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A HART ENERGY PUBLICATION

A Supplement to

E&P:An Invest rs Guide

December 2005


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B E&P: An Investors Guide oilandgasinvestor.com December 2005

This

Special Report

is sponsored

by the followingcompanies:


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The oil and gas exploration and pro-duction (E&P) industry is dy-namic, changing daily, and not just

because of fluctuations that occur nearlyevery second in oil and gas prices.

Instead, each day, members of the in-dustry develop a less-expensive way tofind myriad types of oil and gas in manymyriad more types of traps and faults andother structures, in diverse conditionsfrom the freezing North Slope and

Siberia to the equatorial basins of SouthAmerica, Africa, the Indian Ocean andsouthern Asia.

The industry also regularly finds amore efficient way to extract this oil andgas, a more suitable way to finance eachendeavor, and imaginative ways of hedg-ing all of this risk.

Each day, what is important to andworries each E&P company can change.Today, a producer may be aiming to di-versify his assets from wholly offshore tosome onshore; two years from now, thecompanys debt-to-equity ratio may beforemost in mind; two years ago, it may

have been whether that years roster ofhigh-risk drilling prospects would showoil and/or gas.

When an E&P executive has the rareopportunity to look ahead at the com-panys future and feel confident that allthe oil and gas will surface and all thedollars will come in, this is exactly whenhe worries yet more. It is surely just thecalm before the storm.

This conservative attitude among whatare otherwise wildcatters is because dur-ing the past 150 years or so of the hydro-carbon age, there have been many stormsand almost all of them have left some or

many producers out of time and out ofmoney.

These storms have mostly been boom-to-bust price cycles. What goes up doeseventually come down. Where will thatparticular producer be in the balancesheet when prices come down? And, be-fore prices find bottom? Thats what eachproducer fears.

Other storms are unique to particularproducers. Some use natural gas in liftingoil, for example. At one time, gas priceswere less than $1 per thousand cubic feet.In the past few years, they have been bet-ter than $4 per thousand. A producer who

uses natural gas to extract oil may have to

consider suspending operations. Or, hemay begin to simply sell the gas he isproducing, instead.

The industry faces huge obstaclesapparent impasses that would break othertypes of business, crush them into obso-lescence. Yet, each hurdle is overcome, ifnot in time to bring the project to produc-tion today, then eventually. For example,long-known oil and gas reserves arebeing brought to the surface now with the

use of the steam-assisted, gravity-drainage (SAGD) technique thatwouldnt be economic at lower oil prices.

Elsewhere, thousands of coalbed-methane wells have been drilled andcompleted, each making possibly as littleas 10,000 cubic feet of gas per day. In a$2 natural gas market, the gas from thesewells is worth about $20 a day. Whybother? In todays market, the gas isworth about $120 a day. Over a year,thats $43,800 per well, each well mayhave cost $100,000 or less to drill andcomplete, and the company has 1,000 ofthese. And, the average wells life is 20

years. Suddenly, this small amount of gasis worthwhile.In all of this, investors are the key to a

thriving E&P industry. The risks can attimes be high, but they have been knownto at times be incredibly rewarding too. Ahundred shares of Devon Energy Corp. in1993 cost about $400; today, theyreworth about $6,000a 1,400% return.

Newcomers to the industry are usuallyamazedand sometimes over-whelmedby the jargon, by the technol-ogy, by the peculiarities, by the logistics,by the size of this massive energy busi-ness. This special report was prepared for

those just getting started, and for thosewanting to brush up on some basics.

Newcomers need not be overwhelmed.Industry veterans will gladly admit thatthey learn something new about the busi-ness every day tooand should! Its adynamic, ever-changing industry. Whentheres nothing more to learn about thisbusiness, theres probably nothing newhappening in itno innovation, no greatnew discoveries, no new risk-manage-ment tools, no new sources of capital, nonew playerslike you.

Welcome to the E&P business.Nissa Darbonne,

Executive Editor

THE UPSTREAMLEARNING CURVE

E&P: AN INVESTORS GUIDE

December 2005 oilandgasinvestor.com E&P: An Investors Guide 1

A supplement to

4545 Post Oak Place, Suite 210Houston, Texas 77027-3105

713-993-9320Fax: 713-840-8585

OilandGasInvestor.com

Editor-In-ChiefLeslie Haines

Ext. 151, [email protected]

Executive EditorNissa Darbonne


Photo EditorLowell Georgia

Art DirectorMarc Conly

Senior Financial EditorBrian A. Toal

303-797-2037, [email protected]

Senior Exploration EditorPeggy Williams


Contributing EditorsDick Ghiselin, Joe Fisher

Production ManagerJo Pool


Regional Sales ManagerBob McGarr


Associate PublisherShelley Lamb


Corporate Marketing DirectorJeff Miller

Director of Custom PublishingMonique Barbee


Group Publisher, Electronic ContentCliff Johnson


Vice President and Group Publisher

Bob JarvisExt. 130, [email protected]

Sr. Vice President & CFOKevin F. Higgins

Executive Vice PresidentFrederick C. Potter

President & Chief Executive OfficerRichard A. Eichler

Copyright 2005, Oil and Gas Investor/Hart Energy Publishing LP, Houston, Texas.

Hart Energy Publishing, LP


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2 E&P: An Investors Guide oilandgasinvestor.com December 2005

3 In Pursuit Of Petroleum

Today, the easy oil and gas has already been found, and the hunt for

hydrocarbons is an extremely sophisticated, highly technical effort.

3 Steps In The Life Of A ProspectFrom acquiring seismic to bringing ina rig.

4 An Exploration GlossaryFrom anticline to wellbore.

5 Stranded Energy Some oil and gas finds are too costly to bring tomarket.

9 Unconventional Gas

Conventional U.S. plays have been waning for some time. Unconventional gas

production is increasingly filling in the space.

13 Drilling EconomicsWith smaller, more elusive reservoirs located in increasingly hard-to-develop

places, the U.S. industry has had to turn to technology.

19 A Drilling GlossaryFrom blow-out to workover.

20 How Technology Affects Economics: Three Examples From Coloradoto the North Slope to offshore England

22 Who Sets Oil And Gas Prices?

U.S. oil and gas producers also are price-takers, not price-makers.

23 Factors Affecting Prices Factors ranging from weather to geopolitical

unrest affect oil and gas prices, which are the most volatile among

commodities.

23 Uses Of HydrocarbonsFrom pleather to housepaint to perfume.

24 Crude La Carte They call it black gold, but it isnt always black andthe amount of gold it puts in a producers pocket varies greatly.

25 Reserves And Write-Downs

Feasibility of recovery is among factors determining how much oil and gas a

company owns below the surface.

27 Measuring Gas Whats the difference between an Mcf and an MMBtu?28 How To Value E&P Stocks

Here are key criteria in analyzing a producers worth.

30 An E&P Balance-Sheet Glossary From cash flow to total enterprisevalue.

31 Speaking E&P

From Mcfs to proved acreage, here are terms common in E&P companies

investor presentations.

E&P:An Investors Guide

ABOUT THE COVER: Illustration by Mark Shaver.


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Back in the earliest days of oil exploration,people looked for petroleum by drillingalong creeks, on top of oil seeps, and on

surface domes and structures. Most times, luckwas more of a factor in their success than skill.

The science of petroleum exploration devel-oped along with the industry. Today, the easyoil and gas has already been found, and thehunt for hydrocarbons is an extremely sophisti-

cated, highly technical effort.Oil and gas are now sought in many remotelocations around the globe: in water more than10,000 feet deep in the Gulf of Mexico, thedeserts of Egypt and China, the mountainouswestern Canada and Colombia, the islands ofIndonesia, and the swamps along the coasts ofLouisiana and Nigerias Niger Delta.

Nevertheless, the fundamentals of geologyremain unchanged. Oil and gas are found insedimentary rocks, which cover about 75% ofthe earths land area. About 700 sedimentarybasins dot the world; about half of these havebeen explored for oil and gas. Limestones,

dolomites, sandstones, shales and siltstones arethe hunting grounds for petroleum geologists.

