Chapter 41
Valuation of Oil and Gas Reserves
Forrest A. Garb, H.J. GJII~& Ass,ocs
*
Timothy A. Larson, Ernst& Whitney
Types of Oil and Gas Property Ownership
The most common types of oil and gas property owner-
ship in the U.S. ’ are mineral interests, working interests,
royalties, overriding royalties. net-profits interests. and
production payments.
A mineral interest in a property is a part of the “fee
simple ” interest. In most states, the mineral interest can
be severed from the surface interest and transferred by
a mineral deed (in Louisiana, the mineral and surface in-
terest cannot be severed in perpetuity). The owner of the
minerals, either through fee simple title or by a mineral
deed, can exccutc a lease of the oil and gas rights. Con-
sideration paid for a lease is called a lease bonus. During
the primary term of the lease, it can be held by paying
rentals. production, or drilling activities. The rentals,
usually called delay rentals, are paid in lieu of drilling
or production. From an income-tax standpoint, these rent-
als are ordinary income to the lessor and arc deductible
by the lessee. For tax purposes, a bonus must be capital-
ized as a part of the cost of the lease by the lessee. This
bonus is income that is subject to depletion for the mineral-
interest owner; although if the lease is not eventually
productive, the depletion taken must be restored to in-
come in the year the lcase is proved worthless.
A “royalty” or “royalty interest” is the mineral own-
er‘s share of production free of the cxpcnse of produc-
tion. It is distinguished from a mineral interest by the
absence of operating rights. The basic royalty interest
usually is expressed as a fraction of the total production,
such as g of %. !&of %. Royalty has historically been
subject to production taxes. federal excise taxes [Wind-
fall Profits Tax (WPT)], and in some states, old ~~lore~t
taxes.
An “overriding royalty interest” is an interest in oil
and gas produced free of the expense of production and
in addition to the usual landowner’s royalty. It continues
for the life of the lease and is sub,ject to production taxes.
WPT taxes, and in some states. ud ~~7lowr77 taxes. An
‘Author of the arlglnal chapter was Jan J Arps (deceased)
overriding royalty interest is commonly expressed as a
fraction of the revenue accruing to the working interest;
for example, ‘/8of 7/, of the total oil and gas produced.
In some areas, such as the Rocky Mountains, overrid-
ing royalties are often expressed as a percentage of % of
the total oil and gas produced.
A ‘*net-profits interest” is a share of the gross produc-
tion measured by the lessee’s net profits from the opera-
tion of a specific tract of land. It is normally carved out
of the working interest.
A “carried interest” is a fractional interest in an oil
and gas property that gives the owner no personal obli-
gation for operating or development costs. The opera-
ing or development costs attributable to such fractional
interest are borne and paid by the owners of the remain-
ing fractional working interest, who recoup such expen-
ditures or an agreed sum out of production from the
property.
A “production payment” is a share of the oil, gas, and
other minerals produced from a tract of land, free of the
cost of production, that terminates when a specific sum
from the sale of the oil, gas, and other minerals has been
realized by the owner of the interest. There is no personal
liability to pay the sum specified in the instrument creat-
ing the production payment: the owner looks only to pro-
duction from the tract of land for the sum specified. A
production payment is usually expressed in dollars and
may carry an incremental payment computed in the man-
ner of interest. A production payment is said to be “carved
out” when it is transferred out of another oil and gas in-
terest. It is “reserved” when the interest is retained by
the seller upon the sale of another oil and gas interest.
Production payments limited to oil or gas only are called
“oil payment” or “gas payment,” respectively.
A reversionary interest is usually a portion of the work-
ing interest that reverts to another party on the occurrence
of some defined event. This event is often the payout of
the investment or some multiple of the investment or may
bc the passing of some defined time period.
41-2
TABLE 41.1--REVENUE
A owns: l/sof B/eless ‘/aof I/*of Ve less ‘/aof J/sof a/8, or s/s4(of*/8)or
~OWnS:‘/40f1/gOf8/or1,&(of8/g)or ,..,,
DOwnS:1/gOf1/80f8/g0r1/6~(Of8/g)Or
All or any part of each of these oil and gas interests
may be purchased, sold, or mortgaged at the owner’s
election.
Each economic interest in a property represents the right
to a certain fraction of the gross income from the sales
of oil and gas [revenue-interest fraction (RI)], and an ob-
ligation to pay a certain fraction of the cost of production
[workinginterest fraction (WI)]. In the case of royalty
interests, overriding royalty interests, carried interests,
and production payments. the WI is zero because these
interests are free of the cost of production.
A “working interest” is the lessee’s or operating in-
terest under an oil and gas lease. The typical oil and gas
lease provides for a royalty to be paid to the lessor or other
royalty owners, free of the expenses of production; the
balance of the production represents the working interest
of the lessee, and this part of the production bears the en-
tire expense of production. The working interest created
by an oil and gas lease may be further divided by the cre-
ation of overriding royalties, production payments, net-
profits interests. and carried working interests. When
there is one lessee under an oil and gas lease, he must
pay the entire cost of production and his WI is 100%.
Where two or more lessees jointly own a lease, the WI
of each lessee when totaled should add up to 100% of the
working interest under such lease. The various co-owners
of such a lease normally enter into an operating agree-
ment and designate an operator of the property. For ex-
ample, for a joint-interest owner who owns a quarter of
the working interest, the WI equals 0.25. The WI is in
effect equal to the fraction of the cost of production that
a lessee has to pay.
An RI, also referred to as net interest or division-order
interest, is a fractional interest in the total gross revenue
from a tract of land that represents the actual quantity of
total oil and gas produced from such land attributable to
an oil and gas interest in such land. An RI is commonly
expressed as a decimal fraction of % of the gross revenue
from such production.
An example may clarify the system. Landowner A
leases his land for oil and gas purposes to D, retaining
the usual ‘/ royalty interest. In order to hedge against non-
TABLE 41.2-WORKING AND
Working Interest
(decimal fraction
Landowner (Lessor)
Royalty Owner
Royalty Owner
Overridtng-RoyaltyOwner
Operator
Nonoperator
Total
PETROLEUM ENGINEERING HANDBOOK
INTERESTS
R/=0.07812
,...... R/=0.03125
_... R/=0.01562
productive development, A sells 5/4of his x royalty to
B and l/8of his )/8to C. A, B, and C thus become the
royalty owners under the land mentioned above. Their
RI’s are computed in Table 4 1.1.
D, the original lessee, then conveys the lease to E, re-
taining x6 of ‘/s overriding-royalty interest. The lease is
now said to be burdened with a x6 override. D now owns
l/j6 of ‘/8 or x2s, or RI=0.05469.
To support him with his development and operating
costs, E now sells one-fourth of his interest in the lease
to F. E now owns W of (7/sof % less x6 of 7/sof %) or
31s/ 512, or RI=0.61524, while paying U of the costs or
WI=O.75. F now owns i/4 of (‘/Bof % less x6 of x of
%I or 10%121 or RI=0.20508 while paying i/4 of the costs
or WI=O.25.
The working- and revenue-interest fractions pertaining
to the various economic interests in this example should
now each add up to unity, as shown in Table 4 1.2.
Valuation2-13
Determination of Fair Market Value
Fair market value of an oil- or gas-productive property,
as commonly understood, is the price at which the prop-
erty would be sold after exposure to the market for a
reasonable period of time by a willing seller to a willing
buyer, neither being under compulsion to buy or to sell,
and both being competent and having reasonable knowl-
edge of the facts.
Fiske,3 presenting the viewpoint of the Internal
Revenue Service in 1956, listed six methods used to de-
termine the fair market value in order of preferential
weight: (1) an actual sale of the property near the valua-
tton date: (2) a bona tide offer to sell or purchase the prop-
erty near the valuation date; (3) actual sales of similar
properties in the same or nearby oil and gas fields near
the valuation date; (4) valuations made for purposes other
than federal taxation near the valuation date; (5) analytical
appraisals; and (6) opinions of qualified oil or gas
operators.
This section deals with the determination of the fair mar-
ket value of oil and gas properties by the analytical- or
engineering-appraisal method, enumerated by Fiske as
REVENUE INTEREST FRACTIONS
Fractionof Revenue-
InterestFraction
(decimal fraction
of costs) of revenue)
0 0.07812
0 0.03125
0 0.01562
0 0.05469
0.75 0.61524
0.25 0.20508
1.00 1 .ooooo
VALUATION OF OIL AND GAS RESERVES
Item 5. With this method, the appraiser estimates the
recoverable hydrocarbon reserves from the property and
appraises the probable future net income or cash flow to
be realized from the production and sale of these reserves.
While fair market value for a hydrocarbon-producing
property is not a precise number, it can be approximated
within rather close limits by use of the engineering-
appraisal method. 3
Preparing a Cash-Flow Projection
For the purpose of determining future net income or cash
flow, oil and gas production should be forecast on infor-
mation about future demand for petroleum or on the ba-
sis of purchase contracts if these govern but should not
exceed the physical ability of the well or wells to produce.
Where proration or market curtailment is in force, trends
in oil and gas allowables or market should be considered.
Usually, the gross income from oil and gas sales to be
obtained from such production is based by the appraiser
on current posted prices for crude oil and on predicted
economic conditions.
The constant price projections are required for financ-
ing and Securities Exchange Commission filings, while
the predicted prices that are based on economic studies
are used for business decisions.
Gas prices should be based on gas-purchase contracts
in force on the properties being appraised. The effect of
escalation clauses in such gas-purchase contracts. which
are subject to future approval by regulatory agencies, are
usually set out separately.
In most states, oil and gas production is subject to state,
county. and local taxes payable by the producer. The
producer customarily charges the appropriate part of these
taxes to the various interests in a given property. Tax rates
on oil and gas production in the various states have histor-
ically varied and may be obtained from the state regula-
tory agency. The taxes are usually collected by the pipeline
company by deduction from the runs.
Corporation or private income taxes are normally con-
sidered outside the scope of an oil and gas property valu-
ation, but some valuation formulas make indirect
allowance for them. Tax ramifications can totally change
the economics of a proposed transaction and related cval-
uation. For certain purposes, such as bank evaluations,
income taxes, as an inherent part of the future income,
are sometimes specifically included in the forecast.
Operating or production costs comprise the expenses
required to produce the oil and gas and to maintain the
leases. These costs, usually called direct lifting costs, in-
clude the cost of labor, field supervision, power, fuel,
repairs, stimulation and/or recompletion of wells, plant
repairs, transportation, insurance, and other such items.
As the age of the wells increases, additional expenditures
may have to be made to keep the wells in operating con-
dition and possibly for disposal of produced salt water.
Capital expenditures include the cost of construction of
gasoline plants, repressuring systems. additional devel-
opment wells, artificial lifting equipment, engines. tanks,
and other durable items required to produce all the eco-
nomically recoverable oil.
An owner of a working interest in oil or gas properties
pays the full amount of his working-interest share of direct
costs and capital expenditures, but he pays production and
federal excise taxes only on the production to his net
41-3
revenue interest. Royalty or overriding royalty interests,
however, ordinarily bear none of the normal lifting costs
or capital expenditures but do bear production and feder-
al excise taxes on their revenue-interest portion of the oil
or gas produced.
The gross income to be realized from the production
of the revenue-interest portion of the oil and gas reserves,
when reduced by the amounts necessary for production
and federal excise taxes, the working-interest share of
operating expenses, repairs, recompletions, and additional
capital expenditures, is the future net income or the net
cash flow generated from the production of the estimated
oil and gas reserves. Salvage value of equipment at the
time of abandonment is ordinarily not included in the cash-
flow projection because such income is usually offset by
the cost of properly plugging and abandoning the prop-
erty in compliance with state regulations. An exception
is sometimes made where the life of the property is short
and such salvageable equipment minus abandonment costs
constitutes a major part of the value.
After the technical analysis of the properties has been
made, which results in a determination of the volume and
rate of production of oil and gas, and these data have been
reduced to a projection of future operating net income or
cash flow, it becomes necessary to establish the appraisal
value.
Analytical Methods for
Computation of Appraisal Value
Although there are many methods for computing appraisal
value, only the most popular will be discussed. All these
compute the appraisal value of a property by the
discounted-cash-flow procedure and give proper weight
to the time pattern of future income. Appraisal values that
are based on a given fraction of the undiscounted future
cash income or on payout in a given number of years do
not meet this requirement and are not included.
The examples provided are from the original edition
of this handbook and reflect the economic conditions cur-
rent at that time. The methodology remains valid, how-
ever, and any values in the examples would be subject
to change with time.
Appraisal value equal to a fraction of the present worth
of the net cash flow before federal taxes computed at
a safe rate of interest. Method 1 is relatively simple, easy
to understand, and widely used. It is based on the premise
that future income should only be discounted at an interest
rate that reflects the current-time value of money and that
such interest rate-which fluctuates with the prevailing
cost of money-is not used as a vehicle for the risk fac-
tor. In its application, the combined present worth of the
future operating net income or cash flow is calculated by
discounting the future annual cash-flow increments at
prevailing or projected compound interest rates. An ex-
ample of such a present-worth computation at an interest
rate of lO%/yr is shown in Table41.3. While Table41.3
is a hand calculation, most calculations are made with
electronic data processing equipment, as shown in Table
41.4.
The total present worth of the future net operating in-
come, which in this example is $1,499,941, is not to be
construed as the market value of the oil or gas property.
The purchaser of such a property logically is entitled to
41-4 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.3-CASH-FLOW PROJECTION AND PRESENT-WORTH CALCULATION

FOR XYZ OIL COMPANY’S INTEREST IN PRODUCING OIL PROPERTY
Operakx XYZ co. 011 Sales Price = $29 OO/bbl Lease Mary Jones
Revenue Interest, RI = 0 375 Productron Taxes =~.WO plus $0 0019/bbl Freld Rock Creek
Working Interest:WI = 0.500 Estimated Operatlnq Expenses = 5800 OO/well-month State: Texas
Acres, 100
Date of Evaluation l-l-85 No of Wells 1

Step Estimated Future Operation 111185 1II186 l/1/87 111188 111189 l/1/90 l/l/91 Total

1 Gross lease
productron. bbl 50.301 42,570 30,738 24,180 19.490 13.847 4,506 185,632
2 Net productron to XYZ.
bbl Rlx Step 1 18.863 15,964 11,527 9,068 7.309 5,193 1.690 69,614
3 011 revenue. dollars Step 3 x Price 547.023 462,949 334,276 262,957 211.954 150.586 49.003 2.018.748
4 Production taxes,
dollars (0 046 x step 3]+ [O 0019 x step Z] 25,199 21,326 15,399 12,113 9,764 6,937 2,258 92,996
5 Producing well-months wells x months 12 12 12 12 12 12 12 84
6 Operating costs. dollars Step 5 x $800 9.600 9.600 9,600 9.600 9,600 9.600 9,600 67,200
7 Capital expendttures,
dollars - -
8 XYZ share of operating
plus capital costs,
dollars WI x [Step 6+ Step 71 4.800 4.800 4,800 4.800 4,800 4.800 4,800 33.600
9 Net federal excise*
(WPT). dollars 14,336 7,982 4,957 3,174 1,973 987 152 33,561
10 Future net revenue”.
dollars Step 3 - Step 4 -Step 8 - Step 9 502,688 428,841 309.120 242,870 195,417 137.862 41.793 1.858.591
11 10% annual deferment
factor (Table 41 11) F,, =(Step 1 +i) ‘-’ 09535 08668 0.7880 0.7164 06512 0.5920 0.5382
12 Present worth of XYZ’s
cash flow 479,294 371,713 243.582 173,980 127,261 81.618 22,493 1,499.941

TABLE 41.4-PROJECTION OF ESTIMATED PRODUCTION AND REVENUE AS OF JAN. 1, 1985

XYZ 011 co XYZ 011 co

011 Mary Jones

Working Interest 0.500000 Proved lmtlalWells 1

Net Oil lnteresl 0.375000 Pnmary Rock Creek Freld
Net Gas Interest 0.375000 Producing Texas

Future Production

011 or
Condensate Gas Future Gross Revenue Before Production Taxes (dollars)
Future Discounted
Number of Gross Net Gross Net 011 Gas Total ProductIon Net Value at
Year Wells WI) (bbl) (Mscf) (Mscf) Revenue Revenue Revenue Taxes Costs Revenue 10 00%

1985 1 50,301 18.863 ~ 547.023 547.023 25,199 19,136 ~ 502.688 479,294

1986 1 42,570 15,964 462,949 462,949 21.326 12,782 428.841 371.713
i987 1 30,738 11,527 334,276 334,276 15,399 9.757 309,120 243,582
1988 1 24,180 9,068 262,957 262,957 12,113 7.974 242,870 173,980
1989 1 19,490 7.309 211,954 211,954 9,764 6.773 195,417 127,261
1990 1 I 3,847 5,193 150.586 150.586 6,937 5.787 137,862 81.618
1991 1 4,506 1,690 49.003 49,003 2,258 4.952 41,793 22,493

Sub Total 185.632 69,614 2.018.748 2.018.748 92.996 67.161 1.858.591 1.499.941
Remainlna 0 0 0 0 0 0 0 0 0

Total 185,632 69,614 ~ ~ 2.018.748 2.018.748 92,996 67.161 1.858.591 1.499.941

The asof-date gross oil pnce = $29 OO/bbl. tax tier3. Prices Year $/bbl $/Mscf WFPTX($) Year $/bbl $/Mscf WFPTX ($)
and 1985 29 00 14,336
Windfall 1986 29 00 7.982
Profit 1987 29 00 4,957
Taxes 1988 29 00 3,174
1989 29 00 1.973
1990 29 00 987
1991 29 00 152
Total WFP Tax =$33.561
VALUATION OF OIL AND GAS RESERVES 41-5

TABLE 41 S-DISCOUNTED FUTURE NET CASH INCOME VS. PROPERTY LIFE

Percentage of Average Percentage

Average 5% Equivalent 5% Discounted of 5% Dtscounted
Deferment Factor on Constant-Rate Value of Future Value of Future
Cash-Flow Production Number of Net Cash Income Net Cash Income
Protection (wars) Transactions Paid Paid
0.82 through 0.70 8 through 15 11 60 through 84 71
0.70 through 0.52 15 through 30 13 50 through 89 70
0.52 through 0.40 30 through 45 6 58 through 89 75
0.40 through 0.32 45 through 60 4 68 through 98 78

a profit above the bank interest rate. Also, when cash flow These data show a tendency for the average percentages
is computed by this method, the federal income taxes on of the last column to increase when the estimated life of
the operating net income usually are not deducted, and the properties becomes longer. In none of these transac-
allowance must be made for them. In addition, a risk-of- tions did the total consideration exceed two-thirds of the
doing-business factor is usually included. updiscounted future net cash income before federal tax-
Depending on whether cost-depletion or percentage- es. Fagin ” introduced an empirical “market-value yard-
depletion allowance is applicable and depending on the stick” that is based on the trend in actual prices paid for
amounts of future intangible development expenditures producing properties during the postwar years in long-
and equipment depreciation, thih federal income tax lia- life fields such as East Texas (see Table 41.6). To find
bility will vary on the basis of the tax rate applicable to the market value by this yardstick for constant-rate pro-
the interest owner. duction of a similar character, the percentage shown in
The profit margin required in the transaction may also Co]. 3 of the market-value-yardstick table for the applica-
vary widely because of risks inherent in the operation of ble number of years of constant-rate production of Col.
the property and the respective trading ability of the par- 2 of this table is determined. This percentage is then mul-
ties to the transaction. tiplied with the average 5% deferment factor of Col. I
In addition, in the opinion of many operators, the long- and with the undiscounted future net cash flow to yield
term inflationary trend may put a premium on future in- the estimated market value.
come from sales of a basic raw material, such as crude
oil or natural gas.
Example Problem 1. A property with an estimated fu-
Prospective purchasers should. therefore, weigh all
ture net cash flow of $1 ,OOO.OOO and a IO-year constant-
these factors with the federal taxes payable and the risks
rate life would have a market value of
of the operations as negative factors and the inflationary
0.73x0.79x$1,000,000=$577,000.
effects and possible additional “romance” in the trans-
Solution. When the given cash-flow projection does not
action as plus factors. Thus they can arrive at the proper
show a constant rate, the appropriate percentage is found
fraction of the present worth at some safe interest rate
in Co]. 3, which corresponds to the applicable average
that they are willing to pay.
5% deferment factor from Col. I of Table 41.6. This per-
In a speech presented at the Petroleum Engineers Club
centage is then multiplied by the average 5%’deferment
of Dallas, Oct. 17, 1952, H.J. Gruy considered as fair
factor of Col. I and by the undiscounted future net cash
market value “two-thirds of future net cash income be-
flow to yield the estimated market value.
fore amortization and federal taxes, discounted at 5 %/yr.”
This methodology is still in use. However, the discount
rate at the time of the evaluation is substituted for the Example Problem 2. A property with an estimated fu-
5 %/yr rate. ture net cash flow of $500,000. which has a 5 % discount-
A study by Garb et al. ” in 1981 indicated that, in spite ed value of $375,000 (average deferment factor 0.75).
of varying tax and economic conditions, one classic yard- would have a market value of 0.72 x0.75 x $SOO,OOO=
stick for estimating the value of oil in the ground had re- $270,000.
mained reasonably constant through the years. An analysis
of IO major transactions during the period 1979-8 I, a
volatile oil-price period, indicated that oil reserves in the
ground demonstrated a market value of approximately
one-third of their posted wellhead price. TABLE 41.6-FAGIN’S MARKET-VALUE YARDSTICK
Dodson’ listed in 1959, among some seven different
methods that may be used to determine the fair market Market Value as
Equivalent Percentage of 5%
value of oil and gas reserves, “percentages of the pres- Average 5% Deferment Constant-Rate Discounted Value
ent worth, which may vary from 50 to 100% but which Factor on Cash Flow Projection of Future Net
recently have been from 75 to 80 % ” Projection Wars) Cash Flow
A study by Arpsh of 34 actual property transactions 0.88 5 79
made during the postwar years in the mid-continent, gulf 0.79 10 73
coast, and California showed that the percentage of the 0.70 15 71
0.63 20 68
5% discounted value of future net cash income (before
0.52 30 66
amortization and federal taxes) paid for these properties 0.44 40 70
varied with their future lives. as shown in Table 41.5. 0.32 60 71
41-6 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.7-MIDYEAR LUMP-SUM DEFERMENT FACTORS FLs=(l+~J'h-'

