Distinguished Author Series

5PfE. /3q4b

Oil and Gas Reserves Classification, Estimation, and Evaluation

by Forrest A. Garb, SPE Forrest A. Garb k president of the Gruy Companies and of H.J. GruY and Assocs. Inc., responsible for contracting and supenising evaluation and simulation pro~ects Before joining Gruy in 7957, ho worked for SoCony Mobil Oil Co., specializing in offshore drilling-fluid control and high-pressure cumplet;ons, and, later, in field and resewoir engineering for Mobilrs Venezuelan Div. G?rb re?ent/Y Presented Petroleum seminars to industv personnel in the Peoples Republic of China, and in 7979 was elected chairman of the Natl. Petroleum Commine? of the W.. council for W.China Trade. He is currently chairman of the D8@s SeCtiOn @n@@9 Educatio? Committee and was directorof that section during 1.978-79. Garb has revised the chapters on Estimation of Oil and Gas Resewes and Valuation of Oil and Gas Reserves for SPES 7985 revision of Petroleum Production Handbook. !

Introduction man has been The life-slyle of 2~-century influenced more by oil and gas than any other natural resource, and indications are that ofi and gas reiem= will increase in impintance the remainder of this century. Oil and gas production provides inexpensive portable energy and supplies feedstock to an international petrochemical indust~ that manufactures synthetic textiles and rnedlcines and supports world agriculture. Crops are planted, cultivated, treated with pesticides, fertilized, hqvested, moved to market, and cooked with oil apdlor gas. Wars have been fought to ensure petroleum availability, and reserve estimates have dic@ted actions of governments, entire industries, individual companies, lending institutions, and private investOrs. Many petroleum engineers spend a major part of their professional lives developing estimates of r~erves and production capabilities, along with new methods and techniques for improving ihese estimates. To understand the confidence levels and risks of tie estimates, a clear and consistent set of reserve classifications must be used. The confidence levels and the techniques implemented by the petroleum engineer depend on the quantity and ~e maturity of the d~ta available. The data quality, therefore, establmhes the classification assigned to the reserve estimates and indicates the confidence one should have in the reserve estimates. Abnost alf applications of oif and gas reserve estimates require, in the final analysis, an economic evaluation that considers the predicted production capacity and tie capital and operating cost estimates. The economic analysis is the thermometer used to indicate the health of the reserves owner and wiU be
copyright 19S society of Petmle.m Engineers

representative and reliable only if the data, reserve estimaf+ng procedures, ~d r:se~e classificati%s ~e understood and applied properly. Reserve Ckiasification and Nomenclature The need for one universat classification and nomenclature system for petroleum reserves has long been recogriied by the vaious technical societies, professional organizations, gOvernment~ agencies, and the petroleum indus~. fn spite of the need for a standardization of definitions and concepts, differences in deftitions continue to cloud the absolute meaning of reserve definitions published by technical societies and regulatory bodies. The societies have established study groups to recommend a classification system, however, a upiversal system acce&ble to all estimators Wd users has not been agreed upon. A study group established in 1980, consisting of representatives of oil producing countiies, recommended a set of definitions and classifications. 1 A joint committee of SPE, AAPG, and API developed a set of definitions and a glossary of terms in 1981.2 These definitions, considered cOnsis!ent with U.S. DOE and Securities and Exchange Commission (SEC) definitions, ~: Present~ here afong with my co-rots On their us:. Proved Reserves. Proved reserves of cmd: oil, condensate, natural gas, or natural gas liquids are estimated quantities as ~f a specific date, which geological and engirieering data demonstrate with a reasonable certainty to be recoverable ~ the future from known resetioirs under existing economic conditions. (lvfost reservoir engineers consider 373

MASCH 1985

I .

projected economic conditions but hit reserve estimates to current technology.) Reservoirs are considered proved if economic producibility is supported by actual production or formation tests m if cbre ahlysis amioi log interpretation demonsmate economic producibility with reasonable certainty. (Most engineers require the formation tests.) The area of a reservoir considered proved includes (1) that portion delineated by drilling and defined by fluid contacts, if any, and (2) the adjoining portbns not yet drilled that reasonably can be judged economically productive on the basis of available geological and engineering data (frequently limited to direct offset locations). In the absence of data on fluid contacts, the lowest known structural occurrence of hydrocarbons contiols the lower proved liit of tie reservoir. Proved reserves are estimates of hydrocarbons to be recovered from a given date forward. They are expected to be revised as hydroc~bons axe produced and additional data become available. Proved natural gas resepes are composed of nonassociated gas and associated-dissolved gas. An appropriate reduction in gas reserves is required for the expected removal of natural gas liquids and the exclusion of nonhydrocarbon gases (if tiey occur in significant quantities) necessary for marketability. Reserves that can be produced economically through the application of established improved recovery techniques are included in the proved classification when two qualifications are met. 1. Successild testing by a pilot project or the operation of an installed program in the same reservoir or in one with similar rock and fluid properties provides support for the engineering analysis on wh]ch the project or program was based. 2. It is reasonably certain that tie project will proceed. Reserves to be recovered by improved recovery techniques that have yet to be established through repeated economically successful applications will be inclu&d in the proved category only after successful testing by a pilot project or after the operation of an installed program in the reservoir provides support for the engineering analysis on which the project or program was based. Proved Developed Reserves. A subcategory of proved reserves, proved developed reserves can be expected to be recovered throngh existing wells (including reserves behind-pipe, sometimes called proved developed nonpmducing) with proved equipment and operating methods. Improved recovery reserves can be. considered developed only after an improved recovery project has been installed. (Proved developed reserves do not require major capitaf expenditures to enable production.) Proved Undeveloped Reserves. Another subcategory of proved reserves, proved undeveloped reserves are expected to be recovered from (1) future drilling of
374

wells, (2) deepening of ex@ing wells to a different reservoir, or (3) the inst+ation of an improved recovery project. (Proved undeveloped reserves require major capital investment to enable production.) The probable and possible reserve definitions frequently used by industry do not enjoy offlci~ sanction by the SPE at the present time. The usual deftitions for these categories are as follows. ProbabIe Reserves. Probable reserves are quantities of recoverable hydrocarbons estimated on the basis of engineering and geological data that are similar to those used for proved reserves but that lack, for various reasons, the certainty required to classify the reserves as proved. Probable reserves are less certain to be recovered than proved reserves. In some cases, economic and regulatcny uncertainties may dictate the probable classification. Probable reserves include (1) reserves that appear to exist a reasonable distance beyond the proved liits of productive reservoirs, where water contacts have not been determiried, and proved limits are established only by the Iowest known structural occurrence of hydrocarbons; (2) r.+eryes in formations that appear to be productive from log characteristics only but lack definitive tests or core analyses data; (3) reserves in a portion of a formation that has be.& proved productive in other areas in a field but is separated from the proved area by sealing faults, provided that the geologic inte~retation indicates the probable area is related favorably to the proved potiion of the formation; (4) reserves obtainable by improved recove~ where an improved recove~ program, which has yet ~ be established through repeated economically successful operatio~, is planned but is not yet in operation and a successful pilot test has not been performed, but reservoir and. formstion characteristics appear favorable for its succesv (5) resewes in the same reservoir as proved reserves that would be recoverable if a more efficient recovery mechanism develops than was assumed in estimating the proved reserves; and (6) reserves that depend on a successfd workover, meatment, retreatment, change of equipment, or other mech@cal procedures for recovery, unless such procedures have been proven successful in wells exhibiting similar behavior in the same. reservoir. Possible Reserves. P9ssible reserves ae quantitk of recoverable hydrocarbons estimated on the basis of engineering and geological data that are less complete and less conclusive than the data used bJ estimates of probable reserves. Possible reserves are less certsin to be recovered than proved or probable resemes. In some cases, economic and regulatory uncertainties may dictate the possible classification. Possible reserves include (1) reserves that might be found if certafi geologic conditions exist that are JOUP.NALOF PETROLEUMTECHNOLOGY

