The Enigma of Oil and Gas Finding Costs
Authors: Davis Warren B. 
Published: December 2007

Two serious problems in determining unit finding costs of oil and gas are:

allocation of joint costs and determination of how much oil and gas has been found.

When proved reserves are corrected to total oil found by statistical manipulations of dubious reliability, they indicate a crude-oil finding cost growing from 10 cents-20 cents/bbl in 1940 to 60 cents - 70 cents/bbl by 1960, and a non-associated gas finding cost growing from 1 cents -2 cents/Mcf in 1940 to 6 cents - 7 cents/Mcf by 1960.

Introduction

Let me start out by making it clear what the title of this paper means. The American College Dictionary defines an enigma as "something puzzling or inexplicable," and I think this describes the cost of finding oil and natural gas. I cannot tell you what it costs to find oil and gas. There are only two things I can do. The first is to admit that I do not know exactly what it costs to find oil or gas, and I doubt if anybody else does either. The second is to attempt to describe the problems involved in trying to determine oil and gas finding costs and offer some examples of the approximations that we try to make.

A definition of the term "finding cost" is in order. By "finding cost," I mean only the expenditures on leases, geological and geophysical exploration, and wildcat well drilling. The drilling of field wells and equipping of leases and wells to produce comes under "development cost." Most of this paper refers to finding costs only, and excludes development and producing costs.

There are two distinct types of problems in determining the unit cost of finding oil and gas. One of these problems, and in my opinion the least serious of the two, is an accounting problem. We can determine with fair accuracy the total amount of money spent in searching for both oil and gas. Most of these costs are joint costs and their allocation between the oil found and the gas found is always arbitrary. These accounting problems have received much attention, and I intend only to touch on them briefly, and spend most of my time discussing the second difficulty — determining how much oil and gas we have found. Underground reserves of oil and gas are estimates — not facts. Some of them, such as API proved reserves, are reliable estimates; others, such as total oil discovered, are not reliable. In the year of discovery of an oil and gas field, when we are most interested in the total volume of oil that will be produced from it, competent and honest authorities may make reserve estimates differing by a factor of four. This uncertainty decreases as an oil or gas field is developed and produced, but it is many years before it is resolved. We never know exactly how much oil was found in any field until it is abandoned, and by then the information has little value.

THE PROBLEM OF ALLOCATION OF JOINT COSTS

Because the same type of exploration effort results in discovery of both oil and gas, nearly all exploration costs are joint costs. Since the two products involved, crude oil and natural gas, are both primarily fuels, this problem of joint costs would not be a significant one if these two fuels sold for about the same price per unit of energy at the wellhead. Unfortunately, this is not the case. In the U. S. in 1962 crude oil sold for an average of about 50 cents per million Btu's at the wellhead and gas for an average of about 15 cents per million Btu's. Gas supplied about 47 per cent of the petroleum energy, but provided only 22 per cent of the revenue to the producer. It is obvious that the allocation of joint costs between oil and gas on an energy basis will result in a different allocation than would the use of a wellhead value basis.