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Omowumi Iledare and Mark Kaiser,
“Prospectivity, Productivity, and Profitability on Offshore Petroleum Leases: Empirical Evidence from the U.S. Gulf of Mexico Region,”
Volume 34, Number 2
PROSPECTIVITY, PRODUCTIVITY, AND PROFITABILITY ON OFFSHORE PETROLEUM LEASES: EMPIRICAL EVIDENCE FROM THE U.S. GULF OF MEXICO REGION
Omowumi Iledare and Mark Kaiser*
n the early 1990s, petroleum industry analysts thought the Gulf of Mexico (GOM) region could only attract the small exploration and production (E&P) investors. However, the GOM outer continental shelf (OCS) has re-emerged as the key focal
*Omowumi Iledare, Professor of Petroleum Economics and Policy Research and Director of the Energy Information and Data Division of the Center for Energy Studies (CES) at Louisiana State University (LSU), also is Adjunct Professor in the Department of Petroleum Engineering of LSU and the University of Louisiana, Lafayette. The author, who received a Ph.D. in mineral economics from West Virginia University, is a Visiting Professor to the Institute of Petroleum Studies at the University of Port Harcourt, Nigeria, and to the African University of Science and Technology, Nigeria. Dr. Iledare’s papers appear in proceedings of the Society of Petroleum Engineers (SPE), the U.S. Association for Energy Economics (USAEE), and the International Association for Energy Economics (IAEE) as well as The Energy Journal, Energy Economics, Energy Policy, Pacific and Asian Journal of Energy, World Oil, and Oil and Gas Journal. He serves as associate editor and editorial board member for the SPE’s Journal of Economics and Management. Mark Kaiser, who holds a Ph.D. in industrial engineering from Purdue University, is Professor and Director of the Research and Development Division, CES, at LSU, where he is also an Adjunct Professor in the Department of Petroleum Engineering. The author’s research has been published in a variety of journals such as Applied Mathematics Letters, Applied Mathematical Modeling, Computers and Operations Research, Electric Power System Research, The Electricity Journal, Energy, Energy Economics, Energy Policy, European Journal of Operational Research, Journal of Optimization Theory and Applications, Ocean & Coastal Management, Ocean Development and International Law, Oil and Gas Journal, and Simulation. The authors wish to acknowledge the assistance provided by Hui Wang, Dmitry Mesyanzhibov, Ric Pincomb, Barbara Kavanaugh, and the support of Kristen Strellec of the Minerals Management Service (MMS). All opinions and findings in this paper are solely those of the authors. The Journal of Energy and Development, Vol. 34, Nos. 1 and 2 Copyright Ó 2011 by the International Research Cancer for Energy and Economic Development (ICEED). All rights reserved.
THE JOURNAL OF ENERGY AND DEVELOPMENT
point of oil and gas activity in the United States. The reason for this turn around has been attributed to several technical advancements in offshore drilling and production technology. Because of innovation in technology, areas in the Gulf of Mexico once thought beyond reach in terms of water depth are now explored and developed successfully. Several other factors underlying the reversal in the attractiveness of the GOM region to E&P investors might have included the changing structure of the OCS oil and gas industry, government regulatory programs and fiscal incentives, technical progress, and market conditions resulting in higher oil and gas prices.1 Subsequent to these economic and policy factors, leasing activity in the Gulf OCS increased significantly, particularly in deepwater. New incentives to encourage E&P firms to explore and develop petroleum resources, especially natural gas, in the more difficult areas of the Gulf of Mexico also have contributed to the rising trend in leasing activity in the region. It is estimated that without the increase in GOM oil and gas activities, the overall decline in U.S. oil production over the five-year period from 2000-2005 would have been more than double.2 Thus, the prospect of increasing petroleum reserves and supply in the United States continues to hinge significantly on making new, sizable, and profitable discoveries in the Gulf of Mexico OCS region, especially in the OCS deepwater. In order to facilitate a better understanding of whether petroleum resource development in the federal OCS has been managed well enough to ensure adequate government receipts for its OCS leases and guarantee satisfactory returns on investment for E&P firms, a series of economic studies were conducted in the early 1980s. Most of these studies were conducted using lease-specific data obtained under a set of procedures known as nomination and track selection.3 Subsequent to these studies, however, the leasing policy for OCS oil and gas leases changed in 1983 from a nomination system to area-wide leasing. Moreover, since that time the structure, conduct, and performance of the oil and gas industry have changed significantly as well.4 In a more recent study, A. G. Pulsipher et al. examines the implication of the changes in the U.S. Department of the Interior’s Minerals Management Service (MMS) policy for OCS leases, the changing industry structure, and characterizes high bonus bid value for OCS leases from 1983-1999.5 However, Pulsipher et al. did not evaluate or characterize OCS lease development performance in terms of lease productivity, prospectivity, or aggregate return on investments. Thus, the objectives in this paper are to characterize and analyze petroleum lease sales and development in the U.S. Gulf of Mexico OCS using estimated physical and economic performance measures. The physical performance measures we estimated include lease prospectivity index, lease expeditious index, and lease development productivity. In addition, we estimated two economic performance measures: a profitability index and internal rate of return. This paper is organized into four sections. The first presents a brief introduction and a review of relevant literature. The second part describes the methodology,
LEASES IN THE GULF OF MEXICO
data, and the analytical modeling framework applied in this study. Several cash flow model components are presented and analyzed. The following section describes physical and economic measures of offshore lease development performance measures, including prospectivity, productivity, and profitability indicators. The final portion presents our research summary and conclusions.