It is within these layered rocks that the ex-plorer searches for the four elements necessary

for a petroleum accumulation: source, reservoir,trap and seal. Petroleum source rocks are oftenthick, black marine shales laid down in ancientseas. As soon as a plant or animal dies, bacteriaattack its remains. If oxygen is plentiful, as insoil, bacteria will consume all the organic mat-ter.

But in very fine-grained muds deposited onthe sea floor, oxygen is limited and much of the

organic matter escapes destruction. As thesemuds are buried by successive layers of sedi-ment, rising heat cooks the organic matter,throwing off water, carbon dioxide and hydro-carbons.

Generating crude oil from organic matter insource rocks is a slow process, requiring mil-lions of years. Temperatures must be just per-fectoil can only be formed between 120 and350 degrees Fahrenheit, temperatures found atburial depths between 5,000 and 21,000 feet. Ifthe source rocks get any hotter, natural gas andgraphite are formed instead.

Reservoir rocks are hosts for hydrocarbons.

IN PURSUITOF PETROLEUMThe hunt for oil and natural gas uses tried-and-trueprinciples of petroleum accumulation combined withthe latest state-of-the-art tools.

EXPLORATION

Steps In The Life Of A Prospect1. Acquire seismic, surface and subsur-

face data (well logs, cores and tests) in areaof interest.

2. Generate prospect idea.3. Acquire leases through purchase or

farm-in arrangement.4. Estimate drilling and completion costs

to test prospect.5. Predict expected volume of reserves,

likely production rates and operating costs.

6. Run a model of economics to deter-mine the rate of return, cash flow and ex-pected value generated by the sale of theoil and gas if the prospect is successful.

7. Assess stratigraphic and structuralrisks and determine if the expected returnsare sufficient to justify the capital expendi-tures.

8. Apply for federal and/or state drillingpermits.

9. Contract drilling rig, mud-logger, ce-menting and well logging services.

10. Prepare location and move in rig.

Remotemonitoring in anInput/Output Inc.recording truck ofresults from aseismic survey inRulison Field inColoradosPiceance Basin.


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Much the opposite of good source rocks, reser-voir rocks have porosity and permeability andare deposited in environments of considerableenergy. High-energy environments such aswaves and currents remove mud particles andmost of the organic matter, leaving the poresopen. Reservoir-quality sandstones and lime-stones usually contain very little organic matter;oil and gas migrate into reservoirs after theyhave been generated.

Movement of oil and gas from source rocksinto reservoirs is called primary migration. Of-tentimes, reservoirs are full of oil that hasmoved just a short distance from surroundingshales. But, huge oil accumulations also exist inareas that are hundreds of miles from the origi-nal source rocks.

Once crude oil and natural gas have formed,they continually seek lower pressures, movingthrough natural conduits in the earths layers. If

no barriers intercede, hydrocarbons will eventu-ally seep out on the surface.

What often occurs, however, is that migrat-ing oil and gas hits a sealing layer beyondwhich it cannot pass. Seals are sedimentaryrocks with negligible permeabilities that do notallow oil and gas to migrate any farther upward.Thick salt layers provide excellent seals, as doshales.

Oil and gas are now contained in a trap.Folded or faulted rock layers can formstructural traps, which are commonly

anticlines, domes or horst blocks. Stratigraphictraps form as a result of changes within the rocklayers, as when porous rocks such as reefs orriver-channel sandstones are surrounded bynonporous rock. Combination traps, with bothstructural and stratigraphic elements, are alsopossibilities.

Once in a trap, gas, oil and water separate by


Anticline A fold, generally convex up-wards, whose core contains stratigraphicallyolder rocks.

Core data A solid column of rock up tofour inches in diameter taken from the well-bore so geologists may study the rock forma-tion for clues as to whether oil or gas ispresent.

Drillstem test A test of the productive ca-pacity of an oil or gas reservoir when the wellis uncased. The test is conducted through thedrill pipe to see if oil or gas is present in acertain formation; preliminary sampling aidsthe decision to complete or abandon the well.

Fault A fracture or fracture zone alongwhich the sides have been displaced relativeto one another. A break or fracture in theEarths crust that causes rock layers to shift.

Field An area in which a number of wellsproduce from a reservoir. There may be sev-eral reservoirs at various depths in a singlefield.

Horst An elongate, uplifted block that isbounded by faults on its long sides.

Hydrocarbon An organic compound con-sisting of carbon and hydrogen. Hydrocar-bons can be gaseous, liquid or solid.

Log A continuous record as a function ofdepth of information on the rocks and fluidsencountered in a wellbore. The readings arecommonly obtained by equipment loweredby wireline into the wellbore. Acoustic, ra-dioactive and electrical readings are used toidentify the types of rocks and their charac-teristics. Measurement-while-drilling(MWD) tools can accumulate data as the drillbit drills through the rock formation.

Permeability The capacity of a rock totransmit fluids. A tight rock, sand or forma-tion will have low permeability and thus, lowcapacity to produce oil or gas, unless the wellcan be somehow fracture-stimulated to in-crease production.

Expressed in millidarcies for tight reser-voirs and darcies for extremely permeablereservoirs.

Porosity The volume of small to minuteopenings in a rock that allow it to hold fluids.Measured in percentages, typically from nearzero to about 35%.

Prospect An area that is the potential siteof an oil or gas accumulation. A lease orgroup of leases upon which an operator in-tends to drill.

Reserves The volumes of oil and gas thatcan be profitably recovered from a well withexisting technology and present economicconditions.

Sedimentary rock A layered rock result-ing from the consolidation of sediment. Sedi-ments are materials that are transported and

deposited by wind, water or ice, chemicallyprecipitated from solution or deposited by or-ganisms.

Seismic An earthquake or earth vibration,including those that are artificially induced.

Strike The direction taken by a structuralsurface such as a bedding or fault plane.

Wellbore That part of a well that is belowthe surface. Hole diameters vary with thetype and purpose of wells; a common well-bore diameter is a little less than nine inches.

(Source: Dictionary of Geological Terms,Third Edition)

AN EXPLORATION GLOSSARY

One of the

most tried-and-trueaxioms ofpetroleumexploration isthat the bestplace to lookfor oil and gasis near whereits alreadybeen found.


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density, with gas rising to the cap position, oilin the middle and water occupying the bottom.The boundary between gas and oil is called thegas-oil contact; the boundary between oil andwater is the oil-water contact.

Petroleum exploration toolsMaps have always been key tools of petro-

leum exploration. Since the early 1900s, ex-plorers have found many oil and gas fields bydrilling domes and anticlines that could beidentified from surface mapping. The size, po-sition, dips and strikes of surface beds are allrecorded with instruments such as plane tablesand Brunton compasses. Today, the map of anexplorer includes this traditional information,as well as that gleaned from aerial photographsand satellite pictures.

Early geologists made common use of sam-ple and drilling information from wells. Astechnology advanced, well log data and coredata added a great deal of knowledge.

Today, information from such instruments as

formation sampling tools can assist in the eval-uation of both rocks and fluids in a wellbore.Among wireline tools that provide valuable in-sights into the subsurface are electric, radioac-tive and acoustic logs, as well as dipmeters,borehole imaging logs and magnetic resonanceimaging logs. Data from drillstem tests are alsoincorporated into a subsurface picture. Evengeochemical techniques, which seek to corre-late surface measurements of various chemicalcompounds with the underground occurrence ofhydrocarbons, are sometimes called into play.

G

eophysicists also bring some tremen-

dous tools to the trade of petroleum ex-ploration. Three common geophysicalmethods used to look for oil are magnetic, grav-ity and seismic exploration. Magnetic methodsmeasure the strength of the Earths magneticfield at a specific point on the surface, whilegravity techniques seek to determine thestrength of the Earths gravity at a location.Both methods are useful in reconnaissancemapping and are usually employed in the earlystages of basin evaluation.