indicated by structural extrapolation from developed ares, (2) reserves that might be found if reasonably definitive geophysical interpretations indkate a productive area larger than could be included within the proved and probable limits; (3) reserves that might be found in formations that have somewhat favorable log characteristics but leave a reasonable doubt ax to tkeir certainty; (4) reserves that might exist in untested fault segments adjacent to proved reservoirs where a reasonable doubt exists as to whether such fault segment contains recoverable hydrocarbons; and (5) reserves that might result from a planned improved recovery program that is not in operation and that is in a tield in which formation fluid or reservoir characteristics are such that a reasonable doubt exists as to its success. Several subcategories not recognized for regukitow or financial applications frequently nre used by companies intcmalfy to aid in their decision making. Subcategories such as shut in for market, awaiting workover, awaiting pipeline connection, or awaiting surface facilities are selfexplanatory. AddkionaJ definitions such as active secunday, future secondary, future tertiary, categories sometimes wifl be med. or total-all Prospective reserves are sometimes assigned for unexplored acreage or for deeper zones never penetrated. A number of terms are pertinent in defining resemes. Hydrocarbons injtilly in pface (oil and/or gas) refem to the original volume of hydrocarbons that occupied tic reservoir before production. Ultimate recove~ is the ultimate economically recoverable portion of the hydrocarbons initially in place (oil and/or gas). Reserve is the volume of hydro%rbons remaining to be recovered economically using proven technology as of a specified date. Crude oil is defined technically as a mixture of hydrocarbons that exist in the liquid phase in natural underground reservoirs and remain liquid at atmospheric pressure after passing through surface separating facilities. Volumes repofied as cmde oil include (1) Iiquids technically defined as crude oil and (2) smnll amounts of hydrocarbons that existed in the gaseous phase in natural underground reservoirs but are liquid at atmospheric pressure after being recovered from oilwell (casinghead) gas and lease separators. From a technicaf standpoint, these liquids are termed condensate. However, they frequently are commingled with a crude stream and are impractical to measure and report separately. Major condensate production is repurted as either lease condensate or plant condensate and is included in mtural gas liquids. Small amounts of nofiydrocabons produced with oil are sometimes measured and included in crude oil volumes. Natural gas is a mixture of hydrocarbons and !Wing quantiti= of nonbydrocmbons that exist either m the gaseous phase or in solution with cmde oil in MARCH 1985

natural underground reservoirs. Naturul gas has two subclasses. Asmciazed gas is naturnl gas found in coniact with crude oil in the reservoir. Associated gas may consist of free gas, commonly called gas-cap gas, ador dissolved gas in solution in the crude oil. Nonassociated gas is natural gas found in reservoirs that do not contain significant quantities of crude oil. DissoIved gas and gin-cap gas may be produced concurrently from the same wellbore. In such situations, it is not feasible to measure the production of dissolved gas and gas-cap gas separately. Therefore, production usually is reported under casinghead gas. Reserves and producing capacity estimates for associated and dissoIved gas usually are reported as a combined total. Natural gas liquids (NGLs) are those portions of reservoir gas that are liquefied at the surface in lease separators, field facilities, or gas processing plants. NGLs include, but are not limited to, etbnne, propanes, butanes, pentanes, natural gasoliie, nnd condensate. Improved recovery comprises alf methods for supplementing naturaI reservok forces and energy, or otherwise increasing ultimate recovery from a reservoir, including (1) pressure maintenance, (2) cycling, (3) waterflooding, and (4) aIIY omer secondary recovery technique. Improved recovexy ASO includes recovery techniques called enhanced recovery methods, such as thermal recovery, chemical flooding, steam injection, in-situ combustion, and use of miscible and immiscible dkplacement fluids. These classifications and definitions ae useful for defining stages of development, maturity of data, and the risk associated in accurately estimating the vohtmes and producibility of the reserves. The classifications are used to assign rixk-adjustment factors for fmncinl evacuation of the reserve quantities; therefore, it is obvious that a universal set of definitions should be used by both the petroleum and financiaf communities. Reserve Classification Sununnry

Reserves have five baaic classifications, which may be expanded to meet individual company needs. 1. Classification by ownership MD be subdivided into gross reserve (100 % of well, lease, or reservoir) and net reseme (net to interests evakated after M royalties, overrides, production payments, or reversinnmy interests). 2. ClasWlcation by energy source includes primary and improved recovery. 3. Classification by degree of proof includes proved, probable, possible, and prospective reserves. 4. Classification by development status is divided into developed and undeveloped reserves. 5. Classification by producing status subdivides reserves into producing or nonprnducing. 375 .

Prcdm!bn 1

Pram

W
,

1.
,0,,8,, ,mad

&

Fig. 1Range in estimates of ultimate recovery during the life

of a reservoir.

Estimating

Reserve

VoIumes

A total treatment forestimating reserves under any possible circumstance of reservoir character or data quality is beyond thescope ofthis paper. Expansion of the subject materizd may be found in Chaps. 37 and 38 of Ref. 3 and Chaps. 40 and 41 of Ref. 4. Discussion. Managements decisions are dictated..by anticipated investment results. In the case of oil and gas, the petroleum engineer compares the estimated costs in dollars for some investment opportunity vs. the cash flow resulting from production of barrels of oil or cubic feet of gas. This analysis may be used in formulating policies for (1) exploration and development of oil and gas properties, (2) design and construction of plants, gathering systems, and other surface facilities, (3) determining the division of ownership in unitized projects, (4) determining the fair market value of a property to be bought or sold, (5) determining the collateral value of producing properties for loans, (6) establishing sales contracts,
376 _..

rates, and prices, and (7) obtaining SEC or other regulatory body approvals. Reserve estimates are just that-estimates. They can be no better than the data on whlcb they are based and are subject to the experience of the estimator. Unfortumtely, reliable reserve figures are most needed during the early stages of a project, when only a minimum amount of information is available. Because the information base is cumulative during. the life of a property, the resetwoti engineer has an increasing amount of data with which to work as a project matures, and this increase in data not onfy changes the procedures for estimating reserves but, correspondingly, improves the confidence in the estimates. Reserves frequently are estimated (1) before drilling or any subsurface development, (2) during the development drilling of the field, after some performance data are available, and (3) after performance trends are well established. Fig. 1 demonswates (1) the various periods in the life of an imaginary oil property, (2) the sequence of appropriate recovery estimating methods, (3) the impact on the range of recovery estimates that ttsually results as a property ages and more data become available, (4) a hypothetical production profile, and (5) the relative risk in using the recovery estimates. Tme is shown on the horizontal axis. No particular units are used in thk chart, and it is not drawn to any specific scale. Note that, while the tdtimate recove~ estimates may become accurate at some point in the late. fife of a reservoir, the reserve estimate at that time still may have significant risk. During the last week of production, if one projects a reserve of 1 bbl [0.15 m3] and 2 bbl [0.3 m3] are produced, the reserve estimate was 100 % in error. Reserve estimating methods usually are categorized into three famifies: (1) analogy, (2) volumetric, and (3) performance techniques. The performance technique met30ds usually are subdivided into simulation stttdies, material-balance calculations, and deciine trend amdyses. The relative periods of application fOt these several techniques are shovm on Fig. 1. During Period AB, before any wells ae drilfed on the prope~, any recovery estimates will be of a very general nature based on experience from similar pools or wells in the same area. Thus, reserve estimates during this period are established by anafogy to other production and usually are expressed in barrels per acre. The second period, BC, follows after one or more weUs are drifled and found productive. The welf logs provide subsurface information, which allows an acreage and thickness assignment or a geologic interpretation of the reservoir. The acre-foot volume considered to hold hydrocarbons, calculated oif or gas in place ,per acre-foot, and a recovery factor allow closer liits for the recovery estimates than were possible by analogy alone. Volumetric amdysis data may include well logs, core analyses data, bottomhole
JOURNAL OF PETROLEUM TECHNOLOGY

TABLE IULTIMATE RECOVERY DISTRIBUTION SAMPLE FIELD Estimated Ultimate RecoveT (10 bbl) -

Well 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Cumulative (oh) . 5 10 15 20 25 30 35

8,0
9.0 9.5

10.0
11.0 14.5 16.2 24.0 34.0 35.7 4a.1 43.2 52.0 65.0 66.0 78.0

40
45 50 55 60 65 70 75 80 85 90 95 100

Fig. 2Ukimate

recovery distribution of a sample field

101.0
112.2 128.5 131.9 .. 989.8

Average =989,8/20 =49.5 x 10s bbl [78.7x 103 m] Median recovery = 68.7% average recovery.

