ENCH 687 | ENPE 626

Petroleum Economics
Fall 2018 | Dr. Roman J Shor
Slide pack based on Chapter 3, M.A. Mian, Project Economics and Decision Analysis, Vol 1
Cash Flow Models
• Understand sources of information
• Forecasting production
• Types of Costs
• Capital Expenses
• Operating Expenses
• Other Costs

(c) Roman J. Shor, University of Calgary Sept 26, 2018 2

Capital Investment Analysis
• The decision process is based on:

1. Data gathering about investment alternatives

• Estimation & forecasting

2. Combining qualitative data from (1) with profitability measures

• Also known as decision criteria or profitability yardsticks

3. Making a final decision

(c) Roman J. Shor, University of Calgary Sept 26, 2018 3

Sources of Data for Petroleum Projects
• Reservoir engineers create production forecasts and estimate the number of wells
necessary to achieve production goals.
• Drilling engineers propose well plans and drilling programs based on reservoir
engineers’ forecasts
• Production engineers identify surface and downhole equipment for well competitions,
including
• Surface separation, processing and transportation equipment
• Subsurface lift
• Subsurface reservoir stimulation

• Economists forecast future commodity prices & work with the stakeholders to ensure
quality data and consensus on assumptions

(c) Roman J. Shor, University of Calgary Sept 26, 2018 4

Cash Flow Model
• Done of the entire project life, or up to 28 years, whichever is shorter
• This assumes a 3 year project construction period and a 25 year production life

• A net cash flow projection is simply:

𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 = 𝑐𝑎𝑠ℎ 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑 − 𝑐𝑎𝑠ℎ 𝑒𝑥𝑝𝑒𝑛𝑑𝑒𝑑

(c) Roman J. Shor, University of Calgary Sept 26, 2018 5

Cash Flow Model
• A net cash flow projection is simply:

𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 = 𝑐𝑎𝑠ℎ 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑 − 𝑐𝑎𝑠ℎ 𝑒𝑥𝑝𝑒𝑛𝑑𝑒𝑑

• The cash received, or gross revenue, is production times forecast price. The products
sold may be:
• Crude oil [STBs – standard barrels]
• Natural gas [MMScf or MMBtu – million cubic feet or BTU]
• Liquefied petroleum gas
• Natural gas liquids
• Liquefied natural gas
• Heating oil
• Petrochemicals, etc

(c) Roman J. Shor, University of Calgary Sept 26, 2018 6

Cash Flow Model
• A net cash flow projection is simply:

𝑛𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 = 𝑐𝑎𝑠ℎ 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑 − 𝑐𝑎𝑠ℎ 𝑒𝑥𝑝𝑒𝑛𝑑𝑒𝑑

• The cash expended is divided into:

• Capital Expenditure (CAPEX)
• Geological & geophysical (G&G) costs, drilling costs, facility costs as well as any operating costs incurred
during the construction period
• Operating Expenditure (OPEX)
• Abandonment Costs, Production Taxes and Sunk Costs

(c) Roman J. Shor, University of Calgary Sept 26, 2018 7

Estimating Cost
• Factors which affect future costs are:
1. Inflation
2. Market conditions
3. Escalation (the combination of 1 and 2)
4. Local wage levels and productivity
5. Cost of transportation
6. Taxes and import duties
7. Climactic and terrain conditions

• Factors 4 through 7 are often lumped together and referred to as a location factor.
• Royalties, profit sharing, severance and ad valorem taxes, etc are also costs and are
referred to as state or government take.

(c) Roman J. Shor, University of Calgary Sept 26, 2018 8

Data Required for Project Evaluation
1. Ownership maps, geological structure maps, isopach maps, geological cross sections,
etc
2. Lease location data
3. Well logs
4. Core analysis
5. Reservoir fluid sample data
6. Chronological history of all well operations in the area, including original drilling plan
and completion
7. Monthly oil, water and gas production (including pay zones)
8. Current daily allowable rates for each well (if available)

(c) Roman J. Shor, University of Calgary Sept 26, 2018 9

Data Required for Project Evaluation
9. Gross oil and gas prices, summaries of sales contracts by purchasers and terms
10. Severance and local taxes paid
11. Actual historic gross operating expenses per well per month for each property
12. Estimate of completed or recompleted well costs
13. Ownership interests
14. Any previously prepared geological or engineering reports for the area (or any nearby
areas)
15. Lease and assignment provisions, lease facilities, operating agreements, unitization
agreements, etc

