In this example the reservoir engineer is called on to estimate the potentially recoverable resources in an exploration project that is located near a series of small discoveries. The engineer has a map generated (by geologists and geophysicists) from seismic, geological and petrophysical data and has estimated a “most likely” gas-in-place based on analysis of logs from the nearby discoveries, their actual gas-water contacts and spill points, anticipated pressures, etc. Well costs have been estimated and a success case development plan involving the discovery well and one development well has been made. The company already owns leases for the prospect and has asked the engineer if the exploration prospect should be drilled. This prospect is considered an excellent analog to offset discoveries that have been drilled with very high success rates. There are varying estimates for the likelihood of a discovery ranging from 50 to 90 percent. In the case of an initial dry hole it is anticipated that no further expenditures are likely and the lease and prospect will be abandoned. Another operator has offered to “farm-in” the acreage, assuming all exploration well costs in return for earning 75% of the block. After the other operator recovers 150% of their investments, the reservoir engineer’s company share would rise to 40%. The reservoir engineer must now evaluate retaining all of the future ownership in the field while putting his company’s capital at risk compared to retaining 25% (or ultimately more) of the block but without any risk.
What factors dictate the answer and determine the operator’s decision? While the intrinsic economic attractiveness of the project and the “chance of success” are predominant, the capital situation of the company, its portfolio of investment opportunities, etc., are all important. In a future post, a similar case will be illustrated in more detail to illustrate some of these issues. In the following figure, the Net Present Value at 10% (NPV10) is shown for the “drill” and “farmout” cases as a function of the probability of success. In this case “success” is a single case, viz. the discovery of the gas field with precisely the ultimate recovery and timing estimated pre-drill. The failure case is a single dry hole. In reality, reservoir engineers evaluate numerous alternative cases including a continuum of potential cases and advanced techniques described later are used.
I will be going over how NPV is calculated and alternative (and probably much better) risk analysis techniques in subsequent posts.
Which is preferable, drilling the well or farming out? It is clear that at low chances of success, the farmout case is always superior while as the probability of success approached unity, the drill case becomes increasingly better. But what about a case with 60% probability of success (40% probability of a dry hole)? The NPV10 is slightly greater than farming out. However, there is a reasonably large amount of risk being taken for a small incremental benefit.
NPV of drill and farmout cases vs chance of dry hole