Unit costs per barrel

Quick refresher

“Cost per barrel” on its own means nothing. Name the costs in the numerator, the barrels in the denominator, the discount rate (or its absence), the money units and the year of the prices.
The lifting cost is the operating expenditure of a year divided by the production of the same year. The average over the life is the ratio of the sums, not the average of the yearly values. As the water cut (the share of water in the produced liquid) rises, the cost per barrel of oil grows in inverse proportion to the share of oil in the liquid.
The levelised cost per barrel is the discounted costs divided by the discounted production. It is the constant price at which the project, before tax, earns exactly the discount rate: $\mathrm{NPV} = (P - c)\,Q_\text{disc}$ .
The levelised cost is higher than the undiscounted one, because the investment is made before the barrels are produced. In the example project it is 27.8 $/bbl at 10%, against 22.8 without discounting. It does not depend on the origin, but it depends strongly on the rate.
The break-even price is the technical cost plus the royalty (a share of revenue paid to the state) and the income tax per barrel at that price: 18.8 + 8.4 + 0.6 + 3.2 + 1.4 = 32.4 $/bbl. With exploration and overheads (the full cycle) it is 37.1. When all the investment has been made, it already pays to go on producing at 10.0.
A low cost per barrel is not the same as the best project. Value equals the margin per barrel multiplied by the discounted production, and it depends on the scale, the tax regime and the price of the product.

Key relationships

o_t = \frac{O_t}{Q_t}

the lifting cost in year $t$

c = \frac{\sum_t (C_t + O_t + A_t)(1+i)^{-t}}{\sum_t Q_t\,(1+i)^{-t}}

the levelised technical cost per barrel

\mathrm{NPV}_\text{pre-tax} = (P - c)\,Q_\text{disc}

the value of the project before tax at a constant price

P^{*} = \frac{PV_C + PV_A + (1-T)\,PV_O - T\,PV_D}{(1-r)(1-T)\,Q_\text{disc}}

the break-even price with a royalty and an income tax

Common pitfalls

Averaging the yearly unit costs with a simple average instead of the ratio of the sums of costs and production.
Dividing discounted costs by undiscounted reserves, or undiscounted costs by discounted production.
Comparing the lifting cost of one field with the full cost of another, or comparing the cost per barrel with the price of the benchmark grade (the reference oil whose price is quoted in the market) instead of the netback.
Comparing the capital expenditure per barrel of a project with leased facilities and of a project with owned ones.
Comparing levelised costs in nominal money with a price forecast in constant prices.

After this lesson you can

tell apart the lifting cost and the capital, technical and full cost per barrel, and list what each indicator includes
calculate unit costs without discounting and levelised unit costs, and explain why for a levelised cost the barrels must be discounted as well
calculate capital intensity (the capital expenditure per barrel of daily production), and explain why the result depends on the production rate chosen
link the levelised technical cost with the break-even price, and split the price into costs and payments to the state
tell the full-cycle cost from a calculation “from the current point”, and apply each of them to its own decision
recognise when a comparison by cost per barrel misleads: scale, tax terms, the value of the product, water cut, real and nominal money

Which costs and which barrels

For the same project from the examples of this library, you can say with good reason that the cost is 8.5, 22.8, 27.8 or 32.4 dollars a barrel. None of these numbers is wrong. The first is the operating expenditure per barrel produced. The second and the third are all the costs of creating, running and abandoning the field (closing it down at the end of its life), without discounting and at a rate of 10%. The fourth is the break-even price, that is, the same costs at 10% together with the royalty and the income tax. To understand which indicator is meant, you need answers to five questions.

Which costs? Only operating costs; with capital costs; with exploration (the search for oil) and appraisal (finding out how big a discovery is); with the overheads of the company; with payments to the state.
Which barrels? Those produced in a year, or recoverable reserves (and of which category: Classification of reserves and resources); oil only, or oil together with gas converted into oil equivalent.
Is time taken into account? Are the costs and the production simply added, or brought to one date at a rate, and at which rate?
In what money? The currency, nominal money or constant prices, and of which year (Inflation: nominal and real money).
For which decision? The full cycle from the start of exploration, or only what is still to be spent.

The answers to these questions are the definition of the indicator, and the definition belongs next to the number. Below, the indicators are taken one by one, from the lifting cost to the full-cycle cost. At the end of the lesson we show where a comparison by them misleads, and why a decision on investment is still based on the net present value (NPV).

The main unit-cost indicators

Indicator: Lifting cost
Numerator: operating expenditure of the year
Denominator: production of the same year
What it is for: the efficiency of operations, how close the field is to its economic limit

Indicator: Capital expenditure per barrel
Numerator: capital expenditure on development
Denominator: recoverable reserves
What it is for: comparing development concepts, checking the cost estimate

Indicator: Finding and development cost (F&D)
Numerator: the costs of exploration, appraisal and development in a period
Denominator: the additions to reserves in the same period
What it is for: what it costs the company to replace its reserves

Indicator: Capital intensity
Numerator: capital expenditure
Denominator: daily production, bbl/d
What it is for: comparing facilities of different size

Indicator: Technical cost
Numerator: capital and operating costs, abandonment
Denominator: production over the life
What it is for: what a barrel costs without taxes

Indicator: Full-cycle cost
Numerator: the same plus exploration, overheads and taxes
Denominator: production over the life
What it is for: what price the project must withstand

Indicator	Numerator	Denominator	What it is for
Lifting cost	operating expenditure of the year	production of the same year	the efficiency of operations, how close the field is to its economic limit
Capital expenditure per barrel	capital expenditure on development	recoverable reserves	comparing development concepts, checking the cost estimate
Finding and development cost (F&D)	the costs of exploration, appraisal and development in a period	the additions to reserves in the same period	what it costs the company to replace its reserves
Capital intensity	capital expenditure	daily production, bbl/d	comparing facilities of different size
Technical cost	capital and operating costs, abandonment	production over the life	what a barrel costs without taxes
Full-cycle cost	the same plus exploration, overheads and taxes	production over the life	what price the project must withstand

The names of the indicators differ between companies and reports. The safest way is to give the definition next to the number.

