[nailud]

Pops: You are, as always, a voice of reason.

[azur]

Interesting post. I have a few comments.

$this->bbcode_second_pass_quote('', '1')) We are drilling rig limited

[pup55]

Thanks, Azur for your comments...

But now I have a quesiton on the issue of "hurdle rates" for a drillling project:

Per what you said, it may take $10M in exploration charges plus $160K per day to run the rig to drill out a deposit.

So easy to calculate how expensive a given project will be to drill. Someone was saying not long ago that it might be $7.50-$10 per barrel of estimated reserves.

Also, you know that the company will drill out the most profitable holes first: the ones with the biggest deposits that can be drilled out for a given cost. Also, this will be measured by a rate-of-return calculation to the effect that for X dollars investment, you get back Y amount of oil and/or money for a rate of return of Z%.

Or, for a rate of return of Z% and a capital investment of X dollars, we will not drill a hole unless the yield is Y number of barrels.

In the downstream chemical world, that I am familiar with, current interest rates being what they are, Z% is about 13-15% return. How does this compare with what the exploration people consider an attractive investment? I think the refinery business must currently be using a 20% hurdle rate before doing a project. I'm just trying to get an idea of what Z is so we can estimate the size of X (field size).

Secondly, what consideration is being given to the possibility of a rising price? Under the current scenario, the company has to use some kind of forward pricing assumptions to calculate this ROR. If they believe that $50 oil will prevail for awhile, it makes a big difference compared to oil being $20-$25, which they seem to be saying in their public statements. In other words, can you tell us what the proverbial oil company finance guys are predicting for oil prices at a hypothetical company, not necessarily yours?

Thanks again, Azur, for joining in the conversation.

[azur]

Pup55,

Hope this helps.

First, there is no such thing as a drilling project. Drilling is step 1 of a field exploration and development project. If it stops after the drilling stage it has been a total failure (which happens).

The cost I mentioned of $10 million includes the drill rig time. That would be the total all-up cost of the well assuming around 45 to 50 days to drill the well.

The ROR you mention of 13 to 15% is typical, but the absolute value depends on the project risk level. Higher risk obviously requires higher ROR.

In my experience projects are still, until recently, being checked for sanction at $18 to $20 / bbl. After Saudi’s comments this week that might change now!

When a company takes a license on a block it is obliged to drill a certain number of exploration wells as part of the deal. It will run seismic survey to identify the best possible targets and drill a minimum number to satisfy its license agreement. Depending on the results, it may then go further and appraise any discovery, or drop its license and return the block after meeting the minimum well obligation.

The size of potential recoverable reserves that would make it worth drilling more wells would depend on how close to existing infrastructure the field is, and how difficult the environment is. Offshore, if the field was close by an existing installation which could be used as a host, 10 million bbls could be economic. If not, then 50 million recoverable would be considered marginal. But that was at the $20 hurdle. I guess we can drop that hurdle a notch or two now.

[pup55]

Azur:

Thanks for your response on this.

My thinking was a little too simplistic, I can see.

What I was trying to do is understand the economic effects on what are considered "reserves". In your example below, it is clear that the decision to drill is made on an individual field basis.

There is a line of thinking to the effect that when oil prices go up, certain fields which were marginal during low prices become worth drilling, and therefore more likely to be a potential source of supply. However, I believe that the opposite could be true, for example, if Greenspan raises interest rates by 4% like was suggested the other day, the hurdle rate calculations will have to go up by that much in order to compensate the operators of the project for the higher interest rates. Higher hurdle rates may mean lower "drillable reserves".

The goal of all of this is to try to figure out from the literature how many of these "marginal fields" there are, so as to better estmate overall reserves, and get a better idea on whether the peak is truly nearby or awhile off.

I suppose that this is complicated to do unless you have detailed information on the portfolio of fields available. Too bad. Maybe with the data you have shared, we can go through Skrebowski's list of projects and get some ideas.

Anyway it would be interesting to know how many fields we are talking about, and what effect this would have on global supply.

[azur]

Pup,

What is true is that a decision to develop is made on a field by field basis. Each is very specific. All the factors are fed into the NPV model, including development costs, cost of finance, assumed oil price, taxes, production sharing contract obligations, etc etc.

If a field shows a good NPV on a robust set of assumptions, it will be put forward to the oil company Senior Management and Partners for funding. Each field competes against other prospects for funding until it reaches the top of the pile.

A good example is Clair, west of Shetlands in the Atlantic. It was discovered 27 years ago, and according to BP press releases has 5 billion bbls oil in place. It finally achieved first oil last week. Clair was delayed for many many years due to a very complex reservoir containing heavy oil, in a very hostile environment. Phase 1 is tapping ony 250 million bbls recoverable at a reported project cost of $1.2 billion. To this we must assume has to be added the cost of 17 appraisal wells drilled over the last 25 years. Even massive fields of this size can be unattractive at oil prices of $15-20/bbl.

Interest rates do have a big factor in the NPV calc, but less so than the price of oil assumed and the cost to develop the field.

What must be true is that fields that were marginal 5 years ago, even massive ones like Clair, are now becoming economic and will gradually be submitted for develpoment. How many of these there are, and how the total reserves compare against the 'still to be discovered' reserves in the ASPO model, requires a heavy bout of crystal ball gazing....

[pup55]

Interesting.

Thanks again for your comments. Sounds like the computer modelers are finally in control.