En Act

Chapter 1

• Upstream – activities that include exploration, acquisition, drilling, developing, and producing oil and gas

• Referred to as E&P (Exploration and Production)
• Everything up to the initial point that oil and gas is capable of being used or sold

• Downstream – activities that include refining, processing, marketing, and distribution
• Midstream – activities that include both upstream and downstream activities

• Fleischmann considers processing, marketing, and distribution (logistics) to be Midstream activities

• Integrated – a company that is involved with both upstream (E&P) and downstream activities
• Independent – a company that is primarily involved in only Upstream (E&P) activities

Characteristics of Upstream (E&P) activities:

• A high level of risk
• A long time before ROI
• Lack of correlation between the magnitude of expenditures and value of the resulting reserve
• High level of regulation
• Complex tax rules
• Unique cost-sharing agreements

Brief History

• Late 19th century – to meet the demand for kerosene for lamps
• Early 20th century – increased demand due to automobiles
• 1914-1940s – Increased demand due to WWI and WWII
• Post WWII – Demand for natural gas for home heating
• 1960 – OPEC formed
• 1973-74 – first Arab oil embargo
• 1975 – Energy Policy & Conservation Act – encourage energy conservation, reduce reliance on foreign oil, develop alternative sources
• 1977 – US importing 47% of its petroleum needs
• 1979 – Arab oil embargo II
• 1980 – Decontrol of oil prices
• 1985 – US importing 27% of its petroleum needs
• 1990 – Iraq invasion of Kuwait
• 2005 – US importing 60% of its oil
• 2011 – US became net exporter of petroleum products
• 2014 – US shale success driving worldwide supply glut, dropping prices. US #1 in natural gas production and #2 in oil production in the world.

• Hydrocarbons – organic compound made up entirely of hydrogen and carbon

• Majority are found naturally in crude (unrefined) oil, where decomposed organic matter provides an abundance of carbon and hydrogen.
• Can be…

• gases (methane and butane) – referred to as Natural Gas
• liquids (hexane and benzene) – referred to as Petroleum
• waxes
• solids
• polymers

• A primary energy source of civilizations.
• Predominant use is for combustible fuel [pic 1]
• The main ingredient for the world’s energy and heat sources

• Trap – impervious rock that prevents further movement of oil and gas
• Fault trap – a nonporous rock formation that has shifted stops the movement of oil and gas within an offsetting formation that allows petroleum to migrate
• Anticline – the folding of the earth’s crust into a dome

• Most of the earth’s oil and gas reserves are found in anticlines

• Salt Dome – due to substantial heat and pressure, salt buried deep within the earth starts to move upward causing the rock layers to crack, bend, and fold. Oil and gas are then trapped in these cracks, bends, and folds.
• Reservoir – a large accumulation of hydrocarbons

• There must be a sufficient quantity of hydrocarbons to justify the cost of producing oil and gas

• Porosity – is the measure of the pore space (the openings in a rock in which petroleum can exist)

• The greater the pore space the more fluid (petroleum) the rock can hold
• High porosity is often accompanied by high permeability

• Permeability – measures the “connect-ability” of the pores, which determines the ability of the petroleum to flow through the rock from one pore space to another.
• Fracturing – involves introducing sand mixed with water or oil in to the formation under high pressure to open or clean channels between the pores

• Method used to increase the flow from a “tight” formation

• Acidizing – involves introducing hydrochloric acid to into the formation to enlarge or reopen the channels between the pores

• Method used to increase the permeability of the formation

Conditions for a Reservoir:

1. A source of petroleum, i.e., remains of land and sea life
2. Conditions such as heat and pressure resulting in the transformation of the organic material in to petroleum
3. Porous and permeable rock  through which the petroleum was able to migrate after formation
4. An impervious rock formation that acts as a trap or cap rock, permitting petroleum to accumulate in substantial quantities

• G&G – Geological and Geophysical Techniques

• Geological Methods – rely on the identification of rocks and minerals on or near the surface and the understanding of the environments in which they were formed