instmummts have enabled good calculations after no more thao 5 or 6% of the hydrocarbons in place have been produced. Reserve estimates based on extrapolation of established performance trends, such as during Period DEF, we considered the estimates of highest confidence. Reserve Estimation Methods

mapping. with observed pressure behavior during early production periods, olso msy indicate the type of producing mechanism to be expected for the reservoir. The third period, CD, represents he period after delineation of the reservoir. At tiis time, usually there are performance data adequate to enable reseme estimates to be derived using numerical simulation model studies. Model studies cm yield very useful reserve estimates for a spectrum of operating 0ption3 if sufficient information is available to describe the geometry of the reservoir, any spatial distribution of the rock and fluid characteristics, and the reservoir producing mechanism. Because numerical simulators depend on matching history for calibration to ensure the model is representative of the actual reservoir, numeric6f simulation models performed in the early life of a reservoir may not be considered m have high confidence. Doring Period DE, as performance data mature, the material-balance method may he implemented to check the previous estimates of hydrocarbons initially in place. The pressure behavior studied through the materkd-balance calculations also may offer vakble clues regarding the type of production mechanism existent in the reservoir. Confidence in the material-balance calculations depends on the precision. of the reservok pre3surcs recorded for the reservoir and the engineers ability to determine the tree average pressure at the dates of study. Frequent pressure surveys taken with precision
Interpretation of these data, along MARCH 1935

sample information,

and subsurface

Anafogy. Before a reservoir is drilled, prospective reserves usually are estimated on the basis of analogy. In geologic provinces where production from thetarget formation in other entrapments exists, statistical analyses of the older wells to determine the meao or median reserves can provide useful intoruw.tion. Iflittle ornopmduction from the target formation exists, then statistical damfromw elk completed in formations having characteristics anticipated for the target zone are used. Because no factwd information from the reservoir being stodied is included in the ana.lo=q approach, reseme estimate6 w derived have the lowest confidence and ususlly are expreksed in a minimum to maximum range. When performing a statistical analysis for analogy porposes, a simple average is adeqoate only if the ukimate recovery values found for the wells stodied are reasonably constant. 3f a wide variance is observed, then a statistical dktribution must be prepared to establish a median recovery value. Table 1 presents a sample oltimate reserve distribution for 20 shaJIow oif wells found in the vicinity of a proposed drilling program. Ultinmte recovery ~ estimates for each of the 20 wells were prepared by extrapolation of their per fornwmce trends. These reserves then were arranged in ascendhg order, as shown on the table. The reserve estimates plowed vs. the cumulative percent of the samples is shown on Fig. 2. A smooth cuwe passed through the data point3 indicates a median reserve of approximately 377

OIL-WATER CONTACT -7450 GAS-OIL

-m
E ~ x -7350 k x ,?, -74C0 !$ -7450

-7450
-75C0

Fig. 3Geological reservoir,

map on top (

) and base ()

of a

k. ~
2,4 4~ +$.< 88 Ross L EARING AND WME ~ [(88-4?+ 378 -Z42)+41209-106,] :9~ ACRE FE,, J%., :::,,,. ,W,*., . . ~hND ~ASE?. 242 +;36 37s ,W -. 009 : BCRES .5REb2E&OS;?BY 4c05c1 CONTWR Fig.

24

~A,.o,LcoN,KT

4Acre-feet

diagram.

34,000 bbl [5406 m3 ] per well. The average reserve for the same sampIing is 49,500 bbl [7870 m3]. For this example, the median or most expected well is otdy 68.7% of the average reserve for the group of wells. If only a small drilling program is proposed, tie possible reserve per well should be based on the median. If the drilling program approaches the number of wells analyzed in the distribution, then the use of the average reserve becomes defensible. Similar dktribution analyses of initial producing rates and expected well life derived from the study of existing wells will aid the engineer in time rating the most appropriate reserve estimate. Volumetric Methods. A geologic. interpretation of a reservoir cannot be prepared until sufficient wells have been drilled to delineate its areal geometry and thickness. After completion of the tirst well, reservoir engineers frequently assign a reasonable drainage area and produce thk mea by the net pay thickness indicated by the electric well log. This acre-feet assignment is used only until sufficient subsurface control is available to enable geologic mapping. The computation of reservoir volume, based on geologic mapping, has been presented in several SPE publications, 3,4 which present a sample subsurface geologic map (Fig. 3) contoured on the subsea depth of the top of the sand (solid lines) and on the subsea. depth of the base of the sand (dashed lines). The total area enclosed by each contour is planimetered and. plotted as the abscissa on an acre-feet diagram (Fig. 4) against the corresponding subsea depth as the ordinate. Tbe ga,-oil and oil-water contacts, as determined by core, log, or test data, are shown as horizontal lines on the acre-feet diagram. After connecting the observed points, the combined gross volume of tie oil- andlor gas-bearing zone may be detertnfned by using several methods. 3s4 1. Volume can be calculated by planimetering from the acre-feet diagram. 2. If the number of contour intervals is even, volume can be computed by Simpsons rule:
378

Yq =v3h[(yo+yn)+4(yl +z(y~ +y~+

+Ys + +yn-z)],

+yn-l)

where VR = reservoir volume, acre-tl [m 3], h = contour interval, feet [m], YO = area on top of sand minus area on base of sand at highest contour, and Y = area on top of sand minus area on base of sand at lowest contour. Using this rule, the example calculation reservoir Yolume of: yields a

VR = ;[0+(378

242) +4 X (24 O) + (209 106)

+2 x(88-42)]

=;[(136)+4x(24+

103)+(2x46)],

= 12,267 acre- ft. 3. The volume may be computed with somewhat less accuracy by the Trapezoidal rule vR=h[%(yo+yn)+y, The sample problem VR=50[M(O+136)+ = 12,050 acre-ft. Because the acre-feet diagram shown in Fig. 4 usually is prepared on the top and base of formation porosity, this gross volume must be reduced to JOURNAL OF PETROLEUMTECHNOLOGY .+y~+ .+yn_, ].

when solved by this rule yields: (24+46+103)]

account for any shale stringers or impermeable sections within the formation itself. OZI the basis of a study of the individual well logs or core datx, the engineer must determine what fraction of the gross sand section is expected to contain producible hydrocarbons. This fraction times the gross sand volume yields the net pay volume. If, for example, in the illustrated case it is found that 15% of the gross section consisted of evenly distributed shale or dens: impervious stzenls, the net hydrocarbon pay volumes wovld then reduce to 85% of the gross sxnd volume (10,427 net acre-ft). In contrast to Fig. 3, separate strnchrre maps for the tOP ~d base porosity usually aie prepared. If the mture of the porosity for a zone varies substantially from well to well, or if there is a widely varying water saturation, it is sometimes justified to prepare a hydrocarbon tilckness map, termed an isovol map, based on the pay tilcfmess determined at each well multiplied by the porosity at tfrxt location and by the hydrocarbon saturation [isovol =h x ~ x (1 .9W)]. This computes tbe total void space for hydrocsrbona at each weU point. A map contoured on the hydrocarbon pore t.fichess is pxrticub.dy useful for representing thick sectiom having porosity lerises or Iarnioa, which we diftlcult to correlate between wells and are believed to be irr communication, forming a single reservoir. Computation of Oil or Gas in Place. Once the size of the reservoir is known, along with its lithologic characteristics and the properties of &e reservoir fluids, then the amount of oif or gas initially in place may be computed with the foflowing foqmdas. ~ree Gas or Gas-Cap Present). 43,560 vg4(l
G= ZTIZ,

units of thousand cubic feet, this equation ia G= 43,560 V8@(l SW)P(460+60) zT(14.65)1>000 l,546V#(l ZT If S1 units are used for gas volume measured meters the 1,546 ia replaced by 2.85. Oil irr the Reservoir Saturated Potion). ~= 7,758V04(I B. where N = reservoir oil initially in place, STB [stock-tamk m3], 7,758 = number of bamels per acre-foot, V. = o~-bearing volume of reservoir, acre-ft [m3], and B. = oil formation volume factor, RBISTB [res m3/stock-tank m3]. The 7,758 is omitted if S1 units me used. Sol@on Gas in an Oil Reservoir Present). 7,758 VJJ(1 SW)R$ G.= B. where R, is the solution gas-oil ratio, scf/bbl [std m3 /m3 ] and G, is tle solution gas, scf [std m3 ]. The volumetric method for estimating reservoir size resuka in an estimate of hydrocarbon volumes initially in place. The ultimate recovery of the reserves requires rluther estimation of the percentage recovery. This recovery factor usually is based on empirical correlations or on experience. Performance Techniques (No Free Gas in cubic SW)P ,.

(No Free Gas Present fn the Oil

-SW)

Gas (No Residual

Oil

sw)pT,

G = free reservoir gas in place, Vg = free gas-bearing vohrne of reservoir, acre-ft [m3 ], b = formation porosity, fraction, SW = interstitial water sanrration, psia [kPa],
p, = skm~rd pressure base, psia ma], T = reservoir temperature, degrees absoIute, T, = standard temperature base, degrees absolute, and z = gas deviation factor at reservoir conditions.

