Basic Economics of Oil Well
Mark S. McGrew
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.