Analysis of Appalachian Basin Economics

Abstract

With improved wellhead prices, substantial risk capital is now available for developing modest per-well reserves in the Appalachian Basin. The leasing of tangible well equipment can, in instances where wells are better than marginal, provide additional economic incentives by improving the discounted cash flow rate of return. Introduction The increase in oil and gas drilling activity in the Appalachian Basin continues unabated and shows signs of gaining strength. This can be attributed directly to the improvement in realized prices for oil and gas that has occurred during the past 18 to 36 months. Risk capital is being attracted to the Basin, particularly through drilling funds and other types of particularly through drilling funds and other types of joint ventures. The concept of direct leasing of tangible well equipment has also been introduced in an attempt to spread the risk capital over more wells and to enhance the total investment profitability. An analysis of average oil and gas well profitability, on both a before-tax and an after-tax basis, is generally very favorable. The leasing of tangible well equipment, however, is attractive principally on an after-tax basis and only in terms of improving the discounted cash flow rate of return. Considerations in Determining Appalachian Basin Investments and Profitability In undertaking an analysis of Appalachian Basin economics, several key factors must be recognized. It seems to have become fashionable in the literature of the industry to present somewhat academic dissertations on methods of profitability analysis that invariably get into the question of the ranking of investment opportunity. Certainly at the major-company level such rankings have validity. The fact remains, however, that the vast majority of wells drilled in this country are drilled by independents and many of those are small operators. The average company or individual considering drilling a well in Armstrong County, Pa., does not have, as a practical matter, the alternative of putting the same dollars in a North Sea or Gulf of Mexico or Indonesian venture. For many, this may not be all bad. Attractive factors in the Appalachian area include modest costs of acquiring oil and gas leases; reasonable drilling expenses; few drilling problems in terms of depth or pressures; rapid evaluation of a given prospect, especially if drilled by a rotary rig; unusually low dry-hole risk, although substantial small- or marginal-well risk exists; good wellhead price for both oil and gas; immediate access to markets; and few if any restrictions on rates of production. The matter to be considered here is not whether or not to invest in the Appalachian area, but rather what the profitability of the investment might turn out to be. Therefore, certain methods of measuring profitability for investment opportunity ranking are profitability for investment opportunity ranking are generally not applicable. For example, the concept of discounting profit at the average investment opportunity rate is an abstraction for the small operator in the Appalachian area since his only other investment opportunity may be a savings account at the local bank. Even the idea of measuring everything against his "cost of money" may not be entirely valid. JPT P. 717