Case

Liquid Energy

Solved 4.9k times
3.9 5 80

Problem Definition

Liquid Energy, an Oil & Gas company, is evaluating the purchase of one of three oil fields in Latin America. After purchasing the rights to extract oil from one of these fields, Liquid Energy will outsource the drilling activity. You have been brought in to identify the best investment for Liquid Energy.

How would you evaluate the three oil fields, and which oil field should Liquid Energy purchase?


Comments

Main steps the interviewee should take:

  • Identify days it takes to drill one well in each region, using the depth and penetration rate provided.
  • After this, he/she should be able to quantify the cost associated with drilling one well.
  • The price and barrels extracted by day will allow the interviewee to estimate the total revenue and profit by well. It is essential to consider that in year 1 you can produce different numbers of wells in each region, and that you have limited amount of rigs.
  • After achieving the calculations, the interviewee should consider other factors, risks that could affect the decision investment such as political risks, labor costs, difference in oil quality, insurance costs, future oil prices.

Short Solution (Expand)


Detailed Solution

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

I. Background

The following structure would be a good approach:

First the interviewee should try to understand how to evaluate and decide which region would be the best fitting later on.

Information that can be shared if inquired:

  • The rights being offered to Liquid Energy give them the right to drill for 1 year, and produce oil for 20 years.
    Assume that no oil is produced until the beginning of year 2.
  • Liquid Energy can get the drilling operator to deploy a maximum of 10 rigs in each of the regions.
  • The cost of the rig day includes crew, consumables and services.
  • Any amount of oil being extracted will be sold at the spot market price of the moment.
  • For simplicity assume that the oil wells will produce the same amount of oil for the next 20 years with no maintenance costs.
  • The rights to extract oil cost $40 m annually in each region.

II. Profitability

Here the interviewee should evaluate which region is most profitable.

What are the profits during the first production year?

The answer will be a function of the investment, variable costs, and quantity of oil extracted by field. This last variable will depend on the number of wells drilled in one year.

Share Diagram 2 & 3 with an overview if inquired by the interviewee.

This should give the interviewee enough information to identify the number of wells and the amount of total oil that could be extracted from each field, as well as the yearly production per well.

Information that can be shared if inquired:

  • Spot price = $50/Barrel

Share Table 1 in order for the interviewee to have all data needed to start calculation.

Following is an overview of the calculations needed to solve the problem:

Time to complete a well

Production per well and year by region

Costs per well

Annual revenue per well

Number of wells per year

Profit margin

Total revenue

Total costs

Profit

= Total revenue - Total costs

Share Table 2 with the solution if the interviewee is finished or is stuck.

The result of these calculations should lead to the conclusions in the last step.

III. Conclusion

The interviewee should conclude and present which option would be the best one:

  • Liquid Energy should invest in buying the rights for Region 2.
  • It is important to recognize that even though the profit margin for Region 1 is significantly higher on a per well basis, the return of the investment depends on the total number of wells that you can drill in the first year and the upfront cost for the rights to extract oil in each region.
  • Additionally, the interviewee should be able to identify other qualitative aspects of the investment that might affect the decision to invest in a certain region.
  • An excellent answer would mention and briefly summarize the impact of including an expected value analysis, which would assign different probabilities of extracting the expected barrels per day

There are also other factors that could impact the decision to invest:

  • Insurance costs
  • Political stability of the region - Labour contracts and unions
  • Volatility of oil prices

Oil quality differences


Difficult Questions

What are other issues that would need to be analyzed by Liquid Energy to fully understand the risk of the investment?

Possible Answer:

There are several “qualitative” issues that need to be considered when deciding to make an investment like this.
The interviewee is expected to mention and analyze the impact of at least two of these:

Insurance costs

Countries have different regulations and might differ on the required insurance coverage that an Oil & Gas company will need to hold. Liability caps could vary by country, affecting the insurance cost.

Political stability of the region

Accessing a well site could become a challenge in politically unstable regions. Other property right risks could also affect the risk being bared by this firm.

Volatility of oil prices

Prices below $27/bbl will make all the regions have a negative return.

Oil Quality

Differences in Oil quality could have an impact on the spot price.

More questions to be added by you, interviewer!

At the end of the case, you will have the opportunity to suggest challenging questions about this case (to be asked for instance if the interviewees solve the case very fast).

Related consulting question(s)
Best answer so far out of 4 answers:
McKinsey / Accenture / Got all BIG3 offers / More than 300 real MBB cases / Harvard Business School

Hi! It depends very much on the industry. In some cases (Growth strategy) I will use a broad structure, in others (e.g. “how to increase the excessive luggage revenues for an Airline”) I will use P... (more)

Best answer so far out of 2 answers:
McKinsey / Accenture / Got all BIG3 offers / More than 300 real MBB cases / Harvard Business School

Hi, 1) You proactively ask in the beginning, even before drawing the structure (something like "What kind of products / revenue sources do we have) and then split the structure into price, qty,... (more)

Best answer so far:
McKinsey Engagement Manager & BCG Consultant | Interviewer at McK & BCG for 7 years | Coached 50+ candidates secure MBB offers

Hi Kay, this is indeed one of the fundamental things that you need to learn in order to rigorously disaggregate the value drivers of a business. The driver tree allows you to identify the numerical d... (more)

Hi Elisey, I would personally not recommend to use a single framework for all the so-called business situations (M&A, Entry, New product, Operations etc). Although this would help to more easil... (more)

Best answer so far out of 4 answers:
Bain & Company London | University of Cambridge | CV/Resume writing | 770 GMAT

Broadly agree with Jonathan. A couple extra suggestions: 1) Subscribe to Finimize: They will send you daily updates with recent business/finance news, and explain what is happening (and why) in Lay... (more)

Related BootCamp article(s)

Profitability Case

Learn to crack Profitability Framework Consulting Cases, which are the number 1 reason for real consulting projects and hence are an important case type.

7 Comment(s)

Growth Strategy

Growth questions are among the most common questions in consulting case interviews: gather the necessary Information about volume and price to find the best growth lever

6 Comment(s)

CAGR - Compounded Annual Growth Rate - CAGR

The Compounded Annual Growth Rate (CAGR) Is a theoretical steady growth rate over a specific amount of time, not the average of the Y-o-Y growth rates. It can mask sub-trends within the period

5 Comment(s)

The Value Chain

The Value Chain - as e.g. by Porter - is a classic framework to structure the activities of a business and add value to products by transforming resources.

3 Comment(s)
3.9 (80 ratings)
3.9 5 80
Case exhibits

Case structure


Drilling rate per region


Average depth of wells by region


Wells are continuously dug for only one year and then oil is extracted going forward. Wells are dug by "rigs".

Once a well has been completed, the rig digs another well.


What are the profits during the first production year? (drilling in 1st year and production during 2nd year)


Calculation matrix


Calculation matrix