The 43,560 is omittecj if S1 units are used. For standard conditions of 14.65 psia [101 kFa] and 60 F [15 C], and for gas volumes measured in
MARCH 1985

NurrmricaJ Sirzrufation Models. The first efforts to sirmkte reservoir performance were laboratory experiments using sandpack and, later, electrical network These models were designed (1) to clarify the physical phenomena controlling petroleum reservoir performance, (2) to model reservoir performance under different produc~ng condhions, and (3) to aid in selecting the optimum producing procedure for the reservoir. A field can be produced only once, and if an error is made, any opportunities to improve recovery may be lost forever. A model can be produced or run rnnny times to study the field performance under natural depletion vs. improved recovery or the effects of weU l~cations and spacing. The runs can yield relative information on recoveries, 379 .

prodttcing rates, and capital expenses, thus indicating the method hat will optimize the reservoir. The early physical models, however, were expensive, time consuming to conztict, and unique to the fields that they represented. In addition, variation in field geometry or characteristics were dit%ctdt to alter if production hktory suggested that modifications were necessary. The development of high-speed digit~ computers led to mathematical models with more universal aPP~@iOn. M:tbematica! models cotid be applied to a wide variety of reservoirs by simply changing data, and modifications to. a reservoir could be efficiently implemented. The numerical simulation model, which now is a standard tool of industry, evolved from the materialbalance concepts fust presented by Schilthuia5 in 1936. The material balance, however, treats a reservoir as a single homogeneous tank with no areal or vertical distribution of reservoir rock or fluid characteristics. A numerical simulator reduces the material-bakmce tank to a very small element and considers tiis element to be just one of many within the boundaries of a reservoir. Each element is considered contiguous and in communication with the others surmundhtg it; elements may be arrWged weally and vertically to represent the physical geometry of the reservoir to be studied. Rock and fluid characteristics may be varied within each element to represent any heterogeneities of an anisotiopic reservoir. Reservoirs may be described quite accurately by using very small elements or blocks. Many very small blocks, of course, increase computer time and spatial reservoir definition requirements. Once a reservoti representation has been prepared in the individual element form, the numerical simulation model executis for each of a series of timeateps a collection of material-balance equations for all of the blocks until the dynamic .effect.s of fluid movement, caused by either production or injection into one or more blocks, is balanced. These executio~ are performed in small enough timesteps to indicate the per form?.nce of the reservoir in general and for each producing well considered by the model. Because flow is permitted across the interior block boundaries, fluid front movements can be tracked with numericaJ simulators to monitor changes in g+soil or oil-water contacts. Models also can present the dynamic changes in pressure and changes in rese~oir saturation dktributions. Numerical simulators frequently are executed for two or three dimensions in space and for one, two, or three phases of rezervoir fluids. 6 The sim~ators usually are classified according to the. type of reservoir they are designed to simulate. They may be divided generally into three classifications: (1) gas reservoir simulators, (2) black oil rtxervoir simulators, and (3) compositional rcsemok
3S0

simulators. Gas simulators may be one- or two-phase models, depending on whether or not mobile water is to be considered. A black oil model usually is capable of simulating systems where gas, oil, and water are present in any proportion. Models usually include the ablity to consider gas going in or c@pg out of solution in the oil. The data required for numerical simulation ue much the same as for a material balance. However, the spatial variations must be definable. Each element is identified in an x, y, and, perhaps, z coordinate, while the tital aiea studied is considered to be sealed at the outer bounds.g. To each block or ceil, rock data such as specific permeability and porosity must be assigned. Permeability frequently is assigned iztdependently to the x, y, or z direction. The gmmetricd data consist of the cell dimensions and the cell elevation relative to some datum. Most black oil models requize that an initial phase saturation be provided for each block and, sometimes, block pressures may be assigned. Relative permeabtity, capifbwy pressure, and fluid PVT data also must be provided for each specific problem. Condensate and volatile oil reservoirs usually requize different simulators that can account for the compositional behavior between the individual hydmcxbon components in the gas and liquid phases. This is because PVT infornwtion does not describe fluid behavior adequately for condensate and volatile oits. Transfer of mass between each of the elements is calculated in mole fractions of eit4zer individual components or pseudocornponents combining two or more of the individual hydrocarbon components. Fractured carbonate reservoirs are difficult to simulate because of mtdtipezmeability considerations. Simultaneous flow through a matrix and fracture penneabflities complicate the mathematic.d representations for fluid flow. At this writing, mukipermeabilhy compositional simulators are the frontier. Special reservoir simulators have been developed t? represent reservoir phenomena, such as weUbore coning, gravity segregation, or crossflow between stzingers, as well as tbergd recovew processes, miscible displacement, and other @proved recovev methods. Because any numerical simulation model is made from very limited spati~ distribution information, the model is apt to be inaccurate. Cahbration of the model, however, may be achieved through history matching procedures. The numerical simulator is executed first, using the best data available. The computed results are compared with the obsewed field hktory, and if agreement is not satisfactory, areal data SUChas permeability, relative permeability, or porosity values are varied between computer runs until a satisfactory match is achieved. The simulator then is used to predict performance on the basis of the operating options for the reservoir.
JOURNAL OF PETROLEUM TECHNOLOGY

When a hkto~ match has been achieved, the engineer has determined a combination of reservoir variables that may not be tutique and may not represent reservoir conditions precisely. In general, however, the longer the matched hktory period, the more reliable the predicted per fommnce will be. Material-Bafance Method. If sufficient pressure production performance data are recorded and PVT data describing the reservoir, fluid behavior are available, the amount of oil or gas in place in a reservoir sometimes may be computed by the materid-balapce method. 5 This method is based on the premise that the pore volume (PV) of a reservoir remains constant or changes in a predictable manner with the reservoir pressure drop, as oil, gas, andlor water are produced. .If the reservoir PV remains near constant, then as reservoir fluids are produced ~d rese~ok pressure falls,, the fluids remaining in the reservoir must expand to occupy tie PV. The reservoir fluid unit expansion per pound of pressure loss isdefined bylaboratory PVT analyses. Periodic survey data indicate the loss in reservoir pressure corresponding to withdrawals. The material balance calctdates the volume of reserioir fluids that would berequired toexhiblt anexparision for the observed pressure drop, which would equal the witbdrawxs. Calculations at severul pressure withdrawal points yielding consistent results usually are required. an Successful application of &is method rqdres accurate history of the a~erage pressure of the reservoir, reliable oil, gas, and water production data, and PVT dam on the reservoir fluids. The results from atnaterial-balance culcttlation may be quite erratic, especially when there are unknowns other than the amount of oil in place, such as the size of a free gaacapor the presence of waterdrive. Table2 presents the most frequently used. material-balance equations. It is beyond the scope of this paper to treat each of them. The material bakmce cum be rearranged to solve any of. theunknowm if sufficient dam are known or if arange OFprobable data can be identified. Applications by Schilthuis, 5 Muskat,,6 Taquer, 7 Babson, s and others have been published und arc accepted by indus~. Innovative applications for using the miterial balunce to solve simukaneuusly for oil in place and aquifer activities have been published by Odeh and Havlena9 and McEwen. 10 Materid-bskmce calculations also may be desiSned to extend the observed per fomtance of a reservoir into the future. These predictive tools assume a homogeneous reservoir and require application of relative permeability concepts. The concept of relative pcrmeab:lity is one of the most critical as~cts of rnaterial,b.alance and numerical simulation calculations. Industry accepts that the permeability of porous media to a ,flowing tluid varies with tAe saturation of that fluid, but the change is difficult to predict in advance. Core
MARCH 1985

