Royal Dutch Shell, BP, and Exxon Mobile are considering establishing a consortium to extract oil in Libya, a country with considerable riskiness (see the attached pdf of World Bank country backgrounder for details). The following information is pertinent to your analysis:
- The reference rate for the type of oil is the Brent Crude (https://oilprice.com/oil-price- charts/block/1#) rate.
- Information on Brent Crude oil futures and options can be found here (https://www.cmegroup.com/trading/energy/crude-oil/brent-crude-oil.html) and are traded on the CME. (Open this website and click Contract Specs to find the information)
- All current corporate information on BP, Shell, and Exxon is valid and should be considered in this analysis. For example, use their respective WACCs, annual reports (visions/goals/challenges), bond ratings, etc… when answering the below questions.
- Project specific details are:
o 20-year operational life of this oil facility.
o 2-years’ time-to-build component (facilities and related infrastructure), during which time no barrels of oil can be produced.
o 50% chance for the oil wells (on which the facility is built) to produce 30 million barrels of oil per year; 25% chance of 60 million barrels per year and 25% chance of wells being dry, i.e., 0 barrels of oil will be produced in that case.
o The fixed cost to establish the facility in Libya is $8.5 Billion USD.
o The variable cost is 24 LYD (Libyan Dinars) per barrel of oil extracted.
o Assume the Libyan government charges royalties of 15% on profits of any oil activities in occurring in their territories.
o Furthermore, assume, that the Libyan government has a 10% withholding tax on any monies paid to foreign corporate owners, regardless as to the form of the monies, i.e., dividends, interest on inter-company loans, management fees, ect…
Given the above, answer the following questions:
Note: There are acceptable “degrees of freedom” for these answers, i.e., multiple correct answers are quite possible. I am most interested in the quality of your explanations and thought process here. Feel free to state any reasonable (evidence-based) assumptions you may make while answering these questions.
- What could be the optimal WACC for the consortium be? Explain your methodology. Hint: Think about our discussion of International CAPM. Is this project within the normal operational scope of the consortium’s companies? A good reference on country risk premia is: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html
- Do you think the consortium will be a stable coalition? What assumptions and/or conditions might you want to add for stability of the consortium?
- After year 10, the consortium decides to sell their Libyan oil operations. How would you value this project? Assume US Chevron is the potential buyer. Clearly explain your methodology and any assumptions you make. Intuitively, would the facility’s valuation be different if the buyer was Saudi Aramco? Why or why not?
- Now assume in year 5 there is 70% chance of increased conflict in Libya. Furthermore, assume that if increased conflict happens the facility will be inoperable that year (i.e., no oil produced). How would this affect your time zero’s NPV? In year 8, would this scenario affect the project’s NPV?
- Intuitively, could the consortium take steps to minimize political risk to their operations in Libya? If so, what could they be.
Sample Solution