Year 2% 3% 3'/2% 4% 4'12% 5% 5’12

% 6% 6%% 7% i”h % 8% 8 ‘/2 %
- ~ ~
0.9901 0.9853 0.9829 0.9806 0.9782 0.9759 0.9736 0.9713 0.9690 0.9667 0.9645 0.9623 0.9600
2 0.9708 0.9566 0.9497 0.9429 0.9361 0.9295 0.9228 0.9163 0.9099 0.9035 0.8972 0.8909 0.8848
3 0.9517 0.9288 0.9176 0.9066 0.8958 0.8852 0.8747 0.8645 0.8543 0.8444 0.8346 0.8249 0.8155
4 0.9330 0.9017 0.8866 0.8717 0.8572 0.8430 0.8291 0.8155 0.8022 0.7891 0.7764 0.7639 0.7516
0.9147 0.8754 0.8566 0.8382 0.8203 0.8029 0.7859 0.7693 0.7532 0.7375 0.7222 0.7073 0.6927
6 0.8968 0.8500 0.8276 0.8060 0.7850 0.7646 0.7449 0.7258 0.7073 0.6893 0.6718 0.6549 0.6385
7 0.8792 0.8252 0.7996 0.7750 0.7512 0.7282 0.7061 0.6847 0.6641 0.6442 0.6249 0.6064 0.5884
8 0.8620 0.8012 0.7726 0.7452 0.7188 0.6936 0.6693 0.6460 0.6236 0.6020 0.5813 0.5615 0.5423
9 0.8451 0.7778 0.7465 0.7165 0.6879 0.6605 0.6344 0.6094 0.5855 0.5626 0.5408 0.5199 0.4999
10 0.8285 0.7552 0.7212 0.6889 0.6583 0.6291 0.6013 0.5749 0.5498 0.5258 0.5031 0.4814 0.4607
11 0.8123 0.7332 0.6968 0.6624 0.6299 0.5991 0.5700 0.5424 0.5162 0.4914 0.4680 0.4457 0.4246
12 0.7964 0.7118 0.6733 0.6370 0.6028 0.5706 0.5403 0.5117 0.4847 0.4593 0.4353 0.4127 0.3913
13 0.7807 0.6911 0.6505 0.6125 0.5768 0.5434 0.5121 0.4827 0.4551 0.4292 0.4049 0.3821 0.3607
14 0.7654 0.6710 0.6285 0.5889 0.5520 0.5175 0.4854 0.4554 0.4273 0.4012 0.3767 0.3538 0.3324
15 0.7504 0.6514 0.6072 0.5663 0.5282 0.4929 0.4601 0.4296 0.4013 0.3749 0.3504 0.3276 0.3064
16 0.7357 0.6324 0.5867 0.5445 0.5055 0.4694 0.4361 0.4053 0.3768 0.3504 0.3260 0.3033 0.2824
17 0.7213 0.6140 0.5669 0.5235 0.4837 0.4471 0.4134 0.3823 0.3538 0.3275 0.3032 0.2809 0.2603
18 0.7071 0.5961 0.5477 0.5034 0.4629 0.4258 0.3918 0.3607 0.3322 0.3060 0.2821 0.2601 0.2399
19 0.6932 0.5788 0.5292 0.4841 0.4429 0.4055 0.3714 0.3403 0.3119 0.2860 0.2624 0.2408 0.2211
20 0.6797 0.5619 0.5113 0.4654 0.4239 0.3862 0.3520 0.3210 0.2929 0.2673 0.2441 0.2230 0.2038
21 0.6664 0.5456 0.4940 0.4475 0.4056 0.3678 0.3337 0.302s 0.2750 0.2498 0.2271 0.2064 0.1878
22 0.6533 0.5297 0.4773 0.4303 0.3882 0.3503 0.3163 0.2857 0.2582 0.2335 0.2112 0.1912 0.1731
23 0.6405 0.5142 04612 0.4138 0.3714 0.3336 0.2998 0.2695 0.2425 0.2182 0.1965 0.1770 0.1595
24 0.6279 0.4993 0.4456 0.397s 0.3554 0.3177 0.2842 0.2543 0.2277 0.2039 0.1828 0.1639 0.1470
25 0.6156 0.4847 0.4305 0.3825 0.3401 0.3026 0.2693 0.239s 0.2138 0.1906 0.1700 0.1517 0.1355
26 0.6035 0.4706 0.4159 0.3678 0.3255 0.2882 0.2553 0.2263 0.2007 0.1781 0.1582 0.1405 0.1249
27 0.5917 0.4569 0.4019 0.3537 0.3115 0.2745 0.2420 0.2135 0.1885 0.1665 0.1471 0.1301 0.1151
28 0.5801 0.4436 0.3883 0.3401 0.2981 0.2614 0.2294 0.2014 0.1770 0.1556 0.1369 0.1205 0.1061
29 0.5687 0.4307 0.3751 0.3270 0.2852 0.2489 0.2174 0.1900 0.1662 0.1454 0.1273 0.1115 0.0978
30 0.5576 0.4181 0.3625 0.3144 0.2729 0.2371 0.2061 0.1793 0.1560 0.1359 0.1184 0.1033 0.0901
31 0.5466 0.4059 0.3502 0.3023 0.2612 0.2258 0.1953 0.1691 0.1465 0.1270 0.1102 0.0956 0.0831
32 0.5359 0.3941 0.3384 0.2907 0.2499 0.2150 0.1852 0.1595 0.1376 0.1187 0.1025 0.0885 0.0766
33 0.5254 0.3826 0.3269 0.2795 0.2392 0.2048 0.1755 0.1505 0.1292 0.1109 0.0953 0.0820 0.0706
34 0.5151 0.3715 0.3159 0.2688 0.2289 0.1951 0.1664 0.1420 0.1213 0.1037 0.0887 0.0759 0.0650
35 0.5050 0.3607 0.3052 0.2584 0.2190 0.1858 0.1577 0.1340 0.1139 0.0969 0.0825 0.0703 0.0599
36 0.4951 0.3502 0.294s 0.2485 0.2096 0.1769 0.1495 0.1264 0.1069 0.0905 0.0767 0.0651 0.0552
37 0.4854 0.3400 0.2849 0.2389 0.2006 0.1685 0.1417 0.1192 0.1004 0.0846 0.0714 0.0603 0.0509
38 0.4759 0.3301 0.2753 0.2297 0.1919 0.1605 0.1343 0.1125 0.0943 0.0791 0.0664 0.0558 0.0469
39 0.4665 0.3205 0.2659 0.2209 0.1837 0.1528 0.1273 0.1061 0.0885 0.0739 0.0618 0.0517 0.0432
40 0.4574 0.3111 0.2570 0.2124 0.1758 0.1456 0.1207 0.1001 0.0831 0.0691 0.0575 0.0478 0.0399
41 0.4484 0.3021 0.2483 0.2042 0.1682 0.1386 0.1144 0.0944 0.0780 0.0646 0.0535 0.0443 0.0367
42 0.4396 0.2933 0.2399 0.1964 0.1609 0.1320 0.1084 0.0891 0.0733 0.0603 0.0497 0.0410 0.0339
43 0.4310 0.2847 0.2318 0.1888 0.1540 0.1257 0.1027 0.0840 0.0688 0.0564 0.0463 0.0380 0.0312
44 0.4226 0.2764 0.2239 0.1816 0.1474 0.1197 0.0974 0.0793 0.0646 0.0527 0.0430 0.0352 0.0288
45 0.4143 0.2684 0.2163 0.1746 0.1410 0.1140 0.0923 0.0748 0.0607 0.0493 0.0400 0.0326 0.0265
46 0.4062 0.2606 0.2090 0.1679 0.1350 0.1086 0.0875 0.0706 0.0570 0.0460 0.0372 0.0301 0.0244
47 0.3982 0.2530 0.2020 0.1614 0.1291 0.1034 0.0829 0.0666 0.0535 0.0430 0.0346 0.0279 0.0225
48 0.3904 0.2456 0.1951 0.1552 0.1236 0.0985 0.0786 0.0628 0.0502 0.0402 0.0322 0.0258 0.0208
49 0.3827 0.2384 0.1885 0.1492 0.1183 0.0938 0.0745 0.0592 0.0472 0.0376 0.0300 0.0239 0.0191
50 0.3752 0.2315 0.1822 0.1435 0.1132 0.0894 0.0706 0.0559 0.0443 0.0351 0.0279 0.0222 0.0176

While the examples use a 5 % discount factor that is no
longer valid, the methodology remains valid. Users of this
technique should use discount rates appropriate for the
time of the evaluation.
Appraisal value equal to the present value of the net
cash flow before federal taxes computed at a specula-
tive rate of interest. Unlike Method 1, the profit margin
over and above bank interest rates to take care of inherent
risks and federal income tax liabilities is incorporated in
Method 2 the higher discount rate. The possible range of
such speculative rates of return is reflected by various quo-
tations from the literature. This method is, again, fairly
simple in its application, because federal income taxes are
not included in the computation.
Use of Method 2 leads to comparatively high market
values for properties of very short life. Because experi-
ence shows that very few transactions are made where
the total consideration exceeds two-thirds of the future
net cash income, experienced engineers in such cases
usually limit their appraisal value to this maximum. This
formula also tends to discriminate against long-life trans-
actions because high speculative rates of return compound
rapidly and reduce the value of cash-flow increments 20
to 30 years, hence to very small amounts. For example,
Table 41.7 shows that the midyear lump-sum deferment
VALUATION OFOILANDGASRESERVES 41-7

TABLE 41.7-MIDYEAR LUMP-SUM DEFERMENT FACTORS f Ls =(I + i)‘/‘-’

(continued)

Year 9% 9% % 10% 12% 15% 20% 25% 30% 35% 40% 45% 50% 60% 70%
1 0.9578 0.9556 0.9535 0.9449 0.9321 0.9129 0.8945 0.8770 0.8607 0.8452 0.8304 0.8165 0.7906 0.7670
2 0.8787 0.8727 0.8688 0.8437 0.8105 0.7607 0.7156 0.6747 0.6375 0.6037 0.5727 0.5443 0.4941 0.4512
3 0.6062 0.7970 0.7880 0.7533 0.7046 0.6340 0.5724 0.5190 0.4722 0.4312 0.3950 0.3629 0.3088 0.2654
4 0.7396 0.7279 0.7163 0.6726 0.6129 0.5283 0.4579 0.3992 0.3498 0.3080 0.2724 0.2419 0.1930 0.1561
5 0.6785 0.6647 0.6512 0.6005 0.5329 0.4402 0.3664 0.3071 0.2591 0.2200 0.1879 0.1613 0.1206 0.0918
6 0.6225 0.6070 0.5920 0.5362 0.4634 0.3669 0.2931 0.2362 0.1919 0.1571 0.1296 0.1075 0.0754 0.0540
7 0.5711 0.5544 0.5382 0.4787 0.4030 0.3057 0.2345 0.1817 0.1422 0.1122 0.0894 0.0717 0.0471 0.0318
8 0.5240 0.5063 0.4893 0.4274 0.3504 0.2548 0.1876 0.1398 0.1053 0.0802 0.0616 0.0478 0.0295 0.0187
9 0.4807 0.4624 0.4448 0.3816 0.3047 0.2123 0.1501 0.1075 0.0780 0.0573 0.0425 0.0319 0.0184 0.0110
IO 0.4410 0.4222 0.4044 0.3407 0.2650 0.1769 0.1200 0.0827 0.0578 0.0409 0.0293 0.0212 0.0115 0.0065
11 0.4046 0.3856 0.3676 0.3042 0.2304 0.1474 0.0960 0.0636 0.0428 0.0292 0.0202 0.0142 0.0072 0.0038
12 0.3712 0.3522 0.3342 0.2716 0.2003 0.1229 0.0768 0.0489 0.0317 0.0209 0.0139 0.0094 0.0045 0.0022
13 0.3405 0.3216 0.3038 0.2425 0.1742 0.1024 0.0615 0.0376 0.0235 0.0149 0.0096 0.0063 0.0028 0.0013
14 0.3124 0.2937 0.2762 0.2165 0.1515 0.0853 0.0492 0.0290 0.0174 0.0106 0.0066 0.0042 0.0018 0.0008
15 0.2866 0.2682 0.2511 0.1933 0.1317 0.0711 0.0393 0.0223 0.0129 0.0076 0.0046 0.0028 0.0011 0.0005
16 0.2630 0.2450 0.2283 0.1726 0.1146 0.0593 0.0315 0.0171 0.0095 0.0054 0.0032 0.0019 0.0007 0.0003
17 0.2412 0.2237 0.2075 0.1541 0.0996 0.0494 0.0252 0.0132 0.0071 0.0039 0.0022 0.0012 0.0004 0.0002
18 0.2213 0.2043 0.1886 0.1376 0.0866 0.0411 0.0201 0.0101 0.0052 0.0028 0.0015 0.0008 0.0002
19 0.2031 0.1866 0.1715 0.1229 0.0753 0.0343 0.0161 0.0076 0.0039 0.0020 0.0010 0.0006 0.0001
20 0.1863 0.1704 0.1559 0.1097 0.0655 0.0286 0.0129 0.0060 0.0029 0.0014 0.0007 0.0004
21 0.1709 0.1556 0.1417 0.0980 0.0570 0.0238 0.0103 0.0046 0.0021 0.0010 0.0005 0.0002
22 0.1568 0.1421 0.1288 0.0875 0.0495 0.0198 0.0082 0.0035 0.0016 0.0007 0.0003 0.0002
23 0.1438 0.1298 0.1171 0.0781 0.0431 0.0165 0.0066 00027 0.0012 0.0005 0.0002 0.0001
24 0.1320 0.1185 0.1065 0.0697 0.0374 0.0138 0.0053 0.0021 0.0009 0.0004 0.0002
25 0.1211 0.1082 0.0968 0.0623 0 0326 0.0115 0.0042 0.0016 0.0006 0.0003 0.0001
26 0.1111 0.0988 0.0880 0.0556 0.0283 0.0096 0.0034 0.0012 0.0005 0.0002
27 0.1019 0.0903 0.0800 0.0496 0.0246 0.0080 0.0027 0.0010 0.0004 0.0001
28 0.0935 0.0824 0.0727 0.0443 0.0214 0.0066 0.0022 0.0007 0.0003
29 0.0858 0.0753 0.0661 0.0396 0.0186 0.0055 0.0017 0.0006 0.0002
30 0.0787 0.0688 0.0601 0.0353 00162 0.0046 0.0014 00004 0.0001
31 0.0722 0.0628 0.0546 0.0315 0.0141 0.0038 0.0011 0 0003 0.0001
32 0.0662 0.0573 0.0497 0.0282 0.0122 0.0032 0.0009 0.0003
33 0.0608 0.0524 0.0452 0.0251 0.0106 0.0027 0.0007 00002
34 0.0557 0.0478 0.0411 0.0224 0.0093 0.0022 0.0006 0.0002
35 0.0511 0.0437 0.0373 0.0200 0 0080 0.0019 0.0005 0 0001
36 0.0469 0.0399 0.0339 0.0179 0.0070 0.0015 0.0004
37 0.0430 0.0364 0.0308 0.0160 0.0061 0.0013 0.0003
38 0.0395 0.0333 0.0280 0.0143 0.0053 0.0011 0.0002
39 0.0362 0.0304 0.0255 0.0127 0.0046 0.0009 0.0002
40 0.0332 0.0277 0.0232 0.0114 0.0040 0.0007 0.0001
41 0.0305 0.0253 0.0211 0.0102 00035 0.0006 0.0001
42 0.0280 0.0231 0.0192 0.0091 0.0030 0.0005
43 0.0257 0.0211 0.0174 0.0081 0.0026 0.0004
44 0.0235 0.0193 0.0158 0.0072 0.0023 0.0004
45 0.0216 0.0176 0.0144 0.0065 00020 0.0003
46 0.0198 0.0161 0.0131 0.0058 0 0017 0.0002
47 0.0182 0.0147 0.0119 0.0051 0.0015 0.0002
46 0.0167 0.0134 0.0108 0.0046 0.0013 0.0002
49 0.0153 0.0123 0.0098 0.0041 0.0011 0.0001
50 0.0140 0.0112 0.0089 0.0037 0.0010 0.0001

factor for income received in Year 30 amounts to 0.2371
for 5% interest, 0.0601 for 10% interest, and 0.0046 for
20% interest. Because of these shortcomings, the use of
Method 2 is not recommended, particularly when long-
life properties are involved with a high profit-to-
investment ratio.
In a speech presented at the Oil and Gas Inst. in Dal-
las, March 26, 1949, E.L. DeGolyer commented, “It is
rather surprising that more often than not the latter
method, i.e. one-half of a 4% discounted future net
revenue, is very close to the future net revenue (before
amortization and federal taxes) discounted at 10 ‘/z% per
year.”
Dodson’ listed in 1959 among some seven different
methods that may be used to determine the fair market
value of oil and gas reserves, “rate of return on invest-
ment of apparently 14% or more.”
From a study of five actual and representative valua-
tions that have served as a basis for settlement for gift
or ad valorem taxes, Reynolds’ concluded in 1959 that:
“The range of from 13% to 21% annual rate of return
before tax adjustments provides limits on which the en-
gineer can operate. ” He also observed that the data from
these appraisals “indicate that the project with a short life
will demand a higher rate of return than one with a long
life and low risk. This is probably caused by the inves-
tors’ long-range faith in the oil industry, the belief that
higher prices per unit are in the offing, and the fact that
less money management is necessary for reinvesting
earnings. ”
 41-8 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.7-MIDYEAR LUMP-SUM DEFERMENT FACTORS F,, =(7 +i)“-’ (continued)

Year 80% 90% 100% 1 10% 120% 130% 140% 150% 160% 170% 180% 190% 200%
1 0.7454 0.7255 0.7071 0.6901 0.6742 0.6594 0.6455 0.6325 0.6202 0.6086 0.5976 0.5872 0.5773
2 0.4141 0.3818 0.3536 0.3286 0.3065 0.2867 0.2690 0.2530 0.2385 0.2254 0.2134 0.2025 0.1924
3 0.2300 0.2010 0.1768 0.1565 0.1393 0.1246 0.1121 0.1012 0.0917 0.0835 0.0762 0.0698 0.0641
4 0.1278 0.1058 0.0884 0.0745 0.0633 0.0542 0.0467 0.0405 0.0353 0.0309 0.0272 0.0241 0.0214
5 0 0710 0.0557 0.0442 0.0355 0.0288 0.0236 0.0195 0.0162 0.0136 0.0115 0.0097 0.0083 0.0071
6 0.0394 0.0293 0.0221 0.0169 0.0131 0.0102 0.0081 0.0065 0.0052 0.0042 0.0035 0.0029 0.0024
7 0.0219 0.0154 0.0110 0.0080 0.0059 0.0045 0.0034 0.0026 0.0020 0.0016 0.0012 0.0010 0.0008
8 0.0122 0.0081 0.0055 0.0038 0.0027 0.0019 0.0014 0.0010 0.0008 0.0006 0.0004 0.0003 0.0003
9 0.0068 0.0043 0.0028 0.0018 0.0012 0.0008 0.0006 0.0004 0.0003 0.0002 0.0002 0.0001
IO 0.0038 0.0022 0.0014 0.0009 0.0006 0.0004 0.0002 0.0002 0.0001
11 0 0021 0.0012 0.0007 0.0004 0.0003 0.0002 0.0001
12 0 0012 0.0006 0.0003 0.0002 0.0001
13 0.0006 0.0003 0.0002
14 0.0004 0.0002
15 0.0002
16 0.0001

