Petroleum Economics PAB3023

EXPENSES
Learning Outcomes
 To identify other cost components after drilling and
completion
 To identify methods of claiming expenses
 To calculate depreciation
 Expenses
 Drilling and completion costs – one time expenses
 Operating costs – time dependent
 The cost of operating the well i.e. well maintenance, routine
workovers, staff salaries etc.
 Generated based on previous year’s expenses.
 Expected to change during the life of a well
 i.e. adding artificial lift
 Overhead cost – costs indirectly related to producing oil & gas
 Office building, clerical supports, office supplies, administrative
personnel, corporate level costs etc.
 Finding costs (exploratory geological and geophysical costs) & Lease
hold costs (in the USA)
Expenses
 Production taxes – levied by state (i.e. % of oil & gas value)
– vary as prices vary (Applicable only in the US)
 Property taxes – ad valorem tax
 Production Sharing Contract (Widely practiced
outside US)
Expenses
 Methods of Claiming Expenses
 1. “expense” an item during the time frame the expense
occurred (i.e. claim full capital recovery).
 Tangible expenses – physical items and can be recovered (casing,
tubing, artificial lift equipment, compressors, separators, stock
tanks etc)
Recover / claim tangible expenses through “depreciation”(claim
partial value)
 Depreciation is based on “wear and tear”
 Intangible expenses – items that are not recovered (drilling,
perforating, logging, frac jobs, acid jobs, cement, electrical costs
and labor charges). Usually recovered in the year it occurred.
Tangible expenses
 2. Straight line method of depreciation (SLD).
SLD = Initial cost – Salvage value
Life of Equipment

Example
Price of compressor = $105, 000
Salvage value = $5,000
Last for 5 years
Therefore, annual depreciation claim = $20,000
Any problem with this value i.e. constant depreciation?
 Tangible expenses
 3. Sum of the year’s digits method (SYD).
SYD = (Initial cost – Salvage value) x remaining life of equipment
sum of the years digit
Example
Price of compressor = $105, 000
Salvage value = $5,000
Last for 5 years
Sum of the year’s digits = 1+2+3+4+5 =15
Tangible Expenses
 Sum of the year’s digits method (SYD). – cont’d

Remaining Remaining Life /Sum Depreciation

Year Life of the Years' digits x 1000

1 5 5/15 33

2 4 4/15 27

3 3 3/15 20

4 2 2/15 13

5 1 1/15 7
Total depreciation = $100,000

remaining life of equipment

SYD = (Initial cost – Salvage value) x
sum of the years digit
Tangible Expenses
 4 declining balance method
 Provide fastest early depreciation
 “150%” and “200 %” declining balance (known as double
declining balance)
 The annual depreciation % or rate is calculated as the type
(150% or 200%) divided by the life (years)
Tangible Expenses
 4 declining balance (cont’d) method - steps
 The initial cost is used in the 1st year base value.
 The initial cost less the 1st year’s depreciation is used as the base
value for the 2nd year etc.
 Base value and depreciation become small in later years i.e.
investment can never be recovered!
 Need to switch to straight line depreciation.
 done when depreciation exceeds the declining balance depreciation.
 declining balance method - cont’d
Example
Price of compressor = $105, 000
Salvage value = $5,000
Last for 5 years

• Declining balance rate 200%/5 year = 40%/year

• 1st year’s depreciation = $105,000 x 40% = $42,000
• 2nd year’s depreciation = ($105,000- $42,000)x 40% = $25,200
• Continue calculations further as shown in table
 Table (declining balance method)
base annual
value x depreciation x cumulative time
time 1000 1000 depreciation x 1000 remaining
1 105.00 42.00 42.00 5
2 63.00 25.20 67.20 4
3 37.80 15.12 82.32 3
4 22.68 9.07 91.39 2
5 13.61 5.44 96.84 1

5 13.61 8.61 100.00 1

Note at year 5, claim is less than allowed value 100,000.

Need to claim fully by
• determine the optimum time to switch to SLD method
• i.e. when the SLD exceeds the double declining balance depreciation
• checking, 3rd year SLD = (37.80-5)/3 = 10.93 (i.e. VS 15.12)
• checking, 4th year SLD = (22.68-5)/2 = 8.84 (i.e. vs. 9.07)
• checking, 5th year SLD = (13.61-5)/1 = 8.61 (i.e. vs. 5.44)
• thus switch & wind up to claim fully!