The Harrison Oil Company Limited is a 30% partner in the Edmonton license. There has been a discovery on the license that has proven to be commercial. However, Harrison is heavily committed to the development of another field and does not have the finances to fund the development of this field at the present time. The Operator (Williams) is very keen to proceed with a development as soon as possible and has offered to carry Harrison through the development of the field. Williams will also pay Harrison’s share of any capital expenditure in the first year of production. Harrison will reimburse Williams for the costs paid on their behalf by assigning a percentage of their interest to Williams until the carry has been repaid. The full details of the carry arrangement are as follows;

a. Williams will pay Harrison’s 30% equity share of total development costs.

b. When production from the field starts, Harrison will assign 75% of their equity interest to Williams until the debt has been repaid in full.

c. The amount of the debt repaid shall be the actual realized price of the oil attributable to assigned interest less the average production costs per barrel, calculated on an annual basis. (That is to say, the net profit on the barrels assigned by Harrison to Williams).

d. Any unpaid carried amount at the end of each year after taking the assigned revenue will attract interest at the rate of 6% per annum. A full year’s interest is to be paid at the end of the year on the outstanding balance after offsetting the assigned net revenue. By agreement interest charges will start accruing from the end of year two

e. Williams will pay the production costs directly associated with the assigned barrels.

f. During the period when the carried interest is being repaid, Harrison will retain 25% equity interest in the production from the field and will pay the costs directly associated with this production.

g. When the debt has been repaid in full, Harrison will be entitled to their full equity interest and Williams will have no further claim on Harrison

h. Should the revenues from the field fail to be sufficient for the repayment of monies paid by Williams on behalf of Harrison, then Williams will have no claim against Harrison for any balance that may be outstanding.

Required: From the following information on expenditures, productions and oil prices:

1. Calculate when the carry will have been repaid and; 

2. Harrison’s net cash flow in the years 1 to 8

3. Harrison’s bankers have approached the Company to finance its share of the development and production costs at an annual interest rate of 5.5% for the same 75% revenue to be assigned until the debt is fully paid. Assume all annual development and production cost are to be paid in advance at the beginning of January. Interest will start accruing at the end of first year. As a Finance Director for Harrison, would you advise the Company to opt for the bank financing? What will be the gain or loss if the Company opts for the bank financing instead of being carried by Wilson? 

 

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All figures are in thousands, except for oil price. Year Operating Costs (S'000) 1 2 34567 8 Capital Expenditure (S'000) 550,000 520,000 570,000 480,000 95,000 97,000 104,000 115,000 99,000 Production Mmbbls (000) 33,000 35,000 39,000 44,000 41,000 Oil Price 45 47 49 46 42 All figures are in thousands, except for oil price. Year Operating Costs (S'000) 1 2 34567 8 Capital Expenditure (S'000) 550,000 520,000 570,000 480,000 95,000 97,000 104,000 115,000 99,000 Production Mmbbls (000) 33,000 35,000 39,000 44,000 41,000 Oil Price 45 47 49 46 42

Answer rating: 100% (QA)

1 Calculate when the carry will have been repaid The carry will be repaid when the total debt incurred by Williams on behalf of Harrison has been repaid in full This debt will be the total development ... View the full answer