s h o r e development  the s p e c i f i c  case of H i b e r n i a . In  a d d i t i o n , an o u t l i n e o f the r e l e v a n t r e g u l a t i o n and p r o v i d e d . S t u d i e s o f the economic v i a b i l i t y in this  t a x a t i o n systems  is  of H i b e r n i a are a l s o d i s c u s s e d  s e c t i o n . An examination of the scope of these s t u d i e s and of the  methods on which they were based w i l l improvements and  p o i n t the way  to p o s s i b l e  e x t e n s i o n s . In c e r t a i n c a s e s , the c o n c l u s i o n s reached  these s t u d i e s w i l l  a l s o p r o v i d e a set of benchmarks a g a i n s t which to  by  37  compare the r e s u l t s obtained Finally, necessary of  i n this  thesis.  s e c t i o n 3.4 o u t l i n e s the e x t e n s i o n s  to the approach  to s e t the development and p r o d u c t i o n o f H i b e r n i a i n the context  the n a t i o n a l economy. Linkages  the Canadian economy used  between the macroeconometric model o f  i n the a n a l y s i s and the o f f s h o r e development  model, as i t a p p l i e s to H i b e r n i a , are a l s o d i s c u s s e d i n d e t a i l .  3.2 A Model o f the Development and P r o d u c t i o n o f O f f s h o r e O i l D e p o s i t s 3.2.1 Overview o f the Model The model developed petroleum  deposit  and used i n t h i s t h e s i s  t r e a t s an o f f s h o r e  (or f i e l d ) as a set o f non-communicating  which c o n t a i n crude  o i l o f a known and uniform  reservoirs  q u a l i t y . Each r e s e r v o i r i s  assumed to be homogeneous and to be d e s c r i b e d by two a t t r i b u t e s : p r o d u c t i v i t y o f a w e l l and i n i t i a l model accepts exogenously determined  stock o f r e c o v e r a b l e r e s e r v e s . The values  f o r these a t t r i b u t e s and  assumes that the s t o c k o f r e c o v e r a b l e r e s e r v e s i n each r e s e r v o i r p h y s i c a l measure of r e s o u r c e on the use o f secondary d e c l i n e process  initial  is a  a v a i l a b i l i t y whose magnitude i s c o n d i t i o n a l  recovery  techniques. A modified  exponential  i s used to c h a r a c t e r i z e the d e c l i n e behaviour  o f the  p r o d u c t i v e c a p a b i l i t i e s o f i n d i v i d u a l w e l l s and hence, the p r o d u c t i o n profile  f o r each r e s e r v o i r  and thus  f o r the f i e l d  as a whole.  Each p r o d u c t i o n p l a t f o r m must be c o n s t r u c t e d and i n s t a l l e d w e l l s can be d r i l l e d  and made a v a i l a b l e  before i t s  f o r p r o d u c t i o n . By r e l y i n g on an  exogenous s p e c i f i c a t i o n o f the number o f p r o d u c t i o n w e l l s c o n t a i n e d p l a t f o r m and by keeping r e s e r v o i r s and over production p r o f i l e  t r a c k of the d i s t r i b u t i o n o f p l a t f o r m s  time,  in a  across  the model can d e r i v e endogenous responses  to changes i n the number o f the d i s t r i b u t i o n o f  o f the  38  platforms  (and hence w e l l s ) used to produce the f i e l d . T h i s r e v e a l s a key  p r o p e r t y of the model: i t e s t a b l i s h e s a one-to-one r e l a t i o n s h i p between development plans and s i m u l a t e the behaviour producer  of a p r i c e - t a k i n g ,  under c o n d i t i o n s of  The  net-present-value-maximizing  that o p t i m a l producer  f o r f i v e aspects of development and  to choose the f i r s t  i s e x p l o i t e d to  certainty.  s t r u c t u r e of the model i s such  simulated allowed  production p r o f i l e s . This property  p r o d u c t i o n . The  p e r i o d of development  f o r the  choices  are  producer  is  field  as a  whole, the number of p l a t f o r m s u l t i m a t e l y used to d r a i n the f i e l d , d i s t r i b u t i o n of p l a t f o r m s among r e s e r v o i r s , each p l a t f o r m and simple  the dates  the l e n g t h of the p r o d u c t i v e l i f e  extension w i l l  permit  a s i x t h dimension  of f i r s t  the  activity  of each r e s e r v o i r .  on A  to the o p t i m i z a t i o n  p r o c e s s : the model can a l s o be used to s i m u l a t e the c h o i c e of the type of p r o d u c t i o n system. However, the a t t r i b u t e s of each r e s e r v o i r assumed e x p o n e n t i a l d e c l i n e process  combine to c u r t a i l  and  the  the degree of  f l e x i b i l i t y o f f e r e d by the model when s i m u l a t i n g the behaviour  of a  r a t i o n a l producer.  the  Through t h i s ,  the model attempts to r e f l e c t  consequences of the g e o l o g i c a l and of o f f s h o r e petroleum One  g e o p h y s i c a l c o n s t r a i n t s that  d e p o s i t s are l i k e l y  to f a c e .  of the uses which can be made of t h i s model, and  be emphasized  of a r a t i o n a l producer.  i n c o r p o r a t i n g d e t a i l e d d e s c r i p t i o n s of some r e g u l a t i o n and a l l o w i n g the producer  a f t e r - t a x r e t u r n s , the model w i l l  to o p t i m i z e  which  will  a l l o w us  t a x e s . A s i m i l a r procedure  By  taxation  the net present v a l u e of h i s  to estimate  the p o t e n t i a l d i s s i p a t i o n of net b e n e f i t s induced r o y a l t i e s and  one  i n subsequent c h a p t e r s , i s to study the consequences of  government p o l i c i e s on the behaviour  systems and  producers  the magnitude of  by the a p p l i c a t i o n of  can a l s o be used to t e s t  the  39  model's s e n s i t i v i t y  3.2.2  v a r i a b l e s and  f o l l o w i n g d e s c r i p t i o n of the o f f s h o r e  detailed  than that of the  chapter 2 and  model used and  key  types of d e t e r m i n i s t i c models to be  appendix 1. T h i s  in this  production  five  t h e s i s and  development model i s more  i s i n part due  i t s emphasis on  to the  c h a r a c t e r i z a t i o n of the  time-consuming nature of the  the development and Therefore,  production  of o f f s h o r e  a number of the equations that  the r e l e v a n t  first  activities  are  margins are emphasized by  It  are more  in real  undertaken, when aspects  to o c c u r . It i s hoped a better  production t  Q  —  i n a l l c a l c u l a t i o n s . This  feel  of  that  f o r which modelling  i n annual terms  revenues  are  i s exogenously s p e c i f i e d assumption g r e a t l y  task of model d e s c r i p t i o n . However, the  c u r r e n t - d o l l a r b a s i s does not it  get  pointers  significant  that the model i s d e f i n e d  terms. A time p e r i o d —  the base year used the  first  define  f o r which aspects of the  that a l l e x p e n d i t u r e requirements and  simplifies  a better  rigid.  i s assumed throughout  expressed as  the model and  extra  a c t i v i t i e s r e l a t e d to  f o l l o w simply  simulated  through t h i s d e s c r i p t i o n , the reader w i l l  effort  development  to p r o v i d e  produced as w e l l as when other  offshore  the  petroleum r e s e r v o i r s .  which i n d i c a t e when development e x p e n d i t u r e s are r e s e r v o i r s are  the  of i n d i v i d u a l r e s e r v o i r s . A l a r g e p o r t i o n of the t r a c e d back to an attempt  found  s t r u c t u r e of  simulating  d e t a i l , however, can be  and  parameters.  Model D e s c r i p t i o n The  in  to changes i n other  shift  a f f e c t the model's u n d e r l y i n g  i s t h i s c u r r e n t - d o l l a r v e r s i o n which i s i n f a c t used  to a properties  i n the  be emphasized  and  subsequent  c h a p t e r s of t h i s  t h e s i s . N o n e t h e l e s s , i t should  that  d e s c r i p t i o n that  f o l l o w s , a l l r e l e v a n t magnitudes are expressed  i n the  in units  40  of t  Q  dollars.  In a manner s i m i l a r  to that adopted  o f f s h o r e development model used i n t h i s production well d r i l l e d  i n the O d e l l - R o s i n g model, the t h e s i s assumes that each  from a g i v e n p l a t f o r m can reach o n l y one  r e s e r v o i r . However, not a l l the w e l l s whose p r o d u c t i o n  i s gathered  g i v e n p l a t f o r m need tap the same r e s e r v o i r . In i t s present assumes that each p l a t f o r m can gather maximum o f two r e s e r v o i r s . Although  by a  form, the model  the crude o i l e x t r a c t e d from a  t h i s assumption i s not r e q u i r e d to  c l o s e the model, i t i s made because i t f a c i l i t a t e s  the task o f d e s c r i b i n g  the model. Finally,  as was mentioned e a r l i e r ,  a t t r i b u t e s of the d e p o s i t the  (or f i e l d ) .  f i e l d . A second a t t r i b u t e  the model accepts v a l u e s  First  f o r three  i s the number o f r e s e r v o i r s i n  i s the i n i t i a l  productive c a p a b i l i t i e s  w e l l i n each r e s e r v o i r . T h i r d i s the l e v e l o f r e c o v e r a b l e r e s e r v e s as with  four o f the models reviewed i n chapter  of r e s o u r c e  stock)  i n each  reservoir.  (3.1)  years o f development —  field  tl"' —  f o r p l a t f o r m s with w e l l s  1 J  1  = t 1  + h(np..) J l  independently the p r o d u c t i o n  n  Pij  p e r i o d o f development f o r  h(«) :> 0 .. .. t = t for i,j=l,...,s. 1  J  1  In t h i s e q u a t i o n ,  independent-  t\:  as a whole —  t. t  the obvious  shows the r e l a t i o n s h i p between the v e c t o r o f  l y r e a c h i n g r e s e r v o i r s i and j , and the f i r s t the  with,  the task o f d e s c r i b i n g the model i s w i t h development  a c t i v i t i e s . Equation first  (here,  2 above, a p h y s i c a l measure  Now that the p r e l i m i n a r i e s have been dispensed p l a c e to b e g i n  of a  represents  J  (3.1)  1  1  J  the number o f p l a t f o r m s  with  wells  r e a c h i n g r e s e r v o i r s i and j which i s u l t i m a t e l y used period.  during  41  The r o l e of the  function h(•)  i n the above e q u a t i o n i s  to a s s i g n a  number to each r e l e v a n t p l a t f o r m which determines how many years its  first  p e r i o d of c o n s t u c t i o n a c t i v i t y  bounded below by zero s i n c e the  first  Since i t  the  first  from t^.  be r e q u i r e d  p e r i o d o f development  later,  let  The v a l u e of h ( » ) i s  period of c o n s t r u c t i o n a c t i v i t i e s  p l a t f o r m to be i n s t a l l e d on the will  separate  f i e l d must be the same as  us now d e f i n e  for r e s e r v o i r i . T h i s  is,  i • t^ as the  of c o u r s e ,  on  t^.  first  equal to  the  -t. smallest  element  i n the v e c t o r  t^. •f.  To ensure c o n s i s t e n c y represent wells  the v e c t o r of  w i t h the n o t a t i o n used i n appendix 1,  last  p e r i o d s of development  independently r e a c h i n g r e s e r v o i r s i t. t  let  t ^  for p l a t f o r m s w i t h  and j :  -t.  1 J  = t i  h  1 J  E q u a t i o n (3.2)  + m  m given.  simply s t i p u l a t e s  that  (3.2)  the l a s t  p e r i o d of development  for  any g i v e n p l a t f o r m i s modelled to occur a p r e - s p e c i f i e d number of years — m — after  the b e g i n n i n g o f c o n s t r u c t i o n a c t i v i t i e s  on that p l a t f o r m .  Now,  *. i • let last  •  t^ be the l a r g e s t  element  p e r i o d of development  ii  i n the v e c t o r  activities  Annual c a p i t a l e x p e n d i t u r e s  (in t  t^ and thus r e p r e s e n t  related Q  to r e s e r v o i r i .  d o l l a r s ) on p r o d u c t i o n p l a t f o r m s  w i t h w e l l s i n d e p e n d e n t l y r e a c h i n g r e s e r v o i r s i and j — C E £ j o b t a i n e d as  follows: 0  if  t  —  Therefore, related  =  the  ? ii )  Y  a  r  e  tj*> t > t**  p  CE. .  the  (3.3)  • CEP  £  kt  ij  level  of c a p i t a l e x p e n d i t u r e s  to r e s e r v o i r s i and j i s  otherwise;  CEP., given.  undertaken at time t and  equal to a weighted  sum of p l a t f o r m c o s t s  42  across the  a l l relevant platforms.  cost of b u i l d i n g and  secondary r e c o v e r y , j.  Platform  reflect  and  fact  a production  of d r i l l i n g  represents  an e x p r e s s i o n  to v a r y across  other p h y s i c a l  1  short  estimates. of annual c a p i t a l e x p e n d i t u r e s  to that used i n the p l a t f o r m  d i s t i n g u i s h i n g between p l a t f o r m s reason  destined  f o r emphasizing  d e s i g n of shut-down r u l e s which w i l l productive  life  l o c a t i o n , the  above i s the use  given  is  Odell-Rosing on  to produce d i f f e r e n t  t h i s d i s t i n c t i o n r e l a t e s to  independently  determine the  the  optimal  of each r e s e r v o i r .  Another common element with  expenditure  of  instead  the Lowenstein models. Here, however, more emphasis i s p l a c e d  r e s e r v o i r s . The  and  r e s e r v o i r c o n f i g u r a t i o n s to  to o b t a i n the v a r i o u s C E P i j s but  T h i s approach to the d e t e r m i n a t i o n formally i d e n t i c a l  for  a l l i t s wells into reservoirs i  i n f l u e n c e c o s t s . However, the model f a l l s  r e l i e s on exogenous  and  CEPij  p l a t f o r m equipped  that the depth of r e s e r v o i r s and  c h a r a c t e r i s t i c s may specifying  installing  c o s t s are allowed  the  In the above e q u a t i o n ,  some of the models d i s c u s s e d  i n chapter  of an exogenous weights to d e f i n e the p r o p o r t i o n of  requirements f o r each p l a t f o r m which i s undertaken i n  2  total  any  year:  tj  \ ~ t  Equation  =  j  .  ^ i i i  \  t  =  1  ;  i f  i  fc J>  z  . >  t  .  t  J  . t  h  e  n  \ t  =  (  °-  (3.4)  that the sum  4  )  of the weights  f o r the c o n s t r u c t i o n p e r i o d of each p l a t f o r m e x a c t l y exhausts exogenously g i v e n p l a t f o r m c a p i t a l c o s t —  reservoirs  >  ensures that the p r o f i l e of weights f o r each p l a t f o r m k i s  w e l l d e f i n e d over the r e l e v a n t time p e r i o d and  Equation  3  t  (3.5)  i and  CEPj_j .  shows that the number of p l a t f o r m s  j d u r i n g year  t —  n  Piit  the  —  depends on  producing capital  43  expenditures  undertaken p r i o r  to that  year:  (t-1) n  The  p  iit  in  Z  (  i d e a here  platforms and  =  I i r=tj^  C  E  4  iir^  (  0  g  i  v  e  n  (  *  J  i s to r e l a t e cumulated c a p i t a l  expenditures  and made a v a i l a b l e  >  5  )  on i n d i v i d u a l  to whether or not these p l a t f o r m s have been b u i l t  their wells d r i l l e d  3  and i n s t a l l e d ,  f o r p r o d u c t i o n . The method used  the b a s i c s t a t i c , O d e l l - R o s i n g and Lowenstein models r e l i e s on the  expenditure  and p r o d u c t i o n e s t i m a t e s  f o r the d e p o s i t s under study to  p r o v i d e i n f o r m a t i o n as to when p l a t f o r m s are simulated  to b e g i n  p r o d u c t i o n . The same approach has been adopted  thesis.  In order  to determine the o p t i m a l  individual reservoirs, expenditures  l e n g t h o f the p r o d u c t i v e l i f e o f to d i s t r i b u t e  the c a p i t a l  on p l a t f o r m s across a l l the r e s e r v o i r s which form a g i v e n  f i e l d . Equation d u r i n g year  i t i s necessary  i n this  ( 3 . 6 ) thus r e p r e s e n t s c a p i t a l  t and a t t r i b u t a b l e  expenditures  undertaken  to r e s e r v o i r i :  ).. = e.. = 1 S  i. CE.^ it Equation  —  0^j's  J  = 1  C E . . • CE..^ • i j t  nJ- J.  e.. 9..  e.. 6.. =  i j  i s attributed  t and a t t r i b u t a b l e  JJ  (3.6)  - 6..  t h a t a g i v e n share —  to r e s e r v o i r  then y i e l d  1  i j , Jl A 9. . g i v e n , ij  1  on p l a t f o r m s designed  reservoirs will period  I ,  (3.6) stipulates  expenditures CE-LJJ-  = =  —  o f the c a p i t a l  to produce r e s e r v o i r s  i and j  —  i . Summing across a l l p a i r s o f  the c a p i t a l e x p e n d i t u r e s to r e s e r v o i r  i . As we w i l l  undertaken i n time see l a t e r , the  are exogenously g i v e n and r e p r e s e n t the p r o p o r t i o n o f w e l l s from a  platform straddling reservoirs  i and j which i s used to produce r e s e r v o i r  44  Finally, field  as e q u a t i o n (3.7)  shows, c a p i t a l e x p e n d i t u r e s  d u r i n g year t c o n s i s t of the  reservoirs  i n the  on the  summation of the CE-j_ 's across  entire all  t  field: s  CE  As the the  =  I i-l  last  CE  five  (3.7)  equations  u n i t cost of p l a t f o r m s  is  have demonstrated,  not a f f e c t e d  the model assumes  by the number of  p l a t f o r m s used to produce a g i v e n r e s e r v o i r or f i e l d . [1977a, p.41] few,  make the  same assumption and argue t h a t :  or even no, economies of  two to a three developers [1975],  " [ t ] h e r e are  in particular Frair  same assumption.  ...  Since the b a s i c  and Devine  static  and  do not e x p l i c i t l y model the c o n s t r u c t i o n and i n s t a l l a t i o n it  is  impossible  based on s i m i l a r assumptions  about  to judge whether  the  shape of  of  these two models  the cost curve  are  for  platforms.  For the purposes  of c a l c u l a t i n g the o p p o r t u n i t y cost of the  assumed employed i n d e v e l o p i n g development  O d e l l and Rosing  s c a l e i n the c o s t s of moving from a one to a  the p l a t f o r m l o c a t i o n model,  platforms,  production  equal-sized  to an n - p l a t f o r m f i e l d . " Lowenstein [1977] and the  i m p l i c i t l y make the  MIT models specific  of  that  model cumulates  c a p i t a l whose s e r v i c e  real  seven equations representation Now that  c a p i t a l expenditures  flows are valued at  Since the model assumes that competitive markets,  and producing any g i v e n f i e l d ,  the  two approaches  the essence of the  the model i s  i n s t a l l a t i o n of p l a t f o r m s ,  social  the  offshore  i n t o a stock  of  opportunity cost.  p r i c e s of c a p i t a l goods are determined  to p r o v i d e an a c c u r a t e  approach used  equipped to s i m u l a t e the d r i l l i n g  in  are f o r m a l l y i d e n t i c a l and the  o u t l i n e d above can be s a i d of  their  capital  in this  thesis.  the c o n s t r u c t i o n and  of w e l l s and the b r i n g i n g on  45  stream of individual platforms, i t seems appropriate to turn to a description of i t s reservoir production simulation process. Let t ^ represent the f i r s t year of production from reservoir i . The model posits that the following equation holds: t^ =  + c  Equation (3.8)  c given .  t e l l s us that t ^ is reached  given length of time —  c —  (3.8)  only after a period of a  has passed after the year which marked the  f i r s t period of development of reservoir i — chapter 2 above, this approach was  t^ . As was noted in  used by a l l five models reviewed.  An exponential decline process, in i t s purest form, is the  first  block upon which the production simulation process used in this thesis is erected. It posits a linear relationship between the instantaneous production of a well in reservoir i and cumulative  rate of  production from the  same reservoir:  q!  fc  = q7 - o>  i  • Q  ^7 given  it  where q! is the instantaneous it  (3.9)  production rate of a well in reservoir i at  time t, q^ is the i n i t i a l instantaneous  production rate of the same  well, c j £ is the rate of decline of the well's productivity and, assuming for  the time being that only one well taps the reservoir, Q^  t  cumulative  is the  production from the reservoir at time t.  Under the assumption that each reservoir is homogenous and that a l l wells i n a given reservoir have the same decline behaviour,  i t is possible  to aggregate, across wells in a consistent manner and to represent the instantaneous rate of production of reservoir i at time t — follows:  1  q-j^ —  as  46  N  • q' it  = q. = N it  • q. - N. • u. i l  • Q. . lit  (3.10)  In t h i s e q u a t i o n , Nj_ r e p r e s e n t s the number of w e l l s used to produce reservoir  i , which, f o r the time b e i n g , i s assumed to remain constant  the e n t i r e p r o d u c t i v e l i f e and  of the r e s e r v o i r . As with the Lowenstein model  a v e r s i o n o f the p l a t f o r m l o c a t i o n model  t h i s equation  [Frair  and  Devine, 1975],  i s at the heart of the process used i n t h i s t h e s i s  simulate r e s e r v o i r As Nind  2 and  an e x p o n e n t i a l d e c l i n e process  e s p e c i a l l y pp.31  and  43-44] reminds  as c h a r a c t e r i z e d by e q u a t i o n  which govern r e s e r v o i r p r o d u c t i o n . However, as Nind  and  are w i d e l y used i n the petroleum  convenient  a l s o p o i n t s out,  i n d u s t r y because they  p r o d u c t i v e c a p a b i l i t i e s of g i v e n r e s e r v o i r s over  the petroleum  dynamics  t o o l s t h a t can be used to p r o v i d e e s t i m a t e s  b a s i s of i t s s i m p l i c i t y ,  time.  i t s i n t e r e s t i n g p r o p e r t i e s and  i n d u s t r y and  us,  (3.10) does  not p r o v i d e a complete r e p r e s e n t a t i o n of the i n t r i c a t e p r e s s u r e  simple  to  production.  [1981, chapter  d e c l i n e curves  over  are  of  the  I t i s thus on  the  i t s usage both i n  i n economic s t u d i e s of o f f s h o r e r e s e r v o i r  p r o d u c t i o n that the e x p o n e n t i a l d e c l i n e process was  chosen f o r use  in this  thesis. Let  us now  e x p l o r e some other p r o p e r t i e s of the b a s i c e x p o n e n t i a l  d e c l i n e p r o c e s s . Under the assumption that a l l r e s e r v e s i n i t a l l y  contained  i n a g i v e n r e s e r v o i r can p o t e n t i a l l y be e x t r a c t e d , the f o l l o w i n g w i l l if  the s t o c k of r e c o v e r a b l e r e s e r v e s —  speed of  recovery: l  i  m  Based on e q u a t i o n  RR^  —  i s u n a f f e c t e d by  RR.  given.,  hold  the  2  Q.  = RR.  (3.10),  this  (3.11)  i m p l i e s that the f o l l o w i n g a l s o h o l d s :  47  N. • q. - N. • a). • Q l i l l i t  I™ t*  0 0  That  M  i s , the instantaneous  = 0.  x  (3.12)  r e s e r v o i r p r o d u c t i o n r a t e equals  zero  i n the  limit. By w^,  s u b s t i t u t i n g equation  (3.12) and s o l v i n g f o r  one o b t a i n s the f o l l o w i n g e x p r e s s i o n :  t  As  (3.11) i n t o equation  u  —  t h i s equation  i - qi/RRi-  (3.13)  shows, C J ^ , which w i l l be c a l l e d  the t h e o r e t i c a l d e c l i n e  r a t e o f the p r o d u c t i v i t y o f a w e l l i n r e s e r v o i r i , depends o n l y on q^ and  RR^. Notably,  i t i s independent o f the number o f w e l l s used to  produce the r e s e r v o i r . T h i s p r o p e r t y o f the e x p o n e n t i a l d e c l i n e permits  us to vary  allowing wells  the number o f p r o d u c t i o n w e l l s over  the c o n s i s t e n t a g g r e g a t i o n  time, w h i l e  still  o f the p r o d u c t i v e c a p a b i l i t i e s o f  i n a g i v e n r e s e r v o i r . T h i s allows us to d e r i v e r e p r e s e n t a t i o n s o f  the r e s e r v o i r p r o d u c t i o n p r o f i l e which w i l l the number o f w e l l s , but s t i l l  show the e f f e c t s o f v a r y i n g  be c o n s i s t e n t with  t i o n o f the r e s e r v o i r p r o d u c t i o n process the  process  the chosen  representa-  and the u n d e r l y i n g a t t r i b u t e s o f  reservoir. Therefore,  l e t equation  (3.14) r e p r e s e n t  the number o f w e l l s used to  produce r e s e r v o i r i at time t — ^ i t '  s N. it  =  T 6.. • N • np.. . , i i l i t  N given.  (3.14)  Here, N i s the exogenously g i v e n number o f w e l l s i n a p l a t f o r m and, as we have seen e a r l i e r of  i s the f r a c t i o n o f the number  w e l l s i n a p l a t f o r m s t r a d d l i n g r e s e r v o i r s i and j which produces  reservoir t  i n this subsection,  i . The number o f p l a t f o r m s  i s denoted by n p ^ j . t  producing  r e s e r v o i r s i and j at time  48  The f i r s t process  of  four m o d i f i c a t i o n s  introduced i n this  t h e s i s may now be o u t l i n e d .  w e l l s used to produce r e s e r v o i r i time p e r i o d s  (years,  instantaneous  since  to the b a s i c e x p o n e n t i a l  is  allowed  the model i s  r a t e of p r o d u c t i o n at  If  decline  the number o f  to v a r y across but not w i t h i n  annual),  the  time t becomes,  reservoir's as i n Lowenstein  [1977]:  q. it Through t h i s  ' qT - N. l it  = N. it  equation,  the o f f s h o r e  production of i n d i v i d u a l and i n s t a l l e d ,  and i t s  • co. • Q l it  .  (3.15)  development model b r i n g s on stream  p l a t f o r m s as soon as a g i v e n p l a t f o r m i s  w e l l s have been d r i l l e d  and made a v a i l a b l e  the  built for  production. 1  The s t r u c t u r e o f L o w e n s t e i n s equation (3.5) the r e s e r v o i r ' s  approach i s  can not r e a d i l y be used to s i m u l a t e productive c a p a b i l i t i e s .  c h a r a c t e r i z a t i o n of  for a r e s e r v o i r or f i e l d ,  in this  [1977a]:  it  relies  productive c a p a b i l i t i e s as the r e l e v a n t  a k i n to the procedures  of i n d i v i d u a l  similar  [1975] but uses  followed process  i n O d e l l and  but allows  p l a t f o r m s to come on stream as  i n s t a l l a t i o n and d r i l l i n g  activities  the  soon  are  completed.  