analyses presenting relative permeability curves for a tiny sample of the reservoir sometimes simply are not representative of the tiful r.&emoti system. Although ~eld-derived relative permeabili~, curves solved from obseryed production are highly desirable, the need for the relative permeability curve often precedes having enough data to prepare one from field inforgmtion. The accuracy of a material bulance ulso is hindered by the fact that most calculations assume gas released from solution in the resewoir to be dktributed homogeneously. This average saturation is used to conclude relative permeability values for the calculation. If the reservoir has good vertical permeability, then fluid segregation resulting from gravity @fects may cause the reservoir to perform differently than the material bakmce wotdd $aIculate. When au engineer is forced to assume a relative perineability curve, the engineer assumes a vuriable that will control the results of the materti-baknce calculation. However, relative permeability curves can be estimated to a reasonable degree of accuracy if lithologic conditions are weII known and if sufficient laboratory curves have been prepired during core analyses. Improved Recowy. SpeciuI calculations designed to treat secondaty or improved recovery procedures, such aa the Bucldey-Leverett, 11 Stiles, 12 and have become Pafl Of Dykstra-Parsons 13 ~~c~atiom, the resefioir engineers standard tools. Th&e calculations are greatly enhanced through the use of computers, arid computer programs have been published for application of these standard procedures. 14 Production DecIine Curves. Tbe highest confidence estimates of ultimate recovery result by extrapolation of performance trends. Because the engineer usually wishes to determine the remaining oil reserves and the remaining productive life, the cumulative production and time normally are selected as independent variables and are plotted as abscissus. A vaIYing characteristic of the well performance that can be measured easily is selected as a variable to produce a trend curve. For exmapolation purposes, titk variable (such as rate, pressure, or water cut) must be a continuous function of the independent variable and change in, some uniform, definable mumter. By plotting the vaks of this continuously changing dependent variable as ordmtes against the values of the independent variable as abscissas, and graphically or mathematically extrapolating the aPP~en~ ttend until a ~own endpoint is reached, one may estimate the rematning reserves or the remuining life for a reservoir. For oil reserves, these plbts are usually the Iogurhftm of the producing rate vs. time. For gas reservoirs, similar production curves sometimes are used,, or pressure divided by the compressibility factor for the gas may be plotted vs. cumulative production to derive estimates of initial gas in place.
381

TABLE 2CLASS1FICATION Reservoir Type

OF MATERIAL-BALANCE Material.Balance

EQUATIONS Unknowns - WP) N, We, m Equation

Equation-

NP[B, +0.1781 Bg(RP -R$;)]-(We Oil resewoir with gas cap ad active water drive N= 5 m80r ~ () B@ +(Eft -Bo,)

11

NP[Et +0.1781 .9Q(RP -R*)]+ Oil reservoir with gas can no active water drive (we =0) N= B mBd ~-l () B g; +(Et-Bd)

WP N, m 12

Initially undersaturated oil reservoir with active water drive (m =o& 1, Above bubblepoint

NP(l +APc,J N= [

w. -w. - y .,

1
-orJ1

(1 - SW) N, We 13

APIco +c, -sv/(co

~= 2. Below bubblepoint

NP[B, +0.1781 Bg(RP -R~l)]-(W~B,-Ed

WP)

N, We

14

Initially undersaturated oil reservoi~ no active water drive (m= O), (W. = O): 1. Above bubblepoint

NJ! [ N=

+A/)CO)+

~ d

1
-R4)]+

(1 -SW) N 15

APIco +c, -Sw(Co

-cw/)1
W,

2. Below bubblepoint

~=

NPIBC+0.1781B,(RP s! 6., GPf3g -5.615(Wa

16

- W,) G,W 17

Gas reservoir with active water drive

GP =

B, - B,, GPBg +5,615WP

Gas resewoic

no active water drive (Wa = O)

GR = Bg-BgI

18

where Bg = gas FVF, vol/vol, BO = oil FVF, RBISTB [res m3/stock.tank

m3],

B, = two-phase FVF for oil,. RBISTB [res m31sfock-tank ins], C, = comPressibiliW factor for reservoir rock, vollvcdlpsi, c. = compressibility factor for oil, vollvollpsi, c. = c0mpres5ibility factor for water, KWw31/pSi, GR GP i m N NP RP R, = = = = = ; = = reservoir gas in place, scf [std m3j, cumulative gas produced, scf [std m3], initial conditions, ratio of gascap volume to oil zone olume, reservoir oil in place, STB [stock-tank ins], cumulative oil produced, STB [stock-tank ins], cumulative produced GOR, scf/STB [std m3/stock-tank solution gas ratio, scf/STB [std mslstock-tank m3],

rn3],

SW = interstitial water saturation, fraction of pore space, We = c.mlative water influx, bbl [rn3], ad WP = cumulative water produced, bbl [m3]. .1{S!
M are used, 5.8,s and 0,,75, should be amli,ed.

382

JOURNAL OF PETROLEUM

TECHNOLOGY

The extrapolation procedure is of m empirical nature but represents the, system being nm?lyzed. If the system is not imbulanced because of a change in operations, then the extrapolation should be a reasonable representation of the future reservoir performance. Among the dependent variables usually extrapolated, the logarithm of the rate of production is by far the most POPULWbut only when production is not restricted. Because the volumes of oil andlor gas usually are sold, this dependent variable has the adwmtage of being readily available and accurately recorded. The endpoint of any rate extrapolation is normally the economic limit rate, nnd since actual or estimated operating costs nre usually available, thk endpoint is not dlfticult to determine. Extrapolation of performance curves should be performed carefully to ensure that any established decliie in producing trend is not the result of proration, mechanical wear of lifting equipment, physical changes in or around the wellbore (such as deposition of wax, salt, or asphaltenes), or from loose sand, silt, mud, or cave-ins into tie wellbore, Any changes around the wellbore as the result of gas-cap or water encroachment also must be considered. The engineer extrapolating oilwell perfommnce data dso should determine if the data represent production above or below bubblepoint pressure. Extending an oif perfommnce curve through the bubblepoint is invalid, gas released from solution below bubblepoint pressure will add energy to the producing system, which will alter reservoir saturations and relative permeabilities and change the nature and slope of the decliie curve. Snperpressured reservoirs also require special cxre because projecting datn recorded at above-normal pressure grxdients mny prove nonrepresentative of performance at nnd bdow normal pressure ranges. Extrapolation of a performance trend assumes that the operations in effect during the trend period wifl continue. Inffl ckilIing, gas, steam, or water injection, or any operational change may render the extrapolation invalid. Types of Production Decline Curves. Production decline curves usually plot production rate vs. time or vs. cumulative production. Because productionratehime curves have found more acceptance, the folfowing discussion will focus on this type of plot. There are two dedine terms used in equations describ@ rate-time cumes. The nominal decline rate, a, is defined as the negative slope of the curve representing the natural logarithm of the production rate, q, vs. time, t, or: dlnq dt dqldt . _ . q

mainly in the derivation of the vaious mathematical equations. The effective decline rate, d, is a step function more commonly used in practice and is the drop in production rate from m initial to a final rate for a period of time divided by the production rate at the beginning of the period d= , 92 ql E71 The time period may be 1 month or 1 year for effective monthly or annual decline rates, respectively. Three types of production decline curves commonly Arps, 15,16 in his extensive have been recognized. treatments of decline curves, published the impottnnt relati.onshipi for constant percen~ge (exponential), hyperbolic, and harmonic decline curves. Fig. 5 presents those relationships along with the curve appearmce for rate-time snd rate-cumulative plots for the thee types of curves when plotted on regular coordinate paper, semilog paper, and log-log paper. h analysis of a large number of acmal production decline curves by Cutler 17 indicated that most decline curves demonstrated a hyperbolic shape, with values for the,exponent n fall@ between 0.0 and 0.7, witi the majority falling between 0.0 and 0.4. Gravity drainage production under certain conditions was reported by the API Is to have an exponent n equ~ 0 0.5. The occurrence of harmonic declines (n= 1) is apparently very rare. The constant percentage or exponential decline curve is a straight line on semilog paper. The ratecumtiative curve is a stm.ight line on regular coordinate paper. In either case, the tangent of the xwzle of slope is equal to the nominal decline fr;ction. In the cnse of the hyperbolic-type decline curve, the rate-time relationship.., as well as the rate-cumulative relationship, requires shifting on log-log paper to yield a straight line. Before the development of digital computers, shitiing of curves was a ccamnoa practice, but computer regression procedures have made thk unnecessary. Performance histories can be regressed with computer pro=wmns to identitj the Ieast-squares best fit through historical production information, and the equations thus solved can be extrapolated for predictions of future performance. Because hyperbolic decline cunes asymptotically approach a horizontal line, very long extrapolation of hyperbolic curves can result in optimistic projections. Knowledge of rhe decline rate observed for sfiila aPP~ent *IUUM wefls having more hktory sometimes enables the reservoir engineer to decide at whnt point in the projection the hyperbolic extrapolation should be replaced with an exponential extension to the economic limit. 3s3

~=.