Methodology and Data The framework we adopted in this paper is the discounted cash flow method. The purpose of a cash flow analysis is to assess whether or not the revenues generated by the project cover the capital investment and expenditures and whether or not the return on capital investment is consistent with the risk associated with the project and the strategic objectives of the corporation. The net present value (PV) method for evaluating the profitability of capital investments on leases in the GOM OCS can be represented mathematically by the following equations:6 PV =
k X NCFt t t =1 ð1 + DÞ
IRR = fD [ PV = 0g:
D is the (discount) rate that equates the present value of the net cash flow to zero. The present value of net cash flow (NCF) is the product of a discounting process by which all future cash streams are discounted into present value in recognition of the time value of money. The process involves the application of an equal weight to all future incomes. This can be taken literally to mean the process of owning a project at a point in time. That implies that the owner of a project may be willing to let go of a property provided the price offered for the business is greater or equal to the estimated PV. It is thus important to specify the reference period as well as the discounting factor. The internal rate of return (IRR) computed using equation (2) is a widely accepted measure of project profitability. It is a profitability index that is independent of cash flow and can be calculated on a before-tax or after-tax basis. This index cannot be calculated if all the cash flows are negative; also important, more weights are placed on the earlier cash flows than later ones. In other words, IRR calculations using equation (2) heavily discounted cash flows occurring in the later years of the project. A profitability index (PI), or investment efficiency ratio, normalizes the present value of the project relative to the present value of total investment and is calculated as:
. Production as well as price forecasts of all hydrocarbons are necessary in order to calculate this cash flow item. etc. The gross revenues in year t from hydrocarbon production are defined as: 7 GRRt = Po *Qo + Pg *Qg t t t t where Pto. e. ð5Þ ð4Þ . OOX = other costs. Description of Cash Flow Components: The more generalized relationship for net cash flow computation takes the form of equation (4) under a royalty and tax fiscal system. and DPX = fiscal depreciation and depletion allowance. Gulf of Mexico OCS: NCFt = ð 1ÀA Þ * ½ GRRt À ROYt À OPXt À BNXt À OOXt À ð 1ÀB Þ *CPXt + A* ½ DPXt where NCF = net cash flow. in an aggregate sense.g. environmental fees. A. natural gas.S. the internal rate of return on total investment on lease sales and development in the Gulf of Mexico OCS region. the type governing E&P operations.190 PI = where THE JOURNAL OF ENERGY AND DEVELOPMENT PV ðTRÞ PV ðTCÞ ð3Þ TR = total operating cash flow and TC = total capital investment. The empirical model results are limited to leases issued from 1983-1999 and developed not later than 2004. gas production in year t. CPX = capital expenditure as defined by legislation. The above cash-flow modeling framework is formulated to determine. Gross revenues are earnings from crude oil. B = taxation and investment credit rate. OPX = operating expenses as defined by legislation. Qtg = total oil. ROY = royalty. GRR = gross revenue. and/or natural gas liquids (NGL) sales. abandonment costs. Ptg = average oil. rentals. respectively. in the U.. and Qto. BNX = signature and/or production bonus payments if tax deductible. gas benchmark price in year t.
and before November 28. like bonus payments for a lease.11 Rentals. D. Gulf of Mexico OCS and deepwater is R = 1/8th (12.67 percent). Otherwise. bonus value per lease is an important variable to monitor in lease performance evaluation. lifting costs.8 Bonuses and rentals are pre-discovery payments to the government or land owners for the right of E&P firms to explore. community settlements. and the like. regardless of the primary terms of the lease. management fees. and it is independent of any cost of development or ongoing operation and irrespective of profitability of the discovery. however.5 percent) or R = 1/6th (16. It is therefore considered a regressive type of tax because it is tied to gross revenue or gross production. to lift the oil and gas to the surface. the time of lease sales. . The Act offers minimum royalty suspension volumes by water depth to leases issued as part of an OCS lease sale after November 28. can approach 20 percent or more in the OCS deepwater. The goal to explore and develop petroleum efficiently in the OCS region may be difficult to accomplish if the initial cash payment to the government for granting firms the right to explore for oil in the OCS region is either ‘‘too high’’ or ‘‘too low. Typical examples of OPEX items include all variable costs such as the cost of raw materials. and the incentive schemes. and produce petroleum through a competitive bidding process.13 Operating expenditures (OPEX) represent the money required to operate and maintain production facilities. treat. environmental costs. Johnston suggests that the relationship between annual operating costs and total capital expenditures ranges between 3 percent and 5 percent in the Gulf of Mexico shelf. Royalty is one of the more common fiscal cost items in cash flow analysis from an operator’s perspective.12 The royalty rate R. 0 £ R £ 1. thousand cubic feet (Mcf) of natural gas. In order to quality. such leases must be located in water depths of 200 meters or deeper and satisfy other stipulations of the Act. 2000. develop. or barrels of oil equivalent (boe). 1995. It is based on the value of produced resources and represents payments made in cash or in kind for the right to develop and produce discovered reserves. and transport the hydrocarbons. depends upon the location. other hidden costs of doing business.S. are regressive receipts by the government in the sense that they are independent of lease profitability or prospectivity.’’9 Thus. It is normally calculated as a fraction of gross production. the lease expires unless operations begin within a year from the effective lease date. They are direct costs associated with production or injection. The most recent royalty incentive plan in the Gulf of Mexico is the OCS Deep Water Royalty Relief Act of 1995.10 Rentals represent payments by lease owners to defer E&P operations on the lease for at least a year.14 The ratio. The total amount of production in year t is expressed in terms of barrels (bbl) of oil. There can be no operating costs if there are no production operations. labor costs. The federal royalty rate in the U. and to gather.LEASES IN THE GULF OF MEXICO 191 Oil or natural gas price is based on a benchmark expressed as an average over the time horizon under consideration.
