A Profile of Oil

1
A Profile of Oil Gas Operations

• Exploration and production finding and
  producing oil gas
• Transportation taking the products to a
  refinery
• Refining and gas processing converting the raw
  material to various refined products
• Marketing and distribution selling and
  delivering to the end user

2
Characteristics of Oil Gas Companies

• High level of risk need to manage this risk
• Long time period before company achieves a return
  on investment
• Low correlation between expenditures and value of
  reserves
• High level of regulation
• Complex accounting (financial and tax) rules

3
History of U.S. Oil Gas Industry

• Late 19th century - to meet the demand for
  kerosene for lamps
• Early 20th century - increased demand due to
  automobiles
• 1914-1940s Increased demand due to WWI and WWII
• Post WWII Demand for natural gas for home
  heating
• 1960 OPEC formed
• 1973-74 first Arab oil embargo
• 1975 Energy Policy Conservation Act
  encourage energy conservation, reduce reliance on
  foreign oil, develop alternative sources
• 1977 - US importing 47 of its petroleum needs
• 1979 Arab oil embargo II
• 1980 Decontrol of oil prices
• 1985 - US importing 27 of its petroleum needs
• 1990 Iraq invasion of Kuwait
• 2005 - US importing 60 of its oil

4
Origin of Petroleum

• Start with dead dinosaurs
• Add heat, pressure, and a lot of time
• After formation, the oil and gas rise through the
  sedimentary rocks until it is trapped by an
  impervious layer of rocks (called a trap)

5
Types of traps

• Fault trap movement of the earths crust causes
  different rock strata to shear off
• Anticline a trap caused by the folding of the
  earths crust into a dome. Most common for oil
  and gas
• Salt dome a trap created by a bed of nonporous
  salt pushing up through overlying formations

6
Four Conditions for Oil and Gas

• A source of petroleum (land or sea life)
• Heat and pressure resulting in the transformation
  of organic material into petroleum
• Porous (openings in the rock) and permeable
  (connectability of the pores) rock through which
  the petroleum was able to migrate
• An impervious rock, acting as a trap, that allows
  petroleum to collect

7
Identifying Areas that may Contain Petroleum (GG
Costs)

• Surface surveys Aerial photography, satellite
  imaging, imaging radar, and topographical and
  geological mapping
• Subsurface surveys accumulation of data to
  determine gravitational pull, magnetic field, and
  response to sound waves of rock structures below
  the earths surface. Recent innovations in
  seismographs (3D and 4D)

8
Steps in Drilling Decision

• Broad GG to determine an area of interest
• Enter into lease with mineral owner
• Detailed GG to evaluate area of interest
• If still interested, more seismic work done to
  select drill site
• Drill the well
• Evaluate data to determine whether to complete
  the well

9
Acquisition of Mineral Rights

• Real property consists of surface rights and
  mineral rights
• In US, most mineral rights are owned by private
  entities (individuals, corporations)
• Royalty interest rights to a portion of the
  production burdened only by severance taxes and
  perhaps some transportation costs
• Working interest rights to a portion of the
  production burdened by all costs of exploration
  and production (divided or undivided)

10
Allocating Revenue Expenses (Problem 10)

• Wishful Oil Mr. Hopeful
• 100 WI 20 RI
• Revenue 16,000 4,000
• Expenses 150,000 -0-

11
Acquisition of Mineral Rights (Contd)

• ORI carved out of WI or created in a subleasing
  transaction
• Production Payment Interest a nonworking
  interest created out of the working interest
  limited to a specified amount in dollars,
  barrels, or mcf. Often used in financing
• Net profits interest a specified percentage of
  the net income from the property as defined in
  the agreement

12
Pooling or Unitizations

• Generally required when small mineral rights are
  owned by more than one owner
• Each owner receives a similar interest in the
  pooled or unitized property based on his or her
  percent ownership and acreage

13
Lease Provisions

• Lease bonus amount per acre paid by lessee to
  lessor
• Royalty provision the amount of the revenue the
  lessor will retain
• Primary term of the lease maximum time to
  commence drilling
• Delay rentals must be paid if drilling is not
  commenced within one year