Nomirwd decline is a continuous

MARCH 1985

function and is used

WCLIW

VPE

Constant-Percentage

Decline

Harmonic Decline decline is proportional to production rate =1 D=Kq=~ for

initial conditions

Basic Characteristic

decline is constant =0

-Dt=log.:

q,
Rate.Time Relationship q, =qje-or Q<=jq,dt=sq,eofdt 00 ~ , q,ql. -o = D wbs!it.te from rate.!irne equation

q,

q,
+D,O

.?, q,(l +.D,O =

Q,jq,dt.

qr=qr(l

f (1 +nD,

t]-7rdC

0,= jq,dt= ~ . &ge(, D,

(l+ D,O=: 10find

q,(l ~ +D,t)-dt

+nD,t) - -11 0,= *[(1 ( - 3)D, substi!.t. from rat..time equatiom

,D,o,

substitute from rale.lim. equation

q{. =qz to find late.Cumulative Relationship D D, q, r = . = = ~ =.T-qz (n

to *d Q,=
o, 0, K n

(+0)=(%)
*(%--%-)

0,=+109.:

decline as a fraction of production rate iillal decline initial production rate time

= = = =

omduction rate at time t cumulative oil production at time t constant ex$mllet CURVES

RATE-TIME

RATE - CUMULATIVE

CURVES

CONS,*W .-ROW. uMm(c

KXCIIIAEZ 0s,,1!$! WaMIE

OECLI,

. .

.0 . h

0.

03
X.

.7 - m --------

0,..1, O...w

.H*ER80L(C . . ..mwlc

MC,!., OSCLIN.

(wzFWD

0 ON

LOG LOGI .0$)

m.

----

. . I

,S.lnco

cc

Fig. 5Three types of production and log-log graph paper.

decline

cuwes

and their

appearance

when plotted on coordinate,

Seml109,

384

JOURNAL OF PETROLEUM

TECHNOLOGY

In water drive or waterflood situations, waterloil ratio vs. cumulative production frequently is plotted on semilog paper. This curve usually will appear as a straight line on the semilog plot. An extrapolation of this straight line to a maximum WOR aUowed by economics presents a duect estimation of the total recovery at the economic limit. Modern decline curve analyses techniques employ computers with video screens and interactive programs. These programs allow an engineer to derive mathematically art equation that best represents the recorded data. These best tits, however; may not be adequate for projections since the historical data ITMYinclude production interruptions that affect the mathematical regression. In thk instance, the engineer IMY force a tit though segments of the curve he believes beat represents the producing capacity. As in all methods for estimating reserves, accuracy is improved as data accme to detine the production trend.

dcrive tlds factor, FU,

is:

Evaluation

of Reserves

The selection of a course of action from among various investment options usually is based on a comparison of their relative values at some common point in time to account for the effects of time on the value of money. The life and production profile for each of the several investment or operational options, along with the investment required, is the basis for the evaluation. The following definitions are pertinent ia understanding how a dollar value is developed from a time-rated projection of reserves. Future Gross Revenue is defined as tie total proceeds estimated to accrue from the production and sale of the estimated net reserves. These proceeds may be. determined based on current prices or ones established by contract (SE.C requirement) or may be based on assumed price schedules that consider anticipated changes. Constant prices are used most frequently for financing and SEC fdings, whale forecasted price cases are used most frequently for business decisions. Future Net Cash Flow is determined by deducting from future gross revenue such items as estimated ad vaforem taxes, severance taxes, windfti profits tax, transportation costs, operating costs, and any expected capitaf costs. Estimated costa may or may not be escalated to account for inflation. In general, no deduction is made for federal income taxes, general corporate overhead, or other administrative expenses. Future Net Revenue (FNR) is the total future net caah flow for the life of the property evaluated. A Deferment fDiscount) Factor is used to reduce revenue received in the future to a present value. This factor is solved for each year, based on specified interest rates, tid usually is calculated to represent revenues received once a year at the midpoint of the year. A frequently used equation to M.4RCH 1985 .-

where i is the interest rate expressed aa a fraction, and t is the year. Discounted Future Net Cash Ffow is the .mmd discounted caah flow derived by multiplying each years future net cash flow by the deferment factor for that year. Discounted Future Net Revenue (DFNR) is the sum of the annual dkcounted future net cash flow values over the projected life of the prope~. The DFNR sometimes is calIed the present worth of the prope~. The DFNR or present woti is not the fair market value (FMV). FMV includes a profit for the buyer and compensation for the risk of doing business, but DFNR does not include these two factors Fair Market Value (FMV) commonly is understood as the price at which a property would be sold after exuosure to the mmket for a reasonable veriod of time by a willing seller to a wilhg buy~r, neither being under compulsion to buy or to sell, and both being competent and having reasonable knowledge of the facts. 19 Rate of Return is defined aa that interest rate which results in the discounted present worth of future net income being equal to the initial investment. 20 A broader definition (and one that would appear to have more general application to the oil and gas industiy) is proposed by Watkins21 as that interest rate which restdta in the discounted present worth of future net income being equal to the discounted present worth of all capital investments. The discounted cash flow rate of return generally is considered to be a reasonable standmd for investment analysis and sometimes is referred to as an indicator of the earning power of the investment. A review of fair market value techniques bas been published by Eggleston. 22 Working Interest is the operating interest owned under an oil or gas lease and represents a decimal fraction of the gross costs for developing and operating the property. A typical lease provides for a royalty interest to be paid to the lessor or other royalty owners free of production expenses. The balance represents the working interest of the lessee and bears the total production costs. Net Interests represent tbe revenue interest for the property and is the factor that, when multiplied times the estimated total future production flom a property, will yield the future gross revenue net to the interests evaluated. Reversionary Interest is a portion of the evaluated interest that reverts to another party on the occurrence of some defined event, such as payout of
385

Operator Revenue Interest Workng Intere*t Date of Evaluation RI = WI =

XYZco,
0,375 0,500 01/01/85

Oil Sales Price

Production Taxes Estimated Operating Expenses = 4;6% .

$29.00. bbl per

PIUS

Lease Field County, S!.1. Acres No. of Will

Mary Jones Rock Creek Dallas, Texas 100 1

$0.0019.P9[ kb!.

$800.00/well month

Estimated Future 1. Gross lease production 2. Net production to XYZ 3. 0,1 revenue 4. Productkm taxes 5. Producing well months 6. Operating costs 7. Capim[ expenditures 8. XYZ share of operating plus Cepitd cost, 9. Net federal excise, (windfall profits tax) 10. Fulwe net revenue., 11. 10% annual deferment ,2. P~;RtihofxYz.

Operation RI x(1) (2) x Price [0.046 x (3)]+ [0.0019x (2)] wells x months (5) x $s00

Year 1 Beginning Uni!s 01/01/85 bbl bbl $ $ ; $ 5 $ 50,301 16,863 547,023 25,799 12 9,600

Year 2 Beginning 01/01/S6 42,570 15,964 462,949 21,326 12 9,600 4,600 7,962 426,641

Year 3 Beginning 01/01/87 30,738 11,527 334,276 15,399 12 9,600 4,S00 4,957 309,120

Year 4 Beginning 01/01/SS 24,180 9,068 262,957 T2,113 12 9,600 4,S00 3,174 242,670

Year 5 Beginning 01/0</S9 19,490 7,309 211,954 9,764 12 9,600 . 4,800 1,973 .195,417

Year 6 Beginning 01/01/90 13,847 5,1.93 150,586 6,937 12 9,600

Year 7 Seginning 01/01/91 4,506 1,690 49,003 2,258 12 9,!500

Told 165,632 69,614 2,018,748 92,996 64 67,200

WI x [(6) + (7)]

4,800 14,336 502,688 0.9535

4,800 967 137,662 0.5920

4,S00 152 41,793 0.5382 22,493

33,600 33,561 1,658,591

(3)-(4) - (S)-(9)

(i)-

: 476,294

,;: ,

2H

,:;-

:: 61,616 1,499,941

.Calcla,ed ex,mally mrdhq ,0 WU1860S c,,,, a, time .1 ,Pml,al, . ..4d valomm tam,, if my, should be dadcted at MS steP.

Reglaltos may be Gb,,hed

(mm lax s<02,.!s.

fig.

