Midland Energy Resources

The following short case will give you a good idea of how risks surface in business and project planning and what companies do about it. Consider that you are the Risk Manager as you look at this case, as it will be a good exercise for the time when you will be that Risk Manager!

When implementing project 1, you face technical and market risk. How would you assess the risks embedded in Project 1?

The energy industry is not any different than most commodity-based industries as it faces long periods of boom and bust. Drilling and other service firms are highly dependent on the price and demand for petroleum. These firms are some of the first to feel the effects of increased or decreased spending. If oil prices rise, it takes time for petroleum companies to size up land, setup rigs, take out the oil, transport it and refine it before the oil company sees any profit. On the other hand, oil services and drilling

This report presents information regarding the industry, the primary operator of oil and gas field properties. The industry fuels its key buyers, the Natural Gas Distribution (22121) and the Petroleum Refining (32411) industries, with crude oil and natural gas. The industry continuously battles a shortage of available oil. In addition, many major oil fields have been in use for decades, slowly waning. Currently, the industry grosses among the most profitable in the US despite these and similar obstacles. The benefits of investing here

Without the correct risk adjustment the firms stock will lose value by taking on high risk projects. The firm could also be considered uncompetitive if they reject low cost/low risk projects.

Using the publicly available data, we estimated the weighted average cost of capital of the AMD and Duke Energy. For the AMD, the WACC is 10.83%. For Duck Energy, the WACC is 2.76%

However, investors are becoming increasingly more cautious as the conditions concerning world oil selling prices continue at current levels; potentially creating upward pressure on capitalizations rates as the year progresses. According to this specific Colliers report, Canadian oil producers will be hardest hit, losing around (US) $40 billion in revenues last year, taking a cost on business expenditure and corporate business earnings, with some industry players deciding to cut their growth capital expenditure budgets this

Baker Hughes has a far larger market capitalization than Newpark. Baker Hughes has a higher P/E ratio (22.60) and lower EV/EBITDA (7.88) than Newpark, indicating mixed opinions on whether the firm is over or undervalued from the market’s perspective. However, it does have a higher diluted EPS of 2.88 and ROE of 7.16, which would show inferior performance but superior return to shareholders. Meanwhile, both companies have shown similar trends in their amount of debt carried by decreasing debt. Baker Hughes is not focused on Newpark’s niche mat segment. Baker Hughes’ main source of growth in revenue this past year in the Gulf of Mexico region is its drilling and completion fluids segment, which could be a problem for Newpark. However, these fluids are for both the drilling stage and the completion stage, where all the growth is due to gas, while Newpark only supplies fluids for drilling. Also, Baker Hughes’s growth in the U.S. onshore drilling

Exxon and Chevron are no doubt some of the leading incorporated oil companies on the globe. Exxon Corp. is the second largest oil firm after Royal Dutch Shell, it is respected for getting the biggest revenue return in 2008 which no company in the U.S. have ever reported before. According to Wilson (2009) Chevron has managed to show a lot of profitability in the market despite the decease in its oil production. It graded as one of firms which made a billion dollars profit within a week in the period of July to September 2008. Regardless of profitability trends set by the two oil firms in the U.S. market, they have been facing financial decline like the rest of the companies in other industries. The two firms are like two sailing ships which are taking longer time to sink. In the last few years, the production capacity of Chevron and Exxon has decreased and their listings on the stock market have become weak. The continuation of construction and drilling which requires billions of dollars in expense of oil production might make them experience a bigger financial crisis (Wilson, 2009).

For future cash flows, evaluation is done with WACC rate which consists from cost of equity and cost of debt in a weighted average. In this case, using cost of equity is not appropriate since we doesn’t know cost of debt and weights of equity and debt, it doesn’t reflect the actual rate for WACC.

According to CAPM, which measurement of a project’s risk is relevant? What complications does reality introduce into the CAPM view of risk, and what does that mean for our view of the relevant measure of a project’s risk?

The result for the WACC of the Exploration & Production division is 8.04%. For this calculation we have to compute different variables.

All of these calculated figures can then be used to calculate the WACC which is (17% x 3.47%) + (83% x 11.2%) = 9.87% WACC. This WACC percentage can then be used to value the investment and as a comparative in valuation methods. The full calculation and numerical values are shown in Appendix 1.

As the risk coefficient of the large project is 1.15 and it is known that most projects of Atlantic lie between 0.5 and 0.7 the large project is considered to be a lot more risky compared to the small project which has a risk coefficient of just 0.65.

In order to perform project risk management effectively, the organization or the department must know the meaning of the risk clearly. With regards to a project, the management must focus on the potential effects on the objectives of the project, for example, cost and time (Loosemore, Raftery and Reilly, 2006). Risk is a vulnerability that really matters; it can influence the objectives of the project