Chapter 41

Valuation of Oil and Gas Reserves

Forrest A. Garb, H.J. GJII~& Timothy A. Larson, Ernst&
Ass,ocs * Whitney

Types of Oil and Gas Property Ownership

The most common types of oil and gas property ownership in the U.S. are mineral interests, working interests, royalties, overriding royalties. net-profits interests. and production payments. A mineral interest in a property is a part of the fee simple interest. In most states, the mineral interest can be severed from the surface interest and transferred by a mineral deed (in Louisiana, the mineral and surface interest cannot be severed in perpetuity). The owner of the minerals, either through fee simple title or by a mineral deed, can exccutc a lease of the oil and gas rights. Consideration paid for a lease is called a lease bonus. During the primary term of the lease, it can be held by paying rentals. production, or drilling activities. The rentals, usually called delay rentals, are paid in lieu of drilling or production. From an income-tax standpoint, these rentals are ordinary income to the lessor and arc deductible by the lessee. For tax purposes, a bonus must be capitalized as a part of the cost of the lease by the lessee. This bonus is income that is subject to depletion for the mineralinterest owner; although if the lease is not eventually productive, the depletion taken must be restored to income in the year the lcase is proved worthless. A royalty or royalty interest is the mineral owner share of production free of the cxpcnse of producs tion. It is distinguished from a mineral interest by the absence of operating rights. The basic royalty interest usually is expressed as a fraction of the total production, such as g of %. !&of %. Royalty has historically been subject to production taxes. federal excise taxes [Windfall Profits Tax (WPT)], and in some states, old ~~lore~t taxes. An overriding royalty interest is an interest in oil and gas produced free of the expense of production and in addition to the usual landowner royalty. It continues s for the life of the lease and is sub,ject to production taxes. taxes. An WPT taxes, and in some states. ud ~~7lowr77
Author of the arlglnal chapter was Jan J Arps (deceased)

overriding royalty interest is commonly expressed as a fraction of the revenue accruing to the working interest; for example, of 7/, of the total oil and gas produced. /8 In some areas, such as the Rocky Mountains, overriding royalties are often expressed as a percentage of % of the total oil and gas produced. A *net-profits interest is a share of the gross production measured by the lessee net profits from the operas tion of a specific tract of land. It is normally carved out of the working interest. A carried interest is a fractional interest in an oil and gas property that gives the owner no personal obligation for operating or development costs. The operaing or development costs attributable to such fractional interest are borne and paid by the owners of the remaining fractional working interest, who recoup such expenditures or an agreed sum out of production from the property. A production payment is a share of the oil, gas, and other minerals produced from a tract of land, free of the cost of production, that terminates when a specific sum from the sale of the oil, gas, and other minerals has been realized by the owner of the interest. There is no personal liability to pay the sum specified in the instrument creating the production payment: the owner looks only to production from the tract of land for the sum specified. A production payment is usually expressed in dollars and may carry an incremental payment computed in the manner of interest. A production payment is said to be carved out when it is transferred out of another oil and gas interest. It is reserved when the interest is retained by the seller upon the sale of another oil and gas interest. Production payments limited to oil or gas only are called oil payment or gas payment, respectively. A reversionary interest is usually a portion of the working interest that reverts to another party on the occurrence of some defined event. This event is often the payout of the investment or some multiple of the investment or may bc the passing of some defined time period.

41-2

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.1--REVENUE

INTERESTS

A owns: l/s B/eless /aof I/* Ve less /a J/s a/8, or s/s4 */8) of of of of (of or R/=0.07812 ~OWnS:/40f1/gOf8/or1,&(of8/g)or ,..,, ,...... R/=0.03125 _... R/=0.01562 DOwnS:1/gOf1/80f8/g0r1/6~(Of8/g)Or

All or any part of each of these oil and gas interests may be purchased, sold, or mortgaged at the owner s election. Each economic interest in a property represents the right to a certain fraction of the gross income from the sales of oil and gas [revenue-interest fraction (RI)], and an obligation to pay a certain fraction of the cost of production [workinginterest fraction (WI)]. In the case of royalty interests, overriding royalty interests, carried interests, and production payments. the WI is zero because these interests are free of the cost of production. s A working interest is the lessee or operating interest under an oil and gas lease. The typical oil and gas lease provides for a royalty to be paid to the lessor or other royalty owners, free of the expenses of production; the balance of the production represents the working interest of the lessee, and this part of the production bears the entire expense of production. The working interest created by an oil and gas lease may be further divided by the creation of overriding royalties, production payments, netprofits interests. and carried working interests. When there is one lessee under an oil and gas lease, he must pay the entire cost of production and his WI is 100%. Where two or more lessees jointly own a lease, the WI of each lessee when totaled should add up to 100% of the working interest under such lease. The various co-owners of such a lease normally enter into an operating agreement and designate an operator of the property. For example, for a joint-interest owner who owns a quarter of the working interest, the WI equals 0.25. The WI is in effect equal to the fraction of the cost of production that a lessee has to pay. An RI, also referred to as net interest or division-order interest, is a fractional interest in the total gross revenue from a tract of land that represents the actual quantity of total oil and gas produced from such land attributable to an oil and gas interest in such land. An RI is commonly expressed as a decimal fraction of % of the gross revenue from such production. An example may clarify the system. Landowner A leases his land for oil and gas purposes to D, retaining the usual royalty interest. In order to hedge against non/

productive development, A sells 5/4of his x royalty to B and l/8of his )/8to C. A, B, and C thus become the royalty owners under the land mentioned above. Their RI are computed in Table 4 1.1. s D, the original lessee, then conveys the lease to E, retaining x6 of overriding-royalty interest. The lease is /s now said to be burdened with a x6 override. D now owns l/j6 of or x2s, or RI=0.05469. /8 To support him with his development and operating costs, E now sells one-fourth of his interest in the lease to F. E now owns W of (7/sof % less x6 of 7/sof %) or 31s / 512, or RI=0.61524, while paying U of the costs or WI=O.75. F now owns i/4 of ( of % less x6 of x of /B or %I or 10%121 RI=0.20508 while paying i/4 of the costs or WI=O.25. The working- and revenue-interest fractions pertaining to the various economic interests in this example should now each add up to unity, as shown in Table 4 1.2.

Valuation2-13
Determination of Fair Market Value Fair market value of an oil- or gas-productive property, as commonly understood, is the price at which the property would be sold after exposure to the market for a reasonable period of time by a willing seller to a willing buyer, neither being under compulsion to buy or to sell, and both being competent and having reasonable knowledge of the facts. Fiske,3 presenting the viewpoint of the Internal Revenue Service in 1956, listed six methods used to determine the fair market value in order of preferential weight: (1) an actual sale of the property near the valuatton date: (2) a bona tide offer to sell or purchase the property near the valuation date; (3) actual sales of similar properties in the same or nearby oil and gas fields near the valuation date; (4) valuations made for purposes other than federal taxation near the valuation date; (5) analytical appraisals; and (6) opinions of qualified oil or gas operators. This section deals with the determination of the fair market value of oil and gas properties by the analytical- or engineering-appraisal method, enumerated by Fiske as

TABLE

41.2-WORKING

AND

REVENUE

INTEREST

FRACTIONS RevenueInterest Fraction (decimal fraction of revenue) 0.07812 0.03125 0.01562 0.05469 0.61524 0.20508 1 .ooooo

Fractionof Working Interest (decimal fraction of costs) Landowner (Lessor) Royalty Owner Royalty Owner Overridtng-Royalty Owner Operator Nonoperator Total 0 0 0 0 0.75 0.25 1.00

VALUATION

OF OIL AND

GAS

RESERVES

41-3

Item 5. With this method, the appraiser estimates the recoverable hydrocarbon reserves from the property and appraises the probable future net income or cash flow to be realized from the production and sale of these reserves. While fair market value for a hydrocarbon-producing property is not a precise number, it can be approximated within rather close limits by use of the engineeringappraisal method. 3 Preparing a Cash-Flow Projection For the purpose of determining future net income or cash flow, oil and gas production should be forecast on information about future demand for petroleum or on the basis of purchase contracts if these govern but should not exceed the physical ability of the well or wells to produce. Where proration or market curtailment is in force, trends in oil and gas allowables or market should be considered. Usually, the gross income from oil and gas sales to be obtained from such production is based by the appraiser on current posted prices for crude oil and on predicted economic conditions. The constant price projections are required for financing and Securities Exchange Commission filings, while the predicted prices that are based on economic studies are used for business decisions. Gas prices should be based on gas-purchase contracts in force on the properties being appraised. The effect of escalation clauses in such gas-purchase contracts. which are subject to future approval by regulatory agencies, are usually set out separately. In most states, oil and gas production is subject to state, county. and local taxes payable by the producer. The producer customarily charges the appropriate part of these taxes to the various interests in a given property. Tax rates on oil and gas production in the various states have historically varied and may be obtained from the state regulatory agency. The taxes are usually collected by the pipeline company by deduction from the runs. Corporation or private income taxes are normally considered outside the scope of an oil and gas property valuation, but some valuation formulas make indirect allowance for them. Tax ramifications can totally change the economics of a proposed transaction and related cvaluation. For certain purposes, such as bank evaluations, income taxes, as an inherent part of the future income, are sometimes specifically included in the forecast. Operating or production costs comprise the expenses required to produce the oil and gas and to maintain the leases. These costs, usually called direct lifting costs, include the cost of labor, field supervision, power, fuel, repairs, stimulation and/or recompletion of wells, plant repairs, transportation, insurance, and other such items. As the age of the wells increases, additional expenditures may have to be made to keep the wells in operating condition and possibly for disposal of produced salt water. Capital expenditures include the cost of construction of gasoline plants, repressuring systems. additional development wells, artificial lifting equipment, engines. tanks, and other durable items required to produce all the economically recoverable oil. An owner of a working interest in oil or gas properties pays the full amount of his working-interest share of direct costs and capital expenditures, but he pays production and federal excise taxes only on the production to his net

revenue interest. Royalty or overriding royalty interests, however, ordinarily bear none of the normal lifting costs or capital expenditures but do bear production and federal excise taxes on their revenue-interest portion of the oil or gas produced. The gross income to be realized from the production of the revenue-interest portion of the oil and gas reserves, when reduced by the amounts necessary for production and federal excise taxes, the working-interest share of operating expenses, repairs, recompletions, and additional capital expenditures, is the future net income or the net cash flow generated from the production of the estimated oil and gas reserves. Salvage value of equipment at the time of abandonment is ordinarily not included in the cashflow projection because such income is usually offset by the cost of properly plugging and abandoning the property in compliance with state regulations. An exception is sometimes made where the life of the property is short and such salvageable equipment minus abandonment costs constitutes a major part of the value. After the technical analysis of the properties has been made, which results in a determination of the volume and rate of production of oil and gas, and these data have been reduced to a projection of future operating net income or cash flow, it becomes necessary to establish the appraisal value. Analytical Methods for Computation of Appraisal Value Although there are many methods for computing appraisal value, only the most popular will be discussed. All these compute the appraisal value of a property by the discounted-cash-flow procedure and give proper weight to the time pattern of future income. Appraisal values that are based on a given fraction of the undiscounted future cash income or on payout in a given number of years do not meet this requirement and are not included. The examples provided are from the original edition of this handbook and reflect the economic conditions current at that time. The methodology remains valid, however, and any values in the examples would be subject to change with time. Appraisal value equal to a fraction of the present worth of the net cash flow before federal taxes computed at a safe rate of interest. Method 1 is relatively simple, easy to understand, and widely used. It is based on the premise that future income should only be discounted at an interest rate that reflects the current-time value of money and that such interest rate-which fluctuates with the prevailing cost of money-is not used as a vehicle for the risk factor. In its application, the combined present worth of the future operating net income or cash flow is calculated by discounting the future annual cash-flow increments at prevailing or projected compound interest rates. An example of such a present-worth computation at an interest rate of lO%/yr is shown in Table41.3. While Table41.3 is a hand calculation, most calculations are made with electronic data processing equipment, as shown in Table 41.4. The total present worth of the future net operating income, which in this example is $1,499,941, is not to be construed as the market value of the oil or gas property. The purchaser of such a property logically is entitled to

41-4

PETROLEUM

ENGINEERING

HANDBOOK

TABLE 41.3-CASH-FLOW PROJECTION AND PRESENT-WORTH CALCULATION FOR XYZ OIL COMPANYS INTEREST IN PRODUCING OIL PROPERTY
Operakx Revenue Working XYZ Interest, co. RI = 0 375 011 Sales Price = $29 OO/bbl Productron Taxes =~.WO Estimated Operatlnq plus $0 0019/bbl = 5800 OO/well-month Expenses Lease Mary Jones Creek Freld Rock State: Texas Acres, 100 No of Wells Operation 111185 50.301 Rlx Step 1 Step 3 x Price (0 046 x step 3]+ [O 0019 x step Z] well-months wells x months 18.863 547.023 25,199 12 9.600 1II186 42,570 15,964 462,949 21,326 12 9.600 l/1/87 30,738 11,527 334,276 15,399 12 9,600 111188 24,180 9,068 262,957 12,113 12 9.600 111189 19.490 7.309 211.954 9,764 12 9,600 l/1/90 13.847 5,193 150.586 6,937 12 9.600 l/l/91 4,506 1.690 49.003 2,258 12 9,600 1 Total 185,632 69,614 2.018.748 92,996 84 67,200

Interest:WI = 0.500

Date of Evaluation l-l-85 Step 1 2 3 4 5 6 7 8 Estimated Gross Future

lease

productron. bbl Net productron to XYZ. bbl 011 revenue. dollars Production taxes, dollars Producing

Operating costs. dollars Step 5 x $800 Capital expendttures, dollars XYZ share of operating WI x [Step 6+ Step 71 plus capital costs, dollars

4.800 14,336 4.800 7,982 428,841 08668 371,713 4,800 4,957 309.120 0.7880 243.582 4.800 3,174 242,870 0.7164 173,980 4,800 1,973 195,417 06512 127,261 4.800 987 137.862 0.5920 81.618 4,800 152 41.793 0.5382 22,493 1,499.941 33.600 33,561 1.858.591

9 10 11 12

Net federal excise* (WPT). dollars Future net revenue. dollars 10% annual deferment F,, =(Step 1 +i) - 09535 479,294 factor (Table 41 11) Present worth of XYZs cash flow Step 3 - Step 4 -Step 8 - Step 9 502,688

TABLE
XYZ 011 co

41.4-PROJECTION

OF ESTIMATED

PRODUCTION
011

AND

REVENUE

AS OF JAN. 1, 1985
XYZ Mary Rock Texas 011 co Jones Creek Freld

Working Net Gas

Interest Interest

0.500000 0.375000 0.375000 Future Production 011 or Condensate Gas Gross (Mscf) ~ Net (Mscf)

Proved Pnmary Producing

lmtlalWells 1

Net Oil lnteresl

Future Gross 011 Revenue 547.023 462,949 334,276 262,957 211,954 150.586 49.003 2.018.748 0

Revenue

Before Production Taxes Total Revenue 547.023 462,949 334,276 262,957 211,954 150.586 49,003 2.018.748 0 2.018.748 ProductIon Taxes 25,199 21.326 15,399 12,113 9,764 6,937 2,258 92.996 0 92,996 WFPTX($) 14,336 7.982 4,957 3,174 1.973 987 152

(dollars) Costs 19,136 12,782 9.757 7.974 6.773 5.787 4.952 67.161 0 67.161

Future Net Revenue ~ 502.688 428.841 309,120 242,870 195,417 137,862 41,793 1.858.591 0 1.858.591

Discounted Value at 10 00% 479,294 371.713 243,582 173,980 127,261 81.618 22,493 1.499.941 0 1.499.941 ($)

Number Year 1985 1986 i987 1988 1989 1990 1991 Sub Total Remainlna Total The Wells 1 1 1 1 1 1 1 0

of

Gross WI) 50,301 42,570 30,738 24,180 19,490 I 3,847 4,506 185.632 0 185,632

Net (bbl) 18.863 15,964 11,527 9,068 7.309 5,193 1,690 69,614 0 69,614

Gas Revenue

2.018.748 Prices and Windfall Profit Taxes Year 1985 1986 1987 1988 1989 1990 1991 $/bbl 29 00 29 00 29 00 29 00 29 00 29 00 29 00

asof-date gross oil pnce = $29 OO/bbl. tax tier3.

$/Mscf

Year $/bbl $/Mscf WFPTX

Total WFP

Tax

=$33.561

VALUATION

OF OIL AND

GAS

RESERVES

41-5

TABLE

41 S-DISCOUNTED

FUTURE

NET CASH

INCOME

VS. PROPERTY

LIFE

Average 5% Deferment Factor on Cash-Flow Protection 0.82 through 0.70 through 0.52 through 0.40 through 0.70 0.52 0.40 0.32

Equivalent Constant-Rate Production (wars) 8 15 30 45 through through through through 15 30 45 60

Percentage of 5% Discounted Value of Future Number of Net Cash Income Transactions Paid 11 13 6 4 60 50 58 68 through through through through 84 89 89 98

Average Percentage of 5% Dtscounted Value of Future Net Cash Income Paid 71 70 75 78

a profit above the bank interest rate. Also, when cash flow is computed by this method, the federal income taxes on the operating net income usually are not deducted, and allowance must be made for them. In addition, a risk-ofdoing-business factor is usually included. Depending on whether cost-depletion or percentagedepletion allowance is applicable and depending on the amounts of future intangible development expenditures and equipment depreciation, thih federal income tax liability will vary on the basis of the tax rate applicable to the interest owner. The profit margin required in the transaction may also vary widely because of risks inherent in the operation of the property and the respective trading ability of the parties to the transaction. In addition, in the opinion of many operators, the longterm inflationary trend may put a premium on future income from sales of a basic raw material, such as crude oil or natural gas. Prospective purchasers should. therefore, weigh all these factors with the federal taxes payable and the risks of the operations as negative factors and the inflationary effects and possible additional romance in the transaction as plus factors. Thus they can arrive at the proper fraction of the present worth at some safe interest rate that they are willing to pay. In a speech presented at the Petroleum Engineers Club of Dallas, Oct. 17, 1952, H.J. Gruy considered as fair market value two-thirds of future net cash income before amortization and federal taxes, discounted at 5 %/yr. This methodology is still in use. However, the discount rate at the time of the evaluation is substituted for the 5 %/yr rate. A study by Garb et al. in 1981 indicated that, in spite of varying tax and economic conditions, one classic yardstick for estimating the value of oil in the ground had remained reasonably constant through the years. An analysis of IO major transactions during the period 1979-8 I, a volatile oil-price period, indicated that oil reserves in the ground demonstrated a market value of approximately one-third of their posted wellhead price. Dodson listed in 1959, among some seven different methods that may be used to determine the fair market value of oil and gas reserves, percentages of the present worth, which may vary from 50 to 100% but which recently have been from 75 to 80 % A study by Arpsh of 34 actual property transactions made during the postwar years in the mid-continent, gulf coast, and California showed that the percentage of the 5% discounted value of future net cash income (before amortization and federal taxes) paid for these properties varied with their future lives. as shown in Table 41.5.

These data show a tendency for the average percentages of the last column to increase when the estimated life of the properties becomes longer. In none of these transactions did the total consideration exceed two-thirds of the updiscounted future net cash income before federal taxes. Fagin introduced an empirical market-value yardstick that is based on the trend in actual prices paid for producing properties during the postwar years in longlife fields such as East Texas (see Table 41.6). To find the market value by this yardstick for constant-rate production of a similar character, the percentage shown in Co]. 3 of the market-value-yardstick table for the applicable number of years of constant-rate production of Col. 2 of this table is determined. This percentage is then multiplied with the average 5% deferment factor of Col. I and with the undiscounted future net cash flow to yield the estimated market value. Example Problem 1. A property with an estimated future net cash flow of $1 ,OOO.OOO a IO-year constantand value of rate life would have a market 0.73x0.79x$1,000,000=$577,000. Solution. When the given cash-flow projection does not show a constant rate, the appropriate percentage is found in Co]. 3, which corresponds to the applicable average 5% deferment factor from Col. I of Table 41.6. This percentage is then multiplied by the average 5%deferment factor of Col. I and by the undiscounted future net cash flow to yield the estimated market value. Example Problem 2. A property with an estimated future net cash flow of $500,000. which has a 5 % discounted value of $375,000 (average deferment factor 0.75). would have a market value of 0.72 x0.75 x $SOO,OOO= $270,000.