17 It is reasonable to infer that as capital costs increase. the timing of infrastructure removal and abandonment is significant in a cash flow analysis. production costs and evacuation costs can account for more than one-third and a quarter of total operating expenditures. lease ownership. platform structures. Mian classifies operating expenditures into five components. Removal and abandonment costs of wells and facilities now constitute a significant component of total costs. and the well type and location (shelf. While these costs come at the end of the project life. Capital costs also may occur over the life of a project. facility equipment and installation costs. The other three components—insurance premium. Data Sources and Description: The lease-specific data for this study are primarily from the Minerals Management Service (MMS). and statistics on well status. A. an agency of the U. Information on lease status.15 Typically. at the end of the economic life of a fixed structure in the OCS. and other relevant information on platforms in the Gulf of Mexico was collected from MMS platform masters. number of wells completed.20 Oil and gas production data were obtained from the production information database. such as during re-completing wells into a new formation.19 Borehole files in the MMS well information database provided data on drilling activity. upgrading existing facilities. especially in present value calculations. Department of the Interior. The technical factors affecting drilling costs include geology. The configurations of wells drilled also significantly affect drilling costs as do rig availability and contractual drilling agreements. maintenance costs. ceteris paribus. and removal costs. Total drilling costs (exploratory and development drilling) account for a significant fraction of the exposed capital associated with oil and gas ventures. CAPEX consist of geological and geophysical costs. The type of well drilled can be expressed in terms of well classification—exploratory or development—or in terms of drilling outcome—successful (oil or gas) or dry.18 The abandonment cost portion of CAPEX is driven by the desire to make oil and gas companies socially responsible. project viability decreases. . etc. total drilling costs as a fraction of total costs associated with oil and gas development can range from 25 to 50 percent.S.192 THE JOURNAL OF ENERGY AND DEVELOPMENT M. respectively. effective lease date. or deep) drilled. These costs are usually considerably smaller in magnitude and duration than are the initial capital expenditures. drilling program. and designated lease operator were retrieved from MMS Leasing Information Data files. drilling costs. slope. the structure must be removed and abandoned in an environmentally safe manner. and overhead—account for the remaining 42 percent. It is required that. In fact. and platform locations files.16 Capital expenditures (CAPEX) are the expenditures to develop and produce hydrocarbons that are incurred early in the life of a project and often for several years before revenues are generated.
suggesting that the Gulf OCS is still as attractive to the big firms as it was in the . and total. we estimated gross revenue as the sum of the product of natural gas prices and gas production and oil prices and oil production.21 The survey reports well drilling costs for various areas of the United States. first we collected actual historical data on leasespecific hydrocarbon production through 2004 for all leases purchased by firms during OCS lease sales from 1983 to 1999. The revenue series has two components. for the purpose of this paper.22 To estimate gross revenue. The two generic economic measures discussed in this paper were calculated on a before-income tax basis. Physical Measures of Lease Sales and Development Performance—Lease Ownership and Structure: Descriptive analysis of data on lease ownership in the Gulf of Mexico shows a significant influx of new players in the bidding process for OCS leases over the past two decades. JAS reports drilling for different well depth ranges and for four different types of wells—dry.S.LEASES IN THE GULF OF MEXICO 193 The source of data for estimating drilling costs per lease was the Joint Association Survey (JAS) of the U. Department of Energy’s Energy Information Administration (EIA) adjusted oil and natural gas price trends forecasted for the Gulf of Mexico OCS region in 2004. we have defined lease sales and development performance in terms of lease prospectivity or productivity and economic indicators. otherwise. The aggregate cost estimates for capital expenditures—platform installation and removal and operating or production expenses—are from published public reports and studies. For the purpose of this report. Finally. oil. such wells are classified as oil. Further. Offshore Lease Development Performance Indicators This section describes aggregate measures of performance in lease sales and developments in the Gulf of Mexico OCS for leases issued from 1983 to 1999. the well is classified as gas. wells with no reported production were classified as dry. We used MMS well production and borehole data to classify OCS wells into well types. using the U. Thus. The projected revenue from 2005 to 2017 for any lease that has not reached its economic life limit is based on projected oil and gas prices in 2004 and projected output using an exponential production decline functional approach. Oil and Gas Producing Industry.S. The measures—prospectivity and productivity indices—described in this section are by no means exhaustive. gas. However. We then projected hydrocarbon production on a lease-specific basis to shut down. there is no significant change in the share of cumulative leases owned and controlled by the top four firms as of 2003. if the reported gas production over an entire well production history expressed in boe units is greater than liquid production. The historical revenue from 1983 to 2004 is based on the adjusted historical oil prices in current dollars reported by the EIA.
In an aggregate sense. In other words.6 6.4 percent as of 2004.6 14.8 26. 43 percent qualified as producible leases from 1983 to 2004.60 23.9 40. 26 percent of 13.1 61.6 4. however.65 40.3 8.26 28.2 3. The overall aggregate lease development index for leases issued from 19831999 was 11.6 11.8 16. Further.56 44.6 14.48 16.581 leases with reported drilling. This measure.641 leases issued from 1983-1999 reported some drilling activity as of year-end 2004.6 13.8 16.1 20.13 .19 16. approximately one out of nine leases acquired during this period produced hydrocarbons in the Gulf of Mexico Table 1 DISTRIBUTION OF OUTER CONTINENTAL SHELF LEASES ISSUED FROM 1983-1999 BY FIRM SIZE AND RANKING: PUBLIC VS. An after-the-fact measure of prospectivity by lease category for leases issued from 1983-1999 as of year-end 2004 is presented in table 2.6 29.2 22.4 25. Of the 3. The drilling failure rate in the aggregate was about 57 percent as of 2004. The success rate of drilled leases.1 41.6 10. The analysis suggests that the company identity matters in the bidding process. is calculated as a conditional probability parameter. which also can be expressed as one minus failure rate. within the context of any anti-competitive behavior in the bidding process.5 63. on the other hand. Physical Measures of Lease Sales and Development Performance—Lease Development Prospectivity: The lease development index as a measure of lease prospectivity in this paper is defined as the multiplicative product of drilled lease ratio and successful drilled lease ratio. we analyzed lease ownership data on the basis of an assigned MMS unique identity to lease owners rather than using the unique public identity of firms. on our evaluation of lease ownership on the basis of the public identity of firms (table 1). is the proportion of leases drilled that are producible or productive.194 THE JOURNAL OF ENERGY AND DEVELOPMENT 1980s.63 40.7 20.1 18. The above declarations are based.1 43. Drilled lease ratio is the ratio of the number of leases drilled to the number of leases issued. MINERALS MANAGEMENT SERVICE (MMS) IDENTITY 1983 Public Identity 1983 Rank Top 4 Big 5-8 Big 9-20 All others 2003 Rank Top 4 Big 5-8 Big 9-20 All other MMS Identity 2003 Public Identity MMS Identity 44.6 11.
