Assessing Risk in Estimating Hydrocarbon Reserves and in Evaluating Hydrocarbon-Producing Properties (includes associated papers 18606 and 18610)
Authors: Garb Forrest A. 
Published: December 2007

The petroleum industry has written extensively on the risk associated with exploration. Very little has been published, however, addressing the risks associated with acquisition and operation of producing properties. Because capital budgets usually depend on the income a company realizes from its producing properties, and because current conditions have been interpreted by many to favor the acquisition of existing oil reserves over exploring for new ones, the risk in estimating reserves and in estimating future cash flows for producing properties has taken on a new importance.

The risks associated with estimating the reserves and value of a hydrocarbon-producing property are divided into three classifications:the technical risk that the hydrocarbon values estimated by the geologists and engineers do exist in the ground and that the recoverable amounts can be recovered within the time frame projected by the engineers;the economic risk that product prices, operating costs, equipment costs, inflation, and market conditions will be in reasonable agreement with the assumptions used in the economic analysis; andthe political risk that world economics, international political stability, taxation, and regulations will not be significantly different than projected in the evaluation.

This paper focuses on these risk categories and presents methods for implementing risk estimates in the evaluation of a producing property, taking into account the maturity of the technical data, the location, and the life of the property. A Glossary of important terms is included.

Introduction

The two most important concerns about a producing property are its producing rate and its reserve. The producing rates from the properties, together with oil and gas prices, operating costs, and taxes, control the company's cash flow. The company's reserves are most likely the collateral for its credit and provide the basis for any business transaction, such as property acquisition, sale, or merger. Because capital budgets usually depend on the income a company realizes from its producing properties, and because these capital expenditures frequently are sized on the engineer's estimates of reserves and producing rates, the uncertainty in estimating and evaluating hydrocarbon reserves, while always important, is taking on new critical dimensions under current industry conditions. High exploration costs and poor success ratios have been interpreted by many to favor the acquisition of existing oil reserves in the ground over exploring for new ones. Therefore, it is extremely important that not only oil industry management but also the financial world, which provides funding for much of what we do, understand the risks and uncertainties in evaluating producing properties.

The literature indicates an informal distinction between "risk"and "uncertainty." Although frequently used as synonyms, "risk,"for the most part, has been applied to exploration where there is a risk of complete failure or of some degree of success. There is the risk of drilling a dry hole vs. making a discovery of undetermined value. The term "uncertainty"is most frequently applied to properties already found to be productive but whose profitability cannot be quantified. The current unstable conditions in our industry point out that even though a property is productive, it can still result in a financial loss, and regardless of the term one uses, any technique that properly assesses the risk of acquiring a property vs. alternative investment opportunities is worth understanding. There is even the uncertainty of assigning uncertainty; most engineers, having no good quantitative idea of uncertainty, almost universally tend to understate it. By overstating the precision of their own knowledge, they contribute to decisions that may lead to financial disappointment.

The uncertainty associated with estimating the reserves and value of a hydrocarbon-producing property change with time (Fig. 1) and may be divided into three classifications: technical, economic, and political.