Midland Energy has won a 15-year lease to develop an oil field to extract crude
ID: 2822326 • Letter: M
Question
Midland Energy has won a 15-year lease to develop an oil field to extract crude oil from the shale deposits. The company expects it will need to spend 2 years constructing the facilities in order to start the crude-oil extraction process. Thus, Midland expects to start producing the oil from start of Year 3. Midland has contracted to sell the entire output of this field to Oxy Petro Inc. at a fixed price of $20 per barrel. As part of the agreement, Midland will receive all payments from Oxy Petro Inc. only at the end of the year. Midland expected to produce 100,000 barrels of crude in the first year of production. Thus, if the production goal was met Midland will get its first payment of $ 2 million ($20 x 100,000) at the end of Year 3. Midland expected the oil crude production to decline by 3% each year thereafter. The oil field is on Federal land and after 15 years (from today) all rights will revert back to the Federal Government and Midland will have to relinquish all control. Assume that the appropriate discount rate is 10%.
If the appropriate discount rate is 10% per year, what is the expected present value of the revenues from this oil field today?
Explanation / Answer
Present value of revenues from the oil field today
=20*100000/1.1^3+20*100000*0.9/1.1^4+20*100000*0.9^2/1.1^5+20*100000*0.9^3/1.1^6.....
=(20*100000/1.1^3)*(1-(0.9/1.1)^13)/(1-(0.9/1.1))
=7655960.34