Introduction to the Oil

Industry
What are Hydrocarbons?
• “Hydrocarbon” is the term used to describe any organic compound
consisting only of carbon and hydrogen
• Hydrocarbons reserves are derived from the decomposition of
organic matter
• Oil and gas field form in permeable reservoir rocks
Crude oil
• Crude oil is not a homogenous material
• It is classified according to weight (Density) and Sulphur content
• Density (API Gravity) The higher the API, the lighter the crude
• Light (Exceed 38°)
• Medium
• Heavy (Less than 22°)
• Sulphur content
• Sweet (Less than 1% Sulphur content)
• Sour (More than 1% Sulphur content)

• Crude prices vary depending on the oil’s density, Sulphur content, as well as
its proximity to markets
Natural Gas
• Natural gas is a mixture of light hydrocarbons, predominantly
methane.
• There is no comparable worldwide benchmark price for natural gas as
gas tends to be a regional business (Gas is difficult to transport)
Natural Gas Liquids (NGLs)
• Natural gas liquids are extracted in liquid form from natural gas
• NGLs serve as feedstocks in the petrochemical industry or as blending
agents in the refinery
World Oil Markets
• Oil continues to be the worlds most important source of energy
• The Middle East dominates proven reserves
• The distribution of proven reserves is only a rough approximation of
how oil is distribute around the world. (Insufficient technology to
explore deep waters still)
• Saudi Arabia, Russia and US are the major producers of oil in the
world
• The middle east dominates supply with around 30% of market share
• The clear number two region is North America
• Governments control the majority of oil resources
World Oil Supply Trends
• Global Trends
• World production has frequently risen when prices are falling, and vice versa
• OPEC was founded in 1960 in response to rising global production
• OPEC says its principal aim is to ensure the stabilization of prices in
international oil markets to eliminate harmful and unnecessary fluctuations
• OPEC’s production has varied more than global production
• The greatest swinger of all has been Saudi Arabia
• Regional Trends
• Two of the top three producing areas have seen their production decline
• US oil production peaked in the 1970s
• North Sea production looks to be in decline
Who supplies whom?
• The oil trade is the world’s largest, whether measured by value,
volume, or ton-miles
• The three large consuming regions are: North America, Europe and
Asia Pacific
• The US is the largest single importer
• Crude and prodcuts flow to the nearest markets first due to
transportation costs
World Oil Demand Trends
• The US is easily the largest single consumer of oil
• China is second
What do they use it for?
• Three main uses for oil
• Transportation
• Power generation
• Heating
Global trends
• Globally, Oil demand growth has lagged economic growth because
the world has become much more energy and oil efficient
• The growth in oil demand has been biased toward the higher-quality,
harder-to-refine products
• Overall, transportation now accounts for over half of world oil
demand
The Oil Price Story
• In the last 31 years there have been three oil price shocks
• 1973 The first oil price shock
• 1979/80 The second oil price shock
• 1985/1986 The third oil price shock
Oil Sands
• Oil sands are deposits of sand, clay, water and bitumen
• Found all over the world, but the two largest deposits are in Alberta
Canada and the Orinoco River in Venezuela
World Gas Markets
• Natgas is the worlds third-largest source of primary energy
• Gas burns cleaner than other fossil fuels
• Global natural gas reserves are now as large as global oil reserves
• Natgas discoveries have taken place in places where there is no
market to go to
• US is the largest producer followed by Russia
The Nort American Natural Gas Market
• The most important development on the supply side has been the
increase in Canadian imports
• The US also imports/exports gas via liquified natural gas
• Natural gas storage facilities are used to meet peak demand during
the winter
• Natgas inventory cycle broken into two segments: the winter heting
season and the injection season
US Demand
• Residential
• Commercial
• Industrial
• Electric Utility
• The key factors that typically drive deman are weather, industrial
activity and gas pricing
• The demand sectors most sensitive to pricing are the industrial en
electric utility sectors
• 80% of natural gas in the US is sold through what is known as the
bidweek process
Exploration & Production
• National governments typically own hydrocarbon assets
• Government “take” from the oil and gas industry varies enormously
aroun the world, but principally consists of some combination of
royalties, profits and teaxes.
Upstream Performance Measures
• Finding and development costs
• Finding costs comprise the costs of the exploration and appraisal programmes
alone
• Development costs are the costs of constructing and installing facilities to
produce and transport oil/gas to the sales point
• Rationale: Compare the money spent to add reserves with actual reserves
added.
• 4 Categories of expenditure
• Acquisition of acreage
• Exploration of that acreage
• Development of any successes
• Purchase of existing reserves
Upstream Performance Measures (2)
• Production Costs
• Comprise staff costs, on-site energy costs, rental of capital equipment and
consumables such as drilling mud, drill bits, etc.
• Technical Costs
• Include exploration expenses, depreciation, depletion and amortization and
production; and therefore a number of non-cash items.
• Reserves Replacement
• A company's ability to replace production with new finds, upward revisions to
earlier reserves estimates, or acquisitions
Upstream Accounting Issues
• There are a number of accounting issues peculiar to the oil and gas
sector
• The biggest difference is in the treatment of exploration expenditure
(Full cost versus successful efforts)
• Impairment tests: Determine whether the net book amount of
expenditure within each cost pool or asset is covered by the
anticipated cash flow.
• Abondonment provisions
Full cost versus successful efforts
• Under “successful efforts” exploration expenditure is inmediatley
written off (expensed) if the exploration was unseccesful. Cost
associated with successful exploration are capitalized and depreciated
on a field-by-field basis
• Under full cost accounting all exploration, appraisal and development
expenditure is capitalized in a “cost pool”
• Smaller companies or companies with large exploration programmes
to their size tend to adopt full-cost accounting
Reserves Accounting
• Estimated proved reserves constitute the bulk of the asset value of
E&P companies
• Reserves Revisions
• A primary cause for revision are changes in quarter or year end prices, which
could shorthen or lenghthen the economic life of a well.
• A secondary cause is recognizing that a given field can physically yield
smaller (or larger) amounts of hydrocarbons
Proved undeveloped reserves (PUDs)
• Proved reserves are broken down into two categories:
• Proved developed: Can be recovered with the existing infrastructure
• Proved undeveloped: A major expenditure is required to recover fossil fuels
The exploration process
• It is still not possible to say conclusively that oil exists in a specific
area until a well is drilled
• The first stage in the exploration process is to identify favourable
geological conditions
• The industry uses seismic analysis to identify prospective areas
The drilling process
• Process is similar whether the well is an exploration well or a
development well.
• Main difference is that the company will take more measurements
and will drill in more zones if its explorating
• Well are drilled using a drilling rif