Project valuation with financial leasing contracts

Financial leasing is prevalent in many projects in the oil and energy industries. Examples are tariff payments in existing pipelines, processing tariffs, leasing of rigs and leasing of LNG transportation ships. A common mistake among oil companies in such settings is to treat financial leasing costs as operating cost and discount with the firm's weighted average cost of capital (WACC). This method overstates project profitability and may lead to overinvestment since financial leasing payments should be valued at the costs of debt. We present a practical method for calculating the net present value of projects when there are no investment alternatives, i.e., when leasing is the only option (the cost of investing is not known). Finally, we demonstrate through a real LNG project example, the potential magnitude in the project net present value error.