Oil and Gas - Two Industries in One
Authors: Emerson John D. , Hammar Harold D. 
Published: December 2007

Introduction

This paper presents some information on a program that we have developed and have continued to refine concerning data for use in evaluating the petroleum industry.

In any business venture requiring money to be invested, an element of risk is always present. The risk is that the capital committed may be lost, or that the income produced by the capital may not be as high as could be obtained from an alternative investment. Thus, it has become normal practice to conduct continuous efforts to quantify relative risk and rate of return. This practice is much in evidence in the petroleum industry, particularly when acquisitions are contemplated. Similar considerations also apply to the business of exploring for and developing new reserves of oil and gas. The principal difference is that instead of one investment, we are looking at a series of investments. If we invest X million dollars in the course of Y years, what will the results be in terms of profitability? profitability? The answer, of course, could be anything. Exploring for and developing oil and gas is a gamble. But it is not a gamble like roulette, or craps, or flipping a coin, where the odds are always calculable and constant. To some extent the players choose their own odds, depending upon players choose their own odds, depending upon their different objectives and the way they play. Since they are really in two games the "oil" game and the "gas" game, it would be helpful to them to know whether the odds are the same in both games.

And petroleum is so important to the nation's economic growth that an effort should be made to determine whether the rules under which the game is currently played are serving the long-term needs of consumers in this country. After all, the odds must be right if the gambler is to be induced to play. We have been told by many that we face play. We have been told by many that we face shortages of oil and natural gas. The gas shortages have been better publicized, and a great amount of effort is currently being expended in the search for ways to increase our gas supply.

The key to the supply problem appears to be the rate of additions to proved reserves of gas. It is highly probable that, if more money were invested in the search, more reserves would be found. And if more reserves are found, producibility can be increased. The first step in examining this question is to determine how much capital has been invested in the past, and how much currently is being invested in exploring for gas. We have a good idea of how much is invested each year in the search for oil and gas together. But how much can be attributed to oil and how much to gas? And the second step will be to explore the indicated results of these investments.

We will view the petroleum exploration and development industry as two separate businesses carded on by the same company. The "Oil business" is concerned with the discovery and production of crude oil as the main product and production of crude oil as the main product and with associated natural gas and gas liquids as the by-products. Conversely, nonassociated natural gas is the principal product involved in the "gas business", with nonassociated gas liquids and lease condensate as by-products. Each of these products has economic value to the producer; each products has economic value to the producer; each involves him in costs, and each contributes to the return on his investment and, subsequently, to the funds available for reinvestment.

EXPLORATION AND DEVELOPMENT EXPENDITURES

We have not attempted to allocate investment funds between oil and natural gas, but between the "oil business" and the "gas business", and the two situations are not identical. Rather than use an arbitrary formula, either involving Btu's or relative price which, in themselves, are not cost factors, price which, in themselves, are not cost factors, we have taken each of the areas of specific direct cost and have allocated expenditures to the oil business or the gas business in a way that we feel satisfies the test of logic. We do not claim that it would necessarily satisfy a panel of lawyers representing a public service commission.

Separate data on reserves, production, and price have been available for some time, but up to now investment has been the missing step in making rate-of-return calculations for the two businesses.

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