The second m o d i f i c a t i o n c o n s i s t s of p o s i t i n g reservoir  edge towards  on techniques  and Devine  on an e x p o n e n t i a l d e c l i n e  construction,  assumed to have been  activities  thesis relies  to those found i n Lowenstein [1977] and F r a i r them i n a manner more c l o s e l y  Odell  a l l o w the p r o d u c t i o n of each p l a t f o r m to  come on stream as the c o n s t r u c t i o n and r e l a t e d c o m p l e t i o n . The approach used  the g r a d u a l b u i l d - u p of  Although u s i n g a d i f f e r e n t  the p r o d u c t i o n process  and Rosing [1977a] s p e c i f i c a l l y  Rosing  such that h i s v e r s i o n o f  productive e f f i c i e n c i e s  —  — of  the e x i s t e n c e o f annual  l e s s than 100 per  cent:  49  q  This  it  =  e  N  i t*  q  N  i " i t * " i *  Q  simple t w i s t o f the b a s i c e x p o n e n t i a l  introduced  i n any o f the models reviewed  here to r e f l e c t that  i ' ^  the f a c t  conditions  i S  i v e n  i n chapter 2 above.  production  platforms  a f f e c t e d by the i n t r o d u c t i o n o f t h i s A third modification  productive  imply  i s s i g n i f i c a n t . The  under study. I t i s easy to  o f a time p e r i o d  decline  process  modification.  to the b a s i c e x p o n e n t i a l  d e c l i n e process p o s i t s  at the b e g i n n i n g o f a r e s e r v o i r ' s  l i f e when i t s d e c l i n e r a t e  (and hence the d e c l i n e r a t e o f the  w e l l s which produce i t ) i s l e s s than i t s t h e o r e t i c a l v a l u e . interpreted  I t i s used  f o r f?£ which are exogenously determined and r e f l e c t  p e c u l i a r to the r e s e r v o i r or f i e l d  the e x i s t e n c e  (3.16)  d e c l i n e process was not  show that none o f the key p r o p e r t i e s o f the e x p o n e n t i a l are  -  that maintenance requirements t y p i c a l l y  the down time f o r o f f s h o r e  model a c c e p t s v a l u e s  B  i J  as a simple method o f c a p t u r i n g  a p p l i c a t i o n o f secondary r e c o v e r y  T h i s can be  the consequences o f the  techniques on the r e s e r v o i r ' s  productive  c a p a b i l i t i e s . As was argued i n chapter 2 above, most o f the f i v e models reviewed  t r y to i n c o r p o r a t e  r e s e r v o i r production  the e f f e c t s o f secondary techniques on  but do not r e l y on an e x p l i c i t  Although four o f these models e x p l i c i t l y r e s e r v o i r or f i e l d  peak p r o d u c t i o n  to do s o .  the concept o f a  r a t e which i s maintained  o f time, i t i s not p r i m a r i l y designed recovery  include  formulation  for a period  to capture the e f f e c t s o f secondary  on p r o d u c i b i l i t y . The f i f t h model, that developed by O d e l l and  Rosing, i n c o r p o r a t e s capabilities  a s i m i l a r element but a p p l i e s  of i n d i v i d u a l platforms  to the p r o d u c t i v e  as opposed to that o f r e s e r v o i r s o f  fields. By ces  introducing  an e x p l i c i t  o f secondary r e c o v e r y  formulation  to account  on r e s e r v o i r p r o d u c t i o n ,  f o r the consequen-  the model used i n t h i s  50  t h e s i s o f f e r s a simple e x t e n s i o n recovery  to secondary  techniques i n the models o f chapter 2. However, the o f f s h o r e  development model f a l l s the  o f the treatment a f f o r d e d  extent  recovery  short  of providing  to which i t i s e c o n o m i c a l l y  a d e c i s i o n r u l e to determine  f e a s i b l e to apply  secondary  techniques to i n d i v i d u a l r e s e r v o i r s .  if  t g .> t >_ t ^ ; t g g i v e n ;  3.*[N. «q. - N. *Y-*w.»Q. ] l  1  i t^ i  it l  l ^lt  J T  *it B . ' J N . «q. - N. 'Y!( I it I it l  YJ-UK  i  —  •Q. ]  1  ;  Y  i 8  i v e n  (3.17) t\.  i ft j> t >  t  L  Equation  (3.17) d i s t i n g u i s h e s two p e r i o d s  r e s e r v o i r . The f i r s t  period  way, to t g . During t h i s exogenously g i v e n period  fraction —  Yi —  can be shown that  The  will  contained  During t h i s  i n the  second p e r i o d ,  o f Y^ —  the m u l t i p l i c a t i v e f a c t o r  o f the d e c l i n e r a t e to account  f o r the f a c t  to be slowed down d u r i n g  the f i r s t  exceed u n i t y and w i l l be c o n d i t i o n a l on the assumed v a l u e  idea here i s to d e r i v e  and e x p r e s s i o n  simulation  attributes  of the r e s e r v o i r and that  the  exhausts the stock o f r e c o v e r a b l e  initially  contained  process i s s t i l l  i n the r e s e r v o i r .  that period  of Y i .  f o r Y | which ensures that the  production  limit,  the f u l l  felt.  the v a l u e  the d e c l i n e process was modelled —  gets under  o f i t s t h e o r e t i c a l r a t e . A second  exhausted.  i s assumed to be  which c o r r e c t s the v a l u e  l i f e of a  time, the w e l l d e c l i n e r a t e i s assumed to be an  are to be f u l l y  force of decline It  extends from t ^ , when p r o d u c t i o n  extends from tg to t g , when the r e s e r v e s  reservoir  i n the p r o d u c t i v e  consistent  w i t h the u n d e r l y i n g  the r e s u l t i n g e x t r a c t i o n p r o f i l e , i n reserves  assumed to be  51  The  approach adopted  instantaneous  i n this thesis  i s the f o l l o w i n g . I f the  r a t e o f p r o d u c t i o n of a w e l l at the end o f the f i r s t  is  t r e a t e d as the i n i t i a l  of  the second p e r i o d and i f the remaining  beginning  period  p r o d u c t i v e c a p a b i l i t y o f a w e l l at the b e g i n n i n g stock o f r e s e r v e s at the  o f the second p e r i o d i s d e f i n e d as the d i f f e r e n c e between the  stock of reserves i n i t i a l l y cumulative  contained  i n the r e s e r v o i r —  e x t r a c t i o n at the end o f the f i r s t  period —  RR{ —  Q. i —  and then, the  f o l l o w i n g w i l l hold:"*  Y !( Y.)«w. = i  As argued to  i  /[RR  i  1  (3.18)  - Q i ] . it 3  i n the d e r i v a t i o n o f e q u a t i o n  (3.10) above, i t i s p o s s i b l e  r e p r e s e n t the p r o d u c t i v e c a p a b i l i t i e s o f a w e l l i n a g i v e n r e s e r v o i r as  the flow o f p r o d u c t i o n from the r e s e r v o i r — number of w e l l s used i n p r o d u c t i o n —  c r e a t e s a d i s c o n t i n u i t y at time d u r i n g the two.periods reserves i n i t i a l l y  will  contained  here, q ^ i —  here, N. i . Although it 3  d i v i d e d by the t h i s method  t ^ , the sum of the s t o c k s o f p r o d u c t i o n  nonetheless  equal  i n the r e s e r v o i r .  the stock o f r e c o v e r a b l e In a d d i t i o n , i t should be  clear  that the key p r o p e r t i e s o f the e x p o n e n t i a l d e c l i n e process  still  h o l d w i t h i n each o f the two p e r i o d s . The  will  f o u r t h m o d i f i c a t i o n to the b a s i c e x p o n e n t i a l d e c l i n e process  introduced  i n this thesis  i s to a l l o w the l e n g t h o f the time p e r i o d d u r i n g  which the d e c l i n e r a t e i s c o n s t r a i n e d to be l e s s than i t s t h e o r e t i c a l value  to be s e n s i t i v e  to the i n t e n s i t y o f development. As the number o f  w e l l s (and hence the number o f p l a t f o r m s ) used to produce a g i v e n reservoir  i n c r e a s e s , the model should r e f l e c t  maintenance i s made more d i f f i c u l t  the f a c t  that  pressure  and hence that p r o d u c t i o n r a t e s are  52  likely  to f a l l more r a p i d l y .  Although secondary and  not e x p l i c i t l y  addressing  recovery techniques,  F r a i r and  issues related  to the e f f e c t s  the approaches adopted i n Lowenstein  of  [1977]  Devine [1975] i n c o r p o r a t e an i n v e r s e r e l a t i o n s h i p between  the peak p r o d u c t i o n r a t e and  the l e n g t h of the time p e r i o d f o r which t h i s  peak r a t e i s m a i n t a i n e d .  approach used by O d e l l and  includes a similar  The  Rosing  [1977a]  i n v e r s e r e l a t i o n s h i p . T h i s time, however, i t i s not  w e l l d e f i n e d (nor i s i t as strong) and  operates  through  the assumed  as  rising  i n t e r f e r e n c e among the a r e a l sweeps of p l a t f o r m s which accompanies i n c r e a s e s i n the of p l a t f o r m s used to produce a r e s e r v o i r or Equation  field.  (3.19) p r o v i d e s an a l g e b r a i c r e p r e s e n t a t i o n of the  reservoir  p r o d u c t i o n s i m u l a t i o n process used i n t h i s t h e s i s . At i t s core i s a b a s i c e x p o n e n t i a l d e c l i n e process which, as we four ways. F i r s t , allowed  the number of w e l l s used to produce a g i v e n r e s e r v o i r i s  to v a r y over  time. Second, annual  exogenous., need not equal reservoir  have seen, has been m o d i f i e d i n  100  i s d i v i d e d i n t o two  first  though  per c e n t . T h i r d , the p r o d u c t i v e l i f e of  the  p e r i o d s the f i r s t  a  d e c l i n e r a t e c o n s t r a i n e d to be the l e n g t h of t h i s  productive e f f i c i e n c i e s ,  of which i s marked by  l e s s than i t s t h e o r e t i c a l v a l u e .  period i s inversely related  Finally,  to the number of  w e l l s used to produce the r e s e r v o i r . Thus,  i f t\ > t > tg  0  B. [N. »q. - N.i t *Y.l *w. *Q.. ] l it l l i t  i f t°^ Ni.t J —> t —> t\ *  #  L  J  it  h.'fN. »q. - N. *Y!( Y . ) * i. *Q. l  Equation  L  it  l  it  l  l  I  x  it  I  J  (3.19)  otherwise.  (3.20) d e t a i l s the p o s i t e d r e l a t i o n s h i p between t ^ and  N^ : t  53  t  3  (  N  it  )  =  m  a  X  ^  [ t  2  +  d  l  f  "  N  ]  ' it *  r  dl  given  f  given  (3.20)  ^  where r i s the c u r r e n t year, d l i s the exogenously number of years is  f o r which the f i r s t  p e r i o d o f p r o d u c t i o n can extend  an exogenous constant which r e t r e n c h e s a g i v e n number of years  l e n g t h of the f i r s t given r e s e r v o i r .  p e r i o d of p r o d u c t i o n f o r each w e l l used  every year u n t i l  implicit  the c o n s t r a i n t  i s found  additional production wells d r i l l e d d e c l i n e at a r a t e equal to Finally, cating This  i n equation  p r o d u c t i o n from  reservoir  the  the  to be  t h a t , any  i are assumed to  Y'.'O)..  i f a l l reservoirs  as suggested  from  f  performed  to be b i n d i n g . A f t e r  in a field  then t h e i r p r o d u c t i v e c a p a b i l i t i e s  implies,  (3.20) i s  into a reservoir  and  to produce a  Since the o f f s h o r e development model i s designed  s o l v e d year by y e a r , the t e s t  of  s p e c i f i e d maximum  i n equation  field  are assumed to be are independent  (3.21),  simply equals  non-communi-  o f one  another.  that the i n s t a n t a n e o u s  the sum  production rates across a l l r e s e r v o i r s  o f the  i n the  rate  instantaneous  field:  s q  It  =  t  should be noted  instantaneous or  fields.  (3.21)  q  .\ i t . 1=1 that equations  (3.9)  to (3.21) r e l a t e  to  p r o d u c t i o n r a t e s , whether f o r i n d i v i d u a l w e l l s , r e s e r v o i r s  Based on these, appendix 2 d e r i v e s a number of e x p r e s s i o n s  which can be used  to c a l c u l a t e  total  p r o d u c t i o n d u r i n g time  periods of  g i v e n l e n g t h ( h e r e , y e a r s , s i n c e the o f f s h o r e development model i s annual) and  which are c o n s i s t e n t w i t h the u n d e r l y i n g i n s t a n t a n e o u s  p r o d u c t i o n as r e p r e s e n t e d by equations  (3.9)  appendix 2,  of i n t e g r a t i o n ) d i s c r e t e  these exact  (to a constant  to (3.21). As  r a t e s of  r e p r e s e n t a t i o n s o f the e x p o n e n t i a l d e c l i n e process o f f s h o r e development model.  noted  are a l s o used  in  by  the  54  The model d e f i n e s r e a l annual reservoir  i at time t —  expenditures  0E^  t  —  operating expenditures  as a weighted  a t t r i b u t a b l e to  sum of the r e l e v a n t  a s s o c i a t e d w i t h a l l p r o d u c t i o n p l a t f o r m s whose w e l l s reach  the r e s e r v o i r  i n q u e s t i o n . The weights  are again the p r o p o r t i o n o f each  p l a t f o r m ' s w e l l s which reach r e s e r v o i r i :  i f t\  0  0E.  s £  t  (3.22) 6.. • np.. J  i=l  Equation  • OEP  o t h e r w i s e , OEP g i v e n .  J  (3.22) assumes that the r e a l  annual  cost ( i n t  o p e r a t i n g one p r o d u c t i o n p l a t f o r m —  OEP —  r e s e r v o i r s and i s g i v e n exogenously.  As was suggested  equation  Q  d o l l a r s ) of  does not v a r y a c r o s s i n the d i s c u s s i o n o f  (3.6) above, the d e t e r m i n a t i o n o f the o p t i m a l l e n g t h o f the  productive l i f e  of i n d i v i d u a l r e s e r v o i r s r e q u i r e s that a l l the r e l e v a n t  e x p e n d i t u r e s be d i s t r i b u t e d under study. E q u a t i o n of  t\  > t >  among a l l producing  r e s e r v o i r s i n the f i e l d  (3.22) embodies t h i s p r i n c i p l e  the l e v e l o f o p e r a t i n g e x p e n d i t u r e s  attributable  i n the d e t e r m i n a t i o n to s p e c i f i c  reservoirs. Based on e q u a t i o n (3.5) above, i t i s p o s s i b l e to d e f i n e the number o f p l a t f o r m s used  np  since n p ^ j producing  t  t  to produce the f i e l d s s - [ I I i=l j=l  at time t as f o l l o w s :  .nP l/2  (3.23)  iU  r e p r e s e n t s the number o f p l a t f o r m s with w e l l s  r e s e r v o i r s i and j at time  that no d o u b l e - c o u n t i n g  independently  t . The d i v i s i o n by two simply  occurs when the model i s used  development and p r o d u c t i o n o f a m u l t i - r e s e r v o i r number o f p l a t f o r m s whose w e l l s i n d e p e n d e n t l y  field  ensures  to s i m u l a t e the which c a l l s  for a  produce two r e s e r v o i r s .  55  Following  the lead o f O d e l l and Rosing  95], the o f f s h o r e development model allows of  s c a l e at the o p e r a t i n g  f o r the e x i s t e n c e of economies  stage. P r o v i s i o n s have thus been made to permit  the model's r e p r e s e n t a t i o n o f r e a l field  [1977a, e s p e c i a l l y pp.91 and  annual o p e r a t i n g expenditures  as a whole to r i s e p r o p o r t i o n a t e l y more s l o w l y than  platforms  for a  the number o f  used i n p r o d u c t i o n : s 0E  fc  = FE(np ) +  I i=l  0E  The model i s thus designed defined  expression —  function of np  t  to accept  FE(np ) —  (3.24)  the v a l u e o f an exogenously  which i s e i t h e r  t  and r e p r e s e n t s  FE(') given.  i t  zero or a d e c r e a s i n g  the extent o f economies o f s c a l e at the  o p e r a t i n g stage. A v a l u e o f zero  for FE(np ) s i g n i f i e s t  that there are no  economies o f s c a l e to be e x p l o i t e d by a m u l t i - p l a t f o r m p r o d u c t i o n for  a given  field.  Lowenstein  [1977] and F r a i r  and Devine  system  [1975] impose  t h i s a d d i t i o n a l r e s t r i c t i o n on t h e i r a n a l y s i s . The  f a c t that F E ( n p ) i s not r e s e r v o i r s p e c i f i c c r e a t e s t  problems when t r y i n g to determine the o p t i m a l life  some  l e n g t h o f the p r o d u c t i v e  o f i n d i v i d u a l r e s e r v o i r s . As i t was used i n t h i s  thesis,  the o f f s h o r e  development model c o n t a i n s a number o f r u l e s and t e s t s which ensure that the measure o f o p e r a t i n g expenditures p o t e n t i a l l y avoidable any  operating expenditures  p o i n t i n time. The reader  detailed The  f o r a g i v e n r e s e r v o i r r e f l e c t s the  o u t l i n e of t h i s  undertaken by the producer at  i s r e f e r r e d to appendix 4 f o r a more  procedure.  p a r t i c i p a t i o n o f government i n the revenues from o f f s h o r e o i l  production a c t i v i t i e s  i s u s u a l l y ensured  revenues as w e l l as through other c o n s i d e r a t i o n the e x p e n d i t u r e  taxes  by r o y a l t i e s on gross and l e v i e s which take  requirements  production into  and the revenues generated  by  56  such p r o j e c t s . E q u a t i o n  (3.25) p r o v i d e s a g e n e r a l r e p r e s e n t a t i o n o f net  government revenues from r o y a l t i e s and taxes — G  = G(p -tc ,q ;  t  where p  t  t  t  G^:  CE , C E ^ ,. . .; 0E , O E ^ , . . . ) fc  (3.25)  fc  i s the r e a l crude o i l p r i c e and t c r e p r e s e n t s  t  t  transport  c o s t s , both  exogenously. developing  6  expressed  in t  Q  d o l l a r s per b a r r e l and  N a t u r a l l y , when the model i s used to study  and producing  field-to-shore determined  the economics o f  a g i v e n r e s e r v o i r or f i e l d , a d e t a i l e d d e s c r i p -  t i o n o f the r e l e v a n t government p o l i c i e s  i s substituted for this  general  expression. The  task o f a p p o r t i o n i n g government revenues among the r e s e r v o i r s o f  a given f i e l d and  i s complicated  by two c h a r a c t e r i s t i c s  shared  tax systems p r e v a l e n t i n most j u r i s d i c t i o n s . F i r s t ,  of government r e v e n u e - r a i s i n g instruments against  the p r o d u c t i o n from i n d i v i d u a l  i s designed  fields  by the r o y a l t y  a large  fraction  to be a p p l i e d  (the so-called  'ring  fence'  approach to t a x a t i o n ) . Second, some o f the taxes apply a g a i n s t a measure of t o t a l revenues a c c r u i n g to an economic agent i n a g i v e n  jurisdiction.  In Canada, as i n many other c o u n t r i e s , an example o f such an instrument i s the c o r p o r a t i o n income t a x . For the purposes o f t h i s t h e s i s , the o f f s h o r e development model i n c l u d e s a number o f r u l e s and t e s t s which seek to ensure that the share o f the producer's to a g i v e n r e s e r v o i r corresponds avoidable f i s c a l  costs facing  Equations  o u t l i n e o f these  c o s t s that are a t t r i b u t e d  c l o s e l y to a measure o f the p o t e n t i a l l y  the producer  case with o p e r a t i n g e x p e n d i t u r e s , a more d e t a i l e d  fiscal  of t h i s r e s e r v o i r . As was the  the reader  i s referred  to appendix 4 f o r  procedures.  (3.1) to (3.25) d e s c r i b e the o f f s h o r e development model's  r e p r e s e n t a t i o n o f the development and p r o d u c t i o n o f a g i v e n o f f s h o r e o i l f i e l d . Equation  (3.26) sets out the problem which i s assumed to be s o l v e d  57  by a p r i c e - t a k i n g , n e t - p r e s e n t - v a l u e - m a x i m i z i n g  producer:  •*.  1  1 J  Here, NPV  of  (1 +  c h o i c e of t$ i n the  remaining  .  t _ t  , the v e c t o r of l a s t  the  p e r i o d s of p r o d u c t i o n  the o p t i m i z a t i o n behaviour  across r e s e r v o i r s and  element —  n  Pij  —  over  from  p r o d u c t i o n over  of the producer  represents reservoirs  schedule  r e p r e s e n t i n g the number of years  field  time. Hence, NP  field.  the  The  which  relate  to  and i t s refers  to the  s by s symmetric  matrix  the u l t i m a t e number of  i and  f u n c t i o n h ( • ) , f i r s t encountered  j i s denoted by  i n equation  np.  (3.1), y i e l d s a  s e p a r a t i n g the f i r s t p e r i o d of  f o r each p l a t f o r m from t ^ .  f o l l o w i n g o p t i m i z a t i o n procedure  used to s i m u l a t e  the development and  which e q u a t i o n s  (3.1)  i s a p p l i e d when the model i s  p r o d u c t i o n of a g i v e n f i e l d .  step c o n s i s t s of a s s i g n i n g v a l u e s  step i s then  of the  field.  Finally,  first  to i t s producer  as a whole. The model a l s o s i m u l a t e s  p l a t f o r m s with w e l l s producing  The  °  f i r s t c h o i c e v a r i a b l e i s t ^ , the i n i t i a l year  number of p l a t f o r m s used to produce the  construction  (3.26)  f i v e aspects of the model's r e p r e s e n t a t i o n  the number of p l a t f o r m s u l t i m a t e l y used to produce the  whose ( i , j ) t h  )]  preference.  three aspects of development and  the model s i m u l a t e s  d i s t r i b u t i o n both  +G  p r o d u c t i o n over which the o p t i m i z a t i o n behaviour  f o r the f i e l d  each r e s e r v o i r  d)  +0E z  the net present v a l u e of the f i e l d  i s s i m u l a t e d . The  development  The  [(p - t c ).q -(CE _  t-ti  (3.26) i d e n t i f i e s  development and  producer's  t\ I  =  f o r the r e a l r a t e of time  Equation  producer  NPV  5  represents  and d stands  of  * ),tj}  max np,NP,h(np  {t  to a l l v a r i a b l e s and  parameters  to (3.26) i d e n t i f y as being exogenous. The  to generate  The  second  an exogenous s p e c i f i c a t i o n of a development  p l a n . T h i s c o n s i s t s of a f i r s t p e r i o d of development  f o r the f i e l d  as a  58  whole —  t^ , a number of p l a t f o r m s — n  reservoirs — then  Pij  —  a s  NP  w e l l as over  s o l v e d to determine v a l u e s i  p e r i o d s of development —  —  and  time —  its distribution  h ( n p ^ j ) . The model i s  f o r each element of the v e c t o r of  the  will  ts.  T h i s procedure  i s repeated  for d i f f e r e n t cumbersome,  r e v e a l the c h a r a c t e r i s t i c s of the g l o b a l maximum over  f e a s i b l e set of development plans even though i t might be  to c o n s t r u c t a r i g o r o u s proof of i t s e x i s t e n c e . I t w i l l i n f o r m a t i o n on the steepness various  also y i e l d  of the net present v a l u e s u r f a c e i n i t s  not  emphasized  i n the above d i s c u s s i o n , the model can a l s o  be used to s i m u l a t e development and  production using d i f f e r e n t  p r o d u c t i o n systems. T h i s i m p l i e s that the model can simulate producer's  c h o i c e over a s i x t h aspect  namely, the d e c i s i o n to use  equation  of development and  a specific  In the absence of r o y a l t i e s ,  taxes  and  v a l u e of the  types  the  system.  other r e l e v a n t government  (3.26) i s used to determine the development p l a n the h i g h e s t net  f i e l d . Under the assumption that p r i v a t e and  and  present  s o c i a l r a t e s of  p r e f e r e n c e are e q u a l , t h i s p r o v i d e s a measure of the p o t e n t i a l  present v a l u e of the f i e l d  to  c r e a t e s a wedge between the net present v a l u e of the f i e l d  wedge r e p r e s e n t s captured  by  p r o d u c t i o n which accrue  and  and  the government. As was taxes  argued i n chapter  taxes  the  net  to the producer.  the share of the net present v a l u e of the f i e l d  i n t r o d u c t i o n of r o y a l t i e s and  net  society.  Given a development p l a n , the i n t r o d u c t i o n of r o y a l t i e s  b e n e f i t s of development and  of  production;  type of p r o d u c t i o n  the p r o d u c t i v e l i v e s of r e s e r v o i r s which y i e l d  time  impossible  dimensions.  Although  policies,  last  7  exogenous s p e c i f i c a t i o n s of the development p l a n . Although t h i s procedure  across  That  which i s  2 above, the  i m p l i e s that the p r i v a t e l y  optimal  59  development  p l a n and p r o d u c t i v e l i v e s o f r e s e r v o i r s may d i f f e r  which y i e l d  the p o t e n t i a l net present v a l u e of the f i e l d  In subsequent  c h a p t e r s , the sum o f net b e n e f i t s  from those  to s o c i e t y .  accruing  to the  government and to the producer u s i n g the p r i v a t e l y o p t i m a l development plan w i l l  be c a l l e d  the r e a l i z e d  net present v a l u e o f the f i e l d . The  d i f f e r e n c e between the p o t e n t i a l net present v a l u e o f the f i e l d (calculated value w i l l  under  the assumption that G  t  to s o c i e t y  equals zero) and i t s r e a l i z e d  p r o v i d e us w i t h a measure o f the d i s s i p a t i o n o f net b e n e f i t s  induced by government p o l i c i e s . The o p t i m i z a t i o n procedure w i l l q u a l i t a t i v e and q u a n t i t a t i v e i n f o r m a t i o n about the p o t e n t i a l of p o l i c y - i n d u c e d d i s t o r t i o n s  thus y i e l d  consequences  i n the behaviour o f a r a t i o n a l producer.  3.2.3 On Some P r o p e r t i e s o f the Model One o f the key p r o p e r t i e s o f the model d e r i v e s of the p l a t f o r m as the m a r g i n a l u n i t o f development  from i t s combined  and o f a p r o d u c t i o n  s i m u l a t i o n process which a l l o w s the e x t r a c t i o n p r o f i l e systematically p l a t f o r m s ) used  to changes  use  to respond  i n the number of w e l l s (and hence  the number o f  to produce the r e s e r v o i r or f i e l d . The end r e s u l t o f such  an approach, as was argued i n Lowenstein [1977] and O d e l l and Rosing [1977a], i s the c r e a t i o n o f a one-to-one  r e l a t i o n s h i p between  development  plans and p r o d u c t i o n p r o f i l e s . Each exogenously s p e c i f i e d development is  thus a s s o c i a t e d w i t h a unique endogenously determined  p r o f i l e . As was suggested e a r l i e r ,  t h i s widens  model to s i m u l a t e the r a t i o n a l economic oil  plan  production  the scope o f f e r e d by the  behaviour o f producers o f o f f s h o r e  deposits. The  assumptions r e l a t i n g  determination of c a p i t a l  to the form o f the d e c l i n e process and the  and o p e r a t i n g e x p e n d i t u r e s have  serious  60  implications  f o r the p r o p e r t i e s o f the o f f s h o r e development model. In  p a r t i c u l a r , marginal  and average ( p e r - b a r r e l ) e x t r a c t i o n c o s t s  r a p i d l y as the number of p l a t f o r m s used to d r a i n the f i e l d  rise  i s allowed to  8 increase.  