1962 Economic and Valution Symposium, Dallas, March 15–16, 1962

Introduction

It is obvious that the value of producing oil and gas properties is that sum of money, securities, notes, property or other legal considerations which a seller is willing to accept and a buyer is willing to pay for any particular piece of property. Such a definition reads nicely in text books and has been quoted in innumerable high-sounding speeches before all sorts of august bodies such as this. The truth is, that such a definition is of no value whatsoever to anyone. This type of evaluation has been going on for centuries from the earliest days of recorded history. It means little more than haggling for a bargain in the market place.

In the oil business, however, and particularly in the Southwest, during the first half of the century certain rules of thumb seemed to be the basis for most negotiations. From these rather rough parameters established by experience, most deals were eventually negotiated by hardheaded trading but at least they provided a basis for initial discussions. For example on the West Coast in California, people have thought for years of the value of producing properties as being around $2,000/daily net bbl of production. During the boom days of Signal Hill and the great expansion of the oil industry in California during the 1920's, this figure was higher. During the depression it became somewhat lower but, paradoxically enough, even today people are still talking in terms of $2,000/daily net bbl.

"RULE OF THUMB"

The most widespread "rule of thumb" utilized in the Mid-Continent since World War II has been $l/ bbl. As the allowable picture in Texas began to deteriorate and until Oklahoma and a few other states began to catch up with rigorous control maintained in Texas, this figure crept up in states other than in Texas to around $1.25/bbl.

Now any intelligent engineer with just a modicum of high school economics can readily recognize that such a rule of thumb is truly meaningless. It is abundantly apparent that oil selling for $1.40/bbl at the wellhead is not worth as much as oil selling for $3.30 at the wellhead. It is also obvious that a barrel of oil available after lifting costs next month some time at a figure of $1/bbl, is worth as much as that same barrel delivered one year hence at, say, $1.06 or in two years at $1.12. This is a mere function of the discount factor and reflects only the cost of money. Thus, it is stupid to assume that oil to be produced 40 years from now out of the East Texas field at, say, $3/bbl is worth anything like a similar barrel of oil to be produced from the same property next year. This is an economic platitude and hardly justifies comment but, the truth of the matter is that many a deal has been made on just that theory by someone broadly assuming that the high priced oil to be produced in the early years will average out against the low present worth of the oil to be produced 30 to 40 years down the road.

Oklahoma and Arkansas witnessed many a transaction soley on the basis of rate of payout. A three year payout was long considered reasonably good and a five-year payout rather long. This condition obtained right down until recent times. There is also evidence of the same yardstick being used in Kansas. Such an approach, of course, gave little credence, if any, to the future reserves, rate of decline, etc., and absolutely no consideration to the specific lifting costs and such dreamy possibilities as secondary recovery. Frequently prospective purchasers would calculate that the sale of casinghead gas, if he could find some place to get rid of it instead of flaring it, might offset his operating costs. Also, frequently, no one ever bothered to calculate the burden of severance or ad valorem taxes.

Many great fortunes were made and lost in buying and selling of properties using no more than some of the rough rules of thumb just mentioned. But along in the 30s some people in the industry began to suspect that engineers were capable of doing something more than merely completing a well or interpreting well logs.

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