There are unit indicators for other stages as well. In drilling, there are the cost of a well and the cost per metre drilled (Drilling time and cost). In exploration, there is the cost per barrel of reserves discovered. The logic is the same for all of them: the numerator and the denominator must belong to the same object, the same period and the same money.

Lifting cost: operating expenditure per barrel

Lifting cost (operating cost per barrel; company reports also call it the unit production cost) is the operating expenditure of a year divided by the production of the same year. There is nothing to discount here: the costs and the barrels belong to one year. But when different years are compared, it matters in what money the costs are expressed. In nominal money the lifting cost grows because of inflation alone, so the costs of different years are compared in constant prices (Inflation: nominal and real money). The lifting cost usually includes staff, energy, chemicals, maintenance and routine repair of equipment and wells, gathering and treatment of the product, and the preparation and injection of water. It usually does not include the royalty and other taxes, transport to the market if it is already deducted from the price at the field, depreciation, and the general expenses of the company. Practice differs, so the content of the indicator is always checked. The accounting cost of production is a different indicator. It includes depreciation, that is, capital costs spread over the years by the rules of accounting, and sometimes production taxes too.

How the lifting cost changes from year to year, and how it sets the economic limit, is explained in the lesson on the cash flow model. The fixed part of the costs is divided by the falling production, so the cost per barrel grows towards the end of the life of the field. Here are two questions that arise when you work with this indicator: how to get an average over the life, and how water affects the cost.

Worked exampleAverage lifting cost of the example project

Given (assumed data)

Production in years 3–9: 1.6, 2.4, 2.4, 2.0, 1.6, 1.2 and 0.8 million bbl, 12 million bbl in all
Operating expenditure: US$6 million a year plus $5/bbl, US$102 million in all
Levelised values at 10%: costs 66.05 million dollars, production 7.899 million bbl (origin in the middle of year 1, flows in the middle of the year)

Solution

The lifting cost by year is 8.75, 7.50, 7.50, 8.00, 8.75, 10.00 and 12.50 $/bbl. This is from 7.5 on the plateau (the years of steady, maximum production) to 12.5 in year 9.
The average over the life is the ratio of the sums: $102/12 = 8.50$ $/bbl.
The simple average of the seven yearly values is $63.00/7 = 9.00$ $/bbl. In it, the years of small production get the same weight as the years of the plateau.
The levelised value at 10% is $66.05/7.899 = 8.36$ $/bbl. It is below the average, because the expensive late barrels weigh less after discounting.
Per tonne: $8.50\cdot 7.314 = 62.2$ $/t. At an assumed exchange rate of 500 tenge to the dollar, this is about 31.1 thousand tenge a tonne.

Answer: The average lifting cost of the project is 8.50 $/bbl (about 62.2 $/t), and the levelised one is 8.36 $/bbl. The simple average of the yearly values, 9.00 $/bbl, overstates them.

What it means. Over the life of a field, the lifting cost changes by a factor of 1.7. So one number without the year or the method of averaging says little. Fields at the same stage are compared by the costs of the same year. To value a project, take the average as a ratio of sums, or take the levelised value. The data in this example are assumed for illustration.

The lifting cost rises especially fast at the late stage of waterflooding, when water is injected into the field to push the oil out. Pumps, separators, treatment units and water injection plants work with all the liquid, while only the oil brings revenue. If the costs are proportional to the volume of liquid, the cost per barrel of oil equals the cost per barrel of liquid divided by the share of oil in it. That share is one minus the water cut (the share of water in the produced liquid).

Worked exampleCost per barrel of oil as the water cut grows

Given (assumed data)

Liquid rate of the well: 400 bbl/d (about 64 m³/d), constant: the pump limits it
Costs proportional to the liquid: $1.5 per barrel of liquid: energy for lifting, separation, and preparation and injection of water
Fixed costs of the well: US$0.1 million a year
Price after royalty: $45/bbl ($50/bbl less a royalty of 10%)

Solution

Liquid in a year: $400\cdot365 = 146{,}000$ bbl. The cost per barrel of liquid is $1.5 + 100{,}000/146{,}000 = 2.1849$ dollars.
Per barrel of oil: at a water cut of 50%, $2.1849/0.5 = 4.37$ dollars. At 80%, $2.1849/0.2 = 10.92$ . At 90% it is 21.85, and at 95% it is 43.70 dollars.
The well stops covering its costs when the cost per barrel of oil reaches the price after royalty: $1 - 2.1849/45 = 0.951$ . That is at a water cut of about 95.1%.

Answer: As the water cut grows from 50 to 95%, the cost per barrel of oil grows tenfold, from 4.37 to 43.70 dollars. The limit is about 95.1% of water in the product.

