Recoverable Reserves Are Affected by Oil and Gas Prices
Authors: Garb Forrest A. , Gruy Henry J. , Herron E. Hunter 
Published: December 2007

Analysis of performance curves for stripper-oil production before and after the lifting of stripper price ceilings in 1974 indicates production is currently 270,000 B/D higher than the level that would be projected if prices had not increased. By analogy, the deregulation of domestic oil prices should result in over 420,000 B/D of additional lower-tier production by 1985.

Introduction

The energy crisis has sparked the controversy as to whether the price of oil has any effect on the U.S.'s oil reserve. The nonoil public and, unfortunately, many lawmakers have taken the position that the oil and gas industry is rich and the only function of any price increase is to increase the "obscene" profits.

With domestic production exhibiting a declining trend, it remains an uphill battle to educate the public and government that price increases tend to arrest this production decline. Higher prices increase production by allowing the industry to operate marginal wells to lower production levels and by allowing the development of marginally economic reservoirs. Higher prices also allow enhanced recovery processes to be applied to fields which otherwise would be uneconomical. Higher prices allow higher risk prospects to be drilled without causing the exploring company to face "gambler's ruin" and allow deeper and more costly frontier area prospects to be explored. Without adequate economic return, smaller structures and thinner pay zones will remain undrilled. In addition, higher prices for oil and gas allow competitive energy sources to compete for certain ortions of the market, thus reducing some of the pressures on traditional hydrocarbon supplies.

The public, including media reporters, generally is not knowledgeable in petroleum economics, accounting methods, and financial evaluation. It is easy for the uninformed to believe that if a company reports a profit of "X" dollars, it has that amount in hand to either invest in new business or pay out as dividends. It seldom is realized that a large portion of expenditures is for items that must, by law, be capitalized and charged off on a unit-of-production basis, so that the entire expenditure is not subtracted from income until field abandonment. Moreover, the public does not understand that earnings can reflect costs of materials and depreciable assets that are grossly understated compared with their replacement cost. Thus, profits alone are not a sufficient indicator of a company's ability to maintain its operations.

Analysis of cash flow, rather than book profit, is necessary to determine whether a business is capable of sustaining itself, let alone growing. Cash generation from operations is the underlying determinant of a company's ability to invest in future operations. Cash generation is calculated as the sum of net income and noncash charges (principally depreciation) deducted in determining that net income. Cash-flow analysis relates the generated operating funds to the working capital, the fixed asset requirements of the continuing business, the capital requirements of new business ventures, and financial sources and uses including dividends. Since the flow of funds from operations reflects historical costs, rather than inflated replacement costs, earnings may need to be invested totally just in the maintenance of the current business.