In a d d i t i o n to the assumed constant  f a c t o r s p l a y an important  role  u n i t cost of p l a t f o r m s , two  i n b r i n g i n g about t h i s  Since the i n s t a l l a t i o n o f subsequent p l a t f o r m s occur  later  i n the p r o d u c t i v e l i f e  o f the f i e l d ,  result.  i s c o n s t r a i n e d to  per-well  productivities  are lower because o f the i m p l i c a t i o n s o f past p r o d u c t i o n on the assumed e x p o n e n t i a l d e c l i n e p r o c e s s . Given a d d i t i o n a l platforms  t h i s d e c l i n e p r o c e s s , the use o f  (and thus o f a d d i t i o n a l w e l l s ) to produce the f i e l d ' s  r e s e r v e s a l s o i m p l i e s i n c r e a s e s i n the d e c l i n e r a t e o f some and p o s s i b l y all  reservoirs  i n the f i e l d  Of the f i v e  under  study.  types o f model reviewed  used i n t h i s t h e s i s  i s most c l o s e l y r e l a t e d  O d e l l - R o s i n g models. I t shares with e x p o n e n t i a l d e c l i n e process latter field  i t shares  2 above, the model  to the Lowenstein and  the former i t s r e l i a n c e on an  to s i m u l a t e r e s e r v o i r p r o d u c t i o n . With the  a gradual b u i l d - u p o f the p r o d u c t i v e c a p a b i l i t i e s o f the  as p l a t f o r m s are b u i l t  available  i n chapter  and i n s t a l l e d ,  their wells d r i l l e d  f o r p r o d u c t i o n . In a d d i t i o n , i t shares with both o f these models  an approach which seeks to a s s o c i a t e s p e c i f i c development plans unique p r o d u c t i o n p r o f i l e s . deposit producer  i n h i s c h o i c e o f o p t i m a l development effort  O d e l l - R o s i n g model allows  offers  available  to the  plans.  that n e i t h e r the Lowenstein nor the  i s a c l e a r d i s t i n c t i o n between r e s e r v o i r s and  From an economic s t a n d p o i n t , t h i s permits  the e x t e n s i v e  with  In a l l three models, the a t t r i b u t e s of the  a c t as c o n s t r a i n t s on the degree o f f l e x i b i l i t y  What the present  fields.  and made  (how many p l a t f o r m s are used  the d i f f e r e n t i a t i o n o f  f o r the f i e l d ) and the  61  intensive  (how  many p l a t f o r m s  are used  f o r each r e s e r v o i r ) margins of  development. In t u r n , the o p t i m i z a t i o n procedure can behaviour  of a r a t i o n a l producer  suggested  earlier,  along  these  two  simulate  dimensions. As  the o f f s h o r e development model's treatment  consequences of secondary r e c o v e r y  techniques  a l s o marks a  e x t e n s i o n of the approaches adopted by Lowenstein Rosing  then  the  was  of  the  simple  [1977] and  Odell  and  [1977a].  Since  the model used i n t h i s  t h e s i s r e q u i r e s exogenous e s t i m a t e s  the a t t r i b u t e s of each r e s e r v o i r i n a g i v e n  field,  requirements  of the Lowenstein model.  are s l i g h t l y h i g h e r  than  those  i t s informational  However, because of i t s r e l i a n c e on an e x p o n e n t i a l d e c l i n e process exogenous estimates in this  of  and  on  of the s t o c k of r e c o v e r a b l e r e s e r v e s , the model used  thesis requires substantially  a t t r i b u t e s of the d e p o s i t under study  l e s s i n f o r m a t i o n about  the  than does the O d e l l - R o s i n g  model.  There i s no doubt that t h i s comes at the cost of l e s s g e o l o g i c a l l y p r e c i s e r e p r e s e n t a t i o n s of d e p o s i t s and allows  t h e i r productive  c a p a b i l i t i e s but  the o f f s h o r e development model to be used to study  r e s e r v o i r s and  fields  f o r which t h i s  i t also  the economics of  type of i n f o r m a t i o n i s not  readily  available. Given this  the above d i s c u s s i o n , which margins does the approach used i n  t h e s i s tend  to n e g l e c t ?  Two  that come to mind are both  model's d e f i n i t i o n of a p r o d u c t i o n p l a t f o r m . F i r s t , platforms  are of the same s i z e , where s i z e  related  the  i t i s assumed that a l l  i s d e f i n e d as the number of  p r o d u c t i o n w e l l s i n a p l a t f o r m . Second, the model t r e a t s p l a t f o r m s marginal  to  as  the  u n i t of development whereas t h i s r o l e might be more a p p r o p r i a t e l y  attributed  to a w e l l . Of  the  f i v e models reviewed i n chapter  the p l a t f o r m l o c a t i o n model has  been used  to examine these  2 above, o n l y  types  of i s s u e s  62  and  even then, Two  the a n a l y s i s was  related  quite limited  i n scope.  f a c t o r s argued a g a i n s t the development of a model which  would a l l o w the number of p r o d u c t i o n w e l l s to be determined of  the number of p l a t f o r m s and  which would a l l o w d i f f e r e n t - s i z e d  to be used i n s i m u l a t i n g p r o d u c t i o n . F i r s t , [1972, pp.B-386 and  independently  as noted  platforms  i n Devine and  Lesso  B-387], the t o t a l c o s t of an o f f s h o r e development  p l a t f o r m t y p i c a l l y r i s e s more s l o w l y than does the number of w e l l s which it  c o n t a i n s . Not  o n l y would t h i s c o m p l i c a t e  c a p i t a l expenditure  requirements  the i n f o r m a t i o n a l requirements and  p r o d u c t i o n of s p e c i f i c  the model used i n t h i s field  —  f o r p l a t f o r m s , but  fields.  It  i s f o r these reasons  the p l a t f o r m . Given  proceeding  in this  this  said  i n the next  additional  two  specific  s u b s e c t i o n s , the  i n f o r m a t i o n requirements  that the m a r g i n a l  u n i t of development  fashion w i l l  p r o v i d e lower-bound e s t i m a t e s field  of the  to s o c i e t y . However, the same  about the measure of d i s s i p a t i o n of net b e n e f i t s used i n i s due  to the f a c t  that the two magnitudes from the r e a l i z e d  net  present  s u b j e c t to the e r r o r d i s c u s s e d above but not n e c e s s a r i l y  the same e x t e n t . T h e r e f o r e , the d i r e c t i o n of the b i a s i n the measure  itself  is  to assume that a l l  which t h i s measure i s d e r i v e d (the p o t e n t i a l and  to  to study a  a l l the other c o n s t r a i n t s on the approach,  t h e s i s . This r e s u l t  v a l u e s ) are both  g e n e r a l i n approach,  primarily  that I have opted  p o t e n t i a l net present v a l u e of any can not be  developed  the development  for Hibernia.  p l a t f o r m s are of the same s i z e and is  Second, although  become e v i d e n t  kinds o f data needed to meet these simply not a v a i l a b l e  i t would a l s o r a i s e  a s s o c i a t e d with m o d e l l i n g  t h e s i s was  H i b e r n i a . As w i l l  the model's r e p r e s e n t a t i o n of  cannot be unambiguously  determined.  63  The model can a l s o be used v u l n e r a b i l i t y o f the p r o j e c t undertaking  i n a simple examination  o f the  to changes i n the economic environment. By  a study of the s e n s i t i v i t y o f the model's r e s u l t s  i n the v a l u e s taken by c e r t a i n key parameters and v a r i a b l e s ,  to changes i t is  p o s s i b l e to p a i n t a p i c t u r e o f the f i n a n c i a l r i s k a s s o c i a t e d with the project this  as w e l l as i t s d i s t r i b u t i o n among the p a r t i e s  light,  i n v o l v e d . Seen i n  systems o f r e g u l a t i o n and t a x a t i o n a c q u i r e a new f u n c t i o n :  they are means through which government (as l a n d l o r d ) and i n d u s t r y share the  f i n a n c i a l r i s k a s s o c i a t e d with g i v e n It  should be noted  t h a t , although  projects.  interesting,  such an a n a l y s i s o f  the e f f e c t s o f u n c e r t a i n t y i s r a t h e r l i m i t e d . The key problem i s that expenditure particular  and revenue streams and t h e i r d i s t r i b u t i o n a s s o c i a t e d with any s t a t e o f the world  are p e r c e i v e d by the model as being g i v e n .  In f a c t , however, when a producer specific  contemplates  f i e l d , h i s d e c i s i o n w i l l be based  the f u t u r e time p r o f i l e s o f many v a r i a b l e s . to model e x p l i c i t l y  whether or not to develop a  on u n c e r t a i n e x p e c t a t i o n s about I t would thus appear d e s i r a b l e  the processes by which producers  form  expectations  about many economic and g e o l o g i c v a r i a b l e s . The i n f o r m a t i o n a l requirements a s s o c i a t e d with proceeding  i n this  f a s h i o n are p r o h i b i t i v e . However, i t  would be p o s s i b l e to t r e a t o n l y a subset o f these v a r i a b l e s as being determined  by s t o c h a s t i c p r o c e s s e s . Even then, a number o f d i f f i c u l t  i s s u e s a r i s e : which v a r i a b l e s to use, what form should variables  should  to choose, which p r o b a b i l i t y  the s t o c h a s t i c processes  distributions  take and over  which  they be d e f i n e d .  There e x i s t s ,  i n the petroleum  about which v a r i a b l e s  i n d u s t r y , a ' c o n v e n t i o n a l wisdom'  to emphasize and which d i s t r i b u t i o n s  are l i k e l y to  be a p p r o p r i a t e when m o d e l l i n g development and p r o d u c t i o n d e c i s i o n s based  64  on s t o c h a s t i c p r o c e s s e s . development  However, even though o f f s h o r e petroleum  and p r o d u c t i o n i s now q u i t e common i n areas l i k e  Mexico and the North Sea, the l i k e l y  s c a l e o f the H i b e r n i a  the G u l f o f  development  w i d e l y exceeds anything seen i n the G u l f o f Mexico and the e n v i r o n m e n t a l c o n d i t i o n s on the Grand Banks o f Newfoundland encountered  are even tougher than those  i n the North Sea. T h e r e f o r e , the l a c k o f an adequate analogue  to H i b e r n i a among producing  fields  severely c u r t a i l s  the v a l u e o f any  i n f o r m a t i o n based on t h i s c o n v e n t i o n a l wisdom. For these r e a s o n s , I have adopted a d e t e r m i n i s t i c  approach to m o d e l l i n g the development and  p r o d u c t i o n o f H i b e r n i a and opted f o r a l e s s ambitious a n a l y s i s o f the effects of uncertainty.  3.3 A p p l y i n g the Model t o the Case o f H i b e r n i a 3.3.1 The H i b e r n i a D i s c o v e r y In May of 1979, under a farm-in arrangement with Mobil O i l Canada L t d . , Chevron Standard L t d . spudded a w i l d c a t w e l l , Chevron e t a l . H i b e r n i a 0-15, on the Grand Banks o f N e w f o u n d l a n d .  11  year, the Canadian petroleum i n d u s t r y was convinced u n s u c c e s s f u l e x p l o r a t i o n , an important o i l f i e l d discovered  By the end o f the that a f t e r years o f  had f i n a l l y  been  i n the E a s t e r n Canadian o f f s h o r e area. The c o m p l e t i o n o f n i n e  a p p r a i s a l w e l l s i n the area h e l d by M o b i l O i l Canada L t d . under and  f e d e r a l e x p l o r a t i o n permits has helped  provincial  to d e l i n e a t e and assess the  12 g e o l o g i c a l l y complex H i b e r n i a S i t u a t e d under r e l a t i v e l y  field. shallow waters (between 75 and 85 metres)  some 310 k i l o m e t r e s o f f the s o u t h e a s t e r n shore o f the i s l a n d o f Newfoundland,  the s t r u c t u r e  i s believed  multi-layered  and non-communicating  to c o n t a i n two important 13  zones o f o i l - b e a r m g sands  which  65  have been l a b e l l e d i n d i c a t e that different  the  the Avalon and two  reference  ocean f l o o r  depths with H i b e r n i a being 1 5  It has  l o c a t i o n s of the r e s e r v o i r s are  A recent capabilities  of the H i b e r n i a  model. Based on  reaching  Chipman 1982] u s i n g an  field,  the authors suggest  H i b e r n i a . The  paper a l s o e s t i m a t e s  to approach 4.6  one  quarter-three  Figures  quarters  i n favour  Avalon and  12]  50 per  estimate cent  reserves  a p p r o x i m a t e l y 1.6 Hibernia  that  t h i s country  are  the  i n i t i a l productivity  to exceed that of a w e l l the q u a n t i t i e s of  of Avalon) and  recovery  scheme, Handyside and  r a t e s approaching 30 per  the paper concludes that the  contained  i n the  two  stock  6.1  trillion .  Chipman [1982, cent  for life.  of  r e s e r v o i r s would stand  at  b i l l i o n barrels. i t s way  to becoming the  largest o i l f i e l d  i n Canada. I t s development would mark the  that the expected development and  f i r s t attempt i n  production  l e s s than c u r r e n t world o i l p r i c e s and  those of a l l other  in-place  .  to e x t r a c t crude o i l from an o f f s h o r e d e p o s i t .  i n d i c a t i o n s are Hibernia  petrophysical  Under the assumption that the o i l i s  i s thus w e l l on  ever d i s c o v e r e d  productive  f o r H i b e r n i a over a t h i r t y - y e a r p r o d u c t i v e  Based on these e s t i m a t e s , recoverable  the  16  s t u d i e s the  .  u s i n g a gas-water i n j e c t i o n  3 and  relative  b i l l i o n b a r r e l s of crude o i l ( d i s t r i b u t e d  f e e t of n a t u r a l gas.  extracted  plan.  the  i n t r i c a t e reservoir simulation  17 cubic  that the  to p r e c l u d e  development  i n the Avalon r e s e r v o i r i s l i k e l y  resources roughly  field  i n any  such as  t h e i r review of the g e o l o g i c a l and  p r o p e r t i e s of the of a w e l l  [Handyside and  to be  have  l o c a t e d deeper under  a l s o been suggested  likely  • completion w e l l s  paper  Reports a l s o  r e s e r v o i r s , though p a r t l y o v e r l a p p i n g ,  than i s A v a l o n .  i n c l u s i o n of dual  Hibernia reservoirs.  o f f s h o r e petroleum d e p o s i t s  so  at l e a s t  In a d d i t i o n , costs as  far discovered  low in  for as  66  Canada. The  l a c k o f an adequate analogue to H i b e r n i a among producing  f i e l d s has l e d to much s p e c u l a t i o n about the c h o i c e system. O r i g i n a l l y , members o f the o p e r a t i n g floating sibles.  production  system centered  In the aftermath  interested  of a production  consortium  on two or three  favoured  a  l a r g e semi-submer-  o f the Ocean Ranger tragedy,  companies have been f o r c e d  however, the  to g i v e a second look to a f i x e d 19  production  system based on c o n c r e t e  offshore  gravity platforms.  w r i t i n g , a c l e a r f a v o u r i t e between f i x e d  and f l o a t i n g  • At the time o f  systems had yet to  emerge. In terms o f f i e l d - t o - s h o r e t r a n s p o r t a t i o n , however, a favoured has  emerged: tankers  are seen to have a d i s t i n c t  for  two main r e a s o n s . F i r s t ,  mode  advantage over p i p e l i n e s  the presence o f i c e b e r g s makes the b u r i a l o f  p i p e l i n e s d e s i r a b l e . However, f o r c l o s e to two t h i r d s o f the d i s t a n c e separating there  Hibernia  from Newfoundland, the ocean f l o o r  i s bedrock which  i s r e p o r t e d l y no known way o f t r e n c h i n g . Furthermore, the pour p o i n t at about 10 degrees C e l s i u s  for  H i b e r n i a crude has been estimated  the  average water temperature i n t h i s area o f the North A t l a n t i c  while hovers  around zero. Under such c o n d i t i o n s , an i n t e r r u p t e d flow i n the p i p e l i n e 20 could in  see the crude t u r n to g e l or s o l i d w i t h i n e i g h t hours.  the a n a l y s i s that  follows  t r a n s p o r t a t i o n of Hibernia The  field's  i t i s assumed that  tankers  crude from the p r o d u c t i o n  l o c a t i o n also gives  rise  Therefore,  assure the  facilities  to shore.  to a number o f i n t e r e s t i n g  i s s u e s . In Canada, some important economic powers are d i v i d e d among f e d e r a l and p r o v i n c i a l governments while  others  are shared by these two  j u r i s d i c t i o n s . The d i s t r i b u t i o n o f ownership and t a x a t i o n r i g h t s to petroleum d e p o s i t s  f a l l s w i t h i n these c a t e g o r i e s . T h i s r a i s e s  questions  67  concerning  the source  of j u r i s d i c t i o n and  the d i s t r i b u t i o n of the  govern-  ment share of the net b e n e f i t s from H i b e r n i a . In a d d i t i o n , o i l revenues a c c r u i n g to p r o v i n c i a l governments are s u b j e c t to f i s c a l Canada. Since Newfoundland and e q u a l i z a t i o n payments, any government w i l l  Labrador  equalization in  i s p r e s e n t l y a net r e c i p i e n t  of  i n c r e a s e i n o i l revenues f l o w i n g to i t s  have r e p e r c u s s i o n s on i t s r e l a t i v e p o s i t i o n w i t h i n the  e q u a l i z a t i o n system. T h e r e f o r e , not o n l y can government potentially affect  producer  behaviour  but  they w i l l  policies  certainly affect  d i s t r i b u t i o n of the government share of net b e n e f i t s between Ottawa  the and  St. John's.  21  3.3.2  A D i s c u s s i o n o f the P r i n c i p a l E s t i m a t e s T h i s s u b s e c t i o n i s concerned  and  Assumptions  with the d e t a i l s necessary  o f f s h o r e development model to the case of H i b e r n i a . In doing together e s t i m a t e s and  and  assumptions c o n c e r n i n g  of i t s intended development and  number of d i f f e r e n t  Chipman [1982].  to Avalon,  and  at 1.6  from Handyside  Second, the l a r g e r r e s e r v o i r , designed  remaining  p o r t i o n of the  Handyside and  Chipman put  to  field's stock  i n the H i b e r n i a  the stock of r e s e r v e s i n the  b i l l i o n b a r r e l s , the a n a l y s i s i n t h i s  s i z e s of the two  non-  f i e l d ' s estimated  assumed to be c o n t a i n e d  be based on an assumed stock which d i f f e r s the r e l a t i v e  field  p r o d u c t i o n which were drawn from a  assumptions have been taken  of r e c o v e r a b l e r e s e r v e s i s thus  field  v a r i o u s aspects of the  i s assumed to c o n t a i n t w o - t h i r d s of the  r e c o v e r a b l e r e s e r v e s . The  r e s e r v o i r . Although  so, i t b r i n g s  F i r s t , H i b e r n i a i s assumed to c o n s i s t of two  communicating r e s e r v o i r s . correspond  the  sources.  A number of e s t i m a t e s and  to t a i l o r  thesis w i l l  sometimes  from t h i s e s t i m a t e . However,  reservoirs will  always be  the same as that  68  suggested  by Handyside and Chipman.  T h i r d , these authors drilled  i n Avalon  comparable f i g u r e  assume that the i n i t i a l  i s equal to 15 thousand  p r o d u c t i v i t y of a well  b a r r e l s per day while the  f o r the H i b e r n i a r e s e r v o i r  i s assumed to be 10  22 thousand.  Again, while d i f f e r e n t  assumptions about the a b s o l u t e  magnitude o f these r e s e r v o i r a t t r i b u t e s w i l l relative  sometimes be made, the same  p r o d u c t i v i t i e s of w e l l s i n the two r e s e r v o i r s w i l l  be maintained  throughout. E s t i m a t e s o f p l a t f o r m c o s t s and o p e r a t i n g e x p e n d i t u r e s ( c o n c r e t e g r a v i t y ) and f l o a t i n g were drawn from Directorate  p r e s e n t s the p r i n c i p a l d i s t r i b u t i o n over The  platform Similar  fixed  platforms  Petroleum  [1981] and NLPD [1982]. Table 3.1  c o s t e s t i m a t e s used  i n this  t h e s i s as w e l l as t h e i r  time.  investment  expenditures  ( p u r p o s e - b u i l t semi-submersible)  three s o u r c e s : Newfoundland and Labrador  (NLPD) [1980], Wilby  f o r both  requirements  as w e l l as the t i m i n g o f c a p i t a l  a s s o c i a t e d with the c o n s t r u c t i o n and i n s t a l l a t i o n o f a two-  fixed  system were made a v a i l a b l e  to me by the NLPD  information for a three-platform f l o a t i n g  NLPD [1980, p . l 4 ] .  2 1 +  [1982].  system can be found i n  In both c a s e s , to t r a n s f o r m the e x p e n d i t u r e  estimates  so that i n f o r m a t i o n on i n d i v i d u a l p l a t f o r m s was made a v a i l a b l e , I have relied  on the p r o p o s i t i o n , advanced  i n O d e l l and Rosing  [1977a],  that the  u n i t c o s t o f p l a t f o r m s i s not a f f e c t e d by the number o f e q u a l - s i z e d p l a t f o r m s used A drilling  to produce a g i v e n r e s e r v o i r or f i e l d . program i s a s s o c i a t e d with the i n s t a l l a t i o n o f each  production platform. A fixed for  production wells.  assumed to gather  p l a t f o r m i s assumed to have 21 s l o t s r e s e r v e d  Each f l o a t i n g  p l a t f o r m , on the other hand, i s  the p r o d u c t i o n from two c l u s t e r s o f w e l l s each  69  containing platform  seven p r o d u c t i o n w e l l s .  The d r i l l i n g  program f o r each  i s a l s o assumed to i n c l u d e p r o v i s i o n s f o r a few spare w e l l s and a  number o f gas r e - i n j e c t i o n  and water i n j e c t i o n  wells.  An e s t i m a t e o f the l e v e l and d i s t r i b u t i o n o f the c a p i t a l a s s o c i a t e d with the d r i l l i n g found  program o f a two-platform  i n NLPD [1982]. Since development plans based  f l o a t i n g p l a t f o r m s are here p o s i t e d production wells, applied  i t has been assumed that  proceeding  i n this  on two f i x e d  and three  these e s t i m a t e s can a l s o be  system. Again,  [1977a], I have assumed that  a s s o c i a t e d with the d r i l l i n g  system can be  to r e q u i r e the same number o f  to a t h r e e - p l a t f o r m f l o a t i n g  and Rosing  fixed  expenditures  activities  i n the s p i r i t  of O d e l l  there are no economies o f s c a l e for individual  p l a t f o r m s . However,  f a s h i o n has r e q u i r e d a few m o d i f i c a t i o n s to the  e x p e n d i t u r e e s t i m a t e s , p a r t i c u l a r l y with r e f e r e n c e to the t i m i n g o f drilling two  activities  and to the f a c t  that Avalon  i s the s h a l l o w e r o f the  reservoirs. C o n s i s t e n t with the i n f o r m a t i o n c o n t a i n e d i n NLPD [1982],  assumes that a f i v e - y e a r  the model  l a g s e p a r a t e s the f i r s t year of c o n s t r u c t i o n and  the b e g i n n i n g o f p r o d u c t i o n from a g i v e n f i x e d  p l a t f o r m . In that  year,  o n l y e l e v e n o f the p r o d u c t i o n w e l l s are assumed to be i n o p e r a t i o n . The other t e n w e l l s are brought apparent  the next  year. To conform with the  conventions o f the d a t a source, i t i s assumed that p r o d u c t i v e  capabilities after  on stream  e q u i v a l e n t to those o f one p l a t f o r m can be added i n any year  the f i r s t year o f p r o d u c t i o n from the f i e l d . As with the NLPD s t u d i e s , the d e l a y between b e g i n n i n g o f c o n s t r u c t i o n  and  f i r s t year o f p r o d u c t i o n i s assumed to be four years f o r a f l o a t i n g  p l a t f o r m . Again,  to conform with the conventions o f the data source, the  model assumes t h a t , once i n s t a l l e d , i t i s p o s s i b l e to b r i n g  the p r o d u c t i o n  70  of  an e n t i r e  p l a t f o r m on stream i n one  The model o f f e r s can it  see  all  its  three  27  on  In t h i s  .  .  case,  the p a t t e r n of development,  floating  fixed  its  two r e s e r v o i r s  It or  w e l l s produce each  it  is  assumed  fixed  that a maximum of  to produce the  In i t s  constraints  present  and f l o a t i n g  form,  one  f i e l d while  two such  the model does not  platforms  to be used  to  field.  Finally,  as  tankers w i l l  suggested i n the p r e v i o u s be used  it  adequately  captured by a f i x e d  extracted.  T h i s approach was adopted  e s t i m a t e s of  has a l s o been assumed  that  it  has been  Those for  shore.  of crude o i l  i n NLPD [1982] from which  the  taken.  of annual o p e r a t i n g e x p e n d i t u r e s  o b t a i n e d from NLPD [1982]. 28 p.15] .  assumed  t r a n s p o r t a t i o n c o s t s can be  l e v y on each b a r r e l  t r a n s p o r t c o s t s have been  Estimates  subsection,  to t r a n s p o r t the H i b e r n i a crude to  Therefore,  K  of  of the  the e x i s t e n c e of g e o g r a p h i c a l  are a l l o w e d .  a l l o w for a combination of  that  one h a l f  p l a t f o r m can be used  platforms  d e p l e t e the  l o c a t i o n of each p l a t f o r m .  .  In a n t i c i p a t i o n of  straddling  for the  w e l l s being used to d r a i n e i t h e r  can s t r a d d l e b o t h .  reservoir.  