What it means. At the late stage, the main way to cut the cost per barrel is not saving on staff but producing less water: sealing off the flooded intervals, shutting down or converting the wettest wells, and stopping unnecessary injection. The assumption of a constant liquid rate is a simplification: when the pump or the regime changes, both the volume of liquid and the costs change. The data in this example are assumed for illustration.

CalculatedCost per barrel of oil of an assumed well against the water cut, at a constant liquid rate of 400 bbl/d. The dashed line is the price after royalty, $45/bbl. The curve crosses it at about 95.1% of water.

Capital expenditure per barrel of reserves and per barrel of daily production

The capital expenditure per barrel is the capital expenditure on development divided by the recoverable reserves. Without discounting, for the example project, it is $160/12 = 13.3$ $/bbl (with abandonment, 14.3). The indicator is convenient for checking a cost estimate: if it is half as high for similar fields of the region, the estimate is worth checking again. But the investment is made in the first years and the barrels are produced later, so the levelised value is higher. At 10% it is $PV_C/Q_\text{disc} = 148.3/7.899 = 18.8$ $/bbl.

At the level of a company, a similar indicator is the finding and development cost (F&D): all the costs of exploration, appraisal and development in a period, divided by the additions to reserves in the same period. Money and reserves match badly in time here. A discovery is put on the balance sheet years after the costs, and reserves are revised. So the indicator is averaged over several years, and it is compared only between companies with the same method.

The second kind of capital indicator is capital intensity: the capital expenditure per barrel of daily production, in dollars per 1 bbl/d. It is used to compare facilities of different size: a treatment plant, a pipeline, a whole field. But the “daily production” of a field is not one number. The rate rises, holds on a plateau (a period of steady, maximum output) and falls.

Worked exampleCapital intensity of the example project

Given (assumed data)

Capital expenditure: 50, 90 and 20 million dollars in years 1–3, 160 million dollars in all
Production: a plateau of 2.4 million bbl a year; 12 million bbl over 7 years of production
Rate: 10% (real)

Solution

By the plateau: 2.4 million bbl a year is 6575 bbl/d. $160\cdot10^{6}/6575$ is 24.3 thousand dollars per 1 bbl/d.
By the average over the years of production: $12/7 = 1.714$ million bbl a year is 4697 bbl/d. That is 34.1 thousand dollars per 1 bbl/d.
By the level-equivalent production (level-equivalent production, the level production with the same discounted value as the real profile): 4890 bbl/d, which is 32.7 thousand dollars per 1 bbl/d.
With the value of money during construction taken into account, the investment moved to the middle of year 3 (moving sums in time): $50\cdot1.1^{2} + 90\cdot1.1 + 20 = 179.5$ million dollars. By the plateau, this is 27.3 thousand dollars per 1 bbl/d.

Answer: The same investment gives from 24.3 to 34.1 thousand dollars per barrel of daily production, depending on the production rate chosen and on whether time is taken into account.

What it means. Capital intensity says nothing about the length of production. A field that holds a plateau for three years and a field with a plateau of ten years can have the same capital cost per barrel of daily production. But in the second, every dollar invested is repaid by a much larger volume of oil. So the indicator suits comparing facilities of one type and one service life. For fields, we add the cost per barrel of reserves. The data in this example are assumed for illustration.

Technical cost per barrel: undiscounted and levelised

The technical cost per barrel (the unit technical cost, UTC) is all the costs of creating and running a field, that is, the capital and operating costs and abandonment, divided by the production over its life. Payments to the state are not included, so the indicator describes the project itself, not the tax regime. Without discounting, for the example project, it is $(160 + 102 + 12)/12 = 22.8$ $/bbl. This number answers the question “how much money was spent on each barrel”. But it does not take into account that the money is spent before the barrels are sold.

Time can be taken into account only by discounting both the costs and the production at one rate. This gives the levelised cost per barrel (in the power industry, the levelised cost of electricity is built in the same way). It is the constant price at which the discounted revenue equals the discounted costs. Why the denominator contains the discounted production is explained in the lesson Annuities and discounted production: at a constant price, the discounted revenue equals the price multiplied by the discounted production $Q_\text{disc}$ .

Levelised technical cost per barrel

c = \frac{\sum_t (C_t + O_t + A_t)\,(1+i)^{-t}}{\sum_t Q_t\,(1+i)^{-t}} = \frac{PV_C + PV_O + PV_A}{Q_\text{disc}}

where:

$c$ levelised technical cost per barrel, $/bbl
$C_t,\ O_t,\ A_t$ capital expenditure, operating expenditure and abandonment of the year that is $t$ years from the origin, US$ million
$Q_t$ production (sales) of the same year, million bbl
$PV_C,\ PV_O,\ PV_A$ present values of these costs, US$ million
$Q_\text{disc}$ discounted production, million bbl
$i$ discount rate, fraction per year

Units: US$ million divided by million bbl gives $/bbl; the rate is a fraction per year

Holds when

The costs and the production are discounted at one rate, from one origin and by one convention for the moment of the flows.
The calculation is in constant prices with a real rate, and $c$ is a constant real price. A nominal calculation is covered in the advanced section.
Payments to the state are not included: these are costs before tax.

$c$ is the price at which the project, before tax, returns all the costs together with a return $i$ . At $i = 0$ we get the undiscounted cost per barrel. $c$ does not depend on the origin, because moving the origin multiplies the numerator and the denominator by the same factor. But it depends strongly on the rate.

