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©2014 MConsultingPrep, Inc.
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The gas industry is today in the private and public sector and there are a number
of companies competing in the industry. Some of these companies are government
owned. Others are owned by private shareholders who appoint directors to
represent their interest. The directors appoint professional managers to run the
business. Like electricity and telecommunications, gas is a “network industry”. In
the case of gas, consumers are linked to a central network of gas pipelines.
AJ Gasoline Group, one of the leading energy businesses in the UK, is
an integrated business in that it has activities across the whole range of gas
operations, from the reservoir to the customer. Natural gas is delivered to
customers either by AJ Gasoline Group's transmission and distribution (T&D)
business using pipelines or by the liquefied natural gas (LNG) business via LNG
ships.
Demand for gas is projected to grow at an increasing rate over the next decade,
outstripping the growth in demand for other major sources of energy. As an
energy source, gas is a relatively clean fossil fuel, abundant and is increasingly
becoming the fuel of choice for consumers, on both environmental and economic
grounds. AJ Gasoline Group's exploration and production (E&P) business finds
and develops gas reserves.
Governments own the rights to minerals found on land (onshore) and under water
(offshore) in their countries. Governments divide the ground into exploration
“blocks” and invite energy companies to bid for the right to explore for oil and gas
in those blocks. To earn the right to explore a block, the energy company commits
to a work program, which describes the steps it will take in order to find oil/gas.
The energy company's investment and expertise helps governments access the
mineral wealth beneath the ground. AJ Gasoline Group makes important
decisions as to whether or not to apply for the right to explore for new gas fields
and how much to bid.
AJ Gasoline Group's Statement of Business Principles sets out the fundamental
values and ethical principles within which the Company operates. According to
the Chairman of AJ Gasoline Group, before weighing up the risks, ethics are an
integral part of their consideration in whether to make an investment. He believes
that the best investment decisions will not only consider the economic aspect but
also take social and environmental issues into consideration for the greater good.
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1.
Which of the following statements best reflects the thoughts of the Chairman?
A) It is vital that morally correct investment decisions be made, such as whether
these are concerned with environmental, health, safety or other community
issues
B) It is important to emphasize the weight given to non-financial factors involved
in decision making
C) AJ Gasoline Group will only enter countries where the company can operate
in accordance with its Business Principles
D) AJ Gasoline Group applies its Business Principles, in which its ethical
guidelines are also incorporated, in investment decision making only
2.
Which of the following information, if TRUE, is NOT an explanation to the
importance of investment decision making in the gas business?
A) It is so capital intensive that decisions may typically involve the spending of
several hundred million pounds
B) There are long lead times between the start of a project and the receipt of
earnings from that project
C) Economists are in charge of analyzing market demand, price and government
& partner commercial terms
D) The taxation structure is unique and complex to the energy industry
3
Discounted cash flow (DCF) is an important technique for investment decision
making. The discounted cash flow approach is a way of valuing the future returns on
investment by converting them to their today’s value. For example, DCF approach
can estimate how much £1 in hand today is worth more than £1 in the future.
Appraising investments using the discounted cash flow method allows the company
to undertake a capital allocation process, which involves ranking projects and
selecting those that add the most value to the company. It therefore incurs the
opportunity cost of those projects that add value but cannot be financed as sufficient
funds are not available to undertake them.
3.
Which of the following facts, if true, would NOT support the assertion “£1 in hand
today is worth more than a promise of £1 in the future”?
A) Inflation in the future would lower the purchasing power of money today
B) The money cannot be put to constructive use in the meantime
C) There is always the risk that unforeseen circumstances will prevent you from
receiving the amount you have been promised
D) For every pound debited into the bank today, one year later, you will receive
one pound plus the 12% interest
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Ultimately, the value of any investment is the present value of the future cash flows
- Net Present Value (NPV) - that the investment is expected to generate. Therefore,
it is necessary to forecast the economic cash flows and discount them appropriately
to allow for the fact that they will not be received until sometime in the future.
The NPV calculation always assumes the project is a success. However, there is a
chance that no oil or gas is present (which is called “geological risk”). This must
therefore be reflected in the valuation. This is achieved by assigning probabilities to
the values of successful and unsuccessful outcomes. The sum of these risked values
is the Expected Monetary Value (EMV).
Table 1 represents the collective data of an investment portfolio that AJ Gasoline
Group is currently considering.