The aforementioned rates of return were applied to the
entire transaction. including the reserved production pay-
ment. Because of “leverage” afforded by the then-
permitted ABC method of purchasing properties. the ac-
tual rate of return on the equity capital was higher than
the rate of return for the transaction as a whole.
The calculated pretax internal rate of return remains
a useful yardstick for establishing a fair market value. The
acceptable rate of return at any time will be a function
of comparative investment opportunities and the subjec-
tive assessment of the risk. At the time of this writing,
pretax rate of return must fall between 20 and 30% to
be compctitivc with other investment options.
Appraisal value equal to the present value of the net
cash flow after federal income taxes computed at an
intermediate rate of interest. Method 3 is the most
sophisticated approach to the fair-market-value problem.
It requires an actual computation of the federal tax liability
for each year and is rather laborious. The method also
requires tax and accounting information that may not be
readily available to the evaluating engineer. Those favor-
ing this method generally use electronic-data-processing
facilities that reduce the actual work by the valuation en-
gineer to the preparation of the basic input data. The rate
of return in this type of computation comes close to the
actual rate of return that, aside from price fluctuations
and errors in estimating, may be realized on the purchase.
If this method is followed, the fair market value may be
defined as the cash value that, if paid for the property.
would yield a satisfactory rate of return on the purchase
price. A satisfactory rate of return or yield is one that is
sufficient to induce the buyer to risk his funds in the par-
ticular project rather than in safer investments offering
a lower yield. This rate must be commensurate with the
physical hazards of producing and the economic hazards
of future production. In principle, it is the same incen-
tive recognized in the regulation of public utilities, where
the reasonable rate of return upon the fair value of the
property (the rate base) is held to be that sufficient to in-
duce the investment of capital in establishing, mainrain-
ing. and expanding the property.
Check List of Data Required for Evaluation
of Oil- and Gas-Producing Properties
Bccausc the prcviouxly discuhscd evaluation procedures
are reflections of the pattern of future revenues, most eval-
uation methods are based on the predicted projections of
oil and gas production. These projections are prepared
either by extrapolating established trends in producing ca-
pacity or by academically estimating anticipated produc-
tion on the basis of geologic interpretations and/or analogy
(see Chap. 40).
To make a sound valuation of a given producing prop-
erty, the appraiser requires certain basic data. The fol-
lowing check list may serve as a reminder when collecting
such data.
Maps and Cross Sections. These include ownership
maps, geological-structure maps. isopach maps, geolog-
ical cross sections, etc.
Lease-Location Data. List leases to be included and
show for each lease the lease name, number of produc-
ing wells, number of temporarily abandoned wells, total
number of acres, field name, county, state, and legal
description of lease.
Well Logs. These logs include all electrical, acoustic,
and radioactivity logs that have been run in each well.
Also, if available, geological-sample logs and direction-
al well-survey reports should be included.
Core-Analysis Data. All core-analysis reports for the
zones that have been cored and analyzed should be
included.
Ruid-Sample-Analysis Data. This includes all bottom-
hole fluid-sample-analysis reports and. for gas wells, gas-
analysis, specific-gravity, or recombined-sample-analysis
reports.
Well History. Chronological history of all well opera-
tions including original drilling and completion, recom-
pletions, and remedial work to date should be included.
If not otherwise included in a complete chronological well
history. provide the following data for each well: con-
servation commission completion, potential test, and GOR
reports: completion (and/or recompletion) date; elevation:
kelly bushing, derrick floor, and ground level; total depth*
and plugged-back depth; casing size and setting depth;
tubing size and setting depth; drillstem test data includ-
ing intervals tested. time open, fluid recovered. and bot-
tomhole pressure (BHP) data: coring data. including
intervals cored. footage recovered. and core description:
VALUATION OF OIL AND GAS RESERVES
geological tops of all major formations encountered; well-
location plats or location description: producing forma-
tion name, interval perforated, initial production and
potential test data; depths to top. bottom. oil/water con-
tact, and gas/oil contact: and pay thickness (gross feet and
net feet).
Past-Production History. This history includes tabu-
lation of oil. water, and gas production by months, by
leases, by wells, and by pay zones since original com-
plction. Also, include other past history reports, such as
production methods (type and size of equipment and dates
installed); BHP and wellhead pressure reports; open-flow
potential test reports (gas wells); conservation comniis-
sion (or USGS) production. allowable, and MER reports:
pipeline run statements: water-disposal and (mating
reports: fluid-injection records; and production history of
offset operations.
Current Production Data. Tabulate for each well the
most current actual test of oil. water. and gas produced
and include test date. choke size [or stroke length and
strokes per minute (spm)], producing tubing pressure, and
producing casing pressure. For gas wells, indicate latest
shut-in tubing and casing pressures. including date well
was shut in and duration of shut-in time.
Current-Allowable Data. Summarize allowable formula
and current daily allowable rates for each well, per
producing day, and per calendar day.
Gross Crude Price. For each lease. give the name of
the crude purchaser, the average gravity of the oil, and
the gross price paid. If the crude is trucked. show the
trucking cost per barrel (may be obtained from pipeline
run statements).
Gross Gas Price. For each lease, give the name of the
gas purchaser and summarize the provisions of the gas
contract such as the gross gas price per 1,000 cu ft. the
contract pressure base. the minimum delivery pressure.
the effective date and term ofthe contract. and escalation
clauses (may be obtained from gas contracts and FPC ap-
proval certificates).
Severance and Local Taxes. Indicate the total value of
both severance and local (state, county, school. etc.) taxes
in terms of a percentage of the total gross income or as
an amount per barrel of oil or Mcf of gas produced.
Federal Excise Tax (WPT) information. This should
include. where applicable. tier. company or entity clas-
sification for tax. natural gas classification. and price con-
trols. if any.
Operating Expenses. Tabulate actual gross operating
expenses per well per month for each lease during the past
year. State whether such expenses include. in addition to
all direct costs. such items as well-stimulation expenses,
wjorkover or recompletion expenses. a portion of district
or division overhead expenses. or severance and (xi
1~1/ore777 taxes.
Completion and Recompletion Costs. In case of un-
developed or nonproducing reserves. provide an estimate
of completed well costs or recompletion costs for reserves
behind the casing.
Division of Interests. Tabulate the working interest
(fraction of “/xofthe costs) and the revenue interest (frac-
tion of “/Hof the income) for each interest owner so that
for each lease 100% of the working interest and 100%
of the revenue interest lease is accounted for. Indicate the
lease operator (copy of division orders for oil and gas).
41-9
Existing Production Payments or Liens. Tabulate the
balance due on all production payments or liens as of a
recent date and indicate provisions for the rate of payment.
Lease andAssignment Provisions. Summarize special
provisions of all leases and assignments that may adversely
affect the value of the leases. In particular. show special
provisions concerning shallower or deeper rights and com-
mitments or obligations for the drilling of wells (may be
obtained from lease and assignment agreements).
Lease Facilities. Provide complete information con-
cerning lease-facility wells, such as water wells, disposal
wells, and injection wells. Provide specifications (size,
capacity, etc.) for major lease-facility equipment, such
as gas compressors, oil-treating plants, and water-injection
plants.
OperatingAgreements. In case ofjoint interest or uni-
tized properties, provide a list of the basic provisions of
the operating agreement, such as preferential rights to pur-
chase other interests, obligations for development. basis
of overhead allocation, and “call” on the oil (may be ob-
tained from operating agreements and/or letter
agreements).
Unitization Agreements. In case of unitized properties,
provide a list of the basic provisions of the unitization
agreement concerning the basis for calculation of partic-
ipation percentages and future revisions of same owing
to possible future adjustments in operating methods, uni-
tized area. etc. (may be obtained from unitization
agreements).
Special Reports. Provide a copy of all special geologi-
cal and engineering reports that contain data pertinent to
a current evaluation of the property. In particular, spe-
cial engineering reports concerning plans for future de-
velopment and secondary recovery operations may be
helpful in projecting future production rates and future
net operating income.
Income Tax Information. Include if applicable.
Forecast of Future Rate of ProductionlZ
Declining Production
When a property has a well-established performance his-
tory and the production rate shows a persistent decline.
the appraiser should first make sure that this decline is
not caused by either decreasing effectiveness of the lift-
ing equipment or adverse wellbore conditions.
If he finds that the lifting equipment is operating prop-
erly and that the wellbore is clean, the past decline may
be used as a guide for the projection of future produc-
tion. First the type and rate of decline must be established.
Constant-Percentage Decline
When the drop in production rate per unit of time is a
constant percentage of the production rate. the produc-
tion curve is of the constant-percentage-decline type. This
can best be demonstrated by plotting the production rate
vs. time on semilogarithmic paper, with the production
rate on the log scale. which should then show a straight-
line trend. The production rate may also be plotted vs.
cumulative production on regular coordinate paper. which
should again show a straight-line trend for this type of
decline (Fig. 40. I, Curve I). In either case, the slope of
the curve represents the nominal decline fraction or per-
centage. The decline may also be found by observing the
41-10
Fig. 41.1-Graphical extrapolation of hyperbolicand harmonic
rate/timecurves on semilog paper. Step 1: Smooth
out the given production curve, and select three
equidistantpointson it(A, B, and C). Step 2: Draw
a vertical
linemidway between A and C through Point
B. Step 3: ProjectA and C horizontally on thismid-
dle lineand findPointsA’ and C’. Step 4: Draw A’D
and C’E parallelto BC. Step 5: Project D back
horizontallyon the curve and find Point F. Step 6:
draw DX parallelto FE, and findthe unknown extrap-
olated PointX at the intersectionwith the horizontal
linethrough E.
ratio between the production at the end of a given period
and at the beginning of that period and obtaining the ef-
fective decline by interpolation from Table 40.16 or
40.17. For example, if the production rate from a well
or lease declined from 4,286 to 3,000 bbllmonth in 10
months, the ratio between these two production rates is
0.70, and one may read from Table 40.16 that such a drop
in rate in 10 months corresponds to an effective decline
of 3X %/month.
The forecast may then be made on that basis either by
reading the future rates from an extrapolation of the
straight-line trend on the semilog decline chart or by com-
puting the future rates by means of Table 40.16 or 40.17.
Such extrapolation is then continued until the economic-
limit rate of production is reached.
Hyperbolic Decline
When the drop in production rate per unit of time ex-
pressed as a fraction of the production rate is proportion-
al to a fractional power n of the production rate (0 <n < l),
the production curve is of the hyperbolic-decline type,
This is usually evident from a plot of the production
rate vs. time on semilog paper, which for this case will
not follow a straight line but will show a gradual flatten-
ing out.
A rate-cumulative graph on regular coordinate paper
will show the same type of curvature (Fig. 40.21,
Curve II).
Hyperbolic-decline curves may be straightened out for
extrapolation by plotting on double logarithmic or log-
log paper after the curves are shifted by adding or sub-
tracting a constant amount to all time or cumulative values.
This is a laborious and, with the development of com-
puters, outdated procedure. Most appraisers prefer a
graphical extrapolation of the rate/time curve on semilog
paper. Such extrapolation may be supported by actually
PETROLEUM ENGINEERING HANDBOOK
computing a few points of the curve by means of Eq. 60
of Chap. 40 or by using the graphical extrapolation
method on semilog paper shown in Fig. 41.1, which is
based on the “three-point rule” ‘* : “For any two points
on a hyperbolic rate-time curve, for which the produc-
tion rates are in a given ratio, the point midway in be-
tween will have a production rate which is a fixed number
of times the rate of either the first or the last point, regard-
less of where the first two points are chosen.”
For example, when the three equidistant points on the
past-performance portion of the curve show production
rates of 2,000, 1,300, and 1,000 bblimonth, then the fu-
ture time interval between the ordinates of 1,000 and 650
bblimonth must be equal to the time interval between the
ordinates of 650 and 500 bbllmonth.
The future projection is then obtained by reading the
production rates from the graphically extrapolated curve.
Hyperbolic decline is the most common form of
production-decline trend found with nonprorated or ca-
pacity production. The fractional power n is usually be-
tween 0 and 0.50, with the latter value applicable to
gravity-drainage-type production under certain conditions.
Harmonic Decline
When the drop in production rate per unit of time ex-
pressed as a fraction of the production rate is proportion-
al to the production rate itself, the production curve is
of the harmonic-decline type.
Such a curve, plotted as a rate/time graph on semilog
paper, does not follow a straight line but shows a rather
persistent, pronounced curvature. The rate-cumulative
graph on regular coordinate paper shows the same strong
curvature (see Fig. 40.21, Curve III).
Harmonic decline may be identified graphically by plot-
ting the inverse of the production rate vs. time on regu-
lar coordinate paper, which should then show a straight
line. It may also be demonstrated by plotting the rate-
cumulative relationship on semilog paper, which should
also follow a straight line.
Harmonic decline for production-decline curves does
not occur very often, and extrapolation on this basis usual-
ly provides a projection that is too optimistic. It is occa-
sionally applicable to capacity production from
depletion-type gas wells or to nonprorated production
from reservoirs with a bottomwater drive where it is ec-
onomically feasible to lift and to dispose of large volumes
of water.
Extrapolation of the rate/time graph may best be car-
ried out by plotting the inverse of the production rate vs.
time on regular coordinate paper and extending the straight
line obtained.
A rate/time graph on semilog paper may also be ex-
tended by the same construction on the basis of the three-
point rule for hyperbolic decline illustrated in Fig. 41.1.
Part Constant Rate-Part Declining Production
In the above discussion, it was assumed that past perform-
ance showed the production to be declining, and in such
cases the projection is merely based on a continuation of
that decline trend.
When no past decline trend is available because the
property is relatively new or under proration or market
curtailment, however, the appraiser must base his projec-
tion on a volumetric estimate of the ultimate recovery and
VALUATION OF OIL AND GAS RESERVES
try to match the future performance of the property against
this estimate. This is usually done by assuming a rate of
decline typical for this type of production and comput-
ing. by means of Eq. 55 of Chap. 40, the cumulative
recovery to be obtained when the production is declining
from the prorated rate to the economic limit. The num-
ber of months of constant-rate production preceding this
decline period is then found by subtracting the cumula-
tive production at the appraisal date as well as the esti-
mated production to be obtained during the decline period
from the estimated ultimate recovery and dividing the re-
sult by the assumed monthly production rate under
proration.
Proration or Market Curtailment
Historically, production frequently has been limited by
proration. Future operations may encounter proration to
guard against loss of reserves through wasteful operations
or may encounter curtailment of production because of
low market demand. These considerations must be pro-
jected in a proper assessment of properties located in af-
fected areas.
Produced Product Prices
The volatility of international energy markets has elimii
nated any confidence in estimating future product prices
on the basis of plots of historical data. Most evaluations
are currently performed over a range of assumptions.
Constant oil and gas price evaluations are most frequent-
ly required for securities registration and for financing
purposes. Projected economic conditions that assume
maximum and minimum cost and price assumptions are
usually applied in management decisions.
Development and Operating Costs 13-15
Development Costs
Costs of development include the drilling and completion
of wells and such improvements as roads, buildings, pipe-
lines, tanks, natural-gasoline plants, and power installa-
tions. These costs are changing constantly owing to both
economic conditions beyond the control of the operator
and technical improvements in drilling and production
methods.
The drilling and completion of wells usually constitutes
the chief item of expense for development. Shallow wells
that are drilled with a portable outfit may cost as little
as $20.000. In the hilly districts of Kentucky, it may re-
quire a greater outlay to move the drilling rig to the loca-
tion than the cost of the well itself. Costs on the high side,
apart from exceptional experiences with mishaps or long
fishing jobs, may reach tens of millions of dollars for
18,000 to 25,000 ft.
The initial exploratory well generally costs much more
than the development wells, and the continued develop-
ment of a field almost always brings lowered costs with
improved methods and increased competition among
contractors.
Tangible and Intangible Costs. For income-tax pur-
poses, development costs are divided into two categories:
tangible and intangible. Tangible development costs rep-
resent the physical property that has salvage value, such
as derrick, pipe, and smaller equipment. They are capital-
ized and retired through annual charges to depreciation.
41-11
Intangible drilling and development costs are labor. pow-
er, fuel, freight and hauling, water, repairs, and other
items that provide no salvage return after completion of
the well or that have no physical identity. This class of
costs may either be capitalized and retired through annu-
al charges or written off as an expense item in the income
account during the year it was incurred. Generally, the
latter course is followed. The intangible costs make up
60 to 70% of the entire well cost; the percentage is great-
er with the shallow wells or any other wells where the
casing program requires less pipe than usual.
Well Spacing. An important consideration in appraising
undeveloped properties is the prevailing well spacing.
Properties that are already fully drilled present no prob-
lem, but those that are yet to be developed require con-
sideration of this feature because the future profits will
be controlled greatly by the number of wells required.
The number of development wells commonly required
as a matter of practical necessity by reason of offset, com-
petitive situations, and the specific lease requirements and
obligations is generally much larger than the minimum
number of wells required for proper drainage.
Operating Expenses
These expenses cover the field operations necessary to
bring the oil and gas to the surface and to deliver a sala-
ble product to the stock tank or the gas pipeline.
Direct Lifting Expenses and Direct Expenses. The oper-
ating costs are generally divided into direct lifting ex-
penses at the property, such as labor, power, fuel, repairs,
renewals, and into-the-field organization; or district ex-
penses, such as supervision, engineering, accounting.
timekeeping, warehousing, and general transportation,
which in turn are distributed over a number of property
units on some ratable basis.
In the determination of a proper measure of produc-
tion costs for use in estimates, the appraiser may first as-
certain the definite record of the property under
consideration, or else he may draw on his experience with
similar properties elsewhere.
Cost per Well-Month. Operating expenses are prefera-
bly expressed on a per-well-month basis rather than per
barrel of oil produced. The field cost of operating any
given well is the same, within reasonable limits, whether
the amount pumped is large or small. The pumping as-
sembly that is installed for pumping an 80-B/D well con-
tinues in use when less than half that amount is being
produced, but the cost of the operation continues practi-
cally unchanged.
Average Cost per Barrel. The use of an average cost
per barrel may be acceptable when the production rates
are so severely restricted that they are expected to con-
tinue at a uniform pace over a considerable period of time.
When the production is declining, however, the assump-
tion of an average cost per barrel that is based on a past-
experience figure for the property under consideration
may lead to erroneous results. The reason is that, with
declining production and constant or nearly constant per-
well costs, the operating cost per barrel must increase with
time until it equals the gross income at the economic limit.
41-12
TABLE 41.8-FIELD OR DISTRICT OPERATING COST
Labor, includingbenefits
and transportationfurnished 20 to 30%
Districtexpense, includingInsurance,
professionalservices,damages, etc. 20 to 30%
Repalrs and maintenance 30 to 50%
Power, water, waste disposal, and oiltreating 5 to 15%
In the case of constant-percentage decline: allowance
may be made for this increasing tendency by computing
a weighted-average operating cost per barrel with the fol-
lowing relationship:
0, Inq,/q,, .,....,,,...............
o,,=
where
O,, = weighted average operating cost, dollars.
0, = operating expenses per well-month, dollars,
41 = initial production rate, bbl/D, and
cl,, = production rate at abandonment. bbl/D.
Example Problem 3. If the operating cost per well-
month, 0,, is estimated at $300, and if the initial pro-
duction rate. qi. is 2,113 bbl/welllmonth. while the
economic-limit production rate, q,, is 113 bbliwelli
month, the weighted- average operating costibbl over the
life of the property is
300 In 2,113/113
=$0.44
2.113-113
In the case of hyperbolic decline (n = %), Eq. 1 takes the
form
o,,=o’G. . (2)
4;
In the case of harmonic decline. this relationship reads
In the case of constant-rate production, the average
operating cost per gross barrel is simply the estimated
operating cost per well-month divided by the rate of pro-
duction.
The most desirable cost estimate and the one that is con-
clusive if it can be ascertained is the actually recorded
experience at the property subject to such modifications
as may appear to be warranted in the judgment of the ap-
praiser.
Range of Costs. Operating costs per well for primary pro-
duction range from almost insignificant amounts per well-
month up to $10,000 or more per well-month. The latter
rate is found offshore or where heavy equipment handles
large volumes of water with the oil and where power and
maintenance charges are high. Many farms throughout
the eastern U.S. contain wells that yield less than % BID;
PETROLEUM ENGINEERING HANDBOOK
their profitable operation is possible only because repair
expenses arc negligible
c c and the men who milk the cows
also attend the wells.
For entire fields or districts. operating costs generally
break down as shown in Table 41.8. Labor and district
expense are of about equal magnitude and together corn
prise about half the total operating costs. The other half
is for repairs. maintenance, power, water, waste disposal.
and oil treating.
Stimulation Costs. Stimulation costs-such as reacidiz-
ing, reshooting, refracturing, and other stimulation
treatments-should be considered as part of the operat-
ing costs. Fracturing costs have mounted in recent years
to where such stimulation expenses may add from IO to
(1)
nearly 100% to the operating costs.
Recompletion Costs. Operating costs generally cover
only those expenses necessary to keep a well on produc-
tion for a given productive interval. The cost of recom-
pleting a well into a different producing zone. therefore,
is normally treated as a development cxpcnsc.
Ad Vulorem Taxes. To the direct operating expenses
should be added the ud vmlorrm or property taxes. These
taxes show a wide variation in different states and coun-
ties and may range from almost nothing to as high as 15 %
Trucking Charges. In case the property is not connect-
ed to a pipeline and oil must be trucked out, such charges
are usually charged directly against the gross income from
oil and gas sales on a per-barrel basis.
The various forms of pr-oducriort ~UJXJ.T and WPT’s
directly levied against the oil and gas produced and com-
monly collected by the purchaser are not normally in-
cluded under operating expenses but are charged directly
against the gross income from oil and gas sales.
Administration and Supervision
Under this heading are charged direction. executives,
central-office expense, accounting, insurance, supervi-
sion, personnel relations, and public relations. They are
generally designated as overhead as distinguished from
the field and district controllable expenses. In many com-
pany records, the charges vary widely because of both
management ability and the differences in accounting
methods.
Production Taxes
Taxes levied directly against oil and gas produced by the
various states and usually collected by the pipeline com-
pany come under a variety of names-such as gross pro-
duction taxes, severance tax, excise taxes, stream-
pollution taxes, conservation taxes, maintenance taxes,
license taxes, school taxes, state taxes, or gas-gathering
taxes.
Federal Taxes l6
General
When a projection of future cash net income is made in
the appraisal method previously described, provision for
estimated federal income taxes is made before discount-
ing such future projection to present worth. In this
VALUATION OF OIL AND GAS RESERVES
method, income taxes are considered an inherent part of
the cost of doing business that must be provided for out
of the producing operation.
The producing properties that often have difficulties are
those whose owners failed to provide for future income
taxes. An oil producer may be able to continue explora-
tion and drilling activities at an increasing rate so that his
exploration expenses and intangible drilling deductions
will reduce income taxes for a number of years. But if
such an operator eventually runs out of drilling locations
or funds for further development, he may be forced to
sell property to meet his taxes or loan obligations. Ac-
cording to this method. the correct approach is to include
federal income taxes in the cash-flow projection and to
consider any tax savings obtainable through exploration
and drilling activities solely as a credit to those activi-
ties. reducing their net cost. Often. the appraiser allows
indirectly for such income taxes by a higher than normal
discount rate or by taking a fraction of the present worth
before income taxes. Computation of the net operating
income after federal taxes requires a thorough understand-
ing of current tax provisions. Because of the volatility of
taxation, the tax consequences on the property valuation
at the time of the appraisal should be verified. The most
important points of federal tax provisions are summar-
ized below.
Depletion is generally considered to be the gradual ex-
haustion of a wasting asset through production. The ob-
jective of the depletion allowance is to permit the taxpayer
owing an economic interest a reasonable deduction for
the estimated cost of the reserves thus exhausted. The
1954 Code, Sec. 61 I, as amended provides that. in the
case of oil and gas wells, the taxpayer will be allowed
to deduct a reasonable allowance for depletion and
depreciation of improvements.
Cost depletion under this provision is computed by mul-
tiplying the depletable basis in the property at the end of
the tax period, unadjusted by current period depletion,
by a fraction, the numerator being unit sales for the taxa-
ble period and the denominator unit reserves at the end
of the period plus unit sales during the period. In con-
trast, percentage depletion for oil and gas wells is 15%
of the taxpayer’s gross income from the property but can-
not exceed 50% of its taxable income. It is also limited
to 65% of the total taxable income of the interest own-
er/taxpayer, with any amount disallowed by this limita-
tion deductible in a future year when sufficient taxable
income exists. The taxpayer is permitted to deduct, and
is required to adjust basis for, either cost or percentage
depletion, whichever is highest.
Although cost depletion is limited to the recovery of
the taxpayer’s basis in the property, percentage depletion
is not so limited: if the taxpayer has no depletable basis
in a property or if the entire basis has been recovered
through prior depletion charges, he may still continue to
claim depletion computed on a percentage basis.
Percentage depletion is permitted only as a deduction
to independent producers and royalty owners on a maxi-
mum of 1,000 B/D of oil equivalent. The deduction is
not allowed to integrated oil companies. Gas production
for this purpose is converted to oil equivalent volumes
at a rate of 6 Mcf to 1 bbl oil. It should also be noted
that the transfer of a proven property to another interest
owner will generally cause the loss of the percentage
41-13
depletion deduction to the transferee w,ith rcspcct to that
property.
In determining taxable income from the property for
percentage-depletion purposes, deduction must bc made
not only for ordinary operating expenses of the specific
property, including equipment depreciation, but also for
intangible drilling and development costs and for a propor-
tionate amount of the overhead properly attributable to
the producing function. In determinmg the overhead al-
location, it is customary to allocate general overhead ex-
penses between the producing operations and the other
activities carried on by the taxpayer, frequently in propor-
tion to the expenses directly attributable to each activity.
and then further to allocate that portion of the overhead
attributable to the producing function among specific prop-
erties usually in relation to the direct expense from such
propertics.
Capitalized Leasehold Costs. Ordinarily. a depletable
basis in an oil or gas property is of no particular advan-
tage to the taxpayer. The items that must be capitalized
as leasehold costs are direct costs (such as lease bonuses
or lease-purchase prices) and acquisition costs (such as
title-examination fees, recording fees, documentary
stamps if any), and geological and geophysical expenses
incurred as a result of which the taxpayer either acquires
or retains a property interest. Delay rentals paid on un-
productive properties may be expensed or capitalized at
the election of the taxpayer, and if the taxpayer has elect-
ed to capitalize intangible drilling and development costs,
such items are added to the depletable basis in the
property.
Intangibles. While expenditures for tangible items of well
equipment and related items are capitalized and recov-
ered by periodic depreciation allowances throughout their
useful lives, in the case of expenditures for intangible drill-
ing and development costs (intangibles), the taxpayer in
the oil and gas industry may elect to deduct such items
when they are paid or accrued or to capitalize them for
recovery through depletion allowances. Because percen-
tage depletion is allowed without reference to the basis
of the property, it is apparent that only in infrequent cases
would the taxpayer choose to capitalize intangibles.
This concept requires that all costs of drilling and de-
veloping an oil property be divided into the two
categories-tangible and intangible, the former to be re-
covered through depreciation. In general, items with a
salvage value are classed as tangibles while intangibles
embrace all items without a salvage value. Examples of
intangibles include labor, fuel, repairs, hauling, and sup-
plies used in drilling, shooting, and cleaning of wells: any
necessary site preparation, such as ground clearing,
drainage road making, surveying, and geological work;
and in the construction of derricks, tanks, pipelines, and
other physical structures necessary for drilling and prepa-
ration for production.
The decision to expense intangibles must be made by
the taxpayer for his first taxable year in which intangi-
bles are paid or incurred. The choice is available only
to the owner of an operating or working interest who un-
dertakes the risk of drilling on the property.
Once the capitalized cost and applicable depletion
methods have been determined, the allowable depletion,
DA, is the higher of cost depletion, DC, or percentage
41-14 PETROLEUM ENGINEERING HANDBOOK

depletion, if applicable, with the latter equal to 15% of and

gross income, VDE, but limited as stated above under cost
depletion.
The allowable depletion selected will therefore be I5 % &S xcd,, (6)
of gross depletion, VDE, when N, fs

D, = V,,, where
where Cd, = depletable leasehold cost basis at beginning
of tax period, dollars,
vTI>vDE>DC N,. = reserves at end of tax period, bbl or Mcf,
and and
s = unit sales during periods.
v,,=(o.15xV)<(o.65xl,), .. . .(4)
where
Example Problem 4. An operator owns half of the work-
DA = allowable depletion, highest of DC or
ing interest (WI =0.50) in a two-well lease that produced
lesser of VDE and VT,,
20,000 bbl of oil during the taxable year. His revenue
V DE = “percent of gross” revenue, percentage
interest is % of ‘/s (RI=0.4375). The remaining reserves
depletion, (Q) on Jan. I are estimated to be 50,000 bbl. His deple-
VT, = “50% of net” percentage depletion, equal tion leasehold cost (LC) on Dec. 3 1 of the taxable year
to 50% of taxable net income, dollars, is $20,000. The gross income per barrel of oil produced
DC = cost depletion; portion of leasehold cost is $30, plus $2 from associated gas sales. Local produc-
proportional to reserves produced in a tion taxes are 5 % of gross income, or $1.6O/net bbl, while
given year, dollars, operating expenses, including district expenses and ad
V = gross revenue (value); the total earned dorem taxes, are $2,00O/well/month. General overhead
income from oil and gas sales, dollars, (GO) is $l/net bbl. Intangible development cost during
and the year was $40,000, while equipment depreciation is
$2/net bbl of oil produced. What is the allowable
Ir = interest owner’s taxable income, dollars.
depletion?
The allowable depletion selected will be 50% of net per-
centage depletion, when Solution.