TABLE

41.6-FAGINS

MARKET-VALUE

YARDSTICK Market Value as Percentage of 5% Discounted Value of Future Net Cash Flow 79 73 71 68 66 70 71

Average 5% Deferment Factor on Cash Flow Projection 0.88 0.79 0.70 0.63 0.52 0.44 0.32

Equivalent Constant-Rate Projection Wars) 5 10 15 20 30 40 60

41-6

PETROLEUM

ENGINEERING

HANDBOOK

TABLE Year 2 3 4 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 2% 0.9901 0.9708 0.9517 0.9330 0.9147 0.8968 0.8792 0.8620 0.8451 0.8285 0.8123 0.7964 0.7807 0.7654 0.7504 0.7357 0.7213 0.7071 0.6932 0.6797 0.6664 0.6533 0.6405 0.6279 0.6156 0.6035 0.5917 0.5801 0.5687 0.5576 0.5466 0.5359 0.5254 0.5151 0.5050 0.4951 0.4854 0.4759 0.4665 0.4574 0.4484 0.4396 0.4310 0.4226 0.4143 0.4062 0.3982 0.3904 0.3827 0.3752 3% 0.9853 0.9566 0.9288 0.9017 0.8754 0.8500 0.8252 0.8012 0.7778 0.7552 0.7332 0.7118 0.6911 0.6710 0.6514 0.6324 0.6140 0.5961 0.5788 0.5619 0.5456 0.5297 0.5142 0.4993 0.4847 0.4706 0.4569 0.4436 0.4307 0.4181 0.4059 0.3941 0.3826 0.3715 0.3607 0.3502 0.3400 0.3301 0.3205 0.3111 0.3021 0.2933 0.2847 0.2764 0.2684 0.2606 0.2530 0.2456 0.2384 0.2315

41.7-MIDYEAR 4% ~ 0.9806 0.9429 0.9066 0.8717 0.8382 0.8060 0.7750 0.7452 0.7165 0.6889 0.6624 0.6370 0.6125 0.5889 0.5663 0.5445 0.5235 0.5034 0.4841 0.4654 0.4475 0.4303 0.4138 0.397s 0.3825 0.3678 0.3537 0.3401 0.3270 0.3144 0.3023 0.2907 0.2795 0.2688 0.2584 0.2485 0.2389 0.2297 0.2209 0.2124 0.2042 0.1964 0.1888 0.1816 0.1746 0.1679 0.1614 0.1552 0.1492 0.1435

LUMP-SUM 4'12% ~ 0.9782 0.9361 0.8958 0.8572 0.8203 0.7850 0.7512 0.7188 0.6879 0.6583 0.6299 0.6028 0.5768 0.5520 0.5282 0.5055 0.4837 0.4629 0.4429 0.4239 0.4056 0.3882 0.3714 0.3554 0.3401 0.3255 0.3115 0.2981 0.2852 0.2729 0.2612 0.2499 0.2392 0.2289 0.2190 0.2096 0.2006 0.1919 0.1837 0.1758 0.1682 0.1609 0.1540 0.1474 0.1410 0.1350 0.1291 0.1236 0.1183 0.1132 5% 0.9759 0.9295 0.8852 0.8430 0.8029 0.7646 0.7282 0.6936 0.6605 0.6291 0.5991 0.5706 0.5434 0.5175 0.4929 0.4694 0.4471 0.4258 0.4055 0.3862 0.3678 0.3503 0.3336 0.3177 0.3026 0.2882 0.2745 0.2614 0.2489 0.2371 0.2258 0.2150 0.2048 0.1951 0.1858 0.1769 0.1685 0.1605 0.1528 0.1456 0.1386 0.1320 0.1257 0.1197 0.1140 0.1086 0.1034 0.0985 0.0938 0.0894

DEFERMENT

FACTORS 6% 6%% 0.9690 0.9099 0.8543 0.8022 0.7532 0.7073 0.6641 0.6236 0.5855 0.5498 0.5162 0.4847 0.4551 0.4273 0.4013 0.3768 0.3538 0.3322 0.3119 0.2929 0.2750 0.2582 0.2425 0.2277 0.2138

FLs=(l+~J'h-' 7% 0.9667 0.9035 0.8444 0.7891 0.7375 0.6893 0.6442 0.6020 0.5626 0.5258 0.4914 0.4593 0.4292 0.4012 0.3749 0.3504 0.3275 0.3060 0.2860 0.2673 0.2498 0.2335 0.2182 0.2039 0.1906 0.1781 0.1665 0.1556 0.1454 0.1359 0.1270 0.1187 0.1109 0.1037 0.0969 0.0905 0.0846 0.0791 0.0739 0.0691 0.0646 0.0603 0.0564 0.0527 0.0493 0.0460 0.0430 0.0402 0.0376 0.0351

3'/2% 0.9829 0.9497 0.9176 0.8866 0.8566 0.8276 0.7996 0.7726 0.7465 0.7212 0.6968 0.6733 0.6505 0.6285 0.6072 0.5867 0.5669 0.5477 0.5292 0.5113 0.4940 0.4773 04612 0.4456 0.4305 0.4159 0.4019 0.3883 0.3751 0.3625 0.3502 0.3384 0.3269 0.3159 0.3052 0.294s 0.2849 0.2753 0.2659 0.2570 0.2483 0.2399 0.2318 0.2239 0.2163 0.2090 0.2020 0.1951 0.1885 0.1822

5 % 12
0.9736 0.9228 0.8747 0.8291 0.7859 0.7449 0.7061 0.6693 0.6344 0.6013 0.5700 0.5403 0.5121 0.4854 0.4601 0.4361 0.4134 0.3918 0.3714 0.3520 0.3337 0.3163 0.2998 0.2842 0.2693 0.2553 0.2420 0.2294 0.2174 0.2061 0.1953 0.1852 0.1755 0.1664 0.1577 0.1495 0.1417 0.1343 0.1273 0.1207 0.1144 0.1084 0.1027 0.0974 0.0923 0.0875 0.0829 0.0786 0.0745 0.0706

i % h
0.9645 0.8972 0.8346 0.7764 0.7222 0.6718 0.6249 0.5813 0.5408 0.5031 0.4680 0.4353 0.4049 0.3767 0.3504 0.3260 0.3032 0.2821 0.2624 0.2441 0.2271 0.2112 0.1965 0.1828 0.1700 0.1582 0.1471 0.1369 0.1273 0.1184 0.1102 0.1025 0.0953 0.0887 0.0825 0.0767 0.0714 0.0664 0.0618 0.0575 0.0535 0.0497 0.0463 0.0430 0.0400 0.0372 0.0346 0.0322 0.0300 0.0279

8% 0.9623 0.8909 0.8249 0.7639 0.7073 0.6549 0.6064 0.5615 0.5199 0.4814 0.4457 0.4127 0.3821 0.3538 0.3276 0.3033 0.2809 0.2601 0.2408 0.2230 0.2064 0.1912 0.1770 0.1639 0.1517 0.1405 0.1301 0.1205 0.1115 0.1033 0.0956 0.0885 0.0820 0.0759 0.0703 0.0651 0.0603 0.0558 0.0517 0.0478 0.0443 0.0410 0.0380 0.0352 0.0326 0.0301 0.0279 0.0258 0.0239 0.0222

8 % /2 0.9600 0.8848 0.8155 0.7516 0.6927 0.6385 0.5884 0.5423 0.4999 0.4607 0.4246 0.3913 0.3607 0.3324 0.3064 0.2824 0.2603 0.2399 0.2211 0.2038 0.1878 0.1731 0.1595 0.1470 0.1355 0.1249 0.1151 0.1061 0.0978 0.0901 0.0831 0.0766 0.0706 0.0650 0.0599 0.0552 0.0509 0.0469 0.0432 0.0399 0.0367 0.0339 0.0312 0.0288 0.0265 0.0244 0.0225 0.0208 0.0191 0.0176

0.9713 0.9163 0.8645 0.8155 0.7693 0.7258 0.6847 0.6460 0.6094 0.5749 0.5424 0.5117 0.4827 0.4554 0.4296 0.4053 0.3823 0.3607 0.3403 0.3210 0.302s 0.2857 0.2695 0.2543 0.239s 0.2263 0.2135 0.2014 0.1900 0.1793 0.1691 0.1595 0.1505 0.1420 0.1340 0.1264 0.1192 0.1125 0.1061 0.1001 0.0944 0.0891 0.0840 0.0793 0.0748 0.0706 0.0666 0.0628 0.0592 0.0559

0.2007 0.1885 0.1770 0.1662 0.1560 0.1465 0.1376 0.1292 0.1213 0.1139 0.1069 0.1004 0.0943 0.0885 0.0831 0.0780 0.0733 0.0688 0.0646 0.0607 0.0570 0.0535 0.0502 0.0472 0.0443

While the examples use a 5 % discount factor that is no longer valid, the methodology remains valid. Users of this technique should use discount rates appropriate for the time of the evaluation. Appraisal value equal to the present value of the net cash flow before federal taxes computed at a speculative rate of interest. Unlike Method 1, the profit margin over and above bank interest rates to take care of inherent risks and federal income tax liabilities is incorporated in Method 2 the higher discount rate. The possible range of such speculative rates of return is reflected by various quotations from the literature. This method is, again, fairly

simple in its application, because federal income taxes are not included in the computation. Use of Method 2 leads to comparatively high market values for properties of very short life. Because experience shows that very few transactions are made where the total consideration exceeds two-thirds of the future net cash income, experienced engineers in such cases usually limit their appraisal value to this maximum. This formula also tends to discriminate against long-life transactions because high speculative rates of return compound rapidly and reduce the value of cash-flow increments 20 to 30 years, hence to very small amounts. For example, Table 41.7 shows that the midyear lump-sum deferment

VALUATION

OFOILANDGASRESERVES

41-7

TABLE Year 1 2 3 4 5 6 7 8 9 IO 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 46 49 50 9% 0.9578 0.8787 0.6062 0.7396 0.6785 0.6225 0.5711 0.5240 0.4807 0.4410 0.4046 0.3712 0.3405 0.3124 0.2866 0.2630 0.2412 0.2213 0.2031 0.1863 0.1709 0.1568 0.1438 0.1320 0.1211 0.1111 0.1019 0.0935 0.0858 0.0787 0.0722 0.0662 0.0608 0.0557 0.0511 0.0469 0.0430 0.0395 0.0362 0.0332 0.0305 0.0280 0.0257 0.0235 0.0216 0.0198 0.0182 0.0167 0.0153 0.0140 9% % 0.9556 0.8727 0.7970 0.7279 0.6647 0.6070 0.5544 0.5063 0.4624 0.4222 0.3856 0.3522 0.3216 0.2937 0.2682 0.2450 0.2237 0.2043 0.1866 0.1704 0.1556 0.1421 0.1298 0.1185 0.1082 0.0988 0.0903 0.0824 0.0753 0.0688 0.0628 0.0573 0.0524 0.0478 0.0437 0.0399 0.0364 0.0333 0.0304 0.0277 0.0253 0.0231 0.0211 0.0193 0.0176 0.0161 0.0147 0.0134 0.0123 0.0112

41.7-MIDYEAR 10% 0.9535 0.8688 0.7880 0.7163 0.6512 0.5920 0.5382 0.4893 0.4448 0.4044 0.3676 0.3342 0.3038 0.2762 0.2511 0.2283 0.2075 0.1886 0.1715 0.1559 0.1417 0.1288 0.1171 0.1065 0.0968 0.0880 0.0800 0.0727 0.0661 0.0601 0.0546 0.0497 0.0452 0.0411 0.0373 0.0339 0.0308 0.0280 0.0255 0.0232 0.0211 0.0192 0.0174 0.0158 0.0144 0.0131 0.0119 0.0108 0.0098 0.0089 12% 0.9449 0.8437 0.7533 0.6726 0.6005 0.5362 0.4787 0.4274 0.3816 0.3407 0.3042 0.2716 0.2425 0.2165 0.1933 0.1726 0.1541 0.1376 0.1229 0.1097 0.0980 0.0875 0.0781 0.0697 0.0623 0.0556 0.0496 0.0443 0.0396 0.0353 0.0315 0.0282 0.0251 0.0224 0.0200 0.0179 0.0160 0.0143 0.0127 0.0114 0.0102 0.0091 0.0081 0.0072 0.0065 0.0058 0.0051 0.0046 0.0041 0.0037

LUMP-SUM 15% 0.9321 0.8105 0.7046 0.6129 0.5329 0.4634 0.4030 0.3504 0.3047 0.2650 0.2304 0.2003 0.1742 0.1515 0.1317 0.1146 0.0996 0.0866 0.0753 0.0655 0.0570 0.0495 0.0431 0.0374 0 0326 0.0283 0.0246 0.0214 0.0186 00162 0.0141 0.0122 0.0106 0.0093 0 0080 0.0070 0.0061 0.0053 0.0046 0.0040 00035 0.0030 0.0026 0.0023 00020 0 0017 0.0015 0.0013 0.0011 0.0010 20%

DEFERMENT 25% 0.8945 0.7156 0.5724 0.4579 0.3664 0.2931 0.2345 0.1876 0.1501 0.1200 0.0960 0.0768 0.0615 0.0492 0.0393 0.0315 0.0252 0.0201 0.0161 0.0129 0.0103 0.0082 0.0066 0.0053 0.0042 0.0034 0.0027 0.0022 0.0017 0.0014 0.0011 0.0009 0.0007 0.0006 0.0005 0.0004 0.0003 0.0002 0.0002 0.0001 0.0001

FACTORS 30% 0.8770 0.6747 0.5190 0.3992 0.3071 0.2362 0.1817 0.1398 0.1075 0.0827 0.0636 0.0489 0.0376 0.0290 0.0223 0.0171 0.0132 0.0101 0.0076 0.0060 0.0046 0.0035 00027 0.0021 0.0016 0.0012 0.0010 0.0007 0.0006 00004 0 0003 0.0003 00002 0.0002 0 0001 35%

f Ls =(I + i)/- (continued) 40% 0.8452 0.6037 0.4312 0.3080 0.2200 0.1571 0.1122 0.0802 0.0573 0.0409 0.0292 0.0209 0.0149 0.0106 0.0076 0.0054 0.0039 0.0028 0.0020 0.0014 0.0010 0.0007 0.0005 0.0004 0.0003 0.0002 0.0001 45% 0.8304 0.5727 0.3950 0.2724 0.1879 0.1296 0.0894 0.0616 0.0425 0.0293 0.0202 0.0139 0.0096 0.0066 0.0046 0.0032 0.0022 0.0015 0.0010 0.0007 0.0005 0.0003 0.0002 0.0002 0.0001 50% 0.8165 0.5443 0.3629 0.2419 0.1613 0.1075 0.0717 0.0478 0.0319 0.0212 0.0142 0.0094 0.0063 0.0042 0.0028 0.0019 0.0012 0.0008 0.0006 0.0004 0.0002 0.0002 0.0001 60% 0.7906 0.4941 0.3088 0.1930 0.1206 0.0754 0.0471 0.0295 0.0184 0.0115 0.0072 0.0045 0.0028 0.0018 0.0011 0.0007 0.0004 0.0002 0.0001 70% 0.7670 0.4512 0.2654 0.1561 0.0918 0.0540 0.0318 0.0187 0.0110 0.0065 0.0038 0.0022 0.0013 0.0008 0.0005 0.0003 0.0002

0.9129 0.7607 0.6340 0.5283 0.4402 0.3669 0.3057 0.2548 0.2123 0.1769 0.1474 0.1229 0.1024 0.0853 0.0711 0.0593 0.0494 0.0411 0.0343 0.0286 0.0238 0.0198 0.0165 0.0138 0.0115 0.0096 0.0080 0.0066 0.0055 0.0046 0.0038 0.0032 0.0027 0.0022 0.0019 0.0015 0.0013 0.0011 0.0009 0.0007 0.0006 0.0005 0.0004 0.0004 0.0003 0.0002 0.0002 0.0002 0.0001 0.0001

0.8607 0.6375 0.4722 0.3498 0.2591 0.1919 0.1422 0.1053 0.0780 0.0578 0.0428 0.0317 0.0235 0.0174 0.0129 0.0095 0.0071 0.0052 0.0039 0.0029 0.0021 0.0016 0.0012 0.0009 0.0006 0.0005 0.0004 0.0003 0.0002 0.0001 0.0001

factor for income received in Year 30 amounts to 0.2371 for 5% interest, 0.0601 for 10% interest, and 0.0046 for 20% interest. Because of these shortcomings, the use of Method 2 is not recommended, particularly when longlife properties are involved with a high profit-toinvestment ratio. In a speech presented at the Oil and Gas Inst. in Dallas, March 26, 1949, E.L. DeGolyer commented, It is rather surprising that more often than not the latter method, i.e. one-half of a 4% discounted future net revenue, is very close to the future net revenue (before amortization and federal taxes) discounted at 10 % per /z year. Dodson listed in 1959 among some seven different methods that may be used to determine the fair market

value of oil and gas reserves, rate of return on investment of apparently 14% or more. From a study of five actual and representative valuations that have served as a basis for settlement for gift or ad valorem taxes, Reynolds concluded in 1959 that: The range of from 13% to 21% annual rate of return before tax adjustments provides limits on which the engineer can operate. He also observed that the data from these appraisals indicate that the project with a short life will demand a higher rate of return than one with a long life and low risk. This is probably caused by the investors long-range faith in the oil industry, the belief that higher prices per unit are in the offing, and the fact that less money management is necessary for reinvesting earnings.

41-8

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TABLE Year 1 2 3 4 5 6 7 8 9 IO 11 12 13 14 15 16 80% 0.7454 0.4141 0.2300 0.1278 0 0710 0.0394 0.0219 0.0122 0.0068 0.0038 0 0021 0 0012 0.0006 0.0004 0.0002 0.0001 90%

41.7-MIDYEAR 100% 0.7071 0.3536 0.1768 0.0884 0.0442 0.0221 0.0110 0.0055 0.0028 0.0014 0.0007 0.0003 0.0002 1 10%

LUMP-SUM 120% 0.6742 0.3065 0.1393 0.0633 0.0288 0.0131 0.0059 0.0027 0.0012 0.0006 0.0003 0.0001

DEFERMENT 130% 0.6594 0.2867 0.1246 0.0542 0.0236 0.0102 0.0045 0.0019 0.0008 0.0004 0.0002 140%

FACTORS 150% 0.6325 0.2530 0.1012 0.0405 0.0162 0.0065 0.0026 0.0010 0.0004 0.0002

F,, =(7 +i)- (continued) 160% 0.6202 0.2385 0.0917 0.0353 0.0136 0.0052 0.0020 0.0008 0.0003 0.0001 170% 0.6086 0.2254 0.0835 0.0309 0.0115 0.0042 0.0016 0.0006 0.0002 180% 0.5976 0.2134 0.0762 0.0272 0.0097 0.0035 0.0012 0.0004 0.0002 190% 0.5872 0.2025 0.0698 0.0241 0.0083 0.0029 0.0010 0.0003 0.0001 200% 0.5773 0.1924 0.0641 0.0214 0.0071 0.0024 0.0008 0.0003

0.7255 0.3818 0.2010 0.1058 0.0557 0.0293 0.0154 0.0081 0.0043 0.0022 0.0012 0.0006 0.0003 0.0002

0.6901 0.3286 0.1565 0.0745 0.0355 0.0169 0.0080 0.0038 0.0018 0.0009 0.0004 0.0002

0.6455 0.2690 0.1121 0.0467 0.0195 0.0081 0.0034 0.0014 0.0006 0.0002 0.0001

The aforementioned rates of return were applied to the entire transaction. including the reserved production payment. Because of leverage afforded by the thenpermitted ABC method of purchasing properties. the actual rate of return on the equity capital was higher than the rate of return for the transaction as a whole. The calculated pretax internal rate of return remains a useful yardstick for establishing a fair market value. The acceptable rate of return at any time will be a function of comparative investment opportunities and the subjective assessment of the risk. At the time of this writing, pretax rate of return must fall between 20 and 30% to be compctitivc with other investment options. Appraisal value equal to the present value of the net cash flow after federal income taxes computed at an intermediate rate of interest. Method 3 is the most sophisticated approach to the fair-market-value problem. It requires an actual computation of the federal tax liability for each year and is rather laborious. The method also requires tax and accounting information that may not be readily available to the evaluating engineer. Those favoring this method generally use electronic-data-processing facilities that reduce the actual work by the valuation engineer to the preparation of the basic input data. The rate of return in this type of computation comes close to the actual rate of return that, aside from price fluctuations and errors in estimating, may be realized on the purchase. If this method is followed, the fair market value may be defined as the cash value that, if paid for the property. would yield a satisfactory rate of return on the purchase price. A satisfactory rate of return or yield is one that is sufficient to induce the buyer to risk his funds in the particular project rather than in safer investments offering a lower yield. This rate must be commensurate with the physical hazards of producing and the economic hazards of future production. In principle, it is the same incentive recognized in the regulation of public utilities, where the reasonable rate of return upon the fair value of the property (the rate base) is held to be that sufficient to induce the investment of capital in establishing, mainraining. and expanding the property. Check List of Data Required for Evaluation of Oil- and Gas-Producing Properties Bccausc the prcviouxly discuhscd evaluation procedures

are reflections of the pattern of future revenues, most evaluation methods are based on the predicted projections of oil and gas production. These projections are prepared either by extrapolating established trends in producing capacity or by academically estimating anticipated production on the basis of geologic interpretations and/or analogy (see Chap. 40). To make a sound valuation of a given producing property, the appraiser requires certain basic data. The following check list may serve as a reminder when collecting such data. Maps and Cross Sections. These include ownership maps, geological-structure maps. isopach maps, geological cross sections, etc. Lease-Location Data. List leases to be included and show for each lease the lease name, number of producing wells, number of temporarily abandoned wells, total number of acres, field name, county, state, and legal description of lease. Well Logs. These logs include all electrical, acoustic, and radioactivity logs that have been run in each well. Also, if available, geological-sample logs and directional well-survey reports should be included. Core-Analysis Data. All core-analysis reports for the zones that have been cored and analyzed should be included. Ruid-Sample-Analysis Data. This includes all bottomhole fluid-sample-analysis reports and. for gas wells, gasanalysis, specific-gravity, or recombined-sample-analysis reports. Well History. Chronological history of all well operations including original drilling and completion, recompletions, and remedial work to date should be included. If not otherwise included in a complete chronological well history. provide the following data for each well: conservation commission completion, potential test, and GOR reports: completion (and/or recompletion) date; elevation: kelly bushing, derrick floor, and ground level; total depth* and plugged-back depth; casing size and setting depth; tubing size and setting depth; drillstem test data including intervals tested. time open, fluid recovered. and bottomhole pressure (BHP) data: coring data. including intervals cored. footage recovered. and core description:

VALUATION

OF OIL AND

GAS

RESERVES

41-9

geological tops of all major formations encountered; welllocation plats or location description: producing formation name, interval perforated, initial production and potential test data; depths to top. bottom. oil/water contact, and gas/oil contact: and pay thickness (gross feet and net feet). Past-Production History. This history includes tabulation of oil. water, and gas production by months, by leases, by wells, and by pay zones since original complction. Also, include other past history reports, such as production methods (type and size of equipment and dates installed); BHP and wellhead pressure reports; open-flow potential test reports (gas wells); conservation comniission (or USGS) production. allowable, and MER reports: pipeline run statements: water-disposal and (mating reports: fluid-injection records; and production history of offset operations. Current Production Data. Tabulate for each well the most current actual test of oil. water. and gas produced and include test date. choke size [or stroke length and strokes per minute (spm)], producing tubing pressure, and producing casing pressure. For gas wells, indicate latest shut-in tubing and casing pressures. including date well was shut in and duration of shut-in time. Current-Allowable Data. Summarize allowable formula and current daily allowable rates for each well, per producing day, and per calendar day. Gross Crude Price. For each lease. give the name of the crude purchaser, the average gravity of the oil, and the gross price paid. If the crude is trucked. show the trucking cost per barrel (may be obtained from pipeline run statements). Gross Gas Price. For each lease, give the name of the gas purchaser and summarize the provisions of the gas contract such as the gross gas price per 1,000 cu ft. the contract pressure base. the minimum delivery pressure. the effective date and term ofthe contract. and escalation clauses (may be obtained from gas contracts and FPC approval certificates). Severance and Local Taxes. Indicate the total value of both severance and local (state, county, school. etc.) taxes in terms of a percentage of the total gross income or as an amount per barrel of oil or Mcf of gas produced. Federal Excise Tax (WPT) information. This should include. where applicable. tier. company or entity classification for tax. natural gas classification. and price controls. if any. Operating Expenses. Tabulate actual gross operating expenses per well per month for each lease during the past year. State whether such expenses include. in addition to all direct costs. such items as well-stimulation expenses, wjorkover or recompletion expenses. a portion of district or division overhead expenses. or severance and (xi 1~1/ore777 taxes. Completion and Recompletion Costs. In case of undeveloped or nonproducing reserves. provide an estimate of completed well costs or recompletion costs for reserves behind the casing. Division of Interests. Tabulate the working interest (fraction of /x ofthe costs) and the revenue interest (fraction of /H the income) for each interest owner so that of for each lease 100% of the working interest and 100% of the revenue interest lease is accounted for. Indicate the lease operator (copy of division orders for oil and gas).

