"Oil equivalent" is widely used to measure the total hydrocarbons in a reservoir at a given moment, or produced over some period by a company, etc. Gas is converted to liquids at 6,000 cu ft/bbl.
Companies have generally stayed close to the 6:1 thermal equivalence. TotalFinaElf has used 5.487, Chevron-Texaco and Shell Canada 6:1. However, Suncor Energy Inc., PanCanadian Petroleum Corp., and Scotia Capital have used 10:1.
We have deplored the use of "oil equivalent."
Our late lamented friend John Lohrenz, an engineer who knew oil economics, entitled a brief paper: "In Situ Gas-to-Oil Equivalence 6 Mcf/bbl? Aw C'mon!" Sir John Browne of BP Amoco has said of oil equivalent: "No such thing exists."1
But it keeps being used, even while old and new data discredit it.
The Scotia Group Inc., Dallas, has compiled the sales in January-July 2001 of properties producing oil and gas. (We are indebted to them for the data but are entirely responsible for its use.) There are 27 usable observations, totaling $5,256 million paid, for 123 million bbl of liquids and 2,953 million Mcf of gas. Converting at the usual 6:1 gives 615 million "boe," so unit value is $8.54/boe. This is far wrong.
Five sales were of properties producing only oil and 10 of properties producing only gas. The "pure oil" reserves averaged $3.43/bbl, and the "pure gas" reserves averaged $1.65/Mcf. The oil:gas price ratio was only 2.08:1, not 6:1.
"Value per boe" is a mixup of oil and gas with no rationale. However, we can get a better measure of the in situ value of oil or gas reserves by a regression equation:
Vi = C + aOi + bGi + error
where Vi is the sales price of the ith property, Oi its oil reserves, Gi its gas reserves. The coefficients a and b are the values per unit of oil and-or gas in the ground. The intercept C represents the value of a deposit with zero hydrocarbons. Its value should in theory be near zero.
For deposits sold in January-July 2001, the results (in dollars) are:
Vi = -7.1 + 3.96 Oi +1.68 Gi
The intercept is insignificantly small. The calculated values in situ are $3.96/ bbl, $1.68/Mcf. These values are close to the "pure" estimates (3.43, 1.65), which were based on smaller samples. The gas:oil ratio is only 2.36:1.
The sales of even a few properties register the current value of all proved reserves, just as the sales of a tiny proportion of the stock of a company register the company's total market value. Sales of reserves are for large amounts, and alternatives are carefully considered by buyers and sellers, and by their engineers, bankers, and other adVisors. Our estimates piggyback on their work.
Therefore in situ values can be compared to the January-July wellhead prices of oil and gas, respectively $24.13 and $4.94.2 For many years, a rule of thumb in North America has been that the in-ground value of a developed reserve unit of oil or gas is one-third of the wellhead price. In situ gas in 2001 was near the ex- pected value, but oil was about half of it.
For further calculation, we first make an adjustment. Over the years, a third of the wellhead value has gone to cover operating costs, royalties, and taxes. These must all be subtracted to compare like with like. The owner, considering whether to produce the reserve or hold it or sell it, compares net benefits now and later.
Denoting by P the net wellhead value of a barrel of oil or Mcf of gas, and by V the in-ground sales value (as defined in Equation [1]), we have shown elsewhere3 that the relation is:
V = Pa / (a+i-g)
For North American oil and gas, the annual decline rate is around 10%, and we take the discount rate as around 15%. Using the Vs from Equation [1a], of $3.96/bbl and $1.68/Mcf, in January-July 2001 buyers and sellers expected gas prices to rise at about 5%/year and oil prices to decline at 15%/year. Of course these are very rough guesses. But the market was betting that gas prices would be steady to strong, while oil prices would drop. Buyers and sellers act as if they believed that (1) the gas market is competitive. The recent price increase resulted from gas investment at a rate too low to meet demand, and the price will remain near current levels. But (2) the price of oil is insecurely fixed by a cartel at a level far above its investment cost. These are two markets with different price-determining systems and degrees of price risk.
References
- Petroleum Intelligence Weekly, Mar. 23, 1998, p. 7.
- US Department of Energy, Monthly Energy ReView, July 2001, pp. 117 and 131; for later months to overcome the publication lag, use West Texas Intermediate plus $1.50 for oil and Henry Hub price for gas.
- Adelman, M.A., and Watkins, G.C., "The Value of United States Oil and Gas Reserves: Estimation and Applications," Advances in the Economics of Energy and Resources, Vol. 10, 1997, pp. 158-165.
The authors
M.A. Adelman and G.C. Watkins are associated with the Center for Energy and EnVironmental Policy Research at MIT. E-mail: [email protected]
