Values and Costs of Oil Reserves
Authors: Lohrenz J. , Pederson J.A. 
Published: December 2007

Summary
Oil and gas properties should be evaluated by the distinguishing of searchable, developable, and producible reserve values. Petroleum engineers represent one discipline involved in such evaluations. The varying impacts of mainstream petroleum engineering contributions to these different evaluations are examined.

Introduction
Assigning costs, prices, and values for properties with oil and gas reserves requires the merging of expertise from multiple disciplines. Petroleum engineering is one of the disciplines involved. Geology, geophysics, and economics are others. Our purpose is to present a perspective for petroleum engineers in property evaluation. Properties have searchable, developable, or producible reserve values. Each kind of reserve has a different involvement with petroleum engineering practice. The term "searchable" is applied to reserves purposely. The traditional usage would be "exploration." To many, "exploration" implies a process that adheres to a priori expectations quite well. "Searching" implies a process of hunting for something that may not be found process of hunting for something that may not be found or may not exist. If something is found, it may not be what the hunter was after.
A simple model of the sequence of searching for developing, and operating oil production is structured in the next section. Searchable, developable, and producible reserve values, as well as a cost of finding and a cost of finding and development, are defined mathematically. Values and costs are computed for three base cases that represent current properties. A key finding is that higher costs do not necessarily imply lower reserve values. The sensitivity of contributions from petroleum engineering and other disciplines is also studied. Estimates of future oil prices and their effect on reserve values are demonstrated. The relevant question treated is this: If the oil price is higher or lower, which costs change and when? Alternative answers to that question lead to a recommended answer for assessing reserve values. The overwhelming effect on searchable values of the probability of geological success and, given success, the probability of geological success and, given success, the amount of recoverable reserves found is shown. This leads to a reasonable explanation for what some might consider unreasonably large disagreements between bonus bidders for oil and gas leases.
Searchable, Developable, and Producible Values Producible Values Consider the costs and values that arise in the sequence of searching for, developing, and producing oil. All costs and values are measured as present values appropriately discounted.
The cost incurred in a search is
(1)
BXB is the tax-adjusted present value of bonus paid at time t=0; EXE is the exploration cost collected at t=tE, The cost of any development is
(2)
where development costs are aggregated at t=tD. The costs derived by Eqs. 1 and 2 can only be recouped by production having a positive net value starting at t=ti and terminating at t= ti + delta . With a constant rate of production, the producible value is production, the producible value is (3)
Eqs. 2 and 3, including the value maximizing solution for delta, have been previously justified and treated in detail. Here, Eq. 1 incorporating the search costs has been appended. The model leads to searchable, developable, and producible values. Each search incurs the cost given by Eq.
producible values. Each search incurs the cost given by Eq.
With probability PS, geological success occurs. A recoverable reserve amount, Q &gt;0, is found. With probability (1 - Ps), Q = 0, and the search, a geological probability (1 - Ps), Q = 0, and the search, a geological failure, ceases. If Q is sufficient that, with maximization of postexploration values, future values are positive, then and only then the geological success is developed and produced. In other words, if Eq. 3 is not greater than Eq. produced. In other words, if Eq. 3 is not greater than Eq. 2 with Q &gt;0, the field found is not developed. There are really four distinct outcomes possible from any search:geological failure (Q = 0);geological success with an amount found insufficient to develop;geological success with an amount found sufficient to develop but not compensatory for search costs; andgeological success with an amount found sufficient to develop and more than compensatory for search costs.
The last three outcomes are all geological success; only the last outcome is an economic success. The probability of an economically successful search, PES, is always less than the probability of a geologically successful search, PS. PS. With a geological success, a positive amount, Q, is sampled from a log normal distribution of median size, RG, and variance, .
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