42% 21.528 $200.39% 6.568 1.54% 43.000.13% 23.553 1.28% 69.16% 8.403 150 281 200 334 737 1.000.37% 48.240 1.000 3.000 Bonus > 3.615 Non-competitive 9.937 Top 9-20 2.166 386 765 786 786 969 2 1.510 Top 21-last 3.21% 60.25% 25.65% 57.128 Biding structure Competitive 3.749 $1.517 2.98% 51.62% 54. respectively.515 Water depth Depth£ 60m 5.339 1.68% 56.77% 11.35% 10.79% 21.508 Integrated 7.62% 60.47% 2.69% 54.97% 18.05% EGOM.15% 50.150 17 2.37% 15.29% 4.LEASES IN THE GULF OF MEXICO Table 2 195 AGGREGATE PROSPECTIVITY OF LEASES ISSUED FROM 1983-1999 AT YEAR END 2004 Leases Group/Lease Category Issued Drilled Producible Drilled Ratio Lease Prospectivity Development Index Drilling Risk Lease type All 13.24% 54.02% 62.93% 88.183 200m<Depth£ 900m 2.675 Top 5-8 1.84% 8.21% 69.66% 54.18% 20.47% 17.50% 0.473 1.58% 13.95% 10.63% 57.821 Drainage 820 Firm size Top 4 5.17% 49.877 1.81% 11.249 Bonus £ $400.88% 16.58% 2.98% 21.12% 19.679 Bidding conduct Joint 4.365 60m<Depth£ 200m 2.01% 51.76% 11. and WGOM are eastern.137 414 35.34% 6.24% 67.641 Wildcat 12.091 1.94% 18.996 1.30% 20.116 768 430 267 419 521 747 1.67% 35.996 2.93% 17.32% 13.000 Firm type Independent 6.16% 39.38% 10.950 Bonus size Bonus £ 3.62% 49.15% 68.37% 29.37% 20.40% 51.44% 35.291 290 907 414 741 1.40% 43.000 Bonus £ 2. central. and western Gulf of Mexico. .581 3.90% 30.63% 56.063 Solo 9.213 WGOM 5.04% 27.081 a 3.018 313 141 81 190 220 324 817 26.11% 21.05% 5.07% 6.143 Depth>900m 3.77% 56.89% 59.91% 5. CGOM.87% 51.768 $1.97% 14.29% 4.231 a Planning area EGOM 347 CGOM 8.
In comparison. Fourth.196 THE JOURNAL OF ENERGY AND DEVELOPMENT OCS as of year-end 2004. which qualified as producible leases. on average.9 months prior to first production on leases sold from 1983-1987. including the Gulf of Mexico OCS. that the declining trend with time is not as rapid. while the drilling failure rate for the latter is nearly 10 percentage points higher than the former. however. Physical Measures of Lease Sales and Development Performance—The Expeditious Development Index: Figure 1 portrays the average aggregate lag from sales to first drilling activity (spud) and from spud to first production by lease category. Fifth. These measures are called expeditious development indices. The indices provide insights on the perception of owners regarding the economic potential of a given lease. It seems. decreases with water depth and firm size but increases with bonus size for leases issued from 1983-1999 and developed as of year-end 2004. it took about 78. The global market conditions do affect rig availability and. for joint-venture leases as it is for solo-venture leases. Variations in lease prospectivity within a group are evident in table 2. The drilling ratio of the former is also more than twice the latter. the lease development index measured as a proportion of leases issued. But the reverse was the case in the 1990s. the risk of failure for wildcat leases is higher in the aggregate than the failure rate for drainage leases. The increase in average lag from sale to production with water depth also is evident in a dynamic sense. For example. but drainage leases are more likely to be prospective than wildcat leases issued from 1983-1999. On average. The timing of lease sales and development also is important. First. Declining trends with time in the lag from sales to production on leases are evident in table 3 for all lease categories. the expeditious index for joint-venture leases was bigger in magnitude in the 1980s for solo leases than joint-venture leases. Third. the aggregate lease development index for single leases issued from 1983-1999 is more than twice the index for leases with at least two bids. Second. . the drilling failure rate for joint-venture leases is higher than the failure rate for solo leases. the delay in activity on leases in petroleum-producing regions of the world. hence. on average. it took approximately 50. the aggregate lease development index for independent firms is nearly three times that for integrated firms because of a proportionately lower drilled ratio and higher drilling failure rate for the latter than the former.3 months on average from sales to production for leases sold from 1995-1999. the development index value for joint-venture leases is higher because the drilling ratio is significantly higher than that of solo leases over the study period. however. Figure 1 and table 3 depict the aggregate trend in the promptness of lease development index for leases issued from 1983-1999.