Value of a project through the levelised margin per barrel

\mathrm{NPV}_\text{pre-tax} = P\,Q_\text{disc} - (PV_C + PV_O + PV_A) = (P - c)\,Q_\text{disc}

where:

$\mathrm{NPV}_\text{pre-tax}$ NPV of the project without payments to the state, at the rate $i$ , US$ million
$P$ price at the field, constant in all years, $/bbl
$c$ levelised technical cost per barrel, $/bbl
$Q_\text{disc}$ discounted production, million bbl

Units: US$ million; prices in $/bbl, $Q_\text{disc}$ in million bbl

Holds when

The price is constant in the money of the calculation. All quantities are at one rate and with one origin.
There are no taxes. With taxes, the role of $c$ is played by the break-even price (the next section), and the slope of the NPV against the price is reduced by the share of the royalty and the tax.

The value of a project is the levelised margin per barrel multiplied by the discounted production. This shows that the cost per barrel is only half of the answer: a project with a lower cost per barrel but small production can be worth less than a big project with a higher cost per barrel.

Worked exampleTechnical cost of the example project

Given (assumed data)

Costs: capital: 50, 90 and 20 million dollars in years 1–3; operating: US$6 million a year plus $5/bbl; abandonment: US$12 million in year 10
Production: 12 million bbl in years 3–9
Rate and convention: 10% (real); middle of year 1, flows in the middle of the year
Price: $50/bbl

Solution

Without discounting: capital $160/12 = 13.33$ , operating $102/12 = 8.50$ , abandonment $12/12 = 1.00$ . In all, 22.83 $/bbl.
Present values at 10%: $PV_C = 148.35$ , $PV_O = 66.05$ , $PV_A = 5.09$ million dollars. $Q_\text{disc} = 7.8987$ million bbl.
Levelised cost per barrel: capital $148.35/7.8987 = 18.8$ , operating 8.4, abandonment 0.6. In all, $c = 27.8$ $/bbl.
NPV before tax at $50/bbl: $(50 - 27.8)\cdot 7.8987 \approx 175$ million dollars. The same directly: $50\cdot 7.8987 - (148.35 + 66.05 + 5.09)$ $\approx 175$ million dollars.

Answer: The technical cost of the project is 22.83 $/bbl without discounting and 27.8 $/bbl at 10%. At a price of $50/bbl, the project is worth about 175 million dollars before tax.

What it means. Discounting raised the cost per barrel by 22%, almost entirely through the capital part: the investment is made in the first years, and the barrels are produced in years 3–9. The operating cost per barrel hardly changes with discounting, because it comes together with the barrels. The data in this example are assumed for illustration.

Technical cost per barrel of the project at different rates, $/bbl

Rate: 0%
Capital: 13.3
Operating: 8.5
Total with abandonment: 22.8

Rate: 5%
Capital: 15.9
Operating: 8.4
Total with abandonment: 25.2

Rate: 10%
Capital: 18.8
Operating: 8.4
Total with abandonment: 27.8

Rate: 15%
Capital: 21.9
Operating: 8.3
Total with abandonment: 30.7

Rate: 20%
Capital: 25.2
Operating: 8.3
Total with abandonment: 33.9

Rate	Capital	Operating	Total with abandonment
0%	13.3	8.5	22.8
5%	15.9	8.4	25.2
10%	18.8	8.4	27.8
15%	21.9	8.3	30.7
20%	25.2	8.3	33.9

A rate of 0% means undiscounted costs. The origin is the middle of year 1, with flows in the middle of the year. The numbers do not depend on the choice of the origin. The data in this example are assumed for illustration.

CalculatedTechnical cost per barrel of the example project, and its capital and operating parts, against the discount rate. As the rate grows, almost only the capital part grows.

“Reduced costs” in the Soviet method

In Soviet practice, when options for capital investment were compared, the name “reduced costs” was given to a different quantity: the yearly sum $C + E_\text{n}K$ . Here $C$ is the running cost of a year, $K$ is the capital investment, and $E_\text{n}$ is the standard efficiency coefficient (the yearly return per unit of investment that the planning rules required). So the sum turns investment into a yearly charge. But by itself it does not take into account the service life, or the distribution of costs and production in time. The levelised cost per barrel in this lesson is a different quantity: the discounted costs divided by the discounted production. When you meet the term “reduced costs” in an old project document, check which of the two quantities is meant.

From the technical cost to the break-even price

The technical cost is the price at which the project pays back before tax. But the state takes its share: a royalty on every barrel and an income tax. The price at which the NPV after all payments is zero is the break-even price (break-even values). For the example project at 10% it is 32.4 $/bbl. We can get it from the same discounted sums and split it into items per barrel.

Break-even price from the levelised costs

P^{*} = \frac{PV_C + PV_A + (1 - T)\,PV_O - T\,PV_D}{(1 - r)(1 - T)\,Q_\text{disc}}

where:

$P^{*}$ break-even price: the NPV at the rate $i$ is zero, $/bbl
$PV_C,\ PV_O,\ PV_A$ levelised capital expenditure, operating expenditure and abandonment, US$ million
$PV_D$ discounted depreciation for tax of the capital expenditure, US$ million
$r$ share of revenue that goes to the royalty, fraction
$T$ income tax rate, fraction
$Q_\text{disc}$ discounted production, million bbl

Units: all the discounted sums are at one rate $i$ and from one origin; $r$ and $T$ are fractions

Holds when

The royalty is a constant share of revenue, the income tax is a constant share of profit, and at the price $P^{*}$ the profit is positive in every year of production. Otherwise the price is found by trial in the model.
The capital expenditure reduces the tax through depreciation, the operating expenditure reduces it in the year it is paid, and abandonment does not reduce the tax, as in the assumed regime of the examples.
All sums are in constant prices at a real rate.

