How to Determine the Market Value of Secondary Recovery Reserves

Abstract

Introduction What is the market value of secondary recovery reserves? A few years ago this question was easily answered. Then oil property was bought and sold with little consideration for prospective secondary recovery reserves. They were a "plus", if considered at all. With lots of plus factors the buyer might stretch his purchase price slightly, but undeveloped secondary reserves had no significant effect on the purchase price. Today it is more difficult to determine the market value of undeveloped secondary reserves. In many cases involving a large spread of properties, they are assigned value on the same basis as primary reserves. Other purchasers still feel that they must be considered separately and at a fraction of the value of primary reserves. As a starting point, it is necessary to define the term "secondary recovery". In its broadest sense (as it will be used in this paper) secondary recovery may be defined as any process where a fluid is injected into a reservoir to displace (and, thereby, increase) the ultimate recovery of hydrocarbons. This definition of secondary recovery includes the conventional processes of water flooding, gas injection, pressure maintenance by gas or water, and cycling, as well as the miscible processes such as high-pressure gas, enriched gas, or LPG injection. With this definition, this paper will consider the market value of increased reserves resulting from many different processes which may be used in all stages of depletion. These vary from fully developed projects with considerable production and operating history to newly discovered reservoirs that have not previously been subjected to any fluid injection process. The East Texas field is probably the classic example of the first type; an example of the second type would be the Swan Hills field in Alberta. Another important consideration in determining the market value of secondary reserves is the type and spread of properties involved. One limit would be the case of a large company with a large number of properties in most of the major producing areas. In determining the market value, secondary possibilities in many fields in many formations must be considered. At the other extreme, consider what market value could be assigned to the secondary reserves of a one-well lease in a field still producing under primary depletion. Obviously no simple relationship exists for equating the relative market values of primary and undeveloped secondary reserves. Each case must be considered as a separate problem. Basic Factors Affecting the Market Value of Oil and Gas Reserves The basic factors which determine the market value of any property are the amount of reserves (and their sales price), the future rate of production, the cost of developing and producing the reserves (including taxes), and the loan value. Once these factors are predicted or determined, most companies use the discounted-cash-flow method to determine market value. Table 1 shows a simplified tabulation that summarizes a computation of market value. Market value is the total of the Discounted Cash Flow After Loan plus the amount of the loan (or oil payment). The discount factor used in Table 1 is the rate of return desired by the purchaser. Many properties are bought and sold using other bases than the rate-of-return method illustrated in Table 1. Rules of thumb such as price per barrel of reserves and price per barrel of daily production are used as guides, especially by operators who limit their activities to one area. Others use a fraction, usually 60 to 70 per cent, of the present worth determined by discounting cash flow at 5 or 6 per cent. However. the majority of purchases, and especially the larger ones, are based on a rate-of-return calculation as illustrated in Table 1.The classic definition of fair market value is "the price at which the property would be sold by a willing seller to a willing buyer, neither being under compulsion to buy or sell, and both being competent and having reasonable knowledge of the facts". The most critical factor in determining the price an operator can afford to pay for any property usually is the amount of reserves. JPT P. 829^