Further evaluation of figure 1 shows that the aggregate lag from sales to production for integrated leases . it took on average 26.3 months from effective lease sale time to spud a well on deepwater leases. On average.LEASES IN THE GULF OF MEXICO Figure 1 AGGREGATE EXPEDITIOUS DEVELOPMENT INDEX (in months) 197 If we assume that lease owners are rational economic beings. it is evident in figure 1 that the average lags in months from lease sales to first lease production increases with water depth and firm size. In contrast. Additionally. then leases with expected high cost of development will be delayed for action.3 months from first drilling to first production on leases in the shelf (water depth of 0-200 meters) for all leases. it took 77.
8 79.5 60.8 30.2 127.6 54. water depth in meters (m).2 49.3 61.864 million boe for leases issued in the early 1990s.0 74. Physical Measures of Lease Sales and Development Performance—Lease Development Productivity: Productivity for the purpose of this paper is measured as the ultimate hydrocarbons producible (historical plus projected) per lease drilled.9 55.0 75. No production is projected for undeveloped leases at the end 2004. however.9 41.9 119.9 65.4 59.6 48. is more than the lag for leases acquired by independent firms from 1983-1999 as of 2004.6 82.0 176.9 52.2 71.3 70.4 110.3 83.7 128.2 65.8 1990-1994 55.2 105.5 73.6 74.1 99.2 73.2 82.8 54. the key findings with regards to the productivity of OCS leases issued from 19831999 (table 4) include seven observations.7 54.536 million boe for leases issued from 1983-1987 to 2.198 THE JOURNAL OF ENERGY AND DEVELOPMENT Table 3 GULF OF MEXICO: AGGREGATE AVERAGE LAG IN MONTHS FROM SALES TO FIRST PRODUCTION FOR LEASES ISSUED FROM 1983-1999 Group Type Lease Category Aggregate Wildcat Drainage a 1983-1987 78.3 50.9 75.5 61.6 115.7 123.4 82.1 180.8 E&P type Integrated Independent Top 4 Top 5-8 Top 9-20 Non-top 20 a E&P size a Water depth < 60m 60m – 200m 200m – 900m >900m Solo bidder Joint bidder Conduct a E&P = exploration and production.8 69.0 65. Accordingly. on average.3 53.7 52.5 54.4 56.5 46. lease productivity by structure shows a higher productivity ratio for drilled solo-venture leases in the 1980s and early 1990s than drilled joint-venture leases.7 56. First. was the case for leases issued in the late 1990s.1 47.7 60.6 1985-1989 75.9 51. The reverse. Second.2 48.9 83.0 59. the overall aggregate productivity per drilled lease in the Gulf of Mexico OCS declined significantly from a high of 4. .3 70.3 1995-1999 50.7 63.5 74.
112 4.929 4. and western Gulf of Mexico.$1000K >$1.684 2.145 2. eastern.000 1.923 2. there seems to be increasing lease productivity with lease value. Sixth.958 7.$400K $400K .038 3.688 2.675 2.047 5. however. a Third.977 3.257 2.876 0.323 2.150 2.259 3. a comparison of aggregate lease productivity by bonus size shows a less discernable pattern.638 1990-1994 2.177 1.946 9.927 2.046 0.513 1. water depth in meters (m).908 4.991 3.609 2.350 3.864 3.671 16.000K Aggregate a CGOM a EGOM a WGOM 1983-1987 2.000 2. Fifth.532 4. WGOM = central.808 4.264 4.616 3. there is strong statistical evidence to suggest that leases receiving at least two bids on the Gulf OCS were more productive than leases that received single bids from 1983-1999.180 3. CGOM.445 3. EGOM. the lease development productivity rate as defined above also seems to show an increasing pattern with water depth in the aggregate sense. bonus size in thousand (K) dollars.072 27.900m >900m Solo bidder Joint bidder < $200K $200K . 1983-1999 (aggregate annual average in million barrels of oil equivalent per drilled lease) Group Type Conduct E&P type E&P size a Lease Category Drainage Wildcat Single bid > 2 bids Integrated Independent Top 4 Top 5-8 Top 9-20 Non-top 20 < 60m 60m .379 4.800 1.135 2.899 4.056 1.536 5.681 6.208 4.422 3.538 5.568 4.418 10.819 5. Fourth.278 4.685 2.212 0.452 8.291 1.387 1.438 1.441 3.640 3.249 7.332 2.093 12.440 2. the estimated aggregate lease development productivity for integrated firms is significantly greater than productivity of leases issued to independent firms and the aggregate lease development productivity shows a declining pattern .696 5.741 1985-1989 2.753 4.874 2.904 2.797 4.983 a Water depth a Structure Bonus size a Area E&P = exploration and production.498 4.730 2.LEASES IN THE GULF OF MEXICO Table 4 199 GULF OF MEXICO: TREND IN PRODUCTIVITY BY LEASE CATEGORY.085 3.673 2.516 4.717 1.532 2.831 1.851 2.169 8. as expected.966 2.345 4.794 1.741 4.964 1.789 3.171 8.921 3.200m 200m .746 16.272 3. Lease development productivity rises with water depth but declines significantly across time.018 1.249 2.138 1.649 3.841 1995-1999 12.268 4. In the 1990s.