Seismic is the real workhorse of the industry,however. In seismic prospecting, acousticsources such as dynamite, vibrations or sonic

impulses from compressed air transmit soundinto the ground. As acoustic signals pass intothe subsurface, they are reflected and refractedoff the various sedimentary layers. Signals thatbounce back to the surface are recorded andprocessed to form an image of the subsurface.

Two-dimensional (2-D) seismic yields across-sectional view of the subsurface in twoplanes, length and height, while a 3-D surveydelivers a complete volume of data that allowsthe explorer to image the subsurface in fine de-tail. A further enhancement is 4-D seismic,which adds the dimension of time to the geo-

physical process. In this technique, successive

STRANDEDENERGYThere are many areas of the world inwhich oil and gas have been found or aresuspected to exist, but have not been ex-plored or brought into production. This ismore common with known gas accumula-tions, and the reason is that the gas is in aremote area where there is little or no in-

digenous demand for the product, andmoving the gasvia a liquefied naturalgas (LNG) tanker or a very long pipelineto a location where there is a market wouldbe too costly and financially risky. Thesegas accumulations are commonly calledstranded gas.

Another reason, and this can includeareas of known oil accumulations, may bethat the area is off-limits to exploration andproduction. There are many areas of theU.S., including Alaska, that fall into thiscategory.

Seismic-surveytrucks travelacross RulisonField in Colorado,using shear-waveand conventionalp-wave vibrators.Seismic data isthe workhorse ofthe explorationindustry.



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3-D surveys are acquired over an area to track

the movements of fluids in the subsurface.Traditional seismic relies on the information

carried in compressional waves, but an emerg-ing approach extracts subsurface informationcarried in shear waves. This type of seismic,called multi-component or full-wave seismic, isvery good at imaging stratigraphic reservoirsand fractured reservoirs.

Where shall we drill?Nonetheless, piles of highly processed seis-

mic data, satellite images, high-tech well logsand computer-aided mapping programs cantcreate oil or gas where none exists. The ex-plorer still must hunt for some basic clues.

One of the most tried-and-true axioms of pet-roleum exploration is that the best place to lookfor oil and gas is near where its already beenfound. Working in a known hydrocarbon basineliminates many of the uncertainties of source,reservoir and seal, and the hunt can focus on lo-cation of possible traps.

The first phase of exploration is a search fortraps similar to those that are already produc-ing. Explorers are also ever alert for possibili-ties of new trap types that have not yet beenknown to produce in an area, such as updip pin-

chouts of permeability or fault traps.

Oil and gas shows in previously drilled

wells nearby are of supreme importance, be-cause they are direct indications that a trap ex-ists. Other important clues include changes inthe rate of dip, dip reversal or flattening of dipof the rock layers. The location and position offaults is another key. These can indicate an un-usual structural condition.

Seismic attributes offer other clues. Ampli-tudes of seismic signals contain tremendous ge-ological detail, and much effort is invested ininterpreting these subtleties. One seismic signa-ture may show a promising gas-charged sand;another may indicate a tight limestone bed withno commercial potential.

Geologists and geophysicists formerlyworked with pencils and paper maps and sec-tions; today they build complex, 3-D interpreta-tions on their desktop workstations. Thefundamentals of prospecting remain un-changed, but phenomenal strides have beenmade in an individuals ability to view and inte-grate data from many sources.

The decision to drillIf, after carefully weighing all the dataand

being fully aware of its varying degrees of reli-abilityan explorer still believes that an un-

drilled trap does exist, a prospect has been born.

Often, in spite of computers chock fullof seismic data, months or years ofstudy, and countless pre-drill techni-

cal reviews by hordes of geoscientists andmanagers, wells still come up dry. A dry holecan be defined as a well that does not produce

oil or gas in commercial quantities.There are relative degrees of dry holes, ordusters as they are often called. A hole canlack so much as a whiff of oil or gas, with nohydrocarbon shows detected by even themost sensitive gas chromatographs. Or, awell can be a near miss, with not quiteenough ability to produce petroleum to makethe economic cut.

These latter types of dry holes are often re-visited in times of high oil and gas prices.Too, dry holes that were noncommercialyears ago can sometimes be re-entered andmade into producing wells, thanks to ad-

vances in completion technology.Failures can stem from many factors:1. Mechanical problems can force a com-

pany to abandon a well. Drillpipe or drillingtools can get stuck in the hole, and some-times the well must be abandoned.

2. A hydrocarbon-bearing reservoir isntpresent in the wellboreeven though it maybe a few feet away. Reservoirs can be faultedout by small structural displacements in the

subsurface that cant be detected with seis-mic data.

And, rocks can change laterally; for ex-ample, a sandstone can grade into a shale in-terval.

3. The target reservoir is encountered, but

the interval is too tight or too thin to produceeconomic quantities, or contains water in-stead of hydrocarbons.

4. A well drilled on a seismic anomalyfinds conditions that are indeed anomalous,but that do not correlate to a productivereservoir. For instance, an anomaly may looklike a gas-charged sandstone on seismic data,but drilling reveals it is actually a thin, tightlimestone layer.

5. The reservoir is found at a depth that islower than projections. Many assumptionsabout the acoustic velocity of the rock layersin an area are built into seismic interpreta-

tions, and until wells are actually drilled esti-mates can be imprecise. Low wells areusually wet.

6. A well intersects the reservoir at the an-ticipated depth, and has adequate porosityand permeability, but the hydrocarbons haveleaked off because the seal wasnt adequate.Or, trap, reservoir and seal are all found aspredicted, but oil and gas never migrated intothe area in the first place.


WHOSE FAULT IS IT?Facing page, righands change thebales on the topdrive of a rigwhile drilling the#1-H Dunlavey inthe Barnett Shalein JohnsonCounty, Texas.


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The land situation, productive possibilitiesand expected costs must be considered to ma-ture the idea. Lots of great prospects are neverdrilled because the company couldnt tie up the

acreage through leasing the mineral rights.Other ideas are discarded because the potentialreserves are judged insufficient in light of aprospects risks and drilling expenses.

Some prospects that were once thought to beviable become impossible and must be de-ferred or canceled if oil and gas prices fall

lower than the original assumptions. A prospectis a labor of many months or even years. Com-panies typically have many internal screeningsto evaluate prospects. They consider the risks ofthe geological and geophysical factors; estimatepossible reserves and production rates; designthe drilling and completion programs; and esti-

mate the operating costs, royalty and tax bur-dens, and arrive at estimated cash flow.

Prospects are ranked against other opportuni-ties available to the company, such as drilling

in other U.S. basins or other countries, or ac-quiring reserves or acreage from another com-pany. And, they are reexamined as oil and gasprices, company budgets and capital sourcesfluctuate.

If the decision to drill is made, federal and/orstate drilling permits are secured and a drillingrig is hired. The abstract idea will finally betested with money and with iron. In the end,Mother Nature will have the last word, despiteall the high-tech equipment, intellectual effort,and land and seismic expenses that have beeninvested by the prospector.

Peggy Williams

Sometimes, thegeology of thesubsurface isapparent fromroad cuts. Thiscut is through theDakota Hogbackwest of Denver.The Dakotasandstones areprolific oil andgas reservoirs.


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Its no secret to anyone in the oil and gas in-dustry that the low-hanging fruit in theLower 48 has been picked. Conventional

plays have been waning for some time, makingresources harder to find and more costly toproduce.

According to the U.S. Department of En-ergys Energy Information Administration(EIA), technological improvements and risingnatural gas prices will cause production fromunconventional gas resourcescoalbedmethane, tight gas sands and shalesto in-crease faster than conventional gas production.

In its Annual Energy Outlook 2005, theEIA estimates that Lower 48 unconventionalproduction will grow from 6.6 trillion cubicfeet (Tcf) in 2003 to 8.6 Tcf in 2025 and willaccount for 44% of Lower 48 gas production in2025. Currently, unconventional gas accountsfor nearly one-quarter of total domestic supply.