• Such methods are aimed at gathering data about the surface features that can be used to make inferences regarding the potential existence of petroleum-bearing subsurface formations

• Aerial photography
• Satellite imaging
• Imaging radar
• Topography and geological mapping

• Geophysical Methods – involve subsurface studies which are aimed at locating and detecting the presence of subsurface structures and the determination of their size, shape, depth, and physical properties in order to identify the presence of certain physical characteristics that are indicative of oil and gas reservoirs

• Gravitational studies
• Magnetic and electromagnetic evaluation
• Seismic studies

• Seismology – provides detailed information about subsurface structures by recording the reflection of sound waves on subsurface formations

• 3-D seismic studies
• 4-D seismic studies – 3-D surveys over time (time-lapse) in order to monitor how certain reservoir properties (i.e., movement of fluids, temperature, and pressure) change in response to production

• Reconnaissance Survey – a G&G study covering a large or broad area
• Detailed Survey – a G&G study covering a smaller area, called an Area of Interest

• Usually performed after general reconnaissance studies indicate a formation where high potential for oil and gas accumulation exists.

• If an area of interest is identified by a detailed survey, it can be leased if available and not already leased

• Note: when a piece of land is purchased, one may acquire ownership of the surface rights only, the mineral rights only, or both rights

• Surface owner – has the right to use the surface in any legal way that the owner deems appropriate (i.e., farming, ranching, building a residence, building apartments)
• Mineral Rights (MR) – refers to the ownership, conveyed by deed, of any mineral beneath the surface

• If the minerals rights and surface rights are owned by different individuals, the surface owner must allow the mineral rights owner or the lessee, access to the surface area that is required to conduct E&P operations

• Fee Interest – ownership of both the surface and mineral rights

• Mineral Interest (MI) – an economic interest or ownership of the minerals-in-place, giving the owner the right to a share in the minerals produced either in-kind or in the proceeds from the sale of the minerals

• Sharing In-Kind – the company or individual has elected to receive the oil or gas itself rather than the proceeds from the sale of the minerals
• The united states is one of a few countries in the world that allow individual ownership of mineral rights

• Most mineral rights are owned by individuals therefore if a company wants to obtain a mineral interest, in the united states, they must typically do so by executing lease agreements with individuals

• Outside of the United States, Mineral rights reside with a governmental entity (e.g., a ministry of petroleum)

• If a company wants to obtain a mineral interest outside the United States they must contract with the relevant governmental authority.

• Royalty interest (RI) – created by leasing, the royalty interest is retained by the owner of the mineral rights when that owner enters into a lease agreements with another party

• Usually receives a specified portion (usually 1/8 for nongovernment leases) of the gross revenue from selling the production free and clear of any cost of E&P

• Unless otherwise stated in the contract

• Responsible for any severance or production taxes assessed on his share of the production of the property
• Commonly referred to as the non-operating interest or non-working interest

• The RI is not responsible for E&P; in most cases the working interest owner bears all the E&P costs
• Stated in terms of its share of gross revenue

• Working interest (WI) – created via leasing and is responsible for the exploration, development, and operation of a property

• Amount of revenue is what is left after deducting the share of royalty interest and other nonworking interests
• Stated in terms of how costs are to be shared
• Undivided interest – each company is responsible for 50% of the E&P cost and entitled to 50% of gross revenue net of the royalty interest (50% of 7/8 gross revenue)
• Divided interest – when 100% of the working interest of a portion of a lease are sold to another company(s).

• The two companies are therefore responsible for 100% of the working interest of their portions of the lease and are entitled to the gross revenue net of the royalty interest in their respective portions of the lease

• Joint Working interest – undivided working interest owned by tow or more parties

• Common in the industry
• Since less money is invested in any one property, companies are often able to invest in more properties
• One of the parties is designated as the operator and the rest of the working interest owners are called non-operators

• Operator – manages the day to day operations of the property
• Non-Operators – are only responsible for paying their proportionate share of the costs incurred
• Often call an E&P joint venture

•  Proportionate Consolidation – in a typical E&P joint venture, each working interest owner accounts for its own share of the costs
• Single entity