The key finding in profitability index analysis is that the estimated indices were significantly low for all categories of leases (table 5). on average. Economic Measures of Lease Development Performance: For the purpose of this paper. Third. an indication of how borrowed capital can affect the overall industry’s economic performance (figure 2). which have been suggested to be regressive in nature. our results do not reflect any cross-sectional or time variations in the cost of borrowed capital by firms for projects. the estimated index for solo bidders on aggregate is higher than the index for joint bidders for leases issued from 1983 to 1999. Seventh. but the difference does not seem to be statistically significant. we used two representative discount rates in this report for all categories of leases. For comparative purposes. Therefore. it is interesting to note further that the impact of bonus payments. This finding notwithstanding. It is a relative measure of the efficiency of an investment. for all categories of leases. The first is the average rate of return on revenue before taxes and the historical before-tax average rate of return for corporations in the North American Industry Classification System (NAICS) manufacturing sector. just as lease productivity rises from the shelf to the slope and deepwater. the profitability index increases. on average. Moreover. . Economic Measures of Lease Development Performance—Profitability Index: The profitability index (PI) is defined as the ratio of the present value of total income to the present value of total investment. the productivity ratios in the early 1980s were significantly higher than productivity ratios in the early 1990s. Fourth. both of which recognize the time value of money. Fifth. we adopted two of the more popular economic performance measures to analyze the performance of OCS leases issued from 1983 to 1999 and developed from 1983 to 2004: the profitability index and the internal rate of return. integrated firms reported higher profitability ratios than independent firms. notwithstanding the fact that more leases were issued and drilled in the 1980s than in the early 1990s. is significant in our analysis with respect to the economic performance of lease development (table 5). First. the profitability ratio of leases in the Central Gulf is higher in magnitude than leases in the Western Gulf. with decreasing discount factors. A declining trend over time is unmistakable for the top eight firms. we found five notable patterns in this study. the values of profitability index we calculated are ex-ante. The profitability index rises from the shelf to the slope and the deepwater.200 THE JOURNAL OF ENERGY AND DEVELOPMENT by firm size from big to small size firms. Second.
16 1.38 0.61 2.63 0.200m 200m .13 1.47 1.97 0.95 0.57 0.com/NASApp/NetAdvantage/showIndustrySurvey.50% 0. ceteris paribus. c Representative average return on revenue.85 0.33 1. 2005.91 0.73 0. netadvantage.72 1.000K Aggregate EGOM CGOM WGOM 17.52 0.83 0.86 0.74 0.70 0. and Trade Corporations (Washington.50 0. water depth in meters (m).70 0.72 0.77 0.82 0.10 1.86 7.89 0.90 1.S.60 b 12.99 1. b Historical before-taxes average rate of return for corporations in the NAICS manufacturing sector.79 0. NetAdvantage.19 0. central.41 2.83 0.16 1. at the corresponding discount factors.03 1. and western Gulf of Mexico.01 1.43 0.64 0. Industry Surveys.25 1.do?code=ogp.22 1.77 1.80 c Water depth Conduct Bonus size Area Bolded figures indicate lease categories with added value to investment. 2004).77 1.C.01 2.LEASES IN THE GULF OF MEXICO Table 5 201 GULF OF MEXICO: AGGREGATE PROFITABILITY INDEX FOR LEASES ISSUED FROM a 1983 TO 1999 USING TWO DISCOUNT FACTORS Index (Total Investment Minus Bonus) Group Lease type Structure Firm type Firm size Lease Category Drainage Wildcat Single bid ³ 2 bids Integrated Independent Top 4 Top 5-8 Top 9-20 Non-top 20 < 60m 60m .90 0.23 1.63 0.65 0.04 1.63 0. respectively.01 0.96 0.64 0.98 2.41 1.77 0. a Economic Measures of Lease Development Performance—Internal Rate of Return Analysis: The internal rate of return is defined as the discount rate at which the present value of the sum of net cash flow in terms of cash receipts and disbursements is exactly equal to zero. Department of Commerce.$400K $400K .84 1. Mining.06 1.06 1. and WGOM are eastern. D.63 0.20 1.$1.57 0. bonus size in thousand (K) dollars. Census Bureau.99 2.09 0.18 0.58 0. EGOM.26 1.41 1.63 0.000K >$1.80 0.71 4.19 1.: Government Printing Office.00% 0. Sources: U.65 2. It weights cash receipts rather heavily in .70 0.69 0.99 0.64 0.55 1.54 1.60 0.07 b Index (Total Investment) 17.900m >900m Solo bidder Joint bidder < $200K $200K .12 1.83 1.79 1.standardandpoors.50 0.76 0. available at http://www.81 1.84 0. and Standard & Poor’s.57 c 12.04 0. CGOM.32 1.50% 1.00% 1.51 3.56 1. Quarterly Financial Report for Manufacturing.14 1.39 1.
641 leases issued from 1983 to 1999 in the U. is the case for the 1990s. we found the following aspects significant (table 6). the historical before-taxes average rate of return for corporations in the NAICS manufacturing sector is 17 percent. According to the U. in aggregate. In general. Census Bureau. . First. leases issued in the late 1990s. leases issued in 1990-1994 have a higher annual rate of return on average than leases issued in the 1980s. on average.S.S. the estimated rates of return are low for all categories of leases when compared to the return value of 17 percent in the manufacturing sector during the same period. the aggregate average annual rate of return for leases issued in the 1980s is higher for leases with single bids than for leases with at least two bids.202 THE JOURNAL OF ENERGY AND DEVELOPMENT Figure 2 AGGREGATE TRENDS IN PROFITABILITY INDEX USING TWO DISCOUNT FACTORS. is less than the rate of return in the 1980s and the late 1990s. industries. The reported low profitability measures in terms of internal rates of return notwithstanding. Keeping in mind each portfolio of leases is treated as a unique but interdependent investment decision at different points in time.9 percent. the overall internal rate of return for all 13. However.S. This estimate is extremely low in comparison to the rate of return in comparable U. 1983-1999 the later years of projects and can be calculated on a before-tax or after-tax basis. on the other hand. Second. Gulf of Mexico OCS is estimated as 6. Third. the average rate of return for productive leases from 1990 to 1994. The reverse. have a lower annual rate of return. however.