(c) Roman J. Shor, University of Calgary Sept 26, 2018 10

Forecasting Product Stream
• For upstream projects, this is particularly difficult
• Depends on usually highly uncertain or variable data
• Is subject to interpretation and bias
• May be influenced by operations

• For midstream and downstream projects, this is straightforward

(c) Roman J. Shor, University of Calgary Sept 26, 2018 11

Estimating Oil and Gas Reserves
• Techniques include
• Volumetric calculations
• Historical production and reservoir pressure performance analysis
• Decline curve analysis
• Analogy to similar reservoirs
• Material balance calculations
• Reservoir simulation

(c) Roman J. Shor, University of Calgary Sept 26, 2018 12

Definitions: Oil and Gas Reserves
• Original Oil in Place (OOIP), Original Gas in Place (OGIP), Initial Oil in Place (IOIP),
Initial Gas in Place (IGIP), Gas Initially in Place (GIIP), and Stock Tank Oil Initially In
Place (STOIIP)
• Total estimated volume of hydrocarbon accumulation

• Ultimate Oil and/or Gas Recovery

• Total volume of oil and/or gas which can be feasibly and economically produced using
currently technologies

• Cumulative Oil and/or Gas Production

• Accumulated production since the start of a project

• Oil and/or Gas Reserves

• Generally ultimate recovery minus cumulative production

(c) Roman J. Shor, University of Calgary Sept 26, 2018 13

Volumetric Calculations
• To estimate OOIP, a simple volumetric formula may be used:
7758𝜙 1 − 𝑆𝑤 ℎ𝐴
𝑁[𝑆𝑇𝐵] =
𝐵𝑜
Where:
𝜙 is porosity [fraction]
𝑆𝑤 is water saturation [fraction]
ℎ is formation thickness [ft]
𝐴 is drainage area [acres]
𝐵𝑜 is formation volume factor [RB/STB]
• Ultimate recovery is then obtained by multiplying by a recovery factor, 𝐸𝑅 , which
typically ranges from 12 to 30%

(c) Roman J. Shor, University of Calgary Sept 26, 2018 14

Volumetric Calculations
• To estimate OGIP, a simple volumetric formula may be used:
𝑁[𝑆𝑐𝑓] = 43560𝜙 1 − 𝑆𝑤 ℎ𝐴𝐵𝑔

Where:
𝜙 is porosity [fraction]
𝑆𝑤 is water saturation [fraction]
ℎ is formation thickness [ft]
𝐴 is drainage area [acres]
𝐵𝑜 is formation volume factor [Scf/CF]
• Ultimate recovery is then obtained by multiplying by a recovery factor, 𝐸𝑅 , which
typically ranges from 70-90%

(c) Roman J. Shor, University of Calgary Sept 26, 2018 15

Example: OOIP
• A production zone is between 7815 and 7830 feet deep, average porosity is 15% and
average water saturation is 35%. The oil formation volume factor is 1.125 RB/STB,
drainage area is 80 acres and the recovery factor is 12%. Was the OOIP and the ultimate
oil recovery?

(c) Roman J. Shor, University of Calgary Sept 26, 2018 16

Example: OOIP
• A production zone is between 7815 and 7830 feet deep, average porosity is 15% and
average water saturation is 35%. The oil formation volume factor is 1.125 RB/STB,
drainage area is 80 acres and the recovery factor is 12%. Was the OOIP and the ultimate
oil recovery?
The OOIP is given by

7758𝜙 1 − 𝑆𝑤 ℎ𝐴 7758 × 0.15 1 − 0.35 × 15 × 80

𝑁= = = 747000 𝑆𝑇𝐵
𝐵𝑜 1.215

The Ultimate recovery is:

𝑁𝑢𝑙 = 𝑁 × 𝐸𝑅 = 747000 × 0.12 = 89600 𝑆𝑇𝐵

(c) Roman J. Shor, University of Calgary Sept 26, 2018 17

Decline Curve Analysis
• Future production from a well always declines. To be able to fit a decline curve,
1. Sufficient past production performance is necessary
2. Past production history is based on unrestricted production and assumes no future changes in
property operation

• Three basic types of decline curves (there are many more complicated ones)
1. Exponential Decline
2. Hyperbolic Decline
3. Harmonic Decline