The numerator is the discounted costs after tax deductions, and the denominator is the discounted production after the royalty and the tax. The formula is equivalent to the one through the slope of the NPV against the price in the lesson on sensitivity. But it shows what the price consists of: at $P^{*}$ , each discounted barrel covers the capital and operating costs, abandonment, the royalty $rP^{*}$ and the income tax.

Worked exampleWhat the break-even price of the project consists of

Given (assumed data)

Discounted sums at 10%: $PV_C = 148.35$ , $PV_O = 66.05$ , $PV_A = 5.09$ , $PV_D = 110.28$ million dollars; $Q_\text{disc} = 7.8987$ million bbl
Payments to the state: royalty 10% of revenue, income tax 20%; depreciation is US$32 million a year in years 3–7

Solution

Numerator: $148.35 + 5.09 + 0.8\cdot66.05 - 0.2\cdot110.28$ $= 184.22$ million dollars.
Denominator: $0.9\cdot0.8\cdot7.8987 = 5.6871$ million bbl. $P^{*} = 184.22/5.6871 = 32.39$ $/bbl. Finding the price by trial in the project model gives the same result: 32.39 $/bbl.
Per discounted barrel: capital cost 18.8, operating cost 8.4 and abandonment 0.6 dollars, which together make 27.8 dollars of technical cost. The royalty is $0.1\cdot32.39 = 3.2$ dollars.
Income tax per discounted barrel: $0.2\cdot(0.9\cdot32.39 - 8.36 - 13.96) = 1.4$ dollars, where 8.36 is the operating cost and $110.28/7.8987 = 13.96$ is the depreciation per barrel.
The sum: $27.8 + 3.2 + 1.4 = 32.4$ $/bbl. At this price the profit is positive in all the years of production, with the smallest, 0.65 million dollars, in years 3 and 7. So the formula applies.

Answer: The break-even price of 32.39 $/bbl consists of 18.8 dollars of capital cost, 8.4 of operating cost, 0.6 of abandonment, 3.2 of royalty and 1.4 of income tax for every discounted barrel.

What it means. The split shows what the price works for: almost 60% pays back the investment with a 10% return, a quarter pays for operation, and about 14% goes to the state. The income tax at the break-even price is small, because the profit itself is small. At a price of $50/bbl, the share of the state would be noticeably larger (payments to the state in the model). The data in this example are assumed for illustration.

CalculatedThe break-even price of the example project by item, per discounted barrel (rate 10%). The technical cost is $27.8. With the royalty and the income tax it is $32.4. With exploration, appraisal and overheads it is $37.1 (this step includes the taxes that the higher price brings). The dashed line is the price of $50/bbl.

The same technical cost, different break-even prices

Royalty: 0%
Income tax: 0%
Break-even price, $/bbl: 27.8

Royalty: 10%
Income tax: 20%
Break-even price, $/bbl: 32.4

Royalty: 20%
Income tax: 20%
Break-even price, $/bbl: 36.4

Royalty: 10%
Income tax: 40%
Break-even price, $/bbl: 34.9

Royalty	Income tax	Break-even price, $/bbl
0%	0%	27.8
10%	20%	32.4
20%	20%	36.4
10%	40%	34.9

NPV = 0 at 10%, and the price was found by trial in the project model. The other terms are as in the examples. Ten percentage points of royalty raise the break-even price more than twenty points of income tax. The royalty is taken from revenue whatever the profit is, while at the break-even price the profit is small.

Full-cycle cost and sunk costs

The technical cost and the break-even price above belong to the decision to develop. By then exploration and appraisal have already been paid for, so for this decision they are sunk costs (costs already spent that cannot be recovered; which flows belong to the project). To find out whether the whole enterprise pays for itself, from the seismic survey (mapping the rock layers with sound waves) to abandonment, we calculate the full-cycle cost. We add the costs of exploration and appraisal, including the failed wells of the programme, and the overheads of the company that belong to the project. A calculation from the current point (point-forward; for the moment of the decision to develop it is also called half-cycle) includes only what is still to come (what belongs to the decision).

Worked exampleThe full cycle of the example project

Given (assumed data)

Exploration and appraisal: a seismic survey, an exploration well and an appraisal well: US$24 million, a year before year 1 of the project
Overheads of the company charged to the project: US$1 million in each year of production
Tax: the exploration costs are depreciated like capital costs from the start of production; overheads are deducted in the year they are paid
The rest: as in the examples above; rate 10%, origin in the middle of year 1

Solution

Exploration and appraisal moved to the middle of year 1: $24\cdot1.1 = 26.4$ million dollars. Per discounted barrel it is $26.4/7.899 = 3.34$ dollars.
Overheads: $1\cdot\sum_{t=2}^{8} 1.1^{-t} = 4.43$ million dollars, or 0.56 dollars a barrel.
Full-cycle technical cost before tax: $27.79 + 3.34 + 0.56 = 31.69$ $/bbl.
The full-cycle break-even price, found by trial in the project model with taxes, is 37.1 $/bbl, against 32.4 for the decision to develop.