where
20,000
DC= x20,000=$5,714.
50,000+20,000

VT,=0.50x[0.4375x20,000x(30+2-1.60-l-2)
v~,=o.~oo~~p~l/o~~,Dp, .. .. . .(5)
where
OG =general overhead expenses, dollars,
c PT =local production tax, dollars,
0, =operating expenses per well-month, dollars, In this case, apparently, VT, > VDE > DC and the allow-
CI =intangible drilling and development costs, able depletion is therefore DA = VDE =$7,700.
dollars, and
D, = depreciation, the decline in value of Alternative Minimum Tax. The Internal Revenue Code
tangible assets with use of passage of of 1954 has been amended at various times to include pro-
time (obsolescence), visions requiring that a taxpayer pay a specified rate of
tax on certain defined tax preference items. These prefer-
or cost depletion, DC, when ence items currently include two oil- and gas-related ex-
penses: percentage depletion deductions in excess of the
depletable basis in a specific property and certain intan-
DA =Dc>
gible drilling and development costs. The latter item is
not applicable to corporate taxpayers.
While the percentage depletion preference item is fair-
ly self-explanatory, the determination of the intangibles
that must be included as a preference item requires
computation:

VTI>D,>VDE. CIP =c/x-1,'

VALUATION OF OIL AND GAS RESERVES
TABLE 41.9-TIER AND
Tier 1 (oilother than Tier 2 or 3)
Tier 2 (stripperoiland certainU.S. government interests)
Tier 3 (newly discovered, heavy and incrementaltertiary
Tier 3 (newly discovered oilsubsequent to May 31, 1979)
where
CIp = preference intangible drilling costs, dollars,
and
CIX = intangible costs minus CrA, dollars.
I,, is the net income from productive oil and gas proper-
ties, defined as the aggregate amount of gross income from
all such properties, less deductions allocable to the prop-
erties reduced by CIX as set forth above.
This preference item can be reduced if the taxpayer
chooses to capitalize all or any portion of the intangibles
paid or incurred during the year.
Windfall Profit Tax. In April 1980, Congress passed the
Windfall Profit Tax Act that was designed to tax the oil
and gas interest owner on the windfall profit that was to
be received as a result of the deregulation of domestic
crude-oil prices. The taxable profit is the excess of the
selling price over what the price would have been were
it sold before decontrol, adjusted by an inflation factor.
An additional adjustment is allowed for severance taxes
imposed on the difference between the controlled and
decontrolled price. The tax base is also limited to 90%
of the net income from the property.
Once the tax base is determined, the appropriate tax
rate must then be applied. Three tiers have been specifi-
cally defined into which all taxable crude oil falls. The
rates applicable to each tier depend on the classification
of the interest owner and the nature of the oil produced.
Exemptions for certain interest owners and oil types are
also provided. The current tier and rate structure is given
in Table 41.9.
Newly discovered oil. which falls within Tier 3, is sub-
ject to a tax rate schedule that declines from 22.5% in
1984 to 15% in 1986 and thereafter.
Tax Consequences Related to Conveyances. Oil and gas
taxation of property conveyances has evolved into a com-
plex set of rules that are necessary because of the many
variations of transactions that involve oil and gas interests.
Any appraiser who is valuing an interest that includes tax
consequences should be aware of the types of various
transactions.
There are four primary methods of disposing of oil and
gas interests:sale. sublease, special sharing arrangements
in a partnership, and production payments. The acquisi-
tion of interests may involve the reciprocal of these
methods as well as the receipt of an interest for services.
The sale/purchase of an interest provides the easiest fo-
rum within which to determine the tax consequences. The
41-15
RATE STRUCTURE. WPT
Other than
Independent Independent
Producer Producer
w W)
50 70
30 50
oil) 30 30
15 15
seller will recognize gain that will be characterized as cap-
ital or ordinary, depending on various factors that involve
the classification of the seller and the tax history of the
property. The buyer will merely have basis in the prop-
erty that should be allocated between the mineral interest
and lease and well equipment. Note that an interest own-
er will often look to the appraiser for guidance regarding
the amount that should be allocated to lease and well
equipment.
A sublease commonly arises where the transfer of a
working interest is burdened with a nonoperating interest
retained by the assignor. Consideration received by the
assignor is ordinary income because it is characterized
as a lease bonus. Any basis in the property is attributed
to the nonoperating interest that is depletable; it is not al-
lowed as an offset to the income. The assignee’s purchase
price will be allocated between leasehold cost and lease
and well equipment, if applicable.
Special sharing arrangements are frequently used in a
partnership context to allow special allocation of certain
items of income and deduction. The partnership alloca-
tion rules explained in the Internal Revenue Code and the
regulations published by the Dept. of the Treasury should
be used as a guide to confirm the tax treatment of such
allocations. A problem exists in the standard “third for
a quarter” transaction outside the partnership context: the
expenses paid by the assignee attributable to the seller’s
retained interest are considered leasehold cost. They are
not deductible even if they are in the nature of intangibles.
A production payment is the right to a specific share
of production from an oil and gas property. Where the
production payment is used to finance a project, it is treat-
ed as a loan by the lender and the interest owner who
carved it out of production. Where a working-interest
owner retains a production payment and conveys his
working interest, he is treated as having sold his interest
and should report the proceeds as income realized from
the sale of the property. In certain instances, the holder
of the production payment may be treated as owning an
economic interest. As indicated previously, this would al-
low the possible deduction of depletion, subject to the re-
strictions discussed.
The acquisition of an interest in an oil and gas proper-
ty is frequently made through the performance of serv-
ices. At one time, it was generally believed that. at the
date of transfer, the party receiving the interest was not
involved in a taxable event. He, along with the other ven-
dors, dealers, and professionals involved in the proper-
ty> was merely contributing capital to enable its
development. This position, while originally accepted by
the Internal Revenue Service, has recently come under
 PETROLEUM ENGINEERING HANDBOOK

Fig. 41.2-Discounted-cash-flow method. Rate of return Fig. 41.4-Morkill method. Rate of return I’= YZPn;(C,-S) =
j’= I;P/I;C, = P/C, = constant. At abandonment P/C, -S=constant. At abandonment time t,,C, =S
time, C, = Tm, (no interest). (includinginterest).

attack and is being severely restricted. The government’s

current position is that in most instances, at the date of
transfer, the taxpayer performing services recognizes tax-
able income. The issue is far from settled, and additional
NET
PROFIT activity is expected to clarify the tax consequences of such
P=,‘C transactions.
0
Different Concepts of Valuation
The literature includes many different methods that may
be used to evaluate the known or estimated future projec-
tion of net income from a given venture. ‘7-20 One of
them, the discounted-cash-flow method, illustrated in Fig.
41.2. simply reduces these future income payments to
present worth or present value by a chosen rate of com-
pound interest or rate of return. It represents the banker’s
approach to a stream of future income payments and is
widely used in industrial work.
The Hoskold method, illustratedin Fig. 41.3, was spe-
cifically designed for ventures with a limited life, such
as mines or oil or gas wells, and was first used in mine-
evaluation work.
The Morkill method, illustrated in Fig. 4 1.4. is actual-
ly a refinement of the Hoskold method and is also mainly
applicable to ventures with a limited life, such as mines
and oil or gas wells.
Fig. 41.3~Hoskold method. Rate of returnj’= P/C, = constant.
At abandonment time t,,C, = S (includinginterest.) The accounting method. illustrated in Fig. 41.5, rep-
resents the accounting approach to the valuation problem
and takes into account the actual depletion pattern applica-
ble to the given venture. It is particularly suited for those
ventures where a specified total number of units of pro-
duction is involved and where. as is the case in most ex-
tractive industries. the depletion applied to the original
capital investment is on a unit-of-production basis.
VALUATION OF OIL AND GAS RESERVES
Fig. 41.5-Accounting method. Rate of returnj’= Z/XC,. At
abandonment time t,, C, = ED, (no interest).
The average-annual-rate-of-return method, illustrated
in Fig. 41.6, is essentially a refinement of the accounting
method and, by applying the present-worth concept to both
the net annual profits and the net remaining investment
balances, simplifies the computations and properly weighs
the time pattern of the income.
A complete summary of the basic equations for these
different methods and their appraisal and rate-of-return
equations will be found in Table 41.10. The top part of
this table shows the equations for continuous compound-
ing and the solution for the constant-rate case. The bot-
tom part shows the appraisal equations and the
rate-of-return equations for the general case where the
cash flow, I, varies from year to year.
Discounted-Cash-Flow Method
This method, also referred to as the investors method ‘*
or internal-rate-of-return method, “,‘* is the one most
often used in appraisal work. It is based on the principle
that, in making an investment outlay, the investor is ac-
tually buying a series of future annual operating-income
payments. The rate of return (with this method) is the
maximum interest rate that one could pay on the capital
tied up over the life of the investment and still break even.
The time pattern of these future income payments is,
therefore, given proper weight.
No fixed amortization pattern needs to be adopted with
this method because the annual amounts available for
amortization are equal to the difference between the net
income and the fixed profit percentage on the unreturned
balance of the investment. The computations necessary
for a property evaluation are, therefore, relatively sim-
ple. They usually involve only the discounting of the pro-
41-17
Fig. 41.6-Average-annual-rate-of-return method. Rate of return
j’= present worth of W/present worth of XC, = Area
ABCDElArea FGHK. At abandonment time t,,
C, =ZD, (no interest).
jetted cash flow to present value by means of the desired
rate of interest.
The appraisal value is then
Cj=I,(l+i’)-“+I2(l+i’)-‘I~+. .+Z,(l+i’)“-‘,
fl=r,
C;= C I,(l+i’)“-“, .. . ... .. (7)
n=l
in which I,, I2 . . . I, represents the projection of the cash
income in successive years and the compound-interest fac-
tor for the speculative effective interest rate i’is comput-
ed for the assumption that the entire income for each year
is received at mid-year. Appropriate midyear compound-
interest factors (1 +i’)“-’ will be found in Table 4 1.11
for speculative effective interest rates from 2 to 200%.
In the case of oil-producing properties, the computed earn-
ing power by this method is not necessarily the same as
the average rate of return later shown on a company’s
books for the net investment in the property. Most oil
companies amortize their investments in producing prop-
erties in proportion to the depletion of the reserves or on
a unit-of-production basis. However, no provision for
such amortization pattern is made in the discounted-cash-
flow method. When the production rate and the income
both follow constant-percentage decline and the ratio be-
tween initial and final production rates is substantial, no
serious difference will result. However, when the rate of
production and the income are constant for a long period
of time, a substantial difference may develop and the aver-
age rate of return, as shown later on the company’s books,
may be appreciably higher than the rate of return used
in the evaluation by the discounted-cash-flow method.
41-18 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.10-SUMMARY OF EQUATIONS APPLICABLE TO DIFFERENT VALUATION METHODS

Discounted Cash Flow Hoskold

For continuous compounding, I df=j’C, dl-dC, (8) I dl+jS dt=j’C, dt+dS (14)
basic equation where f=O C, =C, where t=O S=O
t=t, c,=o t=t, s=c,

Appraisal equation for constant

annual income of I dollars
per year (15)

Rate-of-returnequation for Solutionforj’which willsatisfy , je -I’,

constant annual income of I Eq. 9 i’= -
dollarsper year C, l-e-“.

General case: “=ta

” = 1,
Appraisal equation c, = c /,(l+I’)“-” (7)
n=, “5 /“(I+/)‘a-”

c,= (10)

1 + r[(l +,)‘a-‘]

or

FP”E/
c,=i’i’ (11)

--c J i
T-l (1 +i)-‘8

Rate-of-return
equation Solutionfor i’that willsatisfy
Eq. 7
(12)

or

j’=
i
L FP”E’
---(l+i)y’s
C,

1 -(1 +i)-‘a
1 (13)

The method may be illustrated with the diagram of Fig. where

41.2, which shows the application of the discounted-cash- I = yearly net income, dollars,
flow method to a venture that is expected to yield an in- j’ = nominal annual speculative interest rate,
come of $1 OO,OOO/yrevenly over a period of 10 years fraction, and
and where a speculative nominal rate of return j’ of Cs = balance of unreturned portion of
lSX/yr is desired. Time in years is plotted on the horizon-
investment, dollars.
tal axis, while the constant income is represented by the
horizontal line for $lOO,OOO/yr in the upper part of the
diagram. The top portion of the diagram shows how the Integration of this equation for constant-rate income be-
portion of the total income, I, allocated to amortization, tween the limits r=O, CB = C; and t =t,, , Cs =0 leads to
mk, increases, while the net-profit portion (P) decreases the appraisal value C, for a nominal rate of return
with time. The bottom portion of the chart illustrates the j’=O. 15:
manner in which the cumulative Cmk gradually reduces
the unreturned balance of the investment, CB =C; -Cmk,
from its initial value, C;, to zero at abandonment of the c;=(l-a-J”<,)
;
venture. 0J
The computation of the curves for this constant-rate case
is based on the basic differential equation for discounted =[l-e-(o.l”,(lo,]
’
cash flow, (~Y.lY”l=$517,900.
Idt=j’CBdr-dCB, (8) ,...............,............. (9)
VALUATION OF OIL AND GAS RESERVES 41-19

TABLE 41 .lO-SUMMARY OF EQUATIONS APPLICABLE TO DIFFERENT VALUATION METHODS (continued)

Morkill Accountrng Average annual rate of return

I dt+jS dt=j’(C,-S)dt+dS (18)
I(1 tj).‘dt
where t=O S=O
t=t, s=c,

CI t, - [‘“dtl:dt CI“‘(l tj))‘dt-k

J
0 0 0

~f8
where E:I
= I dt where k = ]“dt(l +j) -r1’1dt
I
;I 0 0

fa
and EI= I dt
5
0

t.3’ t,/,(l -e-‘J)

c, = (23) c, =
,+j’.t, j’t,- (-1 (I-e-‘a’)
2 i: I )

c :,
I
Solutionforj’that willsatisfy
(1 -em’a/)(/t ) --l
Eq. 19 j’=2 i-l (22) a t c, ta 1
c, ta j’=
jt,- (1 - e -‘n’)
“=Ca

c /,(lt/+i’)‘a-”
n=, (24)
c =-
i’
1+ ---[(l +i+P)‘a] -’
i+i’

Solutronfor i’ that willsatisfy (25)

Eq. 16

Legend:
I, = net annual operating income during nth year, dollars
XI = totalfuturenet operating income, dollars
C, = balance of unreturned portionof investment,dollars
S = balance of sinking fund, dollars
C, = initial
capitalinvestment or purchase price,dollars
F pv = average deferment factoron cash-flow projectionat a safe rate of interesti; as a
decimal fraction
j= nominal annual safe interestrate or rate of return;as a decimal fraction
j’ = nommal annual speculativeinterestrate or rate of return;as a decimal fraction
i= effectiveannual safe interestrate or rate of return;as a decimal fraction
i’= effectiveannual speculativeinterestrate or rate of return;as a decimal fraction
t= time, years
t, = time untilabandonment, years
e = base naturallogarithms
(Np)n.‘.2= cumulative production at the midpomt of year n
(N,), = cumulative production at abandonment time: the end of the lastyear f,
41-20 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.11-LUMP-SUM DEFERMENT FACTORS FOR EFFECTIVE ANNUAL INTEREST RATES FROM 2 TO 200%/yr,
APPLICABLE TO PAYMENTS AT YEAR END

Year 2% 3% 4% 5% 6% 8% 10% 12% 15% 20% 25% 30% 35% 40% 45%
10.98040.97090.96150.95240.94340.92590.90910.89290.86960.83330.80000.76920.74070.71430.6897
2 0.9612 0.9426 0.9246 0.9070 0.8900 0.8573 0.8264 0.7972 0.7561 0.6944 0.6400 0.5917 0.5487 0.5102 0.4756
3 0.9423 0.9152 0.8890 0.8639 0.8396 0.7938 0.7513 0.7118 0.6575 0.5787 0.5120 0.4552 0.4064 0.3644 0.3280
4 0.9239 0.8885 0.8548 0.8227 0.7921 0.7350 0.6830 0.6355 0.5718 0.4823 0.4096 0.3501 0.3011 0.2603 0.2262
5 0.9057 0.8626 0.8219 0.7835 0.7473 0.6806 0.6209 0.5674 0.4972 0.4019 0.3277 0.2693 0.2230 0.1859 0.1560
6 0.8879 0.8375 07903 0.7462 0.7050 0.6302 0.5645 0.5066 0.4323 0.3749 0.2621 0.2072 0.1652 0.1328 0.1076
7 0.8705 0.8131 07599 0.7107 0.6651 0.5835 0.5132 0.4523 0.3759 0.2791 0.2097 0.1594 0.1224 0.0949 0.0742
8 0.8535 0.7894 0.7307 0.6768 0.6274 0.5403 0.4665 0.4039 0.3269 0.2326 0.1678 0.1226 0.0906 0.0678 0.0512
9 0.8368 0.7664 0.7026 0.6446 0.5919 0.5003 0.4241 0.3606 0.2843 0.1938 0.1342 0.0943 0.0671 0.0484 0.0353
10 0.8203 0.7441 0.6756 0.6139 0.5584 0.4632 0.3855 0.3220 0.2472 0.1615 0.1074 0.0725 0.0497 0.0346 0.0243
11 0.8042 0.7224 0.6496 0.5847 0.5268 0.4289 0.3505 0.2875 0.2149 0.1346 0.0859 0.0558 0.0368 0.0247 0.0166
12 0.7885 0.7014 0.6246 0.5568 0.4970 0.3971 0.3186 0.2567 0.1869 0.1122 0.0687 0.0429 0.0273 0.0176 0.0116
13 0.7730 0.6810 0.6006 0.5303 0.4688 0.3677 0.2897 0.2292 0.1625 0.0935 0.0550 0.0330 0.0202 0.0126 0.0080
14 0.7579 0.6611 0.5775 0.5051 0.4423 0.3405 0.2633 0.2046 0.1413 0.0779 0.0440 0.0254 0.0150 0.0090 0.0055
15 0.7430 0.6418 0.5553 0.4810 0.4173 0.3152 0.2394 0.1827 0.1229 0.0649 0.0352 0.0195 0.0111 0.0064 0.0036
16 0.7284 0.6232 0.5339 0.4581 0.3936 0.2919 0.2176 0.1631 0.1069 0.0541 0.0281 0.0150 0.0082 0.0046 0.0026
17 0.7142 0.6050 0.5134 0.4363 0.3714 0.2703 0.1978 0.1456 0.0929 0.0451 0.0225 0.0116 0.0061 0.0033 0.0018
18 0.7002 0.5874 0.4936 0.4155 0.3503 0.2503 0.1799 0.1300 0.0808 0.0376 0.0180 0.0089 0.0045 0.0023 0.0013
19 0.6864 0.5703 0.4747 0.3957 0.3305 0.2317 0.1635 0.1161 0.0703 0.0313 0.0144 0.0068 0.0033 0.0017 0.0009
20 0.6730 0.5537 0.4564 0.3769 0.3118 0.2145 0.1486 0.1037 0.0611 0.0261 0.0115 0.0053 0.0025 0.0012 0.0006
21 0.6598 0.5375 0.4388 0.3589 0.2942 0.1987 0.1351 0.0926 0.0531 0.0217 0.0092 0.0040 0.0018 0.0009 0.0004
22 0.6468 0.5219 0.4220 0.3418 0.2775 0.1839 0.1228 0.0826 0.0462 0.0181 0.0074 0.0031' 0.0014 0.0006 0.0003
23 0.6342 0.5067 0.4057 0 3256 0.2618 0.1703 0.1117 0.0738 0.0402 0.0151 0.0059 0.0024 0.0010 0.0004 0.0002
24 0.6217 0.4919 0.3901 0.3101 0.2470 0.1577 0.1015 0.0659 0.0349 0.0126 0.0047 0.0018 0.0007 0.0003 0.0001
25 0.6095 0.4776 0.3751 0.2953 0.2330 0.1460 0.0923 0.0588 0.0304 0.0105 0.0038 0.0014 0.0006 0.0002 0.0001
26 0.5976 0.4637 0.3607 0 2812 0.2198 0.1352 0.0839 0.0525 0.0264 0.0087 0.0030 0.0011 0.0004 0.0002 0.0001
27 0.5859 0.4502 0.3468 0.2678 0.2074 0.1252 0.0763 0.0469 0.0230 0.0073 0.0024 0.0008 0.0003 0.0001
28 0.5744 0.4371 0.3335 0.2551 0.1956 0.1159 0.0693 0.0419 0.0200 0.0061 0.0019 0.0006 0.0002 0.0001
29 0.5631 0.4243 0.3206 0.2429 0.1846 0.1073 0.0630 0.0374 0.0174 0.0051 0.0015 0.0005 0.0002
30 0.5521 0.4120 0.3083 0.2314 0.1741 0.0994 0.0573 0.0334 0.0151 0.0042 0.0012 0.0004 0.0001
31 0.5412 0.4000 0.2965 0.2204 0.1643 0.0920 0.0521 0.0296 0.0131 0.0035 0.0010 0.0003 0.0001
32 0.5306 0.3883 0.2851 0.2099 0.1550 0.0852 0.0474 0.0266 0.0114 0.0029 0.0008 0.0002 0.0001
33 0.5202 0.3770 0.2741 0.1999 0.1462 0.0789 0.0431 0.0238 0.0099 0.0024 0.0006 0.0002
34 0.5100 0.3660 0.2636 0.1904 0.1379 0.0730 0.0391 0.0212 0.0086 0.0020 0.0005 0.0001
35 0.5000 0.3554 0.2534 0 1813 0.1301 0.0676 0.0356 0.0189 0.0075 0.0017 0.0004 0.0001
36 0.4902 0.3450 0.2437 0.1727 0.1227 0.0626 0.0323 0.0169 0.0065 0.0014 0.0003 0.0001
37 0.4806 0.3350 0.2343 0 1644 0.1158 0.0580 0.0294 0.0151 0.0057 0.0012 0.0003
38 0.4712 0.3252 0.2253 0.1566 0.1092 0.0537 0.0267 0.0135 0.0049 0.0010 0.0002
39 0.4620 0.3158 0.2166 0.1491 0.1031 0.0497 0.0243 0.0120 0.0043 0.0008 0.0002
40 0.4529 0.3066 0.2083 0.1420 0.0972 0.0460 0.0221 0.0107 0.0037 0.0007 0.0001
41 0.4440 0.2976 0.2003 0.1353 0.0917 0.0426 0.0201 0.0096 0.0032 0.0006 0.0001
42 0.4353 0.2890 0.1926 0 1288 0.0865 0.0395 0.0183 0.0086 0.0028 0.0005
43 0.4268 0.2805 0.1852 0.1227 0.0816 0.0365 0.0166 0.0076 0.0025 0.0004
44 0.4184 0.2724 0.1780 0.1169 0.0770 0.0338 0.0151 0.0068 0.0021 0.0003
45 0.4102 0.2644 0.1712 0.1113 0.0727 0.0313 0.0137 0.0061 0.0019 0.0003
46 0.4022 0.2567 0.1646 0.1060 0.0685 0.0290 0.0125 0.0054 0.0016 0.0002
47 0.3943 0.2493 0.1583 0.1009 0.0647 0.0269 0.0113 0.0049 0.0014 0.0002
48 0.3865 0.2420 0.1522 0.0961 0.0610 0.0249 0.0103 0.0043 0.0012 0.0002
49 0.3790 0.2350 0.1463 0.0916 0.0575 0.0230 0.0094 0.0039 0.0011 0.0001
50 0.3715 0.2281 0.1407 0.0872 0.0543 0.0213 0.0085 0.0035 0.0009 0.0001

