Capital Investments

When investing in a new refinery, or a new module, both fixed capital and working capital is needed to complete the installation. Based on empirical studies by Abdel-Aal, a rule of thumb for fixed capital in new refinery include following items:

• The cost of principal process equipment that usually cover foundation, platforms and erection (illustrated in the figure below). With a calculated multiplication factor of 1.43 for the delivery cost. The product is the column for process equipment. The other columns are empirical based suggestions of what the other costs may be compared to the process equipment costs. Process piping is the cost of building a pipe system to transport fluid or gas through the refinery system. Electrical auxiliaries include electrical substations, feeders and wiring.

• Other costs in connection with constructing a refinery are the labour costs at the construction site like manual and craft labour, indirect labour costs like accountants and clerks, other indirect costs like travel and insurance. However, these costs remain small compared to the costs of acquiring the physical equipments.

Different Capital Costs compared to Process Equipment

Process

Figure 63 Theoretical Investment Costs at a Refinery, Source: Abdel-Aal et al, 1992

There is also a need of working capital before starting the refinery operations. Working capital gives the refinery financial strength to handle the difference between cash inflows and outflows. The author says that the working capital is usually determined by the sum of one month supply of crude oil, one month supply of work-in-process products and one month supply of final products. This is said to be 15 per cent of the total capital costs.

Nevertheless, working capital varies a lot from project to project and one has to take in account the risk of the project and the underlying realities of the need for current assets.

The Mongstad refinery expansion in the 80s became a costly affair for Statoil, which was state-owned at that time. Statoil’s first president had to resign from his job in 1988 after costs exceeded the budget by 6.4 billion NOK (Aftenposten 2005). This figure of 6.4 billion NOK was later known as one unit of “mong” that was meant to measure later deficit in later state-owned projects. When the estimated cost of investment was presented in 1982, the total expansion was to cost 3.8 billion NOK in 1982 money (Strømsvåg 1983). The large deviation in costs proves that cost-controlling in such a large investment project can be very difficult. However, the Mongstad project is not the only project that Statoil has exceeded its cost estimates. Also the ongoing Snøhvit project offshore and onshore will be exceeding the cost estimates dramatically. With several examples of projects exceeding budgets, it can be fair to ask if these extra costs are beyond Statoil’s control or/and is it a case of poor cost estimations.

In an article by Pettersson (Aftenposten 2005), he presents an interesting theory why investment projects in the petroleum industry exceeds the cost estimates. The investment projects are structured almost like a venture company to spread risk where there is a partnership between several companies and one of them has the operator status. By being an operator of a project, gives the company valuable technology knowledge and operator experience for later projects. Pettersson argues that there is little incentive for the operator to focus on costs since the operator gets all of his direct costs in connection with construction fully covered, in addition to getting a share of the indirect costs like administration and R&D covered. Sometimes the partners have to pay the indirect costs as a depending amount of the direct costs, so that the there is a small incentive to increase the direct costs to get more of the indirect costs covered. In addition, there could be some incentive to relocate joint costs to projects as much as possible to get them covered. Also, different projects with different operator share of costs will give different incentives to reduce costs regarding to risk-taking.

An operator in a project with a large share of costs will be more focused on costs (taking less risk) than in a project with smaller share of costs. This theory is an example of agent-principal problem where the agent (operator) does not act in the interest of the partners (principal). This theory on incentive problems in investment projects is also relevant in operation costs since operations are most often structured as partnerships.

In the chart below, we see the development in investment costs from 1990 to 2004. The figures are given in nominal value. The investments have been varying a lot from year to year. With ordinary operation investments like maintenance investments and small modification investments on existing equipments as small inevitable costs all years, the total investment cost makes a large leap every time large investment projects are initiated.

INVESTERINGER (MRDA)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

MNOK

Total Investments Ordinary Operation Investments

Figure 64 Investments at Mongstad Refinery, '90-'04, Source: Statoil ongstad

The investments in installations are being depreciated on analysis basis of 20 years (Mongstad 2005) although most of the installations have a longer life time. The deprecation costs are the largest non-payable cost at Mongstad, amounting to be almost 1/3 (Mongstad 2005 accounting information) of the total cash operating costs. During the installations’

lifetime, some components have to be replaced. It has never been necessary to replace an entire installation. Following large investment projects have been registered in the figures

below that can explain the high investment costs in the years 1990, 1995, 1998, 1999, 2001, 2002, 2003 and 2004:

Figure 65 Description of the largest Investments during '90-'04, Source:

Statoil Mongstad

Year Investments

1990 Finalising the refinery expansion and

upgrade. Buyout of Noroil share of 40 per cent.

1995 New installation for reducing sulphur in

diesel and gas oil.

1998 Revamp of Cracker-installation R-1501 and

upgrade of the crude oil tower due to Vestprosess pipeline system expansion.

1999 Upgrade of the crude oil tower due to

Vestprosess pipeline system expansion.

2001 Desulphurisation installation to improve

quality of gasoline.

2002 Desulphurisation installation to improve

quality of gasoline. Investment in flaring gas compressor to reduce flaring.

2003 Investments in energy recycling and upgrade

of steam production. Also, system for quality improvement of auto diesel.

2004 Expansion of the Vestprosess installation.

New jetty for ship to ship loading of crude oil

There are three different ways of deciding investments at Mongstad. They use net present value (NPV), internal rate of return (IRR) and pay-back time. NPV gives the value of the investment measured in today’s money and the IRR is the discount rate that gives an NPV zero. The payback time is a very simplified tool and measures how many years it takes before the investment has paid-off. The latter tool is not appropriate for investments with a long time profile due to not including the different discount rates. The best tool for deciding the profitability of investments is NPV since the IRR suffers from business logical failure (Jan Bergstrand 2005). This is due to two different investments with different IRR is a logical failure since the same time period should have the same discount rate. For investments at Mongstad, the decisive method is the NPV (Øyvind Arnesen 2005). In the NVP calculation all prices regarding crude oil and products are according to EPA (Economic Planning Assumptions). EPA is a common tool (prices, exchange rates, etc) for all investmenst projects and other economic forecasts in the Statoil corporate. Due to these assumptions, the oil price is to some extent fixed and the basis of the cash flow. The cash flow to total capital is after tax and they use real discount rate after tax. The discount rate is confidential. It is recommended by the department “Group Planning and Analysis”

(Konsernplan og analyse) and the corporate management decides on the investment above the limit of internal decision at Mongstad (discussed soon). The group management, the division and Mongstad will normally demand a substantial positive net present value so the actual rate of return must be higher than recommended by “Group Planning & Analysis”.

Mongstad is delegated to make investment decisions with an upper limit of 50 MNOK (Øyvind Arnesen). In practice, investment decisions less than 20 MNOK are taken at Mongstad. To estimate the cost of investment, the project environment at Mongstad investigates about the cost and works on a project plan. Until 3 October 2005, the responsibility was under P&U (Plan & Development) for projects concerning business development and T&U (Technology & Development) for projects concerning project deployment and modifications of existing investments. The new unit is VMP (Maintenance, Modifications, Projects) that has its responsibility of the two previous units.