• It is easiest to see this decline by plotting on log-linear paper

(c) Roman J. Shor, University of Calgary Sept 26, 2018 18

How far do we extrapolate?
• The Economic Limit is the point at
which a property is abandoned (ie,
it costs more than it produces).
This occurs when net cash flow
becomes negative

(c) Roman J. Shor, University of Calgary Sept 26, 2018 19

How far do we extrapolate?
• The Economic Limit is the point at which a property is abandoned (ie, it costs more than
it produces). This occurs when net cash flow becomes negative
• This can be calculated using:
𝑊𝐼 × 𝐿𝑂𝐸
𝐸𝐿𝑜𝑖𝑙 =
𝐺𝑂𝑅
𝑁𝑅𝐼 𝑃𝑜 1 − 𝑇𝑜 + 𝑃𝑔 1 − 𝑇𝑔 1−𝑇
1000

𝑊𝐼 × 𝐿𝑂𝐸
𝐸𝐿𝑔𝑎𝑠 =
𝑁𝑅𝐼 𝑃𝑔 1 − 𝑇𝑔 + 𝑃𝑜 𝑌 1 − 𝑇𝑜 1−𝑇
• Where
𝐸𝐿𝑜𝑖𝑙 is the economic limit for an oil well (STB/month) and 𝐸𝐿𝑔𝑎𝑠 is the economic limit for a gas
well (MScf/month). 𝑃𝑜 and 𝑃𝑔 are oil and gas prices ($/STB and $/MScf). 𝐿𝑂𝐸 are lease operating
expenses ($/well/month), 𝑊𝐼 is working interest (fraction), 𝑁𝑅𝐼 is net revenue interest (fraction),
𝐺𝑂𝑅 is gas-oil ratio (Scf/STB), 𝑌 is condensate yield (Stb/MScf), 𝑇𝑜 and 𝑇𝑔 are oil and gas
severance/production taxes (fraction) and 𝑇 is the ad valorem tax (fraction)

(c) Roman J. Shor, University of Calgary Sept 26, 2018 20

Example: Economic Limit
• If we take 𝑃𝑜 = $60/𝑆𝑡𝑏, 𝑃𝑔 = $5.5/𝑀𝑠𝑐𝑓, 𝑇𝑔 = 5%, 𝑇𝑜 = 7.5%, 𝐿𝑂𝐸 = $5000/𝑚𝑜𝑛𝑡ℎ, 𝑇 =
12%, 𝑁𝑅𝐼 = 87.5% and 𝐺𝑂𝑅 = 500𝑆𝑐𝑓/𝑆𝑇𝐵, calculate the economic limit.

(c) Roman J. Shor, University of Calgary Sept 26, 2018 21

Example: Economic Limit
• If we take 𝑃𝑜 = $60/𝑆𝑡𝑏, 𝑃𝑔 = $5.5/𝑀𝑠𝑐𝑓, 𝑇𝑔 = 5%, 𝑇𝑜 = 7.5%, 𝐿𝑂𝐸 = $5000/𝑚𝑜𝑛𝑡ℎ, 𝑇 =
12%, 𝑁𝑅𝐼 = 87.5% and 𝐺𝑂𝑅 = 500𝑆𝑐𝑓/𝑆𝑇𝐵, calculate the economic limit.

𝑊𝐼 × 𝐿𝑂𝐸
𝐸𝐿𝑜𝑖𝑙 =
𝐺𝑂𝑅
𝑁𝑅𝐼 𝑃𝑜 1 − 𝑇𝑜 + 𝑃𝑔 1 − 𝑇𝑔 1−𝑇
1000

(c) Roman J. Shor, University of Calgary Sept 26, 2018 22

Example: Economic Limit
• If we take 𝑃𝑜 = $60/𝑆𝑡𝑏, 𝑃𝑔 = $5.5/𝑀𝑠𝑐𝑓, 𝑇𝑔 = 5%, 𝑇𝑜 = 7.5%, 𝐿𝑂𝐸 = $5000/𝑚𝑜𝑛𝑡ℎ, 𝑇 =
12%, 𝑁𝑅𝐼 = 87.5% and 𝐺𝑂𝑅 = 500𝑆𝑐𝑓/𝑆𝑇𝐵, calculate the economic limit.