Existing Production Payments or Liens. Tabulate the balance due on all production payments or liens as of a recent date and indicate provisions for the rate of payment. Lease andAssignment Provisions. Summarize special provisions of all leases and assignments that may adversely affect the value of the leases. In particular. show special provisions concerning shallower or deeper rights and commitments or obligations for the drilling of wells (may be obtained from lease and assignment agreements). Lease Facilities. Provide complete information concerning lease-facility wells, such as water wells, disposal wells, and injection wells. Provide specifications (size, capacity, etc.) for major lease-facility equipment, such as gas compressors, oil-treating plants, and water-injection plants. OperatingAgreements. In case ofjoint interest or unitized properties, provide a list of the basic provisions of the operating agreement, such as preferential rights to purchase other interests, obligations for development. basis of overhead allocation, and call on the oil (may be obtained from operating agreements and/or letter agreements). Unitization Agreements. In case of unitized properties, provide a list of the basic provisions of the unitization agreement concerning the basis for calculation of participation percentages and future revisions of same owing to possible future adjustments in operating methods, unitized area. etc. (may be obtained from unitization agreements). Special Reports. Provide a copy of all special geological and engineering reports that contain data pertinent to a current evaluation of the property. In particular, special engineering reports concerning plans for future development and secondary recovery operations may be helpful in projecting future production rates and future net operating income. Income Tax Information. Include if applicable.

Forecast of Future Rate of ProductionlZ

Declining Production When a property has a well-established performance history and the production rate shows a persistent decline. the appraiser should first make sure that this decline is not caused by either decreasing effectiveness of the lifting equipment or adverse wellbore conditions. If he finds that the lifting equipment is operating properly and that the wellbore is clean, the past decline may be used as a guide for the projection of future production. First the type and rate of decline must be established. Constant-Percentage Decline

When the drop in production rate per unit of time is a constant percentage of the production rate. the production curve is of the constant-percentage-decline type. This can best be demonstrated by plotting the production rate vs. time on semilogarithmic paper, with the production rate on the log scale. which should then show a straightline trend. The production rate may also be plotted vs. cumulative production on regular coordinate paper. which should again show a straight-line trend for this type of decline (Fig. 40. I, Curve I). In either case, the slope of the curve represents the nominal decline fraction or percentage. The decline may also be found by observing the

41-10

PETROLEUM

ENGINEERING

HANDBOOK

Fig. 41.1-Graphical extrapolation hyperbolicand harmonic of rate/time curves on semilog paper. Step 1: Smooth out the given production curve, and select three equidistant pointson it (A, B, and C). Step 2: Draw a vertical midway between A and C through Point line B. Step 3: ProjectA and C horizontally thismidon dle lineand findPointsA and C. Step 4: Draw AD and CE parallel BC. Step 5: Project D back to horizontally the curve and find Point F. Step 6: on draw DX parallel FE, and findthe unknown extrapto olated PointX at the intersection with the horizontal linethrough E.

computing a few points of the curve by means of Eq. 60 of Chap. 40 or by using the graphical extrapolation method on semilog paper shown in Fig. 41.1, which is based on the three-point rule : For any two points * on a hyperbolic rate-time curve, for which the production rates are in a given ratio, the point midway in between will have a production rate which is a fixed number of times the rate of either the first or the last point, regardless of where the first two points are chosen. For example, when the three equidistant points on the past-performance portion of the curve show production rates of 2,000, 1,300, and 1,000 bblimonth, then the future time interval between the ordinates of 1,000 and 650 bblimonth must be equal to the time interval between the ordinates of 650 and 500 bbllmonth. The future projection is then obtained by reading the production rates from the graphically extrapolated curve. Hyperbolic decline is the most common form of production-decline trend found with nonprorated or capacity production. The fractional power n is usually between 0 and 0.50, with the latter value applicable to gravity-drainage-type production under certain conditions. Harmonic Decline When the drop in production rate per unit of time expressed as a fraction of the production rate is proportional to the production rate itself, the production curve is of the harmonic-decline type. Such a curve, plotted as a rate/time graph on semilog paper, does not follow a straight line but shows a rather persistent, pronounced curvature. The rate-cumulative graph on regular coordinate paper shows the same strong curvature (see Fig. 40.21, Curve III). Harmonic decline may be identified graphically by plotting the inverse of the production rate vs. time on regular coordinate paper, which should then show a straight line. It may also be demonstrated by plotting the ratecumulative relationship on semilog paper, which should also follow a straight line. Harmonic decline for production-decline curves does not occur very often, and extrapolation on this basis usually provides a projection that is too optimistic. It is occasionally applicable to capacity production from depletion-type gas wells or to nonprorated production from reservoirs with a bottomwater drive where it is economically feasible to lift and to dispose of large volumes of water. Extrapolation of the rate/time graph may best be carried out by plotting the inverse of the production rate vs. time on regular coordinate paper and extending the straight line obtained. A rate/time graph on semilog paper may also be extended by the same construction on the basis of the threepoint rule for hyperbolic decline illustrated in Fig. 41.1. Part Constant Rate-Part Declining Production

ratio between the production at the end of a given period and at the beginning of that period and obtaining the effective decline by interpolation from Table 40.16 or 40.17. For example, if the production rate from a well or lease declined from 4,286 to 3,000 bbllmonth in 10 months, the ratio between these two production rates is 0.70, and one may read from Table 40.16 that such a drop in rate in 10 months corresponds to an effective decline of 3X %/month. The forecast may then be made on that basis either by reading the future rates from an extrapolation of the straight-line trend on the semilog decline chart or by computing the future rates by means of Table 40.16 or 40.17. Such extrapolation is then continued until the economiclimit rate of production is reached. Hyperbolic Decline When the drop in production rate per unit of time expressed as a fraction of the production rate is proportional to a fractional power n of the production rate (0 <n < l), the production curve is of the hyperbolic-decline type, This is usually evident from a plot of the production rate vs. time on semilog paper, which for this case will not follow a straight line but will show a gradual flattening out. A rate-cumulative graph on regular coordinate paper will show the same type of curvature (Fig. 40.21, Curve II). Hyperbolic-decline curves may be straightened out for extrapolation by plotting on double logarithmic or loglog paper after the curves are shifted by adding or subtracting a constant amount to all time or cumulative values. This is a laborious and, with the development of computers, outdated procedure. Most appraisers prefer a graphical extrapolation of the rate/time curve on semilog paper. Such extrapolation may be supported by actually

In the above discussion, it was assumed that past performance showed the production to be declining, and in such cases the projection is merely based on a continuation of that decline trend. When no past decline trend is available because the property is relatively new or under proration or market curtailment, however, the appraiser must base his projection on a volumetric estimate of the ultimate recovery and

VALUATION

OF OIL AND

GAS

RESERVES

41-11

try to match the future performance of the property against this estimate. This is usually done by assuming a rate of decline typical for this type of production and computing. by means of Eq. 55 of Chap. 40, the cumulative recovery to be obtained when the production is declining from the prorated rate to the economic limit. The number of months of constant-rate production preceding this decline period is then found by subtracting the cumulative production at the appraisal date as well as the estimated production to be obtained during the decline period from the estimated ultimate recovery and dividing the result by the assumed monthly production rate under proration. Proration or Market Curtailment Historically, production frequently has been limited by proration. Future operations may encounter proration to guard against loss of reserves through wasteful operations or may encounter curtailment of production because of low market demand. These considerations must be projected in a proper assessment of properties located in affected areas. Produced Product Prices The volatility of international energy markets has elimii nated any confidence in estimating future product prices on the basis of plots of historical data. Most evaluations are currently performed over a range of assumptions. Constant oil and gas price evaluations are most frequently required for securities registration and for financing purposes. Projected economic conditions that assume maximum and minimum cost and price assumptions are usually applied in management decisions.

Intangible drilling and development costs are labor. power, fuel, freight and hauling, water, repairs, and other items that provide no salvage return after completion of the well or that have no physical identity. This class of costs may either be capitalized and retired through annual charges or written off as an expense item in the income account during the year it was incurred. Generally, the latter course is followed. The intangible costs make up 60 to 70% of the entire well cost; the percentage is greater with the shallow wells or any other wells where the casing program requires less pipe than usual. Well Spacing. An important consideration in appraising undeveloped properties is the prevailing well spacing. Properties that are already fully drilled present no problem, but those that are yet to be developed require consideration of this feature because the future profits will be controlled greatly by the number of wells required. The number of development wells commonly required as a matter of practical necessity by reason of offset, competitive situations, and the specific lease requirements and obligations is generally much larger than the minimum number of wells required for proper drainage. Operating Expenses These expenses cover the field operations necessary to bring the oil and gas to the surface and to deliver a salable product to the stock tank or the gas pipeline. Direct Lifting Expenses and Direct Expenses. The operating costs are generally divided into direct lifting expenses at the property, such as labor, power, fuel, repairs, renewals, and into-the-field organization; or district expenses, such as supervision, engineering, accounting. timekeeping, warehousing, and general transportation, which in turn are distributed over a number of property units on some ratable basis. In the determination of a proper measure of production costs for use in estimates, the appraiser may first ascertain the definite record of the property under consideration, or else he may draw on his experience with similar properties elsewhere. Cost per Well-Month. Operating expenses are preferably expressed on a per-well-month basis rather than per barrel of oil produced. The field cost of operating any given well is the same, within reasonable limits, whether the amount pumped is large or small. The pumping assembly that is installed for pumping an 80-B/D well continues in use when less than half that amount is being produced, but the cost of the operation continues practically unchanged. Average Cost per Barrel. The use of an average cost per barrel may be acceptable when the production rates are so severely restricted that they are expected to continue at a uniform pace over a considerable period of time. When the production is declining, however, the assumption of an average cost per barrel that is based on a pastexperience figure for the property under consideration may lead to erroneous results. The reason is that, with declining production and constant or nearly constant perwell costs, the operating cost per barrel must increase with time until it equals the gross income at the economic limit.

Development and Operating Costs 13-15

Development Costs Costs of development include the drilling and completion of wells and such improvements as roads, buildings, pipelines, tanks, natural-gasoline plants, and power installations. These costs are changing constantly owing to both economic conditions beyond the control of the operator and technical improvements in drilling and production methods. The drilling and completion of wells usually constitutes the chief item of expense for development. Shallow wells that are drilled with a portable outfit may cost as little as $20.000. In the hilly districts of Kentucky, it may require a greater outlay to move the drilling rig to the location than the cost of the well itself. Costs on the high side, apart from exceptional experiences with mishaps or long fishing jobs, may reach tens of millions of dollars for 18,000 to 25,000 ft. The initial exploratory well generally costs much more than the development wells, and the continued development of a field almost always brings lowered costs with improved methods and increased competition among contractors. Tangible and Intangible Costs. For income-tax purposes, development costs are divided into two categories: tangible and intangible. Tangible development costs represent the physical property that has salvage value, such as derrick, pipe, and smaller equipment. They are capitalized and retired through annual charges to depreciation.

41-12

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.8-FIELD

OR

DISTRICT

OPERATING

COST

Labor, includingbenefits and transportation furnished 20 District expense, includingInsurance, professional services, damages, etc. 20 Repalrs and maintenance 30 Power, water, waste disposal, and oiltreating 5

to 30% to 30% to 50% to 15%

their profitable operation is possible only because repair expenses arc negligible and the men who milk the cows c c also attend the wells. For entire fields or districts. operating costs generally break down as shown in Table 41.8. Labor and district expense are of about equal magnitude and together corn prise about half the total operating costs. The other half is for repairs. maintenance, power, water, waste disposal. and oil treating. Stimulation Costs. Stimulation costs-such as reacidizand other stimulation ing, reshooting, refracturing, treatments-should be considered as part of the operating costs. Fracturing costs have mounted in recent years to where such stimulation expenses may add from IO to nearly 100% to the operating costs. Recompletion Costs. Operating costs generally cover only those expenses necessary to keep a well on production for a given productive interval. The cost of recompleting a well into a different producing zone. therefore, is normally treated as a development cxpcnsc. Ad Vulorem Taxes. To the direct operating expenses should be added the ud vmlorrm or property taxes. These taxes show a wide variation in different states and counties and may range from almost nothing to as high as 15 % Trucking Charges. In case the property is not connected to a pipeline and oil must be trucked out, such charges are usually charged directly against the gross income from oil and gas sales on a per-barrel basis. The various forms of pr-oducriort ~UJXJ.T WPT and s directly levied against the oil and gas produced and commonly collected by the purchaser are not normally included under operating expenses but are charged directly against the gross income from oil and gas sales. Administration and Supervision

In the case of constant-percentage decline: allowance may be made for this increasing tendency by computing a weighted-average operating cost per barrel with the following relationship:

o,,=

0, Inq,/q,, .,....,,,...............

(1)

where O,, = weighted average operating cost, dollars. 0, = operating expenses per well-month, dollars, 41 = initial production rate, bbl/D, and cl,, = production rate at abandonment. bbl/D. Example Problem 3. If the operating cost per wellmonth, 0,, is estimated at $300, and if the initial production rate. qi. is 2,113 bbl/welllmonth. while the economic-limit production rate, q,, is 113 bbliwelli month, the weighted- average operating costibbl over the life of the property is 300 In 2,113/113 2.113-113 In the case of hyperbolic decline (n = %), Eq. 1 takes the form o,,=o G. 4; . (2)

=$0.44

In the case of harmonic decline. this relationship reads

In the case of constant-rate production, the average operating cost per gross barrel is simply the estimated operating cost per well-month divided by the rate of production. The most desirable cost estimate and the one that is conclusive if it can be ascertained is the actually recorded experience at the property subject to such modifications as may appear to be warranted in the judgment of the appraiser. Range of Costs. Operating costs per well for primary production range from almost insignificant amounts per wellmonth up to $10,000 or more per well-month. The latter rate is found offshore or where heavy equipment handles large volumes of water with the oil and where power and maintenance charges are high. Many farms throughout the eastern U.S. contain wells that yield less than % BID;

Under this heading are charged direction. executives, central-office expense, accounting, insurance, supervision, personnel relations, and public relations. They are generally designated as overhead as distinguished from the field and district controllable expenses. In many company records, the charges vary widely because of both management ability and the differences in accounting methods. Production Taxes Taxes levied directly against oil and gas produced by the various states and usually collected by the pipeline company come under a variety of names-such as gross production taxes, severance tax, excise taxes, streampollution taxes, conservation taxes, maintenance taxes, license taxes, school taxes, state taxes, or gas-gathering taxes.

Federal Taxes l6
General When a projection of future cash net income is made in the appraisal method previously described, provision for estimated federal income taxes is made before discounting such future projection to present worth. In this

VALUATION

OF OIL AND

GAS

RESERVES

41-13

method, income taxes are considered an inherent part of the cost of doing business that must be provided for out of the producing operation. The producing properties that often have difficulties are those whose owners failed to provide for future income taxes. An oil producer may be able to continue exploration and drilling activities at an increasing rate so that his exploration expenses and intangible drilling deductions will reduce income taxes for a number of years. But if such an operator eventually runs out of drilling locations or funds for further development, he may be forced to sell property to meet his taxes or loan obligations. According to this method. the correct approach is to include federal income taxes in the cash-flow projection and to consider any tax savings obtainable through exploration and drilling activities solely as a credit to those activities. reducing their net cost. Often. the appraiser allows indirectly for such income taxes by a higher than normal discount rate or by taking a fraction of the present worth before income taxes. Computation of the net operating income after federal taxes requires a thorough understanding of current tax provisions. Because of the volatility of taxation, the tax consequences on the property valuation at the time of the appraisal should be verified. The most important points of federal tax provisions are summarized below. Depletion is generally considered to be the gradual exhaustion of a wasting asset through production. The objective of the depletion allowance is to permit the taxpayer owing an economic interest a reasonable deduction for the estimated cost of the reserves thus exhausted. The 1954 Code, Sec. 61 I, as amended provides that. in the case of oil and gas wells, the taxpayer will be allowed to deduct a reasonable allowance for depletion and depreciation of improvements. Cost depletion under this provision is computed by multiplying the depletable basis in the property at the end of the tax period, unadjusted by current period depletion, by a fraction, the numerator being unit sales for the taxable period and the denominator unit reserves at the end of the period plus unit sales during the period. In contrast, percentage depletion for oil and gas wells is 15% of the taxpayer gross income from the property but cans not exceed 50% of its taxable income. It is also limited to 65% of the total taxable income of the interest owner/taxpayer, with any amount disallowed by this limitation deductible in a future year when sufficient taxable income exists. The taxpayer is permitted to deduct, and is required to adjust basis for, either cost or percentage depletion, whichever is highest. Although cost depletion is limited to the recovery of the taxpayer basis in the property, percentage depletion s is not so limited: if the taxpayer has no depletable basis in a property or if the entire basis has been recovered through prior depletion charges, he may still continue to claim depletion computed on a percentage basis. Percentage depletion is permitted only as a deduction to independent producers and royalty owners on a maximum of 1,000 B/D of oil equivalent. The deduction is not allowed to integrated oil companies. Gas production for this purpose is converted to oil equivalent volumes at a rate of 6 Mcf to 1 bbl oil. It should also be noted that the transfer of a proven property to another interest owner will generally cause the loss of the percentage

depletion deduction to the transferee w,ith rcspcct to that property. In determining taxable income from the property for percentage-depletion purposes, deduction must bc made not only for ordinary operating expenses of the specific property, including equipment depreciation, but also for intangible drilling and development costs and for a proportionate amount of the overhead properly attributable to the producing function. In determinmg the overhead allocation, it is customary to allocate general overhead expenses between the producing operations and the other activities carried on by the taxpayer, frequently in proportion to the expenses directly attributable to each activity. and then further to allocate that portion of the overhead attributable to the producing function among specific properties usually in relation to the direct expense from such propertics. Capitalized Leasehold Costs. Ordinarily. a depletable basis in an oil or gas property is of no particular advantage to the taxpayer. The items that must be capitalized as leasehold costs are direct costs (such as lease bonuses or lease-purchase prices) and acquisition costs (such as title-examination fees, recording fees, documentary stamps if any), and geological and geophysical expenses incurred as a result of which the taxpayer either acquires or retains a property interest. Delay rentals paid on unproductive properties may be expensed or capitalized at the election of the taxpayer, and if the taxpayer has elected to capitalize intangible drilling and development costs, such items are added to the depletable basis in the property. Intangibles. While expenditures for tangible items of well equipment and related items are capitalized and recovered by periodic depreciation allowances throughout their useful lives, in the case of expenditures for intangible drilling and development costs (intangibles), the taxpayer in the oil and gas industry may elect to deduct such items when they are paid or accrued or to capitalize them for recovery through depletion allowances. Because percentage depletion is allowed without reference to the basis of the property, it is apparent that only in infrequent cases would the taxpayer choose to capitalize intangibles. This concept requires that all costs of drilling and developing an oil property be divided into the two categories-tangible and intangible, the former to be recovered through depreciation. In general, items with a salvage value are classed as tangibles while intangibles embrace all items without a salvage value. Examples of intangibles include labor, fuel, repairs, hauling, and supplies used in drilling, shooting, and cleaning of wells: any necessary site preparation, such as ground clearing, drainage road making, surveying, and geological work; and in the construction of derricks, tanks, pipelines, and other physical structures necessary for drilling and preparation for production. The decision to expense intangibles must be made by the taxpayer for his first taxable year in which intangibles are paid or incurred. The choice is available only to the owner of an operating or working interest who undertakes the risk of drilling on the property. Once the capitalized cost and applicable depletion methods have been determined, the allowable depletion, DA, is the higher of cost depletion, DC, or percentage

41-14

PETROLEUM

ENGINEERING

HANDBOOK

depletion, if applicable, with the latter equal to 15% of gross income, VDE, but limited as stated above under cost depletion. The allowable depletion selected will therefore be I5 % of gross depletion, VDE, when D, = V,,, where
vTI>vDE>DC

and

&S
N, fs

xcd,,

(6)

and v,,=(o.15xV)<(o.65xl,), .. . .(4)

where Cd, = depletable leasehold cost basis at beginning of tax period, dollars, N,. = reserves at end of tax period, bbl or Mcf, and s = unit sales during periods.

where DA = allowable depletion, highest of DC or lesser of VDE and VT,, V DE = percent of gross revenue, percentage depletion, VT, = 50% of net percentage depletion, equal to 50% of taxable net income, dollars, DC = cost depletion; portion of leasehold cost proportional to reserves produced in a given year, dollars, V = gross revenue (value); the total earned income from oil and gas sales, dollars, and Ir = interest owner taxable income, dollars. s The allowable depletion selected will be 50% of net percentage depletion, when

Example Problem 4. An operator owns half of the working interest (WI =0.50) in a two-well lease that produced 20,000 bbl of oil during the taxable year. His revenue interest is % of (RI=0.4375). The remaining reserves /s (Q) on Jan. I are estimated to be 50,000 bbl. His depletion leasehold cost (LC) on Dec. 3 1 of the taxable year is $20,000. The gross income per barrel of oil produced is $30, plus $2 from associated gas sales. Local production taxes are 5 % of gross income, or $1.6O/net bbl, while operating expenses, including district expenses and ad dorem taxes, are $2,00O/well/month. General overhead (GO) is $l/net bbl. Intangible development cost during the year was $40,000, while equipment depreciation is $2/net bbl of oil produced. What is the allowable depletion? Solution.

where 20,000 DC= 50,000+20,000 x20,000=$5,714.

v~,=o.~oo~~p~l/o~~,Dp, where OG c PT 0, CI = = = =

.. ..