choices  year.  floating  for f i x e d  p l a t f o r m s were  systems are from NLPD [1980,  l  The model r e s p e c t s  the  with a two-platform fixed estimates.  The e s t i m a t e s  slight  degree of economies of  system that  was e v i d e n t  for a f l o a t i n g  i n the  scale  associated  expenditure  system d i s p l a y a s i m i l a r  which can be seen to be p r i m a r i l y the r e s u l t  of  feature  s c a l e economies i n  ice 29  management,  upkeep and the o p e r a t i o n of  simplify  the  floating  system g i v e s r i s e  does that  analysis,  of a f i x e d  it  the d i v i n g support v e s s e l .  has been assumed to the  system.  It  is  that  the o p e r a t i o n of a  same degree of economies of assumed,  To  however,  that  scale  these are  as  71  exhausted  as soon as two f i x e d or three f l o a t i n g  p l a t f o r m s are used to  produce the f i e l d . In  most c a s e s , I have assumed, as do the data s o u r c e s , that  per-platform operating expenditures e n t i r e productive l i f e  remain constant  i n real  annual  terms over the  o f the p l a t f o r m . The o n l y e x c e p t i o n to t h i s  occurs  when p r o d u c t i o n from a s t r a d d l i n g p l a t f o r m c o n t i n u e s a f t e r one o f the reservoirs  i s shut down. In such c a s e s , the same degree o f economies o f  s c a l e as that d e s c r i b e d i n the p r e c e d i n g paragraph for  i s assumed to p r e v a i l  a l l such p l a t f o r m s . As was suggested  i n s u b s e c t i o n 3.3.2 above, the model assumes that  the p r o d u c t i v i t y d e c l i n e process  i s slowed  b e g i n n i n g o f the p r o d u c t i v e l i f e  o f each r e s e r v o i r  .  .  .  .  .  f o r a number o f years at the as a r e s u l t  30  .  r e - i n j e c t i o n and water i n j e c t i o n .  T h i s concept  assuming that the d e c l i n e behaviour  proceeds  t h e o r e t i c a l v a l u e . For the purposes  of t h i s t h e s i s ,  that  this It  fraction  i t has been assumed  i s equal to 0.5.  slow down the d e c l i n e process  r e c o v e r y techniques can  f o r a maximum o f e i g h t years  r e s e r v o i r . The model then shaves one year  p l a n which e n t a i l s  i s made o p e r a t i o n a l by  at a f r a c t i o n o f i t s  i s a l s o assumed that the use o f secondary  f o u r t e e n w e l l s used  f o r each  from t h i s p e r i o d f o r each  to d r a i n a g i v e n r e s e r v o i r . For example, a development the use o f one f i x e d p l a t f o r m to produce each  i s assumed to have an e i g h t - y e a r p e r i o d d u r i n g which secondary assumed to slow down the process o f d e p l e t i o n f o r the f i e l d . corresponds  o f gas  to the b u i l d - u p and constant  reservoir  recovery i s  This  p r o d u c t i o n p e r i o d s o f the 31  exogenous e x t r a c t i o n p r o f i l e  suggested  i n NLPD [1982].  Once the f u l l  f o r c e o f d e c l i n e i s assumed to g o v e r n ^ r e s e r v o i r p r o d u c t i o n , a d d i t i o n a l wells d r i l l e d  i n t o a s t r u c t u r e are assumed not to a f f e c t  the form o f the  72  process. Finally, ice  i t has been argued that the presence  i n the v i c i n i t y o f the p r o d u c t i o n area w i l l  f l o a t i n g platforms until  stop p r o d u c t i o n , d i s c o n n e c t  o f i c e b e r g s and pack  sometime r e q u i r e that and move to s a f e r waters  the t h r e a t of c o l l i s i o n has s u b s i d e d . T h i s , i n c o n j u n c t i o n with  normal maintenance requirements  and the rough seas o f the Grand Banks  a r e a , has l e d some members o f the o p e r a t i n g consortium average annual expected  to suggest  p r o d u c t i v e e f f i c i e n c i e s o f some 75 per cent  for a floating  system. The same source  that  should be  argues that a f i x e d  would have b e t t e r p r o d u c t i v e e f f i c i e n c i e s but f a l l s  system  short o f suggesting an  32  order o f magnitude. maintained  However, c o n c r e t e g r a v i t y p l a t f o r m s must a l s o be  and the d i f f i c u l t  environmental  tanker o p e r a t i o n s under e i t h e r  c o n d i t i o n s are l i k e l y  to a f f e c t  type o f p r o d u c t i o n system. I have t h e r e f o r e  chosen to assume that the average annual  productive e f f i c i e n c y of a fixed  system i s 80 per c e n t . To i n c o r p o r a t e t h i s c o n s i d e r a t i o n i n t o the a n a l y s i s , one may simply assume that a g i v e n p r o d u c t i o n year per cent o f a c a l e n d a r year, as the case may be. During well  i n a given r e s e r v o i r  p o t e n t i a l . For the r e s t p r o d u c t i o n takes  at i t s f u l l  of the c a l e n d a r year, i t i s assumed that no  place. i n t h i s d i s c u s s i o n of p r i n c i p a l  estimates  assumptions has been the l a c k o f r e f e r e n c e s to the r e g u l a t i o n and  t a x a t i o n p o l i c i e s assumed to p r e v a i l . The next and  t h i s p e r i o d , each  i s t r e a t e d as i f i t were producing  The most g l a r i n g o m i s s i o n and  i s 75 or 80  related issues.  s u b s e c t i o n examines  these  73  3.3.3  R e g u l a t i o n and T a x a t i o n  Policies  U n t i l r e c e n t l y , questions r e l a t e d  to the e x e r c i s e of r i g h t s  to the  H i b e r n i a r e s o u r c e s were the cause o f a d i s p u t e between the f e d e r a l government that  and that of Newfoundland  i t was  vested with j u r i s d i c t i o n a l  i s s u e d comprehensive  r i g h t s , each l e v e l of  sets of r e g u l a t i o n s p u r p o r t i n g  e x p l o r a t i o n , development Grand  and Labrador. A c t i n g on the b e l i e f government  to c o n t r o l  the  and p r o d u c t i o n of petroleum r e s o u r c e s on the  Banks. The j u r i s d i c t i o n a l d i s p u t e and the a c t i o n s o f the two  governments  p r o v i d e an i d e a l backdrop f o r a comparative study of the e f f e c t s o f government  p o l i c i e s . By m o d e l l i n g the proposed sets of p o l i c i e s ,  o f f s h o r e development model w i l l  the  a l l o w us not only to compare the e f f e c t s  o f each r o y a l t y and t a x a t i o n system on the investment d e c i s i o n o f the producer but a l s o to examine each system's  i m p l i c a t i o n s on the  d i s t r i b u t i o n of H i b e r n i a revenues between the two  l e v e l s of  The p o l i c y mix proposed by the f e d e r a l government N a t i o n a l Energy Program subsequent update  corporate  i n the and i t s  [Canada. Energy, Mines and Resources 1982b], v a r i o u s  1982]  [Canada. F i n a n c e 1980;  1981], the Canada O i l and  and the l e g i s l a t i o n r e l a t i n g  income. B r i e f l y ,  the p o l i c i e s  to the t a x a t i o n o f  assure Petro-Canada (or another  f e d e r a l Crown c o r p o r a t i o n ) a s u b s t a n t i a l rights  i s described  [Canada. Energy, Mines and Resources 1980]  f e d e r a l budget documents Gas Act [Canada  government.  share of the o f f s h o r e  production  and set a minimum l e v e l o f Canadian ownership of these r i g h t s  b e f o r e the development  of any g i v e n f i e l d  revenue s i d e , the government (FCIT), a basic  imposes  r o y a l t y (FBR) a g a i n s t  incremental r o y a l t y  i s allowed to proceed. On the  the f e d e r a l c o r p o r a t i o n income  tax  a l l p r o d u c t i o n and a p r o g r e s s i v e  (PIR) designed to be r e s p o n s i v e to the cost  conditions  74  field.  Finally,  a l s o a p p l y . The  the p r o v i s i o n s of the petroleum and gas revenue tax (PGRT) f e d e r a l government encourages o f f s h o r e a c t i v i t i e s  e x p l o r a t i o n and development a f f e c t e d by p r o j e c t  through  i n c e n t i v e g r a n t s , the r a t e s of which are  l o c a t i o n s and the degree of Canadian ownership of the  players. Even i f these f e d e r a l p o l i c y p r o p o s a l s were to p r e v a i l ,  the  d i s t r i b u t i o n of government revenues from o f f s h o r e a c t i v i t i e s between Ottawa and  the p r o d u c i n g p r o v i n c e s would  still  be undecided. Over  the  y e a r s , r e v e n u e - s h a r i n g systems have been agreed upon by the  federal  government and a number of p r o v i n c e s . Although Newfoundland  and Labrador  has never been a p a r t y to any such agreement, p o s i t i o n that both Canada and  the p r o v i n c e would  terms of the Maritime Agreement or the Nova S c o t i a Agreement were a p p l i e d  find  the  themselves i n i f the  [Canada. Energy, Mines and Resources  [Canada. Energy, Mines and Resources  1982a]  t a x a t i o n system proposed by the government o f  and Labrador i s d e s c r i b e d  i n the p r o v i n c e ' s Petroleum and  N a t u r a l Gas Act and the a s s o c i a t e d petroleum r e g u l a t i o n s  [Newfoundland  Labrador 1978]. Under the l e g i s l a t i o n approved by the House of the p r o v i n c e r e s e r v e s a s u b s t a n t i a l  share of the r i g h t s  and Labrador Petroleum C o r p o r a t i o n  The p r o v i n c i a l r e g u l a t i o n s s t i p u l a t e  that  and  Assembly,  from a l l o f f s h o r e  p r o d u c t i o n permits i n favour of a Crown c o r p o r a t i o n o f i t s own, Newfoundland  1977]  to the d i s t r i b u t i o n o f the r e l e v a n t H i b e r n i a revenues.  The r e g u l a t i o n and Newfoundland  chapter 6 examines  the  (NLPC). the NLPC may  e x e r c i s e i t s o p t i o n i n the form of e i t h e r a 'working' or a  elect  to  'carried'  i n t e r e s t . Under the p r o v i s i o n s of the working i n t e r e s t , the NLPC e s s e n t i a l l y becomes a f u l l - f l e d g e d member of the o p e r a t i n g c o n s o r t i u m and as such shares p r o p o r t i o n a t e l y i n a l l development  e x p e n d i t u r e s and  75  production that  revenues. The  i t i s not  expenditures investment  NLPC o p t i n g  responsible  f o r any  f o r a c a r r i e d i n t e r e s t would  share of the i n i t i a l  times b e f o r e  revenues can b e g i n .  Since  i m p l i c a t i o n s are  likely  a b a s i c r o y a l t y (NLBR) a p p l i c a b l e at a constant  with  a sliding  s c a l e r o y a l t y (SSR)  the annual p r o d u c t i o n  a l s o be e l i g i b l e  to be  different,  types of r o y a l t y :  rate against a l l  the r a t e of which  from each f i e l d . The  to r e c e i v e i t s share of CIT  to i t s share of the  increases  p r o v i n c i a l t r e a s u r y would  revenues. Under the  the p r o v i n c i a l l e g i s l a t i o n o u t l i n e d above, revenues to the t r e a s u r y are r e s t r i c t e d  operating  have been m o d e l l e d .  P r o v i n c i a l government revenues a l s o accrue from two  and  their  government p a r t i c i p a t i o n i n net  their  the p r o v i s i o n s of both o p t i o n s  production  capital  and must a l l o w p r i v a t e p a r t i c i p a n t s to recoup three  imply  CIT  and  terms of  federal  the p r o v i s i o n s of  the  PGRT. With the e x c e p t i o n fence'  a l l of these p r o v i s i o n s impose a  around the a c t i v i t i e s of a g i v e n  expenditures fields  of the CIT,  i n c u r r e d and  f i e l d . This  income earned cannot be  simply means that  transferred  f o r purposes of t a x a t i o n . In the case of the CIT,  on a company-by-company b a s i s , i t i s assumed that l e g i s l a t i o n can  always be  which i s l e v i e d  i n the e a r l y  of development, i t i s assumed that the companies forming the  allowable  offshore  which they can  them to request  revenues i n kind  years  their  expenditures.  i n s t a n c e , a l l systems r e s e r v e  which enacted  the  operating  c l a i m a l l of  A review of the r e g u l a t i o n systems r e v e a l s a number of For  across  the p r o v i s i o n s of  f u l l y e x p l o i t e d . Therefore,  c o n s o r t i u m have onshore income a g a i n s t  'ring  the r i g h t  similarities.  to the l e v e l of government  payment of the government share of  i n s t e a d of cash and,  i f the  offshore  need i s demonstrated, to  76  reduce r o y a l t y payments.  Furthermore, none o f the systems seem to impose  r e s t r i c t i o n s on the a l l o w a b l e However, i n an e f f o r t capture'  production,  production  to e l i m i n a t e  per w e l l , r e s e r v o i r or f i e l d .  the problems a s s o c i a t e d with  3 5  'rule of  both sets o f r e g u l a t i o n s r e q u i r e that every f i e l d be 36  developed and produced as a u n i t .  3.3.4  Studies The  o f the Economics o f H i b e r n i a  NLPD has undertaken a s e r i e s o f s t u d i e s designed  economics o f the H i b e r n i a d i s c o v e r y development on the p r o v i n c e . particular viability  and the e f f e c t s o f o f f s h o r e  Two o f these s t u d i e s  i n t e r e s t to us. The f i r s t p r o v i d e s o f the H i b e r n i a  study to account  field.  to e v a l u a t e the  [NLPD 1980;1981] are o f  an a n a l y s i s o f the economic  The subsequent e f f o r t  updates the f i r s t  f o r p o l i c y changes by the f e d e r a l government.  Meanwhile, the Economic C o u n c i l o f Canada was busy completing  a study  on  the economic s i t u a t i o n o f Newfoundland which i t had undertaken to  in  1978. When the f i n a l  d e a l i n g with  r e p o r t was r e l e a s e d ,  a  chapter  the e f f e c t s o f o f f s h o r e o i l and gas on the p r o v i n c i a l economy  [Economic C o u n c i l o f Canada 1980, chapter chapter  i t contained  8 ] . Although the scope o f t h i s  was s u b s t a n t i a l l y broader than a study of the economic  of any p a r t i c u l a r f i e l d ,  the C o u n c i l  which d e a l t s p e c i f i c a l l y with Based on expenditure  also published  a background document  the development of H i b e r n i a  estimates  obtained  viability  [Wilby  from a c o n s u l t a n t ' s  1981]. report,  the NLPD proposed a cash flow model o f the development and p r o d u c t i o n o f H i b e r n i a which ignored  a l l considerations  t r a n s p o r t a t i o n . Although c o n c e n t r a t i n g recoverable  reserves  to f i e l d - t o - s h o r e  on the case where the l e v e l o f  was assumed to equal  a l s o examined the economic v i a b i l i t y  relating  one b i l l i o n  b a r r e l s , the study  of s i n g l e - r e s e r v o i r f i e l d s  containing  77  0.5  and 1.5 The  b i l l i o n b a r r e l s of r e c o v e r a b l e  principal  conclusions  of the  proposed r e g u l a t i o n and t a x a t i o n a fixed  p r o d u c t i o n system i s  assumed  that  schemes,  the development  system,  the p r o j e c t  production is  the NLPD i s  governments,  p a r t i c u l a r l y interested  revenues  some e f f o r t  i m p l i c a t i o n s of  it  field  is  is  assumed  a marginal  assumed  between the  was expended  i n the  federal  to be p r i c e d  the proposed p o l i c i e s .  under the  regulations  systems advanced by the  it  s i z e and  and p r o v i n c i a l  on examining the  revenue-sharing  The p r o v i n c e of Newfoundland and  Labrador was shown to capture a l a r g e r share of  the p o t e n t i a l  that  resource  has proposed than under any of  f e d e r a l government,  even a f t e r  the producer share of net  revenues  is  the  the e f f e c t s  on  The study  also  e q u a l i z a t i o n e n t i t l e m e n t s have been taken i n t o a c c o u n t . concludes  of H i b e r n i a with  even i f  is  the  levels.  d i s t r i b u t i o n of net  revenues  under a l l  world o i l p r i c e s p r e v a i l . However, when the  p r o p o s i t i o n o n l y when the r e s u l t i n g  Since  study are that  not p r i v a t e l y p r o f i t a b l e  to be produced with a f l o a t i n g  below world  oil.  its  s i m i l a r under a l l  of  37  the proposed tax  regimes.  The paper by Wilby of  the  follow  [1981] i s  essentially  ideas advanced i n the NLPD s t u d i e s . is  the  same as  that  used  e s t i m a t e s are taken from the conclusions  are s i m i l a r to  same s o u r c e .  profitability  the  extension  Not s u r p r i s i n g l y ,  his  first  of the p r o j e c t  NLPD s t u d y , is  not  p r o p o s i t i o n from the studies.  he concludes  insensitive  to  expenditure  those reached by the NLPD. However, he  s e c t o r ' s p o i n t of view than do the e a r l i e r of  and  The approach he chooses  i n these s t u d i e s and the  H i b e r n i a to be a s l i g h t l y more a t t r a c t i v e  to the r e s u l t s  a refinement  finds  private  Furthermore, contrary that  to the  the  private  system of  78  r e g u l a t i o n and  t a x a t i o n assumed to be  in effect.  d i s c r e p a n c i e s can be e x p l a i n e d by the f a c t  Wilby argues  that  these  that h i s work i n c l u d e s a more  39 a c c u r a t e d e p i c t i o n of the v a r i o u s proposed  tax p r o v i s i o n s .  Wilby's e x t e n s i o n of the NLPD s t u d i e s takes two First, which  the paper p r o v i d e s a short but the development  development  forms.  i n s i g h t f u l d i s c u s s i o n o f the way  of H i b e r n i a w i l l  affect  e q u a l i z a t i o n . Under the terms of the 1977 arrangements  principal  the system of  fiscal  federal-provincial  (which are assumed to apply f o r the e n t i r e  in  fiscal  l e n g t h of the  and p r o d u c t i o n p e r i o d s ) , a change i n the f i s c a l c a p a c i t y o f  any one p r o v i n c e a f f e c t s  the r e l a t i v e  s t a t u s of the other p r o v i n c e s as  w e l l as that of the f e d e r a l government through i t s impact on the average* . However, both the d i s c u s s i o n and presented by Wilby are l i m i t e d Newfoundland and Labrador's  'national  the q u a n t i t a t i v e e s t i m a t e s  to an a n a l y s i s of the e f f e c t s  on  position.  Second, Wilby s u b j e c t s h i s model to an a n a l y s i s of the s e n s i t i v i t y of its  results  to changes i n a number of parameters  i n t e r e s t i n g , the a n a l y s i s offers  little  scope  i s c o n s t r a i n e d by the f a c t  the approach  used by Robinson  development The  and Morgan i n t h e i r  due  approach p l a n i n the  There i s a simple reason f o r  i n large part  a n a l y s i s of the economics above suggested  that  that  of North  the r i g i d i t y  of  to i t s r e l i a n c e on exogenous  p l a n s and p r o d u c t i o n p r o f i l e s .  remaining c h a p t e r s of t h i s  analyses of Hibernia will  Although  adopted by both the NLPD and Wilby i s e s s e n t i a l l y  Sea o i l p r o d u c t i o n . S u b s e c t i o n 2.3.2 t h i s approach was  that the  f o r the producer to a l t e r h i s development  face o f changes i n the economic environment. this:  and v a r i a b l e s .  thesis w i l l  extend  these economic  i n three p r i n c i p a l d i r e c t i o n s . F i r s t ,  the  approach  focus more s h a r p l y on the p o t e n t i a l e f f e c t s of government p o l i c i e s  on  79  producer behaviour as w e l l as on the consequences f o r the d i s s i p a t i o n o f net b e n e f i t s  from development and p r o d u c t i o n .  o f f s h o r e development model i s w e l l since  As suggested e a r l i e r , the  s u i t e d to examine these types o f i s s u e s  i t o f f e r s a number o f channels through which government p o l i c i e s as  w e l l as the economic environment i n g e n e r a l  can a f f e c t the simulated  b e h a v i o u r o f a r a t i o n a l producer. The a n a l y s i s o f c h a p t e r s 4 to 6 seeks to exploit  these p r o p e r t i e s  o f the model.  Second, the r e p e r c u s s i o n s Hibernia do  o f the development and p r o d u c t i o n o f  on the n a t i o n a l economy w i l l be examined. Chapter 7 attempts to  t h i s by s i m u l a t i n g  conjunction  the development and p r o d u c t i o n  of Hibernia i n  with a macroeconometric model o f the Canadian economy.  F i n a l l y , a study o f the p o t e n t i a l impact of H i b e r n i a and  Labrador's e n t i t l e m e n t s  general  should  were changed  and on the system of f i s c a l  be undertaken. F o r i n s t a n c e ,  equalization in  s i n c e the r u l e s o f the game  i n 1982, an i n t e r e s t i n g e x e r c i s e would be to compare the  i m p l i c a t i o n s o f the f i e l d ' s development and p r o d u c t i o n assumption that  under the  the terms o f the 1977 system had been extended  i n d e f i n i t e l y w i t h that r e s u l t i n g from the assumption that of the most recent  system apply  8 takes a few steps  3.4 I n c o r p o r a t i n g So  on Newfoundland  the p r o v i s i o n s  f o r the e n t i r e s i m u l a t i o n p e r i o d .  Chapter  i n that d i r e c t i o n .  an E n e r g y - P r o d u c i n g P r o j e c t  f a r , the d i s c u s s i o n has s h i e d  consideration: modelling  i n t o MACE  away from an important  the i n t e g r a t i o n o f H i b e r n i a  economy. S e t t i n g the development and p r o d u c t i o n i n the n a t i o n a l context  requires  i n t o the n a t i o n a l  o f an o f f s h o r e  o i l field  a view o f the r o l e o f energy i n the  Canadian economy. The MACE ( f o r MACro and Energy) model embodies such a  80  view. Although al.  the i n t e r e s t e d  reader i s r e f e r r e d  to H e l l i w e l l , McRae et  [1983] f o r a d e t a i l e d d e s c r i p t i o n o f MACE, an o u t l i n e can e a s i l y be  sketched. The model d i v i d e s capital  economy i n t o two s e c t o r s : one uses  and n a t u r a l r e s o u r c e s to produce  c a p i t a l , energy energy-using cost  the Canadian  and labour to produce  energy  and the other  e v e r y t h i n g e l s e . The output o f the  s e c t o r i s thus equal to the gross domestic  plus net energy  product  s e c t o r , that  first  sees c a p i t a l  in a constant-elasticity-of-substitution vintage approach.  40  at f a c t o r  imports.  At the core o f MACE i s a t w o - l e v e l p r o d u c t i o n f u n c t i o n , energy-using  uses  'Energized c a p i t a l '  f o r the  and energy bundled  together  i n n e r f u n c t i o n which r e l i e s on a i s then combined with  u n i t s o f labour i n a Cobb-Douglas outer f u n c t i o n to produce  efficiency  output. A l l  f a c t o r demands can then be d e r i v e d c o n s i s t e n t l y and i n such a way as to minimize factors  the t o t a l  i s f r e e to v a r y over the c y c l e , the parameters  f u n c t i o n are e i t h e r determined actual exhibit  c o s t s o f p r o d u c t i o n . Since the r a t e o f u t i l i z a t i o n o f  estimated through  by sample averages.  o f the p r o d u c t i o n  the f a c t o r demand equations or are  In the l a t t e r  case, the c o n s t r a i n t  f a c t o r - u s e r a t i o s be e q u a l , on average,  that  to t h e i r d e s i r e d v a l u e s and  the same trend over the 1952-1980 p e r i o d o f e s t i m a t i o n i s  respected. A dynamic approach  to the i n t e g r a t i o n o f the development and  p r o d u c t i o n o f H i b e r n i a i n t o the n a t i o n a l economy suggests  itself.  I f both  models c o u l d be r u n s i m u l t a n e o u s l y and t h e i r r e s u l t s made to be m u t u a l l y consistent  then, the economic environment  simulated by MACE would be f r e e  to i n f l u e n c e the r e s u l t s o f the o f f s h o r e r e s e r v o i r development model and v i c e v e r s a . To a l l o w f o r t h i s k i n d o f i n t e r a c t i o n ,  l i n k a g e s must be b u i l t  81  between the two models. The  required  fourfold. First,  links  from the o f f s h o r e development model to MACE a r e  the f i e l d ' s p r o d u c t i o n  Canadian energy supply  line.  satisfy will  Since  crude o i l w i l l  this region presently r e l i e s  1  imports. *  i s the r e s u l t  o f investment  expenditures  energy investment The  simply  i n energy p r o d u c t i o n .  associated with  e i t h e r o f two p l a c e s . t r e a t e d as g i v i n g r i s e  p o s i t i o n o f governments r e s u l t i n g  . .  to d i r e c t  by MACE at  .  The p r o v i s i o n s o f the c o r p o r a t i o n  income tax are  taxes on an energy-producing v e n t u r e . A l l  sources o f government revenues and expenditures  the e q u a t i o n  representing  s e c t i o n o f the Canadian f i s c a l  fiscal  thus t r e a t the  o f H i b e r n i a are captured  the p u b l i c s e c t o r  F i n a l l y , MACE i n c l u d e s a separate  modified  MACE w i l l  deposit  any H i b e r n i a development p l a n as  changes i n the f i s c a l  42  directly  flow o f  that would not otherwise have been undertaken.  simulated  relevant  d i s p l a c e s an e q u i v a l e n t  c a p i t a l used to develop any petroleum  from the development and p r o d u c t i o n  other  b r i n g i n g H i b e r n i a on l i n e  1  Second, the p r o d u c t i v e  capital  on f o r e i g n sources to  i n reduced Canadian imports o f energy. From MACE's  perspective, Hibernia production crude o i l  i t is  be consumed east o f the Ottawa  i t s m a r g i n a l demand f o r o i l p r o d u c t s ,  result  to enter the  p i c t u r e . Due to the l o c a t i o n o f H i b e r n i a ,  assumed that the e x t r a c t e d Valley  must be modelled  to capture  enter  balance.  