Question

A company is considering drilling a development well. Wellsite preparation, drilling and testing of the well is expected to cost $2.2 million. Completion of the well and the field equipment necessary to get the well ready for production (wellhead, tubing, flowline, etc.) would cost $1.4 million. Company geologists have suggested that there is a 20% probability that the well will be dry. If that is the case, abandonment and reclamation costs would be $150,000. In the event the well is successful (80% probability), it is anticipated that it would have an initial production rate of 80 barrels/day with production declining by 17% per year and an economic life of 13 years. A $150,000 abandonment and reclamation cost would have to be incurred at the end of the well’s economic life. Operating costs are expected to be $250,000 per year. Oil prices in the first year of production are expected to be $70/barrel and are expected to rise by 2% annually thereafter. Given a marginal opportunity cost of investment for the company of 18%, use the expected monetary value (EMV) criterion to determine whether this well should be drilled. Assume all capital costs occur in the present period (time 0) and production and operating costs begin in year 1.

Answer 1

Answer:

Conclusion: Since net EMV is positive ($147,015 - refer below tables' calculation) hence, project is economically viable and company should drill the well.

We have made following assumptions/changes:

• bbl = barrel, m = million
• Number of operating days in a year. Generally Oil companies have some maintenance period, hence the yearly production has not been calculated by using 365 days instead only 360 days in a year ( 1^st year- 80*360 = 28,800bbl and so on).
• Have converted all the numbers in $ rather in ($ millions) e.g $2.2m to $2,200,000.
• In scenario 2 numbers in red highlights show initial costs (3.6m) and abandonment and reclamation cost(0.15m).