The growth potential of unconventional re-serves is even more dramatic when looked at ona regional basis. David Morrison, chairman of

Edinburgh-based research firm Wood Macken-zie, has said that by 2020, Rockies productioncould be 90% unconventional and 10% conven-tional.

The DOE is reading its own unconventionaltea leaves and in October 2005 announced

$10.7 million in funding for 13 research and de-velopment projects focusing on recoveringlarge, unconventional gas and oil resources andimproving the environmental aspects of drillingfor gas and oil.

Coalbed methaneMethane trapped in coal seams and contained

within the coal itself is an explosion hazard tomining operations. But what used to be ascourge has become a valuable energy com-modity as gas prices climb and coalbed-methane (CBM) extraction technologiesadvance.

According to the EIA, coalbed gas is becom-ing a mature source that in 2004 accounted for9% of U.S. dry gas production. Production in-


UNCONVENTIONALGASNatural gas is increasingly being categorized today as conventional andunconventional. Whats the difference?

NATURAL GAS

Coalbed methanehas become avaluable energycommodity as gasprices climb andextractiontechnologiesadvance.


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creased in 2004, but proved coalbed gas re-serves declined 2% to nearly 18.4 Tcf. (The lastdecline was 10 years earlier in 1994.) Still, itaccounted for nearly 10% of 2004 U.S. dry gasproved reserves. CBM is the fastest growing ofall the unconventional gas categories.

Gas can reside in a coal seam in two fash-ions. It is absorbed into the coal, and it also oc-cupies porous space within the coal seam, infractures and cleats. Operators extract coresamples from coal seams to arrive at estimatesof gas content, as well as an understanding ofhow gas is contained within the seam.

In order for gas to be desorbed from the coalin which it resides, operators usually mustremove vast quantities of water from the

reservoir, depressurizing it and allowing the gasto escape from the coal. It may be days,weeks, even months and a lot of water that youneed to produce prior to seeing any gas produc-tion, explains Kent Perry, director of explo-

ration and production research at the GasTechnology Institute (GTI).

The dewatering process is complicated sig-nificantly by the fact that operators must find aplace to put the produced water. Water disposalon land would not be an option for environmen-tal reasons if the water is salty. Sometimes theproduced water can be treated to make it ac-ceptable. Other times producers opt to drillwater-injection wells and dispose of the waterby re-injecting it. Whatever strategy is chosenfor handling produced water, its important toconsider the associated costs in project eco-nomics.

ShalesShale is a very fine-grained sedimentary

rock, easily breakable into thin, parallel layers.

The rock is very soft but does not dissolve inwater. Shales often hold gas when two thickshale deposits sandwich a thinner area of shale.Fractured shales produce about 500 billioncubic feet (Bcf) of gas per year in the U.S. TheMississippian Barnett Shale in the Fort WorthBasin of North Texas is the leading fractured-shale play in North America.

Fractured shales have been a gas source sincethe early days of the U.S. gas industry. The firstknown U.S. gas production came from a frac-tured shale reservoir in the Appalachian Basin.Production has traditionally been associated

with Devonian-age Ohio shale, butother basins produce significant

quantities of shale gas.The Gas Technology Institute

has researched gas production fromshale basins for about 15 years andhas evaluated formations in Ohio,

Illinois and Texas, as well as focusingon the Antrim Shales in Michigan. Theproperties of shale also make relevantGTIs other research on tight gas sandsfracturing and CBM. Through studying

2,000 wells in Michigan, GTI found thatproduction rates from shale could be doubled

through the use of such techniques as two-stage, deeper hydraulic fracturing.

In 2001, more than 28,000 shale wellswere producing nearly 380 Bcf per year

from the Appalachian, Michigan, Illinois,Forth Worth and San Juan basins. The New Al-bany Shale and other Devonian shales are gar-

Special, gradedsand is used infracturing wells,which has theeffect ofstimulating gasflow. Facingpage, waterdisplacement isused to measuregas releasedfrom coal andshale samples.

Shale-gasproduction hastraditionally beenassociated withDevonian-age

Ohio shale, butother basinsproducesignificantquantities ofshale gas.



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nering renewed interest. There is as much as1.9 Tcf of technically recoverable reserves esti-mated in the New Albany, and several compa-nies are consolidating large lease blocks orobtaining permits to produce gas from the play,according to a late 2005 report by the Ap-palachian and Illinois Basin Directors of the In-terstate Oil and Gas Compact Commission.

One barrier to New Albany gas productionlies in the shortage of infrastructure for gather-ing, compression, and processing to move theresources to market through the interstate gas

transmission network, the report says.Texas Barnett Shale is an extremely hot playas output has jumped five-fold since 2000.Devon Energy is responsible for roughly half ofthe plays total production of 1.1 Bcf per day.Mitchell Energy, which was acquired by Devonin 2002, is credited with making the Barnettplay viable through the development of appro-priate drilling and completion techniques.

Likewise, in the Fayetteville Shale of north-central Arkansas, activity also is picking up.Arkansas produces about 180 Bcf of gas peryear. But some think that could increase asmuch as 20% when production from the Fayet-

teville Shale ramps up in 2006. If the predic-tions of some experts are met, increasedproduction from the Fayetteville Shale couldmake Arkansas a net exporter of gas onceagain.

Tight gas sandsTight gas sands, which account for about

19% of U.S. gas production, are characterizedby low permeability. They are by far the mostprolific of the unconventional gas sources. Gasis trapped in very tight formations, usually im-permeable hard rock, sandstone or limestone.

Hence, production of gas from tight sands de-

pends greatly on suc-cessful fracturing ofthe rock.

Tight gas sandsreservoirs also are

widely dispersed. Be-cause economics dic-

tate wellbore positioningclose to the gas resource,

tight gas reservoirs can re-quire thousands of wells todrain. Horizontal drilling isone technique that can maketight gas sands more eco-

nomic.In the past, tight gas sand pro-

duction was driven by high gasprices and technological ad-vances. Production from thesesands first developed in the SanJuan Basin. By 1970, about 1Tcf of gas from tight sands was

being produced per year. Basins

that tend to dominate in terms of tight produc-tion activity are South Texas, East Texas, SanJuan, Permian and Wyomings Green RiverBasin. Others include Wind River, Uinta,Piceance, Denver, Raton, Anadarko, Arkoma,Arkla, the Texas Gulf Coast and Appalachian.

A high level of drilling is expected in most ofthe major basins for several years, and substan-tial new growth is anticipated in the RockyMountain basins because of the large volume ofgas in place. The National Petroleum Councilhas done studies that estimate 230 Tcf of totalU.S. reserves remain to be discovered in new

fields, largely dependent on technological ad-vances. Of the 230 Tcf, about 58% is in theRocky Mountain basins.

Of the DOE funding for unconventional re-sources R&D announced in October, nearly $1million will go to researchers at the University ofTexas at Austin to enhance 3-D hydraulic frac-ture models. The enhanced model will be testedby designing and executing hydraulic fracturetreatments in tight gas sands. Tight gas operatorsare now benefiting from real-time, near-bit sen-sors that allow alteration of the drilling targetbased on new reservoir information.

Anadarko Petroleum Corp. is one operator

that has pursued tight gas. It operates in north-ern Louisianas Vernon Field and in the BossierPlay in East Texas. Anadarko sometimes fracsthe same wellbore in five or six stages toachieve production. In many tight-gas basins,multistage fracturing is becoming the norm.

In the Texas Panhandle, the tight-sand Gran-ite Wash play has expanded to cover hundredsof square miles. Higher gas prices, improvedcompletion technologies and recent downspac-ing orders by the Texas Railroad Commissionhave caused a surge in drilling activity in Gran-ite Wash.

Joe Fisher

A high level oftight-gas drillingis expected inmost of themajor basins forseveral years,and substantialnew growth isanticipated inthe Rockies.