.(5)

VT,=0.50x[0.4375x20,000x(30+2-1.60-l-2)

general overhead expenses, dollars, local production tax, dollars, operating expenses per well-month, dollars, intangible drilling and development costs, dollars, and D, = depreciation, the decline in value of tangible assets with use of passage of time (obsolescence),

In this case, apparently, VT, > VDE > DC and the allowable depletion is therefore DA = VDE =$7,700. Alternative Minimum Tax. The Internal Revenue Code of 1954 has been amended at various times to include provisions requiring that a taxpayer pay a specified rate of tax on certain defined tax preference items. These preference items currently include two oil- and gas-related expenses: percentage depletion deductions in excess of the depletable basis in a specific property and certain intangible drilling and development costs. The latter item is not applicable to corporate taxpayers. While the percentage depletion preference item is fairly self-explanatory, the determination of the intangibles that must be included as a preference item requires computation:
CIP =c/x-1,'

or cost depletion, DC, when DA =Dc>

VTI>D,>VDE.

VALUATION

OF OIL AND

GAS

RESERVES

41-15

TABLE

41.9-TIER

AND

RATE

STRUCTURE.

WPT Other than Independent Producer W) 70 50 30 15

Independent Producer w Tier 1 Tier 2 Tier 3 Tier 3 (oil other than Tier 2 or 3) (stripper and certainU.S. government interests) oil (newly discovered, heavy and incrementaltertiary oil) (newly discovered oilsubsequent to May 31, 1979) 50 30 30 15

where CIp = preference intangible drilling costs, dollars, and CIX = intangible costs minus CrA, dollars.

I,, is the net income from productive oil and gas properties, defined as the aggregate amount of gross income from all such properties, less deductions allocable to the properties reduced by CIX as set forth above. This preference item can be reduced if the taxpayer chooses to capitalize all or any portion of the intangibles paid or incurred during the year. Windfall Profit Tax. In April 1980, Congress passed the Windfall Profit Tax Act that was designed to tax the oil and gas interest owner on the windfall profit that was to be received as a result of the deregulation of domestic crude-oil prices. The taxable profit is the excess of the selling price over what the price would have been were it sold before decontrol, adjusted by an inflation factor. An additional adjustment is allowed for severance taxes imposed on the difference between the controlled and decontrolled price. The tax base is also limited to 90% of the net income from the property. Once the tax base is determined, the appropriate tax rate must then be applied. Three tiers have been specifically defined into which all taxable crude oil falls. The rates applicable to each tier depend on the classification of the interest owner and the nature of the oil produced. Exemptions for certain interest owners and oil types are also provided. The current tier and rate structure is given in Table 41.9. Newly discovered oil. which falls within Tier 3, is subject to a tax rate schedule that declines from 22.5% in 1984 to 15% in 1986 and thereafter. Tax Consequences Related to Conveyances. Oil and gas taxation of property conveyances has evolved into a complex set of rules that are necessary because of the many variations of transactions that involve oil and gas interests. Any appraiser who is valuing an interest that includes tax consequences should be aware of the types of various transactions. There are four primary methods of disposing of oil and gas interests: sale. sublease, special sharing arrangements in a partnership, and production payments. The acquisition of interests may involve the reciprocal of these methods as well as the receipt of an interest for services. The sale/purchase of an interest provides the easiest forum within which to determine the tax consequences. The

seller will recognize gain that will be characterized as capital or ordinary, depending on various factors that involve the classification of the seller and the tax history of the property. The buyer will merely have basis in the property that should be allocated between the mineral interest and lease and well equipment. Note that an interest owner will often look to the appraiser for guidance regarding the amount that should be allocated to lease and well equipment. A sublease commonly arises where the transfer of a working interest is burdened with a nonoperating interest retained by the assignor. Consideration received by the assignor is ordinary income because it is characterized as a lease bonus. Any basis in the property is attributed to the nonoperating interest that is depletable; it is not allowed as an offset to the income. The assignee purchase s price will be allocated between leasehold cost and lease and well equipment, if applicable. Special sharing arrangements are frequently used in a partnership context to allow special allocation of certain items of income and deduction. The partnership allocation rules explained in the Internal Revenue Code and the regulations published by the Dept. of the Treasury should be used as a guide to confirm the tax treatment of such allocations. A problem exists in the standard third for a quarter transaction outside the partnership context: the expenses paid by the assignee attributable to the seller s retained interest are considered leasehold cost. They are not deductible even if they are in the nature of intangibles. A production payment is the right to a specific share of production from an oil and gas property. Where the production payment is used to finance a project, it is treated as a loan by the lender and the interest owner who carved it out of production. Where a working-interest owner retains a production payment and conveys his working interest, he is treated as having sold his interest and should report the proceeds as income realized from the sale of the property. In certain instances, the holder of the production payment may be treated as owning an economic interest. As indicated previously, this would allow the possible deduction of depletion, subject to the restrictions discussed. The acquisition of an interest in an oil and gas property is frequently made through the performance of services. At one time, it was generally believed that. at the date of transfer, the party receiving the interest was not
involved in a taxable event. He, along with the other vendors,

dealers, and professionals involved in the propercapital to enable its ty> was merely contributing development. This position, while originally accepted by the Internal Revenue Service, has recently come under

PETROLEUM

ENGINEERING

HANDBOOK

c Fig. 41.2-Discounted-cash-flow method. Rate of return j= I;P/I;C, = P/C, = constant. At abandonment time, C, = Tm, (no interest).

Fig.

41.4-Morkill method. Rate of return I= YZPn;(C, -S) = P/C, -S=constant. At abandonment time t,,C, =S (including interest).

NET PROFIT P=, C 0

attack and is being severely restricted. The government s current position is that in most instances, at the date of transfer, the taxpayer performing services recognizes taxable income. The issue is far from settled, and additional activity is expected to clarify the tax consequences of such transactions.

Different Concepts of Valuation

The literature includes many different methods that may be used to evaluate the known or estimated future projection of net income from a given venture. 7-20 One of them, the discounted-cash-flow method, illustrated in Fig. 41.2. simply reduces these future income payments to present worth or present value by a chosen rate of compound interest or rate of return. It represents the banker s approach to a stream of future income payments and is widely used in industrial work. The Hoskold method, illustrated Fig. 41.3, was spein cifically designed for ventures with a limited life, such as mines or oil or gas wells, and was first used in mineevaluation work. The Morkill method, illustrated in Fig. 4 1.4. is actually a refinement of the Hoskold method and is also mainly applicable to ventures with a limited life, such as mines and oil or gas wells. The accounting method. illustrated in Fig. 41.5, represents the accounting approach to the valuation problem and takes into account the actual depletion pattern applicable to the given venture. It is particularly suited for those ventures where a specified total number of units of production is involved and where. as is the case in most extractive industries. the depletion applied to the original capital investment is on a unit-of-production basis.

Fig. 41.3~Hoskold method. Rate of return = P/C, = constant. j At abandonment time t,,C, = S (including interest.)

VALUATION

OF OIL AND

GAS

RESERVES

41-17

Fig. 41.5-Accounting method. Rate of returnj= Z/XC,. At abandonment time t,, C, = ED, (no interest).

Fig. 41.6-Average-annual-rate-of-return method. Rate of return j present worth of W/present worth of XC, = Area = ABCDElArea FGHK. At abandonment time t,, C, =ZD, (no interest).

The average-annual-rate-of-return method, illustrated in Fig. 41.6, is essentially a refinement of the accounting method and, by applying the present-worth concept to both the net annual profits and the net remaining investment balances, simplifies the computations and properly weighs the time pattern of the income. A complete summary of the basic equations for these different methods and their appraisal and rate-of-return equations will be found in Table 41.10. The top part of this table shows the equations for continuous compounding and the solution for the constant-rate case. The bottom part shows the appraisal equations and the rate-of-return equations for the general case where the cash flow, I, varies from year to year. Discounted-Cash-Flow Method

jetted cash flow to present value by means of the desired rate of interest. The appraisal value is then Cj=I,(l+i )-+I2(l+i I~+. )- fl=r, C;= C I,(l+i )-, n=l .. . ... .. (7) .+Z,(l+i , )-

This method, also referred to as the investors method * or internal-rate-of-return method, , is the one most * often used in appraisal work. It is based on the principle that, in making an investment outlay, the investor is actually buying a series of future annual operating-income payments. The rate of return (with this method) is the maximum interest rate that one could pay on the capital tied up over the life of the investment and still break even. The time pattern of these future income payments is, therefore, given proper weight. No fixed amortization pattern needs to be adopted with this method because the annual amounts available for amortization are equal to the difference between the net income and the fixed profit percentage on the unreturned balance of the investment. The computations necessary for a property evaluation are, therefore, relatively simple. They usually involve only the discounting of the pro-

in which I,, I2 . . . I, represents the projection of the cash income in successive years and the compound-interest factor for the speculative effective interest rate iis computed for the assumption that the entire income for each year is received at mid-year. Appropriate midyear compoundinterest factors (1 +i )- will be found in Table 4 1.11 for speculative effective interest rates from 2 to 200%. In the case of oil-producing properties, the computed earning power by this method is not necessarily the same as the average rate of return later shown on a company s books for the net investment in the property. Most oil companies amortize their investments in producing properties in proportion to the depletion of the reserves or on a unit-of-production basis. However, no provision for such amortization pattern is made in the discounted-cashflow method. When the production rate and the income both follow constant-percentage decline and the ratio between initial and final production rates is substantial, no serious difference will result. However, when the rate of production and the income are constant for a long period of time, a substantial difference may develop and the average rate of return, as shown later on the company books, s may be appreciably higher than the rate of return used in the evaluation by the discounted-cash-flow method.

41-18

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.10-SUMMARY

OF EQUATIONS

APPLICABLE

TO DIFFERENT

VALUATION

METHODS

Discounted Cash Flow For continuous compounding, basic equation I df=jC, dl-dC, where f=O C, =C, t=t, c,=o (8)

Hoskold I dl+jS dt=jC, dt+dS where t=O S=O t=t, s=c, (14)

Appraisal equation for constant annual income of I dollars per year

(15)

Rate-of-return equation for constant annual income of I dollars per year General case: Appraisal equation

Solutionforjwhich will satisfy Eq. 9

je -I,

i= C, l-e-.
= 1,

=ta

c, =

c /,(l+I)- n=,

(7)

/(I+/)a-

c,=
1 + r[(l +,)a-] or

(10)

c,ii = FPE/ --c J

i
T-l (1 +i)- 8 Rate-of-return equation Solutionfor ithat will satisfy Eq. 7

(11)

(12)

or

j =

---(l+i)ys C, 1 -(1 +i)- a

FPE

(13)

The method may be illustrated with the diagram of Fig. 41.2, which shows the application of the discounted-cashflow method to a venture that is expected to yield an income of $1 OO,OOO/yrevenly over a period of 10 years and where a speculative nominal rate of return j of lSX/yr is desired. Time in years is plotted on the horizontal axis, while the constant income is represented by the horizontal line for $lOO,OOO/yr in the upper part of the diagram. The top portion of the diagram shows how the portion of the total income, I, allocated to amortization, mk, increases, while the net-profit portion (P) decreases with time. The bottom portion of the chart illustrates the manner in which the cumulative Cmk gradually reduces the unreturned balance of the investment, CB =C; -Cmk, from its initial value, C;, to zero at abandonment of the venture. The computation of the curves for this constant-rate case is based on the basic differential equation for discounted cash flow, Idt=j CBdr-dCB, (8)

where I = yearly net income, dollars, j = nominal annual speculative interest rate, fraction, and Cs = balance of unreturned portion of investment, dollars. Integration of this equation for constant-rate income between the limits r=O, CB = C; and t =t,, , Cs =0 leads to the appraisal value C, for a nominal rate of return j =O. 15:

c;=(l-a-J<,) ; 0 J =[l-e-(o.l ~ =$517,900. ,(lo,] ( Y.lY l

,...............,............. (9)

VALUATION

OF OIL AND

GAS

RESERVES

41-19

TABLE

41 .lO-SUMMARY

OF EQUATIONS

APPLICABLE

TO DIFFERENT

VALUATION

METHODS

(continued)

Morkill I dt+jS dt=j(C,-S)dt+dS where t=O S=O t=t, s=c, (18)

Accountrng

Average annual rate of return

I(1 tj).dt

CI t, - [dtl:dt 0 0

CI(l tj))dt-k J
0

where E:I =

I ;I

~f8 I dt

where k = ]dt(l +j) -r11dt 0 and EI= fa I dt 0

5
0

c, =

t.3
,+j .t, 2

(23)

c, = j t,-

t,/,(l
(-1 i: I

-e- J)
(I-e- ) a )

Solutionforjthat will satisfy Eq. 19

j =2

c :,
i-l c, ta

(22)

j=

I (1 -ema/)(/t ) --l a t c, jt,- (1 - e -n)

ta 1

=Ca

c n=, c =-

/,(lt/+i)a- (24) -

i 1+ ---[(l +i+P)a]

i+i

satisfy Solutronfor i that will Eq. 16

(25)

Legend: I, XI C, S C, F pv = = = = = = net annual operating income during nth year, dollars total futurenet operating income, dollars balance of unreturned portionof investment,dollars balance of sinking fund, dollars initial capitalinvestment or purchase price, dollars average deferment factoron cash-flow projection a safe rate of interest as a at i; decimal fraction nominal annual safe interest rate or rate of return; a decimal fraction as nommal annual speculativeinterest rate or rate of return; a decimal fraction as effective annual safe interest rate or rate of return; a decimal fraction as effective annual speculativeinterest rate or rate of return; a decimal fraction as time, years time until abandonment, years base naturallogarithms cumulative production at the midpomt of year n cumulative production at abandonment time: the end of the lastyear f,

j= j = i= i= t= t, = e = (Np)n..2 = (N,), =

41-20

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.11-LUMP-SUM

DEFERMENT FACTORS APPLICABLE

FOR EFFECTIVE ANNUAL INTEREST TO PAYMENTS AT YEAR END

RATES

FROM 2 TO 200%/yr,

Year

2%

3%

4%

5%

6%

8%

10%

12%

15%

20%

25%

30%

35%

40% 0.5102 0.3644 0.2603 0.1859 0.1328 0.0949 0.0678 0.0484 0.0346 0.0247 0.0176 0.0126 0.0090 0.0064 0.0046 0.0033 0.0023 0.0017 0.0012 0.0009 0.0006 0.0004 0.0003 0.0002 0.0002 0.0001 0.0001

45% 0.4756 0.3280 0.2262 0.1560 0.1076 0.0742 0.0512 0.0353 0.0243 0.0166 0.0116 0.0080 0.0055 0.0036 0.0026 0.0018 0.0013 0.0009 0.0006 0.0004 0.0003 0.0002 0.0001 0.0001 0.0001

10.98040.97090.96150.95240.94340.92590.90910.89290.86960.83330.80000.76920.74070.71430.6897 2 0.9612 0.9426 0.9246 0.9070 0.8900 0.8573 0.8264 0.7972 0.7561 0.6944 0.6400 0.5917 0.5487 3 0.9423 0.9152 0.8890 0.8639 0.8396 0.7938 0.7513 0.7118 0.6575 0.5787 0.5120 0.4552 0.4064 4 0.9239 0.8885 0.8548 0.8227 0.7921 0.7350 0.6830 0.6355 0.5718 0.4823 0.4096 0.3501 0.3011 5 0.9057 0.8626 0.8219 0.7835 0.7473 0.6806 0.6209 0.5674 0.4972 0.4019 0.3277 0.2693 0.2230 6 0.8879 0.8375 07903 0.7462 0.7050 0.6302 0.5645 0.5066 0.4323 0.3749 0.2621 0.2072 0.1652 7 0.8705 0.8131 07599 0.7107 0.6651 0.5835 0.5132 0.4523 0.3759 0.2791 0.2097 0.1594 0.1224 8 0.8535 0.7894 0.7307 0.6768 0.6274 0.5403 0.4665 0.4039 0.3269 0.2326 0.1678 0.1226 0.0906 9 0.8368 0.7664 0.7026 0.6446 0.5919 0.5003 0.4241 0.3606 0.2843 0.1938 0.1342 0.0943 0.0671 10 0.8203 0.7441 0.6756 0.6139 0.5584 0.4632 0.3855 0.3220 0.2472 0.1615 0.1074 0.0725 0.0497 11 0.8042 0.7224 0.6496 0.5847 0.5268 0.4289 0.3505 0.2875 0.2149 0.1346 0.0859 0.0558 0.0368 12 0.7885 0.7014 0.6246 0.5568 0.4970 0.3971 0.3186 0.2567 0.1869 0.1122 0.0687 0.0429 0.0273 13 0.7730 0.6810 0.6006 0.5303 0.4688 0.3677 0.2897 0.2292 0.1625 0.0935 0.0550 0.0330 0.0202 14 0.7579 0.6611 0.5775 0.5051 0.4423 0.3405 0.2633 0.2046 0.1413 0.0779 0.0440 0.0254 0.0150 15 0.7430 0.6418 0.5553 0.4810 0.4173 0.3152 0.2394 0.1827 0.1229 0.0649 0.0352 0.0195 0.0111 16 0.7284 0.6232 0.5339 0.4581 0.3936 0.2919 0.2176 0.1631 0.1069 0.0541 0.0281 0.0150 0.0082 17 0.7142 0.6050 0.5134 0.4363 0.3714 0.2703 0.1978 0.1456 0.0929 0.0451 0.0225 0.0116 0.0061 18 0.7002 0.5874 0.4936 0.4155 0.3503 0.2503 0.1799 0.1300 0.0808 0.0376 0.0180 0.0089 0.0045 19 0.6864 0.5703 0.4747 0.3957 0.3305 0.2317 0.1635 0.1161 0.0703 0.0313 0.0144 0.0068 0.0033 20 0.6730 0.5537 0.4564 0.3769 0.3118 0.2145 0.1486 0.1037 0.0611 0.0261 0.0115 0.0053 0.0025 21 0.6598 0.5375 0.4388 0.3589 0.2942 0.1987 0.1351 0.0926 0.0531 0.0217 0.0092 0.0040 0.0018 22 0.6468 0.5219 0.4220 0.3418 0.2775 0.1839 0.1228 0.0826 0.0462 0.0181 0.0074 0.0031' 0.0014 23 0.6342 0.5067 0.4057 0 3256 0.2618 0.1703 0.1117 0.0738 0.0402 0.0151 0.0059 0.0024 0.0010 24 0.6217 0.4919 0.3901 0.3101 0.2470 0.1577 0.1015 0.0659 0.0349 0.0126 0.0047 0.0018 0.0007 25 0.6095 0.4776 0.3751 0.2953 0.2330 0.1460 0.0923 0.0588 0.0304 0.0105 0.0038 0.0014 0.0006 26 0.5976 0.4637 0.3607 0 2812 0.2198 0.1352 0.0839 0.0525 0.0264 0.0087 0.0030 0.0011 0.0004 27 0.5859 0.4502 0.3468 0.2678 0.2074 0.1252 0.0763 0.0469 0.0230 0.0073 0.0024 0.0008 0.0003 28 0.5744 0.4371 0.3335 0.2551 0.1956 0.1159 0.0693 0.0419 0.0200 0.0061 0.0019 0.0006 0.0002 29 0.5631 0.4243 0.3206 0.2429 0.1846 0.1073 0.0630 0.0374 0.0174 0.0051 0.0015 0.0005 0.0002 30 0.5521 0.4120 0.3083 0.2314 0.1741 0.0994 0.0573 0.0334 0.0151 0.0042 0.0012 0.0004 0.0001 31 0.5412 0.4000 0.2965 0.2204 0.1643 0.0920 0.0521 0.0296 0.0131 0.0035 0.0010 0.0003 0.0001 32 0.5306 0.3883 0.2851 0.2099 0.1550 0.0852 0.0474 0.0266 0.0114 0.0029 0.0008 0.0002 0.0001 33 0.5202 0.3770 0.2741 0.1999 0.1462 0.0789 0.0431 0.0238 0.0099 0.0024 0.0006 0.0002 34 0.5100 0.3660 0.2636 0.1904 0.1379 0.0730 0.0391 0.0212 0.0086 0.0020 0.0005 0.0001 35 0.5000 0.3554 0.2534 0 1813 0.1301 0.0676 0.0356 0.0189 0.0075 0.0017 0.0004 0.0001 36 0.4902 0.3450 0.2437 0.1727 0.1227 0.0626 0.0323 0.0169 0.0065 0.0014 0.0003 0.0001 37 0.4806 0.3350 0.2343 0 1644 0.1158 0.0580 0.0294 0.0151 0.0057 0.0012 0.0003 38 0.4712 0.3252 0.2253 0.1566 0.1092 0.0537 0.0267 0.0135 0.0049 0.0010 0.0002 39 0.4620 0.3158 0.2166 0.1491 0.1031 0.0497 0.0243 0.0120 0.0043 0.0008 0.0002 40 0.4529 0.3066 0.2083 0.1420 0.0972 0.0460 0.0221 0.0107 0.0037 0.0007 0.0001 41 0.4440 0.2976 0.2003 0.1353 0.0917 0.0426 0.0201 0.0096 0.0032 0.0006 0.0001 42 0.4353 0.2890 0.1926 0 1288 0.0865 0.0395 0.0183 0.0086 0.0028 0.0005 43 0.4268 0.2805 0.1852 0.1227 0.0816 0.0365 0.0166 0.0076 0.0025 0.0004 44 0.4184 0.2724 0.1780 0.1169 0.0770 0.0338 0.0151 0.0068 0.0021 0.0003 45 0.4102 0.2644 0.1712 0.1113 0.0727 0.0313 0.0137 0.0061 0.0019 0.0003 46 0.4022 0.2567 0.1646 0.1060 0.0685 0.0290 0.0125 0.0054 0.0016 0.0002 47 0.3943 0.2493 0.1583 0.1009 0.0647 0.0269 0.0113 0.0049 0.0014 0.0002 48 0.3865 0.2420 0.1522 0.0961 0.0610 0.0249 0.0103 0.0043 0.0012 0.0002 49 0.3790 0.2350 0.1463 0.0916 0.0575 0.0230 0.0094 0.0039 0.0011 0.0001 50 0.3715 0.2281 0.1407 0.0872 0.0543 0.0213 0.0085 0.0035 0.0009 0.0001

To find the rate of return corresponding to a given purchase price by the discounted-cash-flow method, no straightforward solution is possible; one has to resort to a trial-and-error procedure. The curve for the unreturned balance. Cg. for this case is shown in the bottom portion of the graph, together with the cumulative amortization (CmL =Ci -CR). The corresponding amortization portion. nrk, of the income, I, is shown in the top portion of the graph. It may be noted from Fig. 41.2 that the rate of return, j is the constant ratio of net profit (P=l-mi, , ) and the unreturned balance of investment (CA = C, -GUI,! ). and the balance, CR, is declining slowly at first and faster toward the end and does not keep pace with the actual depletion of the source of income.