Answer: The full cycle needs a price of 37.1 $/bbl. This is 4.7 dollars more than for the decision to develop a field that has already been discovered.

What it means. Both numbers are right, and they answer different questions. If the price stays near $35/bbl, developing a field that has already been discovered pays, but looking for a new field of the same size and with the same costs does not. So we look at the full cycle when we decide where and how much to explore. We use the calculation from the current point when we decide the fate of a particular discovery. The data in this example are assumed for illustration.

The further a project has advanced, the more of its costs have become sunk, and the lower the price at which it is worth continuing.

Break-even price of the example project at different moments

Moment of the decision: Before exploration starts (full cycle)
What is still ahead: exploration and appraisal, development, operation, overheads, abandonment, taxes
Price, $/bbl: 37.1

Moment of the decision: Decision to develop
What is still ahead: capital and operating costs, abandonment, taxes
Price, $/bbl: 32.4

Moment of the decision: Start of production, the investment is made or already committed
What is still ahead: operating costs, abandonment, royalty; the tax is reduced by the deductions for the investment already made
Price, $/bbl: 10.0

Moment of the decision: The last year of production
What is still ahead: operating costs and royalty of this year
Price, $/bbl: 13.9

Moment of the decision	What is still ahead	Price, $/bbl
Before exploration starts (full cycle)	exploration and appraisal, development, operation, overheads, abandonment, taxes	37.1
Decision to develop	capital and operating costs, abandonment, taxes	32.4
Start of production, the investment is made or already committed	operating costs, abandonment, royalty; the tax is reduced by the deductions for the investment already made	10.0
The last year of production	operating costs and royalty of this year	13.9

The first three rows are NPV = 0 at 10% for the flows that are still ahead (the third row takes the flows from year 3 without capital expenditure, which can no longer be avoided). The last row is a zero cash flow in year 9 (three break-even prices). The price of the last year is higher than that of the whole working field: in year 9 the production is small, and the fixed costs fall on few barrels.

Comparing projects: where cost per barrel helps and where it misleads

Cost per barrel answers well the question “will the project withstand a low price?”, and badly the question “which project is better?”. We show this on two assumed projects.

Worked exampleA long project A and a short project B

Given (assumed data)

Project A: US$100 million now; 2 million bbl at the end of each of 10 years; operating costs $4/bbl
Project B: US$50 million now; 4 million bbl at the end of each of 3 years; operating costs $6/bbl
Terms: rate 10% (real), constant price, no taxes

Solution

Without discounting: A is $(100 + 4\cdot20)/20 = 9.00$ , and B is $(50 + 6\cdot12)/12 = 10.17$ $/bbl. A looks cheaper.
Discounted production: A is $2\cdot a_{10}(10\,\%) = 2\cdot6.1446 = 12.289$ , and B is $4\cdot a_3(10\,\%) = 4\cdot2.4869 = 9.947$ million bbl (the annuity factor).
Levelised costs: A is $100/12.289 + 4 = 12.14$ , and B is $50/9.947 + 6 = 11.03$ $/bbl. Now B is cheaper, because its barrels come earlier.
NPV at a price of $20/bbl: A is $(20 - 4)\cdot12.289 - 100 = 96.6$ , and B is $(20 - 6)\cdot9.947 - 50 = 89.3$ million dollars. At $15/bbl, A is 35.2 and B is 39.5 million dollars.
The NPVs of the projects are equal at a price of 16.9 $/bbl. Above it, A creates more value, and below it, B does.

Answer: By levelised cost, B is cheaper (11.03 against 12.14 $/bbl), but at a price above 16.9 $/bbl A creates more value.

What it means. The undiscounted costs put the projects in the wrong order. The levelised costs put them in the right order of safety margin: B withstands a lower price. But which project is better is decided by the NPV, the margin per barrel multiplied by the discounted production, and A has more barrels. If money is limited, it also matters how much value each invested dollar gives (the decision rule and the NPV index): B needs half the investment. The data in this example are assumed for illustration.

Sunk costs. A full-cycle cost above the price does not yet mean that the field should be closed. What decides is what is still ahead (the table above).
Scale. The fixed costs per barrel fall as production grows, so, other things being equal, big fields are “cheaper”. This is a real advantage, but the margin and the volume together set the value of a project, not the margin alone.
Tax terms. The technical cost does not depend on the regime, but the break-even price does (the table above). Projects in different countries or under different contracts are compared by the technical cost. But to compare the price that they can withstand, we must include the payments to the state (Petroleum fiscal systems and taxation).
The value of the product. Costs are compared with the price at the field, the netback after transport and the discount for quality, not with the price of the benchmark grade. A barrel of heavy oil with an expensive route to the market can cost less and still earn less. Gas converted into oil equivalent lowers the cost per barrel of equivalent, but it does not raise the price of gas.
Average and incremental. The average cost of a field is not the cost of an additional barrel. For an infill well (an extra well between existing ones) or an acceleration project (one that produces the oil sooner), part of the “new” barrels is oil that would have been produced anyway, only later (Acceleration projects and incremental analysis).
Real and nominal money. Costs of different years in nominal money are not comparable. The levelised cost of a nominal calculation is a constant nominal price, and it cannot be compared with a price forecast in constant prices (see the advanced section).