15/36

Make no mistake, drilling, completingand producing oil and gas wells is anextremely complex business. One

might think that the worlds unslakable thirstfor cheap, abundant energy resources makesprofitability a sure thing.

Perhaps that was true in John D. Rocke-fellers day. But with no control of commodityprices, soaring costs and stiff foreign competi-tion, and with smaller, more elusive reservoirslocated in increasingly hard-to-develop places,the U.S. industry has had to turn to technology.

Technology is the great enabler that hasmade exploration more effective, drilling moreefficient and production more prolific. At thesame time, technology has made drilling andproducing oil and gas safer and far less intru-sive to the environment.

Oil-rich OPEC held the rest of the world

hostage in the 1970s with its infamous oil em-bargo, driving prices up, but it does not controlthe market as tightly any more. In todays envi-ronment, companies develop business strategiesfor several different price scenarios, taking intoaccount the cost of capital and regulatory com-pliance. Then they go about attempting to con-trol the two things they can influencetheirexploration success, and their drilling and pro-duction costs.

This is where technology comes in. To usean analogy, the development and use of oilfieldtechnology closely parallels the conquest ofspace. From the early days of the Wright broth-

ers, the technology of flight has increased expo-nentially. The same is true for exploration andproduction of oil and gas.

For example, until the 1980s only one in 10exploratory wellscalled wildcatswere suc-cessfulthat is, they found economically re-coverable amounts of hydrocarbons. Today,thanks to improved technology, about 25% to40% of rank wildcats are successful, and insome states, the success ratio for developmentwells is much higher.

Development wells are those drilled after ex-ploratory wells have indicated hydrocarbons. Is

is often from development wells that oil and

gas are produced. In the Appalachian Basin,many companies report drilling success ratiosof 80% or 90% when drilling developmentwells to develop a field after the initial wildcatcomes in.

Often discovery wells prove to be in loca-

tions that prove to be sub-optimal for efficientproduction of the reservoir, so several develop-

DRILLINGECONOMICSVirtually every oilfield decision is founded onprofitability. With no control of oil and gasprices, and facing steadily rising costs anddeclining reserves, companies basicdecisions are based on constantly movingtargets.

DRILLING TECHNOLOGY


A worn drillbitthat was at workin the BarnettShale ofnortheast Texas.Several drillbitsmay be neededbefore reachingtarget depth.


16/36

ment wells are drilled to fully exploit the dis-covery. The original discovery well may bedeemed unsuitable for production and will beplugged.

Since the beginning of the new millennium,

commodity prices have soared and held steadyat unprecedented levels. Prices reflect strong in-creases in global demand as well as threats tosupplies.

Threats are natural, like hurricanes that canshut down offshore production, or political, likethe crisis in the Middle East, or the actions ofunstable governments. Costs have risen as well,because the new technology required to drilland produce from increasingly difficult areas isnot cheap. Companies are now pursuing theprize in waters as deep as 10,000 feet (3,300meters) and are going after unconventional gas

resources, in tight gas reservoirs, in shales and

in buried coal seams.A new potential gas resource is being ex-

plored called methane hydrate. Methane hy-drates consist of hydrates that are unstablefrozen clusters consisting of a molecule of

methane, completely surrounded by severalmolecules of frozen water. They exist in greatquantities all over the world in a natural stable-state only under specific conditions of pressureand temperature. If they are removed from theirstable environment, they thaw and the methaneescapes to the atmosphere.

Researchers around the world are aggres-sively pursuing the development of enablingtechnology that will permit safe, commercialrecovery of methane gas from hydrate deposits.So far, they have resisted all efforts by compa-nies eager to develop them for commercial pur-

poses. Costs of technology to solve this14 E&P: An Investors Guide OilandGasInvestor.com December 2005

The array ofequipmentneeded to carryout a frac job isimpressive. Inaddition to avast network ofpipe at thesurface, there isa fleet ofpumping trucks,truck-mountedblenders, sand

containers andfracture-fluidtanks and othersupport vehicles.Massive amountsof fluid arepumped into thewell to crack therock and improveflow.


17/36

production problem will be steep.Upon developing a prospect, there are several

cost-risk points at which a company must de-cide whether to continue: Is the prospect worthdrilling? And after a discovery well is drilled,are the initial, visual results worthy of obtainingmore sophisticated test results? If, yes, then, dothese results indicate the prospect is worth com-pleting and bringing into production?

In every case, the decision to proceed mustbe weighed against the cost of the added workthat must be done as well as economic factorsdictated by access to transportation (pipeline,river, road or railroad) to a refinery or con-sumer concentrations.

Drilling the wellWith a few notable exceptions, the basic

technique of drilling a well has not changedmuch. Based on data from surface explorationtechniques such as 2-D and 3-D seismic, geolo-gists and geophysicists decide on suitableacreage for drilling. Companies then secure a

lease from the landowner, or from the appropri-ate authority in the case of federal or state landor offshore leases.

They contract a drilling rig. Contrary to pop-ular opinion, oil companies do not have theirown rigs, relying instead on an experiencedcadre of drilling contractors who supply theequipment and workers to drill the well for aspecific day rate.

Modern rigs have banks of diesel-driven gen-erators to provide the electrical power thatlights the rig and drives the drill. The drillingfunction can be simplified by grouping it intotwo systems: the hoisting/rotating system andthe circulating system. The former consists ofthe familiar derrick with its bright yellow blockand cable hoist that trips the drill pipe into andout of the hole and supports its massive weightduring drilling.

Rotating is accomplished by a rotary drivetraditionally located on the drill floor, but morerecently located atop the drill stringthe so-called top drive. Top drives are a perfect exam-ple of how technology has improved safety andefficiency by reducing the number of timesby a factor of threethe drilling activity mustpause to add a joint of pipe.

The circulating system pumps heavy drillingfluid down the drill pipe to cool and lubricatethe bit, float rock cuttings to the surface, andcontrol well pressures. Drilling fluidcom-monly called mudis really a high-tech for-mula containing chemicals that interact with therock formations to ease drilling and protect theborehole wall. The high pressure imposed bythe heavy column of mud balances formationpressures, and prevents the influx of well fluidsor gas into the borehole.

This prevents the catastrophe known as ablow-out and is usually sufficient, but for addedsafety, each rig has a stack of valves just be-

neath the drill floor or on the seabed calledblow-out preventers (BOPs) that can be closedto seal the well in an emergency. Drilling mudcontaining rock cuttings circulates up the out-side of the drill pipe to the surface where it is

filtered, de-gassed and recirculated.

Reducing drilling costs

The most notable applications of technologyto reduce drilling costs have been in the areasof automated pipe-handling, improved drillingrates and geosteering, whereby real-time geo-logical data are used to steer the bit into the tar-get reservoir and keep it there.

As much as 40% of non-drilling time is spenthandling pipe. Now computer-driven machinesare taking over this time-consuming and dan-gerous job. Drilling rates are facilitated by newbit designs and by the use of underbalanceddrilling, whereby the well is allowed to flowunder controlled conditions while it is beingdrilled.

New instrumented bits allow dozens of criti-cal measurements of formation and drilling pa-rameters to be acquired and transmitted in realtime to the surface. This improves drilling effi-ciency and accuracy. Finally, years of painstak-ing research have yielded environmentallyfriendly drilling and completion fluids as wellas closed circulation systems, and most off-shore locations follow a zero-discharge policy,meaning absolutely no well or rig effluent is

put into the sea.Some things never change, however. Drilling

is still a demanding, 24-hour-a-day job thatmust be accomplished safely and efficiently inall kinds of weather in some of the worldsmost inhospitable locations.