Hoskold Method s Most industries and manufacturing enterprises have an indeterminate life (apparently perpetual) and are therefore not called on to replace the original investment. This does not mean that such enterprises will continue forever; it means merely that, except for competition, nothing is apparent that might cause termination. Because of this uncertainty, appraisal by the discounted-cash-flow method is generally the best method for such ventures. Oil, gas, mining, and other extractive industries. however, differ from the foregoing enterprises. When the oil reservoir is depleted or the ore body mined out. there is no value left except possibly some equipment salvage. It is desirable to return the original capital to the investor by the time the profitable life of the enterprise is ended.

VALUATIONOFOILAND

GAS

RESERVES

41-21

TABLE

41.11-LUMP-SUM

DEFERMENT FACTORS FOR EFFECTIVE ANNUAL INTEREST APPLICABLE TO PAYMENTS AT YEAR END (continued)

RATES

FROM

2 TO 200%/yr,

Year
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

50% 0.6667 0.4444 0.2963 0.1975 0.1317 0.0878 0.0585 0.0390 0.0260 0.0173 0.0116 0.0077 0.0051 0.0034 0.0023 0.0015 0.0010 00007 0.0005 00003 0.0002 00001 00001 00001

60% 0.6250 0.3906 0.2441 0.1526 0.0954 0.0596 0.0373 0.0233 0.0146 0.0091 0.0057 0.0036 0.0022 0.0014 0.0009 0.0025 0.0003 0.0002 0.0001

70% 0.5882 0.3460 0.2035 0.1197 0.0704 0.0414 0.0244 0.0143 0.0084 0.0050 0.0029 0.0017 0.0010 0.0006 0.0003 0.0002 0.0001

80% 0.5556 0.3086 0.1715 0.0953 0.0529 0.0294 0.0163 0.0091 0.0050 0.0028 0.0016 0.0009 0.0005 0.0003 0.0001

90% 0.5263 0.2770 0.1458 0.0767 0.0404 0.0213 0.0112 0.0059 0.0031 0.0016 0.0009 0.0005 0.0002 0.0001

100% 0.5000 0.2500 0.1250 0.0625 0.0313 0.0156 0.0078 0.0039 0.0020 0.0010 0.0005 0.0002 0.0001

110% 0.4762 0.2268 0.1080 0.0514 0.0245 0.0117 0.0056 0.0026 0.0013 0.0006 0.0003 0.0001

120% 0.4545 0 2066 0.0939 00427 0.0194 0 0088 0.0040 0.0018 0.0008 0.0004 0.0002

130% 0.4348 0.1890 0.0822 0.0357 0.0155 0.0068 0.0029 0.0013 0.0006 0.0002 0.0001

140% ~__ 0.4167 0.1736 0.0723 0.0301 0.0126 0.0052 0.0022 0.0009 0.0004 0.0002

150% 0.4000 0 1600 0.0640 0.0256 0.0102 00041 0.0016 0.0007 0.0003 0.0001

160% 0.3846 0.1479 0.0569 0.0219 0.0084 0.0032 0.0012 0.0005 0.0002

170% 0.3704 0.1372 0.0506 0.0188 0.0070 0.0026 0.0010 0.0004 0.0001

160% 0.3571 0.1276 0.0456 0.0163 0.0058 0.0021 0.0007 0.0003

190% 0.3448 0.1189 0.0410 0.0141 0.0049 0.0017 0.0006 0.0002

200% 0.3333 0.1111 0.0370 0.0123 0.0041 0.0014 0.0005 0.0002

This leads to a somewhat different approach to the evaluation of enterprises in such extractive industries. One of the earliest methods, proposed by Hoskold in I877 I ) for the mining industry. emphasizes complete return of the originally invested capital at abandonment time by means of a sinking fund. Hoskold method presupposes s a uniform rate of return at the speculative rate of interest i on the original capital and provides for redemption of capital at abandonment time by annual reinvestment of the balance of the yearly earnings in a sinking fund at a safe rate of interest i. No fixed amortization pattern is used, but proper weight is given to the specific time pattern of the future cash-income payments. The appraisal value by the Hoskold method is computed with

price may be computed directly with the general rate-ofreturn equations.

i1 =
or i =

,I=, I, [
C I,,(1 +i) ,,?l ,I= I (l+i) -1 lJ

i l/C,

1I
-I

(12)

i[(FpVCI/C;)-(1 +i) - (<I *-(,+i) -,,, .

(13)

(IO)

in which the numerator represents the combined value of the cash-Income payments. I,, (no depreciation or depletion), computed at abandonment time (t,,) including compound interest at the safe rate (i) per year. When the weighted average deferment factor or discount factor on the production rate and income projection (FpL,) is available at a safe interest rate of 5%/yr. this equation reduces to
FpL,CI (; /;)-[(; /j)-l](l+;)- ,, . ....

c, =

(11)

The rate of return corresponding

to a given purchase

The interesting feature of this method is Its concept of a safe or bank interest rate (i) that is used to build up the sinking fund to full return of the invested capital at the end of the project life, while at the same time a cons stant speculative interest rate (i is earned on the origi) nal capital investment (Ci ) throughout the same period. This speculative interest rate (i is not comparable with ) the rate of return used in the discounted-cash-flow, accounting, or average-annual-rate-of-return methods because it applies strictly to the entire initial investment and not to the declining balances of such investment. This method may be illustrated with Fig. 41.3. which shows what would happen to the net profit, the contributions to the sinking fund, and the sinking fund itself if the Hoskold method were applied to the same venture as before that yielded $lOO,OOO/yr income evenly over 10 years. It was assumed that a speculative rate of return (j ) of IS %/yr is desired, while the safe nominal interest rate (j) is 5%/yr. The constant-income rate (f ) is again shown as the horizontal line in the top part of the diagram. This portion of the chart shows further that the net-profit portion of this annual income (P) is not declining as in the

41-22

PETROLEUM

ENGINEERING

HANDBOOK

previous case but is a constant percentage (15%) of the initial investment (Ci). The remaining portion of the income. which is diverted to the sinking fund, is also constant for this case. The curve on the bottom part of Fig. 41.3 illustrates how the payments to the sinking fund plus interest at a safe rate build this fund up to where the entire initial investment (C;) is available again at abandonment time. Computation of the data for this constant-rate case is based on the basic differential equation for the Hoskold method: Idt+jSdt=j Cidt+dS, where j = nominal annual speculative interest rate, fraction, S = sinking fund balance, dollars, and C, = initial capital investment or purchase price, dollars. Integration of this equation for constant-rate income between the limits t=O, S=O and t=t,, S=C; leads to the appraisal value C; for a speculative interest rate (j =O.lS) and a safe nominal interest rate (j=O.OS). ( 1 -e -?I) )I c, = I j'-(j'-j)epJf,, . . . .. . .(14)

in which the numerator represents the combined value at abandonment time (tU) of the annual cash-income payments, I, (no depreciation), including compound interest at the total interest rate (i+i ). It may be of interest to note that, if the safe interest rate (i) is zero, this equation reduces to the appraisal equation for the discounted-cash-flow method, if the compound-interest factors at the speculative rate (i are ) applied at year end instead of midyear:
li I,, =

Ci=

C Z,(l +i )-. tl=l

..

. . (17)

Appropriate year-end compound-interest factors (1 +i - will be found in Table 41.11 for speculative in) terest rates from 2 to 200%. To find the rate of return corresponding to a given purchase price for the Morkill method, no direct solution is possible, and one has to resort to a trial-and-error procedure. Morkill method is illustrated in Fig. 41.4, which s shows the net profit, contributions to the sinking fund, and growth of the sinking fund if this method were applied to the same venture as the other examples that yielded a $lOO,OOO/yr income evenly over 10 years. As in the Hoskold method, it was assumed that a speculative nominal rate of return (j of lS%/yr is desired, while the safe ) nominal interest rate (j) is 5%/yr. The horizontal line in the top part of the diagram represents the constant-rate income (I) of $lOO,OOO/yr. The other curves for this constant-rate case are computed from the basic differential equation for the Morkill method, Idt+jSdt=j (Ci-S)dt+dS. Integration of this equation for constant-rate tween the limits t=O, S=O and t = t, , S= C; appraisal value (Ci) for a speculative nominal (j =O.lS) and a safe nominal interest rate
[,(,+.i)f, 111 _ c; =
j+j,(j+iV,,

= [I -~-~~~~~~~ ~~](loo,ooo) 0.15-(0.10)[e-~~~~~~~] =$440,400. . (15) .. (18)

Correspondingly, the constant-net-profit portion (P) of the annual income is 0.15 ~440,400=$66,060, while the annual sinking fund payment is $lOO,OOO-$66,060= $33,940, as shown on the top portion of the diagram. The curve for the sinking fund (S) for this case is shown in the bottom portion of the figure together with the remaining unreturned portion of the investment (C, -S). It may be observed that the rate of return (j is the ) ratio of the net annual profit (P) to the initial investment (C,), and the remaining net investment balance (C, -S) is declining somewhat more slowly in the beginning than in the end. Although the curvature is much less than in the discounted-cash-flow method, it still does not keep pace with the actual depletion of the source of income. Morkill Method s A variation of the Hoskold equation was proposed in 19 18 by Morkill. who felt that the risk or speculative rate of interest (i should be expected only from the amount ) of capital remaining unreturned, while the security or safe rate of interest (i) should apply to the sinking fund. The appraisal value by Morkill method may be coms puted from
II =, ,I

income beleads to the interest rate (j=O.OS).

[e(O.*O)( - I]( 100,000) O) = 0.05+(o.l5)[e 0.*00 ]

=$551,560.

_.

(19)

The growth of the sinking fund is shown by the curve in the bottom portion of Fig. 41.4, together with the remaining unreturned portion of the investment (Ci -S). The net-profit portion (P) of the operating income (I) shown in the top portion is by definition equal to j times the amount C, -S. It may be noted from this chart that the rate of return (j is the constant ratio of net profit (P) ) and the unreturned balance of the investment (C; -S), and the sinking fund is growing slowly at first and faster toward the end and does not keep pace with the actual depletion of the source of income. Accounting Method

C I,,(1 +i+i ~~p ) ,I= I c, = I +[i /(i+i )][( I +i+i cl )

- 1] .

.(16)

This method, also referred to as the average-book method, I8 is closely related to many of the concepts used in conventional oil-company accounting procedure and

VALUATION

OF OIL AND

GAS

RESERVES

41.23

computes the rate of return on a proposed investment as the ratio of the average net annual profits over the life of the venture (after depletion) to the average book investment over its life. It takes into account the actual depletion pattern and provides results that are compatible with the actual average rate of return later shown by a company books. With amortization of an investment s on a unit-of-production basis or in proportion to the depletion of the reserves, the appraisal value by this method may be expressed for the case where the net income per unit of production is constant as
CI c, = ,I =I,

part of the diagram divided by the total of the annual investment balances as represented by the area of Triangle EFG in the bottom portion of the diagram or, algebraically,

td-D,)=.i t,y,
while

C,

&=ci,
f <I

(N,),,- ,,2 lVP 1u

l+i

c II= I

(20) so that, after substitution,

toI l+J& = (lwloo>ooo) =$571 4oo

in which Cl represents the total of the operating net income payments in successive years,

c; =

l + (O.lS)(lO) 2 ... 2

. (23)

i the desired speculative rate of return, (N,),,- ti the cumulative production at the mldpoint of the nth year. and (N,), the cumulative production or estimated ultimate at abandonment time. Although this method is comparatively simple, it has found only limited application. The rate of return (i for a given purchase price (C;) ) may be computed directly by (WC;) - 1 =+ ,, _ (N,),,_ ,,~,

It may be noted that this method, in contrast to those previously discussed, allows for a depletion pattern that follows the actual depletion of the source of income. This is indicated for this constant-rate case by the diagonal straight line in the bottom portion of Fig. 41.5. Average-Annual-Rate-of-Return Method

j =

(21)

,:

L-

(N,,), 1
case by

or for the constant-rate

(22)

Its principal features are illustrated in Fig. 4 1S, which shows the net profit (P), the amounts reserved for depletion (DE), and the cumulative depletion @DE) if the accounting method were applied to the same venture as before that yielded $lOO,OOO/yr income evenly over 10 years. It was assumed that an average speculative rate of return (j of 15%/yr is desired. The horizontal line in ) the top part of the figure represents the $lOO,OOO/yr income rate. Because the income rate and the depletion of the reserves for this simplified case are assumed to be constant, the amounts reserved for depletion (DE) are, therefore, also shown by a horizontal straight line. Simultaneously, the cumulative depletion in the bottom part of the diagram is a straight line running from zero in the beginning to the capital investment (C,) at abandonment time (scale on right side). By definition the rate of return (j is the average net ) profit (P) divided by the average investment balance (C,) and is also equal to the total of the annual net profits as represented by the area of Rectangle ABCD in the top

The average rate of return, computed by this method, is essentially the ratio of the present value of the future net profits (after depletion) to the present value of the net book investments over the life of a property. The method is particularly suited for investments in oil- and gasproducing properties, where amortization of the invested capital is customarily on a unit-of-production basis and, therefore, is proportional to the depletion of the reserves. The average annual rate of return used in this method corresponds closely to the one later shown by the company books, while the time pattern of income payments s is properly weighted. The equation is particularly simple in its application because the discounting to present worth needs to be done only for the safe interest rate (i). Because this interest rate is usually a fixed number. a series of weighted-average-deferment-factor charts for the most common types of production decline may be prepared in advance. Such charts for i=O.OS are shown in Figs. 41.7 and 41.8. According to Arps,6 the appraisal value by the average-annual-rate-of-return method for the case where the net operating income per unit of production is constant may be computed from
c; =
FPV~~

(i /i)-[(if/i)-l]FPV

(24)

where I represents the total of the operating net income payments in successive years,

41-24

PETROLEUM

ENGINEERING

HANDBOOK

YEARS40 45 50 55 60 65 70

1.0

09

0.8

864~.1..

042 0 5 IO 15 20 25 30 35 40 45 50 55 60 65 70

/ /
2 RATIO 3456eso INITIAL FINAL PRODUCTION PRODUCTION ;3 w 4G = F, 60 8v IX RATE (q ,) RATE (q,)

03

YEARS

Fig. 41.7-Lump-sum and constant-rate deferment factorsfor 5% interest.

Fig. 41.8-Constant-percentage-decline deferment factor 5% for interest.

and i and i are the speculative and safe interest rates, respectively. FPV is the weighted average deferment factor on production and income at the interest rate i. The rate of return (i for a given purchase price (C;) ) may be computed directly by means of the equation

..

. . (25)

The relative simplicity of these equations derives from the fact that, with amortization on a unit-of-production basis, the deferment factor (Fpv) for the production rate and the net operating income will be identical to the average deferment factor applicable to the annual amounts set aside for amortization. For further details of the derivation and equations, refer to Ref. 21. In cases where the deferment factor on the net operating income is not exactly equal to the deferment factor applicable to the production rates, such as when the lifting costs per barrel are increasing with time, it is customary to use the weighted average deferment factor applicable to the netoperating-income projection in the equation. The principal features of this method are illustrated in Fig. 41.6, which shows the net profit (P), the amounts reserved for depletion (DE), and the cumulative depletion @DE) if the average-annual-rate-of-return method

were applied to the same venture as before that yielded a $lOO,OOO/yr income evenly over 10 years. It was again ) assumed that an average speculative rate of return (j of 15%/yr is desired. The horizontal line in the top part of the figure representing the annual depletion rate, and the diagonal line in the bottom portion of the diagram, representing the cumulative depletion, are the same as previously discussed for the accounting method shown in Fig. 41.5. The average constant-rate deferment factor for continuous compounding, a safe nominal interest rate (j=O.OS), an&a total life (t=lO yrs) may be read from Fig. 41.7 as FcR =0.787 so that the initial capital investment (C;) may be computed by means of Eq. 25 as (0.787)( lO)( 100,000) (0.15/0.05)-[(0.1510.05)ll(O.787) =$551,900.

Cj =

The present worth of the net profit, discounted at the safe interest rate (j=O.OS) is shown by Curve ABC, while the present worth of the net remaining investment balances at the same rate of interest is shown by Curve GHK in the bottom part of the diagram. The speculative rate of return (j with this method is then graphically represented ) by the ratio of Area ABCDE and area FGHK.

VALUATION

OF OIL AND

GAS

RESERVES

41-25

Interest Tables and Deferment Factors I7

Simple and Compound Interest Interest rate is the ratio between the amount paid for or gained from the use of funds and the amount of funds used. Simple Interest. In simple interest. the interest to be paid on repayment of a loan is proportional to the length of time the principal sum has been borrowed. For example, on a loan of $100 at a nominal interest rate of 6% iyr for a period of 2 months. the interest due upon repayment oftheloanwouldbe0.06~$100~2/;,=$1.00. Loansare rarely made at simple interest for periods of more than I year. Compound Interest. In compound interest. the loan is increased by an amount equal to the interest due at the end of the interest period-e.g., on a loan of S 1,000 at an interest rate of5 %/yr for a period of 4 years, the total amount due upon repayment of the loan would be 1.0S1x$l,000=$l.216. Compounding can be annually. semiannually, quarterly, monthly, or continuously, depending on the length of the stipulated interest period. Effective and Nominal Interest The effective annual interest rate (i) is the total compound interest over a year time, expressed as a fraction or pers centage of the amount outstanding at the beginning of the year. The nominal annual interest rate (j) applies when the interest is compounded over M periods in a year and is equal to M times the interest rate j/M for one period. When interest is compounded once a year, the nominal (j) and effective (i) interest rates are identical. The relationships between effective (i) and nominal (j) annual interest rate are

and ,j=ln(l +i). .(29)

Table 4 I. I2 expresses the relationships between effective annual interest rate i and nominal annual interest rate j for annual, semiannual (M=2), quarterly (M=4), monthly (M= 12). and continuous (M=m) compounding. Lump-Sum Deferment Factor A deferment factor Fpv, also referred to as average discount factor or present-worth factor, is defined as the ratio of the present worth of one or a series of future payments and the total undiscounted amount of such future payments. The following deferment factors are commonly used in valuation work. The lump-sum deferment factor F,,. also known as the single-payment present-worth factor. is the ratio of the present value or present worth of a single future payment made t years hence and the amount of the G$e payment. For an effective annual interest rate (i). the lump-sum deferment factor for t years is F,,=(l +i) --f. . .(30)

j= 1+L -I ( M >
and j=M[(I+i)I]. . (27)

Tables 4 1.7 and 4 I. 1 I show lump-sum deferment factors for effective annual interest rates i from 2 to 200%/yr for payments falling either at year end (I +i) - or at midyear (1 +i)- , respectively; e.g., the present worth of a lump-sum payment of $200 to be made 10 years hence, if interest is computed at 5%/yr. is $200~ 1.05~=$200x0.6139=$122.78. The midyear lump-sum deferment factors are used in the discounted-cash-flow method when a future-income projection by years is to be discounted to present value. It is then customary to assume that the entire year income s is received at the midyear point. For fractional years, the lump-sum deferment factor for an interest rate of 5 %iyr may also be read directly from Fig. 41.7. Curve A. For a nominal annual interest rate j. compounded M times a year, the corresponding equation is
-lM

. . . . . . . . ..__.........

(31)

When the nominal annual interest rate is jzO.06 or 6%/yr and compounding is on a monthly basis (M= l2), the monthly interest rate is .i -=M 0.06 12 =O.OOS. or /z%,

For continuous compounding (M= 00) at a nominal annual interest rate (j) this equation reduces to F,s=e-. _, _. ,(32)

and the effective annual interest rate is i=(l +O.OOS) ~ I =0.06168 or 6.168%/yr.

The lump-sum deferment factor for continuous compounding may be read directly from the graph in Fig. 41.9 for given values of rj. Constant-Rate Deferment Factor, FCK

For the case where interest is compounded continuously (M-t 00). these relations reduce to i-e/-l . .... .. (28)

Also known as the equal-payment-series present-worth factor, this is the ratio of the present worth of a series of Mt equal payments, made at equal intervals of 12/M months over a period oft years in the future, and the total amount of such payments.