To find the rate of return corresponding to a given pur- Hoskold’s Method

chase price by the discounted-cash-flow method, no
straightforward solution is possible; one has to resort to
a trial-and-error procedure.
The curve for the unreturned balance. Cg. for this case
is shown in the bottom portion of the graph, together with
the cumulative amortization (CmL =Ci -CR). The cor-
responding amortization portion. nrk, of the income, I,
is shown in the top portion of the graph.
It may be noted from Fig. 41.2 that the rate of return,
j’, is the constant ratio of net profit (P=l-mi, ) and the
unreturned balance of investment (CA = C, -GUI,! ). and
the balance, CR, is declining slowly at first and faster
toward the end and does not keep pace with the actual
depletion of the source of income.
Most industries and manufacturing enterprises have an in-
determinate life (apparently perpetual) and are therefore
not called on to replace the original investment. This does
not mean that such enterprises will continue forever; it
means merely that, except for competition, nothing is ap-
parent that might cause termination. Because of this un-
certainty, appraisal by the discounted-cash-flow method
is generally the best method for such ventures.
Oil, gas, mining, and other extractive industries. how-
ever, differ from the foregoing enterprises. When the oil
reservoir is depleted or the ore body mined out. there is
no value left except possibly some equipment salvage. It
is desirable to return the original capital to the investor
by the time the profitable life of the enterprise is ended.
VALUATIONOFOILAND GAS RESERVES 41-21

TABLE 41.11-LUMP-SUM DEFERMENT FACTORS FOR EFFECTIVE ANNUAL INTEREST RATES FROM 2 TO 200%/yr,
APPLICABLE TO PAYMENTS AT YEAR END (continued)

Year 50% 60% 70% 80% 90% 100% 110% 120% 130% 140% 150% 160% 170% 160% 190% 200%
~__
1 0.6667 0.6250 0.5882 0.5556 0.5263 0.5000 0.4762 0.4545 0.4348 0.4167 0.4000 0.3846 0.3704 0.3571 0.3448 0.3333
2 0.4444 0.3906 0.3460 0.3086 0.2770 0.2500 0.2268 0 2066 0.1890 0.1736 0 1600 0.1479 0.1372 0.1276 0.1189 0.1111
3 0.2963 0.2441 0.2035 0.1715 0.1458 0.1250 0.1080 0.0939 0.0822 0.0723 0.0640 0.0569 0.0506 0.0456 0.0410 0.0370
4 0.1975 0.1526 0.1197 0.0953 0.0767 0.0625 0.0514 00427 0.0357 0.0301 0.0256 0.0219 0.0188 0.0163 0.0141 0.0123
5 0.1317 0.0954 0.0704 0.0529 0.0404 0.0313 0.0245 0.0194 0.0155 0.0126 0.0102 0.0084 0.0070 0.0058 0.0049 0.0041
6 0.0878 0.0596 0.0414 0.0294 0.0213 0.0156 0.0117 0 0088 0.0068 0.0052 00041 0.0032 0.0026 0.0021 0.0017 0.0014
7 0.0585 0.0373 0.0244 0.0163 0.0112 0.0078 0.0056 0.0040 0.0029 0.0022 0.0016 0.0012 0.0010 0.0007 0.0006 0.0005
8 0.0390 0.0233 0.0143 0.0091 0.0059 0.0039 0.0026 0.0018 0.0013 0.0009 0.0007 0.0005 0.0004 0.0003 0.0002 0.0002
9 0.0260 0.0146 0.0084 0.0050 0.0031 0.0020 0.0013 0.0008 0.0006 0.0004 0.0003 0.0002 0.0001
10 0.0173 0.0091 0.0050 0.0028 0.0016 0.0010 0.0006 0.0004 0.0002 0.0002 0.0001
11 0.0116 0.0057 0.0029 0.0016 0.0009 0.0005 0.0003 0.0002 0.0001
12 0.0077 0.0036 0.0017 0.0009 0.0005 0.0002 0.0001
13 0.0051 0.0022 0.0010 0.0005 0.0002 0.0001
14 0.0034 0.0014 0.0006 0.0003 0.0001
15 0.0023 0.0009 0.0003 0.0001
16 0.0015 0.0025 0.0002
17 0.0010 0.0003 0.0001
18 00007 0.0002
19 0.0005 0.0001
20 00003
21 0.0002
22 00001
23 00001
24 00001

This leads to a somewhat different approach to the eval- price may be computed directly with the general rate-of-
uation of enterprises in such extractive industries. One return equations.
of the earliest methods, proposed by Hoskold in I877 I’)
,I=,I,

for the mining industry. emphasizes complete return of
the originally invested capital at abandonment time by
means of a sinking fund. Hoskold’s method presupposes
a uniform rate of return at the speculative rate of interest
i’ on the original capital and provides for redemption of
capital at abandonment time by annual reinvestment of
the balance of the yearly earnings in a sinking fund at a
safe rate of interest i. No fixed amortization pattern is
used, but proper weight is given to the specific time pat-
tern of the future cash-income payments.
The appraisal value by the Hoskold method is computed
with
in which the numerator represents the combined value of
the cash-Income payments. I,, (no depreciation or deple-
tion), computed at abandonment time (t,,) including com-
pound interest at the safe rate (i) per year.
When the weighted average deferment factor or dis-
count factor on the production rate and income projec-
tion (FpL,) is available at a safe interest rate of 5%/yr.
this equation reduces to
FpL,CI
c, =
(;‘/;)-[(;‘/j)-l](l+;)-‘,, “.‘....“”
The rate of return corresponding to a given purchase
i’=1 1I
i l/C, C I,,(1 +i)‘,,?l -I
[ ,I= I
, (12)
(l+i)‘lJ -1
or
i[(FpVCI/C;)-(1 +i) -‘(<I
i’= *-(,+i) -,,, . (13)
The interesting feature of this method is Its concept of
a safe or bank interest rate (i) that is used to build up the
sinking fund to full return of the invested capital at the
end of the project’s life, while at the same time a con-
(IO) stant speculative interest rate (i’) is earned on the origi-
nal capital investment (Ci ) throughout the same period.
This speculative interest rate (i’) is not comparable with
the rate of return used in the discounted-cash-flow, ac-
counting, or average-annual-rate-of-return methods be-
cause it applies strictly to the entire initial investment and
not to the declining balances of such investment.
This method may be illustrated with Fig. 41.3. which
shows what would happen to the net profit, the contribu-
tions to the sinking fund, and the sinking fund itself if
the Hoskold method were applied to the same venture as
before that yielded $lOO,OOO/yr income evenly over 10
years. It was assumed that a speculative rate of return (j’)
of IS %/yr is desired, while the safe nominal interest rate
(11) (j) is 5%/yr. The constant-income rate (f ) is again shown
as the horizontal line in the top part of the diagram. This
portion of the chart shows further that the net-profit por-
tion of this annual income (P) is not declining as in the
41-22
previous case but is a constant percentage (15%) of the
initial investment (Ci). The remaining portion of the in-
come. which is diverted to the sinking fund, is also con-
stant for this case.
The curve on the bottom part of Fig. 41.3 illustrates
how the payments to the sinking fund plus interest at a
safe rate build this fund up to where the entire initial in-
vestment (C;) is available again at abandonment time.
Computation of the data for this constant-rate case is
based on the basic differential equation for the Hoskold
method:
Idt+jSdt=j’Cidt+dS, . . . .. . .(14)
where
j = nominal annual speculative interest rate,
fraction,
S = sinking fund balance, dollars, and
C, = initial capital investment or purchase price,
dollars.
Integration of this equation for constant-rate income be-
tween the limits t=O, S=O and t=t,, S=C; leads to the
appraisal value C; for a speculative interest rate
(j’=O.lS) and a safe nominal interest rate (j=O.OS).
c, = ( 1 -e -?I) )I
I j'-(j'-j)epJf,,
= [I -~-~~~~~~~‘~~](loo,ooo)
=$440,400. . (15)
0.15-(0.10)[e-~~~~~“‘~~]
Correspondingly, the constant-net-profit portion (P) of
the annual income is 0.15 ~440,400=$66,060, while the
annual sinking fund payment is $lOO,OOO-$66,060=
$33,940, as shown on the top portion of the diagram. The
curve for the sinking fund (S) for this case is shown in
the bottom portion of the figure together with the remain-
ing unreturned portion of the investment (C, -S).
It may be observed that the rate of return (j’) is the
ratio of the net annual profit (P) to the initial investment
(C,), and the remaining net investment balance (C, -S)
is declining somewhat more slowly in the beginning than
in the end. Although the curvature is much less than in
the discounted-cash-flow method, it still does not keep
pace with the actual depletion of the source of income.
Morkill’s Method
A variation of the Hoskold equation was proposed in 19 18
by Morkill.‘” who felt that the risk or speculative rate
of interest (i’) should be expected only from the amount
of capital remaining unreturned, while the security or safe
rate of interest (i) should apply to the sinking fund.
The appraisal value by Morkill’s method may be com-
puted from
II =,
,I
C I,,(1 +i+i’)‘~~p”
,I= I
c, = .(16)
I +[i’/(i+i’)][( I +i+i’)‘cl - 1] .
PETROLEUM ENGINEERING HANDBOOK
in which the numerator represents the combined value at
abandonment time (tU) of the annual cash-income pay-
ments, I, (no depreciation), including compound interest
at the total interest rate (i+i’).
It may be of interest to note that, if the safe interest
rate (i) is zero, this equation reduces to the appraisal equa-
tion for the discounted-cash-flow method, if the
compound-interest factors at the speculative rate (i ‘) are
applied at year end instead of midyear:
li= I,,
Ci= C Z,(l +i’)-“. .. . . . . (17)
tl=l
Appropriate year-end compound-interest factors
(1 +i ‘) -’ will be found in Table 41.11 for speculative in-
terest rates from 2 to 200%.
To find the rate of return corresponding to a given pur-
chase price for the Morkill method, no direct solution is
possible, and one has to resort to a trial-and-error proce-
dure. Morkill’s method is illustrated in Fig. 41.4, which
shows the net profit, contributions to the sinking fund,
and growth of the sinking fund if this method were ap-
plied to the same venture as the other examples that yield-
ed a $lOO,OOO/yr income evenly over 10 years. As in the
Hoskold method, it was assumed that a speculative nomi-
nal rate of return (j’) of lS%/yr is desired, while the safe
nominal interest rate (j) is 5%/yr.
The horizontal line in the top part of the diagram rep-
resents the constant-rate income (I) of $lOO,OOO/yr. The
other curves for this constant-rate case are computed from
the basic differential equation for the Morkill method,
Idt+jSdt=j’(Ci-S)dt+dS. .. (18)
Integration of this equation for constant-rate income be-
tween the limits t=O, S=O and t = t, , S= C; leads to the
appraisal value (Ci) for a speculative nominal interest rate
(j’=O.lS) and a safe nominal interest rate (j=O.OS).
[,(,+.i’)f,
_ 111
c; =
j+j’,(j+i’V,,
[e(O.*O)(‘O)
- I]( 100,000)
=$551,560. _. (19)
= 0.05+(o.l5)[e’0.*0”‘0’]
The growth of the sinking fund is shown by the curve in
the bottom portion of Fig. 41.4, together with the remain-
ing unreturned portion of the investment (Ci -S). The
net-profit portion (P) of the operating income (I) shown
in the top portion is by definition equal to j’ times the
amount C, -S. It may be noted from this chart that the
rate of return (j’) is the constant ratio of net profit (P)
and the unreturned balance of the investment (C; -S),
and the sinking fund is growing slowly at first and faster
toward the end and does not keep pace with the actual
depletion of the source of income.
Accounting Method
This method, also referred to as the average-book
method, I8 is closely related to many of the concepts used
in conventional oil-company accounting procedure and
VALUATION OF OIL AND GAS RESERVES 41.23

computes the rate of return on a proposed investment as part of the diagram divided by the total of the annual in-
the ratio of the average net annual profits over the life vestment balances as represented by the area of Triangle
of the venture (after depletion) to the average book in- EFG in the bottom portion of the diagram or, al-
vestment over its life. It takes into account the actual gebraically,
depletion pattern and provides results that are compati-
ble with the actual average rate of return later shown by C,
a company’s books. With amortization of an investment td-D,)=.i’t,y,
on a unit-of-production basis or in proportion to the deple-
tion of the reserves, the appraisal value by this method while
may be expressed for the case where the net income per
unit of production is constant as
&=ci,
f <I
CI
c, = (20)

1
,I =I,
(N,),,- ,,2 ’ so that, after substitution,
l+i’ c l-
II= I VP 1u
toI (lwloo>ooo) =$571 4oo
in which Cl represents the total of the operating net in- c; = =
come payments in successive years, l+J& l + (O.lS)(lO) ’
2 2
... . (23)

It may be noted that this method, in contrast to those

i’ the desired speculative rate of return, (N,),,- ti the cu-
mulative production at the mldpoint of the nth year. and
(N,), the cumulative production or estimated ultimate at
abandonment time.
Although this method is comparatively simple, it has
found only limited application.
The rate of return (i’) for a given purchase price (C;)
may be computed directly by
(WC;) - 1
j’= (21)
‘=+ ,, _ (N,),,_ ,,~, .
,: L- (N,,), 1
or for the constant-rate case by
(22)
Its principal features are illustrated in Fig. 4 1S, which
shows the net profit (P), the amounts reserved for deple-
tion (DE), and the cumulative depletion @DE) if the ac-
counting method were applied to the same venture as
before that yielded $lOO,OOO/yr income evenly over 10
years. It was assumed that an average speculative rate of
return (j’) of 15%/yr is desired. The horizontal line in
the top part of the figure represents the $lOO,OOO/yr in-
come rate. Because the income rate and the depletion of
the reserves for this simplified case are assumed to be con-
stant, the amounts reserved for depletion (DE) are, there-
fore, also shown by a horizontal straight line.
Simultaneously, the cumulative depletion in the bottom
part of the diagram is a straight line running from zero
in the beginning to the capital investment (C,) at aban-
donment time (scale on right side).
By definition the rate of return (j’) is the average net
profit (P) divided by the average investment balance (C,)
and is also equal to the total of the annual net profits as
represented by the area of Rectangle ABCD in the top
previously discussed, allows for a depletion pattern that
follows the actual depletion of the source of income. This
is indicated for this constant-rate case by the diagonal
straight line in the bottom portion of Fig. 41.5.
Average-Annual-Rate-of-Return Method
The average rate of return, computed by this method, is
essentially the ratio of the present value of the future net
profits (after depletion) to the present value of the net book
investments over the life of a property. ’ The method is
particularly suited for investments in oil- and gas-
producing properties, where amortization of the invest-
ed capital is customarily on a unit-of-production basis and,
therefore, is proportional to the depletion of the reserves.
The average annual rate of return used in this method cor-
responds closely to the one later shown by the compa-
ny’s books, while the time pattern of income payments
is properly weighted. The equation is particularly simple
in its application because the discounting to present worth
needs to be done only for the safe interest rate (i). Be-
cause this interest rate is usually a fixed number. a series
of weighted-average-deferment-factor charts for the most
common types of production decline may be prepared in
advance. Such charts for i=O.OS are shown in Figs. 41.7
and 41.8.
According to Arps,6 the appraisal value by the
average-annual-rate-of-return method for the case where
the net operating income per unit of production is con-
stant may be computed from
-
FPV~~
c; = (24)
(i’/i)-[(if/i)-l]FPV
where I represents the total of the operating net income
payments in successive years,
41-24 PETROLEUM ENGINEERING HANDBOOK

YEARS-
40 45 50 55 60 65 70
1.0

09

0.8 864~.1.. +

// 03
042 ’
2 3456eso ;3 w 4G 60 8v IX
INITIAL PRODUCTION RATE (q ,)
“0 5 IO 15 20 25 30 35 40 45 50 55 60 65 70 RATIO
F,
YEARS - FINAL PRODUCTION RATE (q,) =

Fig. 41.7-Lump-sum and constant-ratedeferment factorsfor Fig. 41.8-Constant-percentage-decline

deferment factorfor5%
5% interest. interest.

and i ’and i are the speculative and safe interest rates, re-
spectively. FPV is the weighted average deferment fac-
tor on production and income at the interest rate i.
The rate of return (i’) for a given purchase price (C;)
may be computed directly by means of the equation
..
The relative simplicity of these equations derives from
the fact that, with amortization on a unit-of-production
basis, the deferment factor (Fpv) for the production rate
and the net operating income will be identical to the aver-
age deferment factor applicable to the annual amounts set
aside for amortization. For further details of the deriva-
tion and equations, refer to Ref. 21. In cases where the
deferment factor on the net operating income is not ex-
actly equal to the deferment factor applicable to the pro-
duction rates, such as when the lifting costs per barrel
are increasing with time, it is customary to use the weight-
ed average deferment factor applicable to the net-
operating-income projection in the equation.
The principal features of this method are illustrated in
Fig. 41.6, which shows the net profit (P), the amounts
reserved for depletion (DE), and the cumulative deple-
tion @DE) if the average-annual-rate-of-return method
were applied to the same venture as before that yielded
a $lOO,OOO/yr income evenly over 10 years. It was again
assumed that an average speculative rate of return (j’)
of 15%/yr is desired. The horizontal line in the top part
of the figure representing the annual depletion rate, and
the diagonal line in the bottom portion of the diagram,
representing the cumulative depletion, are the same as
. . (25) previously discussed for the accounting method shown in
Fig. 41.5.
The average constant-rate deferment factor for continu-
ous compounding, a safe nominal interest rate (j=O.OS),
an&a total life (t=lO yrs) may be read from Fig. 41.7
as FcR =0.787 so that the initial capital investment (C;)
may be computed by means of Eq. 25 as
(0.787)( lO)( 100,000)
Cj = =$551,900.
(0.15/0.05)-[(0.1510.05)- ll(O.787)
The present worth of the net profit, discounted at the safe
interest rate (j=O.OS) is shown by Curve ABC, while the
present worth of the net remaining investment balances
at the same rate of interest is shown by Curve GHK in
the bottom part of the diagram. The speculative rate of
return (j’) with this method is then graphically represented
by the ratio of Area ABCDE and area FGHK.
VALUATION OF OIL AND GAS RESERVES
Interest Tables and Deferment Factors I7
Simple and Compound Interest
Interest rate is the ratio between the amount paid for or
gained from the use of funds and the amount of funds
used.
Simple Interest. In simple interest. the interest to be paid
on repayment of a loan is proportional to the length of
time the principal sum has been borrowed. For example,
on a loan of $100 at a nominal interest rate of 6% iyr for
a period of 2 months. the interest due upon repayment
oftheloanwouldbe0.06~$100~2/;,=$1.00. Loansare
rarely made at simple interest for periods of more than
I year.
Compound Interest. In compound interest. the loan is
increased by an amount equal to the interest due at the
end of the interest period-e.g., on a loan of S 1,000 at
an interest rate of5 %/yr for a period of 4 years, the total
amount due upon repayment of the loan would be
1.0S1x$l,000=$l.216.
Compounding can be annually. semiannually, quarter-
ly, monthly, or continuously, depending on the length of
the stipulated interest period.
Effective and Nominal Interest
The effective annual interest rate (i) is the total compound
interest over a year’s time, expressed as a fraction or per-
centage of the amount outstanding at the beginning of the
year.
The nominal annual interest rate (j) applies when the
interest is compounded over M periods in a year and is
equal to M times the interest rate j/M for one period. When
interest is compounded once a year, the nominal (j) and
effective (i) interest rates are identical.
The relationships between effective (i) and nominal (j)
annual interest rate are
j= 1+L -I
( M‘>‘”
and
j=M[(I+i)““- I]. . (27)
When the nominal annual interest rate is jzO.06 or 6%/yr
and compounding is on a monthly basis (M= l2), the
monthly interest rate is
.i 0.06
-=- =O.OOS. or ‘/z%,
M 12
and the effective annual interest rate is
i=(l +O.OOS)” ~ I =0.06168 or 6.168%/yr.
For the case where interest is compounded continuously
(M-t 00). these relations reduce to
i-e/-l . .... ..
41-25
and
,j=ln(l +i). .(29)
Table 4 I. I2 expresses the relationships between effec-
tive annual interest rate i and nominal annual interest rate
j for annual, semiannual (M=2), quarterly (M=4),
monthly (M= 12). and continuous (M=m) compounding.
Lump-Sum Deferment Factor
A deferment factor Fpv, also referred to as average dis-
count factor or present-worth factor, is defined as the ra-
tio of the present worth of one or a series of future
payments and the total undiscounted amount of such fu-
ture payments. The following deferment factors are com-
monly used in valuation work.
The lump-sum deferment factor F,,. also known as the
single-payment present-worth factor. is the ratio of the
present value or present worth of a single future payment
made t years hence and the amount of the G$e payment.
For an effective annual interest rate (i). the lump-sum
deferment factor for t years is
F,,=(l +i) --f. . .(30)
Tables 4 1.7 and 4 I. 1 I show lump-sum deferment fac-
tors for effective annual interest rates i from 2 to 200%/yr
for payments falling either at year end (I +i) -’ or at
midyear (1 +i)“-‘, respectively; e.g., the present worth
of a lump-sum payment of $200 to be made 10 years
hence, if interest is computed at 5%/yr. is $200~
1.05~‘“=$200x0.6139=$122.78.
The midyear lump-sum deferment factors are used in
the discounted-cash-flow method when a future-income
projection by years is to be discounted to present value.
It is then customary to assume that the entire year’s income
is received at the midyear point. For fractional years, the
lump-sum deferment factor for an interest rate of 5 %iyr
may also be read directly from Fig. 41.7. Curve A.
For a nominal annual interest rate j. compounded M
times a year, the corresponding equation is
-lM
. . . . . . . . . ..__......... (31)
For continuous compounding (M= 00) at a nominal an-
nual interest rate (j) this equation reduces to
F,s=e-“. _, _. ,(32)
The lump-sum deferment factor for continuous com-
pounding may be read directly from the graph in Fig. 41.9
for given values of rj.
Constant-Rate Deferment Factor, FCK
Also known as the equal-payment-series present-worth
factor, this is the ratio of the present worth of a series
of Mt equal payments, made at equal intervals of 12/M
months over a period oft years in the future, and the to-
(28) tal amount of such payments.
41.26 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.12--RELATIONSHIP BETWEEN EFFECTIVE ANNUAL INTEREST RATE i