9 0.0 9.6 8.5 11.2 6. EGOM.1 7.5 15.8 9.7 15.6 9. than for leases in the .4 16.8 Water depth in meters (m).7 10.2 10.9 4. on average. CBOM.2 7.2 5.0 0.2 8.1 8.9 25. Fourth. but no definitive trend is apparent across firm size in the 1990s.0 4.4 7. and western Gulf of Mexico. respectively.2 9.5 12.5 12.9 5.1 10.6 6.4 9.7 19.8 9.5 16. there is evidence to suggest that the rate of return for productive leases in the Western Gulf planning area is higher.1 6.7 8.2 10.000K Area Aggregate CGOM EGOM WGOM a 5. from 1983 to 1994 the rate of return rises with water depth and across time for all productive leases. Fifth.7 percent in 1990-1994 and dropped to 5.2 4.2 0.0 8.9 20. probably because of data limitations.8 7. b Limited data.2 9.3 7.9 0.6 4.3 10.2 8.$400K $400K .2 9.9 8.2 5.7 percent in 1985-1989 to 10.5 18.0 10.7 4.2 7.4 1.2 8.0 3.2 13.7 4.5 2.3 8.0 9.8 0.1 9.8 0.0 10.4 15.4 6.1 5.6 1.8 7.2 9.2 6.4 11.2 9.7 13. Seventh.6 5.0 3.1 12.3 6.7 4.6 10.7 percent for leases issued from 1995 to 1999.6 17.1 9. The same pattern is not evident in the late 1990s.9 21.4 7.1 8.7 5. have a higher rate of return than independent firms across the lease-effective year.6 13.6 8.0 22. Sixth.1 9.4 9.LEASES IN THE GULF OF MEXICO Table 6 203 GULF OF MEXICO: ANNUAL AVERAGE INTERNAL RATE OF RETURN DYNAMICS.8 10.3 9.7 8.900m >900m Conduct Solo bidder Joint bidder Bonus size < $200K $200K .200m 200m .2 2. bonus size in thousand (K) dollars. eastern.7 10.7 9.0 3.6 27.4 15.$1000K >$1.3 3. Eighth. a 1983-1999 (in percent) Group Type Lease Category 1983-1987 1985-1989 1990-1994 1995-1999 1983-1999 6.1 8. on average.9 2.7 13.0 5. the aggregate annual average rate of return rises with firm size in the 1980s.1 5.4 6.4 9.9 7.2 b Drainage Wildcat Structure Single bid > 2 bids Firm type Integrated Independent Firm size Top 4 Top 5-8 Top 9-20 Non-top 20 Water depth < 60m 60m .0 8.6 17.6 1. the estimated rate of return for all lease developments by the top four firms declined from 12. WGOM are the central.3 8.8 13.4 5.3 10. all leases issued to integrated firms.
The evidence. in an aggregate sense.204 THE JOURNAL OF ENERGY AND DEVELOPMENT Central Gulf over the study period. The drilling failure rate in the aggregate was about 57 percent as of 2004. Regarding productivity as a measure of physical performance of lease development in the Gulf of Mexico. so does the average time lag from sales to first production on the lease. The key finding .641 leases issued from 1983 to 1999. we found evidence that the overall aggregate productivity per drilled lease declined significantly from a high of 4. Regarding prospectivity of the OCS in terms of a lease development index. despite the fact that more leases were issued and drilled in the 1980s than in the early 1990s. Of those 3. does not suggest a similar trend for the aggregate rate of return for all leases. approximately one out of nine leases produced hydrocarbons in the Gulf of Mexico OCS. we used two representative discount rates in this report to calculate profitability indices for all categories of leases. it took approximately 50. As the average water depth of a lease increases. it took about 78. The time interval from lease sale to first drilling activity (spud) and from sales to first production by lease category is called the expeditious development index in this report. Further.864 million boe for leases issued in the early 1990s. In other words. On average.3 months on average from sales to production for leases sold from 1995 to 1999. according to our empirical analysis. Independent producers. The time interval between sales to first drilling and between first drilling to first production decreases as the signature bonus payment increases. for all categories of leases. Our study shows evidence of declining trends over time in the average lag from sales to production on leases issued from 1983 to 1999. For comparative purposes. tend to attain first production after lease sales more quickly than integrated firms. In comparison.467 leases reporting drilling activity from 1983 to 1994. The average time lag from sales to spud increases with firm size just as the average time lag from spud to production also increases with firm size. we found that of the 13. MMS qualified 43 percent as producible leases.536 million boe for leases issued from 1983-1987 to 2. Thus. 26 percent reported some drilling activity as of 2004. The overall aggregate lease development index (the product of the proportion of drilled leases and the proportion of successful drilled leases) for leases issued from 1983 to 1999 was 11. Summary and Conclusions The framework adopted in this paper is such that each annual portfolio of leases is treated as a unique but interdependent investment decision by firms at different points in time.9 months prior to first production on leases sold from 1983 to 1987.4 percent as of 2004. however. the productivity ratios in the early 1980s were significantly higher than productivity ratios in the early 1990s. the rates of return earned from investment by leases and also by important lease categories in the Gulf of Mexico OCS region are estimated.