Testing the wellSince the beginning, oil companies have tried

to evaluate their wells to answer these basicquestions: Is there oil or gas? How much? Canit be produced technically, and economically?How fast? For how long? Should we completethis well, or abandon it now before spending

December 2005 OilandGasInvestor.com E&P: An Investors Guide 15

Costs to Drill & Equip a Well

Drillingcontractor

30.7%

Purchased items:Miscellaneous 20.0%

Wellhead equipment 1.8%

Special tool rentals 2.7%

Drill bits 2.3%

Logs & wireline testing 3.7%

Formation treating 4.4%

Road & site preparation 4.4%

Cementing 4.8%

Supervision/overhead 5.6%

Drill ing mud/additives 5.8%

Pipe (casing & tubing) 13.7%

Source: Independent Petroleum Association of America

The drilling rig,the largest singlecost of drilling awell, is paid forby the day or bythe footagedrilled. Thats

followed by drillpipe and tubulargoods.


18/36

any additional time and money? Where shouldthe next well be drilled?

The answers to these questions are funda-mental to every economic decision that must bemade over the life of the well or reservoir. For-mation evaluation technology has kept pacewith drilling technology with new sophisticatedwell logs, cores and well tests.

Periodically during drilling, the drill pipe andbit are removed, i.e., tripped out of the hole,so electronic instruments can be introduced intothe well on an electrical cable called a wireline.The measurements made by these instrumentsare plotted on a chart called a log. Alterna-tively, some logging data can be acquired whiledrilling, as noted earlier.

Logs are used to determine the location andthickness of hydrocarbon-bearing strata and in-dicate their orientation in geospace. Cores, oncethe only sure way to determine formation min-eralogy and physical characteristics, are forma-tion samples cut and recovered from the rock.Cores are now being challenged by sophisti-cated high-resolution nuclear spectroscopy logimages to accurately describe formation tex-

ture, porosity and permeability.

Well tests help determine reservoir volumetricsas well as pressure and flow rate of the wellonce it is placed on production.

Information is the key. Now computerdatabases are constructed from the outset, in-creasing reservoir knowledge with compatiblyscaled data as each measurement is taken. Thisknowledge base facilitates decision-making andreduces risk. Virtually every decision is pref-aced by a cost-benefit analysis that projects itseconomic effect. Today, sophisticated computerreservoir models can be integrated with dy-namic surface-production-system models tosimulate the entire production system from poreto export pipe.

Real-time downhole test data can be trans-mitted via satellite from the field back to acompanys headquarterseven in anothercountryso that scientists, engineers and man-agers at home base can evaluate the well andmake the proper decisions.

Completing the well

As the well reaches its completion phase, de-cisions become easier because discounted cash

flow models can be used to compare the incre-16 E&P: An Investors Guide OilandGasInvestor.com December 2005

Crown block

Mast

Drilling line

Traveling block

Hook

Swivel

Kelly

Draw works

Rotary Draw works motor

Pump motor

Mud pump

Mud pit

Drilling mud

Drilling bit

Well hole orwell bore

Surface pipe

CementBlow-outpreventer

Pipe rack

Drill pipe

Mud hose

Modern drillingrigs oftenincludeautomated pipe-handlingequipment,computerizedcontrols, thinnerpipe (calledcoiled tubing)and other newequipment toimprove

efficiency andsafety, or speedup the time ittakes to reach tototal targetdepth.Technologyenablescompanies todrill into high-pressure, high-temperaturezones as deep as25,000 feet andoffshore wellsjust as deepinwater up to10,000 feetdeep.

Facing page,Kerr-McGeeCorp.s GlobalProducer VIII is afloatingproduction,storage andoffloading (FPSO)ship thatreceivesproduction fromBohai Bay,

offshore China.


19/36


20/36

mental benefit of each expenditure with the out-of-pocket cost. The immediate effect of tech-nology improvements can be felt as the well iscased and casing is cemented in place toachieve hydraulic isolation of producing forma-tions.

New expandable casing technology has beendeveloped to reduce the cost of casing the well,and improved cements provide a higher marginof safety at less cost. New, deep-penetratingperforating guns fire explosive charges down-hole, piercing the casing of the wellbore, the ce-ment and the rock itself to provide flow pathsfor the hydrocarbons to enter the well and flowto the surface.

Finally, a string of production tubing and apacker is run downhole to provide a high-pres-sure conduit for production and the well istopped by a system of valves called a Christ-mas Tree. Often the drilling rig is releasedonce casing is set, and completion is accom-plished with a smaller, less expensive unit.

Intelligent wells are increasing in popu-larity. These contain permanent monitor-ing sensors that measure pressure,

temperature and flow and telemeter these datato surface. More importantly, these wells con-tain surface-adjustable downhole flow-controldevices, so, based on the dynamic productioninformation from all the wells in the reservoir,flow rates can be optimized without having toperform a costly intervention.

Wells that do not have sufficient natural for-mation pressure are produced by new high-techelectrical submersible pumps. These containsensors that measure pump performance and ef-ficiency, and telemeter the information to theproduction-operations center. The most signifi-cant result of these improvements is optimized

production rates and extended reservoir life.

Well stimulation

Regardless of the quantity of hydrocarbonspresent, oil and gas wells do not always behaveas we would wish them to. Some require exten-sive, and expensive, treatments before they willproduce economically. Sometimes the subsur-face formation must be washed with acid toclean out clay or other materials that are clog-ging the pores and impairing flow.

In formations with low permeability such aslimestones, hydraulic fracturing is used to crackthe rock and create a greater area of flow be-tween the wellbore and formation pores. Con-versely, in unconsolidated sandstones, screensmust be placed within the well to keep sandfrom flowing into the well bore, clogging it anderoding the tubulars. Each treatment can be ac-curately costed, and justified in advance, usingcash flow modeling based on incrementaladded production.

Where natural reservoir pressure is lacking,wells will not flow to the surface and must beassisted by pumps or artificial-lift systems. Lift-

ing costs can be considerable, and must be con-sidered along with finding and developmentcosts, which are those expended to this point.

In the United States, average lifting costs areabout equal to average finding/developmentcosts, making many wells uneconomic. Com-plicating things is unwanted water production.More often than not, water is co-producedalong with the oil or gas. Not only does eachbarrel of water produced mean one less barrelof oil, but the water must be safely disposeditis usually salty and of no value for drinking orirrigation.

Typically the water is pumped into a nearby

18 E&P: An Investors Guide OilandGasInvestor.com December 2005

Deepwater Development SystemsGulf of Mexico

FixedPlatform

(to 1500 ft.)

CompliantTower

(1,500 to3,500 ft.)

SeaStar(Mini-TLP)

(600-3,500 ft.)

SubseaSystem

(to 7,000 ft.)

SparPlatform(2,000 to

10,000 ft.)

CompliantTower

(1,500 to3,500 ft.)

TensionLeg

Platform(1,500 to7,000 ft.)

Developmentsystems produce oiland gas from wells.They enter thepicture after rigs drillthe wells and theyare completed.Offshore, costsdictate that entirefields be producedfrom as few facilitiesas possible. Oneplatform may serve

20 or more wells, forexample. In the Gulfof Mexico, a varietyof developmentsystems are used,depending on waterdepth. The sparsystem can be usedin ultra-deepwater.(Source: MineralsManagement Service)

Intelligentwellscontainsurface-adjustabledownholeflow-controldevices,soflow ratescan be

optimizedwithouthaving toperform acostlyintervention.


21/36

Blow-out An uncontrolled, accidental re-lease of well pressure, either to the surfaceor to another formation (in this case, calledan underground blow-out).

Blow-out preventer (BOP) A series ofvalves, which offshore can be as high as 50feet, to control the well and prevent a blow-out.

Casing Steel pipe used to protect the well-bore from caving in. When casing is ce-mented in place, it forms a hydraulic sealwith the rock formations, preventing wellfluid from migrating up or down the outsideof the casing. It also keeps the well fluidsseparate from groundwater sources adjacentto the wellbore.

Circulation Analogous to the human cir-culatory system, mud is pumped into thewell from a reservoir called a mud pit. It cir-culates down the inside of the drill pipe,flows out through ports in the bit and circu-lates back to the surface up the outside of thedrill pipe, where it is filtered, de-gassed andreturned to the pit.

Fishing Slang for retrieving pipe, tools,cable or objects that have been dropped intothe well.