AND NOMINAL INTEREST RATE j FOR SEMIANNUAL,
QUARTERLY, MONTHLY, AND CONTINUOUS COMPOUNDING

EffectiveAnnual InterestRate i
When the Nominal Rateiis Comoounded
Semiannually Quarterly Monthly
m=2 m=4 m=lZ
Nommalannual
interestrate Continuously
1+h -1 m=m
(DeAmal) j'* e'=l
0.01 0.01002 0.01004 0.01004 0.01005
0.02 0.02010 0.02015 0.02018 0.02020
0.03 0.03022 0.03034 0.03042 0.03045
0.04 0.04040 0.04060 0.04074 0.04081
0.05 0.05062 0.05094 0.05117 0.05127
0.06 0.06090 0.06136 0.06168 0.06184
0.07 0.07122 0.07186 0.07299 0.07251
0.08 0.08160 0.08243 0.08300 0.08329
0.09 0.09202 0.09308 0.09381 0.09417
0.10 0.10250 0.10381 0.10471 0.10517
0.11 0.11302 0.11462 0.11572 0.11628
0.12 0.12360 0.12551 0.12682 0.12750
0.13 0.13422 0.13648 0.13803 0.13883
0.14 0.14490 0.14752 0.14934 0.15027
0.15 0.15562 0.15865 0.16075 0.16183
0.16 0.16640 0.16986 0.17227 0.17351
0.17 0.17722 0.18115 0.18389 0.18530
0.18 0.18810 0.19252 0.19562 0.19722
0.19 0.19902 0.20397 0.20745 0.20925
0.20 0.21000 0.21551 0.21939 0.22140
0.22 0.23210 0.23882 0.24360 0.24608
0.24 0.25440 0.26248 0.26824 0.27125
0.26 0.27690 0.28647 0.29333 0.29693
0.28 0.29960 0.31080 0.31888 0.32313
0.30 0.32250 0.33547 0.34489 0.34986
0.32 0.34560 0 36049 0.37137 0.37713
0.34 0.36890 0.38586 0.39832 0.40495
0.36 0.39240 3.41158 0.42576 0.43333
0.38 0.41610 0.43766 0.45369 0.46228
0.40 0.44000 0.46410 0.48213 0.49182
0.42 0.46410 0.49090 0.51107 0.52196
0.44 0.48840 0.51807 0.54053 0.55271
0.46 0.51290 0.54561 0.57051 0.58407
0.48 0.53760 0.57352 0.60103 0.61607
0.50 0.56250 0.60181 0.63209 0.64872
0.55 0.62562 0.67419 0.71218 0.73325
0.60 0.69000 0.74901 0.79586 0.82212
0.65 0.75562 0.82630 0.88326 0.91554
0.70 0.82250 0.90613 0.97456 1.01375
0.75 0.89062 0.98854 1.06989 1.11700
0.80 0.96000 1.07360 1.16942 1.22554
0.85 1.03062 1.16136 1.27333 1.33965
0.90 1.10250 1.25188 1.38178 1.45960
0.95 1.17562 1.34521 1.49495 1.58571
1.00 1.25000 1.44141 1.61304 1.71828
1.10 1.40250 1.64266 1.86471 2.00417
1.20 1.56000 1.85610 2.13843 2.32012
1.30 1.72250 2.08222 2.43593 2.66930
1.40 1.89000 2.32150 2.75909 3.05520
1.50 2.06250 2.57446 3.10989 3.48169
1.60 2.24000 2.34160 3.49047 3.95303
1.70 2.42250 3.12344 3.90311 4.47395
1.80 2.61000 3.42051 4.35025 5.04965
1.90 2.80250 3.73334 4.83448 5.68589
2.00 3.00000 4.06250 5.35860 6.38906
VALUATION OF OIL AND GAS RESERVES 41-27

When the interest rate over the time interval between 41.7 for oil- and gas-appraisal work. Table 41.14 pro-
payments is j/M and the first payment occurs at the end vides these factors for effective interest rates between 3
of the first interest period, the constant-rate deferment fac- and 20%/yr.
tor is
Constant-Percentage-Decline
-
l-[l+(j/M)JPM’ Deferment Factor DcpD
FCR= . (33) This is the ratio of the present value or present worth of
rj a series of future payments that follow constant-percentage
decline and the total amount of such income. When the
When the payments are due at the end of each year,
pipeline income from oil and gas production and the oper-
the equation reads
ating expense are accounted for at the end of each month,
and when the compounding of interest and the effective
- I-(lI
ti)
-f decline d are also on a monthly basis, the equation for
F, = ti . .. . (34)
the deferment factor takes the form

When the annual payments are due at midyear, and the

1
first payment is 6 months hence, the deferment factor is F,-(1-d)(l++
F
F,-(l-d) ’
[I-(l+i)-‘] (l+i)“-(l+i)‘+’
FCR=(l+i)‘,+ =
ti ti . . . . . . . ... .. . . . .... . (38)

. . . . . ..~................... (35) where

Constant-rate deferment factors for this case and effec-
tive interest percentages from 3 to 10% are listed in Table
41.13.
The pipeline income from oil or gas production and the
operating expenses are normally accounted for on a
monthly basis, and the constant-rate deferment factor for
such monthly payments then takes the form
1-[1+(j/12)]-‘2f = I-(l+i)-’
F CR=
ti 12t[(l+i)x,-l].
. . . (36)
The constant-rate deferment factor according to this
equation for an effective annual interest rate of 5%/yr,
monthly payments, and monthly compounding may be
read directly against the number of years t on Fig. 4 1.7,
Curve B.
For continuous compounding (M=a) at a nominal in-
terest rate (j) the equation reduces to
- tj . .
FcR-~+"
-
F cp~ = constant percentage-decline deferment
factor; the average deferment factor
applicable to a series of future payments
that follow constant-percentage decline,
fraction,
d = effective decline rate, drop in production
rate per unit of time divided by the pro-
duction rate at the beginning of the
period, fraction,
F, = ratio between initial and final production
rates or payments,
i = effective annual compound safe interest
rate, fraction, and
f, = abandonment time or future life, years.
The constant-percentage-decline deferment factors ac-
cording to this equation for an effective annual interest
rate of 5 %/yr or 0.4074%/month, monthly payments, and
monthly compounding may be read directly from the
graph in Fig. 41.8 for varying ratios F, and different ef-
fective decline rates d.
For continuous compounding (M= 00) at a nominal in-
. (37a)
terest rate j, the equation reduces to

The constant-rate deferment factor for such continuous

compounding may be read directly from the graph in Fig.
4 1.9 for given values of tj. The constant-rate deferment
factor for the equal monthly payments received at the end
of each month during a specific interval of 1 year between
(f- 1) and I years from now takes the form
(l+i)‘-‘-(l+i)-’
FCR= 12[(l+i)~~-11 . “.“.“““”
(39)
The constant-percentage-decline deferment factors for
such continuous compounding may be read directly from
the graph in Fig. 41.9 for given values of ratio F, and rj.
Time t, may be computed from Eq. 56 or 57 in
(37b) Chap. 40:

In F y _ NPII F, In F,
This “annual deferment factor” is more accurate than the to =
midyear lump-sum deferment factor of Eq. 30 and Table a qi (Fy-1)
41-20 PETROLEUM ENGINEERING HANDBOOK

TABLE 41 .13-CONSTANT-RATE DEFERMENT FACTORS F cR = (1 + i) ‘a - (1 + i) H-r/fi

Each Annual Income Received !n One Payment at Midyear

Year 3% 3%% 4% 4%% 5% 5% % 6% 6%% 7% 7% % 8% 8wo 9% 9 '12

% 10% lO%% 11%
--
10.98530.98290.98060.97820.97590.97360.97130.96900.9667096450.9623o.96oo0.95780.95560.95350.9513
2 0.9710 0.9663 0.9617 0.9572 0.9527 0.9482 0.9438 0.9394 0.9351 0.9308 0.9266 0.9224 0.9183 0.9142 0.9101 0.9061 0.9021
3 0.9569 0.9501 0.9433 0.9367 0.9302 0.9237 0.9173 0.9111 0.9049 0.8988 0.8927 0.8868 0.8809 0.8751 0.8694 0.8638 0.8582
4 0.9431 0.9342 0.9254 0.9168 0.9084 0.9001 0.8919 0 8838 0.8759 0.8682 0.8605 0.8530 0.8456 0.8383 0.8311 0.8241 0.8172
5 0.9296 0.9187 0.9080 0.8975 0.8873 0.8772 0.8674 0.8577 0.8483 0.8390 0.8299 0.8209 0.8122 0.8036 0.7952 0.7869 0.7788

6 0.9163 0.9035 0.8910 0 8788 0.8668 0.8552 0.8438 0.8326 0.8218 0.8111 0.8007 0.7905 0.7806 0.7708 0.7613 0.7520 0.7429
7 0.9033 0.8887 0.8744 0.8605 0.8470 0.8339 0 8211 0.8086 0.7964 0.7845 0.7729 0.7617 0.7507 0.7399 0.7294 0.7192 0.7092
8 0.8905 0.8742 0.8583 08428 0.8279 0.8133 0 7992 0.7854 07721 07591 07465 0.7342 0.7223 0.7107 0.6994 0.6884 0.6777
9 0.8780 0.8600 0.8425 0.8256 0.8093 0.7934 0.7781 0.7632 0.7488 0 7349 0.7213 0.7082 0.6955 0.6831 0.6711 0.6595 0.6482
10 0.8657 0.8461 0.8272 0.8089 0.7912 07742 07578 07419 07265 07117 0.6973 0.6835 0.6700 0.6570 0.6444 0.6323 0.6205

11 0.8537 0.8325 0.8122 0.7926 0.7738 0.7556 0.7382 0.7214 0.7052 0 6895 0.6745 0.6599 0.6459 0.6324 0.6193 0.6067 0.5945
12 0.8419 0.8192 0.7976 0.7768 0.7568 0.7377 0.7193 0.7016 0.6847 0 6683 0.6526 0.6375 0.6230 0.6090 0.5955 0.5825 0.5700
13 0.8303 0.8063 0.7833 0.7614 0.7404 0.7203 0.7011 0.6827 0.6650 06481 0.6318 0.6162 0.6013 0.5889 0.5731 0.5598 0.5470
14 0.8189 0.7936 0.7695 0.7465 0.7245 0.7036 0.6836 0.6644 0.6462 0.6287 0.6120 0.5960 0.5806 0.5660 0.5519 0.5384 0.5254
15 0.8077 0.7811 0.7559 0.7319 0.7091 0.6873 0.6666 0.6469 0.6281 0.6101 0.5930 0.5767 0.5610 0.5461 0.5318 0 5182 0 5051

16 0.7968 0.7690 0.7427 0.7178 0.6941 0.6716 0.6503 0.6300 0.6107 0.5924 0.5749 0.5583 0.5424 0.5273 0.5128 0.4991 0.4859
17 0.7860 0.7571 0.7298 0.7040 0.6796 0.6564 0 6345 0.6138 0 5941 0 5754 0.5576 0.5407 0.5247 0.5094 0.4949 0.4810 0.4678
18 0.7755 0.7455 0.7172 0.6906 0.6655 0.6417 0.6193 05981 0.5781 05591 0.5411 0.5240 0.5078 0.4925 0.4779 0.4640 0.4506
19 0.7651 0.7341 0.7049 0.6776 0.6518 0.6275 0.6046 0.5831 0.5627 0.5435 0.5253 0.5081 0.4918 0.4764 0.4617 0.4479 0.4347
20 0.7549 0.7229 0.6930 0.6649 0.6385 0.6137 0.5905 0.5685 0.5479 0 5285 0.5102 0.4929 0.4765 0.4611 0.4465 0.4326 0 4195

21 0.7450 0.7120 0.6813 0.6525 0.6256 0.6004 0.5768 0.5546 0.5337 0.5141 0.4957 0.4783 0.4620 0.4465 0.4319 0.4182 0 4051
22 0.7352 0.7014 0.6699 0.6405 0.6131 0.5875 0.5635 0.5411 0.5201 0 5004 0.4819 0.4645 0.4481 0.4327 0.4182 0.4045 0 3915
23 0.7256 0.6909 06587 0.6268 0.6009 0.5750 0.5507 0.5261 0.5070 04872 0.4686 0.4512 0.4349 0.4195 0.4051 0.3915 0.3787
24 0.7162 0.6807 06479 0.6174 0.5891 0.5629 0.5384 0.5156 0.4943 04745 0.4559 0.4385 0.4223 0.4070 0.3926 0 3792 0.3665
25 0.7069 0.6707 0.6373 0.6063 0.5777 0.5511 0.5265 0.5035 0.4822 0.4623 0.4437 0.4264 0.4102 0.3950 0.3808 0.3675 0.3549

26 0.6978 0.6609 0.6269 0.5955 0.5665 0.5397 0 5149 0.4919 0.4705 0 4506 0.4321 0.4148 0.3987 0.3836 0.3695 0.3563 0.3440
27 0.6889 0.6513 0.6168 0.5650 0.5557 0.5287 0.5037 0.4806 0.4592 0.4394 0.4209 0.4037 0.3877 0.3728 0.3588 0 3458 0.3335
28 0.6801 0.6419 06069 0.5748 0.5452 0.5180 0.4929 0.4696 0.4484 04286 0.4102 0.3931 0.3772 0.3624 0.3486 0.3357 0.3237
29 0.6715 0.8327 0 5472 0.5648 0.5350 0.5077 0.4825 0.4593 0.4379 0 4182 0.3999 0.3829 0.3671 0.3525 0.3389 0.3261 0.3143
30 0.6631 0.6237 05878 0.5550 0.5251 0.4976 0.4724 0.4492 0.4279 04082 0.3900 0.3731 0.3575 0.3430 0.3296 0.3170 0.3053
31 0.6548 0.6149 0 5786 0.5456 0.5154 0.4879 0.4626 0.4394 0.4182 0 3986 0.3805 0.3638 0.3483 0.3340 0.3207 0 3083 0.2968
32 0.6466 0.6062 0.5696 0.5363 0.5060 0.4784 0.4531 0.4300 0.4088 0.3693 0.3714 0.3548 0.3395 0.3254 0.3122 0.3000 0.2887
33 0.6386 0.5978 05608 0.5273 0.4969 0.4692 0.4440 0.4209 0.3998 03804 0.3626 0.3462 0.3311 0.3171 0 3041 0 2921 0.2810
34 0.6308 0.5895 0 5522 0.5165 0.4880 0.4603 0.4351 0.4121 0.3911 0.3718 0.3542 0.3379 0.3230 0.3092 0 2964 0.2846 0.2736
35 0.6231 0.5814 0 5438 0.5100 0.4794 0.4517 0.4265 0.4036 0.3827 0 3636 0.3461 0.3300 0.3152 0.3016 0.2690 0 2774 0.2666

36 0.6155 0.5734 05356 0.5016 0.4710 0.4433 0.4161 0.3953 0.3745 03556 0.3382 0.3224 0.3076 0.2943 0.2819 0.2705 0.2598
37 0.6090 0.5656 0.5276 0.4935 0.4628 0.4351 0.4101 0 3874 0.3667 0 3479 0.3307 0.3150 0.3006 0.2873 0.2751 0.2638 0.2534
38 0.6007 0.5580 05198 0.4856 0.4549 0.4272 0.4022 0.3796 0.3591 0.3405 0.3235 0.3080 0.2937 0.2807 02686 0.2575 0.2473
39 0.5935 0.5505 0.5121 0.4778 0.4471 0.4195 0.3946 0.3722 0.3516 0.3334 0.3165 0.3012 0.2871 0.2742 0.2624 0.2515 0.2414
40 0 5865 0.5431 0 5046 0.4703 0.4396 0.4120 0.3873 0.3650 0.3448 0 3265 0.3098 0.2946 0.2808 0.2681 0 2564 0.2457 0.2358

41 0.5795 0.5359 04973 0.4629 0.4322 0.4048 0.3801 0.3560 0.3379 0.3198 0.3033 0.2883 0.2747 0.2622 02507 0.2401 0.2304
42 05727 05289 04909 04557 0.4251 0.3977 0.3732 0.3512 0.3313 03134 0.2971 02823 0 2688 02565 02452 0.2348 0.2252
43 0 5660 0 5220 0.4631 0.4487 0.4161 0.3909 0.3665 0.3446 0.3249 0.3072 0 2911 0.2765 0.2631 0.2510 0.2399 0.2296 0.2202
44 0.5594 0.5152 0.4763 0.4419 0.4113 0.3842 0.3600 0.3382 0.3187 0.3012 0.2852 0.2708 0.2577 0.2457 0.2348 0.2247 0.2155
45 0.5530 0.5086 0 4696 0 4352 0 4047 0.3777 0 3536 0.3321 0.3127 0.2953 0.2796 0.2654 0.2525 0.2407 0.2299 0.2200 0.2109

46 0.5466 0.5021 04630 04286 0 3983 0 3714 0.3475 0.3261 0.3069 02697 0.2742 0.2602 0.2472 0.2358 0.2252 0.2154 0.2065
47 0.5404 0.4957 0 4566 0.4223 0.3920 0.3653 0.3415 0.3203 0.3013 0.2843 0.2690 0.2551 0.2425 0.2311 0.2206 0.2111 0.2023
48 0.5342 0.4694 0 4503 0 4160 0.3859 0.3593 0.3357 0.3147 0.2959 0.2791 0.2639 0.2502 0.2378 0.2265 0.2162 0.2068 0.1962
49 0.5282 0.4833 04442 0.4100 03799 0.3535 03300 03092 0.2906 02740 0.2590 0.2455 0.2333 0.2222 02120 0.2028 0.1943
50 0.5223 0.4773 04382 0.4040 0.3741 0.3478 0.3246 0.3039 0.2855 0.2691 02543 0.2409 0.2289 0.2179 0.2060 0.1989 0.1905

001 002 0.04 0.07OI 0.2 04 07 I 2 4 7 IO 20 30

902 GO4 0070.1 02 04 07 I 2 4 7 IO 20 30

---II
TIME ,ty,jx
NOMINAL INTEREST RATE ,,,,)(CONTINKlUSLY
COMPO"NOED,

Fig. 41 .9-Deferment factorsfor lump-sum, constant-rate,

and constant-percentagedecline.
VALUATION OF OIL AND GAS RESERVES 41-29

TABLE 41.13-CONSTANT-RATE DEFERMENT FACTORS F cR =(I +i)” -(l +i)“-‘hi (continued)

Each Annual Income Received m One Payment at Midyear

Year llVz% 12% 12'h% 13% 13'/2% 14% 14% % 15% 15'2% 16% 16'/2% 17% 17'12% 16% 18'/2% 19% 19'/2% 20%
I 0 9470 0 9449 0.9428 0 9407 0.9386 0 9366 0 9345 0 9325 o 9305 09285 o 9265 0 9245 0.9225 0 9206 0.9186 0 9167 0.9148 0 9129
2 08982 0 8943 0.8904 08666 0.8828 08791 0 8754 08717 08680 08644 08609 08573 0.6536 08504 0.8469 0 8435 0.8401 0 8368
3 08527 08473 08419 08366 08314 08263 08212 08162 08112 08063 08015 07967 07920 07873 07827 07781 0.7736 0.7692
4 08103 08036 07970 07905 07841 07777 07715 07654 07594 07534 07476 07418 07361 07305 07250 07196 0.7142 07090
5 0.7708 0 7630 0 7553 0 7478 07404 07331 07260 07190 07121 07053 06987 06921 06857 06794 06732 06671 0.6611 0.6552
6 07339 07252 07166 070'32 07000 06920 06841 06764 06688 06614 06542 06470 06401 06332 06265 06199 06135 06072
7 06995 06900 06807 06716 06628 06541 06456 06374 06293 06214 06137 06061 05987 05915 05844 05775 05707 0.5641
8 06673 06572 06473 0.6376 06283 06191 06102 06015 05930 05848 05767 05688 05612 0.5537 0 5464 0.5392 0 5322 0.5254
9 06372 06265 06162 06061 05963 05868 05776 05686 05598 05513 05430 05349 05270 05194 05119 05046 04975 0.4906
10 06090 05980 05872 05768 05667 05569 05474 05382 05292 05206 05121 05039 04959 04862 04806 04733 04662 0.4593
11 0.5827 05713 05602 05496 05393 05293 05196 05102 05012 04924 04838 04756 04676 0.4598 0 4522 0.4449 0 4378 0.4309
12 0.5579 05463 05351 0 5242 05137 05036 04939 04944 04753 04665 04579 04496 04416 0.4339 0 4264 0.4191 0 4121 0.4052
13 0.5347 05229 05115 05006 04900 04798 04700 04606 04514 04426 04341 0.4259 04179 0.4102 04026 03956 03887 03619
14 05130 05010 04896 04765 04679 04577 04479 04385 04294 04206 04122 0.4040 03962 03686 03613 03742 03674 0.3608
15 04925 04805 04690 04580 04474 04372 04274 04180 04090 04003 03920 0.3839 03762 03687 03615 03546 03479 0.3414
16 0.4733 04613 04496 04388 04282 04181 04084 03991 03901 03816 03733 03654 03576 03505 03434 0.3366 03301 0.3238
17 04552 04432 04317 04208 04103 04003 03907 03815 03727 03642 03561 03483 03409 03337 03268 0.3202 03138 0.3077
18 04382 04262 04148 04039 03936 03836 03741 03651 03564 03481 03402 03325 03252 03182 03115 03050 02988 0.2929
19 04222 04103 03989 03862 03779 03681 03588 03496 03413 03332 03254 03179 03108 03039 02974 02911 02851 02793
20 04071 03952 03840 03734 03632 03536 03444 03356 03273 03193 03117 03044 02974 02907 02843 02782 02723 0.2667
21 0.3928 03811 03700 03595 03495 03400 03310 03224 03142 03063 02969 02918 02850 02765 02723 02663 02606 0.2552
22 03793 03677 03568 03464 03366 03272 03184 03100 03019 02943 02870 02601 02734 02671 02611 02553 02498 0.2445
23 0.3666 03551 0 3444 0 3341 03245 03153 03066 02983 02905 02830 02759 02692 0.2627 0 2566 0.2507 02451 02397 02345
24 03545 03433 03326 03226 03131 03041 02956 02875 02798 02725 02656 02590 0.2527 02467 02410 02355 02303 02253
25 0.3431 03320 03215 03117 03023 02935 02852 02773 02696 02627 02559 02495 0.2434 02375 02320 02267 02216 02168
26 03323 03214 03111 0.3014 02922 02836 02754 02677 02604 02534 02469 02406 02346 02290 02236 02184 02135 02088
27 03221 0 3113 03012 0.2917 02827 02742 0.2663 02587 02516 02448 02384 02323 02265 0 2210 0.2157 02107 02059 02014
28 03124 03018 02918 0.2825 02737 02654 02576 02502 02432 02366 02304 02244 0.2188 02134 0.2083 02035 01988 01944
29 03031 02927 02830 02738 02652 02571 02495 02422 02354 02290 02229 02171 02116 02064 0.2014 01967 0.1922 01879
30 02944 02842 0 2746 02656 02572 02492 0.2418 02347 02281 02218 02158 02102 0.2048 0 199.8 0.1949 0 1903 0.1660 01.318
31 02861 02760 02666 02578 02495 02418 02345 02276 02211 02150 02092 02037 0.1965 0 1935 0.1886 0 1844 0.1801 01761
32 02781 02683 02590 02504 02423 02347 02276 02209 02145 02085 02029 01975 01925 0 1876 0.1831 0 1787 0.1746 01707
33 02706 02609 02519 02434 02355 02280 02211 02145 02083 02025 01969 01917 01668 01821 01777 01734 01694 0.1656
34 02634 02539 02450 0.2367 02290 02217 02149 02085 02024 01967 0.1913 01862 01814 01769 01725 01684 01645 01608
35 02565 02472 02385 02304 02228 02157 02090 02027 01968 01913 01860 01810 01763 01719 01677 01637 0.1599 01562
36 0.2500 02408 02323 02244 02169 02100 02034 0 1973 0 1915 01861 011310 01761 01715 01672 01631 01592 01555 01519
37 02437 02348 02264 02186 02113 02045 01961 0 1921 01865 01612 01762 01714 01670 01627 01587 01549 01513 01479
38 02378 02290 02206 02131 02060 01993 01931 01872 01617 01765 01716 01670 01626 0.1565 01546 0.1509 01474 0.1440
39 02321 02234 02154 02079 02009 01944 01883 01825 01771 01721 0.1673 01628 0 1585 0.1545 01507 0.1470 01436 0.1403
40 02266 02181 02102 02029 01960 01897 01637 01781 01726 01676 01632 0.1568 0 1546 0.1507 01469 0.1434 0.1400 0.1368
41 02214 02130 02053 01981 01914 01851 01793 01738 01687 01638 01592 01549 0 1509 0.1470 01434 0.1399 01366 0.1335
42 02164 02082 02006 01935 01870 0 1808 01751 01697 01647 01600 01555 01513 0 1473 0.1436 01400 0.1366 01334 0.1303
43 02116 0.2035 0 1961 01892 01827 01767 0.1711 01659 01609 01563 01519 0.1478 0 1439 01402 0.1367 0.1334 01303 01273
44 02069 0.1991 0 1916 0.1650 01787 01728 01673 01621 01573 01526 01485 0.1445 0 1407 0.1371 01337 01304 01274 01244
45 02025 01948 01876 0.1810 01748 01690 01636 01586 01538 01494 0 1452 01413 01376 01340 01307 01275 01245 0.1217
46 01983 01907 01836 01771 01710 01654 01601 01552 01505 01462 01421 0.1382 01346 01311 01279 0.1248 01218 01190
47 01942 0 1867 01798 01734 01675 01619 01567 01519 0,474 0 1431 01391 0.1353 0 1317 0.1283 01252 01221 01192 0.1165
48 01903 0.1829 01762 01699 01640 01586 01535 01488 01443 0 1401 O 1362 01325 0.1290 01257 0.1226 01196 01168 01141
49 01865 01793 01726 01665 01607 01554 0.1504 01457 0 1414 01373 01334 01296 01264 01231 01201 01171 01144 01118
50 0 1828 0 1758 0 1692 0 1632 0 1576 0 1523 01474 0 1429 0,386 01345 0 1306 0 1272 0.1238 0 1207 01177 0 1148 01121 01095

Hyperbolic-Decline Deferment Factor, FH? where f=future life (in years) determined from Eq. 64
or 65 of Chap. 40.
This is the ratio of the present value or present worth of
a series of future payments that follow hyperbolic decline
(decline proportional to a fractional power of the produc- r-NPlI JFY = 2(JFy -1)
tion rate) and the total amount of such payments. 4, a;
For continuous compounding (M= w) at a nominal in-
terest rate ,j the average deferment factor is I’) The hyperbolic-decline deferment factors for such con-
tinuous compounding of interest may bc read from the
graph in Fig. 41.10 for given values of ratio F, and prod-
uct tj.