𝑊𝐼 × 𝐿𝑂𝐸
𝐸𝐿𝑜𝑖𝑙 =
𝐺𝑂𝑅
𝑁𝑅𝐼 𝑃𝑜 1 − 𝑇𝑜 + 𝑃𝑔 1 − 𝑇𝑔 1−𝑇
1000

1 × 5000
𝐸𝐿𝑜𝑖𝑙 =
500
0.875 60 1 − 0.075 + 5.5 1 − 0.05 1 − 0.12
1000

𝐸𝐿𝑜𝑖𝑙 = 111.73 𝑆𝑡𝑏/𝑚𝑜𝑛𝑡ℎ

(c) Roman J. Shor, University of Calgary Sept 26, 2018 23

Example: Economic Limit
• If we take 𝑃𝑜 = $60/𝑆𝑡𝑏, 𝑃𝑔 = $5.5/𝑀𝑠𝑐𝑓, 𝑇𝑔 = 5%, 𝑇𝑜 = 7.5%, 𝐿𝑂𝐸 = $5000/𝑚𝑜𝑛𝑡ℎ, 𝑇 =
12%, 𝑁𝑅𝐼 = 87.5% and 𝐺𝑂𝑅 = 500𝑆𝑐𝑓/𝑆𝑇𝐵, calculate the economic limit.

We can also calculate the revenues:

𝑂𝑖𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝐸𝐿𝑜𝑖𝑙 × 𝑃𝑜 1 − 𝑇𝑜 × 𝑁𝑅𝐼 × 1 − 𝑇 = $4774.78

𝐺𝑎𝑠 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 𝐸𝐿𝑜𝑖𝑙 × 𝐺𝑂𝑅 = 55865 𝑆𝑐𝑓/𝑚𝑜𝑛𝑡ℎ or 55.865 𝑀𝑆𝑐𝑓/𝑚𝑜𝑛𝑡ℎ

𝐺𝑎𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑄𝑔 × 𝑃𝑔 1 − 𝑇𝑔 × 𝑁𝑅𝐼 × 1 − 𝑇 = $224.76

(c) Roman J. Shor, University of Calgary Sept 26, 2018 24

Exponential decline
• Also known as constant
percentage decline
which follows 𝑦 = 𝑎𝑒 𝑏𝑥
• If plotted on log-linear
paper, appears linear

(c) Roman J. Shor, University of Calgary Sept 26, 2018 25

Exponential decline
• For the time interval from 𝑡 = 0 to 𝑡 = 𝑡0 , the oil produced is equal to
𝑞𝑖 − 𝑞𝑜 × 12
Δ𝑁𝑝 =
𝑎

• The time required to produce ΔNp is given by

𝑞𝑖
ln
𝑞𝑜
𝑡=
𝑎

• The rate at 𝑡 = 𝑡0 is
𝑞0 = 𝑞𝑖 𝑒 −𝑎𝑡0
𝑞𝑖 − 𝑞0 𝑞0
𝑑= = 1 − = 1 − 𝑒 −𝑎𝑡
𝑞𝑖 𝑞𝑖
ln 𝑞𝑖 − ln 𝑞0
𝑎 = − ln 1 − 𝑑 =
𝑡

Where 𝑞𝑖 is the rate at the beginning of the time period (STB/month), 𝑞0 is the rate the end of the time period (or at EL)
(STB/month), 𝑡 is the time period between 𝑞𝑖 and 𝑞𝑂 (years), ΔNp is cumulative production during the time period (STB), 𝑎 is
nominal decline rate (fraction) and 𝑑 is the effective decline rate (fraction)

(c) Roman J. Shor, University of Calgary Sept 26, 2018 26

Exponential decline
• To change between effective monthly decline rate and effective yearly decline rate:
𝑑𝑦 = 1 − 1 − 𝑑𝑚 12

1/12
𝑑𝑚 = 1 − 1 − 𝑑𝑦

(c) Roman J. Shor, University of Calgary Sept 26, 2018 27

Example: Exponential Decline
• For the production data and
forecast shown, and knowing
that cumulative oil production
through 12/31/2001 is 78,044 Stb,
calculate:
a) Effective and nominal decline
rates
b) Oil reserves from 1/1/2002
through an EL of 200
Stb/month
c) Time required to produce the
oil calculated in (b)
d) Production rate on 12/31/2004
e) Ultimate oil recovery (𝑁𝑢𝑙 )