14
Delay Rentals (Problem 9)

• Core signed a 4-year primary term lease on
  1/1/06.
• a. When is first delay rental payment due? --
  On or before 1/1/07 unless drilling commenced
• b. What is the maximum number of delay rentals
  payments? -- 3
• c. By what date must drilling be commenced in
  order to keep the lease from terminating? --
  1/1/10

15
Delay Rentals (Problem 9 Contd)

• d. Assume drilling commences on 1/2/07
• -- Would first delay rental be necessary
  Yes, due on 1/1/07
• -- If the well is still in process on 3/2/08,
  would the second delay rental be necessary? No,
  drilling holds lease
• -- If well completed and production began on
  10/3/07 would second delay rental be necessary?
  No, production holds lease.
• -- If production ceased by 12/25/08, would
  delay rental payment be due on 1/1/09? -- Lessor
  has to begin paying delay rental first due after
  60 days after production stops. Therefore, no
  delay rental payment due on 1/1/09. (See item 6,
  page 18.)

16
Delay Rentals ( Problem 13)

• Garza obtained a 3-year primary lease on 8-1-06
• Drilling commenced on 6-1-07 and the hole was
  deemed dry on 10-15-07.
• Would delay rental be due on 8-1-07? No,
  drilling commenced
• How many more delay rentals are due?
• Delay rental due 8/1/08 see p. 18
• Does lease terminate on 8/1/09?
• No, drilling commenced on 5/1/09
• How many years will lease continue?
• As long as there is production

17
Lease Provisions (Contd)

• Shut-in payments Usually required when the well
  is shut in such as where no pipeline is available
  or an oversupply of gas exists. Usually not
  recoverable from future production
• Offset clause may require drilling if a well on
  an adjoining property within a specified distance
  is drilled into the reservoir
• Minimum royalty This clause provides that the
  royalty may not be below a specified amount.
  Usually recoverable from future production

18
Drilling Operations

• Pre-drilling activities
• Build roads
• Prepare site for drilling
• Drilling contract
• Day rate
• Footage rate
• Turnkey

19
Drilling the Well

• Initial 20-100 feet may be drilled with
  truck-mounted rig
• Rotate the drill bit down through the formations
  toward the target depth
• Approx. every 30 feet a joint of drill pipe is
  added
• Drill mud is constantly circulated down the
  wellbore to (1) raise the cuttings to the
  surface, (2) lubricate the drill bit, and (3)
  keep formation fluids from entering the wellbore.
• Casing is cemented into the wellbore to (1)
  prevent caving in of the hole, (2) protect fresh
  water sands, (3) confine production to the
  wellbore, and (4) control formation pressure

20
Drilling the Well (Contd)

• Conventional, directional, and horizontal wells
• Pet. Engineer or Geologist examines cuttings to
  determine fluid content and rock structure. May
  also collect core samples
• After total depth is reached, a logging device is
  lowered into the well to measure and record
  properties of the formation and the fluids
  residing in them.

21
Completing the Well

• Install production casing
• Install tubing through which the oil is produced
• Perforate the casing to allow the oil to enter
  the wellbore
• Install the Christmas tree (valves and fittings
  at the wellbore that somewhat resemble a
  Christmas tree)
• Construct production facilities separators,
  heater treaters, tanks, etc.

22
Completion Decision (Prob. 14)

• Aggie Oil incurred 275,000 in costs prior to the
  time to decide whether to complete the well.
  Estimated completion costs are 175,000.
  Expected net cash flows from production are
  300,000. Should they complete the well?
• Yes, this would limit their loss to 150,000
  instead of 275,000. Think sunk cost!!!

23
Recovery Process

• Primary recovery Either by natural reservoir
  drive or by pumping
• Secondary recovery Initiate artificial drive
  through a process such as waterflooding (Inject
  water under pressure)
• Tertiary recovery inject chemicals gas, or heat
  to modify the fluid properties (also microwave
  techniques)

24
Production and Sales

• Before the product is sold, it has to be
  separated, measured, and treated
• Oil generally goes to storage tanks where it is
  held until it is sold. It is measured when
  transferred to truck or pipeline.
• Gas is measured as it is transferred to the
  pipeline

25
Regulators

• The state regulates production of oil and gas
  (Oklahoma Corporation Commission, Texas Railroad
  Commission)
• Spacing state determines the spacing
  requirements
• State issues drilling permits