Economic Life of Oil and Gas Fields in the United States

Abstract

Abstract The economic life of oil and gas fields can he dividedinto four diagnostic periods of time:the initialdevelopment period;the time lag in years from discoverydate to year of peak production;the half-life period; andtotal years of economic life. A workingknowledge of these factors could be useful in planningdevelopment, programming future expenditures and inmaking preliminary valuations. Introduction Although the economic life of oil and gas fields hasoccupied the attention of economists, appraisal engineersand reservoir engineers for many years, it was not untilthe Phillips decision in 1959 that the question of therelative life of oil and gas fields became a controversialissue. The decision in the Phillips Case' in discussingthe Reserves Added Realization method (RAR) made thefollowing observations: "Caplan (a witness) concludedthat in determining current relative commercialimportance of the additions to reserves of the severalprimary products (oil, gas and natural gas liquids) it wasnecessary that the future flow of revenue from theseseveral sources should be discounted ... After consideringvarious alternative possibilities Caplan adopted a 20-yeardiscount period for gas and natural gas liquids, and a10-year discount period for oil . . ."In defense of the 20 and 10 ratio for gas and oilfields, Caplan stated: "I assumed that the 20 and 10represented a reasonable approximation of the relativelives of the gas and oil reserves. Now that didn't meanthat there would be 20 years for the gas or there wouldbe 10 years for the oil, but that the 20 and 10represented a reasonable relationship between the reserves andtheir recoverability."The following discussion is intended to develops amethod by which the economic life of oil and gas fieldsmay be measured in a consistent and logical manner. The economic life of oil and gas fields can be dividedinto diagnostic periods of time that are significantmeasurements in determining a basis for classificationand analysis. Initial Development PeriodDefinition: the amount of oil or gas produced duringthe first ten years as a percentage of the ultimateproduction. Money is frequently borrowed during the early lifeof an oil or gas field to finance development work.investment bankers and financial houses are primarilyconcerned with rates of production, and the amount ofproduction that will be recovered during the period ofa loan. Oil loans are normally collateralized by the oiland gas reserves. To keep the risk factor small, theremaining reserves at the end of the loan period shouldhe substantial. It is, therefore, pertinent to determinethe percentage of the total ultimate production that ismost likely to be produced in the early life of an oilor gas field. Year of Peak ProductionDefinition: the time in years from the date of discoveryto the year of peak production. The year of peak production generally signals the endof major development costs and is frequently the yearof maximum operating profit. (This year may not bethe year of maximum net profit since income taxes andaccounting practice will have an effect on the net profit.)The peak production of a field is generally a clue andoften a guide to the size of the field and the extentand amount of reserves. There is often a closerelationship between rates of production and reserves, particularly in fields within the same petroleum province. The Half-Life PeriodDefinition: the half-life period is defined as the time inyears required to produce one-half of the totalestimated recoverable production (ultimate reserves). Oil and gas recoverable during the half-life periodhave a greater value than the oil and gas recoverable inthe later stages of production both from an operatingcost standpoint and a present worth basis. Total Economic LifeDefinition: the number of years from discovery date tothe year when the economic limit of production is reached. The total economic life of an oil or gas field has abearing on the commercial life of the operator and uponthe hydrocarbon reserves that can be carried on thebooks of a company. JPT P. 661ˆ