(c) Roman J. Shor, University of Calgary Sept 26, 2018 28

Example: Exponential Decline
• For the production data and
forecast shown, and knowing
that cumulative oil production
through 12/31/2001 is 78,044 Stb,
calculate:
a) Effective and nominal decline
rates
𝑠𝑡𝑏
On 1/1/2002, 𝑞 = 843
𝑚𝑜𝑛𝑡ℎ
𝑠𝑡𝑏
On 1/1/2003, 𝑞 = 717
𝑚𝑜𝑛𝑡ℎ

(c) Roman J. Shor, University of Calgary Sept 26, 2018 29

Example: Exponential Decline
• For the production data and forecast shown, and knowing that cumulative oil production
through 12/31/2001 is 78,044 Stb, calculate:
a) Effective and nominal decline rates
𝑠𝑡𝑏 𝑠𝑡𝑏
On 1/1/2002, 𝑞 = 843 On 1/1/2003, 𝑞 = 717
𝑚𝑜𝑛𝑡ℎ 𝑚𝑜𝑛𝑡ℎ

The effective decline rate is given by:

843 − 717
𝑑= × 100 = 14.94% = 15%
843
Which gives
𝑎 = − ln 1 − 0.15 = 0.1625

(c) Roman J. Shor, University of Calgary Sept 26, 2018 30

Example: Exponential Decline
• For the production data and forecast shown, and knowing that cumulative oil production
through 12/31/2001 is 78,044 Stb, calculate:
b) Oil reserves from 1/1/2002 through an EL of 200 Stb/month

The oil reserves are given by

𝑞𝑖 − 𝑞𝐸𝐿 843 − 200
𝑁𝑅 = = = 47,483 𝑆𝑡𝑏
𝑎 0.1625

(c) Roman J. Shor, University of Calgary Sept 26, 2018 31

Example: Exponential Decline
• For the production data and forecast shown, and knowing that cumulative oil production
through 12/31/2001 is 78,044 Stb, calculate:
c) Time required to produce the oil calculated in (b)

The time required is given by:

𝑞𝑖 843
𝑞𝐸𝐿 200
𝑡 = ln = ln = 8.85 𝑦𝑒𝑎𝑟𝑠
𝑎 0.1625

(c) Roman J. Shor, University of Calgary Sept 26, 2018 32

Example: Exponential Decline
• For the production data and forecast shown, and knowing that cumulative oil production
through 12/31/2001 is 78,044 Stb, calculate:
d) Production rate on 12/31/2004

The production rate is given by

𝑞𝑜𝑡 = 𝑞𝑖 𝑒 −𝑎𝑡𝑜 = 843𝑒 −0.1625×3 = 518 𝑆𝑡𝑏/𝑚𝑜𝑛𝑡ℎ

(c) Roman J. Shor, University of Calgary Sept 26, 2018 33

Example: Exponential Decline
• For the production data and forecast shown, and knowing that cumulative oil production
through 12/31/2001 is 78,044 Stb, calculate:
e) Ultimate oil recovery (𝑁𝑢𝑙 )

The Ultimate recovery is given by:

𝑁𝑢𝑙 = 𝑁𝑝 + 𝑁𝑟 = 78044 + 47483 = 125,527 𝑆𝑡𝑏

(c) Roman J. Shor, University of Calgary Sept 26, 2018 34

Hyperbolic Decline Curve
• If plotted on a log-linear plot,
hyperbolic decline curves are
concave upward and can be
described with a hyperbolic
exponent, 𝑏.

(c) Roman J. Shor, University of Calgary Sept 26, 2018 35

Hyperbolic Decline Curve
• If plotted on a log-linear plot, hyperbolic decline curves are concave upward and can be described with a hyperbolic exponent,
𝑏.

• The French Curve Method allows this curve to be estimated. The equation results with the following:
𝑏
𝑞𝑖
Δ𝑁𝑝 = 1−𝑏
1 − 𝑏 𝑎𝑖 𝑞𝑖 1 − 𝑏 − 𝑞𝑜

𝑞𝑖 𝑏
−1
𝑞𝑜
𝑡=
𝑏𝑎𝑖
−1/𝑏
𝑞𝑜𝑡 = 𝑞𝑖 1 + 𝑏𝑎𝑖 𝑡𝑜
𝑏
𝑞𝑡 1 −𝑏
𝑎𝑡 = 𝑎𝑖 = 1 − 𝑑𝑖 −1
𝑞𝑖 𝑏
𝑞𝑖 − 𝑞𝑜
𝑑=
𝑞𝑖
𝑑𝑡 = 1 − 1 + 𝑏𝑎𝑡

