FULL-CYCLE ECONOMICS HELPS FOCUS PROGRAMS, FINANCIAL PERFORMANCE

Dan L. Wilson
Consulting Geologist
Denver

Economic analysis of an exploration program from initial concept through production can help predict a company's financial performance over time.

This type of economics can help a company select plays that will meet economic expectations and help a company plan for success.

What follows is a method of determining profitability for exploration programs in established plays. The author has used the method successfully for nearly 10 years to identify favorable plays and discover significant quantities of oil and gas at an extremely low finding cost.

FULLY-CYCLE ECONOMICS

The economic analysis of an exploration program from the initial concept to production can be called exploration full-cycle economics.

It sometimes is called cradle to grave economics. In this type of analysis all aspects of the exploration process are important.

All exploration investments such as seismic and other geophysical expenses, land costs, staff and overhead costs, drilling costs, and production costs are considered. In some cases abandonment liabilities are also significant.

This information, along with historical completion data and average field size data, can be used to determine the overall economics of a play.

The author prefers to use a method of analysis in which the costs for a play are proportionally charged against one exploratory well. There are other, more precise methods, but this is conceptually the easiest to handle and probably as accurate as any other method.

To use this method, one would determine the total land, seismic, and other costs for a play over a representative period of time and simply divide those numbers by the total number of exploratory wells one would expect to drill in the play.

This would include all regional and prospect seismic and all land costs, including seismic and land that is unsuccessful in generating prospects. A company may acquire seismic and land on three prospects but only drill one.

The investments of all three prospects should be included. This is not commonly done in most full-cycle analyses, but it is essential to understanding the true economics of a play.

DATA COLLECTION

The investment data collected for the analysis should be representative of the costs a company would expect in the play of interest. Exploration and drilling costs should be easy to estimate.

The exploratory success ratio should be estimated for the play from historical data in the area of interest. The success ratio is the completed exploratory wells divided by the total number of exploratory wells. This represents the chance factor of the play.

Reserve estimates should be made from recent historical data. The average historical discovery size should be used in the economic analysis. It is possible for a company to exceed the average to some degree, but a company should not plan its future on discovering exceptionally large field sizes.

In general, as the targeted field size begins to exceed the average for a play, the chance of success gets smaller. The author's observation for U.S. plays is that for prospects of 10 million bbl or larger, the success ratio is approximately one tenth the average success ratio for all prospects.

For this reason, economic modeling of an exploration program with targets larger than average size may be misleading and is not recommended.

After the data are gathered, economics should be calculated with all of the average exploration costs charged to the exploratory well.

FULL-CYCLE EXAMPLE

Full-cycle economic analysis allows a company to compare different plays and choose the plays that are most attractive.

The accompanying figure represents full-cycle exploration economics for several Rocky Mountain plays.

The plays were analyzed using old cost data and $15/bbl pricing, They are not representative of today's economics and are presented here only as an example.

The figure shows the profitability index for the plays. Profitability index also known as investment efficiency, is essentially the present value of a project divided by the project investments. It is a good method of ranking projects with different capital requirements.

The figure shows the dramatic difference between full-cycle economics, and well economics (AFE economics) in which pre-drilling investments such as land, seismic, and staff costs are not charged against the exploratory well.

In one case the well economics are positive but the full-cycle economics (play economics) are negative. By comparing the full-cycle economics of plays, one can identify the plays with the best economics for his company.

In most cases this type of full-cycle economic analysis will be representative of the average economics of a play.

In situations where the average reserve size is large, such as the Gulf of Mexico, the full-cycle economic method used here may not be representative of the play because very large fields often have more than one exploratory well.

The first exploratory well discovers the field, but it does not prove the entire reserve potential of the field.

Often, several exploratory wells will be drilled in a large field.

To model the full-cycle economics of a play such as this, great care would be taken to understand the timing, chance, and reserves associated with each exploratory well.

Full-cycle economics provides a more accurate analysis of the sensitivity of exploration programs to pre-drilling investments.

The economic sensitivity of a play to land costs, for example, can easily be determined.

The sensitivity of a play or exploration program to oil and gas prices can also be easily understood.

SUMMARY

Full-cycle economics is a useful means of assessing the economic potential of exploratory plays over time.

The economics of an exploration program cannot be assessed by well (AFE) economics alone. The full-cycle economic potential of plays can be compared to help focus on exploration program on the most economically favorable plays. In this way, full-cycle economics can help a company plan for success.