Table 1
Exploration Well Investment Portfolio, 2014
Project
% of Success:
the exploration
well is drilled and
gas is found there
NPV of Success
(£ million)
% of Failure: the
exploration well
is drilled and gas
is not found there
NPV of Failure
(£ million)
A
B
C
D
E
F
35%
78%
54%
21%
47%
89%
167
71
98
219
53
26
65%
22%
46%
79%
53%
11%
- 15
-9
-24
- 3.5
- 23
-4
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4.
Which of the following statements can be concluded from the data given in Table
1?
A) Of all projects in the portfolio, project F is the least favorable investment
B) In terms of EMV only, if NPV of Success of Project A is 10% higher, it would
be more worthy to put an investment into than Project B
C) In terms of EMV only, AJ Gasoline Group should invest in Project C rather
than Project D
D) The percentage of failure of Project F is very low because the exploration well
lies in the government’s land property
5.
Which of the following types of additional input would be most helpful for the
company to compare the investment potential of these projects?
A) Health and safety standards set for the energy industry in UK
B) Projected cost paid to the mining contractor in each project
C) AJ Gasoline Group’s set of standards in category planning, sourcing and
contract management
D) Anticipatory non-financial barriers from the government in each project
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LNG is liquefied natural gas, a clear, colorless, non-toxic liquid that forms when
natural gas is cooled to -162ºC (-260ºF). This shrinks the volume of the gas 600
times, making it easier to store and ship to energy-hungry towns and cities
overseas. When LNG reaches its destination, it is returned to a gas at regasification
facilities. It is then piped to homes, businesses and industries.
Traditionally, the LNG industry has been based on volumes sold under long-term,
fixed point-to-point agreements. AJ Gasoline Group has developed a different
approach that offers their customers greater accessibility and enhanced security of
supply. They have established market positions in the UK and the US, which can
be supplied by either pipeline gas or LNG, as well as a portfolio of flexible LNG
volumes sourced from North Africa, West Africa and the Caribbean. This
combination allows them to divert their cargoes to markets worldwide to best
match changing global demand conditions. Applying this model allows them to
adopt a portfolio approach to the LNG business.
6.
Which of the following facts, if true, would BEST explain why AJ Gasoline Group
decided to approach their LNG business as a flexible portfolio?
A) Their fleet of around 25 owned and leased LNG carriers will grow as their
supply portfolio increases
B) Latest estimates suggest there are now over 60,000 heavy trucks in China
alone running on LNG
C) As a result of the strong growth in gas demand all over the world, the LNG
trade is expected to grow significantly at an average of 2.4% a year over the
period until 2025
D) They can manage contractual terms such as delivery schedules, optimize
logistics, in particular making their fleet of LNG ships run as efficiently as
possible, and purchase spot cargoes if opportunities are presented.
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Presented below are international regulations on metrics, prices and conversions
in relation to the LNG industry.
7.

Metrics and prices
o LNG capacity, production and demand are measured in mtpa
(million tonnes per annum)
o LNG or natural gas prices are priced in US$/mmbtu (million
British Thermal Units)
o Natural gas reserves are measured in cf (cubic feet) or cm (cubic
metres)

Conversions
o 1 cubic metre = 35.3 cubic feet
o 1 million tonnes of LNG = 1.35 billion cubic metres ≈ 49,240,000
mmbtu
o £ 1 = US$ 1.67
What is the formula to calculate the price (in £) of X billion cubic feet of natural
gas reserves 100% converted into LNG, given that the current price of LNG is Y US
dollars per mmbtu?
A) 618,715.5 * XY
B) 723,126.5 * X/Y
C) 214,674.2 * XY
D) 482,920.7 * X/Y
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8.
Assume that in 2013, the country’s total trade of LNG is 24 mtpa, of which AJ
Gasoline Group’s market share was 35%. How much (in £) did the company make
from LNG sales in 2013, given that the price of LNG was 4.35 US dollars per
mmbtu?
A) £854 million
B) £1,077 million
C) £1,669 million
D) £1,974 million
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In this answer, we occasionally use concepts and terminologies thoroughly explained
at:
http://www.mconsultingprep.com/problem-solving-test/how-to-prepare/
1. Client Interpretation – A
We will illustrate the Chairman’s thoughts in a simple language:
When making investment decisions, in addition to the economic aspect, AJ
Gasoline Group considers the ethical aspect which involves:


Environmental issues
Social issues
B is incorrect because it refers to non-financial factors whose scope is broader than
that of ethical issues mentioned by the Chairman.
C is incorrect as it is in fact a point made in the context, but not what the
Chairman expressed himself.
D is incorrect because the Business Principles are applied in every aspect of the
company’s operation. Furthermore, Business Principles are not the main idea of
the Chairman.
A correctly refers to the importance of ethical decisions (morally corrected
decisions) which are concerned with environmental and social factors.