(c) Roman J. Shor, University of Calgary Sept 26, 2018 36

Harmonic Decline
• Special Case of Hyperbolic Decline where 𝑏 = 1

𝑞𝑖 𝑞𝑖
Δ𝑁𝑝 = ln
𝑎𝑖 𝑞𝑜

𝑞𝑖
−1
𝑞𝑜
𝑡=
𝑎

𝑞𝑖
𝑞𝑜𝑡 =
1 + 𝑎𝑖 𝑡

(c) Roman J. Shor, University of Calgary Sept 26, 2018 37

Low permeability (tight) gas reservoirs
• If reservoir permeability is less than
0.1 md for gas reservoirs, they are
considered ‘tight’ by the U.S.
Federal Energy Regulatory
Commission (FERC). The following
equations should be used:
1
log 𝑞𝑔 = − log 𝑡 + log 𝐶
2
𝐶
𝑞𝑔 =
𝑡
Or
1
= 𝑚 𝑡 + 𝐶1
𝑞𝑔
1
So these can be fit by plotting vs
𝑞𝑔
𝑡

(c) Roman J. Shor, University of Calgary Sept 26, 2018 38

Production Forecasting by Analog
• If two reservoirs:
• Have the same type of geologic
age and formation
• Have the same reservoir drive
mechanism
• Have similar petrophysical
properties

• Then the analogous reservoir

with a longer production
history may be used to estimate
production

(c) Roman J. Shor, University of Calgary Sept 26, 2018 39

Production Forecasting by Analog
• If two reservoirs:
• Have the same type of geologic
age and formation
• Have the same reservoir drive
mechanism
• Have similar petrophysical
properties

• Then the analogous reservoir

with a longer production
history may be used to estimate
production

(c) Roman J. Shor, University of Calgary Sept 26, 2018 40

Product Pricing
• Depending on the crude type
(API gravity), different end
products may be produced.
• In general, they are gasoline,
propane and butane, cat feed,
distillate and residual fuel
(used for heavy fuel oil and
asphalt)

(c) Roman J. Shor, University of Calgary Sept 26, 2018 41

Benchmark Pricing
• There is no single benchmark price for
crude oil. Major benchmarks include:
• West Texas Intermediate (WTI): 38𝑜 to 40𝑜
API with < 0.3% sulfur
• West Texas Sour: 33𝑜 API with 1.6% sulfur
• West Canada Select (WCS): typical price
obtained by Alberta producers
• Saudi Arabian (Arab light): 33.4𝑜 API and
1.8% sulfur
• Brent crude (North Sea): 38.3𝑜 API
• Ekofisk: 42.8𝑜 API
• Urals-Mediterranean: primarily used for
Russian production entering western
markets
• Singapore: primarily used for far east oil

(c) Roman J. Shor, University of Calgary Sept 26, 2018 42

Capital Expenditures (CAPEX)
• One-off costs incurred
• At the beginning of a project (referred to as front-end costs), or
• As single sums during the economic life of a project

• Often large and occur before any revenue can be obtained

• In upstream projects, primarily consist of:
• Geological and geophysical costs
• Drilling costs
• Facility costs

(c) Roman J. Shor, University of Calgary Sept 26, 2018 43

Drilling Costs
• Typically require the well to be designed, and depend on:
• The type of well
• Exploratory, appraisal, delineation or development well
• Well configuration
• Vertical, deviated, horizontal, multilateral, new vs sidetrack, water disposal, injection, etc
• Type of drilling contract and rig type
• Onshore: $10,000 - $50,000 per day
• Offshore: $35,000 - $250,000 per day
• Deepwater: $450,000 - $1.2M per day

• Depth of the well and complexity of the formations

• Case scheme and type of casing
• Drilling mud and drill bits
• Testing and coring requirements
• Completion and completion equipment

(c) Roman J. Shor, University of Calgary Sept 26, 2018 44

Drilling Time
• The total time to drill a well consists of:
• Drilling rate (Rate of Penetration, ROP)
• Trip time
• Hole problems
• Running casing
• Logging, coring and pressure surveys
• Directional / horizontal drilling
• Well completion

• Often reported as a depth vs time plot

(c) Roman J. Shor, University of Calgary Sept 26, 2018 45

Facility Costs
• Production facilities
typically consist of:
• Artificial lift
• Oil – water – gas
separation
• Onsite storage
• Distribution
equipment
• Heat exchangers
• Compressor stations
• Power generation