treatment o f the o i l and gas  e q u a l i z a t i o n system. I t s p r o v i s i o n s w i l l be  the e f f e c t s o f changes i n Newfoundland and Labrador's  p o s i t i o n that would r e s u l t  from the development and p r o d u c t i o n o f  H i b e r n i a . T h i s i n f o r m a t i o n on the i m p l i c a t i o n s o f H i b e r n i a on the e q u a l i z a t i o n system can then be used i n an a n a l y s i s of the d i s t r i b u t i o n o f 1+3 economic r e n t s from o i l and gas p r o d u c t i o n among the d i f f e r e n t r e g i o n s .  82  The r e q u i r e d  linkages  e a s i l y be d e s c r i b e d .  First,  number of parameters (such after-tax opportunity  from MACE to the o f f s h o r e development model can the H i b e r n i a model draws the values  as the r a t e o f economic d e p r e c i a t i o n , the  cost o f c a p i t a l ,  the r a t e o f d i s c o u n t  opportunity  cost o f c a p i t a l ) and o f a number o f v a r i a b l e s  particular,  the o f f s h o r e  endogenous exchange  development model  economic environment which, i n t u r n ,  and the t a x  from MACE. In variables  the p r i c e o f f o r e i g n  Canadian crude o i l p r i c e . T h i s  feedback mechanism has been i n s t i t u t e d :  project.  accepts three  to MACE: the domestic r a t e o f i n f l a t i o n ,  and the r e l e v a n t  of a  implies  that a  the p r o j e c t can a f f e c t the  influences  the economics o f the  83  FOOTNOTES 1  This  is  shown i n Nind  [1981, chapter 2 ] .  2 T h i s amounts to assuming that the r a t e o f r e c o v e r y i s always below the maximum e f f i c i e n t r a t e (MER). For n o n - t e c h n i c a l d i s c u s s i o n s of MER, see  Davidson  [1963, pp.92-94] and Dasgupta and Heal [1979, pp. 440-441].  However, i t i s not e q u i v a l e n t to assuming, as Uhler [1979, p.109] does, that p r e s s u r e dynamics are such that there e x i s t s a g i v e n maximum p r o d u c t i o n r a t e a s s o c i a t e d with each r e s e r v o i r . 3 4  This  issue is  f u r t h e r e x p l o r e d i n appendix  2.  The p r o p e r t i e s of the e x p o n e n t i a l d e c l i n e process are such that the stock of r e s e r v e s i n i t i a l l y c o n t a i n e d i n a g i v e n r e s e r v o i r would, i n t h e o r y , be f u l l y exhausted o n l y i n the l i m i t , as t •*• . 0 0  5  6  7  8  9  10  1 1  E x p r e s s i o n s r e p r e s e n t i n g c u m u l a t i v e p r o d u c t i o n as w e l l as b e g i n n i n g - and e n d - o f - p e r i o d instantaneous p r o d u c t i o n r a t e s for time p e r i o d s o f g i v e n l e n g t h s are d e r i v e d i n appendix 2. Although not apparent from e q u a t i o n ( 3 . 2 5 ) , the government bear a tax o p p o r t u n i t y cost on i n v e s t e d c a p i t a l .  is  assumed  Once the flow of p r o d u c t i o n from a g i v e n r e s e r v o i r i s s t o p p e d , does not a l l o w i t to become p o s i t i v e at a l a t e r d a t e .  to  the model  T h i s p r o p e r t y i s common among models which a l l o w for an endogenous d e t e r m i n a t i o n of the s i m u l a t e d p r o d u c t i o n p r o f i l e . See, for example, O d e l l and Rosing [1977a, e s p e c i a l l y chapter 4 ] . See, i n p a r t i c u l a r , Devine and Lesso [1975]. See,  for example,  The w e l l has  [1972] as w e l l  as F r a i r  and Devine  S u l l i v a n [1982].  s i n c e been r e d e s i g n a t e d  Chevron et  a l . Hibernia  P-15.  In order of spudding d a t e , the nine completed a p p r a i s a l w e l l s a r e : M o b i l et a l . H i b e r n i a 0-35, B-08, G-55 and G-55A, K - 1 8 , the i l l - f a t e d J - 3 4 , 1-46, K-14 and B - 2 7 . At the time of w r i t i n g , d r i l l i n g was p r o c e e d i n g on another H i b e r n i a w e l l , C-96. Since G-55 was abandoned a f t e r r e a c h i n g a depth of o n l y 212 m e t r e s , i t i s u s u a l l y ignored i n d i s c u s s i o n s of d r i l l i n g a c t i v i t y (see E a s t e r n O f f s h o r e News [ 3 ( 1 ) , p.3]) . 1 3  Some w e l l s have a l s o encountered a t h i r d zone of o i l - b e a r i n g sands which has been l a b e l l e d Jeanne d ' A r c . At the time of w r i t i n g , however, l i t t l e was known about i t s g e o l o g i c a l p r o p e r t i e s ( s e e , for example, Oilweek [33(36), p . 3 7 ] ) . As a r e s u l t , the a n a l y s i s i g n o r e s i t s existence.  84  1k  I t s h o u l d be n o t e d t h a t t h e o f f s h o r e d e v e l o p m e n t model i s d e s i g n e d t o a c c o m o d a t e any number o f r e s e r v o i r s . The f a c t t h a t t h e H i b e r n i a f i e l d c o n s i s t s o f o n l y two r e s e r v o i r s r e d u c e s t h e d i m e n s i o n a l i t y o f t h e p r o b l e m b u t does n o t o t h e r w i s e a f f e c t t h e p r o p e r t i e s o f the m o d e l .  1 5  See O i l w e e k  1 6  See E a s t e r n O f f s h o r e News  [32(28),  pp.13-28]. [6(2),  pp.2-3].  17 A l t h o u g h H a n d y s i d e and Chipman [1982, pp.5-6] a l s o document t h e presence o f small q u a n t i t i e s o f condensates, the a n a l y s i s w i l l ignore the p o s s i b i l i t y o f e x t r a c t i n g t h e s e r e s o u r c e s . 18 See E a s t e r n O f f s h o r e pp.12-13].  News  [ 6 ( 2 ) , pp.2-3] and O i l w e e k  [33(14),  19 Compare, f o r e x a m p l e , with Oilweek [33(21), See  Oilweek  Oilweek p.10].  [31(23),  pp.12-20] and L e B l a n c  [1980]  [32(4), p . 4 ] .  21 A p p e n d i x 4 c o n t a i n s a t r a n s l a t i o n from m a c h i n e - r e a d a b l e language o f the o f f s h o r e d e v e l o p m e n t model as i t was a p p l i e d t o t h e c a s e o f H i b e r n i a . 22 See  Handyside; and Chipman  [1982, T a b l e s  3 and 5 ] .  23  . W i t h t h e e x c e p t i o n o f t h e p r o v i s i o n s f o r berms d e s i g n e d t o p r o t e c t f i x e d p l a t f o r m s from i c e b e r g s , t h e s e e s t i m a t e s a r e s i m i l a r t o t h o s e p r e s e n t e d i n W i l b y [1981, p . 1 2 ] . .  24  . . . The e s t i m a t e s used i n t h i s t h e s i s do n o t i n c l u d e t h e 30 p e r c e n t c o n t i n g e n c y a l l o w a n c e assumed by t h e NLPD ( s e e NLPD [1980, p . 1 0 ] ) . W i l b y [1981] a l s o used t h e s e e s t i m a t e s and i g n o r e d t h e c o n t i n g e n c y allowance.  25 T h i s a s s u m p t i o n does n o t seem t o v i o l a t e common N o r t h Sea p r a c t i c e s w i t h r e s p e c t to the use o f c o n c r e t e g r a v i t y p l a t f o r m s . See K l i t z [1980, c h a p t e r 7 ] , O f f s h o r e E n g i n e e r [ A p r i l 1982, pp.55-63] and W o r l d O i l [195(3), pp.159-166]. 26 T h i s i s a common-assumption i n d i s c u s s i o n s o f t h e p r o d u c t i o n o f t h e H i b e r n i a f i e l d u s i n g s e m i - s u b m e r s i b l e s . See, f o r e x a m p l e , O i l w e e k [31(33), pp.64-66]. 27 ' • • The t w e n t y - f i r s t w e l l o f e a c h f i x e d p l a t f o r m i s assumed t o r e a c h Avalon. 28 Please  refer  to t a b l e  3.1.  29 Refer It  t o NLPD  should  be remembered- t h a t  recoverable use  [1980, p.15] and compare  reserves  o f secondary  reserves  that  the model's  contained  recovery  the l a s t  i n each  techniques.  are producible only  two c o l u m n s .  assumptions  r e s e r v o i r .are Therefore,  as a r e s u l t  about  the l e v e l o f  conditional  on t h e  any a d d i t i o n a l  of i n j e c t i o n  are already  85 i n c l u d e d i n t h e m o d e l ' s e s t i m a t e s . The p u r p o s e o f t h i s m o d i f i c a t i o n i s simply to r e f l e c t the f a c t that pressure maintenance u s u a l l y slows the d e c l i n e p r o c e s s i n a d d i t i o n t o c r e a t i n g more r e s e r v e s . 31  32 33  34  35  36  37  38  I t i s , h o w e v e r , l o n g e r by two y e a r s t h a n t h e c o r r e s p o n d i n g p e r i o d s s u g g e s t e d i n t h e NLPD s t u d i e s . T h i s r e l a t i o n s h i p a l s o h o l d s f o r a t w o - p l a t f o r m f l o a t i n g s y s t e m . See W i l b y [1981, pp.8-9]. See  Oilweek  [31(33),  pp.64-65].  A p p e n d i x 3 p r o v i d e s a more d e t a i l e d d i s c u s s i o n o f t h e i s s u e s s u r r o u n d i n g j u r i s d i c t i o n and t h e p r o p o s e d g o v e r n m e n t p o l i c i e s . U n f o r t u n a t e l y , some d e g r e e o f o v e r l a p b e t w e e n t h i s s u b s e c t i o n and t h e appendix i s u n a v o i d a b l e . A l l o f them a l s o i n c l u d e some k i n d o f 'me f i r s t ' p r o v i s i o n s u n d e r w h i c h the p r o d u c e r i s e x p e c t e d , whenever p o s s i b l e , t o g i v e p r e f e r e n c e t o l o c a l l a b o u r and s o u r c e s o f s u p p l i e s . The model assumes t h a t s u c h p r o v i s i o n s a f f e c t n e i t h e r the investment requirements a s s o c i a t e d w i t h any d e v e l o p m e n t p l a n n o r p r o d u c e r d e c i s i o n s . However, u n d e r t h e terms o f t h e r e g u l a t i o n s a d o p t e d by N e w f o u n d l a n d and L a b r a d o r , t h e p r o v i n c i a l government r e s e r v e s t h e r i g h t to d e l a y t h e d e v e l o p m e n t and p r o d u c t i o n o f c e r t a i n f i e l d s o t h e r t h a n H i b e r n i a . See N e w f o u n d l a n d and L a b r a d o r , M i n e s and E n e r g y [1977, pp.35-45] and N e w f o u n d l a n d and L a b r a d o r [1978, pp.1007-1008]. The o f f s h o r e d e v e l o p m e n t m o d e l e x p l o i t s t h i s p r o v i s i o n i n t h e f o l l o w i n g manner. A l t h o u g h t h e p r o d u c t i o n r i g h t s t o H i b e r n i a w i l l most l i k e l y be d i s t r i b u t e d among f i v e o r s i x f i r m s , most o f t h e a n a l y s i s assumes t h a t t h e o p e r a t i n g c o n s o r t i u m a c t s as a s i n g l e f i r m , r e f e r r e d t o as ' t h e producer'. However, t h e s e c o n d s t u d y c o n c l u d e s t h a t t h e p r o v i s i o n s c o n t a i n e d i n t h e f e d e r a l g o v e r n m e n t ' s N a t i o n a l E n e r g y P r o g r a m [Canada. E n e r g y , M i n e s and R e s o u r c e s 1980] r e s u l t i n a g r e a t e r s h a r e o f n e t r e v e n u e s f l o w i n g to t h e f e d e r a l t r e a s u r y a t t h e d e t r i m e n t o f b o t h p r o d u c e r and provincial coffers. The a u t h o r s u g g e s t s t h a t t h e p r o d u c e r s h a r e o f n e t r e v e n u e s i s l o w e r u n d e r t h e r e g u l a t i o n s p r o p o s e d by t h e g o v e r n m e n t o f N e w f o u n d l a n d and L a b r a d o r t h a n u n d e r any o f t h e f e d e r a l p r o p o s a l s , i n c l u d i n g t h e p r o v i s i o n s c o n t a i n e d i n t h e N a t i o n a l E n e r g y P r o g r a m . See W i l b y [1981,  pp.43-44]. 39 40  1+1  See  Wilby  [1981, pp.83-84].  T h r o u g h i t s use o f a v i n t a g e a p p r o a c h , MACE r e c o g n i z e s t h a t t h e age s t r u c t u r e o f the c a p i t a l s t o c k a f f e c t s i t s energy e f f i c i e n c y . I f , a t any t i m e , t h e s i m u l a t e d l e v e l o f o u t p u t from H i b e r n i a e x c e e d s C a n a d i a n c r u d e o i l i m p o r t r e q u i r e m e n t s , MACE w i l l assume t h a t t h e s u r p l u s p r o d u c t i o n i s e x p o r t e d t o t h e U n i t e d S t a t e s and p r i c e d a t p r e v a i l i n g world l e v e l s .  86  In MACE, 'the government' r e f e r s to a l l three p r o v i n c i a l and m u n i c i p a l .  levels: federal,  The treatment o f f e r e d by MACE o f the d i s t r i b u t i o n o f economic r e n t s among the r e g i o n s i s based on the p r o v i s i o n s of the e q u a l i z a t i o n system, consumption f o r consumer r e n t s , p r o d u c t i o n f o r r e n t s a c c r u i n g to the p r o v i n c i a l governments and p o p u l a t i o n f o r the Canadian share o f producer r e n t s and that a c c r u i n g to the f e d e r a l government.  Table 3.1 Estimates o f P l a t f o r m Costs and O p e r a t i n g E x p e n d i t u r e s PLATFORM COSTS Type Location 3  Cost  1  2  Cost :D i s t r i b u t i o n by Year 3 4 5 6  7  FIXED  Avalon Hibernia Both  2210 2430 2320  0.065 0.059 0.062  0.093 0.085 0.089  0.164 0.149 0.156  0.281 0.268 0.274  0.282 0.295 0.268  0.109 0.138 0.145  FLOATING  Avalon Hibernia Both  1385 1475 1400  0.029 0.026 0.028  0.335 0.316 0.325  0.469 0.465 0.444  0.148 0.176 0.185  0.017 0.015 0.016  0.002 0.002 0.002  0.002 0.002 0.002  8 0.002 0.002 0.002  9 0.002 0.002 0.002  OPERATING EXPENDITURES —  —  each f i x e d p l a t f o r m : 67 m i l l i o n 1983 d o l l a r s — a d d i t i o n a l f i x e d charge f o r f i r s t p l a t f o r m used: 15 m i l l i o n  1983 d o l l a r s  each f l o a t i n g p l a t f o r m : 106 m i l l i o n 1983 d o l l a r s — a d d i t i o n a l f i x e d charge f o r f i r s t p l a t f o r m used: 29 m i l l i o n 1983 d o l l a r s — a d d i t i o n a l f i x e d charge f o r second p l a t f o r m used: 23 m i l l i o n 1983 d o l l a r s  These e s t i m a t e s have been adapted from NLPD [1980, pp.14-15;1982]. See a l s o Wilby [1981, pp.11-12]. The t o t a l cost of one p l a t f o r m i s expressed i n m i l l i o n s of 1983 d o l l a r s and i n c l u d e s a l l e x p e n d i t u r e requirements r e l a t e d to c o n s t r u c t i o n , i n s t a l l a t i o n and d r i l l i n g . D i f f e r e n c e s i n c o s t s and d i s t r i b u t i o n s a c r o s s l o c a t i o n s are due to estimated d i f f e r e n c e s i n d r i l l i n g c o s t s which are r e l a t e d to the depths o f the two r e s e r v o i r s . In subsequent f i g u r e s and t a b l e s , any p l a t f o r m producing only the Avalon r e s e r v o i r w i l l be denoted by A. S i m i l a r l y , any p l a t f o r m producing only the H i b e r n i a r e s e r v o i r w i l l be denoted by H w h i l e any p l a t f o r m w i t h w e l l s r e a c h i n g both r e s e r v o i r s w i l l be denoted by B. Thus, f o r example, AB w i l l r e f e r to a twop l a t f o r m p r o d u c t i o n system where the f i r s t p l a t f o r m i n s t a l l e d produces o n l y Avalon w h i l e the second p l a t f o r m w i l l have w e l l s r e a c h i n g both r e s e r v o i r s . O p e r a t i n g e x p e n d i t u r e s are expressed i n annual terms.  88  CHAPTER 4 GOVERNMENT POLICIES AND THE DECISION TO DEVELOP  4.1  Introduction The  key concern o f t h i s chapter i s to examine the p o t e n t i a l  the consequences o f d i s t o r t i o n s  i n producer  government p o l i c i e s . A f t e r o u t l i n i n g , upon which the a n a l y s i s  behaviour  f o r and  induced by  i n s e c t i o n 4.2, the key assumptions  i s based, the remaining  s e c t i o n s o f the chapter  d e s c r i b e and apply a two-step approach to s t u d y i n g the impacts o f royalties  and taxes on the development and p r o d u c t i o n o f H i b e r n i a .  Since one o f the o b j e c t i v e s o f t h i s  thesis  e s t i m a t e s o f the e f f e c t s o f government p o l i c i e s ,  i s to d e r i v e q u a n t i t a t i v e i t i s necessary  to d e r i v e  y a r d s t i c k measures o f the p o t e n t i a l net present v a l u e o f H i b e r n i a i n alternative 4.3  s t a t e s o f the world. T h i s i s the task undertaken  where MACE and the o f f s h o r e development model o u t l i n e d  above are used of  i n chapter 3  to assess the economics o f the development and p r o d u c t i o n  H i b e r n i a . At t h i s j u n c t u r e , the p r o j e c t  reach o f government p o l i c i e s d i r e c t e d models a r e used  i n section  to i d e n t i f y ,  i s assumed to be o u t s i d e the  at developments o f t h i s k i n d . The  for d i f f e r e n t  c a s e s , the development  plans  which maximize the p o t e n t i a l net present v a l u e o f the f i e l d . The  behaviour  of a p r i c e - t a k i n g ,  net-present-value-maximizing  producer  i s probed  i n s e c t i o n 4.4. By i n c o r p o r a t i n g i n t o the o f f s h o r e  development model the p r o v i s i o n s o f a number o f a l t e r n a t i v e p o l i c y and  r e p e a t i n g the e x e r c i s e performed  i n s e c t i o n 4.3, i t i s p o s s i b l e to  s i m u l a t e the e f f e c t s o f these p o l i c i e s on producer use of  the t e r m i n o l o g y the r e a l i z e d  regimes  behaviour  and thus, to  i n t r o d u c e d i n the p r e v i o u s c h a p t e r , o b t a i n e s t i m a t e s  net present v a l u e o f the f i e l d .  The r e s u l t i n g  distribution  89  o f net b e n e f i t s of  between government and producer i s an a d d i t i o n a l  product  t h i s experiment. Finally,  sections  s e c t i o n 4.5 compares the r e s u l t s o f the p r e v i o u s two  and measures the d i s s i p a t i o n o f p o t e n t i a l net b e n e f i t s  resulting  from the d i s t o r t i o n a r y e f f e c t s o f government p o l i c i e s on producer decisions. relegated  However, save for a few e x c e p t i o n s , s e n s i t i v i t y  analysis i s  to chapter 5.  4.2 The Framework o f A n a l y s i s 4.2.1  Assumptions R e l a t i n g For  sector the  the purposes o f t h i s t h e s i s , the equations o f MACE's energy-using  are solved  relevant  determined The  to MACE  endogenously u n t i l  MACE v a r i a b l e s  required  1996.  After  that  by the o f f s h o r e  time, v a l u e s f o r  development model are  exogenously.  version  o f MACE used has been tuned to r e p l i c a t e h i s t o r y i n the  1974-1982 i n t e r v a l . For MACE to d e r i v e over the 1983-1996 p e r i o d , and  1  a p i c t u r e o f the Canadian economy  a few t a r g e t s  and r u l e s have to be s p e c i f i e d  assumptions must be made about the v a l u e s o f c e r t a i n Canadian, US and  OECD v a r i a b l e s . Of primary importance are f i s c a l  and monetary p o l i c y i n  Canada, the i n t e r n a t i o n a l trade and f o r e i g n exchange markets and f o r e i g n i n f l a t i o n r a t e s , r e a l income growth and i n t e r e s t Over the 1983-1986 p e r i o d , government i n Canada f o l l o w  rates.  r e a l e x p e n d i t u r e s by a l l three l e v e l s o f  the p r o j e c t i o n s  o f the A p r i l  1983 f e d e r a l  budget. In l a t e r years they are assumed to r i s e 2 per cent a n n u a l l y i n real  terms. T a x a t i o n r a t e s  provisions  introduced  c o n t i n u e at 1982 l e v e l s m o d i f i e d by the  i n the A p r i l  1983 f e d e r a l budget.  90  Canadian monetary p o l i c y i s assumed  to be a t r a d e o f f between i n t e r e s t  r a t e and monetary growth t a r g e t s . The monetary a u t h o r i t y growth r a t e o f the stock  from an estimated  policy  f u n c t i o n . The l a t t e r depends p r i m a r i l y on the l e v e l of f o r e i g n  exchange r e s e r v e s forecast  a target  o f high-powered money o f 8 per cent and a t a r g e t  (nominal) s h o r t - t e r m i n t e r e s t r a t e d e r i v e d reaction  i s given  and the US bond r a t e  o f 8.4 per cent  growth of the stock  ( f o r which a Bank o f Canada  i s used over the e n t i r e 1983-1996  period).  Actual  o f high-powered money i s then s e t equal to the  geometric mean o f these two t a r g e t s . Some o f the r e s u l t i n g p r e s s u r e i s s h i f t e d to the f o r e i g n exchange market where a ' l e a n i n g  against  the wind' exchange r a t e  determination  mechanism ensures that movements i n the p r i c e of f o r e i g n exhange (US c u r r e n c y ) are cushioned by Bank o f Canada i n t e r v e n t i o n but always occur i n the d i r e c t i o n i n d i c a t e d by the balance o f payments. A f t e r of  1996, the p r i c e  f o r e i g n exchange i s assumed to equal $Cdn 1.30 i n a l l c a s e s . Forecasts  f o r most US and OECD v a r i a b l e s were o b t a i n e d as a r e s u l t o f 2  MACE's p a r t i c i p a t i o n i n a recent  Energy Modeling Forum study.  Between  1983 and 1986, r e a l US GNP i s thus set to grow at annual r a t e s between 1 and 4 per c e n t . A f t e r c e n t . Real output  1986, t h i s r a t e  i n major OECD c o u n t r i e s  varying  i s assumed to equal 3 per  (excluding  Canada and the United  S t a t e s ) i s s e t to grow at r a t e s which v a r y between 1 and 3.5 per cent i n the  1983 to 1986 p e r i o d .  S t a r t i n g i n 1987, t h i s annual r a t e o f growth i s  set at 3 per c e n t . The r a t e of i n c r e a s e  i n the i m p l i c i t  p r i c e index o f US  absorption  v a r i e s between 3 and 6 per cent i n the years up to and i n c l u d i n g i s equal to 6 per cent  thereafter. A version  assumed to be m a i n t a i n e d  1986 and  o f p u r c h a s i n g power p a r i t y i s  i n the post-1996 p e r i o d . The general  rate of  91  price  inflation  i n Canada i s thus s e t to grow at an annual r a t e o f 6 per  cent a f t e r 1996. Although  p r o j e c t e d e a r l y on i n the f o r e c a s t  and 9 per c e n t , the OECD GDP d e f l a t o r as the i m p l i c i t Similarly,  p e r i o d to v a r y between 7  i s assumed to grow at the same r a t e  US a b s o r p t i o n p r i c e index i n the  the growth r a t e o f the p r i c e of world  non-energy exports s t e a d i l y d e c l i n e s per cent i n 1987 and m a i n t a i n s  post-1986 p e r i o d . export goods and  from 9 per cent u n t i l  i t reaches 6  t h i s v a l u e u n t i l 1996.  Based on exogenous f o r e c a s t s o f c e r t a i n world v a r i a b l e s world  crude o i l p r i c e , MACE endogenously  energy  i n c l u d i n g the  d e r i v e s p r o j e c t i o n s o f domestic  demand as w e l l as i t s breakdown among o i l p r o d u c t s , n a t u r a l gas and  e l e c t r i c i t y . The processes o f d i s c o v e r y and e x p l o i t a t i o n o f the Western p r o v i n c e s ' r e s e r v e s o f c o n v e n t i o n a l o i l and gas have a l s o been The  output  of the Great  p l a n t s completes  Canadian  modelled.  O i l Sands (now Suncor) and Syncrude  MACE's r e p r e s e n t a t i o n o f Canadian  o i l and gas  p r o d u c t i o n . To c o n c e n t r a t e on the r o l e o f H i b e r n i a , i t has been assumed that n e i t h e r a d d i t i o n a l o i l sands p l a n t s nor any other developments come on stream d u r i n g the f o r e c a s t are thus assumed to make up any remaining  frontier  p e r i o d . Imports  shortfall  o f domestic  from OPEC production  over demand. Canadian  exports o f crude petroleum  exogenous to MACE. The l e v e l s used past e x p e r i e n c e and are l i m i t e d The  drop  to the U n i t e d States are  i n the f o r e c a s t  to heavy  p e r i o d are based on  oil.  i n world o i l p r i c e s between 1981 and 1983 combined with the  c o n t i n u i n g d e r e g u l a t i o n o f n a t u r a l gas p r i c e s have c r e a t e d what has been called  a gas 'bubble'  i n the United S t a t e s . As a r e s u l t ,  of n a t u r a l gas are c u r r e n t l y p r o c e e d i n g at l e s s  than h a l f  Canadian  exports  the volumes  92  approved by the N a t i o n a l Energy Board l e v e l of s a l e s , Canadian n a t u r a l gas reduced. reflect  export  The v e r s i o n of MACE used i n t h i s these  to the U n i t e d  p r i c e s were  t h e s i s has  that  substantially  been m o d i f i e d  to  developments.  In January  that  (NEB). Furthermore, to m a i n t a i n  1983,  the NEB  approved a d d i t i o n a l exports of n a t u r a l gas  S t a t e s f o r the 1983  to 2000 p e r i o d .  these e n t i r e a d d i t i o n a l volumes w i l l  3  I t has  be exported  been assumed  without  any  change  i n the c u r r e n t p r i c i n g s t r u c t u r e .  4.2.2  Assumptions R e l a t i n g to the O f f s h o r e Development Model Since the o b j e c t i v e of t h i s chapter  i s to look at the economics of  the development d e c i s i o n , e x p l o r a t i o n and expenditures  a l l other  pre-development  on H i b e r n i a are t r e a t e d as sunk c o s t s and  net-present-value  thus  ignored i n the  c a l c u l a t i o n s . However, when these expenditures  r o y a l t y and  tax deductions  development  takes p l a c e , they are l i n k e d  that would o n l y be a v a i l a b l e to the producer i f to revenues from the p r o j e c t .  Government g r a n t s r e c e i v e d by the producer C a p i t a l expenditures  represent  are t r e a t e d  i n c u r r e d as a r e s u l t  of the  similarly. simulated  development of H i b e r n i a are cumulated  into a r e a l  i s assumed to d e p r e c i a t e at an annual  r a t e of 5 per c e n t . W i t h i n one  p e r i o d of p r o d u c t i o n from the  the c a p i t a l  stock i s f u l l y d e p r e c i a t e d . Other parameters used i n the  (after  c a l c u l a t i o n s are taken  tax) supply  p r i c e of c a p i t a l  are assumed to be equal on i n d u s t r i a l c a p i t a l c e n t . I t has  any  remaining  which  of the l a s t  present-value  field,  stock of c a p i t a l  p o r t i o n of  from MACE. Thus, the average to b u s i n e s s  to 7 per c e n t .  4  The  and  year  net-  real  the r e a l d i s c o u n t r a t e  average r e a l  annual  tax r e t u r n  (the tax o p p o r t u n i t y c o s t ) i s assumed to equal 3 per  a l s o been assumed that one  t h i r d of the p r i v a t e (and  Petro-  93  Canada) investment ten-year p e r i o d The  i s d e b t - f i n a n c e d . Bonds are subsequently r e t i r e d  following  over a  the b e g i n n i n g o f p r o d u c t i o n .  