Harmonic-Decline Deferment Factor FH~

This is the ratio of the present value or present worth of
[Ei($-,)--Ei( &!,)I. ...C40) a series of future payments that follow harmonic decline
(decline proportional to the production rate) and the total
 41-30 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.14-ANNUAL DEFERMENT FACTORS FcR = (1 +i)‘-‘- (1 +i) -‘/12[(1+i)“’ -I]

Annual Deferment Factors are Apphcable to Equal Payments Received at the End of Each Month
During a SpeclflcInterval
of 1 Year Between (f-l) and t Years From Now

Year 3% 3% Q/cl 4% 4'/2% 5% 5'/2% 6% 6%% 7% 7%% 8% 6% % 9% 9% % 10% 10% % 1 1% 11% %

1 0.9842 0.9816 09790 0.9765 0.9740 0.9715 0.9691 0.9666 0.9642 0.9618 0.9594 0.9570 0.9547 0.9524 09500 09477 0.9455 09432
2 0.9555 0.9484 09414 0.9345 0.9276 0.9209 09142 09076 0.9011 0.8947 0.8883 0.8621 0 8759 0.8697 08637 0 8577 0.8518 08459
3 0.9277 0.9163 09052 08942 0.6835 0.8729 08625 08522 0.8422 0.8323 0.8225 0.6130 0.8035 0.7943 07852 07762 0.7674 0.7587
4 0.9006 0.8853 08704 08557 0.8414 0.8274 0.8136 08002 0.7871 0.7742 0.7616 0.7493 0.7372 0.7254 07138 07024 0.6913 0.6804
5 08744 08554 08369 08189 0.8013 07642 07676 07514 0.7356 07202 07052 0 6906 06763 0.6624 06489 06357 06228 06102
6 0.8489 0.8265 08047 0.7836 0.7632 07434 07241 07055 0.6875 0.6699 06530 0.6365 0.6205 0.6050 05899 05753 0 5611 0.5473
7 0.8242 0.7985 07738 0.7499 0.7268 07046 06832 06625 0.6425 0.6232 0.6046 0.5866 0.5692 0.5525 05363 05206 0 5055 0.4909
8 08002 07715 07440 07176 06922 06679 06445 06220 0.6005 05797 05598 0.5407 0.5222 0.5045 0.4875 04711 04554 0.4402
9 07769 0.7454 07154 0.6867 0.6593 0.6330 06080 05841 0.5612 05393 05183 0.4983 0.4791 0.4608 04432 04264 04103 03946
10 07543 0 7202 06879 06571 0.6279 0.6000 05736 05484 0.5245 0.5017 0.4799 0.4593 0.4396 0.4208 04029 03859 03696 03541
11 0.7323 06959 06614 06288 05980 05688 05411 05149 0.4901 04667 0.4444 0.4233 0.4033 0.3843 03663 03492 0 3330 0.3176
12 0.7110 06723 06360 0.6017 0.5695 05391 05105 04835 0.4581 0.4341 0.4115 0.3901 0.3700 0.3509 03330 03160 03000 02848
13 0.6903 06496 0.6115 05758 05424 0.5110 04816 0.4540 0.4281 04038 0.3810 0.3596 0.3394 0.3205 03027 02860 02703 02555
14 0.6702 06276 0.5880 0.5510 0 5165 0.4844 04543 0.4263 0.4001 03756 0.3528 0.3314 0.3114 0.2927 02752 02588 02435 02291
15 06506 0 6064 05654 05273 04919 04591 04286 04003 0.3739 03494 03266 03054 02857 0.2673 02502 02342 02193 02055
16 0 6317 0.5859 05436 05046 04685 0.4352 04044 03758 0.3495 0.3251 0.3024 0.2815 0.2621 0.2441 02274 0.2120 01976 01843
17 0 6133 0.5661 05227 0.4829 0.4462 0 4125 03815 03529 0.3266 0.3024 0.2800 0 2594 0.2405 0.2229 02068 0.1918 0.1780 0 1653
18 05954 0.5469 05026 04621 04250 03910 03599 03314 0.3052 02813 02593 0.2391 02206 0.2036 01880 01736 0.1604 01482
19 05781 0 5264 04833 04422 0.4047 0.3706 03395 0.3111 0.2853 02617 02401 02204 02024 0.1859 01709 0 1571 0.1445 0.1329
20 05612 05106 0.4647 0.4231 03855 03513 03203 02922 0.2666 02434 0.2223 0.2031 0.1857 0.1698 01553 0 1422 0.1302 01192
21 0 5449 0.4933 04468 04049 0.3671 03330 03022 02743 0.2492 0.2264 0.2058 0.1872 0.1703 01551 0 1412 0 I287 0.1173 0 1069
22 05290 04766 04296 03675 0.3496 03156 02851 02576 02329 0.2106 0.1906 0.1725 0.1563 01416 01284 0.1164 0.1056 00959
23 05136 04605 04131 0.3708 0 3330 0.2992 02689 02419 0.2176 0.1959 0.1765 0 1590 01434 0 1293 01167 01054 0.0952 00660
24 0 4987 0 4449 03972 0.3548 0 3171 02836 02537 02271 0.2034 0.1823 0.1634 01466 0.1315 0.1181 0 1061 0 0954 00857 00771
25 04841 04299 03819 03395 03020 02688 02393 02132 0.1901 01695 01513 01351 0.1207 0.1079 00965 00863 00772 0.0692
26 04700 04154 0.3673 03249 0.2676 02548 0.2258 02002 0.1777 0 1577 0 1401 01245 0.1107 0.0985 00877 0 0781 0.0696 0.0620
27 04563 04013 03531 03109 0.2739 02415 02130 01880 01660 01467 01297 01148 0.1016 0.0900 0 0797 00707 00627 0.0556
28 04431 03877 03395 02975 0.2609 02289 02010 01765 0.1552 01365 0.1201 01058 0.0932 00822 00725 Q0640 00565 0.0499
29 04302 03746 03265 02847 0.2485 02170 01896 01658 0.1450 0 1270 01112 0 0975 0.0855 0.0750 0 0669 0 0579 00509 00448
30 04176 03620 0.3139 02725 0.2366 02057 01788 01556 0.1355 0 1181 01030 0 0898 0.0784 0.0665 0.0599 00524 00458 00401
31 04055 03497 03019 02607 0.2254 01949 01687 01461 0.1267 01099 0 0953 00628 0.0720 00626 00544 00474 00413 0.0360
32 03936 03379 02902 02495 0.2146 01848 01592 01372 0.1184 01022 0.0883 00763 0.0660 0.0571 0.0495 0 0429 00372 0.0323
33 0 3822 0.3265 02791 02368 0.2044 0.1751 01502 0.1288 0.1106 0.0951 0.0817 00703 0.0606 0.0522 00450 00388 00335 0 0290
34 03711 0.3154 02683 02285 0.1947 01660 01417 0.1210 0.1034 0.0884 00757 00648 0.0$56 0.0477 0.0409 0.0351 00302 0.0260
35 0 3602 0.3048 02580 02186 0.1854 0.1574 01336 0 1136 0.0966 0.0823 0.0701 0.0597 0.0510 0.0435 00372 00318 00272 00233
36 0 3498 0.2945 02481 02092 0.1766 01491 0.1261 0.1067 0.0903 0.0765 0.0649 0.0551 0.0468 0.0397 0.0338 0.0288 00245 0.0209
37 0 3396 0.2845 02386 02002 0.1682 01414 0.1189 01002 0.0844 00712 00601 0.0508 0.0429 0.0363 0.0307 00260 00221 0.0187
38 0 3297 0 2749 02294 0.1916 0.1602 0.1340 01122 00940 0.0789 0.0662 0.0556 0.0468 0.0394 0.0331 0 0279 0.0236 0.0199 0 0168
39 0 3201 02656 02206 01833 01525 0.1270 0.1059 0.0883 0.0737 0.0616 0.0515 0.0431 0.0361 00303 00254 0.0213 00179 00151
40 0 3107 0.2566 02121 0.1754 01453 01204 00999 00829 0.0689 0.0573 0.0477 00397 0.0331 0.0276 00231 0.0193 0.0161 0.0135
41 0 3017 0.2479 0.2039 0 1679 0.1384 01141 0.0942 00779 0.0644 00533 0.0442 0.0366 0.0304 0.0252 0.0210 00175 00145 00121
42 0 2929 0.2395 01961 0.1607 01318 0.1062 0.0889 00731 0.0602 0 0496 0.0409 00338 0.0279 0.0231 00191 0.0158 00131 00109
43 0.2644 0.2314 01885 0.1537 01255 01025 00839 00686 0.0562 00461 0.0379 00311 00256 0.0211 00173 00143 OOlla 00098
44 0 2761 02236 0 1813 0.1471 0.1195 0.0972 00791 00645 0.0526 0.0429 0.0351 0.0287 0.0235 0.0192 00158 "",L'S ""l"6 """67
45 0 2681 0.2160 0 1743 0.1408 0 1138 0.0921 00746 00605 0.0491 0.0399 0.0325 0.0264 0.0215 0.0176 00143 00117 00096 00078
46 0 2602 0.2087 0 1676 0.1347 0.1084 0.0673 00704 00568 0.0459 0.0371 0.0301 0.0244 0.0198 0.0160 00130 0.0106 0.0086 0.0070
47 02527 0.2017 01612 0.1289 0.1032 00626 00664 00534 0.0429 0.0345 0.0278 0.0224 0.0181 0.0146 OOlla 0.0096 0.0078 0.0063
48 02453 01949 01550 01234 00983 0.0784 00627 0.0501 0.0401 00321 0.0258 0.0207 0.0166 0.0134 00108 00087 00070 0.0057
49 0 2362 0.1883 01490 0.1181 0.0936 0.0744 00591 0.0470 0.0375 0.0299 0.0239 0.0191 0.0153 0.0122 00098 00079 00063 0.0051
50 02312 0.1819 01433 0.1130 00892 0.0705 00558 00442 0.0350 0.0278 00221 0.0176 00140 0.0112 00089 3 0071 00057 0.0046

TIUEf l,,)x NOMINAL INTEREST RATETE(,,,)lCONTlNUDUSLYCOMPOUNDED)

Fig. 41 .lO-Deferment factorsfor hyperbolicdecline (n= %)

VALUATION OFOILANDGAS RESERVES 41-31

TABLE 41 .14-ANNUAL DEFERMENT FACTORS F CR = (1 + i) ’-’ - (1 + i) -‘/12[(1 + i)“’ - I] (continued)

Annual Deferment Factors are Appkable to Equal Payments Received at the End of Each Month
During a Specific Intervalof 1 Year Between (1-l) and t
Years From Now
JP/~ ,z',z% ,3% 131/z% 14% 14%% 15% 15'W~ 169/o 16%9/o 17% 17'/2% iB% lB'z'"/" 19% 19%0/o 20%
09410 0 9387 0!3365 09343 0 9322 09300 0.9278 09257 09236 09215 0.9194 0.9173 09153 09132 09112 09092 09072
08401 08344 08288 08232 08177 08122 08068 08015 07962 07910 0.7858 07807 07757 07707 07657 07608 07560
07501 07417 0.7334 07253 07173 07094 0 7016 0.6939 06864 06790 0.6716 0.6644 06573 06504 06435 06367 06300
06698 06593 0.6491 06390 0.6292 06195 06101 0.6008 05917 05828 05741 0.5655 05571 05488 0 5407 05328 0 5250
05980 05860 0.5744 05630 05519 05411 05305 0.5202 05101 05003 0.4906 0.4813 04721 04631 04544 04459 04375

0 5339 0 5209 05083 0 4960 04841 04725 04613 0.4504 04397 04294 04194 0 4096 04001 0.3908 0 3618 03731 0 3646
04767 04630 0 4498 04370 04247 04127 04011 03899 03791 0 3686 03584 03486 03390 0 3298 0 3209 03122 0 3038
04256 0.4116 0 3981 03851 0.3725 03604 0 3488 0.3376 03268 0 3164 0.3063 0.2967 02873 02783 0 2696 02613 0 2532
03600 0 3659 0 3523 0 3393 0.3268 03148 0 3033 0.2923 02817 0 2716 02618 0.2525 02435 0.2349 0 2266 02196 02110
0 3393 03252 03118 0 2989 0.2866 0 2749 0 2637 0.2531 02429 0 2331 02238 0.2149 0 2064 0.1982 0 1904 0 1830 0 1758
03030 02891 0 2759 02634 0.2514 0 2401 0 2293 02191 0 2094 0 2001 0 1913 0.1829 01749 01673 0 1600 01531 0 1465
02705 02570 02441 02320 0.2206 0 2097 0 1994 0.1897 01805 0 1718 01635 0.1556 01482 0.1412 0 1345 0 1281 0 1221
02415 0 2284 02161 0.2044 0 1935 01832 0 1734 01642 01556 0 1474 01397 0 1325 01256 01191 01130 01072 0 1017
02156 0 2030 01912 O.lBOl 01697 0 1600 0.1508 0 1422 01341 0 1265 0 1194 0 1127 01064 0 1005 0 0950 0 0897 0 0848
0 1925 01805 0 1692 01587 0 1489 01397 0.1311 01231 01156 0.1086 01021 0.0959 0.0902 00848 0 0798 00751 00707
0 1719 0 1604 01497 0.1398 01306 01220 0.1140 01066 0 0997 0 0932 00872 0.0817 00764 00716 00671 00628 0 0569
01535 01426 01325 0 1232 01146 01066 0.0992 0.0923 0 0859 0 oaoo 00746 0.0695 00648 00604 00563 00526 0 0491
01370 01267 0 1173 01085 0 1005 0 0931 00862 0 0799 00741 0 0687 00637 0 0591 0 0549 00510 00474 00440 0 0409
01224 01127 0 1038 0 0956 0 0881 00813 00750 0 0692 0 0639 0.0590 00545 0.0503 00465 00430 0 0398 0036.3 0 0341
0 1093 01001 00918 0.0843 00773 00710 0.0652 0 0599 00551 0.0506 00466 0.0428 0.0394 0.0363 00334 00308 0 0284
0 0975 0 0890 00813 00742 60678 00620 00567 0.0519 00475 00434 0 0398 00365 00334 00306 0 0281 00258 0 0237
00871 0 0791 00719 0.0654 0 0595 00541 0.0493 0.0449 00409 0 0373 00340 00310 00283 0 0259 0 0236 00216 0 0197
00778 00703 00636 00576 00522 0.0473 0.0429 00389 00353 0.0320 00291 00264 00240 00218 00198 00181 00164
00694 00625 0.0563 00508 00458 00413 00373 00337 00304 0.0275 00248 00225 0.0203 00184 00167 00151 00137
00620 00556 00498 0.0447 00402 00361 00324 0.0291 00262 00236 00212 0.0191 00172 00155 00140 00126 00114
00554 00494 00441 00394 00352 00315 0.0282 0.0252 00226 00202 00181 00163 00146 00131 00118 00106 00095
00494 00439 0.0390 00347 00309 0.0275 00245 0.0218 00195 0.0174 00155 00139 00124 00111 00099 00089 00079
00441 0.0390 0.0345 00306 00271 0.0240 0 0213 0.0189 00168 0.0149 00133 00118 0.0105 0 0093 0.0083 00074 0 0066
0 0394 0.0347 0.0306 00270 00238 0.0210 0 0185 0.0164 00145 0.0128 00113 0.0100 0.0089 0 0079 0.0070 00062 0 0055
00352 0.0306 00271 0.0237 0 0209 0.0183 0 0161 00142 00125 0.0110 0 0097 0.0085 0.0075 00066 0 0059 00052 0 0046
00314 0.0274 0.0239 0 0209 0.0183 0.0160 00140 00123 00108 0.0094 00083 0.0073 0.0064 00056 0 0049 00043 0 0038
00280 0.0244 0.0212 00184 00160 0.0140 0 0122 0.0106 0 0093 0 0081 0.0071 0.0062 0.0054 00047 00041 00036 0 0032
0 0250 00217 00188 0 0162 00141 0.0122 0.0106 00092 00080 0.0070 00060 0.0053 0.0046 00040 00035 00030 00027
0 0224 00193 00166 0 0143 00123 00107 0.0092 0 0080 0 0069 0.0060 00052 00045 0.0039 0 0034 0.0029 00025 0.0022
0 0200 0.0171 00147 0 0126 0 0108 0 0093 00080 00069 0 0059 0.0051 00044 0 0038 0.0033 00028 00025 00021 oooia
00178 00152 00130 00111 0 0095 0.0081 0.0070 00060 00051 0.0044 00038 0 0032 0.0028 00024 0.0021 00018 0.0015
00159 00135 00115 0 0098 00083 00071 0.0061 0 0052 00044 0.0038 00032 00028 0.0024 0 0020 0.0017 00015 0.0013
0.0142 00120 00102 00086 0.0073 00062 00053 00045 00038 0.0032 00028 00024 0.0020 00017 0.0015 00012 00011
0.0127 00107 0 0090 00076 0.0064 00054 00046 00039 00033 0.0028 00024 0.0020 0.0017 00014 0.0012 00010 0 0009
0.0113 0 0095 0 0080 00067 0.0056 00047 0.0040 00034 00026 00024 00020 00017 0.0014 00012 0.0010 0 0009 00007
00101 00084 00071 0.0059 0 0049 0.0041 0.0035 0 0029 00024 0.0020 00017 00014 0.0012 00010 0.0009 00007 00006
00090 0 0075 00062 0.0052 00043 00036 0.0030 00025 00021 0.0018 00015 00012 0.0010 00009 0.0007 00006 00005
00081 00067 0.0055 0.0046 00038 0.0032 00026 0.0022 00018 0.0015 00013 0.0010 0.0009 00007 0.0006 00005 00004
0 0072 0.0059 0.0049 0.0040 00033 0.0028 00023 00019 00016 0.0013 00011 00009 00007 00006 0.0005 00004 00004
0 0064 0.0053 0.0043 00036 00029 00024 00020 00016 00013 0 0011 00009 0 0008 00006 00005 00004 00004 00003
0 0057 0.0047 0.0038 0.0031 00026 0.0021 0.0017 0 0014 0.0012 0.0010 0.0008 0.0006 00005 00004 0.0004 00003 00002
0 0051 0.0042 0.0034 0.0028 00022 0.0018 00015 0.0012 00010 0.0008 00007 0 0006 00005 00004 00003 00003 00002
0 0046 00037 0.0030 0.0024 00020 0.0016 00013 0.0011 00009 00007 00006 0.0005 00004 0.0003 00003 00002 00002
0 0041 0.0033 00027 0.0021 00017 00014 0.0011 00009 00007 00006 00005 00004 OM)O3 0.0003 00002 00002 00001
00036 00029 0.0023 0 0019 00015 00012 00010 0.0008 00006 00005 00004 00003 00003 0.0002 0.0002 0.0001 0 0001

amount of such payments. For continuous compounding Calculation of Loan Payout

(M= co) at a nominal interest rate (j), the average defer- In the preparation of an engineering report. it is some-
ment factor is I7 times necessary to include a projection of future income
and a payout schedule for a proposed loan. To prepare
such a payout schedule, the balance of the loan at the end
~
FHU = of each year or period must be determined.
A calculation procedure has been suggested by Wilson
and Boyd *’ based on the following assumptions: (I) the
principal amount of the loan is growing by virtue of
.... .. . . . . . . . . . . . . . . (4 1) monthly compounding of interest; (2) the loan payments
during any year are made in equal monthly installments
where that are deposited at the end of each calendar month; and
(3) both the principal and the loan payments bear interest
N,, (F,-1) compounded monthly at the nominal annual interest rate
t, =- of the loan.
4, In F, ’ Wilson and Boyd use two numerical factors to deter-
mine the balance at the end of each year. These are listed
The harmonic-decline deferment factors for such con- in Table 41.15.
tinuous compounding of interest may be read directly from Factor 1 is the total value of $1, invested at the speci-
the graph in Fig. 4 1.11 for given values of ratio F, fied annual nominal interest rate. compounded monthly.
and tj. Factor 2 is the total value of $1, invested each month,
41-32 PETROLEUM ENGINEERING HANDBOOK