(c) Roman J. Shor, University of Calgary Sept 26, 2018 46

Operating Expenses (OPEX)
• Are incurred during operations and are necessary for day-to-day operation of the project.
• Typically consist of
• Fixed costs
• Variable costs per unit of production
• Maintenance of facilities
• Maintenance of wells
• Overhead

(c) Roman J. Shor, University of Calgary Sept 26, 2018 47

Operating Expenses
• These can be broken down further to
• Feedstock
• Utilities
• Maintenance
• Inspection costs | Preventative maintenance | Remedial costs
• Administration and general overhead
• Labor | Materials and supplies | Services
• Production costs
• Lifting costs | Treatment | Workover | Secondary Recovery Costs | Water Disposal
• Evacuation (midstream) costs
• Pumps & compressors | Tanker rentals | Pipeline tariffs | Operating Terminals and Jetties
• Insurance
• Usually 0.5 – 4% of replacement cost

(c) Roman J. Shor, University of Calgary Sept 26, 2018 48

Rule of Thumb
• Operating Expenses
• Production Costs : 35% of OPEX
• Evacuation Costs : 23% of OPEX
• Insurance Premiums : 21% of OPEX
• Maintenance Costs : 17% of OPEX
• Overhead : 4% of OPEX

• OPEX are typically 5% of engineering CAPEX

• Typically workover 10% of wells each year
• $150,000 for an offshore well, $22,000 for an onshore well

(c) Roman J. Shor, University of Calgary Sept 26, 2018 49

Types of Cost Estimates
• Order of magnitude estimate
• Can be estimated quickly and is usually ±25-40% accurate
• Use general information available and often use analogs

• Optimization study estimate

• Run various development scenarios to select candidates
• Take more time to conduct but result in ±15-25% accuracy

• Budget estimates
• Fix the development design, and vendors are asked to submit bids
• Usually take considerable time but result in ±10-15% accuracy

• Control estimate
• After project execution starts and contracts are awarded, actual vs expected expenditures can be
monitored – by using an S-Curve which plots cumulative expenditure vs time

(c) Roman J. Shor, University of Calgary Sept 26, 2018 50

Cost Estimates

(c) Roman J. Shor, University of Calgary Sept 26, 2018 51

Statistical View

(c) Roman J. Shor, University of Calgary Sept 26, 2018 52

Transfer Pricing
• For large vertically integrated companies, product needs to be transferred between
divisions. For example, if a company has three divisions:
• Upstream (oil and gas production)
• Midstream (pipelines and transportations)
• Downstream (oil and gas processing and petrochemical)

• Transfer pricing refers to the internal bookkeeping of product going between divisions.
Prices may be set as:
• At cost (variable cost or full (absorption) cost)
• At market price
• At a negotiated market price

• General formula:
• Transfer price = variable cost per unit + lost margin per unit on an outside sale

(c) Roman J. Shor, University of Calgary Sept 26, 2018 53

Leasing
• Mineral interest in a property is divided into:
• Working (operating) interest (WI)
• Net Revenue Interest (NRI) is working interest reduced by non-operating working interest
• Non-operating interest
• Royalty, production payment or profits interest

• Selected types of interest arrangements

• Leasehold interest – paid to property owner
• Primary term – initial pre-production lease
• Lease bonus – bonus payment on lease signing
• Delay rental – payment for deferment of production
• Carried interest – the property owner doesn’t get any payments until certain conditions are met
• Production payment interest (PPI)
• Joint working interest
• Pooled working interest

(c) Roman J. Shor, University of Calgary Sept 26, 2018 54

Example: Leasing
• Company X agrees to pay a 12.5% royalty to a landowner. To reduce risk, Company X
sells 30% of the deal to Company Y. What is the NRI of each company?

(c) Roman J. Shor, University of Calgary Sept 26, 2018 55

Example: Leasing
• Company X agrees to pay a 12.5% royalty to a landowner. To reduce risk, Company X
sells 30% of the deal to Company Y. What is the NRI of each company?

Working Interest Revenue Interest

Amount Spent (%) Amount Earned (%)
Lessor 0 12.5
Company X 70 61.25
Company Y 30 26.25
Total 100 100

Net lease = 1 – 0.125 = 0.875

Company X = 0.70 × 0.875 = 0.6125
Company Y = 0.30 × 0.875 = 02625

(c) Roman J. Shor, University of Calgary Sept 26, 2018 56