Fracturing (frac job) If the target reser-voir lacks sufficient porosity or permeabilityto produce on its own in commercial quanti-ties, this stimulation technique can improvethe flow. Enormous pressure is applied tothe reservoir by pumping in massiveamounts of fluid (water or polymer) to en-large the channels between pores in the rock.

Kick An unplanned influx of formationfluid into the wellbore, caused by the unex-pected presence of hydrocarbons.

Lost circulation Leak-off of mud into asubsurface formation or through a hole inthe well casing. Can be stopped by circulat-ing plugging material similar to radiatorstop-leak used in automobiles.

Mud Mixture of water and chemicals thatoccupies the borehole during drilling orcompletion of a well. Its main task is to exerthydrostatic pressure on the reservoir to bal-ance the natural formation pressure and pre-vent an accidental influx of formation fluidinto the borehole. It prevents the sides of thewell from caving in as the hole is cut. And, ittransports the rock cuttings from the bottomof the hole to the surface, where the geolo-gist can examine them for clues as to thetype of rock being penetrated.

Packer A mechanical seal between tubing

and casing, usually set just above the pro-ducing formation.

Perforating A downhole perforating gun,lowered by wireline, that fires shapedcharges through the casing into the desiredrock formation, resulting in perforationsthrough which reservoir fluids may flow intothe wellbore and up to the surface.

Plug & Abandon (P&A) When a well isdepleted of economically recoverable oiland/or gas, a permanent plug is set to sealthe bottom of the well, as much casing aspossible is recovered, and the surface loca-tion is restored to its original condition. Thewell is abandoned and a report is filed withthe governing authority.

Seismic exploration Sound waves arepulsed into the earth. They reflect off sub-surface layers and the reflected waves areprocessed to create a subsurface image ofthe earth from which promising rock forma-tions can be identified for potential drilling.

Spudding The act of beginning to drill aborehole, usually starting with driving apiece of large diameter pipe (casing) into theground (or seabed) to guide the bit and pro-tect the surface immediately surrounding theborehole.

Trip The act of removing the drill pipefrom the borehole (to put on a fresh drillbit,for example) and/or reinserting the pipe intothe hole. Each phase has a name: tripping-out, tripping-in or round-tripping. This func-tion is usually done manually byroughnecks, or it can be done by automaticpipe-handling equipment.

Tubing High-pressure pipe runs inside thecasing through which the oil or gas is pro-duced.

Wildcat An exploratory borehole drilledin virgin territory, usually at least a mile ortwo away from the nearest production of oilor gas. A rank wildcat is a well drilled many

miles away from the nearest production andis inherently more exploratory in nature, andthus more risky. On the other hand, the rankwildcat may tap into a virgin subsurfacezone that has high pressure and offers muchgreater daily oil or gas production.

Workover An oilfield term meaningoverhaul. Periodically, wells must beworked over to address cleaning, wear andcorrosion of the downhole equipment, orpressure issues. Special light-duty rigs calledworkover rigs perform this task at a fractionof the cost of a drilling rig.

A DRILLING GLOSSARY


Drilling is stilla demanding,24-hour-a-dayjob that mustbeaccomplishedsafely andefficiently insome of theworlds mostinhospitablelocations.


22/36

injection well, or it is trucked away from thesurface location, to be safely disposed else-where, according to local or state regulations.New technology allows oil and water to be sep-arated downhole and the unwanted water isreinjected into a nearby nonproductive forma-tionnever reaching the surface.

WorkoversThroughout the life of the individual well and

reservoir, periodic interventions are made to ac-quire production data and perform overhauls,called workovers. Slim logging tools can passthrough the production tubing and make flowmeasurements. The result of this allows reme-dial steps to be taken to optimize flow.

As long as they can be economically justi-

fied, elaborate enhanced-production schemescan be launched to improve the ultimate recov-ery factortotal percentage of recoverable oilfrom the wellwhich can reach as much as70% in some cases.

Enhanced oil-recovery (EOR) methods in-clude water-flooding, where water is pumpedinto injection wells drilled around the flanks ofthe reservoir, forcing more oil out the central,producing well. Other EOR techniques includesteam-flooding or CO2 (carbon dioxide) injec-tion that melt or dissolve viscous oil depositsand improve their flow characteristics.

Even more exotic methods involve fire-flooding, in which a downhole fire is startedto melt heavy oil, or the injection of microbesthat eat the polymers that are binding the oil

As oil companies apply new or im-proved technology and best prac-tices, and learn more about a

particular play by drilling more wells, theyare often able to reduce either the time ittakes to drill and complete a well, or reducethe costs, or both. This can help them offsetany commodity price weakness they mayexperience during the time they are develop-ing a field.

The goal is not just to produce oil or gas,thereby increasing the companys proved re-serves, or increasing its immediate cash flowfrom production. Savvy companies also tryto achieve an adequate return on capital em-ployed (ROCE). A company is essentiallystanding still if it spends $1 to achieve $1 ofincome. Even if technology fosters improve-ments that are less than dramatic, that stillmatters. Here are three real-life examplesfrom early 1999:

In Colorados Denver-Julesburg Basin,northeast of Denver, operators deepened ex-isting wellbores that yield from the Codellformation to get new gas production from

the so-called J Sand, a zone that is about 500feet deeper.

A grassroots well drilled to the J Sandcosts about $330,000. Deepening an existingwell to that depth is cheaper, and used tocost $250,00 to $270,000, including frac-ture-stimulation.

But that cost was brought down to$200,000 per well. Whats more, drillingtimes were cut from about 30 hours per wellto about eight, creating significant savingsand making the play more economic. Thewells produce an average of between 600-

and 800 million cubic feet of gas in theirproductive lives.

In Alaska, the economic threshold forfield development on the North Slope usedto be 250 million barrels of recoverable oil, afairly large field, due to high drilling, pro-duction and transportation costs. However,thanks to improved technologies and prac-tices, producers are now able to produceever-smaller fields, called satellite fields,often using tie-backs to existing surface fa-cilities nearby.

The industry has managed to reduce thesize of an economically viable field therefrom 250 million barrels to 50 million, ac-cording to a former North Slope field devel-oper, Arco, which is now owned by BP. Thishas allowed the development of reservoirspreviously thought not worth the expense,and increased U.S. oil output.

At Wytch Farm, along the southern coastof England, BP applied technology to pro-duce extremely deep offshore wells that aredrilled directionally from land. These wellshave reached a total depth of 31,355 feet: a

vertical depth of 5,887 feet and a horizontaldeparture from the wellbore of another29,324 feet. Thats almost six miles of sub-surface drill pipe that needs to be controlledand kept in the target producing reservoir!

Through process changes, technology,teamwork and advanced planning with theservice and equipment vendors, BP was ableto reduce the time it takes to drill such a longhorizontal well by 40%, drilling and com-pleting the well in a record-breaking 81days. Measurement-while-drilling and log-ging-while-drilling tools were used.

HOW TECHNOLOGY AFFECTS

ECONOMICS: THREE EXAMPLES


The goal (indrilling) is notjust toproduce oil or

gasSavvycompaniesalso try toachieve anadequatereturn oncapitalemployed.


23/36

in place.Each of these schemes undergoes a cost/ben-

efit analysis before attempted. Even under thebest of scenarios, a well may only produce 10%to 20% of the oil in place in its lifetime, absentstimulation.

OffshoreOffshore, costs dictate that entire fields be

produced from as few facilities as possible.This is especially true in deep waters or inharsh environments such as the North Sea. Tall

jacket platforms sit on the ocean floor and serveas production facilities for 20 or more wells.The wells all come together at the surface, butbranch out in all directions underground to tapthe farthest reaches of the reservoir.

In harsh environments, huge gravity-basestructures combine the roles of supporting theproduction facilities and serving as storagetanks for the crude oil. Recently, tension-legplatforms and spars have been introduced.

