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P=?
Nig Job
P=?
Nig Acada
c UK
S Nig Oil Coy
M
Nig Bank
MSc Nig
Nig Business
No
M Nig Acada
Sc
Nig Oil Coy
Nig Bank
Decision
Node Nig Business
02/09/2022 Nig D.
Prof. Oyinkepreye Acada
Orodu 7
Chance Node
P=0.6 0
P=0.3
$2MM
P=0.1
ll
Dri
$4MM
Don’t drill
4 3 00
-
C D
3 2 5
-4
Map of well location & Structural elevation contours
b b 0.12 1 1
0. 2
c 0.048 2 1
Well A c
0.8 0.1
d 0.1296 3 1
Well B
d
0.9 0.3 e 0.3024 4 0
Well C
0.7
Well D e 1.000
• Carry out decision analysis on the way forward, to buy acreage or not to buy
acreage.
le
0.15 field
ho
0.09 0.2 field
y
F 0.15 D
Dr
C marginal 0.2 marginal
Dr field
l l yh field
Ru r i 0.7 o
I Se n m ic G D le
rill 0.6
ism i s s Dr D
S e firm o
E nd cat Drill hole
ic o n ac p 2 ld
c ad0.5 re wi Drop
e
e a
ag
l
ac y
g
Bu
H e
Dr rea
acreage
re
op ge
ac
is m
sh str acr
J
No rop
ic
Do 0.5
(D
ac n’t
re bu
ag y
ur
e
e
e)
-$5MM
Dro
acr p
eag -$4MM
e
EMVA=(0.075)(+$35MM)+(0.075)(+$10MM)+(0.85)(-$5MM)=
-$0.875MM
EMVC=(0.05)(+$36MM)+(0.075)(+$11MM)+(0.9)(-$0.875MM)=
+$1.5625MM
EMVD=(0.2)(+$33MM)+(0.2)(+$8MM)+(0.6)(-$7MM)=
+$4MM
EMVF= +$33MM
+$9.25MM +$9MM EMVD=
F +$4MM
+$8MM
EMVG=
G EMVE= D
+$9.25MM
+$4MM
H
E
EMVH= -$6MM
+$21.25MM
EMVF=(0.15)(+$34MM)+(0.15)(+$9MM)+(0.7)(+$4MM)=+$9.25MM
EMVH=(0.5)(+$9.25MM)+(0.5)(-$5MM)=+$2.125MM
I Ru
n Se
i sm
EMVI=+$2.125MM ic
EMVH=+$2.125MM
EMVJ= EMVI=+$2.125MM
+$2.125MM e age
cr
Bu ya
Do
n ’t b
J uy
a cre
a ge
+$0
02/09/2022 Prof. Oyinkepreye D. Orodu 20
Rollback evaluation of a probability tree
• The process starts at the terminal ends of the branches, at the terminal even, &
works backwards to the present.
Economic Description
A company (Company-A) owns lease on 120 acres. An adjoining
lease by another company (Company-B) is on 520 acres.