TABLE41.15-LOAN PAYOUTCALCULATION FACTORS

Nominal Interest Nominal Interest

Rate Months Factor 1 Factor 2 Rate Months Factor 1 Factor 2
4% 1 1.003333 1.000000 6%% 1 1.005417 1.000000
(W/o/month) 2 1.006678 1.001667 2 I.010863 1.002709
3 1.010033 1.003337 3 1.016338 1.005426
4 1.013400 1.005011 4 1.021843 1.008154
5 1.016778 1.006689 5 1.027378 1.010892
6 1.020167 1.008370 8 1.032943 1.013640
1.023588 1.010056 7 1.038538 1.016397
8 1.026980 1.011745 8 1.044164 1.019165
9 1.030403 1.013438 9 1.049820 1.021943
IO 1.033838 1.015134 10 1.055506 1.024730
II 1.037284 1.016834 11 1.061224 1.027528
12 1.040742 1.018539 12 1.066972 1.030336
4'12% 1.003750 1.000000 7% 1 1.005833 1.000000
(3/&/month) : 1.007514 1.001875 (7/,$Wmonth) 2 1.011701 1.002917
3 1.011292 1.003755 3 1.017602 1.005845
4 1.015085 1.005639 4 1.023538 1.008784
5 1.018891 1.007528 5 1.029509 1.011735
6 1.022712 1.009422 6 1.035514 1.014697
1.026547 1.011321 7 1.041555 1.017671
8 1.030397 1.013224 8 1.047631 1.020657
9 1.034261 1.015132 9 1.053742 1.023654
IO 1.038139 1.017045 IO 1.059889 1.026663
11 1.042032 1.018963 11 1.066071 1.029683
12 1.045940 1.020885 12 1.072290 1.032715
5% 1 1.004167 1.000000 7%% 1 1.006250 1.000000
(5/,12%/month) 2 1.008351 1.002083 ('%p/olmonth) 2 1.012539 1.003125
3 1.012552 1.004172 3 1.018867 1.006263
4 1.016771 1.006267 4 1.025235 1.009414
5 1.021008 1.008368 5 1.031643 1.012578
6 1.025262 1.010475 6 1.038091 1.015756
7 1.029534 1.012587 7 1.044579 1.018947
8 1.033824 1.014705 8 1.051108 1.022151
9 1.038131 1.016830 9 1.057677 1.025368
10 1.042457 1.018960 IO 1.064287 1.028599
II 1.046800 1.021096 11 1.070939 1.031843
12 1.051162 1.023238 12 1.077633 1.035101
5'/2% 1.004583 1.000000 8% 1.006667 1.000000
(~$&Jo/month) : 1.009188 1.002292 (2/,%/month) : 1.013378 1.003333
3 1.013813 1.004590 3 1.020134 1.006681
4 1.018480 1.006896 4 1.026935 1.010045
5 1.023128 1.009209 5 1.033781 1.013423
6 1.027817 I.011529 6 1.040673 1.016816
1.032528 1.013856 7 1.047610 1.020224
8 1.037260 1.016190 8 1.054595 1.023647
9 1.042014 1.018531 9 1.061625 1.027086
10 1.046790 1.020879 IO 1.068703 1.030540
11 1.051588 1.023235 11 1.075827 1.034009
12 1.056408 1.025597 12 1.083000 1.037494
6% 1 1.005000 1.000000 8%% 1 1.007083 1.000000
(Wdmonth) 1.010025 1.002500 (17/2,0/dmonth) 2 1.014217 1.003542
: 1.015075 1.005008 3 1.021401 1.007100
4 1.020151 1.007525 4 1.028636 1.010675
5 1.025251 1.010050 1.035922 1.014267
6 1.030378 1.012584 i 1.043260 1.017876
1.035529 I.015126 7 1.050650 1.021503
8' 1.040707 1.017676 8 1.058092 1.025146
9 1.045911 1.020235 9 1.065586 1.028807
10 1.051140 1.022803 10 1.073134 1.032485
11 1.058396 1.025379 11 1.080736 1.036180
12 1.061678 1.027964 12 1.088391 1.039893
9% 1 1.007500 1.000000 11% 1.009187 1.000000
@/p/o/month) 2 1.015056 1.003750 (ll/Ip%/month) : 1.018417 1.004583
3 1.022669 1.007519 3 1.027753 1.009195
4 1.030339 I.011306 4 1.037174 1.013834
5 1.038067 I.015113 5 1.046681 1.018502
6 1.045852 1.018939 6 1.056276 1.023199
7 1.053696 1.022783 7 1.065958 1.027924
8 1.061599 1.026647 8 1.075730 1.032678
9 1.069581 1.030531 9 1.085591 1.037482
IO 1.077583 1.034434 IO 1.095542 1.042275
11 1.085664 1.038357 11 1.105584 1.047117
12 1.093807 1.042299 12 1.115719 1.051989
VALUATION OFOILANDGASRESERVES 41-33

TABLE 41 .I 5-LOAN PAYOUT CALCULATION FACTORS (continued)

Nominal Interest Nominal Interest

Rate Months Factor 1 Factor 2 Rate Months Factor 1 Factor 2

9 ‘/2 o/o 1.007917 1.000000 II %% 1 1.009583 1.000000

(~9/,,%/month) 2 1.015896 1003958 (*3/&%/month) 2 1.019259 1.004792
3 1.023939 1.007938 3 1.029026 1.009614
4 1.032045 1.011938 4 1.038888 1.014467
5 1.040215 1.015959 5 1.048844 1.019351
6 1.048450 1.020002 6 1.058895 1.024267
7 1.058750 1.024066 7 1.069043 1.029214
8 1.065116 1.028151 8 1.079288 1.034192
9 1.073548 1.032259 9 1.089631 1.039203
IO 1.082047 1.036388 10 1.100074 1.044246
11 1.090614 1.040538 11 1.110616 1.049321
12 1.099248 1.044711 12 1.121259 1.054429
10% 1.008333 1.000000 12% I 1.010000 1.000000
(s/,%/month) 2 1.016736 1.004167 (l%lmonth) 2 1.020100 1.005000
3 1.025209 1.008356 3 1.030301 1.010033
4 1.033752 1.012570 4 1.040804 I.015100
5 1.042367 1.016806 5 1.051010 1.020201
6 1.051053 1.021066 6 1.061520 1.025336
7 1.059812 1.025350 7 1.072135 1.030505
8 1.068844 1.029658 8 1.082857 1.035709
9 1.077549 1.033990 9 1.093685 1.040947
10 1.086529 1.038346 IO 1.104622 1.046221
11 1.095583 1.042726 11 1.115668 1.051530
12 1.104713 1.047131 12 1.126825 1.056875
10% o/o 1.008750 1.000000 12'/2% 1 1.010417 1.000000
(7/,%/month) 1.017577 1.004375 (11/&/month) 2 1.020942 1.005208
1.026480 1.008778 3 1.031577 1.010453
1.035462 1.013202 4 1.042322 1.015734
1.044522 1.017654 5 1.053180 1.021051
1.053662 1.022132 6 1.064150 1.026406
1.062881 1.026636 7 1.075235 1.031798
8 1.072182 1.031167 8 1.086436 1.037228
9 1.081563 1.035724 9 1.097753 1.042695
10 1.091027 1.040308 10 1.109188 1.048201
11 1.100573 1.044919 11 1.120742 1.053745
12 1.110203 1.049557 12 1.132416 1.059328
13% i.010833 1.000000 15% 1 1.012500 1.000000
(11/12a/o/month) 2 1.021784 1.005417 (1'/4%/month) 2 1.025156 1.006250
3 1.032853 1.010872 3 1.037971 1.012552
4 1.044043 1.016368 4 1.050945 1.018907
5 1.055353 1.021903 5 1.064082 1.025314
6 1.066786 1.027478 6 1.077383 1.031776
7 1.078343 1.033093 7 1.090850 I.038291
8 1.090025 1.038749 8 1.104486 1.044861
9 1.101834 1.044447 9 1.118292 1.051486
10 1.113770 1.050185 10 1.132271 1.058167
11 1.125836 1.055966 11 1.146424 1.064903
12 1.138032 1.061788 12 1.160755 1.071697

13%% 1.011250 1.000000 15%% 1 1.012917 1.000000

(Ii/,%/month) 1.022627 1.005625 (17/24%/month) 1.026000 1.006458
1.034131 1.011292 : 1.039253 1.012972
1.045765 1.017002 4 1.052676 1.019542
1.057530 1.022755 5 1.066273 1.026169
1.069427 1.026550 6 1.080046 1.032853
1.081458 1.034390 7 1.093997 1.039595
1.093625 1.040274 8 1.108128 1.046395
9 1.105928 1.046201 9 1.122441 1.053254
10 1.118370 1.052174 IO 1.136939 1.060173
11 1.130951 1.058192 11 1.151624 1.067152
12 1.143674 1.064255 12 1.166500 1.074191
14% 1.011667 1.000000 16O/b 1.013333 1 .oooooo
(IJ/,%/month) 2 1.023469 1.005833 (I%%/month) : 1.026844 1.006667
3 1.035410 1.011712 3 1.040536 1.013393
4 1.047490 1.017637 4 1.054410 1.020178
5 1.059710 1.023607 5 1.068468 1.027025
6 1.072074 1.029624 6 1082715 1.033932
7 1.084581 1.035689 7 1.097151 1.040901
8 1.097235 1.041800 8 1 111779 1.047932
9 1.110036 1.047960 9 1.126603 1.055026
IO t 122986 1.054167 IO 1.141625 1.062184
11 1.136088 1.060423 11 1.156846 1.069406
12 1.149342 1.066729 12 1.172271 1.076692
41-34 PETROLEUM ENGINEERING HANDBOOK

TABLE 41.15-LOAN PAYOUT CALCULATION FACTORS (continued)

Nominal Interest Nominal Interest

Rate Months Factor 1 Factor 2 Rate Months Factor 1 Factor 2

14% O/O 1 1.012083 1.000000 16X% 1 1.013750 1.000000

(1~/~4%/month) 2 1.024313 1.006042 (lg/z.,%/month) 2 1.027689 1.006875
3 1.036690 1.012132 3 1.041820 1.013813
4 1.049216 1.018271 4 1.056145 1.020815
5 1.061894 1.024460 5 1.070667 1.027881
6 1.074726 1.030699 6 1.085388 1.035012
7 1.087712 1.036989 7 1.100313 1.042208
8 1.100855 1.043329 8 1.115442 1.049471
9 1.114157 1.049721 9 1.130779 1.056801
10 1.127620 1.056165 10 1.146327 1.064199
11 1.141245 1.062661 11 1.162089 1.071665
12 1.155035 1.069209 12 1.178068 1.079201
17% 1 1.014167 1.000000 19% 1 1.015833 1.000000
(15/,$S/month) 2 1.028534 1.007083 (l%,%/month) 2 1.031917 1.007917
3 1.043105 1.014234 3 1.046256 1.015917
4 1.057882 1.021451 4 1.064853 1.024002
5 1.072869 1.028738 5 1.081714 1.032172
6 1.088068 1.036093 6 1.098841 1.040429
7 1.103482 1.043518 7 1.116239 1.048774
8 1.119115 1.051013 8 1.133913 1.057207
9 1.134969 1.058580 9 1.151866 1.065730
10 1.151048 1.066219 10 1.170104 1.074343
11 1.167354 1.073931 11 1.188631 1.083049
12 1.183892 1.081716 12 1.207451 1.091847

1 7%% 1 1.014583 1.000000 19%% 1 1.016250 1.000000

(l~~/2~%/month) 2 1.029379 1.007292 (115/24a/o/month) 2 1.032764 1.008125
3 1.044391 1.014654 3 1.049546 1.016338
4 1.059622 1.022088 4 1.066602 1.024640
5 1.075075 1.029595 5 1.083934 1.033032
6 1.090753 1.037175 6 1.101548 1.041516
7 1.106660 1.044829 7 1.119448 1.050092
8 1.122798 1.052558 8 1.137639 1.058761
9 1.139173 1.060362 9 1.156126 1.067526
10 1.155785 1.068243 10 1.174913 1.076386
11 1.172641 1.076202 11 1.194005 1.085343
12 1.189742 1.084238 12 1.213408 1.094398
18% 1 1.015000 1.000000 20% 1 1.016667 1.000000
(lq/2%/month) 2 1.030225 1.007500 (12/,%lmonth) 2 1.033611 1.008333
3 1.045678 1.015075 3 1.050838 1.016759
4 1.061364 1.022726 4 1.068352 1.025279
5 1.077284 1.030453 5 1.086158 1.033894
6 1.093443 1.038258 6 1.104260 1.042604
7 1.109845 1.046142 7 1.122665 1.051412
8 1.126493 1.054105 8 1.141376 1.060319
9 1.143390 1.062148 9 1.160399 1.069325
10 1.160541 1.070272 10 1.179739 1.078433
11 1.177949 1.078478 11 1.199401 1.087642
12 1.195618 1.086768 12 1.219391 1.096955
18%% 1 1.015417 1.000000
(1~3/2&/month) 2 1.031071 1.007708
3 1.046967 1.015496
4 1.063107 1.023364
5 1.079497 1.031312
6 1.096139 1.039343
7 1.113038 1.047457
8 1.130197 1.055655
9 1.147621 1.063937
10 1.165314 1.072305
11 1.183279 1.080761
12 1.201521 1.089304
VALUATION OF OIL AND GAS RESERVES 41-35

01 II]
0.01 002 004 00701 0.2 0.4 0.7 I 2 4 7 IO 20 3040
-11
TIME (t,, ) x NOMINAL INTEREST RATE (j,,)(CONTINUOUSLY COMPOUNDED)

Fig. 41.11-Deferment factors for harmonic decline.

with monthly compounded interest, at the end of a given where

number of months, divided by the number of months. The F, = Factor 1,
equations for the factors are F2 = Factor 2,
j = annual nominal interest rate, and
.f r = time, months.
F,=
( >
1+$
The calculation steps are (1) multiply the previous year-
end balance of the loan by Factor 1; (2) multiply the to-
and tal annual payment by Factor 2; (3) deduct the product
of Step 2 from the product of Step 1 (the difference is
F2= VI--l) then equivalent to the year-end balance of the loan); and
(4) for a period of time less than 1 year, the appropriate

(’Jxt
factors for the number of months involved are used in-
12 >’ stead of the 12-month period for the entire year.

TABLE 41.16~SAMPLE LOAN-PAYOUT CALCULATION

Total Loan Loan Loan Year-End
Working- Payments Balance Balance Payment Loan AllocatIon Allocation
Interest to Loan Start of x Factor 1 x Factor 2 Balance to Pnnclpal to Interest
Revenue 80% of (1) Period Factor 1 (3)x (4) Factor 2 (2)x (6) (5)-(7) (3)-W (2)- (9)
Year (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
9 months 1957 $ 675,240 $ 540,192 $2,000,000 1.042014 $2,084,028 1.016531 $550,202 $1,533,826 $ 446,174 $ 74,016
1958 835,200 668,160 1.533,8261.056408 1,620,346 1.025597 685,263 935,083 598,743 69,417
1959 776.100 620,880 935,083 1.056408 987.829 1.025597 636,733 351,096 584,027 36,853
1960 632,200 356,776’ 351,056 * . * 0 351,056 7,720
1961 514,000 Payout = 9h0
1962 714,240
Thereafter 1,232.090

Totals $5,082,070 $2.188,008 $2,000,000 $188,008

41-36
A sample calculation shown in Table 4 1.16 deals with
the problem of determining the date of payout. the total
payments required, and the annual amount of interest pay-
ments for a loan of $2,000.000 at 5 % 70 nominal interest
per year, payable out of 80 % of the net runs. The calcu-
lations are shown in considerably more detail than re-
quired solely for clarity.
Nomenclature
a = nominal decline rate; instantaneous rate of
change divided by the instantaneous pro-
duction rate, decimal fraction
Cs = balance of unreturned portion of
investment, dollars
C,,, = depletable leasehold cost basis at beginning
of tax period, dollars
Ci = initial capital investment or purchase price,
dollars
Cl = intangible drilling and development costs.
dollars
CIA = deduction if intangibles were capitalized
and amortized over 120 months or
depleted by use of cost depletion rates,
dollars
CIP = preference intangible drilling costs, dollars
CIX = intangible costs minus C,,, , dollars
C PT = local production tax, dollars
C WI = working interest, decimal fraction of gross
costs
d = effective decline rate, the drop in produc-
tion rate per unit of time divided by the
production rate at the beginning of the
period, decimal fraction
DA = allowable depletion. highest of DC or
lesser of VDE and I/,
DC = cost depletion: portion of leasehold cost
proportional to reserves produced in a
given year. dollars
DE = depletion; the decline of a capital value as
a result of intentional piecemeal removal
or gradual consumption in use
DKB = depth measurement below kelly bushing
D, = depreciation; the decline in value of
tangible assets with use or the passage of
time (obsolescence)
e = base of natural logarithms
E(x) = exponential integral of x
Fr = total value of dollars invested at specified
annual interest compounded monthly.
dollars
F2 = total value of dollars invested each month
with monthly compounded interest at end
of month divided by the number of
months since investment, dollars
F cPD = constant-percentage-decline deferment
factor; the average deferment factor
applicable to a series of future payments
that follow constant-percentage decline,
decimal fraction
PETROLEUM ENGINEERING HANDBOOK
F cK = constant-rate deferment factor: the average
deferment factor applicable to a series of
equal future payments made at equal
time intervals, decimal fraction
F Ho = harmonic-decline deferment factor: the
average deferment factor applicable to a
series of future payments that follow
harmonic decline, decimal fraction
F HV = hyperbolic-decline deferment factor: the
average deferment factor applicable to a
series of future payments that follow
hyperbolic decline, decimal fraction
F LS = lump-sum deferment factor; the average
deferment factor applicable to one single
future payment. decimal fraction
F PV = deferment factor; a factor used to reduce
revenue received in the future to a pres-
ent value, decimal fraction
F, = ratio between initial and final production
rates or payments
i = effective annual compound safe interest
rate, decimal fraction
i’ = effective annual compound speculative
interest rate. decimal fraction
;R = revenue interest: decimal fraction of gross
revenue
I = yearly net income, dollars
I, = net operating income: the total earned
income from oil and gas sales after
deduction of lease operating expenses,
federal excise taxes, and production
taxes, dollars/yr
I,, = net annual operating income during Year n,
dollars
Ir = interest owner’s taxable income, dollars
j = nominal annual safe interest rate; used
when interest is compounded over M
periods in a year and equal to M times
the interest j/M over one period, decimal
fraction
j’ = nominal annual speculative interest rate,
decimal fraction
mk = amortization; extinguishment of an
intangible asset or indebtedness
M = number of times the interest is
compounded per year
n = number of yearly payments
N, = cumulative oil produced, bbl
N, = reserves at end of tax period, bbl or Mcf
0, = operating expenses, including ad rvAmm
taxes, dollars
0~ = general overhead expenses, dollars
0, = operating expenses per well-month, dollars
0, = weighted average operating costs per
barrel, dollars
P = net profit; the total net operating income
after deduction of capital expenditures.
dollars
VALUATION OF OIL AND GAS RESERVES
F’pc, = future net revenue or cash flow; the
projection of total annually earned
income from oil and gas sales after
deduction of production taxes. federal
excise taxes, operating expenses, and
incidental capital expenditures, dollars
y = production rate, bbl/D/month. or bbl/yr
s = unit sales during periods
S = sinking fund balance
I = time, months or years
t = abandonment time or future life. years
T,!E = Windfall Profit Tax (WPT)
V = gross revenue (value); the total earned
income from oil and gas sales, dollars
V,L- = “percent of gross” revenue. percentage
depletion
VT, = “50% of net” percentage depletion, equal
to 50% of taxable net income, dollars
Cl = total future net operating income. dollars
Subscripts
a = abandonment
i = initial
t = conditions at Time t
References
1. Foster. V.: “The A-B-C‘\ of Oil Loans,” Louisiana State U.. Baton
Rouge (1958).
2. Daws. R.E. and Stephemon. EA.: “The Valuatmn of Netural Gas
Propertie\*” J. Put. Tdr. (July 1953) 9-13.
3 Fiske. L.E. : nw V&c~rwn of Oii wc/ G~rs ProJprrrirs vz E,srtr/c~.\
rrrzrl Trx\~.~. second editmn. Rocky Mountain Mineral Law Inst.
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4. Egg&ton. W.S.: “Methods and Procedures for Estimatmg Fair-
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_5 DeColyer, E.L. and MacNaughton. L.W : “Valuatmn In the Pe-
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7. Reynolds. F.S.: “Dscounted Cash Flow as a Measure of Market
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8. Terry. L.F. and Hill, K E.: “Valuation of Producmg PropertIes
for Loan Purposes.” J. Per. T~L (July 1953) 23-26.
9. Dodson, C.R.: “The Petroleum Engineer’s Function in 011 and Gas
Financing,” J. Pc~t. Tec,h. (April 1960) 19-22.
10. Garb, F.A., Gruy. H.J.. and Wood. J.W.: “Determinmg the Value
of Oil and Gas in the Ground,” Wdd Oil [March 1982) 105~08.
II. Fagm. K.M.: “An Empuxal Yardatlck ior Appraising the Pres-
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Section. SPE. Nov. I. 1956.
I?. Arps. J.J.: “Analysis of Decline Curves.” 7rww, AIME (1945)
160. 228-47.
13. Paine. P.: 011 Prop~~rt~ VNII~IO~I, John Wiley & Sons Inc.. New
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14. Morrisey, N.S.: “Active Fields Report Drilling Data.” Oil trnd
Gas J. (Oct. 6. 1958) 172.
41-37
15. “Joint A\wciatmn Survey of Indwry Drllllng Couth IYSY.” 4PI.
lP4.4. and M&Contlnent Oil and Gu\ Asw. (March 1961).
16. Breeding, C.W. and Hercfeld. J.R.: “Effect ol’T,ixatwn on Valw
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21-2s.
17. Brons. F. and McCarty. J.S. Jr : “Method\ ot Calculating Profitlc-
bilities.” paper SPE 870-G presented at the lYS7 SPE Annual Mcct-
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18. Hdl. H.G.: “A New Method ofcomputing Rate of Return on Cap-
&d Expenditures,” paper prcsentcd at the Philadelphia Chapter 01
the Natl. A\hn. for Business Budgctinp, Aug. lY53.
I’). Hoskold. H.D.: ~t~~irwc~r‘.s Vrriui~~,~A.\ti\rlrnr. Longman\. Green
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20. Morkill. D.B. Fonw/rr.c ,/iv Miw Vr~l~rairwz. MirunF nnd Scww
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!I. Wilson. W.W. and Boyd. W.L : “Simplified Calculutions Deter-
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General References
Arph. J.J.: “Reason for Diffcrcnccz in Recovery El’l’lclcncy.” paper
SPE 2068 presented al the 1968 SPE Hydrocarbon Economics und
Evaluation Sympowm. Dallas. March 4-S
Campbell. J.M. and Hubbard. R.A.: “Price Forcc;istlng and ProJcct
Evaluation in the I98O‘s.” 1. PH. Tdi. (May 1984) 817-25.
Campbell. J.M. ef crl. : Mirwwl Prc~pc+ Er~o~zow~x. Campbell Petrw
leum Scncs. Norman. OK (19771.
Chan. S.A.: “Fmancu~l and Engineermg Considerations In Petroleum
Property Acquisitions.” paper SPE II301 presented at the 1983 SPE
Hydrocarbon Economlch and Evaluation Symposium, Dallas. March
3-4.
Cozzolino. J.M.: “A Simplified Utility Framework For the Analysis
of Financial Risk.” paper SPE 6359 presented at the 1977 SPE
Hydrocarbon Economics and Evaluation Sympoalum. Dallas, Feb.
21-22.
Ecotam~i(:~am/ Finunw, Reprint Senec. SPE. Richardson. TX (1980) 16.
Grossling, B.F.: *‘In Search of a Statistical Probdbllity Model for
Petroleum-Resource Assessment.” U.S. Dept. of the Interior, Rc\ton.
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Gentry, R.W. and McCray. A.W.: “The Effect of Re\ewow Fluid Prop-
erties on Production Decline Curves.” /. Per. T&T. (Sept. 1078)
1327-41.
Greenwalt. W.A.: “Determimng Venture Participalion.” J. Pd. Ted.
(Nov. 1981) 2189-95.
Mintz. F.: “Reserve Based Financmg-Specific Requlrcmenth and Al-
tcmatives,” paper SPE 9578 presented at the 1981 SPE Hydrocar-
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Newendorp. P.D.: “A Strategy for Implementing Rick Analyses.” J.
Per. TNh. (Oct. 1984) 1791-96.
Petrie. T.A. and Paasch. R.D.: “Implications of Evolvmg U.S. Oil Pric-
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34lL48.
Srcmlnrds furruining ro rhe Esrirncuiq mid AuclififlR of Oil cd Gas
Reserw Infi,nwtion SPE. Richardson. TX ( I YXO).