• Overriding Royalty Interest (ORI) – is a non-working interest created from the working interest

• Share of the revenue is a stated percentage of the share of revenue belonging to the working interest
• Owner of the ORI doesn’t pay E&P costs but is responsible for his share of any severance or production taxes
• Created either by being retained by the working interest owner when the working interest is sold or otherwise transferred, or by being carved out
• Carved out – when the WI owner sells or transfers the ORI and retains the WI

• Production Payment interest (PPI) – a non-working interest created out of a working interest and is similar to an ORI, except that a production payments  interest is limited to a specific amount of oil and gas, money, or time, after which it reverts back to the interest from which it was created and ceases to exist.

• Payable in money – payment is typically stated as a % of the working interest’s share of revenue
• Payable in product – typically stated as a % of the working interest’s share of current production
• Like ORIs, PPIs are created by carve-out or retention

• Net profits interest (NPI) – non-working interest is created on onshore property typically from the working interest

• This is the typical type interest that the government, as the MR owner, often retains when leasing an offshore block to a petroleum company
• Similar to an RI or ORI, except that the owner receives a specified % of the net profit from the property instead of gross revenue
• Created by retention or carve-out
• Not responsible for any losses incurred in property development and operations

• Pooled/Unitized working interest – created when the working and non-working interests in two or more properties are combined

• Interest owners own the same type of interest (but a smaller %) in the total combined property as they held previously in the separate property
• Pooled and unitization are used interchangeably, however the most common usage of each word is as follows

• Pooling – combing of undrilled acreage to form a drilling unit
• Unitization – a larger combination involving an entire producing field or reservoir for purposes of enhanced oil and gas recovery

• Landman – an individual who specializes in searching for and obtaining leases

• In many cases acts as an agent for an undisclosed principal in trying to obtain a lease at the lowest price possible

• Note: The Lessor is the MR owner who leases the property to the Lessee who receives the WI

Most lease contract contain the following provisions:

• Lease bonus – initial payment to the MR owner for the rights to E&P

• Payments are usually in dollar amounts per acre

• Royalty provision – specified fraction of the oil and gas production free and clear of an costs (expect severance taxes and certain cost related to marketing) to which the RI owner is entitled
• Primary term – initial terms of the lease; is the maximum time that the lessee has to begin drilling or commence production from the property

• The Lessee or WI usually has 1 year to start drilling
• The WI can make delay rental payments to keep the lease is drilling hasn’t started at the end of the primary term

• Delay rental payment – yearly payment made during the primary term in the absence of drilling( or production) in order to retain the lease
• Paid up lease – short term lease ( two- or three-year primary term)

• Require the lessee or WI to pay the delay rental at the inception of the lease
• After the primary term the lease can only be held by drilling or production

• Shut-in payments – payments made the lessee to hold the lease when a well is capable of producing oil but is shut-in (not producing)
• Right to assign interest – the rights of each party to assign in part or in whole without the approval of the other party
• Option payment – payment made to obtain a preleasing agreement that gives the oil company (lessee) a specified period of time to obtain the lease

• Also states –

• Lease form
• Royalty interest
• Bonus to be paid, etc.

• Offset clause – requires an offset well to be drilled if, for example, a well is drilled on lease B close to (but within a distance specified in the lease) the property line of lease A.

• The purpose of this offset well, built on Lease A, is to prevent the well in lease B from draining the entire reservoir, which stretches over both leases A and B

• Minimum royalty – a minimum payment made by the lessee to the lessor regardless of production
• Pooling provisions – if the working interest owner forms a pool or unit with other leases, the royalty interest and other nonworking interest owners may also be forced to combine their interest with nonworking interest owners of the other leases forming the unit

• Drilling contract – an agreement between the Lessee (WI) and a drilling contractor for the drilling of the well

• Day rate – payment based on the number of days drilled
• Footage rate – payment based on the number of feet drilled
• Turnkey basis payment of a fixed sum of money based on drilling to a certain depth or stage of completion