The low profitability measures in terms of internal rates of return notwithstanding. Baud.9 percent.641). D. OCS Study MMS 2000-022 (New Orleans. ‘‘The Competing Influences of Technology. Finally.S. in aggregate. the positive benefits added also are only marginal for several of these lease categories. H. The results suggest that the choice of discount rate in the determination of project viability is significant. and D. Pulsipher. O. several lease categories added value to the investment. Department of the Interior. Baumann. which has been suggested to be regressive in nature.S.’’ The Energy Journal. Minerals Management Service. we found that the leases issued in the early 1990s. A. H.S. industries. is significant on the economic performance of lease development. 2 (1995). The reason for this low return most likely is due to the number of productive drilled leases (1.S. Deepwater Gulf of Mexico: America’s Emerging Frontier.’’ OCS Study MMS 2003-04 (New Orleans. Sorensen. vol. ‘‘Effects of an Increasing Role for Independents on Petroleum Development. Iledare. 2003). Mesyanzhinov. 5976. V. Peterson. Pulsipher. and R. This finding notwithstanding. 37940. 1983-1999. the overall internal rate of return for all leases issued from 1983 to 1999 is estimated as 6. Geological Survey. 16. O. O. Gulf of Mexico OCS Region. pp. Proceedings of the SPE Hydrocarbon Economics and Evaluation Symposium. Changing Patterns of Ownership and Control in the Petroleum Industry: Implications for the Market for Oil and Gas Leases in the Gulf of Mexico OCS Region. 2000). For the most part. R. Several lease categories were found to have added value to capital investment if signature bonus payments were excluded in the calculation of the profitability index. G. 1954-1969 (Reston. Mead and P. Doyle.LEASES IN THE GULF OF MEXICO 205 in the profitability index analysis is that the estimated indices were significantly low for all categories of leases. and E. G. C. O. 5 4 . Department of the Interior. Depletion and Economics on Petroleum Drilling Productivity: How Persuasive is the Evidence on the Gulf of Mexico Outer Continental Shelf. Iledare and A. Pulsipher. Iledare. when we discounted the operating cash flow by 12. have a higher annual rate of return on average than leases issued in the late 1980s. R. 1997.0 percent.5 percent. Competition and Performance in OCS Oil and Gas Lease and Lease Development. 1980). However. we found that the impact of a bonus payment. A. no. E. The profitability index for several categories of leases added positive benefits to initial investments using a 17-percent discount factor. Louisiana: U. 2 1 O. Gulf of Mexico OCS Region. NOTES O. Minerals Management Service. Richardson. Louisiana: U. The return for productive leases. G.567 out of 13. J. in aggregate. also is low at 13. 3 W. This estimate is extremely low in comparison with the rate of return in comparable U.’’ Society of Petroleum Engineers (SPE) paper no. Virginia: U.
9 M. vol. A. 7 8 Ibid. ‘‘An Empirical Analysis of the Determinants and Value of High Bonus Bids for Petroleum Leases in the U. Pulsipher.gov/pub/oil_gas/natural_gas/data_publications/cost_indices_equipment_ 22 . and Contract Analysis (Tulsa.: DOE/EIA. 2004). pp. Minerals Management Service (MMS). Risk.gov/ homepg/pubinfo/freeasci/leasing/freeleas. G. Regulation and Enforcement (BOEMRE). Gulf of Mexico Region. Johnston.: DOE/MMS. Department of the Interior. 20 U.gomr.206 THE JOURNAL OF ENERGY AND DEVELOPMENT 6 M. 2003). D. Outer Continental Shelf (OCS). Oil and Gas Lease Equipment and Operating Costs 1987 through 2005 (Washington. cit. cit. A. Oklahoma: PennWell Books. L. cit.S. op. Department of Energy (DOE).S. Olatubi.C. oil. International Exploration Economics. 2006).mms. 2003).C. Johnston. 2002). 19 The Minerals Management Service (MMS) has been reorganized and is now called the Bureau of Ocean Energy Management.S. Mesyanzhinov. Pulsipher. op. The Leasing of Federal Lands for Fossil Fuels Production (Baltimore.html. Minerals Management Service. Iledare.gomr. U.doe. J. O. Production Information. available at www. available at www.html. Minerals Management Service. McDonald. 21 American Petroleum Institute (API). 1979). V. Kaiser and A. Gulf of Mexico OCS Region. D. Oklahoma: PennWell Books. 1: Deterministic Models.eia. 2002 Joint Association Survey on Drilling Costs (Washington. Maryland: Johns Hopkins University Press. Milan. cit. U.: API. Milan. and other mineral resources on the outer continental shelf. S. Leasing Information. and D.’’ Energy Economics.S. 2006). Mian. D.mms. 10 O.S. Fiscal System Analysis: Concessionary and Contractual Systems Used in Offshore Petroleum Arrangements. M. W. March 2004. (Tulsa. 14 15 16 17 18 13 12 11 D.gov/homepg/offshore/royrelef. Gulf of Mexico Region. 239-59. O. Products/Free Data. D. G. Department of the Interior. op. and Data. OCS Study MMS 2004-016 (New Orleans. Barrels of oil equivalent (boe) are the amount of natural gas that has the same heat content of an average barrel of oil. D. Policy Analysis and Statistics Department. M. Royalty Relief Information (Washington. Project Economics and Decision Analysis. 1 boe is about 5.62 thousand cubic feet (Mcf) of gas. Louisiana: U. Johnston.C. available in ASCII at www. BOEMRE is an agency of the United States Department of the Interior that manages the nation’s natural gas. Energy Information Administration (EIA). Ibid. op. Department of the Interior (DOI).
V. D. 2004). G. Minerals Management Service. Gulf of Mexico OCS Region. Modeling the Economic Impacts of Offshore Oil and Gas Activities in the Gulf of Mexico: Methods and Applications. Mesyanzhinov. Pulsipher. American Petroleum Institute. D. Dismukes. J. LongTerm Oil and Gas Structure Installation and Removal Forecasting in the Gulf of Mexico: A Decision. V. E. cit.html. . Pulsipher.. Department of Interior.and Resource-Based Approach. and A. and M.S. Gulf of Mexico OCS Region. OCS Study MMS 2004-009 (New Orleans. Mesyanzhinov. Kaiser. O. D. OCS Study MMS 2003-018 (New Orleans. Olatubi. op. W. 2003). and A.LEASES IN THE GULF OF MEXICO 207 production/current/coststudy. Louisiana: U. Minerals Management Service.S Department of Interior. Louisiana: U.G.
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