An investment analysis of developing a new oil well in the prevailing economic downturn in the petroleum sector of Nigerian economy

Abstract

From 2017 to year 2020 (except for a gradual rise in 2018), the price per barrel of oil has been on the decline, thereby slowing down investment in the petroleum sector of Nigerian economy. This dwindling oil price creates an impelling need to investigate the viability or otherwise of investing in this sector. The net present value (NPV) and internal rate of return (IRR) are two major indicators used to assess the viability of investing in projects. In this paper the two indicators have been used to assess the viability of investing in the oil sector of Nigerian economy. Analysis shows that given the cost of drainage per barrel of oil at US$25, a 40% royalty payment, an overall 10% taxation on profit, and price per barrel of oil at US$40, the net present value of a new oil well will be negative while the cost of capital will be higher than return on investment. However the break-even point occurs at US$42 price per barrel, yielding an internal rate of return equal to cost of capital. The conclusion is that the investment climate of the Nigerian oil sector is currently gloomy. Our analysis also shows that the investment climate can be improved by applying a dynamic royalty system whereby the royalty payable to the Federal Government is reduced when the oil price declines, and increased when the oil price rises.