Basic Economics of Oil Well

Mark S. McGrew

Photo: Basic Economics of Oil Well

Exxon reported earnings of $40 billion last year. They produce 2.6 million barrels of oil per day (BOPD), with 7 billion barrels in reserve. They produce about 1 billion barrels per year, with an after expense earning of approximately $40 per barrel.

An average oil well in the United States of America, excluding Alaska and Hawaii, produces about 20 BOPD. Some wells produce in the thousands of BOPD.

A small well, of 20 BOPD may cost $500,000 to drill. 20 BOPD selling at $100 produces an income of $720,000 per year. Costs to produce that oil must be taken out. Costs to produce can be royalty payments to the owner of the land, getting the oil to a refinery, taxes, maintenance and miscellaneous other fees. By subtracting these costs, we can assume that the oil is only going to produce an income of 75% of the market price of oil. Maybe less in some cases.

Suppose, the income to the producer of that oil is $75 per barrel, which would be $540,000 a year. That small well will produce for 7 to 15 years, and actually starts declining in the middle of the term until it eventually stops producing.

From the $540,000 per year, the producer pays back the investors who paid to make that well. The investors will get 75% of the revenue, or $400,000 and the producer will end up with $140,000 per year for a few years, until the well starts to decline. The investors get back their money in a little more than a year. That is an “average” well.

Suppose we want to do better than average. We need to spend more money for geology, more money for land and more money to drill. A conservative example would be that we are going to spend $4 million, hoping to find 300 BOPD.

There is NEVER a guarantee that you will produce oil. It matters not what anybody says, you will never know if the oil is in the spot you chose to drill, until the oil actually comes flowing up and out. A well can be drilled into a proven producing field and the driller can still make a mistake, or a miscalculation and you end up with nothing. The best geologists in the world make dry holes some times. The biggest companies on Earth, make dry holes sometimes.

In the early 1980s a huge structure, in the Arctic Ocean, north of Alaska, USA was drilled. After spending $2 billion they discovered salt water. This was the Mukluk.

Anyone who guarantees that “the oil is there” is either stupid or lying.

Let’s take a chance with $4 million. We buy the land, pay the geologists, drill the well and we hit a 300 BOPD well that will produce for 10 to 15 years.

Using the formulas above, we sell the oil for $75 a barrel, giving us $8 million a year. The investor gets 75% of that, or $6 Million a year and has his money back in a year. The producer earns $2 million a year and can buy himself a new car, every two weeks.

Now we’re making money! Money is a weapon.

Now we can hunt for bigger game and instead of hunting rabbits or deer, we can go out for an elephant, something that can feed the whole village for a long time.

Many people who live there, call it God’s country. Alaska. The last frontier. Where the cold wind blows and the timid don’t go. Home of Mukluk.

We spend $7 million and get land, geology, equipment and drill in the Cook Inlet of Alaska, and like others before us, we get lucky and hit what would be an “average” oil well in Cook Inlet.

1,000 BOPD. Now, we’re not only making money, we’re having fun doing it.

1,000 BOPD, selling for a net price of $75, pays the investors $20 million a year. And one of the fun parts is, this well won’t die in five years, or fifteen. It will reach old age in 20 years or more and still produce as it gradually slows down.

The producer’s 25% will make him $6 million a year. Now if he wants a new car, he can just take one off the lot of the new car dealership he is going to buy.

And the oil pool he hit is big enough to drill ten more wells, and maybe he only gets oil from five of them. He will make $30 million a year, have a problem spending it all, and as most Americans do when they make a lot of money, he will donate large sums to a charity. Now, not only is he making enough money for his own family and his future generations, he is contributing to the lives of many unfortunate people, some of whom, will grow up and do the same thing he did. Americans are the most charitable people on Earth. That is a fact of life.

And if he is smart, and lucky, he brought his investors to a site that holds One BILLION barrels of oil. And if so, this producer and his investors are now 1/6 the size of Exxon in oil reserves.

Fields on the Kenai Peninsula and offshore in the Cook Inlet have produced a cumulative total of 1.2 billion barrels of crude oil and 5.6 trillion cubic feet of natural gas. How much is left in those known fields and how much more is there yet to be discovered?

From conception to production, that level can be reached in less than ten years.

But, our producer friend is not happy. He enjoys the game too much to retire. He wants more thrill, more excitement and more oil. He has enough money and talent that he can go anywhere in the world and play with his friends. But he caught a rare disease: The Alaska Bug.

There is only one cure and that is on the North Slope of Alaska, where the polar bears roam, above the Arctic Circle.

An average well is 3,000 BOPD and some have come in at 10,000 BOPD and more.

He buys land, equipment, brains, and rough tough rock hard men who enjoy the life or death excitement of six months of daylight and six months of darkness in one of the most hostile environments on Earth. They thrive in the Arctic!

He decides to drill 20 oil wells and hits on the first one. 2,000 BOPD. He has committed to spending $10 million on each well. Two Hundred Million Dollars.

That 2,000 BOPD well will pay his investors back their entire $200 million in five years. It will earn him $13 million a year for 30 years or more.

The next 19 wells come in at an average of 2,000 BOPD. It’s no longer rocket science. They found three 300 million barrel oil fields and now are 1/3 the size of Exxon. It will take ten to twenty years. But it took Exxon over 100 years to get where they are today.

The investors will make $810 MILLION a year for 30 years, or more. $25 billion from a $200 million risk. The producer will make $8 Billion over the life of the wells, if he lives that long.

The investors and the producer set up a Trust Fund for 20% of their earnings to go to various charities, with 80% of that being paid out each year. $160 million can buy a lot of medicine, clothes, housing, education, or legal fees to fight oppression etc. etc.

And that is one more reason why we call Alaska, “God’s Country”.

The above scenarios have been accomplished in Cook Inlet by several companies. The North Slope scenario has been performed by Robert Anderson of Arco discovering 20 billion barrels on the North Slope and a new player in town is Pioneer Natural Resources from Texas.

Pioneer has a 50 well program to spend $500 million and on June 9th of 2008, their first producing well came in at 2,000 to 3,000 BOPD. Their entire investment is secured.

There is indeed a trap in the Cook Inlet that may hold 1.5 billion barrels of oil.

The men, the situations, the production and the charitable scenarios have already happened and can happen again. The North Slope has produced over 15 billion barrels and still has at the least, another proven 13 billion barrels in the ground, just in the Prudhoe Bay field.

Mark McGrew