Terms and symbols

Lifting cost: The operating expenditure of a year divided by the production of the same year. It leaves out taxes, depreciation and, as a rule, transport to the market.
Capital expenditure per barrel: The capital expenditure on development divided by the recoverable reserves. It can be undiscounted or levelised.
Finding and development cost (F&D): The costs of exploration, appraisal and development in a period divided by the additions to reserves in the same period. It is an indicator of a company.
Capital intensity: The capital expenditure per barrel of daily production. It depends on which rate is taken: the plateau, the average or the equivalent.
Technical cost: The capital and operating costs and abandonment per barrel of production over the life of the project. Payments to the state are not included.
Levelised cost per barrel $c$: The discounted costs divided by the discounted production. It is the constant price at which the project earns exactly the discount rate.
Full-cycle cost: The cost including exploration and appraisal, overheads and taxes. Its opposite is the calculation from the current point, without the costs already made.
Break-even price $P^{*}$: The price at which the NPV at the given rate is zero. It equals the technical cost plus the payments to the state per barrel at this price.

Common mistakes and misconceptions

Wrong

“The average lifting cost over the life is the average of the yearly values.”

In fact

The average of the yearly values gives the small years the same weight as the plateau years. The right way is the sum of the costs divided by the sum of the production. In the example project it is 8.5 $/bbl, not 9.0.

Wrong

“Levelised cost per barrel: discount the costs and divide by the reserves.”

In fact

Then the late costs are reduced and the late barrels are not, and the result is too low: 18.3 instead of 27.8 $/bbl in the example project. The costs and the production are discounted at one rate.

Wrong

“The technical cost is $28/bbl at a price of $50, so the project has a huge margin.”

In fact

Add the payments to the state (the break-even price is $32.4/bbl). For a decision on exploration, add also the costs of exploration and the overheads ($37.1/bbl). And even then the safety margin is not value: value is shown by the NPV.

Wrong

“The project with the lower cost per barrel is better.”

In fact

It withstands a low price better, but value equals the margin per barrel multiplied by the discounted production. In the example of the lesson, the project with the higher cost per barrel creates more value at a price above $16.9/bbl, because it has more barrels.

Wrong

“The full cost is above the price, so it is time to close the field.”

In fact

The costs of exploration and construction have already been made and do not depend on the decision. It pays to go on producing as long as the price covers what is still ahead. In the example project, after the end of the investment, this is $10.0/bbl, not $37.1/bbl.

In depth: advanced detail

Where the break-even formula comes from, and why a capital dollar costs more

As long as the profit is positive every year, the net cash flow of a year has four parts. The first is the revenue less the royalty and the tax: $(1 - r)(1 - T)\,P\,Q_t$ . From it we subtract the capital expenditure and abandonment. We also subtract the operating expenditure reduced by the tax deduction, $(1 - T)\,O_t$ . Last, we add the tax saved by depreciation, $T\,D_t$ . Discount by year and set the NPV to zero, and we get the formula of the section. In words: the discounted production after the royalty and the tax, multiplied by $P^{*}$ , equals the discounted costs after the tax deductions.

From this we see what a dollar of each item really costs the project. A dollar of operating expenditure costs $1 - T = 0.8$ dollars: a fifth is returned by the tax of the same year. A capital dollar returns tax through depreciation, which comes later and is worth less in discounted money. In the example project, $T\,PV_D/PV_C = 0.2\cdot110.28/148.35 = 0.149$ , so a capital dollar costs 0.85 dollars (where the slopes come from). Abandonment does not reduce the tax in the assumed regime, and it costs a full dollar.

If at the price $P^{*}$ the profit is negative in some year, the tax of that year is zero, the loss is carried forward to the following years, and the NPV no longer changes in a straight line with the price. Then the formula gives a wrong answer, and the break-even price is found by trial in the model. In the example project, the profit at $P^{*}$ is positive in all the years of production, although in years 3 and 7 it is only 0.65 million dollars.

Levelised cost in nominal money

If the model is built in nominal money, the levelised cost is calculated at the nominal rate, and the result is a constant nominal price. With inflation its purchasing power falls, so the nominal levelised cost is always higher than the real one. It can be compared only with a nominal price, for example the price of a contract without indexation (the consistency of the flow and the rate).

Worked exampleThe same costs at inflation of 5% a year

Given (assumed data)

Project: from the examples; all the costs grow with general inflation from the prices of year 1, production is as before
Inflation: 5% a year
Rate: 10% real, that is $1.10\cdot1.05 - 1 = 15.5$ % nominal

Solution

The nominal costs, discounted at the nominal rate, give the same sum as the costs in constant prices at the real rate: 219.48 million dollars.
The production, discounted at the nominal rate of 15.5%, is 6.4428 million bbl, against 7.8987 at the real rate.
The levelised cost in nominal money is $219.48/6.4428 = 34.07$ $/bbl. In constant prices it is 27.8 $/bbl.
A constant nominal 34.07 dollars is, in the prices of year 1, $34.07/1.05^{2} = 30.90$ dollars in year 3 and $34.07/1.05^{8} = 23.06$ dollars in year 9.

Answer: At inflation of 5% a year, the levelised cost in nominal money is 34.07 $/bbl, and in constant prices it is 27.8. These are different quantities, not different estimates.

What it means. A constant real price of 27.8 dollars, and a real price that falls from 30.90 to 23.06 dollars, bring the project the same present value of revenue. An error arises when the nominal 34.07 $/bbl is compared with a forecast in constant prices, and the project seems worse. Or the real 27.8 is compared with a fixed nominal price of a contract, and the project seems better. Taxes in a nominal calculation behave differently (where inflation is not neutral). So the break-even price after tax is found by recalculating the whole model. The data in this example are assumed for illustration.