• Rigging up – when the drilling rig and related equipment move in and set up

• This is usually done after the initial 20 to 100 feet are drilled by a small truck-mounted rig
• When the rig is all set up the well is ready to be spudded in

• Spud date – date the rotary bit touches the ground
• Cutting – pieces of the formation that have been cut away
• Mud – drilling fluid that is constantly circulated down the wellbore

• Raises the cuttings
• Lubricates the drill bit
• Keeps formation fluids from entering the wellbore

• Mousehole connection – when a joint of drill pipe is added (approximately every 30 feet)
• Tripping out – removing drill pipe from the hole
• Tripping in – when the pipe is lowered back into the hole
• Stand – consists of 3 joints of drill pipe

• Removing and lowering drill pipe is usually done 3 joints, a stand, at a time

• Depends on the height of the derrick or mast

• Casing – steel pipe that is set (cemented) into the wellbore

• Prevents the wellbore from cave-ins
• Protects freshwater sands, etc.

• Directional well – a well that is drilled straight down and is then gradually curved or angled to reach the desired location
• Horizontal well – a well that is initially drilled vertically and is then gradually curved or angled to run parallel the earth’s surface
• Core sample – a piece of formation rock which is analyzed to determine if there is oil
• Logged – lowering a device to the bottom of the well and pulling it back up

• The device measures and records properties of the formation and the fluids residing in them
• A decision is made whether to complete the well or not

Completing a Well

1. Obtaining and installing production casing

1. Casing – concreting steel pipe into wellbore

1. Installing tubing

1. Tubing – steel pipe suspending in the wellbore through which oil and gas are produced

1. Perforating – setting off charges to create holes in the casing and cement so formation fluids can flow from the formation into the wellbore
2. Installing the Christmas tree

1. Christmas tree – valves and fittings controlling production at the well head that somewhat resemble a Christmas tree

1. Constructing production facilities and installing flow lines

1. Production facilities – separators, heater-treaters, tanks, etc.

• Note: plugging and abandoning a well would include removal of any equipment possible and cementing the wellbore to seal the hole
• Multiple completion – the well is capable of simultaneous production from multiple zones containing oil and gas
• Stratigraphic Test Well – well drilled fro information only

• Often drilled…

• in offshore areas where very little is known about the types and depths of the subsurface formations
• prior to the bidding process and paid for by multiple companies that agree to share the information.

• Exploratory well – wells drilled in an area not known to contain oil or gas

• drilled using mobile rigs, which are chosen based on the specific location

• Drilling and barges and ships – these are towed to location
• Jack-up drilling platform – the platforms are towed to the location and then the legs are lowered to the ocean floor.  The body is then jacked up high enough above the water level so as to clear the waves and proved a stable platform for drilling
• Submersible and semisubmersible drilling platforms – the platforms are towed to location, and then the pontoon-like legs are flooded with water for extra stability in the open ocean

• Ultra Deepwater -  the outer continental areas where the water depths are 1,500 meters or greater
• Primary recovery – recovery of oil and gas is either by natural reservoir drive or pumping
• Natural reservoir drive – when natural pressure exists in the reservoir which drives the oil and gas to the wellbore
• Secondary recovery – consists of inducing an artificial drive into the formation to replace the natural drive

• Water flooding – involves injecting water, under pressure, into the formation to drive the oil to the wellbore

• Most common method

• Tertiary recovery – enhanced recovery methods used to produced oil and gas

• Injection of chemicals, gas, or heat into the well to modify the fluid properties and thereby enhance the movement of the oil through the formation

• Run Ticket – the amount of oil transferred from the storage tanks is recorded on a run ticket

• The amount of payment for the oil is based upon information contained in the run ticket
• Gas settlement statement – used to record similar information for the production and sale of gas

• Maximum efficiency rate (MER) – the maximum rate at which oil or gas can be produced without damaging the reservoir’s natural energy

Chapter 2

• Four basic cost incurred by companies with oil and gas exploration and producing activities:

• Acquisition Costs – incurred in acquiring property, i.e., costs incurred in acquiring the rights to explore, drill, and produce oil and natural gas