economics o f the development d e c i s i o n have been examined f o r  three c a s e s . Table 4.1 summarizes t h e i r g e o l o g i c (and p h y s i c a l ) and economic assumptions. available falling  Case 1 r e p r e s e n t s a c o n s o l i d a t i o n o f the c u r r e n t l y  i n f o r m a t i o n on H i b e r n i a upon which i s imposed, a f t e r  r e a l world o i l p r i c e . The g e o l o g i c and p h y s i c a l assumptions are  taken from Handyside  and Chipman [1982] and the e x p e n d i t u r e l e v e l s  NLPD [1980;1982], as summarized For It  1983, a  treats  Handyside  the purposes  of t h i s  the r e s e r v o i r  from  i n t a b l e 3.1.  t h e s i s , case 2 i s c o n s i d e r e d the base c a s e .  s i z e and the p r o d u c i b i l i t y assumptions  and Chipman [1982] as o v e r l y o p t i m i s t i c  a c c o r d i n g l y . O v e r a l l , the f i e l d  and reduces  i s here assumed to c o n t a i n 1.2  made i n them billion  b a r r e l s o f r e c o v e r a b l e crude o i l , 25 per cent l e s s than suggested by Handyside  and Chipman. S i m i l a r l y , the i n i t i a l  productive c a p a b i l i t i e s of  w e l l s r e a c h i n g the two r e s e r v o i r s have been reduced and 6 thousand  b a r r e l s per day f o r Avalon and H i b e r n i a , r e s p e c t i v e l y .  The warning  issued  i n a r e p o r t on North Sea o i l p r o d u c t i o n [ U n i t e d  Kingdom. Department o f Energy  1976] i s a l s o heeded: p r o j e c t s with a l a r g e  development content can be expected exacerbated by the absence among producing  by 40 per c e n t , to 9  fields.  to run over budget.  o f an adequate  T h i s problem i s  p r o d u c t i o n analogue  In response, p r o j e c t e d investment  i n c r e a s e d by 50 per cent over those o f case  to H i b e r n i a  requirements are  1. However, world o i l p r i c e s  f o l l o w the same path as that assumed i n case 1. Case 3 assumes that  the c h a r a c t e r i s t i c s o f the f i e l d  are the same as  i n case 2, but s e t s i t s development and p r o d u c t i o n i n an economic environment  c h a r a c t e r i z e d by lower world o i l p r i c e s and even h i g h e r  94  capital  and o p e r a t i n g c o s t s .  As  the above d e s c r i p t i o n s r e v e a l , case 1 embodies the most  optimistic  view of H i b e r n i a , case 3 the most p e s s i m i s t i c , w i t h case 2 f a l l i n g i n between.  Cases  1 and 3 are designed to p r o v i d e upper  the economic v i a b i l i t y  o f the f i e l d .  of  p r o d u c t i o n of H i b e r n i a w i l l  the development and  I t i s f e l t that  and  lower bounds o f  the a c t u a l outcome  likely  fall  within  these bounds which i n part e x p l a i n s the s e l e c t i o n of case 2 as the base case. As  f a r as such comparisons  differences  i n the approaches  [1981] seem most s i m i l a r the assumptions  are p o s s i b l e and  adopted,  f a i r , g i v e n the  the assumptions  to those o f case 1. The  made i n Wilby  same can be s a i d  made i n NLPD [1980;1981] w i t h the e x c e p t i o n of  about  their  p r o v i s i o n o f a 30 per cent c o n t i n g e n c y allowance on c a p i t a l e x p e n d i t u r e s , thus moving a few steps i n the d i r e c t i o n of case 2. However, the world o i l price  f o r e c a s t s used by both Wilby and  project  than those of cases 1 and  The  1983  [Canada. price and to  Ottawa-Alberta energy  Energy, Mines and Resources  1981.  r e c e i v e the NORP.  1983]  extended  suggest  use  that  throughout  the remaining  1974  eligible  such a cumbersome d e f i n i t i o n of r e a l revenues? i n the r e l e v a n t  sections  w i l l be measured at the  thus be net of the cost of f i e l d - t o - s h o r e  themselves:  o i l reference  the p r o d u c t i o n from H i b e r n i a i s  c h a p t e r s of t h i s t h e s i s , p e r - b a r r e l revenues  t i o n . Why  the new  5  i t should be noted  wellhead and w i l l  agreement  to i n c l u d e a l l o i l i n pools d i s c o v e r e d between  I t i s thus assumed that  Finally, and  2.  amendments to the 1981  (NORP) coverage  the NLPD are more f a v o u r a b l e to the  transportaTwo  reasons  government documents, NORP i s d e f i n e d  as the p r i c e o f a b a r r e l of o i l d e l i v e r e d  at M o n t r e a l .  6  T h e r e f o r e , the  95  p r i c e r e c e i v e d by  the producer at the p r o d u c t i o n  a p p r o p r i a t e l y adjusted oil,  royalties  with due thesis,  and  4.3  taxes are u s u a l l y assessed  adjusted  a g a i n s t wellhead  costs.  i t thus seemed more a p p r o p r i a t e  For  to use  for transport  revenues  the purposes of  this  a measure of wellhead  costs.  Development i n the Absence o f Government The  i s NORP  f o r t r a n s p o r t c o s t s . Second, i n the case of crude  allowance made f o r t r a n s p o r t  revenues that was  facilities  Policies  r e s u l t s from the o p t i m i z a t i o n runs of the o f f s h o r e development  model i n the absence of government p o l i c i e s through 4.4  and  t a b l e 4.2.  are summarized  in figures  These r e s u l t s r e v e a l t h a t , i n a l l three  cases,  i t i s p o s s i b l e to i d e n t i f y at l e a s t one  yields  a non-negative net  present  value  maximized when o n l y the r e s e r v e s  development p l a n which  f o r the  assumptions of case 3, the p o t e n t i a l net  field.  present  contained  However, under  value  of the  field  too c o s t l y to warrant development and  i n the Avalon r e s e r v o i r are  two  types of p r o d u c t i o n  i n t e n s i t y of development r i s e s ,  systems  the r e s u l t s a l s o  suggest  the n e t - p r e s e n t - v a l u e - m a x i m i z i n g development p l a n always i n v o l v e s  choice had  be  production.  Although d i f f e r e n c e s between the  that  the  is  e x t r a c t e d . Under these c o n d i t i o n s , the H i b e r n i a r e s e r v o i r i s shown to  decrease as the  4.1  of f i x e d  reached  platforms.  the o p p o s i t e  explained?  By  reservoir,  the NLPD and  avoidable effect  assuming that the  a bias  studies  c o n c l u s i o n . How field  at l e a s t  i n favour  of  can  [1980]  and  equal  Wilby  [1981])  t h i s d i f f e r e n c e be produced as a s i n g l e  importance of the  floating  l a r g e r than those of f i x e d  (NLPD  can be  Wilby reduce the  c o s t s of p r o d u c t i o n  creates  c o s t s are  Earlier  the  expected  c o n s t r a i n t that  revenues. T h i s i n  systems s i n c e t h e i r  systems. The  model used  operating  in this  96  t h e s i s p r o v i d e s a b e t t e r c h a r a c t e r i z a t i o n of t h i s c o n s t r a i n t on p r o d u c t i o n since  the margin of development can be  identified  independently  f o r the  10  two  reservoirs.  used  More important, however, are d i f f e r e n c e s  i n the e x p e n d i t u r e  i n the e a r l i e r s t u d i e s and  e s t i m a t e s used  NLPD and Wilby were based fixed  t h i s one.  The  on the assumption  estimates  by both  the  that the i n s t a l l a t i o n of a  p r o d u c t i o n system would r e q u i r e the c o n s t r u c t i o n of p r o t e c t i v e berms  on the ocean f l o o r . Since f l o a t i n g p l a t f o r m s can be moved to a v e r t the t h r e a t of a c o l l i s i o n with an i c e b e r g , p r o t e c t i v e berms were b e l i e v e d unnecessary. The  expenditure  were taken  estimates  for fixed  p l a t f o r m s used  from NLPD [1982] where no allowance  c o n s t r u c t i o n of p r o t e c t i v e berms. Rather, p l a t f o r m s c o n s i d e r e d f o r H i b e r n i a would be c o l l i s i o n s with  in this  thesis  i s made f o r the  i t i s b e l i e v e d that the k i n d of solid  enough to w i t h s t a n d  i c e b e r g s s m a l l enough to p e n e t r a t e the r e l a t i v e l y  shallow  waters of the n o r t h e a s t e r n Grand Banks. Under the assumptions of case this results expenditure  i n a decrease requirements  of 1.5  of a two-platform  c o r r e s p o n d i n g l y more i n cases However, by changing government p o l i c i e s  dollars  fixed  determine  whether or not t h i s  system, and  t h i s model. The  or f l o a t i n g  the two  capital of  3.  a n a l y s i s of s u b s e c t i o n 4.4.3 i s the  to the t a b l e 4.2  will  ranking a l l o w us to  case.  and  f i g u r e s 4.1  .to 4.4,  i d e n t i f y development plans which are o p t i m a l along  fixed  i n the  could by i t s e l f r e v e r s e the f i x e d / f l o a t i n g  by  to  2 and  1980  c o n d i t i o n s at the margin, the i n t r o d u c t i o n o f  suggested  By r e f e r r i n g  billion  four  i t is possible dimensions:  system, number of p l a t f o r m s , t h e i r d i s t r i b u t i o n  r e s e r v o i r s and  1,  the l a s t  p e r i o d of p r o d u c t i o n f o r Avalon  between  and  97  H i b e r n i a . But what about the f i r s t  period of a c t i v i t y  f o r the f i e l d  whole and f o r each i n d i v i d u a l p l a t f o r m ? The model suggests i n the b e g i n n i n g o f a c t i v i t i e s  past  1985 r e s u l t s  as a  that any d e l a y  i n a r e d u c t i o n o f net  b e n e f i t s . For example, a one-year d e l a y i n the development o f the f i e l d reduces  the net present v a l u e o f the o p t i m a l plan f o r case  b i l l i o n end-1984 d o l l a r s the assumptions of case  (9 per c e n t ) . T h i s i s due to the f a c t  management o f the r e s o u r c e would thus suggest i s more p r o f i t a b l e  moves from case is  1.4  that under  1, the ( r e a l ) net p r i c e o f an e x t r a c t e d u n i t o f  the r e s o u r c e grows more s l o w l y than the r a t e of i n t e r e s t .  present  1 by about  1 to case  Optimal  that e x t r a c t i o n  i n the  than i n the f u t u r e , c e t e r i s p a r i b u s . As one 3, the net e f f e c t  of the changes i n assumptions  to make the ( r e a l ) net p r i c e o f the r e s o u r c e grow even more s l o w l y over  time. Any d e l a y w i l l  thus reduce  cases 2 and 3." The r e s u l t s  present v a l u e s by more i n the h i g h e r - c o s t  f o r d e l a y s , longer than the minimum assumed by  the model, between the i n s t a l l a t i o n o f i n d i v i d u a l p l a t f o r m s a r e , when applicable, similar The  i n c h a r a c t e r but s m a l l e r i n magnitude.  o p t i m a l development plans a s s o c i a t e d with cases  1 and 2 i n v o l v e  the i n s t a l l a t i o n o f three and two f i x e d  platforms r e s p e c t i v e l y  the s i n g l e p l a t f o r m o f case  e a r l i e r , p o t e n t i a l net b e n e f i t s  3. As noted  instead of  are maximized under the assumptions o f case 3 when o n l y the Avalon reservoir  i s developed  and produced. O v e r a l l , the o p t i m a l development  p a t t e r n always i n v o l v e s more w e l l s d r i l l e d H i b e r n i a . The assumptions r e l a t i v e reservoir The floating  i n t o Avalon  to i n i t i a l  systems never  into  p r o d u c t i v e c a p a b i l i t i e s and  s i z e are l a r g e l y r e s p o n s i b l e f o r t h i s development plans which y i e l d  than  result.  the h i g h e s t net b e n e f i t s f o r  once i n v o l v e d the maximum number o f s t r a d d l i n g  p l a t f o r m s allowed by the model. Any advantage that might have been d e r i v e d  98  from the to be  4.4  i n s t a l l a t i o n of a second s t r a d d l i n g p l a t f o r m  small  exploited.  Development under A l t e r n a t i v e P o l i c y Regimes  4.4.1  Introduction The  o b j e c t i v e s of t h i s  producer behaviour of the and  were thus too  s e c t i o n are  relevant  relevant  N&L  t a b l e s ) are  c and  N&L  First,  ' c a r r i e d ' and  w,  'working' i n t e r e s t s  and  the  contrasted.  of the r e l e v a n t  Since  r o y a l t y and  focus  text and  compared. Second,  d i s t r i b u t i o n s of net b e n e f i t s between producer and three  the Newfoundland  r e s p e c t i v e l y , i n the  to be estimated and  the p r o v i s i o n s of the  the e f f e c t s on  federal l e g i s l a t i o n ,  Labrador l e g i s l a t i o n with both  ( F e d e r a l or Fed.,  twofold.  taxation  the  the  government i m p l i e d  systems w i l l be  of t h i s chapter i s not  on  by  derived  the d i s t r i b u t i o n  share of net b e n e f i t s between f e d e r a l and p r o v i n c i a l  governments, I have chosen to r e p o r t  r e s u l t s o n l y on  the  all-government  share. The Included  r e s u l t s reported are  which y i e l d of the  the development p a t t e r n s the h i g h e s t  three  i n t a b l e s 4.3  those i n which the net  i t s highest  point  and  3. However, these would y i e l d  t h e i r key 4.6  to i n c l u d e  present  them i n the  constructed few  explained  later  and,  The  f o r the  systems  provisions remaining  to the producer reaches  system and with the  opted  follows.  floating  a number of  r e s u l t s f o r cases 1  a d d i t i o n a l i n s i g h t s and  text but  i m p l i c a t i o n s i n t a b l e 4.6.  w i l l be  value  a type of p r o d u c t i o n  S i m i l a r t a b l e s can be  chosen not  f o r both f i x e d and  the base case assumptions. The  e n t r i e s are  platforms.  were s e l e c t e d as  net b e n e f i t s to the producer under the  p o l i c y regimes and  given  to 4.5  instead  references time b e i n g ,  to  to  I have  summarize  'relief  in table  the d i s c u s s i o n  will  99  be r e s t r i c t e d  to the cases p r e f i x e d by  form of r o y a l t y and  tax r e l i e f  'w/o  relief,  meaning  'without  f o r the producer' .  Net b e n e f i t s a c c r u i n g to Petro-Canada  are here subsumed i n the  producer  share. Reasons f o r proceeding i n t h i s manner are o u t l i n e d i n  appendix  3. T h i s presupposes  participants'  any  that Petro-Canada  assumed o b j e c t i v e of maximizing  shares i n the p r i v a t e the present v a l u e o f the net  r e t u r n s a c c r u i n g to them.  4.4.2  Optimal Development P l a n s T a b l e s 4.3  to 4.6  contain selected  i n the presence o f s p e c i f i c suggest  t h a t , on average,  government exceeds within a r e l a t i v e l y  r o y a l t y and  results  from the o p t i m i z a t i o n  t a x a t i o n systems.  These  runs  results  the share o f net b e n e f i t s which accrues to the  70 per c e n t . In g e n e r a l , the s i z e of t h i s share v a r i e s narrow band a l t h o u g h i t c o n s i s t e n t l y reaches i t s  12 lowest p o i n t under the terms of the f e d e r a l r e p o r t e d , however, development remains presence o f r o y a l t i e s closest  and  t a x e s . The  legislation.  privately profitable  to having government p o l i c i e s r e v e r s e the producer's d e c i s i o n to  assumptions  c are j o i n e d  to the  of case 3. In t h i s case, a s m a l l change i n assumptions  a 5 per cent r e d u c t i o n i n the s i z e of Avalon) development p r i v a t e l y  to  i n the  set of c i r c u m s t a n c e s which comes  develop o c c u r s when the p r o v i s i o n s of the N&L  So  In a l l cases  is sufficient  (e.g.,  to render  unprofitable.  f a r , I have o n l y d i s c u s s e d the p o t e n t i a l  f o r government  policies  r e v e r s e the producer's d e c i s i o n to develop. What other forms o f  d i s t o r t i o n can be captured by the model and how  important  are they?  The  o f f s h o r e development model allows the d i s t o r t i o n a r y e f f e c t s o f government policies  to be  f e l t along s i x dimensions.  100  First,  r o y a l t i e s and  taxes a p p l i e d a g a i n s t the r e t u r n s to f a c t o r s of  p r o d u c t i o n are p e r c e i v e d as p o t e n t i a l l y a v o i d a b l e c o s t s of p r o d u c t i o n net-present-value-maximizing t a b l e 4.1,  their  producers.  introduction is likely  Given  the assumptions l i s t e d  to make the e a r l i e r  by in  shutdown of a  g i v e n r e s e r v o i r p r i v a t e l y p r o f i t a b l e , c e t e r i s p a r i b u s . T h i s i s the most common form of d i s t o r t i o n and productive l i f e shortened  by  of Avalon  i n every case:  the i n t r o d u c t i o n of the p o l i c y regimes.  present v a l u e of the  the  and, when a p p l i c a b l e , H i b e r n i a i s always  e f f e c t s are q u i t e small and  left  can be observed  In g e n e r a l ,  these  never exceed 2 per cent of the r e a l i z e d  f i e l d . However, the a d d i t i o n a l  net  p r o p o r t i o n of r e s e r v e s  i n the ground i s g e n e r a l l y twice as l a r g e as that of net b e n e f i t s  d i s s i p a t e d . The  high-grading  moderated by the  fact  e f f e c t s of government p o l i c i e s  that the crude  o i l left  are  thus  i n the ground would have  been r e l a t i v e l y c o s t l y to e x t r a c t . In the l i m i t ,  the above i m p l i e s that government p o l i c i e s may  the development d e c i s i o n as p e r c e i v e d by earlier,  although  t a b l e s 4.3  to 4.6  the producer.  show no  small changes i n assumptions would be  As was  such o c c u r r e n c e s ,  sufficient  producer's  rankings of the two  three systems of r o y a l t i e s and  and  relatively result.  to r e v e r s e  the  types of p r o d u c t i o n systems. Although taxes modelled  changes i n assumptions, the economics of f i x e d those of t h e i r  suggested  to r e v e r s e t h i s  Second, i t i s a l s o p o s s i b l e f o r government p o l i c i e s  reverse  f l o a t i n g counterparts  respond  the  n o n - l i n e a r l y to  systems s t i l l  dominate  from the p e r s p e c t i v e of both  producer  s o c i e t y . T h e r e f o r e , the i n t r o d u c t i o n of government p o l i c i e s does not  r e v e r s e the f i x e d / f l o a t i n g r a n k i n g d e r i v e d i n s e c t i o n 4.3  above.  T h i r d , g i v e n a type of p r o d u c t i o n system, r o y a l t i e s and induce  the producer  to choose a number of p l a t f o r m s d i f f e r e n t  taxes  may  from that  101  which maximizes the net present r e s u l t s o f t a b l e s 4.3  to 4.6  value  o f the f i e l d  show, four  to s o c i e t y . As the  such cases emerge. The model  suggests that under the assumptions o f case 1 and the terms of both versions  o f the Newfoundland and Labrador l e g i s l a t i o n ,  chooses a t w o - f i x e d - p l a t f o r m per in  cent  the producer  development p l a n with the r e s u l t  o f p o t e n t i a l net b e n e f i t s are d i s s i p a t e d . For reasons  subsection  that about 5 discussed  3.2.3 above, the p r o p e r t i e s o f t h i s model are such that the  simulated  i n s t a l l a t i o n of a third  fixed  increases  i n m a r g i n a l and average ( p e r - b a r r e l ) e x t r a c t i o n c o s t s . Under the  assumptions o f case 1, these i n c r e a s e s  platform  i s accompanied by l a r g e  i n c o s t s are l a r g e enough to make  the magnitude o f the a d d i t i o n a l net b e n e f i t s generated by the i n s t a l l a t i o n of a t h i r d  fixed platform  relatively  government p o l i c i e s which r e v e r s e additional platform  will  small. Therefore,  the consequences o f  the producer's d e c i s i o n to i n s t a l l  a l s o be r e l a t i v e l y  this  small.  Under the assumptions of case 2, the i n c e n t i v e systems i m p l i c i t i n the N&L c and N&L w are again one  fewer p l a t f o r m  value  o f the f i e l d  r e l y on an A - f i x e d  such that  the producer chooses to i n s t a l l  than the number which would maximize the net present to s o c i e t y . In these cases, production  the p o t e n t i a l net present  system i m p l i e s  value  o f the f i e l d  however, the d e c i s i o n to  that more than 13 per cent o f could  be d i s s i p a t e d . A  comparison o f these two sets o f government p o l i c i e s with the terms o f the federal  l e g i s l a t i o n reveals  that  the l a t t e r ' s e x c l u s i o n o f a s l i d i n g  r o y a l t y and i t s lower e f f e c t i v e CIT r a t e  ( i n c l u d i n g the e x i s t e n c e o f  development i n c e n t i v e g r a n t s ) are m a i n l y r e s p o n s i b l e differences Fourth,  scale  f o r the simulated  i n producer b e h a v i o u r . given  a type o f system and a number o f p l a t f o r m s ,  p o s s i b l e to make the producer choose a d i f f e r e n t  i t is  d i s t r i b u t i o n o f platforms  102  than that which y i e l d s results  the h i g h e s t  reported i n tables  implicit  i n the  net  present v a l u e  4.3 to 4.6 i n d i c a t e that  to  Fifth,  the i n c e n t i v e  the h i g h e s t  net  The  systems  the  the producer always chooses  d i s t r i b u t i o n o f p l a t f o r m s which y i e l d s field  field.  three p o l i c y regimes modelled are such that at  p r i v a t e l y o p t i m a l development p l a n ,  the  for the  the  present v a l u e o f  society. i t may be i n the p r o d u c e r ' s best  interests  development and p r o d u c t i o n when faced with s p e c i f i c and t a x a t i o n . R e s u l t s not presented  i n the  tables  to d e l a y  forms o f r e g u l a t i o n  showed that  the  i n t r o d u c t i o n of the p o l i c y regimes modelled never changed the p r o d u c e r ' s c h o i c e of the year which marks the b e g i n n i n g of a c t i v i t i e s Finally,  field.  the producer may respond to the i n t r o d u c t i o n o f government  p o l i c i e s by choosing lags between  the  i n s t a l l a t i o n of  which are longer than the minimum lengths results  on the  not r e p o r t e d i n the t a b l e s  individual  platforms  imposed by the model. A g a i n ,  showed that none of the r o y a l t y and  t a x a t i o n systems modelled were such as to induce the producer to do so. A few d i f f e r e n c e s  i n the dynamic p r o p e r t i e s o f the three p o l i c y  regimes modelled have a l r e a d y been n o t e d . Are there any other and what are t h e i r causes? reveal  that under the  share o f net b e n e f i t s p o t e n t i a l net  terms o f the  of t h i s  fully  reported in tables  implicit  4.3 to 4.6  f e d e r a l l e g i s l a t i o n and the N&L c ,  a c c r u i n g to the government tends  present v a l u e of the  the consequences which do not  The r e s u l t s  differences  field  falls.  to r i s e as  the  As was suggested e a r l i e r ,  r e l i a n c e on instruments of  respond to changes  the  taxation  i n cost and revenue c o n d i t i o n s c o u l d  e v e n t u a l l y be s t r o n g enough to render p r i v a t e l y u n p r o f i t a b l e p r o j e c t s w i t h positive  net present v a l u e s  to  society.  103  Under the terms of the N&L realized  w,  however, the producer  net b e n e f i t s e s s e n t i a l l y remains constant  c a s e s . What accounts  across a l l three  f o r t h i s d i f f e r e n c e between the N&L  two  p o l i c y regimes modelled? As r e p o r t e d i n appendix 3,  N&L  w provide  f o r a payment by  a c q u i s i t i o n of a 40 The in  two  policy  systems modelled  make no  other the  for i t s to the  field.  that t h i s payment would be made  i n a l l three cases  s i n c e i t s magnitude depends almost  the  the terms of  per cent share of the p r o d u c t i o n r i g h t s  exceed $600 m i l l i o n  and  w and  the NLPC to p r i v a t e producers  o f f s h o r e development model e s t i m a t e s 1985  share of the  e x c l u s i v e l y on sunk c o s t s . The similar  4.1  outlined in table  other  p r o v i s i o n for a d i r e c t  payment  13  by the government to p r i v a t e producers. under the N&L  w,  assumptions and the r e l a t i v e The  the net present v a l u e effective  The  results  thus  to the producer  tax r a t e s i s almost  suggest  that  of changes i n  e x a c t l y o f f s e t by changes i n  importance of the NLPC payment.  r o y a l t y and  t a x a t i o n systems modelled  a l s o respond  differently  changes i n the number of p l a t f o r m s used to produce the f i e l d . i n c r e a s e s i n the  i n t e n s i t y of development r e s u l t  present v a l u e of the  field  to s o c i e t y , the  As  long as  i n i n c r e a s e s i n the  federal  legislation  to i n s t a l l  p l a t f o r m s . However, the same can not be  about the p r o v i s i o n s of  v e r s i o n s of the Newfoundland and reported  i n t a b l e s 4.3  to 4.6  Two of  key  field  both  results  c and  N&L  w  are  when the number of p l a t f o r m s used to  i s small.  f a c t o r s account  f o r t h i s r e s u l t . As  an a d d i t i o n a l p l a t f o r m i n c r e a s e s the r e a l i z e d  field,  additional  l e g i s l a t i o n . As the  show, the terms of the N&L  more f a v o u r a b l e to the producer produce the  Labrador  net  seems to  p r o v i d e adequate i n c e n t i v e s f o r the producer said  the  to  the b e n e f i t s c o n f e r r e d upon the producer  long as the  installation  net present v a l u e of by  the  the c o n d i t i o n s r e l a t i n g  104  to NLPC p a r t i c i p a t i o n f a l l  as a p r o p o r t i o n  o f t o t a l net b e n e f i t s . Another  f a c t o r a p p l i e s more g e n e r a l l y . The p r o v i s i o n s royalty  i n both v e r s i o n s  such that  o f the Newfoundland  f o r the s l i d i n g  scale  and Labrador l e g i s l a t i o n are  the r o y a l t y r a t e r i s e s with the annual p r o d u c t i o n  from a g i v e n  field.  