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Drilling Program Economics November 27th, 2007

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Director of Planning & Budgeting, Lower 48 E&P. 3. Agenda ... Aruba. Bonaire. Nevis. Barbados. Trinidad. Tobago. Cotton Valley Lime. Depth. Depth. 5 ... – PowerPoint PPT presentation

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Title: Drilling Program Economics November 27th, 2007


1
Drilling Program Economics November 27th, 2007
2
Introduction
  • Shu Rau shu.rau_at_conocophillips.com
  • UT Class of 1994 Chemical Engineering
  • MBA from LSU, 2001
  • Director of Planning Budgeting, Lower 48 EP

3
Agenda
  • Operations Overview
  • Economics Examples
  • Big Picture Applications

4
Hydrocarbons Reservoir
5
Operations Overview
Gas Well
6
Declining Production Profile
  • Production declines because pressure falls
  • Like draining water from a bathtub, or letting
    air out of a balloon
  • Economics are quite different from manufacturing
    / steady operations

7
Economics Examples
  • Economics for a single well
  • 3 well program factoring in risk
  • Unrisked economics
  • Risked based on success rate
  • Risked based on rigorous probabilistics
  • The big picture strategic planning

8
Net Cash Flow Net Income
  • Revenues
  • - Expenses
  • IBRT (Income Before Reserves Taxes)
  • - DDA (Tax or Financial)
  • IBT (Income Before Taxes, or Taxable Income)
  • - Income Taxes (Tax or Financial)
  • Cash From Operations (Tax) or Net Income
    (Financial)
  • - Capital Expenditures
  • Net Cash Flow
  • Economic measures NPV, PI, AARR
  • Based on Net Cash Flow

9
Gross vs. Net Production
  • Gross production 100 of revenue / volume
  • Royalty owners X of revenues, no costs
  • 1/8th, 1/6th, etc. negotiated rate, differs by
    area
  • International very different terms, indexed to
    price
  • Working interest share of ownership, often have
    partners
  • Example 100 WI, 1/8th Royalty
  • Royalty owner (land owner, state, US, Indian)
    receives 12.5 of all revenues or volumes, pays
    no costs
  • COP receives 87.5 of revenues, pays 100 of costs

10
Revenues Production x Price
  • Production forecasts provided by Engineers
  • Gas Index Price NYMEX quote, Henry Hub, LA
    (why?)
  • http//www.nymex.com/ng_pre_agree.aspx
  • Take historical realized price, vs. this index
  • Regional differences vs. index East Coast,
    Rockies, Gulf, etc.
  • Platts - Gas Daily

11
US Natural Gas Pipelines
Henry Hub
Lobo
12
Revenue Calculation
13
Costs Expenses
  • BOE Barrel of Oil Equivalent
  • All liquids (Oil, NGL) in barrels Gas in MCF/6
  • Converts gas volume to a liquid equivalent based
    on approximate energy content
  • 6.00/BOE Operating Expenses
  • Personnel, maintenance, separation treating,
    etc.
  • Incremental costs only, based on historical data
  • 2.00/BOE Transportation
  • Compression, fuel, etc. to get the product to
    sales point
  • Based on actual contract terms
  • 5 Severance Tax
  • State and Local tax, usually a of revenues
  • Set by government entity

14
Income Before Reserves Taxes
15
Capital Investment
  • Drilling Related activities to drill complete
    a well
  • Facilities Physical equipment from the wellhead
    to the separation / treating equipment
  • Leasehold costs to acquire rights to develop
    resources
  • These all have different Tax depreciation methods

16
DDA Cash Taxes
  • Split of Drilling-Related capital, rule of thumb
  • IDC Intangible Drilling Costs rig rental, mud,
    non-permanent items
  • Accelerated depreciation on these items time
    value benefit
  • Depreciables piping, casing, permanent stuff
  • Standard MACRS (modified accelerated cost
    recovery schedule)
  • Leasehold Units of Production basis
  • Financial all depreciation on Units of
    Production basis
  • Benefits from Capital last the life of the asset
    depreciate as used

17
Tax vs. Financial DDA Expense
  • Tax varying methods defined by tax code
  • Financial all Units of Production

18
Tax vs. Financial DDA Expense
  • Same total 4MM depreciated, but very different
    timing
  • Acceleration for tax purposes improves economics

19
Net Cash Flow
20
Net Cash Flow vs. Net Income
  • Same total over life, different timing

21
Economic Measures
  • Net Present Value
  • Varies with discount rate select one
  • Mid-year discounting at COP
  • Rate of Return (aka AARR, IRR, ROR)
  • Profitability Index (Cash vs. Capital)
  • Cash version any current-year income reduces
    cash outlay, improves returns
  • Capital version NPV vs. Capital

22
NPV vs. Discount Rate
??
23
Rate of Return
  • Most common economic measure, despite pitfalls
  • Easiest to discuss
  • COP discount rate WACC formula
  • Based on CEOs desired target for shareholder
    return and debt / equity ratio at the time (2004)

24
Profitability Index
  • Two methods cash or capital based
  • Cash based Investment is smaller
  • NPV of inflows / NPV of outflows
  • Investment is reduced by current year profits
  • Usually results in higher answer
  • Capital based Use full Capital for investment

25
Risking Probability of Success
  • Inherent risk, lots of obstacles to cause failure
  • Trying to target a small pocket miles below the
    earth with a thin straw
  • Use historical success rate
  • Ps (probability of success)
  • 2/3rds for this example

26
3 Well Program Factoring in Risk
  • Risked case 1 of 3 wells failed, 3MM Capital
  • Capital reduced 1MM no facilities needed for
    failed well
  • No profits from failed well, but economics
    burdened by 3MM Capital
  • AARR reduced from 21 to 10
  • PI _at_ 9 discount rate falls from 1.46 to 1.05
  • NPV falls from 3.5MM to 0.4MM

27
Risking Range of Outcomes
  • Probabilistic approach, multiple trials
  • More advanced, rigorous probabilistic approach
  • Flowstream
  • Greater odds of lower production than forecasted
    due to failure risk
  • Some potential upside vs. forecast
  • Capital
  • Greater odds of cost overrun than cost reduction
  • Trouble time with drilling operations

28
Probabilistic Forecasting
17 AARR
1.31 PI
12.7MM Capital
2.54MM NPV
29
Summary of Results
30
High-Level Application
  • Prioritize Capital funding in a constrained
    environment
  • Strategic reasons can override economic measures
  • Business realities supersede application of
    economic optimization / efficient frontier
    theories
  • However, economic optimization is used for
    prioritizing discretionary decisions

31
Lower 48 Vision Strategy
  • Multi-faceted strategy for Lower 48
  • Maximize returns through becoming basin leaders
  • Capture growth opportunities restock the pantry
  • Preserve value keep leases, Non-Op consent, etc.

32
Portfolio Optimization Example
If your criteria are gt1.3 PI, gt20 AARR Cut
93MM
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