A best reflects the Chairman’s thoughts.
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2. Others – C
A is not the answer. If investments in the gas industry are so capital intensive, it
would be very difficult and need serious consideration and carefulness in deciding
whether an investment should be funded and undertook.
B is not the answer. Because of the long lead times between the start of a project
and its receipt of earnings, it would require heavy calculations and consideration
relating to real returns, opportunity costs, and economic fluctuations such as
inflation or interest rates.
D is not the answer. The complex taxation structure imposed by the government
on the energy industry, as well as other governmental barriers would pose a lot of
threats and difficulties to the investment.
C is the answer. The statement shows the expert responsible for addressing some
risks in typical gas projects. This does not explain the importance of investment
decision making.
C is the correct answer.
3. Others – A
B is not the answer. Examples of constructive uses of money may be earning
interest in the bank or investment in another project (opportunity costs). If the
money is not put to these constructive uses, it earns no return in the meantime.
That is why its value today is higher than that of the future.
C is not the answer. If we cannot receive the returns of our money in the future, it
means that our money’s value today is higher than that of the future.
D is not the answer. If we put our money in the bank, we receive 12% interest rate
every year. This means that ₤1 today is equivalent to ₤1.12 in the future. So ₤1
today is worth more than ₤1 in the future.
A is the correct answer. Increasing inflation in the future would lower the
purchasing power of money in the future instead of today.
A is the correct answer.
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4. Fact-based Conclusion – B
Formula to calculate Expected Monetary Value (EMV):
EMV = (% of Success x NPV of Success) + (% of Failure x NPV of Failure)
According to this formula, EMV of Projects A to F, respectively, is: £48.7 million,
£53.4 million, £41.88 million, £43.225 million, £12.72 million, and £22.7 million.
A is UNPROVEN. Based on only one factor of EMV, it cannot be determined
which project has the least potential for investing in. Furthermore, in terms of
EMV solely, as EMV of Project E is lowest, it is the least worthy of investment, not
Project F.
C is FALSE. In terms of EMV only, the company should invest in Project D rather
than Project C because Project D’s EMV is higher.
D is UNPROVEN. The factors that lead to the low percentage of failure of Project
F are not provided in the context.
B is TRUE. If NPV of Success of Project A is 10% higher, which is £183.7 million,
its EMV would be £54.5 million, higher than that of Project B.
B is the correct answer.
5. Others – D
A is incorrect. The common standards of health and safety set for the whole
industry, and therefore for all projects, would not help compare the projects
with each other.
B is incorrect. The projected cost paid to the mining contractor in each project is
already calculated in the NPV of each project.
C is incorrect. The company’s standards in category planning, sourcing and
contract management, which apply for all projects, are not helpful in assessing
different projects. (Similar to A)
D is the correct answer. Anticipatory non-financial barriers from the government
in each project would be very helpful for the company in assessing the potential
of each project.
D is the correct answer.
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6. Root-cause Reason – C
A is incorrect. The advanced and efficient infrastructure system, here specifically is
the growing system of LNG carriers all over the world, is the supportive factor for
the approach, not one of the root-cause reasons that lead to the decision.
B is incorrect. The huge quantity of LNG carrying trucks in China is evidence of
the growing demand of LNG in a specific country as well as in the world. Though
related, this information is not the root-cause reason why AJ Gasoline Group
chose the approach.
D is incorrect. The advanced and efficient operations capacity as mentioned is also
just a supportive factor for the approach, not one of the root-cause reasons that
lead to the decision. (Similar to A)
C is correct. The information indicates that gas demand is growing strongly all
over the world, leading to the need of a flexible approach in business which can
facilitate providing supply to all parts in the world.
C is the correct answer.
7. Formulae - A
Convert X billion cubic feet of natural gas reserves to unit of mmbtu: X billion
cubic feet = (X/35.3 * 49,240,000/1.35) mmbtu
Multiply with price per mmbtu: US$ (X/35.3 * 49,240,000/1.35 * Y)
Convert the price from US$ to £: US$ (X/35.3 * 49,240,000/1.35 * Y) / 1.67 ≈
618,715.5 * XY
A is the correct answer.
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8. Word Problem – B
The company’s sales of LNG in 2013 = 24 mtpa * 35% = 8.4 mtpa = 8.4 mtpa x
49,240,000 mmbtu = 413,616,000 mmbtu
Price = 413,616,000 mmbtu x US$ 4.35 = US$ 1,799,229,600 = US$
1,799,229,600 / 1.67 ≈ £1,077 million
B is the correct answer.
***
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