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  | isbn    = 0891816607

  | isbn    = 0891816607

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Each of the many economic parameters used in assessing and comparing oil and gas ventures has utility in measuring some desired aspect of the proposed opportunity. Unfortunately, no single parameter “does it all,” but some are better than others. For a thorough treatment of this subject, see Capen et al.,<ref name=pt02r3>Capen, E. C., Clapp, R. V., Phelps, W. W., 1976, Growth rate—a rate-of-return measure of investment efficiency: Journal of Petroleum Technology, v. 28, p. 531–543., 10., 2118/4613-PA</ref> Newendorp,<ref name=pt02r13>Newendorp, P. D., 1975, Decision analysis for petroleum exploration: Tulsa, OK, PennWell Books, 668 p.</ref> Megill,<ref name=pt02r12>Megill, R. E., 1988, An introduction to exploration economics, 3rd ed.: Tulsa, OK, PennWell Books, 238 p.</ref> and Thompson and Wright.<ref name=pt02r16>Thompson, R. S., Wright, J. D., 1985, Oil property evaluation, 2nd ed.: Golden, CO, Thompson-Wright Associates, 212 p.</ref> The ''yardsticks'' discussed below represent the more commonly used economic measures. The key economic parameters for the example development well and the example multiwell extension project, given in the article [[Building a cash flow model]], are summarized here in Tables 1 and 2, respectively.

Each of the many economic parameters used in assessing and comparing oil and gas ventures has utility in measuring some desired aspect of the proposed opportunity. Unfortunately, no single parameter “does it all,” but some are better than others. For a thorough treatment of this subject, see Capen et al.,<ref name=pt02r3>Capen, E. C., R. V. Clapp, and W. W. Phelps, 1976, Growth rate—a rate-of-return measure of investment efficiency: Journal of Petroleum Technology, v. 28, p. 531–543., 10., 2118/4613-PA</ref> Newendorp,<ref name=pt02r13>Newendorp, P. D., 1975, Decision analysis for petroleum exploration: Tulsa, OK, PennWell Books, 668 p.</ref> Megill,<ref name=pt02r12>Megill, R. E., 1988, An introduction to exploration economics, 3rd ed.: Tulsa, OK, PennWell Books, 238 p.</ref> and Thompson and Wright.<ref name=pt02r16>Thompson, R. S., and J. D. Wright, 1985, Oil property evaluation, 2nd ed.: Golden, CO, Thompson-Wright Associates, 212 p.</ref> The ''yardsticks'' discussed below represent the more commonly used economic measures. The key economic parameters for the example development well and the example multiwell extension project, given in the article [[Building a cash flow model]], are summarized here in Tables 1 and 2, respectively.

{| class = "wikitable"

{| class = "wikitable"

If treasury growth<ref name=pt02r3 /> is the goal of the firm, selecting projects based on DCFROR will not necessarily result in the best selection of projects. Thompson and Wright<ref name=pt02r16 /> discuss the use of DCFROR as a decision criterion and the reinvestment assumption.

If treasury growth<ref name=pt02r3 /> is the goal of the firm, selecting projects based on DCFROR will not necessarily result in the best selection of projects. Thompson and Wright<ref name=pt02r16 /> discuss the use of DCFROR as a decision criterion and the reinvestment assumption.

It is the authors' opinion that DCFROR should not be used as a “risking measure”—this measure has nothing whatever to do with project risk! Some firms think (incorrectly) that by setting high DCFROR hurdle rates, they are selecting the better projects. Ideally, such hurdle rates should reflect the current real earning performance of the firm. For a discussion of the use of high hurdle rates to account for risk, see Thompson and Wright.<ref name=pt02r17>Thompson, R. S., Wright, J. D., 1992, Oil and gas property evaluation, 3rd ed.: Golden, CO, Thompson-Wright Associates, in prep.</ref> Excessively high DCFROR hurdles in fact tend to favor short-term, lower reserve, high profit projects (which, upon project completion, the company has a hard time replacing) at the expense of long-term, larger reserve projects—the kind of projects that build corporations. ''DCFROR is only recommended as a minimum hurdle that all proposed projects must clear to be considered''.

It is the authors' opinion that DCFROR should not be used as a “risking measure”—this measure has nothing whatever to do with project risk! Some firms think (incorrectly) that by setting high DCFROR hurdle rates, they are selecting the better projects. Ideally, such hurdle rates should reflect the current real earning performance of the firm. For a discussion of the use of high hurdle rates to account for risk, see Thompson and Wright.<ref name=pt02r17>Thompson, R. S., and J. D. Wright, 1992, Oil and gas property evaluation, 3rd ed.: Golden, CO, Thompson-Wright Associates, in prep.</ref> Excessively high DCFROR hurdles in fact tend to favor short-term, lower reserve, high profit projects (which, upon project completion, the company has a hard time replacing) at the expense of long-term, larger reserve projects—the kind of projects that build corporations. ''DCFROR is only recommended as a minimum hurdle that all proposed projects must clear to be considered''.

The present value profile for the two example cases ([[:file:key-economic-parameters_fig1.png|Figure 1]]) shows graphically that the DCFROR for the development well is approximately 45% and that the DCFROR for the extension project is approximately 28%. These two DCFRORs demonstrate an important point about development well economics and exploration economics. Development wells are evaluated on an incremental basis. If over the long term the firm is to generate sufficient cash flow from production to sustain a continuing exploratory program, the DCFROR for the development well must be greater than the DCFROR for the exploration project. This is true because the development well must (1) earn enough to pay for itself, (2) earn a satisfactory return as an investment, and (3) provide additional earnings proportionally equivalent to at least the true cost of the exploratory effort required to discover it (including exploratory [[dry hole]]s).

The present value profile for the two example cases ([[:file:key-economic-parameters_fig1.png|Figure 1]]) shows graphically that the DCFROR for the development well is approximately 45% and that the DCFROR for the extension project is approximately 28%. These two DCFRORs demonstrate an important point about development well economics and exploration economics. Development wells are evaluated on an incremental basis. If over the long term the firm is to generate sufficient cash flow from production to sustain a continuing exploratory program, the DCFROR for the development well must be greater than the DCFROR for the exploration project. This is true because the development well must (1) earn enough to pay for itself, (2) earn a satisfactory return as an investment, and (3) provide additional earnings proportionally equivalent to at least the true cost of the exploratory effort required to discover it (including exploratory [[dry hole]]s).

[[Category:Economics and risk assessment]]

[[Category:Economics and risk assessment]]