• Oil, gas, and mineral lease

• Exploration Costs – incurred in exploring property, i.e., costs incurred in identifying areas that may warrant examination and examining specific areas including drilling exploratory wells
• Development Costs – incurred in preparing proved reserves for production, i.e., costs incurred to obtain access to proved reserves and to provide facilities for extracting, treating, gathering, and storing oil and gas
• Production Costs – incurred in lifting the oil and gas to the surface and in gathering, treating, and storing the oil and gas

• Reservoir – A porous and permeable underground formation containing a natural accumulation of producible oil and/or gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs
• Unproved Reserves – all reserves not satisfying the conditions for proved reserves
• Proved Reserves – those reserves that are…

• Reasonably certain to be recovered in the future
• From known reservoirs under existing economic and operating conditions, such as

• Current prices and costs
• Current technology

• Economic producibility supported by actual production or conclusive formation tests

• Proved Developed Reserves – reserves expected to be recovered through

• Existing wells with existing equipment and operating methods
• Improved recovery techniques, if

• Successful pilot project, or
• Successfully installed program

• Proved Undeveloped Reserve – reserves expected to be  recovered from either

• New wells drilled on undrilled acreage (must be offsetting productive units)
• Existing wells where a relatively major expenditure is required for recompletion
• Improved recover techniques, only if effective actual test in the same area and in the same reservoir

• Exploratory Well – a well drilled in an unproved area

• drilled for the purpose of discovering new proved reserves

• Development Well – an additional well that is drilled within the proved area, to the proved depth

• Drilled in a proved area for the purpose of producing proved undeveloped reserves

• New field wildcat well – the first well drilled in a location where there has been no previous drilling or production

• Drilled in new unproved areas
• Classified as an exploratory well  

• Delineation well – a well drilled along what the engineers believed to be the outer perimeter of the reservoir

• If drilled in an unproved area, it should be classified as an exploratory well
• If drilled in a proved area for the purpose of developing proved undeveloped reserves, the well should be classified as a development well

• Extension well – a well that is drilled to test whether a known, proved reservoir actually extends beyond what engineers had previously believed to be the outer reservoir perimeter

• Successful efforts treats exploration costs that do not directly find oil or gas as period expenses, and successful exploratory costs as capital expenditures

• Acquisition and development costs are capitalized and production costs are expensed

• Full cost, all exploration costs are capitalized

• Acquisition and development costs are capitalized and production costs are expensed

[pic 2]

Chapter 3

• Exploration costs are defined in Reg. S-X 4-10, par. 16 (pg. 75 of the book)

Principle types of exploration costs

• Nondrilling explorations costs {expensed as incurred SFAS No. 19}

• G&G costs (1)
• Cost of carrying and retaining undeveloped properties (2)
• Dry hole contributions and bottom hole contributions (3)

• Drilling exploration costs

• Costs of drilling and equipping exploratory wells (4)
• Costs of drilling exploratory-type stratigraphic test wells (5)

• G&G costs – purpose: to locate or identify areas with the potential of producing oil and/or gas in commercial quantities Def.: chapter 1

• Surface and subsurface techniques are used

• Reconnaissance survey – G&G study covering a large or broad area
• Detailed survey – G&G study covering a smaller area

• Sometimes a result of of a reconnaissance survey

• Shooting rights – the right to access the surface property after obtaining the mineral lease

• Obtained from the property owner
• Pay a fee for the rights
• Typically the rights are coupled with the option to sale
• Surface owner should be compensated with rent and any damages done to the property

Common carrying and retaining costs

• Delay rentals
• Property rentals
• Legal costs for title defense
• Clerical and record-keeping costs

• Test-well contribution – when one company (A) drills a well and another company (B), that owns the WI in a nearby acreage, agrees to pay the company (A) drilling for certain G&G information

Basic types of test well contributions

• Dry-hole contribution – payment is made only if the well is dry or not commercially producible
• Bottom-hole contribution – payment is made when an agreed-upon depth is reached, regardless of the outcome of the well