Frequently Asked Questions
Why
bother with spreadsheet analysis?
How difficult
are the spreadsheets to use?
What well information will I need for using the
spreadsheets?
Who created the spreadsheets?
How accurate are the cash flow projections?
How
do the spreadsheets account for cash flows after 10 years?
Can you mail the spreadsheet files to me on a cd?
How
can the spreadsheets be used for evaluating companies drilling the Marcellus
Shale, Barnett Shale,
Cotton Valley Sandstone, Bakken Shale, and other highly active oil and
gas plays?
Why bother with spreadsheet analysis?
In today's oil and gas industry it is easy to invest in a well that will be a drilling success (completed as a producing well), but will be an economic failure (will be unprofitable or barely profitable). A quick multiplication of a well's oil/gas production rate, the sales price of oil and gas , and your interest in the well grossly overestimates investment performance because it does not account for steep, early production decline or risk. A cash flow projection provided to you by the offeror of a drilling deal often does not account for the risk of a dryhole or low production rate. Your own quick run of well cash flow in the Petroleum Evaluator spreadsheets can help you avoid the third "d" of the three d's of why investors typically exit a drilling partnership: divorce, death, or disgust. (spreadsheets probably aren't much help on the first two d's.)
How difficult are the spreadsheets to use?
To complete a basic cash flow projection for a well and an alternative investment, you enter values in the Input sheet for:
Initial oil and gas production rates for three scenarios (low, medium, and high production rates),
Your guess at the chance of each scenario occurring,
The estimated cost for well drilling and for well completion, and
Your working interest and net revenue interest in the well.
Pop-up comment boxes guide you through making each entry with suggested ranges of values. These few entries in the Input sheet generate all of the other sheets and graphs, and they are ready to print. You make entries only in the Input spreadsheet, although you can make changes in the other sheets if desired. We believe that it will take a few minutes to complete a basic cash flow projection, if the user has not used a spreadsheet before, but has basic computer skills such as typing, opening, and saving files. The user can spend more time and refine their cash flow projection as much as they want, but the basic entries mentioned above generate a complete cash flow projection for a well and alternative investment, and includes adjustments for taxes, geologic risk, and discounted for time. The user can easily change an entry in the Input sheet to see how it affects investment performance as it is shown in the graphs. This gives the user an intuitive feel for how changing a variable changes the investment performance.
What information will I need for using the spreadsheets?
While more information specific to your deal makes a better cash flow projection, often only two pieces of information specific to a well are used for projecting cash flow: the initial production rate, and the cost of well drilling and well completion. Other information (production decline rates, tax rates, and operating expenses) is estimated based on the type of well, in a rough estimate of well economics.
At the bare minimum, you need the following two pieces of information for the spreadsheets:
| 1. | The likely range of initial production from the well. This is not the wells' initial potential or the first day's production. The average daily production rate for oil and gas for the second month of production would be appropriate because in the second month production often stabilizes and begins to decline. (For a coalbed methane well, the average daily production rate once gas production has peaked would be appropriate.) This information is based on similar wells that have been drilled, which you would need to obtain either from the offeror of the deal or you could research yourself. You can use production rates from a similar well in the examples that come with the spreadsheet package. | ||
| 2. | The drilling cost of the well (dryhole cost) and completion cost of the well. |
The following items would significantly improve your cash flow projection because it makes the projection specific to your conditions:
The percentage
that production will decline in the first and third years of
production. The Input sheet of the Petroleum
Evaluator gives you generic values that can be
used. (You do not need the decline for year 2, because it can be estimated as being
half-way between
years 1 and 3.) You can also use decline rates from a similar well in the
examples that come with the Petroleum
Evaluator.
Your
interest in the well, although it may be sufficient to just enter a generic value
in the Input sheet (say 1% for working interest and 0.7% for net revenue
interest) because this will give you the well's investment performance
(rate-of-return, internal rate of return, NPV, and payout time.).
Your initial investment (which you can calculate by multiplying your working interest times the drilling and completion cost).
Who created the spreadsheets?
A veteran petroleum geologist created the Petroleum Evaluator package after friends outside the industry asked him to evaluate drilling deals they were being offered.
How accurate are the cash flow projections?
The Petroleum Evaluator spreadsheets are based on a discounted cash flow model commonly used in the oil and gas industry. The spreadsheet package uses standard petroleum engineering, geology, and tax accounting methods for projecting risk-adjusted cash flows of an oil or gas well.
How do the spreadsheets account for cash flows after 10 years?
As commonly done in multi-year cash flow models, the Petroleum Evaluator spreadsheets assume the interest in the well is sold for a residual value in the last year of the investment period (the sale price in Year 10). This sale price would recognize the value of production that will occur after Year 10. The spreadsheet automatically calculates the sale price as an amount equal to the projected revenue for the 24-month period following the end of Year 10 (that is the projected revenue in Years 11 and 12). The assumption that the sale price at the end of Year 10 will be equal to the next 24 months of revenue is based on numerous observed sales prices of fractional working interests in mature oil and gas wells. It is important to recognize that wells more than 10 years old often need expensive work-overs, mechanical repairs, and in the case of unconventional reservoirs, re-fracing treatments. Cash flows late in the life of a well (for example, in Year 15 or 20), usually have minimal present value today due to production decline and discounting for time, even if the discount rate is a very low of 3 or 4%.
Can you mail the spreadsheet files to me on a CD?
No, we are sorry, but we are set up only for a customer to download the files over the internet.
How
can the spreadsheets be used for evaluating companies drilling the Marcellus
Shale, Barnett Shale, Cotton Valley Sandstone, Bakken Shale
or other highly active oil and gas plays?
A company whose income source is oil or gas production can be no more profitable than the wells it drills. The spreadsheets in the Petroleum Evaluator package can easily be used for determining whether or not the type of well a company drills is likely to be as profitable as the company claims. An early high production rate reported for a well can give an overly optimistic impression of profit potential because rapid early production decline, coupled with well operating expenses incurred during several years of production , can ultimately make a well marginally profitable or uneconomic. Only a multi-year, discounted cash-flow evaluation can adequately determine well profitability. A simple multiplication of well reserves and the price of natural gas cannot distinguish a profitable well from a marginally economic well. The spreadsheets for the example wells that come with the Petroleum Evaluator package provide hypothetical well economics in numerous U.S. oil and gas plays, with the spreadsheets completely filled-out for wells in these plays. Or, you can use the package to quickly run the numbers yourself for a company's well using their reported production rates and well costs.