6Cash flow projection

snd present worth calculation

for

XYZ Oil Co.s interest

in producing

oil property.

a loan, passing of a time period, or recovery from moduction of a dollar amount. When revemionarv titerests are included in evaluations, the before payout (BPO) atd after payout (APO) interest factors, along with the basis for fheir use, must be considered. A mineral interest is a part of the fee-simple interest. In most states, a mineral interest can be severed from the surface interest and transferred by a mineral deed. In certsin states, the mineral interest may not be severed from the surface interests in perpemity and will revert to the surface interests under certain conditions. The owner of a mineral interest can execute a lease for the oil and gas rights independently from any surface usage and may receive bonuses, rentsls, snd royalties resulting from such a lease. &erriding Royalty Interest is an interest in an oil or gas producing property free of expense of production and usuafly free of any landowners royalty that has been carved out of a leasehold (working) interest. It continues for the fife of the lease and is subject to production taxes, federal excise or windfall profits taxes, and ad vaforem taxes. Net Proj?ts Interest is a share of the future net revenue or protits from the operation of a specific tract or property. It normally is taken from the working interests. Carned Interest is a fractioiid interest in an oil or gas property carved out of the working interest that carries no obligation for operating or development costs. The operating and development costs 386

attributable to the carried interest are borne and paid by the owners of the remaining working interests. A can-ied interest converts to a working interest when specific events occur. Production Payment is a share of the revenue from the sale of oil, gas, snd other minersls produced from a propeny. It is usually free of the cost of production and terminates when a specific sum from the sale of the minerals has been reafiied by the owner of such interests. This payout frequently is the trigger for reversiotity iniirests.

Discounted

Cash Ffow or Present

Worth

Calculation

After the rates of production for the projected reserves have been prepared, economic considerations for the evaluation must be developed. These include consideration for any purchase contracts for the oif and gas produced, any capitaf requirements, estimated operating costs, and taxes, includ]ng state, federal, and local. Capital costs for well repairs or for additional development drilling must be scheduled and costs estimated. A projection for oil and gas prices under contracts affech-ng the property or based on projected trends must be developed. Financiaf institutions generalfy prefer and the SEC requires that the projections be b~ed on existing prices with no consideration for escalation of prices or inflation of costs other than those contracted. Management usually itmists on the price cost modeling to reflect real world trends. These economic considerations then are extended into an operating cash flow, which is
JOURNAL OF PETROLEUM TECHNOLOGY

discounted on the basis of the deferment factor and then studied by whatever comparatives or yardsticks one may choose to define the fair market vahte. Fig. 6 presents a sample cash flow and present worth calculation. A hypothetical lease having an estimated future life of 7 years has been projected. Line 1 presents the gross production to the Ieaae for the I-yeur period. Lke 2, tie net production, ia computed by multiplying each years gross production times the revenue interest (net interest) factor. The net production times the product price results in the oil revenue on Lke 3. Production taxes, in thk case for the state of Texas, are deducted on Line 4. The number of well months operated each year times the operating costs per weU month is used to compute the tcital annual operating costs shown on L]ne 6. No capital expenditures am considered in th~ projection; therefore, the XYZ Co.s share of the operating plus capitaf costs becomes the working (cost) interest times the totaf annual operating costs. Net federal excise or windfall profits taxes were computed outside of tie projection iccordkg to regulations current at the time of the appraisal and are shown on Line 9. The future net revenue, shown on Line 10, then becomes the total oil revenue less production taxes, operating and capital costs, and windfall profit tuxes. Annual deferment factors are on Line 11, and the discounted cash flow is shown on Lke 12. The total dkcounted fatare net revenue for the example lease is $1,499,941. This is sometimes referred to as Me present worth of the property. Tbe format for Fig. 6 is presented to detail tbe cdcufarion. Such @bles usually are performed by computers. Tbe discounted cash flow method for appraising properties presented here is used widely in industrial work. OtJIcr methods, such as tie H9skold metfmd23 and the MorHll method, 24 dso have been used on occasion in the petroleum industry. Tlie discounted cash flow method, however, is by far the most generally accepted first step in any evaluation of oil and gas producing propeflies. Fair Market Vafue. The fair market value for a p~oducing property ,is not a unique value that may be derived by solving a formula. It is, rather, a subjective estimate reflecting the economic expectations of the buyer and the seIler at the timeof the trade. Any change in the economic outlook may consequently change the estimated fair market value. A number of yardsticks have evolved in different till- and gas-producing provinces for determining the fair market vafue of oil and gas properties. The ~going market, based on similar past transactions, has been suggested frequently as the best guideline for establishing vufue. Because a wilkng seller und a wifling buyer, under no compulsion to sefl or to buy, seldom exists, use of a single transaction to establish a value is not recommended unless all circumstances are known. Buyers are frequently under some comptdsion to buy. They may need fuel for plants or
MARCH 1985

feedstock for an industry or may require an assured ener~- stipply. Sellers may be obligated to sell bemuse of financial preasurea. A number of transactions indicating similar sales values, however, probably are the best reflections of the fair market value of a property. Yardsticks used by indusmy include (1) a specified fraction of the discounted fanue net revenue, (2) specified years of future net revenue, (3) payout time of the investment, (4) a price per barrel of oil reserver in the ground (with @ volumes converted to equivalent barrels of oil on either a heating value or price ratio), (5) a specified price per barel per &y of producing rate for the first year of the remaining life of the, property, (6j prOfitto-inveatfnent mtio, and (7) before or after income tax internal rate of return vafues. Because most of the above evaluation procedures are reflections of tbe time pattern of future revenues, most evaluation methods are based on annual projections of future production and the correspondbtg cash flow &lculatiOns. Gmy considered as a fair gmket value in 1952 two-thirds of fature net cash income before amortization and federal tuxes, discounted at five percent per year.* The two-tlirds fraction has varied slightly vikh industry condhions, but this methodology is stiff in general use. However, the discount rate at the time of the current evaluation is substimted for the 5% per yew rate reported in the referenced paper. Dodson listed in 1959, .#nong some seven different mefhods that may be used to determine the fair market value of oil and gas reserves, percentages of the present worth which niay vary from 50 to 100% but which recently have been from 75 to 80%. 25 A smdy bY Gmy et al. 26 in 1981 indicated that in spite of varying tax and economic condhions, one classicaJ yardstick for estimating the vafue of oif in the ground had remained reasonably constant through the years. An analysis of 10 major transactions during 1979-81, a very volatile oil price period, indicated that equivalent oil reserves in the ground had a market value of approximately one-third of their posted welfiead price. Fig. 7 presents a review of sevemf frequently used yardsticks for identifying fair market value. The future net revenues calctdated on Fig. 6 (Line 10) of the Mary Jones, lease were USed as data for this a@ysis. Data for this hypothetical lease would suggest that, if the appropriate dkcount rate at analysis time were 15%, then a price based on twotbiids of the discounted fatwe. net revenue woufd amount to $912 million. This would be equivalent to a pretax internal rate of return of 44.8%, a return on the high side of average at the present time. It would also equaf a per barrel in the ground price of $13.10. (This approximates the one-third posted wellhead sales price yardstick.) The dollurs per barrel per day

387

PROJECT

IDENTIFICATION

=XYZ

OIL CO. MARY JONES =1 = 12 = 0.15 =0 = .1 .2 .3.4.5.6 = 69.614 = 0 =8 = 18.863 =0 = 69,614 = 5.170779E

LEASE

NUMBER OF CASH FLOWS MONTHS IN FIRST YEAR PRIMARY DISCOUNT RATE, frac SECONDARY DISCOUNT RATE, frac SECONOARY DISCOUNT RATE, frac OIL RESERVE FOR APPRAISED INTEREST GAS RESERVE FOR APPRAISED INTEREST GAWOIL EQUIVALENCE ,FACTOR FIRST YEAR OIL PRODUCTION FIRST YEAR GAS PRODUCTION TOTAL RESERVE IN EQUIVALENT bbls FIRST PERIOD RATE, EQUIVALENT bblld CASH FLOW NO. 1 RISK AJUSTMENT FACTOR PROJECTION LIFE YEAR CASH FLOW 503 1 429 2 309 3 J. 243 195 5 138 6 42 7 0 REMAINING = i ,859 FOR DISCOUNT YEAR 1 2 3 4 5 6 7 8 RATE = .15 CUM FNR 502.7 931.5 1240.6 ?483.5 1678.9 1616.8 1S58.6 1S58,6

-02

=1 .7

AVERAGE

YEAR = 8

TOTAL FNR 502.7 428.8 309.1 242.9 195.4 137,9 41.8 0.0

DISC. FNR 468.8 347,7 217.9 148,9 104.2 63,9 16.9 0.0

CUM DISC, FNR 469 .816 1,034 1,183 <,288 1,351 1,366 1,368

CASH FLOW NO. 1 IS 100.000 PERCENT OF TOTAL CASH FLOW PRICE FOR 3 TO 1 FUTURE NET REVENUE TO COST RATIO PRICE BASED ON 2% OF DISCOUNTED FUTURE NET REVENUE PRICE BASED .ON 3A OF DISCOUNTED FUTURE NET REVENUE THREE YEAR CUM OF FUTURE NET REVENUE FOUR YEAR CUM OF FUTURE NET REVENUE SIX YEAR CUM OF DISCOUNTED NET REVENUE DISCOUNTED .75 .1 .2 ,3 .4 .5 .6 PRICE 1,368 1,259 1,166 1,088 i ,020 961 750 912 IRR 15.00 20.00 25.00 30,00 35.00 40.00 65.76 44,77 VALUE PROFILE 1.368 1 ;500 1,259 1,0S8 961 864 788 .31BSL. 19,66 18.08 16.76 15,63. 14,65 13.81 10.77 13.10. $lSSLfD 26,463 24,344 22,558 21,036 T9,726 18,588 14,505 17,638 RETURN 1.358 1.477 1.593 i .709 1.822 1.934 2.478 2.038