I n c r e a s e s i n the number o f p l a t f o r m s used to produce the f i e l d  result  i n higher i n i t i a l  proportionately  greater  with the s l i d i n g  r a t e s o f p r o d u c t i o n which increases  i n turn bring  i n the s i z e o f the tax burden  about associated  s c a l e r o y a l t y . Under the assumptions o f cases 1 and 2,  these c o n s t r a i n t s on the p r i v a t e l y o p t i m a l i n t e n s i t y o f development key r o l e i n i n d u c i n g  the producer to i n s t a l l  number which maximizes  the net present v a l u e o f the f i e l d  What are the consequences tax r e l i e f  o f the producer's l i a b i l i t y  revenues exceed cumulated  e l i m i n a t i o n o f the s l i d i n g to i n s t a l l platform  of extending s p e c i f i c  than the  to s o c i e t y .  forms o f r o y a l t y and  to the producer? As the r e s u l t s o f t a b l e 4.6 r e v e a l , the  postponement operating  one fewer p l a t f o r m  play a  a third  under  platform  to the PGRT u n t i l  capital  cumulative net  e x p e n d i t u r e s and the  scale royalty restore  the producer's i n c e n t i v e  under the assumptions o f case 1 and a second  the assumptions o f case 2, based on the p r o v i s i o n s o f the  N&L c and N&L w. Under the assumptions o f a l l cases modelled and the p r o v i s i o n s o f the federal allowing  l e g i s l a t i o n , postponing the producer's l i a b i l i t y PGRT payments to be d e d u c t i b l e  to the PGRT and  f o r purposes o f PIR had no e f f e c t  on producer d e c i s i o n s . In such c a s e s , r o y a l t y and tax r e l i e f a c t s as a means by which the p r o d u c e r .  primarily  the government t r a n s f e r s some o f i t s revenues to  105  4.5  Summary Six  d e c i s i o n v a r i a b l e s were i d e n t i f i e d  the o f f s h o r e development model. The suggest  that  importance  i n chapter 3's d i s c u s s i o n o f  r e s u l t s of s e c t i o n s 4.3  these can be broken down i n t o two  i n the o p t i m i z a t i o n procedure. The  groups  and 4.4  above  as to t h e i r m a r g i n a l  four most  important  d e c i s i o n s have to do w i t h the i n t e n s i t y of development, the type o f p r o d u c t i o n system used, the d i s t r i b u t i o n of p l a t f o r m s between r e s e r v o i r s and  the f i r s t p e r i o d of development. Of l e s s  d i s t r i b u t i o n o f p l a t f o r m s over time and p r o d u c t i o n from each Once the f i r s t  importance  the c h o i c e of the l a s t  four v a r i a b l e s are at t h e i r o p t i m a l s e t t i n g s , the net to s o c i e t y and  the producer  a t t a i n e d over 90 per cent of i t s maximum v a l u e . The a p p r o x i m a t e l y evenly s p l i t  generally  remaining p o r t i o n i s  between the o t h e r two v a r i a b l e s . T e a r i n g apart  the r e s u l t s o f the o p t i m i z a t i o n procedure  the three most important elements to  p e r i o d of  reservoir.  present v a l u e of the p r o j e c t  further  are the  is difficult.  However,  of any o p t i m a l development s t r a t e g y seem  be the d e c i s i o n to develop Avalon b e f o r e H i b e r n i a , the c h o i c e of a  f i x e d over a f l o a t i n g  system  and  the d e c i s i o n , when warranted,  to use  two  platforms. A more d e t a i l e d  examination of the p o t e n t i a l  e f f e c t s by government p o l i c i e s was  for d i s t o r t i o n a r y  a l s o undertaken.  that a l t h o u g h a l l three r o y a l t y and  The r e s u l t s  suggest  t a x a t i o n systems were shown to have  dynamic e f f e c t s on producer b e h a v i o u r , t h e i r  introduction  generally  induced the d i s s i p a t i o n of l e s s than 5 per cent of the net present v a l u e of  the f i e l d .  that  R a p i d l y r i s i n g m a r g i n a l c o s t s of e x t r a c t i o n and  the o i l p o t e n t i a l l y  left  i n the ground  l a r g e l y responsible for this r e s u l t .  In two  would be c o s t l y  the  fact  to e x t r a c t  cases (case 2, N&L  c and  are  N&L  106  w),  however, the d i s s i p a t i o n o f p o t e n t i a l net b e n e f i t s  induced by  government p o l i c i e s exceeds 13 per c e n t . I t was argued that for a s l i d i n g differences  s c a l e r o y a l t y and h i g h e r e f f e c t i v e CIT r a t e s  with the i n c e n t i v e  system i m p l i c i t  the p r o v i s i o n s account  f o r the  i n the f e d e r a l  legislation. The  introduction  o f s p e c i f i c forms o f r o y a l t y and tax r e l i e f was  shown to reduce the d i s t o r t i o n a r y e f f e c t s o f government p o l i c i e s . In some instances, the  project  however, the r e s u l t i n g i n c r e a s e s to s o c i e t y were small  and r e l i e f  i n the net present v a l u e o f acted p r i m a r i l y as a means  through which the government t r a n s f e r r e d  some o f i t s revenues to the  producer. Whether these c o n c l u s i o n s  i n the presence o f d e p a r t u r e s  hold  from the base case assumptions w i l l be examined i n d e t a i l  i n chapter 5.  107  FOOTNOTES The l i n k a g e s between MACE and the o f f s h o r e development model are d i s c u s s e d i n s e c t i o n 3.4 above. I t should be noted that the energyproducing s e c t o r of MACE i s solved endogenously over the e n t i r e simulation period. For a more complete d e s c r i p t i o n of sources see H e l l i w e l l [1983]. See Canada, N a t i o n a l Energy Board P r i v a t e and  and MacGregor  [1983, e s p e c i a l l y p.84].  s o c i a l d i s c o u n t r a t e s are assumed to be  equal.  The o r i g i n a l f e d e r a l - p r o v i n c i a l energy agreements (see Canada, Energy, Mines and Resources [1981]) extended the NORP coverage to a l l o i l produced from the Canada Lands. However, o n l y o i l produced from p o o l s s i t u a t e d w i t h i n p r o v i n c i a l boundaries and i n i t i a l l y d i s c o v e r e d i n 1981 or l a t e r was e l i g i b l e to r e c e i v e NORP. I f these same c o n d i t i o n s had a p p l i e d and i f Newfoundland and Labrador were to have e x e r c i s e d j u r i s d i c t i o n , H i b e r n i a p r o d u c t i o n would t e c h n i c a l l y not have been e l i g i b l e to r e c e i v e NORP s i n c e the f i e l d was i n i t i a l l y d i s c o v e r e d i n 1979. See, f o r example,  Canada, Energy, Mines and Resources  See, f o r example,  Canada [1981,  [1981, p . 4 ] .  p.2679].  Unless o t h e r w i s e s t a t e d , a l l r e s u l t s presented i n t h i s chapter are c o n d i t i o n a l on the assumption that the development of H i b e r n i a s t a r t s i n 1985. A more comprehensive study of the i m p l i c a t i o n s of d e l a y i n g the b e g i n n i n g o f a c t i v i t i e s i s r e l e g a t e d to c h a p t e r 5. 9  10  11  12  13  As noted i n t a b l e 3.1, i n a l l the r e l e v a n t f i g u r e s and t a b l e s , A stands f o r a p l a t f o r m on Avalon, H f o r one on H i b e r n i a and B f o r a p l a t f o r m with w e l l s r e a c h i n g both r e s e r v o i r s . In a d d i t i o n , i t i s not known whether the NLPD and Wilby i m p l i c i t l y used d i f f e r e n t average annual p r o d u c t i v e e f f i c i e n c i e s f o r f i x e d and f l o a t i n g systems as i s the case here; see s u b s e c t i o n 3.3.1 above. P o t e n t i a l net b e n e f i t s f a l l by about 575 m i l l i o n end-1984 d o l l a r s per cent) i n case 2 and $215 m i l l i o n (17 per cent) i n case 3.  (11.5  It should be remembered that the producer must f i n a n c e a l l c a p i t a l e x p e n d i t u r e s under the terms of the f e d e r a l l e g i s l a t i o n and the N&L c. However, 40 per cent of these e x p e n d i t u r e s are f i n a n c e d by the NLPC under the terms of the N&L w. T h i s i s not s t r i c t l y c o r r e c t . As mentioned i n appendix 3, the f e d e r a l l e g i s l a t i o n does i n c l u d e p r o v i s i o n s f o r a payment by Petro-Canada to the other i n t e r e s t h o l d e r s as a r e s u l t of the 25 per cent b a c k - i n arrangement. The l e g i s l a t i o n a l s o s t i p u l a t e s that such a payment i s to be made o n l y a f t e r p r o d u c t i o n from the f i e l d has s t a r t e d . E s t i m a t e s d e r i v e d w i t h the o f f s h o r e development model suggest that the payment i s  108  not l i k e l y to exceed $75 m i l l i o n and should occur i n 1989 or 1990 depending on whether a f l o a t i n g o f a f i x e d p r o d u c t i o n system i s chosen. However, f o r the purposes o f t h i s t h e s i s , Petro-Canada i s c o n s i d e r e d to be a p r i v a t e producer. T h e r e f o r e , t h i s payment here takes the form o f a t r a n s f e r among producers and as such i s not allowed to a f f e c t the development d e c i s i o n . There are s i g n i f i c a n t e x c e p t i o n s to these g e n e r a l c o n c l u s i o n s . In p a r t i c u l a r , note that the a d d i t i o n o f a t h i r d p l a t f o r m (when warranted) does not add much to the net present v a l u e o f the p r o j e c t (see f i g u r e 4.1 and t a b l e 4.6). Repeated i n c r e a s e s i n the i n t e n s i t y o f development of a g i v e n r e s e r v o i r can have s e r i o u s r e p e r c u s s i o n s on the magnitude o f net b e n e f i t s (check the r e s u l t s f o r AAA i n f i g u r e 4.1).  109  Table 4.1 Some of the Assumptions Underlying Cases 1, 2 and 3 Case 1 - o p t i m i s t i c  Case 2 - base  Case 3 - pessimistic  Avalon: 1066.0 MM barrels  Avalon: 800.0 MM barrels  Avalon: 800.0 MM barrels  Hibernia: 533.0 MM barrels  Hibernia: 400.0 MM barrels  Hibernia: 400.0 MM barrels  I n i t i a l per-welI productivity  Avalon: 15.0 M barrels per day Hibernia: 10.0 M barrels per day  Avalon: 9.0 M barrels per day Hibernia: 6.0 M barrels per day  Avalon: 9.0 M barrels per day Hibernia: 6.0 M barrels per day  Capital expenditures  as in table 3.1 in real terms; nominal values growing at the Canadian rate of inflation  1.5 times that in table 3.1 in real real terms; nominal values growing at the Canadian rate of i n f l a t i o n  2.0 times that i n t a b l e 3.1 In real real terms; nominal values growing at the Canadian rate of I n f l a t i o n  Operating expenditures  as in table 3.1 in real terms; nominal values growing at the Canadian rate of In fI at I on  as in t a b l e 3.1 in real terms; nominal values growing at the Canadi an rate of I n fI at i on  2.0 times that in table 3.1 in real terms; nominal values growing a t the Canadian rate of i n fI at Ion  Oil price  Nominal p r i c e of OPEC o i I (FOB Gulf) Is $US 29 from 1983 t o 1986; thereafter f a l I I n g 2 per cent annually in real terms; a l l o i l produced from f i e l d receives NORP in Montreal  Nominal price of OPEC oi I (FOB Gulf) is $US 29 from 1983 t o 1986; thereafter f a l I i n g 2 per cent annually i n real terms; a l l o i l produced from f i e l d receives NORP in Montreal  Nominal price of OPEC o i I (FOB Gulf) is $US 29 in 1983;$US 26 from 1984 t o 1986; thereafter f a l l i n g 2 per cent annua 11y in real terms; a 11 oiI produced from f i e l d receives NORP in Montreal  Reservoir s i z e  110  FIGURE  4.1  NET PRESENT VALUE OF ALTERNATIVE HIBERNIA DEVELOPMENT PLANS IN ABSENCE OF GOVERNMENT POLICIES, BILLIONS END-84$ CASE 1. FIXED PLATFORMS  PLATFORM LOCATIONS: A - AVALON H - HIBERNIA B - BOTH  Legend A AAHH X AABHH • ABHH H BAH AAA  NO. OF PLATFORMS  Ill  FIGURE 4.2  NET PRESENT VALUE OF ALTERNATIVE HIBERNIA DEVELOPMENT PLANS IN ABSENCE OF GOVERNMENT POUCIES, BILLIONS END-84$ CASE 1. FLOATING PLATFORMS  PLATFORM LOCATIONS: A - AVALON H - HIBERNIA B - BOTH oo  I  Q  CD  „ 12  UJ  Legend  to UJ Q_  A  AAAA  X  AAHHH  •  BAH  B  ABBHH  XX AABBH X- AABHH  NO. OF PLATFORMS  FIGURE  4.3  NET PRESENT VALUE OF ALTERNATIVE HIBERNIA DEVELOPMENT PLANS IN ABSENCE OF GOVERNMENT POLICIES, BILLIONS END-84$ CASE 2. FIXED PLATFORMS  PLATFORM LOCATIONS: A - AVALON H - HIBERNIA B - BOTH 3.5H  Legend A AAA X AHH • BAH El  ABH AAHH  2  3  NO. OF PLATFORMS  FIGURE  4.4  NET PRESENT VALUE OF ALTERNATIVE HIBERNIA DEVELOPMENT PLANS IN ABSENCE OF GOVERNMENT POLICIES, BILLIONS END-84$ CASE 2. FLOATING PLATFORMS PLATFORM LOCATIONS: A - AVALON H - HIBERNIA B - BOTH  /  4.2H  I  4H  Legend A AAA X AAHH •  ABBH  KI BAH ffi ABH X AABB <S> AABH 1  -1  1  2  1  3 NO. OF PLATFORMS  1  4  Table  4.2  Net Present Value of A l t e r n a t i v e H i b e r n i a Development Plans i n Absence of Government P o l i c i e s , b i l l i o n s end-1984 d o l l a r s Case 3. F i x e d and F l o a t i n g P l a t f o r m s Production  System  1  NPV  Fixed  Platforms A  1  Floating  Platforms  1.26  0.40  AA  -1.40  -1.09  AH  -0.61  -0.48  1.05  -0.30  B  *  NPV  BB  *  -1.81  BA  -0.36  -1.03  AB  -0.32  -1.01  not a p p l i c a b l e  A stands f o r a p l a t f o r m on Avalon, H f o r one on H i b e r n i a and B f o r one with w e l l s r e a c h i n g the two r e s e r v o i r s . AB d i f f e r s from BA i n that f o r the former, the p l a t f o r m on Avalon i s i n s t a l l e d b e f o r e the one p r o d u c t i n g the two r e s e r v o i r s w h i l e the o p p o s i t e i s t r u e f o r BA.  115  Table 4.3 Net Present Value of A l t e r n a t i v e Hibernia Development Plans, b i l l i o n s end-1984 d o l l a r s Federal Regulations Case 2. Fixed and Floating Platforms  NPV Producers Prod. System  w/o PIR w PIR holiday holiday  NPV Governments  Prod. Avalon  Prod. Hiber.  NPV  w/o PIR wPIRh PV holiday holiday prod.  A BA AAH  90-17 90-09 90-05  * 91-20 92-10  4.27 4.87 3.60  1.36 1 .66 0.95  1.47 1.69 same  2.92 3.21 2.65  2.80 • 3.19 same  291.49 444.10 513.91  15.31 19.24 23.66  29.96 30.21 30.67  3  90-08  92-21  4.92  1.69  1.71  3.23  3.21  444.26  19.17  30.24  A BA AAH  89-16 89-11 89-06  * 89-12 91-08  3.37 4.16 4.03  1.01. 1.32 1.24  1.11 1.38 same  2.36 2.84 2.79  2.26 2.78 same  238.89 375.56 453.36  15.92 19.27 21.94  30.02 30.40 30.82  3  89-10  90-12  4.23  1.35  1.42  2.88  2.82  375.78  19.15  30.41  1  Pbbl. Pbbl prod. prod 2 2 costs rev.  FIXED  AB  FLOATING  AB  not applicable The present value of production i s expressed in m i l l i o n s of end-1984 b a r r e l s . The production costs and revenues are expressed in end-1984 d o l l a r s per b a r r e l . Revenues are net of field-to-shore transportation costs. Optimal producer choice given the type of production system.  Table Net  4.4  Present Value o f A l t e r n a t i v e H i b e r n i a Development P l a n s , b i l l i o n s end-1984 d o l l a r s Newfoundland and Labrador R e g u l a t i o n s — " c a r r i e d i n t e r e s t " o p t i o n Case 2. F i x e d and F l o a t i n g P l a t f o r m s  Prod. System  Prod. Avalon  Prod. Hibernia  NPV  NPV NPV Producers Govts.  PV prod.  1  Pbbl. prod. costs  2  Pbbl. prod. rev. 2  FIXED B AB A  3  90-32 90-07  91- 16 92- 21  4.20 4.90  0.99 0.93  3.21 3.97  307.01 442.51  15.24 19.20  28.93 30.27  90-17  *  4.27  1.05  3.22  307.01  15.24  28.93  0.84 0.88 0.64  2.53 3.27 3.39  238.89 372.85 453.36  15.92 19.29 21.94  30.02 30.40 30.82  0.91  3.32  375.78  19.15  30.41  FLOATING A BA AAH AB  * 1  3  3  *  89-16 89-10 89-06  89-11 91-08  3.37 4.14 4.03  89-10  90-12  4.23  not a p p l i c a b l e The present v a l u e of p r o d u c t i o n i s expressed i n m i l l i o n s o f end-1984 b a r r e l s . The p r o d u c t i o n c o s t s and revenues are expressed i n end-1984 d o l l a r s per b a r r e l . Revenues are net of f i e l d - t o - s h o r e t r a n s p o r t a t i o n c o s t s . Optimal producer c h o i c e g i v e n the type of p r o d u c t i o n system.  Table Net  Present  Prod. System  4.5  Value o f A l t e r n a t i v e H i b e r n i a Development P l a n s , b i l l i o n s end-1984 d o l l a r s Newfoundland and Labrador R e g u l a t i o n s — "working i n t e r e s t " o p t i o n Case 2. Fixed and F l o a t i n g P l a t f o r m s  Prod. Avalon  Prod. Hiber.  NPV  NPV Producers  NPV Govts.  PV prod.  90-32 90-07  91- 16 92- 21  4.20 4.90  1.08 0.98  3.12 3.92  90-17  *  4.27  1.10  89-16 89-10 89-06  * 89-11 91-08  3.37 4.15 4.03  89-10  90-12  4.23  1  Pbbl prod. costs  Pbbl prod. rev.  307.01 442.51  15.24 19.20  28.93 30.27  3.17  291.49  15.31  29.96  0.92 0.94 0.71  2.45 3.21 3.31  238.89 372.85 453.36  15.92 19.29 21.94  30.02 30.40 30.82  0.96  3.28  372.85  19.29  30.40  FIXED B AB A  3  FLOATING A BA AAH AB  * 1  3  not a p p l i c a b l e The present v a l u e of p r o d u c t i o n i s expressed i n m i l l i o n s o f end-1984 b a r r e l s . The p r o d u c t i o n c o s t s and revenues are expressed i n end-1984 d o l l a r s per b a r r e l . Revenues are net o f f i e l d - t o - s h o r e t r a n s p o r t a t i o n . Optimal producer c h o i c e given the type o f p r o d u c t i o n system.  118  Table 4.6 Optimal Producer Choices Under Various P o l i c y A l t e r n a t i ves Reg. l System  No govt. Fed. N&L c N&L w 6  2 No govt. w/o r e l i e f Fed. N&L c N&L w 6  2 w relIef  6  Fed. N&L c N&L w  3 No govt. w/o r e l I e f Fed. N&L c N&L w 3 w relief  * 1  2  6  Fed. N&L c N&L w  Prod. Prod. Prod. System 2 Hi ber. Av a 1 on  ABH ABH AB AB  90-08 90-07 90-05 90-05  AB AB A A  90-11 92-24 90-08 92-21 90-17 90-17  AB AB AB  90-08 90-07 90-07  A A A A  90-14 90-12 90-12 90-12  A A A  90-12 90-12 90-12  92-03 92-02 92-22 92-22  92-21 92-21 92-21  * * * * * * *  NPV  15.17 15.16 14.49 14.49 4.94 4.92 4.27 4.27 4.92 4.90 4.90 1.26 1.24 1.24 1.24 1.24 1.24 1.24  NPV NPV PV 3 3 Prods. Govts. prod.  * 5.60 3.21 3.01  * 9.57 11.28 11.47  3  Pbbl prod. costs  5  Pbbl prod. rev. 5  755.94 753.49 658.08 658.08  11.47 11.44 9.18 9.18  31.33 31.56 31.20 31.20  *  *  1.71 1.05 1.10  3.21 3.22 3.17  448.52 444.26 291.49 291.49  19.14 19.17 15.31 15.31  30.16 30.24 29.96 29.96  2.22 1.60 1.39  2.70 444.26 3.29 . 442.51 3.51 442.51  19.17 19.20 19.20  30.24 30.27 30.27  *  *  0.21 0.04 0.32  1.03 1.21 0.92  289.06 286.64 286.64 286.64  0.52 0.35 0.51  0.73 0.90 0.74  286.64 286.64 286.64  21.98 26.34 22.00 26.37 22.00 26.37 22.00 26.37 22.00 22.00 22.00  26.37 26.37 26.37  not applicable The optimal production system always involves fixed platforms. A stands for a platform on Avalon, H for one on Hibernia and B for a platform with wells reaching the two r e s e r v o i r s .  3 4  5  6  All The The are The the  net present values are expressed in b i l l i o n s of end-1984 d o l l a r s . present value of production i s expressed in m i l l i o n s of end-1984 b a r r e l s . production costs and revenues are expressed in end-1984 d o l l a r s per b a r r e l . Revenues net of field-to-shore transportation costs. d i s t r i b u t i o n of the net present value between producers and governments incorporates e f f e c t s of the three-consecutive-year PIR holiday.  119  CHAPTER 5 SENSITIVITY  5.1  ANALYSIS  Introduction The p r e v i o u s chapter r e v e a l e d a few i n s t a n c e s where p r i v a t e l y o p t i m a l  development of  plans d i f f e r e d  the f i e l d  to s o c i e t y . As we  o f f s h o r e development the  from those which maximize  these d i f f e r e n c e s arose because  the  model a l l o w s the producer to respond r a t i o n a l l y to  i n t r o d u c t i o n of s p e c i f i c  chapter  saw,  the net present v a l u e  r o y a l t y and tax regimes. The purpose of t h i s  i s to examine i n a more s y s t e m a t i c manner the scope f o r  policy-induced testing  distortions  i n producer b e h a v i o u r . Two  the r o b u s t n e s s of the r e s u l t s r e p o r t e d  approaches to  i n chapter 4 have been  adopted. The  sensitivity  simulating  a n a l y s i s undertaken i n s e c t i o n 5.2  the consequences  3 w h i l e h o l d i n g unchanged will  yield  of each a l t e r n a t i v e assumption of cases 1 and  the other assumptions o f case 2. T h i s  i n f o r m a t i o n on the e f f e c t s of i n d i v i d u a l  assumptions as w e l l as the endogenous responses that the  r o y a l t y and  changes relief  this  t a x a t i o n regimes m o d e l l e d . The  i n assumptions on the consequences packages modelled w i l l  The  a l s o be  i n the  these t r i g g e r  through  i m p l i c a t i o n s of these  of the two r o y a l t y and tax  a n a l y s i s of s e c t i o n 5.3 d e p a r t s from that undertaken so f a r i n  thesis  economics  i n one c r u c i a l way.  of the development  o f f s h o r e development  changes  changes  exercise  examined.  Up to t h i s p o i n t , the a n a l y s i s has  assumed that any change i n c o n d i t i o n s was  the  consists of  known to the producer when the  d e c i s i o n were c o n s i d e r e d . In t h i s  model w i l l  always  section,  be used to t r a c e the e f f e c t s o f  i n the assumed a t t r i b u t e s o f the f i e l d as w e l l as i n economic  120  c o n d i t i o n s which were not a n t i c i p a t e d w i t h development paid  at the time the d e c i s i o n to proceed  and p r o d u c t i o n was taken. P a r t i c u l a r  to the consequences of government  a t t e n t i o n w i l l be  p o l i c i e s and the p r o v i s i o n s f o r  r o y a l t y and tax r e l i e f . S e c t i o n 5.4 d i s c u s s e s the i m p l i c a t i o n s of the p r e v i o u s r e s u l t s on the d i s t r i b u t i o n between financial  risks  likely  government  sections'  and producer o f the  to be a s s o c i a t e d with the development and  production of Hibernia.  5.2 Changes  i n the Base Case Assumptions  T a b l e 5.1 p r o v i d e s a l i s t  o f mnemonics and d e s c r i p t i o n s o f each  d e p a r t u r e from the assumptions o f case 2. The three which move the base case towards case 1 are c a l l e d  ' f a v o u r a b l e changes'.  'Adverse changes' are  thus the m o d i f i c a t i o n s which move the base case i n the d i r e c t i o n o f case 3. The consequences o f a one-year d e l a y i n the i n i t i a l development  i s a l s o examined. The nature and impacts o f the 'adverse  shocks' mentioned  i n t a b l e 5.1 w i l l  Tables 5.2 to 5.4 r e p o r t  be d i s c u s s e d  the r e s u l t s  the development  (when the p r o j e c t  plans that maximize  i n the next s e c t i o n .  from a l i m i t e d  s i m u l a t i o n s o f the o f f s h o r e development model. are  period of  Included  number o f i n these t a b l e s  the net present v a l u e o f the f i e l d  i s assumed to be o u t s i d e the reach o f government  p o l i c i e s ) as w e l l as those which are p r i v a t e l y o p t i m a l under the p r o v i s i o n s o f the three p o l i c y regimes m o d e l l e d . The r e s u l t s o f t a b l e 5.2 show that p o l i c i e s , high well p r o d u c t i v i t y benefits per  i n the absence o f government  (HIGH PROD) i n c r e a s e d  the most (79 per c e n t ) , l a r g e r r e s e r v o i r s  c e n t ) with lower c a p i t a l c o s t s  p o t e n t i a l net  (LARGER) the l e a s t (34  ( K l ) , at 55 per cent, almost e x a c t l y  121  half-way capital  between the other two. c o s t s (K2)  cent and  i s thus  other adverse  reduces  the  lower  5.4  r e v e a l that h i g h e r field  by 42  per  impact.  Two  though s m a l l e r e f f e c t s . Both h i g h e r  o i l p r i c e s (LOWER P) reduce p o t e n t i a l  net  s l i g h t l y more than 25 per cent. F i n a l l y , a one-year d e l a y i n  f i r s t p e r i o d of development  the net present v a l u e of the Of  and  change with the most s i g n i f i c a n t  changes have s i m i l a r and  5.3  the net present v a l u e of the  the adverse  o p e r a t i n g c o s t s (02) b e n e f i t s by  Tables  the seven departures  above, o n l y one  induces  (DELAY) r e s u l t s  A - f i x e d p r o d u c t i o n system y i e l d s  field  in  from the base case assumptions d i s c u s s e d  a change i n the number of p l a t f o r m s  However, the model suggests  fall  field.  maximizes the net present v a l u e of the  v a l u e of the  i n an 11 per cent  which  f i e l d . Under the terms of K2,  an  the h i g h e s t p o t e n t i a l net b e n e f i t s .  that l e s s than  would be d i s s i p a t e d  10 per cent of the net  i f an A B - f i x e d  present  system were used  instead. A tendency f i r s t encountered tables  5.2  to 5.4  generally f a l l  Given a number of p l a t f o r m s , net b e n e f i t s to faster  when c o n d i t i o n s are allowed terms of the f e d e r a l  the net present v a l u e of the  the  field  to worsen. T h i s tendency i s s t r o n g e r under the N&L  the  c s i n c e the p r o v i s i o n s f o r  to dampen i t s i n f l u e n c e under the terms of  the  w. This i m p l i c i t  respond  r e l i a n c e on instruments  to changes i n cost and  p r o s p e c t s of d i s t o r t i o n s in  than  l e g i s l a t i o n and  the NLPC payment operate N&L  of  when the s i m u l a t i o n s i n c l u d e the p r o v i s i o n s of the  p o l i c y regimes modelled. producer  i n chapter 4 emerges from the r e s u l t s  s u b s e c t i o n 4.4.2  of t a x a t i o n which do not  revenue c o n d i t i o n s again r a i s e s  induced  by government p o l i c i e s . As was  above, the model o f f e r s  fully  the suggested  s i x dimensions along which  122  producers can respond  to the i n t r o d u c t i o n of government p o l i c i e s . Four of  those are not observed reversal  i n t a b l e s 5.2  to 5.4:  i n the f i x e d / f l o a t i n g r a n k i n g and  both  forms of d e l a y , a  a change i n the o p t i m a l  d i s t r i b u t i o n o f p l a t f o r m s a c r o s s r e s e r v o i r s g i v e n a number of p l a t f o r m s . The most common form of d i s t o r t i o n encountered prematurely  i n the presence o f government p o l i c i e s . Although  producer response all of  i s observed  net b e n e f i t s never reaches more than 2.5  v a l u e of the  the r e s u l t i n g  per cent of the  form o f  and f o r  dissipation potential  field.  