Methodology and general assumptions

• On a standalone basis, 1 mmscf/d flares do not offer attractive financial returns but can be clustered to reach an aggregate project size closer to 5–10 mmscf/d.

• FMR projects at 5–10 mmscf/d flare sites (unique flares or clusters) involve a capital investment estimated in the range of US$7 million to US$59 million, depending on the FMR solution adopted and according to the model’s assumptions.

It must be emphasized that the financial models proposed in this chapter do not reflect each and every factor that may affect FMR returns. Such factors include implementation delays and cost overruns; complex negotiations with the oil producer and the off-taker; the competitive situation in local power or gas offtake markets; the volatility of end-product prices (power, gas, CNG, LNG) over the project period and availability of hedging tools; complications arising from the location of flare sites and the distance from end-product markets; and any local regulations creating additional compliance costs.

METHODOLOGY AND GENERAL ASSUMPTIONS

Base case assumptions are derived from publicly available information, complemented by interviews. Because of the varying conditions of each region and circumstances in which potential FMR projects occur, base case assumptions can only be indicative, and the same applies as a result to NPVs and IRRs. Appendix B includes a full print-out of the financial model. This section discusses general assumptions applicable to all solutions modeled. Additional solution-specific assumptions are discussed in the following sections.

Sensitivity analyses are provided to identify the parameters that have the greatest impact on project returns. For each FMR solution presented in this chapter, sensitivity of NPV and IRR to a range of variables is analyzed. In addition to highlighting financial risks to prospective FMR developers, the analysis also helps validate the robustness of conclusions emerging from the financial modeling exercise. In several FMR solutions, for instance, base case assumptions point to negative returns for projects taking place at small flare sites (1 mmscf/d).

The analysis in this chapter assumes that FMR projects are developed by a third-party project developer (see chapter 2), not the operator of the oil production facility, and that the developer aims to maximize the project’s unlevered, pretax net NPV and IRR. It is assumed that developers finance FMR projects entirely through equity. This practice is often, but not always, the case because many FMR projects do not meet contractual project finance criteria—for instance, they may not have guaranteed feedstock supply agreements in place. In addition, tight development lines may limit the window of opportunity to contractually arrange a debt package. In some cases, however, depending on the project cashflow profile and available sources of debt in the project country, it is possible that FMR projects can be levered.

The financial model assumes zero inflation and no impact of exchange rate changes. NPV calculations are based on a 10 percent real discount rate, indicated by several industry participants as the floor equity return required considering FMR project-specific and macroeconomic risks. General assumptions are summarized in table 3.1 at the end of this section.