Society of Petroleum Engineers 6200 North Central Expressway Dallas, Texas 75206

THIS PAPER IS SUBJECT TO CORRECTION

American Institute of Mining, Metallurgical, and Petroleum Engineers, Inc.

Introduction

The purpose of the drilling program is to raise venture capital for exploration and, to a lesser extent, development activities of petroleum producers. As a financing form, petroleum producers. As a financing form, although not entirely unique, it is particularly well adapted to the petroleum industry. The programs are able to capitalize on -the various features of the industry to provide an investment package that is attractive to (wealthy) outside investors.

Drilling programs are joint ventures, usually organized as limited partnerships, which permit petroleum operators and outside investors to participate in petroleum exploration and development. The operator assumes the role of general partner with the outside investors becoming limited partners. One feature of these programs is that they permit the pass-through to the outside investor of any tax benefits of the venture. Although this is the feature that receives the most attention, it is not the main purpose of these programs.

To the operator, the drilling program form of financing provides an additional degree of flexibility that is not available through more traditional financing sources. By taking advantage of this flexibility, the petroleum operator can not only obtain the needed financing, but can also receive other benefits.

Goals such as meeting current cash needs and providing continued support of the technical operations of the petroleum operator are also met by drilling programs. However, the target of this paper is to concentrate on the effects on the operator's risk/return position. It is aimed at showing how specific features of drilling programs provide the means of achieving satisfactory risk/return levels for the operator. It also is intended to point out particular risk/return characteristics that particular risk/return characteristics that would be unacceptable to the operator.

STANDARD FINANCIAL THEORY

Standard financial theory basically assumes that sources of funds employed by a firm can be classified as either equity or debt. Although this theory recognizes that variations of debt and equity exist, the analytical approach generally applied is to convert these "nonstandard" forms of financing into an equivalent debt or equity amount.

The use of fixed return securities, i.e., debt or its equivalent, results in the creation of "financial leverage." Just as a fulcrum is present when leverage is considered in present when leverage is considered in mechanics, the fulcrum involved with financial leverage is the fixed, after tax, payment required on these securities.

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