e l e v e n c a s e s , however, the model suggests that  o p t i m a l development plans would be based different  this  under a l l p o l i c y regimes modelled  d e p a r t u r e s from the base case assumptions,  In  i s s h u t t i n g down p r o d u c t i o n  the  privately  on a number of p l a t f o r m s  from that which maximizes the net present v a l u e of the f i e l d  s o c i e t y . Under f a v o u r a b l e changes i n the assumptions,  to  the p o l i c y - i n d u c e d  d i s s i p a t i o n o f p o t e n t i a l net b e n e f i t s v a r i e s between 2 per cent (KI w i t h federal, w,  t a b l e 5.2)  t a b l e 5.2).  investment and  and more than 9 per cent (HIGH PROD with N&L  In the case o f KI under the f e d e r a l  tax c r e d i t ,  the lower  the a v a i l a b i l i t y o f development  (than under the p r o v i n c i a l  CIT r a t e are s u f f i c i e n t  assumed to f a l l  fixed platform  the net present v a l u e of the  the r e a l market p r i c e of the r e s o u r c e i s  over time, these r e s u l t s  suggest  that the impact  government p o l i c i e s can be s t r o n g enough to induce the producer the f i e l d ' s  output p r o f i l e  the  incentive grants  to make the i n s t a l l a t i o n of a t h i r d  to s o c i e t y . Even though  N&L  l e g i s l a t i o n ) e f f e c t i v e marginal  p r o f i t a b l e even i f doing so s l i g h t l y reduces field  legislation,  c and  towards the present to a degree  which maximizes p o t e n t i a l net b e n e f i t s  to s o c i e t y .  of to  tilt  exceeding  that  123  It and  should be p o i n t e d out t h a t , i n d i v i d u a l l y , none o f the r o y a l t i e s  taxes i n c l u d e d  discussed  i n the f e d e r a l  above. In f a c t ,  l e g i s l a t i o n w i l l b r i n g about  t h i s o b s e r v a t i o n can be made about  case of p o l i c y - i n d u c e d d i s t o r t i o n s documented suggests  that  additive:  the consequences  in this  the r e s u l t  almost  every  thesis. This  o f i n d i v i d u a l measures are not s t r i c t l y  the e f f e c t s of p o l i c y regimes  as a whole tend to d i f f e r  from the  sum o f the impacts o f each r o y a l t y or tax instrument taken on i t s own. Two f a c t o r s are r e s p o n s i b l e f o r t h i s r e s u l t . F i r s t ,  the producer's  payments under the p r o v i s i o n s o f some r o y a l t i e s and taxes are d e d u c t i b l e f o r the purposes and  o f other instruments o f t a x a t i o n .  Second, most  royalties  taxes tend to move the p r i v a t e l y o p t i m a l s o l u t i o n i n the same  direction.  In some i n s t a n c e s , the combined e f f e c t s o f a l l forms o f  t a x a t i o n i s s t r o n g enough to induce the producer  to make a change i n the  development p l a n that would not have been p r o f i t a b l e  i f the consequences  of the r o y a l t i e s and taxes had been s i m u l a t e d i n d i v i d u a l l y . When considering  issues related  thus important  to the e f f i c i e n c y o f r e s o u r c e t a x a t i o n ,  i t is  to keep i n mind the dynamic i n t e r a c t i o n among r o y a l t y and  tax instruments as w e l l as i t s consequences  f o r producer  behaviour.  Under KI and the terms of the N&L c and N&L w, the r e s u l t s show that a r a t i o n a l producer would opt f o r a l e s s  i n t e n s i v e development  Although many f a c t o r s c o n t r i b u t e to b r i n g i n g about role  i s a g a i n played by the s l i d i n g  s i m u l a t i o n s where t h i s  this result,  pattern. the key  s c a l e r o y a l t y . For example, i n  form o f r o y a l t y i s e l i m i n a t e d and the o t h e r  p r o v i s i o n s o f the two v e r s i o n s o f the Newfoundland and Labrador l e g i s l a t i o n are m a i n t a i n e d , an A B - f i x e d system was shown to be p r i v a t e l y o p t i m a l . By r e d u c i n g the e f f e c t i v e m a r g i n a l tax r a t e , the e l i m i n a t i o n o f the s l i d i n g  s c a l e r o y a l t y here r e s t o r e s  the producer's  i n c e n t i v e to adopt  124  the development  p l a n which maximizes the net present v a l u e of the f i e l d  to  society. In the presence of the adverse changes c o n s i d e r e d , p o l i c y - i n d u c e d distortions  i n the number o f p l a t f o r m s used  to produce  the f i e l d  are  r e l a t i v e l y more frequent and more s y s t e m a t i c across the three p o l i c y regimes m o d e l l e d . For example, a l t h o u g h o n l y the N&L the producer's d e c i s i o n with r e s p e c t  c and N&L  w distort  to the number o f p l a t f o r m s i n the  case of DELAY (which should not be s u r p r i s i n g g i v e n the r e s u l t s of case reported  i n t a b l e 5.3), a l l t h r e e s e t s o f p o l i c i e s  r e l y on an A - f i x e d though society  system  induce the producer to  i n the presence of both 02 and LOWER P  even  an A B - f i x e d system maximizes the net present v a l u e o f the f i e l d (see t a b l e  2,  to  5.4).  Although not e v i d e n t from an examination o f the r e l e v a n t  tables, in  none of the cases c o n s i d e r e d d i d the a v a i l a b i l i t y of a PIR h o l i d a y the terms o f the f e d e r a l  l e g i s l a t i o n have an impact  under  on producer  b e h a v i o u r . In g e n e r a l , the PIR h o l i d a y acted as a r e d i s t r i b u t i v e mechanism through which  the government t r a n s f e r r e d  a p o r t i o n o f i t s net b e n e f i t s to  the producer. In some c a s e s , t h i s aspect of the f e d e r a l also i n s i g n i f i c a n t always  reveal impacts  that  linked  to the p r o f i t a b i l i t y o f i n d i v i d u a l  fields,  to PIR  the r e s u l t s  redistributive  i n the presence of adverse changes i n assumptions. these r e s u l t s  suggest  producer faces a m a r g i n a l f i s c a l  best  Since the producer's l i a b i l i t y  the PIR h o l i d a y tends to have i t s s m a l l e s t  Overall,  average  was  s i n c e the c o n d i t i o n s were such that PIR payments were  zero o r , at b e s t , n e g l i g i b l e .  is closely  legislation  fiscal  interest  that under  cost  each p o l i c y regime,  curve which  c o s t . In some c a s e s , t h e r e f o r e ,  lies  above that  the f o r the  i t i s i n the producer's  ( a l t h o u g h not n e c e s s a r i l y that of s o c i e t y ) to adopt  a less  125  i n t e n s i v e development p l a n and face a lower average What are the consequences described  o f the two r o y a l t y and tax r e l i e f  i n c h a p t e r 4 above? As t a b l e s  benefits  packages  5.2 to 5.4 show, these two r e l i e f  packages t r a n s f e r , on average, a p p r o x i m a t e l y net  tax r a t e .  10 per cent o f the p o t e n t i a l  from the government to the producer under the p r o v i s i o n s o f  the f e d e r a l l e g i s l a t i o n and the N&L c. In the cases c o n s i d e r e d , the average  size of this transfer f a l l s  because  o f the NLPC's assumed p a r t i c i p a t i o n as a f u l l  the p r o j e c t The  (and i t s treatment  r e s u l t s of tables  specific  to about  5 per cent under the N&L w  5.3 and 5.4 a l s o  packages r e s t o r e  show t h a t ,  the producer's  from s o c i e t y ' s p e r s p e c t i v e .  i n the face o f  these two r o y a l t y and  incentive  i n t e n s i v e development plans i n seven o f e i g h t desirable  partner i n  as a source o f government r e v e n u e s ) .  adverse changes i n base case assumptions,  tax r e l i e f  equity  to adopt more  cases where t h i s was deemed  In the remaining case  (02 under the  N&L w, t a b l e 5.4), the a v a i l a b i l i t y o f the form o f r e l i e f modelled sufficient  to induce the producer  to adopt  the more i n t e n s i v e development  p l a n which maximizes the net present v a l u e o f the f i e l d t h i s case, the p o l i c y - i n d u c e d remains  at s l i g h t l y  The restores  i s not  to s o c i e t y . In  d i s s i p a t i o n o f p o t e n t i a l net b e n e f i t s  l e s s than 5 per c e n t .  r e s u l t s o f t a b l e 5.2 show that the producer's  the r e l i e f  i n c e n t i v e to i n s t a l l  package modelled  an A B - f i x e d p r o d u c t i o n system  i n the case o f HIGH PROD, under the N&L c and N&L w. P r e d i c t a b l y , the lower m a r g i n a l and average  tax r a t e s r e s u l t i n g from the a v a i l a b i l i t y o f  r o y a l t y and tax r e l i e f do not curb the producer's d e s i r e AAH-fixed  system  to r e l y on an  under the f e d e r a l l e g i s l a t i o n and i n the presence o f K l .  Table 5.2 a l s o r e v e a l s K l and under the p r o v i s i o n s  a d i f f e r e n t kind  o f r e s u l t . In the presence o f  o f the N&L c, the r e l i e f  package modelled  126  induces the producer net b e n e f i t s suggest  to i n s t a l l  three f i x e d p r o d u c t i o n p l a t f o r m s . Since  to s o c i e t y are maximized by an A B - f i x e d system,  the  that a p p r o x i m a t e l y 3 per cent of the p o t e n t i a l net present v a l u e  of the f i e l d  would be d i s s i p a t e d  i f an AAH-fixed  system were used  i n s t e a d . Here, riot o n l y d i d the a v a i l a b i l i t y of r e l i e f r e s u l t t r a n s f e r of a share of government revenues affected  producer behaviour  net b e n e f i t s  r o y a l t y and  i n a way  to the producer but  which reduced  Up  i n e l e v e n of the cases c o n s i d e r e d , the s p e c i f i c  tax r e l i e f modelled  have no e f f e c t  and  1  Shocks  to t h i s p o i n t , the a n a l y s i s has been based  on the assumption  that  were known by  the  at the time the economics o f the development d e c i s i o n were  s i m u l a t e d . In t h i s s e c t i o n , I t r y to r e l a x t h i s assumption some events which, was  forms o f  on producer behaviour  the time paths of a l l r e l e v a n t v a r i a b l e s and parameters producer  i t also  Hibernia"s potential  thus act p r i m a r i l y as mechanisms o f r e d i s t r i b u t i o n .  Adverse  i n the  to s o c i e t y .  Finally,  5.3  results  though  unexpected  taken, are allowed to a f f e c t  consequences  of two  shocks  r e s e r v o i r s are s m a l l e r and  and i n t r o d u c e  at the time the d e c i s i o n to develop  the economics o f the f i e l d .  are examined: the d i s c o v e r y that l e s s p r o d u c t i v e than o r i g i n a l l y  (SMALL/LOW) and a sudden f a l l  i n world o i l p r i c e s  c o n t a i n s more d e t a i l e d d e s c r i p t i o n s of these two  The the  anticipated  (P DROPS). Table adverse  5.1  shocks.  When a shock o c c u r s , the past a c t i v i t i e s of the producer g i v e n . However, i t i s assumed that  two  are taken as  i n the a f t e r m a t h o f the shock,  the  producer can a l t e r c e r t a i n aspects o f the development p l a n i f i t i s i n h i s best  interests  to do so. The model allows these responses  to take  two  127  forms. F i r s t , production  the producer may  reservoirs).  and  for a d i f f e r e n t  s e l f - i n t e r e s t may  i n t r o d u c t i o n of  responses which are i n the  reduce p o t e n t i a l net b e n e f i t s to s o c i e t y .  To  l i k e l y c o n s t r a i n t s on the speed of producer response, i t i s a l l shocks  are s i m u l a t e d to occur i n  changes i n the development p l a n are f i r s t Results  from the r e l e v a n t  c o n s t r u c t i o n and  where ' ( B ) ' s i g n i f i e s  installation activities  were assumed to stop i n 1989.  the f i e l d  f o r purposes  Although that  behaviour  the two  related  that  the  to the second p l a t f o r m  prior  to the t e r m i n a t i o n o f  p l a t f o r m to be claimed a g a i n s t the revenues  from  of t a x a t i o n . shocks have s e r i o u s r e p e r c u s s i o n s , the r e s u l t s  there i s l i t t l e  to a f f e c t  1989.  In such c a s e s , the model allowed (when  a p p r o p r i a t e ) a l l e x p e n d i t u r e s undertaken a c t i v i t i e s on the second  possible only i n  1988,  s i m u l a t i o n s of the o f f s h o r e development  model are r e p o r t e d i n t a b l e 5.5  scope  f o r r a t i o n a l changes i n producer  the magnitude o f p o t e n t i a l net b e n e f i t s . Under a l l the  s e t s of c i r c u m s t a n c e s r e p o r t e d i n t a b l e 5.5 i r r e v e r s i b l e nature of a c t i v i t i e s undertaken  and g i v e n the assumed prior  to 1989,  per cent of the maximum net present v a l u e of the f i e l d and  The  intensity  again c r e a t e a wedge between r e t u r n s to the  those to s o c i e t y . Consequently,  assumed that even though  suggest  opt  an  (over time and a c r o s s  f o r a g i v e n type o f p r o d u c t i o n system.  government p o l i c i e s w i l l  reflect  f i n a l periods of  platform distributions  In a d d i t i o n , the producer may  of development  producer's  different  f o r both r e s e r v o i r s g i v e n a type of p r o d u c t i o n system,  i n t e n s i t y of development and  producer  choose  more than 95  to both  producer  s o c i e t y i s reached without any change i n s i m u l a t e d producer  b e h a v i o u r . While  i t i s never  i n anybody's best i n t e r e s t s  to a d j u s t the  number of p l a t f o r m s , changes i n the l e n g t h o f the p r o d u c t i v e l i v e s o f both '  128  r e s e r v o i r s do i n c r e a s e net b e n e f i t s a c c r u i n g to producer and s o c i e t y . However, the gains are l e s s than 5 per c e n t . The lumpiness o f the investment  program i s the p r i n c i p a l  f a c t o r behind t h i s  result.  Once a g a i n , the dynamic p r o p e r t i e s o f the p o l i c y regimes modelled a r e shown to be such t h a t , when c o n d i t i o n s are allowed to worsen, net b e n e f i t s a c c r u i n g to the producer tend to f a l l present v a l u e o f the f i e l d simulated, this under  at a f a s t e r r a t e than does the net  to s o c i e t y . For the two adverse  tendency has i t s s t r o n g e s t e f f e c t  the terms o f the f e d e r a l l e g i s l a t i o n .  available  Another  interesting result  when development assumptions, field  assumptions  the base  case  the h i g h e s t net present v a l u e o f  the terms o f the f e d e r a l  t h i s same  l e g i s l a t i o n . The same d i d  the N&L c and N&L w. Under the base  case  and the terms o f both v e r s i o n s o f the Newfoundland and  Labrador l e g i s l a t i o n , opt  imbalance and  emerges from t a b l e 5.5. As shown e a r l i e r ,  an A B - f i x e d system y i e l d s  a p p l y , however, under  to the  r e t u r n on h i s investment.  and p r o d u c t i o n are s i m u l a t e d under  p l a n under  l o s s . The  (assumed announced p r i o r  to s o c i e t y . In a d d i t i o n , the producer would choose  development not  In t h i s case the best outcome  o f c o n s t r u c t i o n a c t i v i t i e s ) operates to r e d r e s s t h i s  a l l o w s the producer to r e a l i z e a normal  the  f o r P DROPS ( t a b l e 5.5)  to the producer i n v o l v e s a p o s i t i o n o f net p r i v a t e  i n t r o d u c t i o n o f r o y a l t y and tax r e l i e f start  shocks  f o r an A - f i x e d  the r e s u l t s  suggest that a r a t i o n a l producer would  p r o d u c t i o n system and, as a r e s u l t ,  an estimated 13 per  cent of p o t e n t i a l net b e n e f i t s to s o c i e t y would be d i s s i p a t e d . However, the consequences such that a s i n g l e  o f the two adverse shocks c o n s i d e r e d are  f i x e d p l a t f o r m on Avalon y i e l d s  v a l u e to s o c i e t y and the producer p o l i c y regimes modelled)  a h i g h e r net present  (even i n the presence of the three  than does an A B - f i x e d system. The r e s u l t s o f  129  t a b l e 5.5 show that  f o r t h i s c o n c l u s i o n to h o l d , i t i s necessary  c o n s t r u c t i o n and i n s t a l l a t i o n not  activities  to have been undertaken p r i o r  shock. When t h i s  i s the case,  c and N&L w d i s t o r t ex post,  r e l a t e d to the second  to the occurrence  the f a c t  f o r the  platform  o f e i t h e r adverse  t h a t , ex ante,  the terms o f the N&L  the producer's c h o i c e o f development p l a n turns o u t ,  to c r e a t e a s i t u a t i o n which i s p r e f e r r e d by both producer and  society. Since  the r o y a l t y and tax r e l i e f  N&L c and N&L w p r o v i d e s an AB-fixed  production  the  to apply under the  the i n c e n t i v e s f o r a r a t i o n a l producer to adopt  system under the base case assumptions,  i n t r o d u c t i o n precludes previous  program modelled  the emergence o f the r e s u l t d i s c u s s e d  paragraph. By the time e i t h e r o f the u n a n t i c i p a t e d  s i z e and i r r e v e r s i b l e nature  undertaken p r i o r desirable  i n the shocks  o f the investment on the second  to 1989 i s s u f f i c i e n t  from the producer's,  its  to make an A B - f i x e d  occurs,  platform  development  as w e l l as s o c i e t y ' s , p e r s p e c t i v e .  These r e s u l t s draw a t t e n t i o n to the l i m i t a t i o n s  inherent  i n any  a n a l y s i s o f the consequences o f u n c e r t a i n t y which i s c a s t i n terms o f c e r t a i n t y e q u i v a l e n t s . Keeping i n mind the r e s e r v a t i o n s expressed i n chapter on these  3 above, Monte C a r l o techniques  could be used to shed more l i g h t  issues.  A more i n t e r e s t i n g explicitly  approach, however, would be to r e c o g n i z e  the time- and a c t i v i t y - d e p e n d e n t  example, i t could  take  nature  i n t o c o n s i d e r a t i o n the f a c t  o f the u n c e r t a i n t y . For that u n c e r t a i n t y about  the a t t r i b u t e s o f a d e p o s i t can be reduced by i n v e s t i n g i n development activities.  Such a model would then t r e a t  the producer as a r a t i o n a l  economic agent who must make d e c i s i o n s with but  who a l s o r e a l i z e s  less  than complete  information  t h a t , as time goes on and development and p r o d u c t i o n  130  activities  proceed, he l e a r n s more about  the a t t r i b u t e s of the f i e l d  the g e n e r a l economic c l i m a t e . Not o n l y would producer  i t then be p o s s i b l e  and  f o r the  to a l t e r h i s plans as more i n f o r m a t i o n becomes a v a i l a b l e but  could a l s o take i n t o account the u n c e r t a i n t y when f i r s t  the time- and  he  a c t i v i t y - d e p e n d e n t nature o f  c o n s i d e r i n g the economics of development  and  p r o d u c t i o n , whether i n the presence of government p o l i c i e s or not. An approach used  similar  to the one d e s c r i b e d i n the p r e v i o u s paragraph i s  i n a s t y l i z e d model developed  i n Roberts  i n Weitzman [1979] and  and Weitzman [1981]. M o d i f y i n g t h i s approach  later  extended  to make i t  n u m e r i c a l l y t r a c t a b l e would l i k e l y y i e l d v a l u a b l e i n s i g h t s  into  the  economics of l a r g e - s c a l e p r o j e c t s such as the development and p r o d u c t i o n of H i b e r n i a . However, i n t h i s of the consequences  t h e s i s , I have opted  f o r a s i m p l e r treatment  of u n c e r t a i n t y i n favour of a broader  examination  of  the impacts of H i b e r n i a on the economy as a whole, and on revenue s h a r i n g and  fiscal  equalization,  5.4  Conclusion  in particular.  What are the i m p l i c a t i o n s  i n terms of the e f f i c i e n c y of r e s o u r c e  t a x a t i o n o f changes i n assumptions  i n the presence of s p e c i f i c  t a x a t i o n systems?  i n chapter 4 above, a l l three systems  modelled  include  As was  suggested  instruments of t a x a t i o n which do not  changes i n cost and revenue producer  tend to f a l l  faster  royalty  f u l l y respond  c o n d i t i o n s . As a r e s u l t , net b e n e f i t s  to the  the p o t e n t i a l f o r  d i s t o r t i o n a r y e f f e c t s by government p o l i c i e s . R e s u l t s from s e c t i o n  policies results  to  than the net present v a l u e o f the f i e l d when  c o n d i t i o n s are allowed to worsen, thereby c r e a t i n g  above a l s o suggest  and  5.2  t h a t , i n some c i r c u m s t a n c e s , the presence of government  i n p r i v a t e l y o p t i m a l development plans which are more  131  intensive  than those maximizing p o t e n t i a l net b e n e f i t s to s o c i e t y . In a l l  cases c o n s i d e r e d , induced by  however, the d i s s i p a t i o n of p o t e n t i a l net  government p o l i c i e s never exceeds 15 per  Differences  i n the dynamic p r o p e r t i e s  of the  benefits  cent.  three  p o l i c y regimes  modelled a l s o emerge from the r e s u l t s of the experiments undertaken i n t h i s chapter. increases,  some cases, N&L  platforms  the  assumed i n t e n s i t y of development  f a s t e r than that embodied  this  tendency was  w would d i s t o r t to use  strong  the  tax r a t e  do  i n the  w h i l e the  so. However, i n other i n the  i n s t a l l a t i o n of an a d d i t i o n a l p l a t f o r m  low  under the  the  the  N&L  federal  marginal  construction  rise  and  even though i t would reduce  insulated against  terms of both v e r s i o n s existence  and  design  i n the  revenue  changes i n assumptions  of the Newfoundland and of the c o n d i t i o n s  NLPC p a r t i c i p a t i o n i n the revenues from the comparable p r o v i s i o n s  In  to s o c i e t y .  s l i g h t l y better  l e g i s l a t i o n . The  for t h i s  cases,  w  the number of  terms of the  i n t e n s i t i e s of development, the producer's net  p o s i t i o n was  N&L  f e d e r a l l e g i s l a t i o n would not  f a s t enough to render p r i v a t e l y u n p r o f i t a b l e  At  c and  federal l e g i s l a t i o n .  producer's d e c i s i o n concerning  incorporated  p o t e n t i a l net b e n e f i t s  i n the N&L  enough that the p r o v i s i o n s of the  i n producing H i b e r n i a  l e g i s l a t i o n would not effective  as  the m a r g i n a l e f f e c t i v e tax r a t e i m p l i c i t  tends to r i s e  c and  In g e n e r a l ,  field,  federal l e g i s l a t i o n ,  and are  Labrador relating  to  the  the absence of largely  responsible  result.  What are  the consequences of the  packages modelled? In g e n e r a l ,  specific  r o y a l t y and  these forms of r e l i e f r e s t o r e  producer i n c e n t i v e s necessary to b r i n g about the number of p l a t f o r m s  tax  which maximizes the net  relief  the  set  i n s t a l l a t i o n of  the  present  value  of the  of  field  to  132  s o c i e t y . In the  few  cases where t h i s r e s u l t d i d not  d i s s i p a t i o n of p o t e n t i a l net b e n e f i t s was possibility itself,  that  the  induce the  platforms specific  could  i n t r o d u c t i o n of r o y a l t y and  not  be d i s c a r d e d .  i s s u e which has  possibility delays  small but  tax r e l i e f  the  could,  by too many  However, i n a l a r g e number of cases, no e f f e c t on producer behaviour  the and  e x c l u s i v e l y as mechanisms of r e d i s t r i b u t i o n , t r a n s f e r r i n g a  share of the net b e n e f i t s An  the  producer to choose a development p l a n based on  forms of r e l i e f modelled had  thus acted  relatively  obtain,  that  i n the  the  first  from the government to the  not been explored  in this  producer.  t h e s i s i s the  i n t r o d u c t i o n of government p o l i c i e s period  could  also  of development. Examples coming to mind  the p o l i c y regimes' p r o v i s i o n s  f o r the completion of environmental  induce involve impact  3 studies preceding  the approval  of any  DELAY ( t a b l e 5.3)  suggest that  the p o l i c y - i n d u c e d  net  b e n e f i t s would i n c r e a s e but  and  t a x a t i o n systems modelled would otherwise be What have the  last  two  f i n a n c i a l r i s k s associated Hibernia? inherent  Simply put, i n a l l three  downside r i s k s  the  that  development p l a n .  The  r e s u l t s for  d i s s i p a t i o n of p o t e n t i a l  the dynamic p r o p e r t i e s of the  royalty  unaffected.  c h a p t e r s t o l d us about the d i s t r i b u t i o n of with the development a