Running a large factory or an oil platform costs a lot of money. It costs a lot of money to build the thing, it costs a lot of money to run the thing. The only reason people build and run these things is that they get even more money in, than they have to spend on building and operating their assets. In this post we are going to look at the operating expenditure and loss related to downtime on oil production platforms. What is special about these platforms compared to other factories is that they are producing from a more or less fixed reservoir of resources, and when you have depleted the reservoir, the party is over. Production downtime is often included as a risk category in SIL allocation work – often hidden under a somewhat diffuse name such as “asset impact” or “financial loss”. An accident causes financial loss in many ways:
- Lost market confidence
- Lost contract opportunities
- Direct production loss
- Repair costs
- Extra money needed for marketing and branding
In risk discussions we normally think about direct production loss and repair costs – the other things are not included. This is OK. We’ll put the repair costs aside for now, and look at three different views people tend to take when discussing production downtime.
- Lost production is a complete loss of income
- Lost production means simply that income will come at the end of the production horizon and there is no loss provided the oil price stays the same
- Lost production will lead to a loss measured in present value depending on the oil price and the cost of capital
The first one is the easiest to use in assessments (3 days of downtime x 10 million dollars per day = 30 million dollars lost). The second one means that you do not care about downtime – and is not very realistic. Usually someone will convince the person claiming this that he or she is wrong. The last option is obviously the most “correct” but also the most difficult to use for anything in practice. Who can tell what the oil price is in 20 years? And in particular, which engineer can do this calculation in real time during a risk assessment discussion? These obvious difficulties often lead people to go with the “it’s all lost” option. Let’s have a look at what this really means for two different scenarios. The assumptions we make is that one day of production is worth 10 million dollars and that all operating expenses are fixed. We compare a production horizon of 5 years with a production horizon of 20 years. So we need to compare the value of 1 day of production now, in 5 years and in 20 years in terms of present value. Since we do not know the cost of capitcal for this particular operator we will calculate with a discount factor similar to what could be obtained by not trying to recover the production but rather investing the same amount of money in company stock. For simplicity we assume a 7% discount rate (it’s an arbitrary choice but not orders of magnitude away from what can be expected). The present value of 1 day of production in 5 years is thus:
5 years deferred production: 10 million / (1+0.07)5 = 7.1 million
20 years deferred production: 10 million / (1 + 0.07)20 = 2.6 million
We see that deferring production by 5 years at an opportunity cost of 7% per year we get a present value loss of 29%, whereas for deferring production for 20 years we lose 74%. For a 7% opportunity cost we can draw this graph for cost of deferred production in per cent of the current value:
This should not be a topic for discussion during a risk assessment workshop but should be baked into the risk acceptance criteria. For projects with long production horizons (say 15-20 years), a day of downtime may conservatively be assumed to be lost. For shorter durations the asset owner should define acceptable frequency of downtime, e.g.
1-3 days downtime: 0-10 years between
4-10 days downtime: 10 – 30 years between
This type of acceptance definition is more practical to use than a dollar value.