Company-B has proposed a test well. Well spacing is 640 acres
& combined leases make up one drilling unit, in which one well
can be drilled. Company-A has its choice of either participating
in the working interest on an acreage basis, or it can farm-out
its interest, for
1/16 of 7/8 overriding royalty interest under its 120 acres
0 1 2 n
𝑛
0.5
(1 + 𝑖) −1
𝑃 = 𝐴ሺ1 + 𝑖 ሻ 𝑛
൨
𝑖(1 + 𝑖)
0 1 2 n
𝑛
(1 + 𝑖) − 1
𝑃 = 𝐴ሺ1 + 𝑖 ሻ0.5 ൨ሺ1 + 𝑖 ሻ−2
0 1 2
𝑖(1 + 𝑖)𝑛
for
i=0.15
n=18
P=0.276056 E
02/09/2022 Prof. Oyinkepreye D. Orodu 31
Operating costs
Total operating costs:
($150 per month)(12 months/yrs)(18yrs)=$32,400
Investment
Net additional investment for the 3/16 working interest
Completed well:
(3/16)($40,000+$32,000)=$13,500
Dry hole:
(3/16)($40,000)=$7,500
0.3
0.5
5 0.2
0.3
n g 0.65 Dry hole
i
o rk
a lw
a rti rest
P te
in
0.3
0.5
Ov 5 Prod. well
Ro errid 0.3 0.2
ya
lty ing
int 0.65 Dry hole
ere
st
Decision tree for choosing between a partial working interest and an overriding
royalty interest
02/09/2022 Prof. Oyinkepreye D. Orodu 35
Outcome Event Conditional Pro. PV, $ Expected PV, $
For partial working interest, producing well
5300mmscf 0.3 19100 5730
3750mmscf 0.5 9110 4560
2500mmscf 0.2 1010 200
10490
For partial working interest, prior to drilling
Producing well 0.35 10490 3670
Dry hole 0.65 -7500 -4880
-1210
For overriding royalty interest, producing well
5300mmscf 0.3 2140 640
3750mmscf 0.5 1520 760
2500mmscf 0.2 1010 200
1600
For overriding interest, prior to drilling
Producing well 0.35 1600 560
Dry well 0.65 0 0
560
• Economic description
• Company must decide to farm-out or not (8,000 acres)
• Subject to royalties and overriding royalties amounting to 20%
• Farm-out acceptance under obligation of drilling minimum 3 wells
• Horizon, gas sand at depth ≈2,800ft
• 15% annual discounting, neglecting income tax
• The 8,000 acres is north of adjoining gas field
• Prospect of discovering gas, 25%
• 25% exploratory success average for the area
• Regional average for development wells is 70% successful
• Well spacing, 640 acres , so, 12 possible drilling locations on the property
Operating expenses:
(10yr)(12months/yr)($150/month) = $18,000
0.33
4 3 66,600
0.25
Reject
No Change
o n
ti
p le Zone-A
o m
- c
o re Zone-B
N A PA,S=probability , side-track A is successful
(1-PB,S)=probability, production From Zone B is killed (failure)
tB tB tB
CB e it qB e Dt dt e it dt Po e it q B e Dt dt
PA,S PB,S 0 t 0 t 0 t
C A e it e it e it q A e Dt dt e it e it dt Po e it e it q A e Dt dt
s s
A
s
A
s
A
Re 0 0 0
-co -CAPEX-Variable OPEX- Fixed OPEX + REVENUE
m
pl
eti B B1
o PA,S (1-PB,S)
n PA,S
Decision analysis problem
solved by production
B2
optimization (NPV), PB,S (1-PA,S)
thereby optimizing the
time to sidetrack to Zone-
B3 (1-PA,S) (1-PB,S) (1-PB,S) PA,S
A or recomplete to B4
(1-PA,S) PB,S Dependency (1-PA,S)
produce from Zone-A
EMVB=NPVB1×PA,S PB,S + NPVB2×PA,S (1-PB,S) + NPVB3×(1-PA,S)(1-PB,S) + NPVB4×(1-PA,S) PB,S
02/09/2022 Prof. Oyinkepreye D. Orodu 46
B1
e-i•ts 0
Zone A
tA
0 Zone B
tS tB
B2 e-i•ts 0 Zone A
tA
0 Zone B
tS
B3 e-i•ts B4
0 Zone A e-i•ts 0 Zone A
0 Zone B
tS Zone B 0 tS tB
PA PB B3
A P’A (1-P’B)
A1 B
B4
(1-P’A) P’B
A2 C (1-PA) PB
B
P’A
D E1
PA (1-PB)
Sidetrack (1-P’A)
F E2
(1-PA) (1-PB)
0.2 360,000
0.4 80,000
0.4 80,000
0.4 0
(b)
A larger operator has offered to drill and produce the well with the first
operator retaining 1/16 of 7/8 overriding royalty. What would be the
present-value profit under this arrangement?
0.2 150
0.4 60
0.4 -50