41.26

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.12--RELATIONSHIP BETWEEN EFFECTIVE ANNUAL INTEREST AND NOMINAL INTEREST RATE j FOR SEMIANNUAL, QUARTERLY, MONTHLY, AND CONTINUOUS COMPOUNDING Effective Annual Interest Rate i the Nominal Rateiis Comoounded Quarterly m=4 Monthly m=lZ

RATE i

When Semiannually

m=2
Nommalannual interest rate

1+h (DeAmal) 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.10 0.11 0.12 0.13 0.14 0.15 0.16 0.17 0.18 0.19 0.20 0.22 0.24 0.26 0.28 0.30 0.32 0.34 0.36 0.38 0.40 0.42 0.44 0.46 0.48 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00 1.10 1.20 1.30 1.40 1.50 1.60 1.70 1.80 1.90 2.00 0.01002 0.02010 0.03022 0.04040 0.05062 0.06090 0.07122 0.08160 0.09202 0.10250 0.11302 0.12360 0.13422 0.14490 0.15562 0.16640 0.17722 0.18810 0.19902 0.21000 0.23210 0.25440 0.27690 0.29960 0.32250 0.34560 0.36890 0.39240 0.41610 0.44000 0.46410 0.48840 0.51290 0.53760 0.56250 0.62562 0.69000 0.75562 0.82250 0.89062 0.96000 1.03062 1.10250 1.17562 1.25000 1.40250 1.56000 1.72250 1.89000 2.06250 2.24000 2.42250 2.61000 2.80250 3.00000 0.01004 0.02015 0.03034 0.04060 0.05094 0.06136 0.07186 0.08243 0.09308 0.10381 0.11462 0.12551 0.13648 0.14752 0.15865 0.16986 0.18115 0.19252 0.20397 0.21551 0.23882 0.26248 0.28647 0.31080 0.33547 0 36049 0.38586 3.41158 0.43766 0.46410 0.49090 0.51807 0.54561 0.57352 0.60181 0.67419 0.74901 0.82630 0.90613 0.98854 1.07360 1.16136 1.25188 1.34521 1.44141 1.64266 1.85610 2.08222 2.32150 2.57446 2.34160 3.12344 3.42051 3.73334 4.06250

j'*

-1

Continuously

m=m
e'=l 0.01005 0.02020 0.03045 0.04081 0.05127 0.06184 0.07251 0.08329 0.09417 0.10517 0.11628 0.12750 0.13883 0.15027 0.16183 0.17351 0.18530 0.19722 0.20925 0.22140 0.24608 0.27125 0.29693 0.32313 0.34986 0.37713 0.40495 0.43333 0.46228 0.49182 0.52196 0.55271 0.58407 0.61607 0.64872 0.73325 0.82212 0.91554 1.01375 1.11700 1.22554 1.33965 1.45960 1.58571 1.71828 2.00417 2.32012 2.66930 3.05520 3.48169 3.95303 4.47395 5.04965 5.68589 6.38906

0.01004 0.02018 0.03042 0.04074 0.05117 0.06168 0.07299 0.08300 0.09381 0.10471 0.11572 0.12682 0.13803 0.14934 0.16075 0.17227 0.18389 0.19562 0.20745 0.21939 0.24360 0.26824 0.29333 0.31888 0.34489 0.37137 0.39832 0.42576 0.45369 0.48213 0.51107 0.54053 0.57051 0.60103 0.63209 0.71218 0.79586 0.88326 0.97456 1.06989 1.16942 1.27333 1.38178 1.49495 1.61304 1.86471 2.13843 2.43593 2.75909 3.10989 3.49047 3.90311 4.35025 4.83448 5.35860

VALUATION

OF OIL AND

GAS

RESERVES

41-27

When the interest rate over the time interval between payments is j/M and the first payment occurs at the end of the first interest period, the constant-rate deferment factor is l-[l+(j/M)JPM
FCR= .

41.7 for oil- and gas-appraisal work. Table 41.14 provides these factors for effective interest rates between 3 and 20%/yr. Constant-Percentage-Decline Deferment Factor DcpD

rj

(33)

When the payments are due at the end of each year, the equation reads F,

I (I - lti) f
ti .

..

. (34)

This is the ratio of the present value or present worth of a series of future payments that follow constant-percentage decline and the total amount of such income. When the pipeline income from oil and gas production and the operating expense are accounted for at the end of each month, and when the compounding of interest and the effective decline d are also on a monthly basis, the equation for the deferment factor takes the form

When the annual payments are due at midyear, and the first payment is 6 months hence, the deferment factor is [I-(l+i)- ] FCR=(l+i) ,+
ti

F,-(1-d)(l++ F F,-(l-d)

(l+i)-(l+i) +
ti . . . . . . . ... .. . . . .... .

1
(38)

. . . . . ..~...................

(35)

Constant-rate deferment factors for this case and effective interest percentages from 3 to 10% are listed in Table 41.13. The pipeline income from oil or gas production and the operating expenses are normally accounted for on a monthly basis, and the constant-rate deferment factor for such monthly payments then takes the form 1-[1+(j/12)]- 2f
ti

F CR=

I-(l+i)- 12t[(l+i)x,-l].

(36)

The constant-rate deferment factor according to this equation for an effective annual interest rate of 5%/yr, monthly payments, and monthly compounding may be read directly against the number of years t on Fig. 4 1.7, Curve B. For continuous compounding (M=a) at a nominal interest rate (j) the equation reduces to

where F cp~ = constant percentage-decline deferment factor; the average deferment factor applicable to a series of future payments that follow constant-percentage decline, fraction, d = effective decline rate, drop in production rate per unit of time divided by the production rate at the beginning of the period, fraction, F, = ratio between initial and final production rates or payments, i = effective annual compound safe interest rate, fraction, and = abandonment time or future life, years. f, The constant-percentage-decline deferment factors according to this equation for an effective annual interest rate of 5 %/yr or 0.4074%/month, monthly payments, and monthly compounding may be read directly from the graph in Fig. 41.8 for varying ratios F, and different effective decline rates d. For continuous compounding (M= 00) at a nominal interest rate j, the equation reduces to

FcR-~+"

tj

. .

(37a)

The constant-rate deferment factor for such continuous compounding may be read directly from the graph in Fig. 4 1.9 for given values of tj. The constant-rate deferment factor for the equal monthly payments received at the end of each month during a specific interval of 1 year between (f- 1) and I years from now takes the form (l+i) -(l+i)- - 12[(l+i)~~-11

(39)

FCR=

. ..

(37b)

The constant-percentage-decline deferment factors for such continuous compounding may be read directly from the graph in Fig. 41.9 for given values of ratio F, and rj. Time t, may be computed from Eq. 56 or 57 in Chap. 40: In F y _ NPII F, In F,
a qi (Fy-1)

This annual deferment factor is more accurate than the midyear lump-sum deferment factor of Eq. 30 and Table

to =

41-20

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41 .13-CONSTANT-RATE
Each Annual

DEFERMENT
Income Received

FACTORS
!n One Payment

F cR = (1 + i) - (1 + i) H-r/fi a
at Midyear 9% 0.9183 0.8809 0.8456 0.8122 0.7806 0.7507 0.7223 0.6955 0.6700 0.6459 0.6230 0.6013 0.5806 0.5610 0.5424 0.5247 0.5078 0.4918 0.4765 0.4620 0.4481 0.4349 0.4223 0.4102 0.3987 0.3877 0.3772 0.3671 0.3575 0.3483 0.3395 0.3311 0.3230 0.3152 0.3076 0.3006 0.2937 0.2871 0.2808 0.2747 0 2688 0.2631 0.2577 0.2525 0.2472 0.2425 0.2378 0.2333 0.2289 9 '12 % 0.9142 0.8751 0.8383 0.8036 0.7708 0.7399 0.7107 0.6831 0.6570 0.6324 0.6090 0.5889 0.5660 0.5461 0.5273 0.5094 0.4925 0.4764 0.4611 0.4465 0.4327 0.4195 0.4070 0.3950 0.3836 0.3728 0.3624 0.3525 0.3430 0.3340 0.3254 0.3171 0.3092 0.3016 0.2943 0.2873 0.2807 0.2742 0.2681 0.2622 02565 0.2510 0.2457 0.2407 0.2358 0.2311 0.2265 0.2222 0.2179 10% 0.9101 0.8694 0.8311 0.7952 0.7613 0.7294 0.6994 0.6711 0.6444 0.6193 0.5955 0.5731 0.5519 0.5318 0.5128 0.4949 0.4779 0.4617 0.4465 0.4319 0.4182 0.4051 0.3926 0.3808 0.3695 0.3588 0.3486 0.3389 0.3296 0.3207 0.3122 0 3041 0 2964 0.2690 0.2819 0.2751 02686 0.2624 0 2564 02507 02452 0.2399 0.2348 0.2299 0.2252 0.2206 0.2162 02120 0.2060 lO%% 0.9061 0.8638 0.8241 0.7869 0.7520 0.7192 0.6884 0.6595 0.6323 0.6067 0.5825 0.5598 0.5384 0 5182 0.4991 0.4810 0.4640 0.4479 0.4326 0.4182 0.4045 0.3915 0 3792 0.3675 0.3563 0 3458 0.3357 0.3261 0.3170 0 3083 0.3000 0 2921 0.2846 0 2774 0.2705 0.2638 0.2575 0.2515 0.2457 0.2401 0.2348 0.2296 0.2247 0.2200 0.2154 0.2111 0.2068 0.2028 0.1989 11% 0.9021 0.8582 0.8172 0.7788 0.7429 0.7092 0.6777 0.6482 0.6205 0.5945 0.5700 0.5470 0.5254 0 5051 0.4859 0.4678 0.4506 0.4347 0 4195 0 4051 0 3915 0.3787 0.3665 0.3549 0.3440 0.3335 0.3237 0.3143 0.3053 0.2968 0.2887 0.2810 0.2736 0.2666 0.2598 0.2534 0.2473 0.2414 0.2358 0.2304 0.2252 0.2202 0.2155 0.2109 0.2065 0.2023 0.1962 0.1943 0.1905

4% 4%% 3%% 5% 5% % 6% 6%% 7% 7% % 8% 8wo Year 3% -10.98530.98290.98060.97820.97590.97360.97130.96900.9667096450.9623o.96oo0.95780.95560.95350.9513 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 0.9710 0.9569 0.9431 0.9296 0.9163 0.9033 0.8905 0.8780 0.8657 0.8537 0.8419 0.8303 0.8189 0.8077 0.7968 0.7860 0.7755 0.7651 0.7549 0.7450 0.7352 0.7256 0.7162 0.7069 0.6978 0.6889 0.6801 0.6715 0.6631 0.6548 0.6466 0.6386 0.6308 0.6231 0.6155 0.6090 0.6007 0.5935 0 5865 0.5795 05727 0 5660 0.5594 0.5530 0.5466 0.5404 0.5342 0.5282 0.5223 0.9663 0.9501 0.9342 0.9187 0.9035 0.8887 0.8742 0.8600 0.8461 0.8325 0.8192 0.8063 0.7936 0.7811 0.7690 0.7571 0.7455 0.7341 0.7229 0.7120 0.7014 0.6909 0.6807 0.6707 0.6609 0.6513 0.6419 0.8327 0.6237 0.6149 0.6062 0.5978 0.5895 0.5814 0.5734 0.5656 0.5580 0.5505 0.5431 0.5359 05289 0 5220 0.5152 0.5086 0.5021 0.4957 0.4694 0.4833 0.4773 0.9617 0.9433 0.9254 0.9080 0.8910 0.8744 0.8583 0.8425 0.8272 0.8122 0.7976 0.7833 0.7695 0.7559 0.7427 0.7298 0.7172 0.7049 0.6930 0.6813 0.6699 06587 06479 0.6373 0.6269 0.6168 06069 0 5472 05878 0 5786 0.5696 05608 0 5522 0 5438 05356 0.5276 05198 0.5121 0 5046 04973 04909 0.4631 0.4763 0 4696 04630 0 4566 0 4503 04442 04382 0.9572 0.9367 0.9168 0.8975 0 8788 0.8605 08428 0.8256 0.8089 0.7926 0.7768 0.7614 0.7465 0.7319 0.7178 0.7040 0.6906 0.6776 0.6649 0.6525 0.6405 0.6268 0.6174 0.6063 0.5955 0.5650 0.5748 0.5648 0.5550 0.5456 0.5363 0.5273 0.5165 0.5100 0.5016 0.4935 0.4856 0.4778 0.4703 0.4629 04557 0.4487 0.4419 0 4352 04286 0.4223 0 4160 0.4100 0.4040 0.9527 0.9302 0.9084 0.8873 0.8668 0.8470 0.8279 0.8093 0.7912 0.7738 0.7568 0.7404 0.7245 0.7091 0.6941 0.6796 0.6655 0.6518 0.6385 0.6256 0.6131 0.6009 0.5891 0.5777 0.5665 0.5557 0.5452 0.5350 0.5251 0.5154 0.5060 0.4969 0.4880 0.4794 0.4710 0.4628 0.4549 0.4471 0.4396 0.4322 0.4251 0.4161 0.4113 0 4047 0 3983 0.3920 0.3859 03799 0.3741 0.9482 0.9237 0.9001 0.8772 0.8552 0.8339 0.8133 0.7934 07742 0.7556 0.7377 0.7203 0.7036 0.6873 0.6716 0.6564 0.6417 0.6275 0.6137 0.6004 0.5875 0.5750 0.5629 0.5511 0.5397 0.5287 0.5180 0.5077 0.4976 0.4879 0.4784 0.4692 0.4603 0.4517 0.4433 0.4351 0.4272 0.4195 0.4120 0.4048 0.3977 0.3909 0.3842 0.3777 0 3714 0.3653 0.3593 0.3535 0.3478 0.9438 0.9173 0.8919 0.8674 0.8438 0 8211 0 7992 0.7781 07578 0.7382 0.7193 0.7011 0.6836 0.6666 0.6503 0 6345 0.6193 0.6046 0.5905 0.5768 0.5635 0.5507 0.5384 0.5265 0 5149 0.5037 0.4929 0.4825 0.4724 0.4626 0.4531 0.4440 0.4351 0.4265 0.4161 0.4101 0.4022 0.3946 0.3873 0.3801 0.3732 0.3665 0.3600 0 3536 0.3475 0.3415 0.3357 03300 0.3246 0.9394 0.9111 0 8838 0.8577 0.8326 0.8086 0.7854 0.7632 07419 0.7214 0.7016 0.6827 0.6644 0.6469 0.6300 0.6138 05981 0.5831 0.5685 0.5546 0.5411 0.5261 0.5156 0.5035 0.4919 0.4806 0.4696 0.4593 0.4492 0.4394 0.4300 0.4209 0.4121 0.4036 0.3953 0 3874 0.3796 0.3722 0.3650 0.3560 0.3512 0.3446 0.3382 0.3321 0.3261 0.3203 0.3147 03092 0.3039 0.9351 0.9049 0.8759 0.8483 0.8218 0.7964 07721 0.7488 07265 0.7052 0.6847 0.6650 0.6462 0.6281 0.6107 0 5941 0.5781 0.5627 0.5479 0.5337 0.5201 0.5070 0.4943 0.4822 0.4705 0.4592 0.4484 0.4379 0.4279 0.4182 0.4088 0.3998 0.3911 0.3827 0.3745 0.3667 0.3591 0.3516 0.3448 0.3379 0.3313 0.3249 0.3187 0.3127 0.3069 0.3013 0.2959 0.2906 0.2855 0.9308 0.8988 0.8682 0.8390 0.8111 0.7845 07591 0 7349 07117 0 6895 0 6683 06481 0.6287 0.6101 0.5924 0 5754 05591 0.5435 0 5285 0.5141 0 5004 04872 04745 0.4623 0 4506 0.4394 04286 0 4182 04082 0 3986 0.3693 03804 0.3718 0 3636 03556 0 3479 0.3405 0.3334 0 3265 0.3198 03134 0.3072 0.3012 0.2953 02697 0.2843 0.2791 02740 0.2691 0.9266 0.8927 0.8605 0.8299 0.8007 0.7729 07465 0.7213 0.6973 0.6745 0.6526 0.6318 0.6120 0.5930 0.5749 0.5576 0.5411 0.5253 0.5102 0.4957 0.4819 0.4686 0.4559 0.4437 0.4321 0.4209 0.4102 0.3999 0.3900 0.3805 0.3714 0.3626 0.3542 0.3461 0.3382 0.3307 0.3235 0.3165 0.3098 0.3033 0.2971 0 2911 0.2852 0.2796 0.2742 0.2690 0.2639 0.2590 02543 0.9224 0.8868 0.8530 0.8209 0.7905 0.7617 0.7342 0.7082 0.6835 0.6599 0.6375 0.6162 0.5960 0.5767 0.5583 0.5407 0.5240 0.5081 0.4929 0.4783 0.4645 0.4512 0.4385 0.4264 0.4148 0.4037 0.3931 0.3829 0.3731 0.3638 0.3548 0.3462 0.3379 0.3300 0.3224 0.3150 0.3080 0.3012 0.2946 0.2883 02823 0.2765 0.2708 0.2654 0.2602 0.2551 0.2502 0.2455 0.2409

001

002

0.04 0.07OI

0.2

04

07

IO

20

30

902

GO4

0070.1

02

04

07

IO

20

30

---II TIME ,ty,jx NOMINAL INTEREST RATE ,,,,)(CONTINKlUSLY COMPO"NOED,

Fig. 41 .9-Deferment

factorsfor lump-sum, constant-rate, and constant-percentagedecline.

VALUATION

OF OIL AND GAS RESERVES

41-29

TABLE

41.13-CONSTANT-RATE

DEFERMENT
Income 15% 0 9325 08717 08162 07654 07190 06764 06374 06015 05686 05382 05102 04944 04606 04385 04180 03991 03815 03651 03496 03356 03224 03100 02983 02875 02773 02677 02587 02502 02422 02347 02276 02209 02145 02085 02027 0 1973 0 1921 01872 01825 01781 01738 01697 01659 01621 01586 01552 01519 01488 01457 0 1429

FACTORS

F cR =(I
Payment 16'/2% o 9265 08609 08015 07476 06987 06542 06137 05767 05430 05121 04838 04579 04341 04122 03920 03733 03561 03402 03254 03117 02969 02870 02759 02656 02559 02469 02384 02304 02229 02158 02092 02029 01969 0.1913 01860 011310 01762 01716 0.1673 01632 01592 01555 01519 01485 0 1452 01421 01391 O 1362 01334 0 1306

+i)

-(l

+i)- hi

(continued)

Each Annual Year I 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 llVz% 0 9470 08982 08527 08103 0.7708 07339 06995 06673 06372 06090 0.5827 0.5579 0.5347 05130 04925 0.4733 04552 04382 04222 04071 0.3928 03793 0.3666 03545 0.3431 03323 03221 03124 03031 02944 02861 02781 02706 02634 02565 0.2500 02437 02378 02321 02266 02214 02164 02116 02069 02025 01983 01942 01903 01865 0 1828 12% 0 9449 0 8943 08473 08036 0 7630 07252 06900 06572 06265 05980 05713 05463 05229 05010 04805 04613 04432 04262 04103 03952 03811 03677 03551 03433 03320 03214 0 3113 03018 02927 02842 02760 02683 02609 02539 02472 02408 02348 02290 02234 02181 02130 02082 0.2035 0.1991 01948 01907 0 1867 0.1829 01793 0 1758 12'h% 0.9428 0.8904 08419 07970 0 7553 07166 06807 06473 06162 05872 05602 05351 05115 04896 04690 04496 04317 04148 03989 03840 03700 03568 0 3444 03326 03215 03111 03012 02918 02830 0 2746 02666 02590 02519 02450 02385 02323 02264 02206 02154 02102 02053 02006 0 1961 0 1916 01876 01836 01798 01762 01726 0 1692 13% 0 9407 08666 08366 07905 0 7478 070'32 06716 0.6376 06061 05768 05496 0 5242 05006 04765 04580 04388 04208 04039 03862 03734 03595 03464 0 3341 03226 03117 0.3014 0.2917 0.2825 02738 02656 02578 02504 02434 0.2367 02304 02244 02186 02131 02079 02029 01981 01935 01892 0.1650 0.1810 01771 01734 01699 01665 0 1632 13'/2% 0.9386 0.8828 08314 07841 07404 07000 06628 06283 05963 05667 05393 05137 04900 04679 04474 04282 04103 03936 03779 03632 03495 03366 03245 03131 03023 02922 02827 02737 02652 02572 02495 02423 02355 02290 02228 02169 02113 02060 02009 01960 01914 01870 01827 01787 01748 01710 01675 01640 01607 0 1576 14% 0 9366 08791 08263 07777 07331 06920 06541 06191 05868 05569 05293 05036 04798 04577 04372 04181 04003 03836 03681 03536 03400 03272 03153 03041 02935 02836 02742 02654 02571 02492 02418 02347 02280 02217 02157 02100 02045 01993 01944 01897 01851 0 1808 01767 01728 01690 01654 01619 01586 01554 0 1523

Received m One 15'2% o 9305 08680 08112 07594 07121 06688 06293 05930 05598 05292 05012 04753 04514 04294 04090 03901 03727 03564 03413 03273 03142 03019 02905 02798 02696 02604 02516 02432 02354 02281 02211 02145 02083 02024 01968 0 1915 01865 01617 01771 01726 01687 01647 01609 01573 01538 01505 0,474 01443 0 1414 0,386 16% 09285 08644 08063 07534 07053 06614 06214 05848 05513 05206 04924 04665 04426 04206 04003 03816 03642 03481 03332 03193 03063 02943 02830 02725 02627 02534 02448 02366 02290 02218 02150 02085 02025 01967 01913 01861 01612 01765 01721 01676 01638 01600 01563 01526 01494

at Midyear 17% 0 9245 08573 07967 07418 06921 06470 06061 05688 05349 05039 04756 04496 0.4259 0.4040 0.3839 03654 03483 03325 03179 03044 02918 02601 02692 02590 02495 02406 02323 02244 02171 02102 02037 01975 01917 01862 01810 01761 01714 01670 01628 0.1568 01549 01513 0.1478 0.1445 01413 0.1382 0.1353 01325 01296 0 1272 17'12% 0.9225 0.6536 07920 07361 06857 06401 05987 05612 05270 04959 04676 04416 04179 03962 03762 03576 03409 03252 03108 02974 02850 02734 0.2627 0.2527 0.2434 02346 02265 0.2188 02116 0.2048 0.1965 01925 01668 01814 01763 01715 01670 01626 0 1585 0 1546 0 1509 0 1473 0 1439 0 1407 01376 01346 0 1317 0.1290 01264 0.1238 16% 0 9206 08504 07873 07305 06794 06332 05915 0.5537 05194 04862 0.4598 0.4339 0.4102 03686 03687 03505 03337 03182 03039 02907 02765 02671 0 2566 02467 02375 02290 0 2210 02134 18'/2% 0.9186 0.8469 07827 07250 06732 06265 05844 0 5464 05119 04806 0 4522 0 4264 04026 03613 03615 03434 03268 03115 02974 02843 02723 02611 0.2507 02410 02320 02236 0.2157 0.2083 19% 0 9167 0 8435 07781 07196 06671 06199 05775 0.5392 05046 04733 0.4449 0.4191 03956 03742 03546 0.3366 0.3202 03050 02911 02782 02663 02553 02451 02355 02267 02184 02107 02035 01967 0 1903 0 1844 0 1787 01734 01684 01637 01592 01549 0.1509 0.1470 0.1434 0.1399 0.1366 0.1334 01304 01275 0.1248 01221 01196 01171 0 1148 19'/2% 0.9148 0.8401 0.7736 0.7142 0.6611 06135 05707 0 5322 04975 04662 0 4378 0 4121 03887 03674 03479 03301 03138 02988 02851 02723 02606 02498 02397 02303 02216 02135 02059 01988 0.1922 0.1660 0.1801 0.1746 01694 01645 0.1599 01555 01513 01474 01436 0.1400 01366 01334 01303 01274 01245 01218 01192 01168 01144 01121 20% 0 9129 0 8368 0.7692 07090 0.6552 06072 0.5641 0.5254 0.4906 0.4593 0.4309 0.4052 03619 0.3608 0.3414 0.3238 0.3077 0.2929 02793 0.2667 0.2552 0.2445 02345 02253 02168 02088 02014 01944 01879 01.318 01761 01707 0.1656 01608 01562 01519 01479 0.1440 0.1403 0.1368 0.1335 0.1303 01273 01244 0.1217 01190 0.1165 01141 01118 01095

14% % 0 9345 0 8754 08212 07715 07260 06841 06456 06102 05776 05474 05196 04939 04700 04479 04274 04084 03907 03741 03588 03444 03310 03184 03066 02956 02852 02754 0.2663 02576 02495 0.2418 02345 02276 02211 02149 02090 02034 01961 01931 01883 01637 01793 01751 0.1711 01673 01636 01601 01567 01535 0.1504 01474

02064 0.2014 0 199.8 0.1949 0 1935 0 1876 01821 01769 01719 01672 01627 0.1565 0.1545 0.1507 0.1470 0.1436 01402 0.1371 01340 01311 0.1283 01257 01231 0 1207 0.1886 0.1831 01777 01725 01677 01631 01587 01546 01507 01469 01434 01400 0.1367 01337 01307 01279 01252 0.1226 01201 01177

01462 0 1431 0 1401 01373 01345

Hyperbolic-Decline

Deferment Factor, FH?