Connections to other topics

Annuities and discounted production — why the discounted production stands in the denominator of the levelised cost.
Cash flow model of an oil and gas project — the lifting cost by year, the economic limit, leasing of facilities and payments to the state in the model.
Project cash flow — capital and operating costs, sunk costs and the incremental principle.
Net present value (NPV) — the value of a project, on which the decision is made, and the NPV index.
Sensitivity analysis and scenarios — the break-even price as a safety margin, and its dependence on other assumptions.
Inflation: nominal and real money — constant prices and nominal money, matching the rate to the money of the calculation.
Choosing the discount rate — which rate the levelised cost and the break-even price depend on.
Drilling time and cost — the cost per metre drilled and of a well: the unit costs of drilling.
Annual capital charge — equal yearly charges for capital instead of one-off investments.

Check yourself

1
In a year, a field produced 4.5 million bbl of oil at an operating expenditure of 36 million dollars. What is the lifting cost per barrel and per tonne, at an oil density of 0.86 t/m³?
1. A.$8.0/bbl, about $1.1/t
2. B.$8.0/bbl, about $6.9/t
3. C.$8.0/bbl, about $58.5/t
4. D.$0.125/bbl, about $0.9/t
Show the answer
Correct answer: C. $8.0/bbl, about $58.5/t
$36/4.5 = 8.0$ $/bbl. A tonne contains $6.2898/0.86 = 7.31$ barrels, so per tonne it is $8.0\cdot 7.31 \approx 58.5$ dollars. The 1.1 comes from dividing by the number of barrels in a tonne instead of multiplying. The 6.9 comes from multiplying by the density. The 0.125 comes from dividing the production by the cost.
2
A project in constant prices: an investment of 80 million dollars now, then 2 million bbl at the end of each of 8 years, at an operating expenditure of $6/bbl. What is the levelised technical cost per barrel at a real rate of 12%?
1. A.$14.1/bbl
2. B.$17.7/bbl
3. C.$8.7/bbl
4. D.$11.0/bbl
Show the answer
Correct answer: A. $14.1/bbl
$Q_\text{disc} = 2\cdot a_8(12\,\%) = 2\cdot 4.9676 = 9.935$ million bbl. $c = 80/9.935 + 6 = 14.1$ $/bbl. The 11.0 is the cost without discounting, $(80 + 96)/16$ . The 8.7 is the discounted costs divided by the undiscounted 16 million bbl. The 17.7 is the undiscounted costs divided by the discounted production.
3
Why do levelised costs per barrel not depend on the choice of the origin, while the NPV does?
Show the answer
Moving the origin by $\Delta$ years multiplies all the discounted quantities by the same factor $(1+i)^{\Delta}$ . The NPV is a difference of discounted sums, and the whole of it is multiplied by this factor. The levelised cost per barrel is the ratio of the discounted costs to the discounted production, so the factor cancels. So it has no “date”, but it has a rate, and it depends on the rate strongly.
4
A field has been developed and is producing. The price has fallen to $25/bbl. The full-cycle break-even price of this project was $37/bbl, and at the decision to develop it was $32/bbl. Should production be stopped?
Show the answer
Not necessarily. The costs of exploration and construction have already been made and do not depend on the decision. So the price must be compared with what is still ahead: operating costs, royalty, taxes and abandonment (taking into account that stopping brings abandonment closer). In the example project, after the end of the investment, it pays to go on producing at a price above $10.0/bbl. A full cost above the price says that the whole enterprise turned out to be unprofitable, and that similar projects should not be started at this price. It does not say that a working field should be closed.
5
The costs proportional to the liquid are $1.2 per barrel of liquid. How will the cost per barrel of oil change if the water cut rises from 75% to 90% at the same liquid rate?
1. A.It will rise by about 15%
2. B.It will fall from $1.6 to $1.3
3. C.It will not change: the cost per barrel of liquid is the same
4. D.It will rise from $4.8 to $12.0
Show the answer
Correct answer: D. It will rise from $4.8 to $12.0
Oil is only the share $1 - 0.75 = 0.25$ of the liquid, and then $0.10$ . The cost per barrel of oil is $1.2/0.25 = 4.8$ and $1.2/0.10 = 12.0$ dollars, which is 2.5 times more. The option “will fall” comes from dividing by the water cut instead of the share of oil ( $1.2/0.75$ and $1.2/0.90$ ). The option “by 15%” comes from carrying the rise of the water cut by 15 points over to the costs.
6
Project A has a levelised cost of $30/bbl and a discounted production of 40 million bbl. Project B has $24/bbl and 15 million bbl. There are no taxes, and the price is constant. Which project creates more value at a price of $45/bbl, and at what price are they equal in value?
Show the answer
The NPV before tax is $(P - c)\,Q_\text{disc}$ . At $45/bbl, A gives $15\cdot40 = 600$ and B gives $21\cdot15 = 315$ million dollars. A creates more, although its barrel is more expensive. The projects are equal when $(P - 30)\cdot40 = (P - 24)\cdot15$ , so $25P = 840$ and $P = 33.6$ $/bbl. Below this price B is better. At a price between $24 and $30/bbl, A makes a loss.

Updated: 16 October 2026