Oil & Gas Financial Journal: “Great Basin Elephant Hunt: The Great Basin Shales are not just as orginically rich as other shales, they are many times thicker”

Date of Source: 18 Jan 2017

Summary:
The Great Basin, which underlies most of Nevada and large swaths of the American Southwest, could become host to the next great North American hydrocarbon province. Although production from the Great Basin slipped to a mere 313,000 BOE in 2014 (from its peak of 4.01 MMBOE in 1990), the region is still largely unexplored. Geologist Alan K. Chamberlain believes that there are potentially hundreds of billions still left in geological formations underlying the Great Basin. […]

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Drilling for Value, Pt. 4: The Economics of Petroleum Exploration and Production

Note: this post has been heavily redacted since its original data of publication in order to expand on the fundamentals of petroleum geology and the upstream business elsewhere. 

Summary

  • Economic models use assumptions which simplify the effects of accounting, taxes, regulations, and other minutiae in order to glean insights into the drivers of market behavior and value.
  • The effects depletion and commoditization, relatively low cash costs, and often prohibitive resource replacement costs drive the endemically cyclical petroleum investment cycle
  • Petroleum economics are strongly levered to petroleum prices and other extrinsic factors.
  • Maintaining a sufficiently low cost of supply is the primary operational lever capable of creating long-term investment value in the upstream business.
  • Timings of costs are a key consideration for evaluating investment decisions — known discount rates simplify decisions regarding timing preferences.

Figure 1: Pecos, Texas Oilfield
February-22-Hogue-1937-Pecos-AOGHS
Source: Alexander Hogue. Pecos, Texas Oilfield. 1937

The Economics of the Upstream Petroleum Industry
The economics of the petroleum extraction is overwhelmingly colored by the economic factors of depletion and commoditization. Due to the fact that production depletes limited natural resources, the upstream industry must constantly explore for and develop additional resources. Given that the capital investments required to replace depleted resources are usually quite significant in relation to operating costs, resource replacement is a primary driver of costs. Commoditization describes the lack of differentiation in upstream business models and their end products. As a direct result of commoditization, the value propositions of upstream businesses are strongly levered to external market conditions (i.e., namely prices). Taken together, high replacement costs and supplier susceptibility to external market conditions have resulted in endemically cyclical petroleum supplies and prices.

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Drilling for Value, Pt 3: The Fundamentals of Upstream Investing

Author’s note: Content on the geological considerations of petroleum resource management was redacted and re-posted elsewhere in order to expand more on the resource fundamentals there and the business fundamentals here.

  • The upstream business cycle can be sub-divided into five functional areas: Exploration and Evaluation, Development, Production, Marketing, and Retirement.
  • The exploration and evaluation functional area creates potential value by discovering quantities of petroleum and reducing geological uncertainty.
  • The remaining business functional areas realize geological value potential by adhering to more closely to the cost-centric logic of conventional value chain analysis.
  • Integration between business units maximizes the value potential of an exploration and production concern.
  • Markets for upstream assets are minimally inefficient; retail investors must think outside the box if they hope to compete with sophisticated and well-capitalized institutions.

Figure 1: Coyote Hills, California

Source: Coyote Hills, California. Lee Alban Fine Art.

Different petroleum exploration and production (E&P) businesses operate differently depending on their focuses and asset bases. Major differences can also be observed between various operators within a single basin. However, their business models are all strikingly similar: get oil and gas out the ground and sell it to the highest bidder. A generalized upstream business model has five functional activities: exploration and evaluation (E&E); development; production; marketing; and retirement. The E&E function essentially drives the process of identifying opportunities for potential value creation — it also broadly includes the evaluation of assets for acquisitions and divestitures (A&D). The remainder of the business functional areas support the exploitation of this value potential. In this way, the exploration functions abide by the principles value configuration theory 1, whereas the production abides by conventional industrial logic according to Michael Porter’s value chain framework.

It is notable that an upstream operating concern which is rationally integrated into a larger petroleum value chain does not need to be particularly good at either activity in order to create value.

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Footnotes   [ + ]

1. Roberta Olmstead. Competitive advantage in petroleum exploration. Oil and Gas Journal. 23 April 2001

Drilling for Value, Pt 2: Fundamentals of Petroleum Resource Management

Author’s note: this article has been heavily redacted since its original publish date. Content on the upstream business was redacted and re-posted elsewhere in order to expand more on the business fundamentals there and the resource fundamentals here.

Summary

  • The previous installment established that cost-of-supply is the overwhelming driver of petroleum exploration and production value.
  • The geological processes which resulted in the accumulation of hydrocarbons and resulted in the formation of petroleum reservoirs strongly influence the quantities of recoverable resources and their production characteristics.
  • Additionally, geology is a key determinant of cost, and therefore also a key driver of upstream value.
  • A grasp of geological concepts facilitates the interpretation of language within company disclosures — ultimately helping investors identify instances where value and price diverge.

Figure 1: A Different Kind of LeaseA Different Kind of Lease
Source: Art and Framing Plus

Overview
Part 1 of this series broadly addressed the fundamentals of the broader petroleum value chain, especially from an investor’s perspective. This installment deep dives on the fundamentals of economic geology (i.e., petroleum resource management) in order to impart a holistic view of geological and technical factors governing petroleum recovery. Since cost-of-supply is the overwhelming driver of value in the upstream oil and gas business, and geology is often the overwhelming factor underlying cost, a basic understanding of petroleum geology is necessary to fully grasp the economic drivers. Topics include petroleum geology, petroleum geography, resource classification, petroleum recovery, and the fundamentals of resource quantity and production estimation. Following installments will leverage this knowledge to address the business fundamental of exploration and production, and subsequently the economics of the upstream business. At a later point, these foundations in petroleum geology, business fundamentals, and economics will help us maximize the utility of financial reports and unravel accounting minutiae.

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