This is the ratio of the present value or present worth of a series of future payments that follow hyperbolic decline (decline proportional to a fractional power of the production rate) and the total amount of such payments. For continuous compounding (M= w) at a nominal interest rate ,j the average deferment factor is I )

where f=future life (in years) determined from Eq. 64 or 65 of Chap. 40.
r-NPlI 4, JFY = 2(JFy a; -1)

The hyperbolic-decline deferment factors for such continuous compounding of interest may bc read from the graph in Fig. 41.10 for given values of ratio F, and product tj.

Harmonic-Decline

Deferment Factor FH~

[Ei($-,)--Ei(

&!,)I.

...C40)

This is the ratio of the present value or present worth of a series of future payments that follow harmonic decline (decline proportional to the production rate) and the total

41-30

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.14-ANNUAL

DEFERMENT

FACTORS

FcR = (1 +i)-- (1 +i) -/12[(1 +i) -I]

Annual Deferment Factors are Apphcable to Equal Payments Received at the End of Each Month During a SpeclflcInterval 1 Year Between (f-l) and t Years From Now of Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 3% 0.9842 0.9555 0.9277 0.9006 08744 0.8489 0.8242 08002 07769 07543 0.7323 0.7110 0.6903 0.6702 06506 0 6317 0 6133 05954 05781 05612 0 5449 05290 05136 0 4987 04841 04700 04563 04431 04302 04176 04055 03936 0 3822 03711 0 3602 0 0 0 0 0 3498 3396 3297 3201 3107 3% Q/cl 0.9816 0.9484 0.9163 0.8853 08554 0.8265 0.7985 07715 0.7454 0 7202 06959 06723 06496 06276 0 6064 0.5859 0.5661 0.5469 0 5264 05106 0.4933 04766 04605 0 4449 04299 04154 04013 03877 03746 03620 03497 03379 0.3265 0.3154 0.3048 0.2945 0.2845 0 2749 02656 0.2566 0.2479 0.2395 0.2314 02236 0.2160 0.2087 0.2017 01949 0.1883 0.1819 4% 09790 09414 09052 08704 08369 08047 07738 07440 07154 06879 06614 06360 0.6115 0.5880 05654 05436 05227 05026 04833 0.4647 04468 04296 04131 03972 03819 0.3673 03531 03395 03265 0.3139 03019 02902 02791 02683 02580 02481 02386 02294 02206 02121 0.2039 01961 01885 0 1813 0 1743 0 1676 01612 01550 01490 01433 4'/2% 0.9765 0.9345 08942 08557 08189 0.7836 0.7499 07176 0.6867 06571 06288 0.6017 05758 0.5510 05273 05046 0.4829 04621 04422 0.4231 04049 03675 0.3708 0.3548 03395 03249 03109 02975 02847 02725 02607 02495 02368 02285 02186 02092 02002 0.1916 01833 0.1754 0 1679 0.1607 0.1537 0.1471 0.1408 0.1347 0.1289 01234 0.1181 0.1130 5% 0.9740 0.9276 0.6835 0.8414 0.8013 0.7632 0.7268 06922 0.6593 0.6279 05980 0.5695 05424 0 5165 04919 04685 0.4462 04250 0.4047 03855 0.3671 0.3496 0 3330 0 3171 03020 0.2676 0.2739 0.2609 0.2485 0.2366 0.2254 0.2146 0.2044 0.1947 0.1854 0.1766 0.1682 0.1602 01525 01453 0.1384 01318 01255 0.1195 0 1138 0.1084 0.1032 00983 0.0936 00892 5'/2% 0.9715 0.9209 0.8729 0.8274 07642 07434 07046 06679 0.6330 0.6000 05688 05391 0.5110 0.4844 04591 0.4352 0 4125 03910 0.3706 03513 03330 03156 0.2992 02836 02688 02548 02415 02289 02170 02057 01949 01848 0.1751 01660 0.1574 01491 01414 0.1340 0.1270 01204 01141 0.1062 01025 0.0972 0.0921 0.0673 00626 0.0784 0.0744 0.0705 6% 0.9691 09142 08625 0.8136 07676 07241 06832 06445 06080 05736 05411 05105 04816 04543 04286 04044 03815 03599 03395 03203 03022 02851 02689 02537 02393 0.2258 02130 02010 01896 01788 01687 01592 01502 01417 01336 0.1261 0.1189 01122 0.1059 00999 0.0942 0.0889 00839 00791 00746 00704 00664 00627 00591 00558 6%% 0.9666 09076 08522 08002 07514 07055 06625 06220 05841 05484 05149 04835 0.4540 0.4263 04003 03758 03529 03314 0.3111 02922 02743 02576 02419 02271 02132 02002 01880 01765 01658 01556 01461 01372 0.1288 0.1210 0 1136 0.1067 01002 00940 0.0883 00829 00779 00731 00686 00645 00605 00568 00534 0.0501 0.0470 00442 7% 0.9642 0.9011 0.8422 0.7871 0.7356 0.6875 0.6425 0.6005 0.5612 0.5245 0.4901 0.4581 0.4281 0.4001 0.3739 0.3495 0.3266 0.3052 0.2853 0.2666 0.2492 02329 0.2176 0.2034 0.1901 0.1777 01660 0.1552 0.1450 0.1355 0.1267 0.1184 0.1106 0.1034 0.0966 0.0903 0.0844 0.0789 0.0737 0.0689 0.0644 0.0602 0.0562 0.0526 0.0491 0.0459 0.0429 0.0401 0.0375 0.0350 7%% 0.9618 0.8947 0.8323 0.7742 07202 0.6699 0.6232 05797 05393 0.5017 04667 0.4341 04038 03756 03494 0.3251 0.3024 02813 02617 02434 0.2264 0.2106 0.1959 0.1823 01695 0 1577 01467 01365 0 1270 0 1181 01099 01022 0.0951 0.0884 0.0823 0.0765 00712 0.0662 0.0616 0.0573 00533 0 0496 00461 0.0429 0.0399 0.0371 0.0345 00321 0.0299 0.0278

8%
0.9594 0.8883 0.8225 0.7616 07052 06530 0.6046 05598 05183 0.4799 0.4444 0.4115 0.3810 0.3528 03266 0.3024 0.2800 02593 02401 0.2223 0.2058 0.1906 0.1765 0.1634 01513 0 1401 01297 0.1201 01112 01030 0 0953 0.0883 0.0817 00757 0.0701 0.0649 00601 0.0556 0.0515 0.0477 0.0442 0.0409 0.0379 0.0351 0.0325 0.0301 0.0278 0.0258 0.0239 00221

6% % 0.9570 0.8621 0.6130 0.7493 0 6906 0.6365 0.5866 0.5407 0.4983 0.4593 0.4233 0.3901 0.3596 0.3314 03054 0.2815 0 2594 0.2391 02204 0.2031 0.1872 0.1725 0 1590 01466 01351 01245 01148 01058 0 0975 0 0898 00628 00763 00703 00648 0.0597 0.0551 0.0508 0.0468 0.0431 00397 0.0366 00338 00311 0.0287 0.0264 0.0244 0.0224 0.0207 0.0191 0.0176

9% 0.9547 0 8759 0.8035 0.7372 06763 0.6205 0.5692 0.5222 0.4791 0.4396 0.4033 0.3700 0.3394 0.3114 02857 0.2621 0.2405 02206 02024 0.1857 0.1703 0.1563 01434 0.1315 0.1207 0.1107 0.1016 0.0932 0.0855 0.0784 0.0720 0.0660 0.0606 0.0$56 0.0510 0.0468 0.0429 0.0394 0.0361 0.0331 0.0304 0.0279 00256 0.0235 0.0215 0.0198 0.0181 0.0166 0.0153 00140

9% % 0.9524 0.8697 0.7943 0.7254 0.6624 0.6050 0.5525 0.5045 0.4608 0.4208 0.3843 0.3509 0.3205 0.2927 0.2673 0.2441 0.2229 0.2036 0.1859 0.1698 01551 01416 0 1293 0.1181 0.1079 0.0985 0.0900 00822 0.0750 0.0665 00626 0.0571 0.0522 0.0477 0.0435 0.0397 0.0363 0.0331 00303 0.0276 0.0252 0.0231 0.0211 0.0192 0.0176 0.0160 0.0146 0.0134 0.0122 0.0112

10% 09500 08637 07852 07138 06489 05899 05363 0.4875 04432 04029 03663 03330 03027 02752 02502 02274 02068 01880 01709 01553 0 1412 01284 01167 0 1061 00965 00877 0 0797 00725 0 0669 0.0599 00544 0.0495 00450 0.0409 00372 0.0338 0.0307 0 0279 00254 00231 0.0210 00191 00173 00158 00143 00130 OOlla 00108 00098 00089

10% % 09477 0 8577 07762 07024 06357 05753 05206 04711 04264 03859 03492 03160 02860 02588 02342 0.2120 0.1918 01736 0 1571 0 1422 0 I287 0.1164 01054 0 0954 00863 0 0781 00707 Q0640 0 0579 00524 00474 0 0429 00388 0.0351 00318 0.0288 00260 0.0236 0.0213 0.0193 00175 0.0158 00143 "",L'S 00117 0.0106 0.0096 00087 00079 3 0071

1 1% 0.9455 0.8518 0.7674 0.6913 06228 0 5611 0 5055 04554 04103 03696 0 3330 03000 02703 02435 02193 01976 0.1780 0.1604 0.1445 0.1302 0.1173 0.1056 0.0952 00857 00772 0.0696 00627 00565 00509 00458 00413 00372 00335 00302 00272 00245 00221 0.0199 00179 0.0161 00145 00131 OOlla ""l"6 00096 0.0086 0.0078 00070 00063 00057

11% % 09432 08459 0.7587 0.6804 06102 0.5473 0.4909 0.4402 03946 03541 0.3176 02848 02555 02291 02055 01843 0 1653 01482 0.1329 01192 0 1069 00959 00660 00771 0.0692 0.0620 0.0556 0.0499 00448 00401 0.0360 0.0323 0 0290 0.0260 00233 0.0209 0.0187 0 0168 00151 0.0135 00121 00109 00098 """67 00078 0.0070 0.0063 0.0057 0.0051 0.0046

0 3017 0 2929 0.2644 0 2761 0 2681 0 2602 02527 02453 0 2362 02312

TIUEf l,,)x NOMINAL

INTEREST

RATETE(,,,)lCONTlNUDUSLYCOMPOUNDED)

Fig. 41 .lO-Deferment

factorsfor hyperbolicdecline (n= %)

VALUATION

OFOILANDGAS

RESERVES

41-31

TABLE

41 .14-ANNUAL
Annual

DEFERMENT

FACTORS

F CR = (1 + i) - - (1 + i) - /12[(1

+ i) - I] (continued)
Month 19%0/o 09092 07608 06367 05328 04459 03731 03122 02613 02196 0 1830 01531 0 1281 01072 0 0897 00751 00628 00526 00440 0036.3 00308 00258 00216 00181 00151 00126 00106 00089 00074 00062 00052 00043 00036 00030 00025 00021 00018 00015 00012 00010 0 0009 00007 00006 00005 00004 00004 00003 00003 00002 00002 0.0001 20% 09072 07560 06300 0 5250 04375 0 3646 0 3038 0 2532 02110 0 1758 0 1465 0 1221 0 1017 0 0848 00707 0 0 0 0 0 0569 0491 0409 0341 0284

Deferment Factors are Appkable to Equal Payments Received at the End of Each Years From Now During a Specific Interval of 1 Year Between (1-l) and

JP/~ 09410 08401 07501 06698 05980 04767 04256 03600 0 3393 03030 02705 02415 02156 0 1925 0 1719 01535 01370 01224 0 1093 0 0975 00871 00778 00694 00620 00554 00494 00441 0 0394 00352 00314 00280 0 0250 0 0224 0 0200 00178 00159 0.0142 0.0127 0.0113 00101 00090 00081 0 0072 0 0064 0 0057 0 0051 0 0046 0 0041 00036

,z',z% 0 9387 08344 07417 06593 05860 04630 0.4116 0 3659 03252 02891 02570 0 2284 0 2030 01805 0 1604 01426 01267 01127 01001 0 0890 0 0791 00703 00625 00556 00494 00439 0.0390 0.0347 0.0306 0.0274 0.0244 00217 00193 0.0171 00152 00135 00120 00107 0 0095 00084 0 0075 00067 0.0059 0.0053 0.0047 0.0042 00037 0.0033 00029

,3% 0!3365 08288 0.7334 0.6491 0.5744 05083 0 4498 0 3981 0 3523 03118 0 2759 02441 02161 01912 0 1692 01497 01325 0 1173 0 1038 00918 00813 00719 00636 0.0563 00498 00441 0.0390 0.0345 0.0306 00271 0.0239 0.0212 00188 00166 00147 00130 00115 00102 0 0090 0 0080 00071 00062 0.0055 0.0049 0.0043 0.0038 0.0034 0.0030 00027 0.0023

131/z% 09343 08232 07253 06390 05630 0 4960 04370 03851 0 3393 0 2989 02634 02320 0.2044 O.lBOl 01587 0.1398 0 1232 01085 0 0956 0.0843 00742 0.0654 00576 00508 0.0447 00394 00347 00306 00270 0.0237 0 0209 00184 0 0162 0 0143 0 0126 00111 0 0098 00086 00076 00067 0.0059 0.0052 0.0046 0.0040 00036 0.0031 0.0028 0.0024 0.0021 0 0019

14% 0 9322 08177 07173 0.6292 05519 04841 04247 0.3725 0.3268 0.2866 0.2514 0.2206 0 1935 01697 0 1489 01306 01146 0 1005 0 0881 00773 60678 0 0595 00522 00458 00402 00352 00309 00271 00238 0 0209 0.0183 00160 00141 00123 0 0108 0 0095 00083 0.0073 0.0064 0.0056 0 0049 00043 00038 00033 00029 00026 00022 00020 00017 00015

14%% 09300 08122 07094 06195 05411 04725 04127 03604 03148 0 2749 0 2401 0 2097 01832 0 1600 01397 01220 01066 0 0931 00813 00710 00620 00541 0.0473 00413 00361 00315 0.0275 0.0240 0.0210 0.0183 0.0160 0.0140 0.0122 00107 0 0093 0.0081 00071 00062 00054 00047 0.0041 00036 0.0032 0.0028 00024 0.0021 0.0018 0.0016 00014 00012

15% 0.9278 08068 0 7016 06101 05305 04613 04011 0 3488 0 3033 0 2637

15'W~ 09257 08015 0.6939 0.6008 0.5202 0.4504 03899 0.3376 0.2923 0.2531

169/o 09236 07962 06864 05917 05101 04397 03791 03268 02817 02429 0 2094 01805 01556 01341 01156 0 0997 0 0859 00741 0 0639 00551 00475 00409 00353 00304 00262 00226 00195 00168 00145 00125 00108 0 0093 00080 0 0069 0 0059 00051 00044 00038 00033 00026 00024 00021 00018 00016 00013 0.0012 00010 00009 00007 00006

16%9/o 09215 07910 06790 05828 05003 04294 0 3686 0 3164 0 2716 0 2331 0 2001 0 1718 0 1474 0 1265 0.1086 0 0932 0 oaoo 0 0687 0.0590 0.0506 00434 0 0373 0.0320 0.0275 00236 00202 0.0174 0.0149 0.0128 0.0110 0.0094 0 0081 0.0070 0.0060 0.0051 0.0044 0.0038 0.0032 0.0028 00024 0.0020 0.0018 0.0015 0.0013 0 0011 0.0010 0.0008 00007 00006 00005

17% 0.9194 0.7858 0.6716 05741 0.4906 04194 03584 0.3063 02618 02238 0 1913 01635 01397 0 1194 01021 00872 00746 00637 00545 00466 0 0398 00340 00291 00248 00212 00181 00155 00133 00113 0 0097 00083 0.0071 00060 00052 00044 00038 00032 00028 00024 00020 00017 00015 00013 00011 00009 0.0008 00007 00006 00005 00004

17'/2% 0.9173 07807 0.6644 0.5655 0.4813 0 4096 03486 0.2967 0.2525 0.2149 0.1829 0.1556 0 1325 0 1127 0.0959 0.0817 0.0695 0 0591 0.0503 0.0428 00365 00310 00264 00225 0.0191 00163 00139 00118 0.0100 0.0085 0.0073 0.0062 0.0053 00045 0 0038 0 0032 00028 00024 0.0020 00017 00014 00012 0.0010 00009 0 0008 0.0006 0 0006 0.0005 00004 00003

iB% 09153 07757 06573 05571 04721 04001 03390 02873 02435 0 2064 01749 01482 01256 01064 0.0902 00764 00648 0 0549 00465 0.0394 00334 00283 00240 0.0203 00172 00146 00124 0.0105 0.0089 0.0075 0.0064 0.0054 0.0046 0.0039 0.0033 0.0028 0.0024 0.0020 0.0017 0.0014 0.0012 0.0010 0.0009 00007 00006 00005 00005 00004 OM)O3 00003

lB'z'"/" 19% 09132 07707 06504 05488 04631 0.3908 0 3298 02783 0.2349 0.1982 01673 0.1412 01191 0 1005 00848 00716 00604 00510 00430 0.0363 00306 0 0259 00218 00184 00155 00131 00111 09112 07657 06435 0 5407 04544 0 0 0 0 0 3618 3209 2696 2266 1904

0 5339 0 5209

0 2293 02191 0 1994 0.1897 0 1734 01642 0.1508 0 1422 0.1311 01231 0.1140 0.0992 00862 00750 0.0652 01066 0.0923 0 0799 0 0692 0 0599

0 1600 0 1345 01130 0 0950 0 0798 00671 00563 00474 0 0398 00334 0 0281 0 0236 00198 00167 00140 00118 00099 0.0083 0.0070 0 0059 0 0049 00041 00035 0.0029 00025 0.0021 0.0017 0.0015 0.0012 0.0010 0.0009 0.0007 0.0006 0.0005 00004 0.0004 00003 00003 00002 0.0002

00567 0.0519 0.0493 0.0449 0.0429 00389 00373 00337 00324 0.0291 0.0282 00245 0 0213 0 0185 0 0161 00140 0 0122 0.0106 0.0092 00080 0.0070 0.0061 00053 00046 0.0040 0.0035 0.0030 00026 00023 00020 0.0017 00015 00013 0.0011 00010 0.0252 0.0218 0.0189 0.0164 00142 00123 0.0106 00092 0 0080 00069 00060 0 0052 00045 00039 00034 0 0029 00025 0.0022 00019 00016 0 0014 0.0012 0.0011 00009 0.0008

0 0237 0 0197 00164 00137 00114 00095 00079 0 0066 0 0055 0 0046 0 0038 0 0032 00027 0.0022 oooia 0.0015 0.0013 00011 0 0009 00007 00006 00005 00004 00004 00003 00002 00002 00002 00001 0 0001

0 0093 0 0079
00066 00056 00047 00040 0 0034 00028 00024 0 0020 00017 00014 00012 00010 00009 00007 00006 00005 00004 00004 0.0003 0.0003 0.0002

amount of such payments. For continuous compounding (M= co) at a nominal interest rate (j), the average deferment factor is I7

Calculation of Loan Payout In the preparation of an engineering report. it is sometimes necessary to include a projection of future income and a payout schedule for a proposed loan. To prepare such a payout schedule, the balance of the loan at the end of each year or period must be determined. A calculation procedure has been suggested by Wilson and Boyd * based on the following assumptions: (I) the principal amount of the loan is growing by virtue of monthly compounding of interest; (2) the loan payments during any year are made in equal monthly installments that are deposited at the end of each calendar month; and (3) both the principal and the loan payments bear interest compounded monthly at the nominal annual interest rate of the loan. Wilson and Boyd use two numerical factors to determine the balance at the end of each year. These are listed in Table 41.15. Factor 1 is the total value of $1, invested at the specified annual nominal interest rate. compounded monthly. Factor 2 is the total value of $1, invested each month,

~ FHU =

.... .. where N,, 4, (F,-1) In F,

. . . . . . . . . . . . . . (4 1)

t, =-

The harmonic-decline deferment factors for such continuous compounding of interest may be read directly from the graph in Fig. 4 1.11 for given values of ratio F, and tj.

