Petroleum Economics PAB3023

EXPENSES & RISK

By: Dr. Ismail M. Saaid

Acknowledgement: Prof. L.F. Koedritz, UMR 1992
 outcomes
• To identify components of expenses
• To classify types of risks
• To calculate risks
• To analyze decision tree method
 Expenses
Drilling and completion are the biggest & main
initial costs/investment in upstream activities.
– Dry Hole Cost
Cost of Preparing the drill site, drilling contract,
mud, surface casing, cement, logs, Drillstem Test
(DST) etc

– Completion Cost
Casing, packers, tubing, perforating,
fracturing, chokes etc
 Expenses
Dry Hole Risk:
• Additional cost that a producing well needs to
share the cost of dry holes.
• Example:-
5 wells are drilled at $250,000 each and only 3 wells find
recoverable hydrocarbons.
2 Unsuccessful Wells x $250,000 / 3 Successful Wells =
$166,667

Each producer well needs to recover at least $416,667 (i.e.

$ 250,000 + $166,667)
 Expenses
• Chance Factor, CF
o % of instances a specified result will occur from an action
o Chance of success
3 Successful wells out of 5 drilled wells = 60% CF
 Expenses
• Calculating Dry Hole Risk or simply Drilling Risk (dr) :-
“failure”
dhc = dry hole cost
(1- CFd ) CFd = drilling chance factor
dr = dhc x
CFd
“success”
• Example:

dr = $ 250,00 x (1 – 0.6) / 0.6 = $ 167, 667

This formula says that the wells drilled and finding
hydrocarbons must pay for the dry holes
 Expenses
• Completion Cost (cc)
– Cost to complete the well after dry hole cost (i.e. decided
that well will be a producer)

• Completion Risk (cr) dhc = dry hole cost

(1- CFc ) CFc = chance factor completion
cr = (cc + dhc) x
CFc
o Example: The completion cost is $100, 000
o The CFc = 80%
o cr = ($ 250,00 + $ 100,000) x (1 – 0.8) / 0.8
= $ 87, 500
 Expenses

• Note that CFc is not the same with CFd.

• Continue from the previous example:-
 6 wells find reserves
 0.8 x 6 = 4.8 wells are completed
 6 – 4.8 = 1.2 wells are lost on completion
 ($ 100, 000 + $ 250,000) x 1.2 / 4.8 = $ 87,500
 Expenses
If we consider to drill 10 wells, 4 wells being dry
holes and 1.2 wells being lost on completion,
our total expenses will be:-
4 x $ 250k = $ 1000k
1.2 x ($100k +$ 250k) = $ 420k
4.8 x ($100k +$ 250k) = $ 1680k
Total = $ 3100k

So, the $ 3100k must be recovered by the 4.8

producing wells, $3100k / 4.8 = $654.83k
 Expenses
• If we add up the drilling cost (dc), completion
cost (cc), drilling risk (dr) and the completion
risk (cr),
dc = 250k
cc = 100k
Total = 604.17k
dr = 166.67k
cr = 87.5k
 Expenses
• What the difference means?
($ 645.83k – $604.17k = $41.66k)
 Due to the fact that we allocated some of the
drilling risk to wells that could not be completed. $
41.66k is the additional drilling risk which maybe
also be calculated from:-
(1- CFc ) adr = additional drilling risk
adr = dr x CFc = chance factor completion
CFc
 Expenses
adr = additional drilling risk
(1- CFc )
adr = dr x CFc = chance factor completion
CFc

= $166.67k x ([1 – 0.8] / 0.8) = $ 41.66k

Thus, the total drilling risk = $166.67k + $41.66k

= $208.33k
 Expenses
total risk (tr) = total drilling risk (dr) + completion risk (cr)

1  CFd   1  1  CFc 
 dhc     cc  dhc  
 CF d  d 
CF  CF c 
dhc(1  CFd )  (cc  dhc)(1  CFc )(CFd )

CFd CFc

= 250 (1-0.60) +(100+250)(1-0.80)(0.60)

(0.60)(0.80)
= 295.85 k$
 Expenses
• Note that many projects require more than one chance factor
• For logical decisions, need to evaluate both chance factors
and reserves.

 composite chance factor Described by a

 composite reserves “decision tree” method