620 912 1,026 1,241 1,484 I ,351

Fig. 7Printout of a fair market analysis for XYZ Oi Co.s interest in the Mary Jones Lease. 388 JOURNAL OF PETROLEUM TECHNOLOGY

range observed for a number of actual properties was found to be between $14,000 and $20,000ibbl/D production. The $17,638 for tbk hypotfzeticsl lease is within a ususl range. The return on investment of 2.038 to. 1. is. lower than the frequently quoted 3 to 1 yardstick. Risk Adjustment. The envelope of fair market values using the several yadsticks. may be developed fOr the range of tiknown factors that affect the prope fly value. Multiple executions varying reserve, property life, product prices, tax assumptions, capital investments, and operating method can require more executions &h sre practical, Analyses frequently are adjusted for such variances with a single risk adjustment factor. A best estimate case is first prepared. If the producing properties being evaluated include seversI estimated cash flows having dhYereit confidence levels (e.g., proved developed, proved undeveloped, and probable reserves), then the most likeIy case for each of the c~h flows can be accumulated to a risk-adjusted. total by applying separate weight factors to the individwd cash flows. The riding risk-adjusted total cash flow is then analyzed using the method shown on Fig. 7 by assigning a range of plus or minus adjustment factors represeriting the confidence in the assumptions being used. The risk associated with the predicted cash flow wiO M dictated by the confidence one bas in the basic data and the reserve projections derived froin these data. If one assigns a factor of 1.0 to the proved developed resewes, then the corresponding risk factors for, the other reserve classifications usually ate within the following ranges. proved undeveloped Probable Possible 0.75 to 0.90 0.35 to 0.60

item. The reservoir engineer usually is the individual faced with the Tesponsibllity for evaluating the resemes he has estimated. The evahzation of an oil- OT gas-producing property includes (1) the physics and laws of mture for predicting reserve stid recovery rates, (2) the political aspects of taxation, and (3) the econbmic impacts of the cost for drilling and operations. Because evaluations include such an extensive spectrum of variables, many of which me little better than guesses, there is an absolute necessi~ for good communication between the evafuator and each user. There are at least four specialktsthe evaluation engineer, tax consultant, financidl anslyst,, zmd attorney-that should bi. communicating before the fiiIal terms of a transaction based ofi a reserve evaluation me agreed on. These four experts must understand, through use of common terminology and lexicon, the confidence in the evaluation. Bypassing any of the four experts in, r~chhg a fnal decision on tie transaction can prove to be a very expensive experiment.

References 1. World Pctml.xun CoaSress S@+dyYields Reserves Ckissiticatio.,

Nomenclamre,,z Oil cud Go. J. (Nov. 21, 19g3). 2. TrcIvcd ReservesDe finitions, J. Per. Tech. (Nov, 1981) 2113-14. 3. Perroleum Pro&mon Handbook, T.C. Frick (cd.),. McGraw-Hill Book Co. Inc., New York City (1962) V.1, fI, C}aPs. 37 and 38. H.B. B,ed@ 4. P,zF.k.m ,%i~d.g ad PTO<IUCdOII ?!~book [cd.). SPE. Richardson. TX, ChaPS. 40 and 41:10 be p.bl~hwJ in 19S5. 5. Sciikbuis. R. J.: SACdVCOil in Reservoir Energy,,, Tram,, MME (1936) 118, 33-52. 6. M.skat. .. and Tavbr. M. O.: WSf&t of Re$ecvoir Fluid & Rock M. . ._. . characteristics on Pmd.cdcm Hismries of Gas-@vi Re$ewoir$. Trans.:., AIME (1946) 165, 78-S3. r llffer.nt . . . 7. TarneI, .1 z , ?-TOW .. .. . . .. %... Gascapsand Pres,um Maintenance ... . Programs Affect Amount of R..< waable Oil,? Oil Weekly (1... 12, 1944) 32. 8. Babson, EC.: .Prediction of Reservoir Behatior.Fmm Lab?mw Data,, Trans., A21vtE (1944) 155, 1?0:26. and Havlena, D.: 4The btateridBalaq& as,an Equation 9. Odeh, of a Str@ht Line; Appl;edPermleum Rtwrwir En~ineerh~, B.C. Craft and M.F. Hawkins (eds.), Pr=nlic.- f++, ~~e?o.d Cjiffs, NJ (1959) Chap. 5. 10. McEwen, C. R.: %lateriaf Bahce Cafcu!Mioms with Water fn~ux i tbc ~ence of Uncertainty in FRssures,, s... Per,Eng.J. (km. 1962) 120-28. 11. Buckley, S.E. and Leverat, MC.:. . Mechanism of ,~uid Displacemerm in Sands,, S Tram., AME (1942) 146, 107-16. 12. Stiles, W .E.: US. of Penneabiliw Distribution i Waterfhod Calwiati.m,,x Trans., ,AJME (1949) 186, 9-14. 13. DYkstra, H. and Parsons, R. L.: The Prediction of Oil Recovery by Water flood,, s Skmdary RecoveIY of Oil in ihe United states, second edition, API, Dallas (1950) 160-74. 14. Garb, F. A,: Wa@700d Calculadom for Hind-Held Computers, Gulf Pubtkhing Co., Houston (1982). 15. Arps, J. J.: Analysis of Decline Curves, Tram.. AIME (1945) 166, 228-32. 16. Arm, J.J.: <Estimation of Primary Oil Reserves,, Tram., AfME (1956) 207, 1S2-91. 17. Cutler, W. W. Jr.: T3tinu.tie of Undecsronnd Oil Reserves by Well Pmdwio CIJrves,, s Bull. 228, U3BM, Washington,DC

0.0 to 0.10

Undeveloped leasehold interests frequently are evaluated by using t%o methods. If reserve volumes Cari be estimated by analogy or perhaps using prospect weas defined by geology or geophysics, then the dkmunted cash flow method, heavily risk adjusted, is sometimes used. If analogy is inappropriate for estimating prospective reserves or if no actual drilling prospects are defined, then the undeveloped leasehold interests usually are valued equal to ihe estimated cost for obtaining similar leases in the same area. Conclusion The value of the successful oil- and gas-producing company is dominated by that companys hydrocarbon reserves and producing capacity. Although future estimated oil and gas. prices and taxes may in ffuence a companys value significantly, its reserves remain the single most important inveritory
MARCH 1985

AS.

(1924) 389

18. Annual

Reporl on proved Reserves of Crude OiJ, Natural Gas

Liquids, and Naluml Gas,, >America. Petroleum Institute, Dallas.

19, Mont8mneV, C. T.: Fedsm2 Taxes,,, 37th edidon, The Ronald Press Co., New York City (1958). 20. Phillips, C. E.: The Relationship Between Rate of Return, Pay Out and Uldmate Return in Oil and Gas proper ties,,, J. Pet. Tech, (Sept. 1958) 22-25. 21. Wzkim, P.B. : Econmnic Evaluations,,, J, Pet. Tech, (NW. 1960) 20-28. 22, Egglemm, W .S.: ,Methads and Procedures for Esimating FairNMkec Value of Petroleum Properties,,. J. Pet. Tech. (May 1964) 481-86. 22, Hoskold, H.D.:, E.@werSs Valuing Awi.sr.nt, Lo.smans, Green and Co. Inc., New York City (1877) 34. 24. MorkiU, D, B.: Fmm& for Mine Vduotim, Mining aad Scientific press, New York City (1966) 276, Finaaci&,,, J, PCI. Tech. (April ~960) 19-22.

26. Gruy, H. J., Garb, F. and Wind, J.W,: <Determining the VahJe A., 105-08. of Od and Gas in the Ground,x, World Oil (March 1982)

S1 Metric

Conversion

Factors E+03 E01 E01 = mz = m3 = m

m

acre X 4.046873 >:bbl X 1.589873 ft X 3.048*

Yhwemion

factori, exact

390

JOURNAL OF PETROLEUM

TECJJNOLOGY