41-32

PETROLEUM

ENGINEERING

HANDBOOK

TABLE41.15-LOAN Nominal Interest Rate Months 4% (W/o/month) 1 2 3 4 5 6 8 9 IO II 12 4'12% (3/&/month) : 3 4 5 6 8 9 IO 11 12 5% (5/,12%/month) 1 2 3 4 5 6 7 8 9 10 II 12 : 3 4 5 6 8 9 10 11 12 6% (Wdmonth) 1 : 4 5 6 8' 9 10 11 12 9% @/p/o/month) 1 2 3 4 5 6 7 8 9 IO 11 12

PAYOUTCALCULATION

FACTORS

Factor 1 1.003333 1.006678 1.010033 1.013400 1.016778 1.020167 1.023588 1.026980 1.030403 1.033838 1.037284 1.040742 1.003750 1.007514 1.011292 1.015085 1.018891 1.022712 1.026547 1.030397 1.034261 1.038139 1.042032 1.045940 1.004167 1.008351 1.012552 1.016771 1.021008 1.025262 1.029534 1.033824 1.038131 1.042457 1.046800 1.051162 1.004583 1.009188 1.013813 1.018480 1.023128 1.027817 1.032528 1.037260 1.042014 1.046790 1.051588 1.056408 1.005000 1.010025 1.015075 1.020151 1.025251 1.030378 1.035529 1.040707 1.045911 1.051140 1.058396 1.061678 1.007500 1.015056 1.022669 1.030339 1.038067 1.045852 1.053696 1.061599 1.069581 1.077583 1.085664 1.093807

Factor 2 1.000000 1.001667 1.003337 1.005011 1.006689 1.008370 1.010056 1.011745 1.013438 1.015134 1.016834 1.018539 1.000000 1.001875 1.003755 1.005639 1.007528 1.009422 1.011321 1.013224 1.015132 1.017045 1.018963 1.020885 1.000000 1.002083 1.004172 1.006267 1.008368 1.010475 1.012587 1.014705 1.016830 1.018960 1.021096 1.023238 1.000000 1.002292 1.004590 1.006896 1.009209 I.011529 1.013856 1.016190 1.018531 1.020879 1.023235 1.025597 1.000000 1.002500 1.005008 1.007525 1.010050 1.012584 I.015126 1.017676 1.020235 1.022803 1.025379 1.027964 1.000000 1.003750 1.007519 I.011306 I.015113 1.018939 1.022783 1.026647 1.030531 1.034434 1.038357 1.042299

Nominal Interest Rate Months 6%% 1 2 3 4 5 8 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 IO 11 12 1 2 3 4 5 6 7 8 9 IO 11 12 : 3 4 5 6 7 8 9 IO 11 12 1 2 3 4 i 7 8 9 10 11 12 11% (ll/Ip%/month) : 3 4 5 6 7 8 9 IO 11 12

Factor 1 1.005417 I.010863 1.016338 1.021843 1.027378 1.032943 1.038538 1.044164 1.049820 1.055506 1.061224 1.066972 1.005833 1.011701 1.017602 1.023538 1.029509 1.035514 1.041555 1.047631 1.053742 1.059889 1.066071 1.072290 1.006250 1.012539 1.018867 1.025235 1.031643 1.038091 1.044579 1.051108 1.057677 1.064287 1.070939 1.077633 1.006667 1.013378 1.020134 1.026935 1.033781 1.040673 1.047610 1.054595 1.061625 1.068703 1.075827 1.083000 1.007083 1.014217 1.021401 1.028636 1.035922 1.043260 1.050650 1.058092 1.065586 1.073134 1.080736 1.088391 1.009187 1.018417 1.027753 1.037174 1.046681 1.056276 1.065958 1.075730 1.085591 1.095542 1.105584 1.115719

Factor 2 1.000000 1.002709 1.005426 1.008154 1.010892 1.013640 1.016397 1.019165 1.021943 1.024730 1.027528 1.030336 1.000000 1.002917 1.005845 1.008784 1.011735 1.014697 1.017671 1.020657 1.023654 1.026663 1.029683 1.032715 1.000000 1.003125 1.006263 1.009414 1.012578 1.015756 1.018947 1.022151 1.025368 1.028599 1.031843 1.035101 1.000000 1.003333 1.006681 1.010045 1.013423 1.016816 1.020224 1.023647 1.027086 1.030540 1.034009 1.037494 1.000000 1.003542 1.007100 1.010675 1.014267 1.017876 1.021503 1.025146 1.028807 1.032485 1.036180 1.039893 1.000000 1.004583 1.009195 1.013834 1.018502 1.023199 1.027924 1.032678 1.037482 1.042275 1.047117 1.051989

7% (7/,$Wmonth)

7%% ('%p/olmonth)

5'/2% (~$&Jo/month)

8% (2/,%/month)

8%% (17/2,0/dmonth)

VALUATION

OFOILANDGASRESERVES

41-33

TABLE

41 .I 5-LOAN

PAYOUT

CALCULATION

FACTORS

(continued)

Nominal Interest Months Rate 9 o/o /2 (~9/,,%/month) 2 3 4 5 6 7 8 9 IO 11 12 2 3 4 5 6 7 8 9 10 11 12

Factor 1 1.007917 1.015896 1.023939 1.032045 1.040215 1.048450 1.058750 1.065116 1.073548 1.082047 1.090614 1.099248 1.008333 1.016736 1.025209 1.033752 1.042367 1.051053 1.059812 1.068844 1.077549 1.086529 1.095583 1.104713 1.008750 1.017577 1.026480 1.035462 1.044522 1.053662 1.062881 1.072182 1.081563 1.091027 1.100573 1.110203 i.010833 1.021784 1.032853 1.044043 1.055353 1.066786 1.078343 1.090025 1.101834 1.113770 1.125836 1.138032 1.011250 1.022627 1.034131 1.045765 1.057530 1.069427 1.081458 1.093625 1.105928 1.118370 1.130951 1.143674 1.011667 1.023469 1.035410 1.047490 1.059710 1.072074 1.084581 1.097235 1.110036 t 122986 1.136088 1.149342

Factor 2 1.000000 1003958 1.007938 1.011938 1.015959 1.020002 1.024066 1.028151 1.032259 1.036388 1.040538 1.044711 1.000000 1.004167 1.008356 1.012570 1.016806 1.021066 1.025350 1.029658 1.033990 1.038346 1.042726 1.047131 1.000000 1.004375 1.008778 1.013202 1.017654 1.022132 1.026636 1.031167 1.035724 1.040308 1.044919 1.049557 1.000000 1.005417 1.010872 1.016368 1.021903 1.027478 1.033093 1.038749 1.044447 1.050185 1.055966 1.061788 1.000000 1.005625 1.011292 1.017002 1.022755 1.026550 1.034390 1.040274 1.046201 1.052174 1.058192 1.064255 1.000000 1.005833 1.011712 1.017637 1.023607 1.029624 1.035689 1.041800 1.047960 1.054167 1.060423 1.066729

Nominal Interest Months Rate II %% (*3/&%/month) 1 2 3 4 5 6 7 8 9 10 11 12 I 2 3 4 5 6 7 8 9 IO 11 12 1 2 3 4 5 6 7 8 9 10 11 12 15% (1'/4%/month) 1 2 3 4 5 6 7 8 9 10 11 12 1 : 4 5 6 7 8 9 IO 11 12 16O/b (I%%/month) : 3 4 5 6 7 8 9 IO 11 12

Factor 1 1.009583 1.019259 1.029026 1.038888 1.048844 1.058895 1.069043 1.079288 1.089631 1.100074 1.110616 1.121259 1.010000 1.020100 1.030301 1.040804 1.051010 1.061520 1.072135 1.082857 1.093685 1.104622 1.115668 1.126825 1.010417 1.020942 1.031577 1.042322 1.053180 1.064150 1.075235 1.086436 1.097753 1.109188 1.120742 1.132416 1.012500 1.025156 1.037971 1.050945 1.064082 1.077383 1.090850 1.104486 1.118292 1.132271 1.146424 1.160755 1.012917 1.026000 1.039253 1.052676 1.066273 1.080046 1.093997 1.108128 1.122441 1.136939 1.151624 1.166500 1.013333 1.026844 1.040536 1.054410 1.068468 1082715 1.097151 1 111779 1.126603 1.141625 1.156846 1.172271

Factor 2 1.000000 1.004792 1.009614 1.014467 1.019351 1.024267 1.029214 1.034192 1.039203 1.044246 1.049321 1.054429 1.000000 1.005000 1.010033 I.015100 1.020201 1.025336 1.030505 1.035709 1.040947 1.046221 1.051530 1.056875 1.000000 1.005208 1.010453 1.015734 1.021051 1.026406 1.031798 1.037228 1.042695 1.048201 1.053745 1.059328 1.000000 1.006250 1.012552 1.018907 1.025314 1.031776 I.038291 1.044861 1.051486 1.058167 1.064903 1.071697 1.000000 1.006458 1.012972 1.019542 1.026169 1.032853 1.039595 1.046395 1.053254 1.060173 1.067152 1.074191 1 .oooooo 1.006667 1.013393 1.020178 1.027025 1.033932 1.040901 1.047932 1.055026 1.062184 1.069406 1.076692

10% (s/,%/month)

12% (l%lmonth)

10%

o/o

(7/,%/month)

12'/2% (11/&/month)

8 9 10 11 12 13% (11/12a/o/month) 2 3 4 5 6 7 8 9 10 11 12

13%%
(Ii/,%/month)

15%%

(17/24%/month)

9 10 11 12 14% (IJ/,%/month) 2 3 4 5 6 7 8 9 IO 11 12

41-34

PETROLEUM

ENGINEERING

HANDBOOK

TABLE

41.15-LOAN

PAYOUT

CALCULATION

FACTORS

(continued)

Nominal Interest Rate Months 14% O/O (1~/~4%/month) 1 2 3 4 5 6 7 8 9 10 11 12 17% (15/,$S/month) 1 2 3 4 5 6 7 8 9 10 11 12 1 7%% (l~~/2~%/month) 1 2 3 4 5 6 7 8 9 10 11 12 18% (lq/2%/month) 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12

Factor 1 1.012083 1.024313 1.036690 1.049216 1.061894 1.074726 1.087712 1.100855 1.114157 1.127620 1.141245 1.155035 1.014167 1.028534 1.043105 1.057882 1.072869 1.088068 1.103482 1.119115 1.134969 1.151048 1.167354 1.183892 1.014583 1.029379 1.044391 1.059622 1.075075 1.090753 1.106660 1.122798 1.139173 1.155785 1.172641 1.189742 1.015000 1.030225 1.045678 1.061364 1.077284 1.093443 1.109845 1.126493 1.143390 1.160541 1.177949 1.195618 1.015417 1.031071 1.046967 1.063107 1.079497 1.096139 1.113038 1.130197 1.147621 1.165314 1.183279 1.201521

Factor 2 1.000000 1.006042 1.012132 1.018271 1.024460 1.030699 1.036989 1.043329 1.049721 1.056165 1.062661 1.069209 1.000000 1.007083 1.014234 1.021451 1.028738 1.036093 1.043518 1.051013 1.058580 1.066219 1.073931 1.081716 1.000000 1.007292 1.014654 1.022088 1.029595 1.037175 1.044829 1.052558 1.060362 1.068243 1.076202 1.084238 1.000000 1.007500 1.015075 1.022726 1.030453 1.038258 1.046142 1.054105 1.062148 1.070272 1.078478 1.086768 1.000000 1.007708 1.015496 1.023364 1.031312 1.039343 1.047457 1.055655 1.063937 1.072305 1.080761 1.089304

Nominal Interest Rate Months 16X% (lg/z.,%/month) 1 2 3 4 5 6 7 8 9 10 11 12 19% (l%,%/month) 1 2 3 4 5 6 7 8 9 10 11 12 19%% (115/24a/o/month) 1 2 3 4 5 6 7 8 9 10 11 12 20% (12/,%lmonth) 1 2 3 4 5 6 7 8 9 10 11 12

Factor 1 1.013750 1.027689 1.041820 1.056145 1.070667 1.085388 1.100313 1.115442 1.130779 1.146327 1.162089 1.178068 1.015833 1.031917 1.046256 1.064853 1.081714 1.098841 1.116239 1.133913 1.151866 1.170104 1.188631 1.207451 1.016250 1.032764 1.049546 1.066602 1.083934 1.101548 1.119448 1.137639 1.156126 1.174913 1.194005 1.213408 1.016667 1.033611 1.050838 1.068352 1.086158 1.104260 1.122665 1.141376 1.160399 1.179739 1.199401 1.219391

Factor 2 1.000000 1.006875 1.013813 1.020815 1.027881 1.035012 1.042208 1.049471 1.056801 1.064199 1.071665 1.079201 1.000000 1.007917 1.015917 1.024002 1.032172 1.040429 1.048774 1.057207 1.065730 1.074343 1.083049 1.091847 1.000000 1.008125 1.016338 1.024640 1.033032 1.041516 1.050092 1.058761 1.067526 1.076386 1.085343 1.094398 1.000000 1.008333 1.016759 1.025279 1.033894 1.042604 1.051412 1.060319 1.069325 1.078433 1.087642 1.096955

18%% (1~3/2&/month)

VALUATION

OF OIL AND

GAS

RESERVES

41-35

01 0.01 002
TIME

II] 004 00701 4 7 IO 0.4 0.7 I 2 -11 INTEREST RATE (j,,)(CONTINUOUSLY COMPOUNDED) 0.2 20 3040

(t,, ) x NOMINAL

Fig. 41.11-Deferment

factors

for harmonic

decline.

with monthly compounded interest, at the end of a given number of months, divided by the number of months. The equations for the factors are

F,=

.f ( >
1+$

where F, F2 j r

= = = =

Factor 1, Factor 2, annual nominal interest rate, and time, months.

and

F = VI--l) 2 Jxt ( > 12

TABLE
Total WorkingInterest Revenue Year 9 months 1957 1958 1959 1960 1961 1962 Thereafter Totals $ (1) 675,240 $ Payments to Loan 80% of (1) (2) 540,192 620,880 356,776

The calculation steps are (1) multiply the previous yearend balance of the loan by Factor 1; (2) multiply the total annual payment by Factor 2; (3) deduct the product of Step 2 from the product of Step 1 (the difference is then equivalent to the year-end balance of the loan); and (4) for a period of time less than 1 year, the appropriate factors for the number of months involved are used instead of the 12-month period for the entire year.

41.16~SAMPLE
Loan Balance Start of Period

LOAN-PAYOUT
Loan

CALCULATION
Loan Payment x Factor 2 Factor 2 (2)x (6) (7) $550,202 685,263 636,733 * Year-End Loan Balance AllocatIon to Pnnclpal Allocation to Interest (2)- (9)

Balance
x Factor 1

Factor 1
(4) 1.042014 1.056408 *

(3) (4) x
(5) $2,084,028 1,620,346 987.829

(5)-(7)

(3)
$2,000,000 935,083 351,056

(6)
1.016531 1.025597 1.025597 .

(8)
$1,533,826 935,083 351,096 0 Payout = 9h0 $

(3)-W (9)
446,174 598,743 584,027 351,056

(10)
$ 74,016 69,417 36,853 7,720

835,200
776.100 632,200 514,000 714,240 1,232.090 $5,082,070

668,160 1.533,8261.056408

$2.188,008

$2,000,000

$188,008

41-36

PETROLEUM

ENGINEERING

HANDBOOK

A sample calculation shown in Table 4 1.16 deals with the problem of determining the date of payout. the total payments required, and the annual amount of interest payments for a loan of $2,000.000 at 5 % 70 nominal interest per year, payable out of 80 % of the net runs. The calculations are shown in considerably more detail than required solely for clarity.

Nomenclature
a = nominal decline rate; instantaneous rate of change divided by the instantaneous production rate, decimal fraction Cs = balance of unreturned portion of investment, dollars C,,, = depletable leasehold cost basis at beginning of tax period, dollars Ci = initial capital investment or purchase price, dollars Cl = intangible drilling and development costs. dollars CIA = deduction if intangibles were capitalized and amortized over 120 months or depleted by use of cost depletion rates, dollars CIP = preference intangible drilling costs, dollars CIX = intangible costs minus C,,, , dollars C PT = local production tax, dollars C WI = working interest, decimal fraction of gross costs d = effective decline rate, the drop in production rate per unit of time divided by the production rate at the beginning of the period, decimal fraction DA = allowable depletion. highest of DC or lesser of VDE and I/, DC = cost depletion: portion of leasehold cost proportional to reserves produced in a given year. dollars DE = depletion; the decline of a capital value as a result of intentional piecemeal removal or gradual consumption in use DKB = depth measurement below kelly bushing D, = depreciation; the decline in value of tangible assets with use or the passage of time (obsolescence) e = base of natural logarithms E(x) = exponential integral of x Fr = total value of dollars invested at specified annual interest compounded monthly. dollars F2 = total value of dollars invested each month with monthly compounded interest at end of month divided by the number of months since investment, dollars F cPD = constant-percentage-decline deferment factor; the average deferment factor applicable to a series of future payments that follow constant-percentage decline, decimal fraction

F cK = constant-rate deferment factor: the average deferment factor applicable to a series of equal future payments made at equal time intervals, decimal fraction deferment factor: the F Ho = harmonic-decline average deferment factor applicable to a series of future payments that follow harmonic decline, decimal fraction F HV = hyperbolic-decline deferment factor: the average deferment factor applicable to a series of future payments that follow hyperbolic decline, decimal fraction F LS = lump-sum deferment factor; the average deferment factor applicable to one single future payment. decimal fraction F PV = deferment factor; a factor used to reduce revenue received in the future to a present value, decimal fraction F, = ratio between initial and final production rates or payments i = effective annual compound safe interest rate, decimal fraction i = effective annual compound speculative interest rate. decimal fraction = revenue interest: decimal fraction of gross ;R revenue I = yearly net income, dollars I, = net operating income: the total earned income from oil and gas sales after deduction of lease operating expenses, federal excise taxes, and production taxes, dollars/yr I,, = net annual operating income during Year n, dollars Ir = interest owner taxable income, dollars s j = nominal annual safe interest rate; used when interest is compounded over M periods in a year and equal to M times the interest j/M over one period, decimal fraction j = nominal annual speculative interest rate, decimal fraction extinguishment of an mk = amortization; intangible asset or indebtedness M = number of times the interest is compounded per year n = number of yearly payments N, = cumulative oil produced, bbl N, = reserves at end of tax period, bbl or Mcf 0, = operating expenses, including ad rvAmm taxes, dollars 0~ = general overhead expenses, dollars 0, = operating expenses per well-month, dollars 0, = weighted average operating costs per barrel, dollars P = net profit; the total net operating income after deduction of capital expenditures. dollars

VALUATION

OF OIL AND GAS RESERVES

41-37

F = future net revenue or cash flow; the pc, projection of total annually earned income from oil and gas sales after deduction of production taxes. federal excise taxes, operating expenses, and incidental capital expenditures, dollars y = production rate, bbl/D/month. or bbl/yr s = unit sales during periods S = sinking fund balance I = time, months or years t = abandonment time or future life. years T,!E = Windfall Profit Tax (WPT) V = gross revenue (value); the total earned income from oil and gas sales, dollars V,L- = percent of gross revenue. percentage depletion VT, = 50% of net percentage depletion, equal to 50% of taxable net income, dollars Cl = total future net operating income. dollars Subscripts a = abandonment i = initial t = conditions at Time t

15. Joint A\wciatmn Survey of Indwry Drllllng Couth IYSY. 4PI. lP4.4. and M&Contlnent Oil and Gu\ Asw. (March 1961). 16. Breeding, C.W. and Hercfeld. J.R.: Effect ol T,ixatwn on Valw ation and Production Engineering. J. PC,/. 7?ch. (Sept. 19581 21-2s. Method\ ot Calculating Profitlc17. Brons. F. and McCarty. J.S. Jr : bilities. paper SPE 870-G presented at the lYS7 SPE Annual Mccting. Dal&. Oct. 6-9. 18. Hdl. H.G.: New Method ofcomputing A Rate of Return on Cap&d Expenditures, paper prcsentcd at the Philadelphia Chapter 01 the Natl. A\hn. for Business Budgctinp, Aug. lY53. .s A.\ti\rlrnr. Longman\. Green I Hoskold. H.D.: ~t~~irwc~r Vrriui~~,~ ). & Co. Inc.. New York City ( 1877). 20. Morkill. D.B. Fonw/rr.c ,/iv Miw Vr~l~rairwz. MirunF nnd Scww tllrc Pres\, I I7. 276. Simplified Calculutions Deter!I. Wilson. W.W. and Boyd. W.L : mine Loan Payout. World O/I (May 19.581.

General References
Arph. J.J.: Reason for Diffcrcnccz in Recovery El lclcncy. paper l SPE 2068 presented al the 1968 SPE Hydrocarbon Economics und Evaluation Sympowm. Dallas. March 4-S

Campbell. J.M. and Hubbard. R.A.: Price Forcc;istlng and ProJcct Evaluation in the I98O s. 1. PH. Tdi. (May 1984) 817-25. Campbell. J.M. ef crl. : Mirwwl Prc~pc+ Er~o~zow~x. Campbell Petrw leum Scncs. Norman. OK (19771. Chan. S.A.: Fmancu~l and Engineermg Considerations In Petroleum Property Acquisitions. paper SPE II301 presented at the 1983 SPE Hydrocarbon Economlch and Evaluation Symposium, Dallas. March 3-4. Cozzolino. J.M.: Simplified Utility Framework For the Analysis A of Financial Risk. paper SPE 6359 presented at the 1977 SPE Hydrocarbon Economics and Evaluation Sympoalum. Dallas, Feb. 21-22. Ecotam~i(:~am/ Finunw, Reprint Senec. SPE. Richardson. TX (1980) 16. Grossling, B.F.: * Search of a Statistical Probdbllity Model for In Petroleum-Resource Assessment. U.S. Dept. of the Interior, Rc\ton. VA (1975). Gentry, R.W. and McCray. A.W.: The Effect of Re\ewow Fluid Properties on Production Decline Curves. /. Per. T&T. (Sept. 1078) 1327-41. Greenwalt. W.A.: Determimng (Nov. 1981) 2189-95. Venture Participalion. J. Pd. Ted.

References
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