These are floating platforms tethered to the

ocean floor, but free to move about with windand current. They can often be economically re-located and re-used for other fields when theoriginal field is depleted.

With deepwater discoveries, an entirely newtechnology has made production economical.Floating production, storage and offloading(FPSO) vessels are converted oil tankers withproduction and processing equipment on deck.These receive oil from flexible risers connectedto gathering stations and subsea wellheads lo-cated on the sea floor. They process the crudeand store it until offloaded by a shuttle tanker.

In highly developed areas such as the Gulf ofMexico, FPSOs may not be as economical asrunning a subsea pipeline several miles fromthe wellhead to connect to a fixed platform inshallower waters. Subsea connectors as long as100 miles are in use today in the Gulf of Mex-ico.

Current challenges

In the United States, producers face stiffchallenges. More than half of the countrys oilnow comes from stripper wells, which pro-duce 10 barrels of oil per day or less. If oilfetches $11 or $12 per barrel at the wellhead as

it did in the late 1990s, then most of these wellsare uneconomical, once finding and lifting costsand taxes are factored in.

However, if a well is abandoned, it mightnever be brought back on production. So, oilcompanies most of them small independentoperators are faced with a real dilemma.They can try to hang on and hope for higherprices, they can invest in expensive cost-cuttingschemes with little hope of a quick recovery, orthey can shut-in their wells.

Even with todays high prices, its a gamble.No one knows how long high prices will last.Should the wells owner invest millions to try

to improve a poor producer? Will the owner beable to recoup the investment before the nextdown-cycle?

Compounding the problem is the intensifica-

tion of natural decline rates from existing wells.Over time, whether it takes four years or 30years, every well will produce less and lessuntil it is no longer economically viable.

U.S. reserves are being depleted faster thanever before. More discoveries are needed andmore technology is required to improve exist-ing productivity. Americans are going to beasked in the not-too-distant future if they arewilling to accept importing as much as 75% oftheir oil from sources abroad.

What national security and economic risksdoes this imply?

Dick Ghiselin


Offshorefacilities, suchas thisproductionmodule for theCameronHighway oil-pipelinesystem in theGulf of Mexico,can be huge,and expensive,structures.


24/36

Its sad but true for oil and gas producers, butcommodity prices are rarely, if ever, set at thewellhead. Just as farmers dont control the

price of wheat or ranchers of cattle, energy pro-ducers also are price-takers, not price-makers.

They operate at the mercy of a host of unpre-dictable domestic, international, economic andpolitical factors beyond their control. Even the

weather affects oil and gas prices. No wondercash flows can vary greatly.Studies show that of all commodities

wheat, sugar, orange juice, pork bellies, plat-inum, copper, gold, whateveroil, gas andelectricity are the most volatile of all.

Their daily prices onthe New York Mercan-tile Exchange (Nymex)change more often, andto a greater degree, thanthat of other commodi-ties. This in turn affectsthe price that buyers of

the product will pay atthe wellhead. Producerscan mitigate thisvolatility, in part, byprice-risk management(commonly calledhedging) or by sellingforward a portion oftheir production at anagreed price (volumet-ric production pay-ments or VPPs).

Over time, the corre-

lation between Nymexcrude oil prices and thecash or spot price forWest Texas Intermedi-ate (the U.S. bench-mark crude traded onNymex) has proved tobe very tight.

That price is formedby a complex set offactors, not the least ofwhich are perceptionsof traders and specula-tors. As the old joke

goes, when traders

from Long Island emerge from the subway,Manhattans weather sets the tone for that daystrading. More seriously, analysts note the affecton Nymex of speculative hedge funds and oth-ers who can move the price based on their ownperceptions. When oil can swing by as much as$1.50 per barrel in one day, thats not onlyworld supply and demand affecting the price,

its someones perception, fear or greed.Who trades on Nymex? Oil companies, refin-ers, end-users such as airlines and manufactur-ers, and oil and gas marketers involved directlyin the industry who understand the fundamen-tals, typically hold about 60% to 70% of the

WHO SETSOIL AND GAS PRICES?Once the well begins flowing in commercial quantities, the revenues beginand so does a price roller-coaster.

COMMODITY PRICES

22 E&P: An Investors Guide

Energy traderson the floor ofthe New YorkMercantileExchange usevoice andgestures toindicate buy andsale orders for

oil, natural gas,gasoline andheating oil.


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crude contracts on any given day. The rest areheld by speculators, hedge funds and WallStreet investment houses, and by the odd-lotholders of a small number of contracts. Eachday they react to weather conditions, global andnational news events, and weekly and monthlyreports from various agencies.

Some of the most closely watched data on in-ternational supply, demand and storage comefrom three sources: the International EnergyAgency (IEA) in Paris; the American Petro-leum Institute, a Washington-based trade

group; and the U.S. Department of EnergysEnergy Information Administration (EIA).

As the world produces about 84 million bar-rels per day, and the U.S. produces about 21trillion cubic feet of gas per year, it is difficultto monitor and measure specific production anddemand numbers. It is also difficult to trackbarrels or cubic feet that are in storage ownedby governments and individual companies, andbarrels that are in transport on the high seas.

In the end, all this leads back to the wellheadin the field, where wholesale oil and gas buyersand brokers post the price they will pay eachday. Typically they arrange to buy for a 30-dayperiod, as negotiated with the producer. In-creasingly, these spot cash prices are tied to theclosing price recorded on Nymex a day or twoearlier.

No. 2 heating oil began trading on Nymex in1978, crude oil futures in 1983, natural gas in1990, and electricity in 1996. Instantaneousprice transparency and computerized communi-cation affect the worldwide price each day and

in overnight trading as well.The vast majority of oil and gas traded on

Nymex is never delivered. Instead, the trade isclosed, or liquidated, by assuming an equal andopposite position in the market. Whats left is

Uses Of Hydrocarbons

Beside the generation of energy in elec-tricity-generation plants, ships, automobilesand airplanes, there are some surprisinguses of hydrocarbon-based products andpetrochemicals.

Examples include lipstick, preservatives,contact lenses, antihistamines, shampoo, faux

leather jackets and knit suits, pharmaceuticalcapsules, dyes, housepaint, insecticides, per-fume, rope, glue, countertops, fertilizer, roof-ing, candles, shaving cream, dentures,crayons, ink, golf balls and bandages.

If delivery istaken, oilmust bedelivered atCushing,Oklahoma,where manymajor oilpipelinesintersectGas must bedelivered atthe HenryHub, a gaspipelineintersectionnear Erath,Louisiana.

G

oing Up From the demand side, theglobal or U.S. economy improves, or

turns out to be more robust than wasforecast, boosting the need for oil used intransportation, oil or gas in manufacturingand petrochemicals, or other. A colder-than-normal winter hikes demand in Canada, U.S,Europe, Russia and Japan. A hotter-than-nor-mal summer boosts air-conditioning demand.

From the supply side, global oil produc-tion or the amount in storage is lower thanforecast, lagging demand growth. Theguesstimates were wrong. Unexpectedand/or temporary production shortfalls occurdue to hurricanes in the Gulf of Mexico,problem wells, disappointing drilling results,

project delays in bringing new production tomarket, pipeline restraints, or civil unrest inproducing areas such as Nigeria or Colom-bia. The global or U.S. rig count falls unex-pectedly, or by more than forecast, leadingeventually to reduced available supply. Re-finery are shut-in due to emergency or rou-tine maintenance.

Geopolitics affect prices too. OPEC meet-ings and informal OPEC pronouncementsspook oil markets and traders. War in theMiddle East or elsewhere causes major sup-ply disruptions. Guerillas sabotage oil or gas

pipelines or other production facilities. Stateor federal regulation, legislation or tax

changes make drilling and production moreeconomic, thus boosting activity.Going Down From the demand side, a

slowdown in overseas or U.S. economies re-duces demand for oil or refined products(diesel fuel, jet fuel, kerosene, etc.) or natu-ral gas. A warmer winter than usual reducesthe need for heating oil or gas.

From the supply side, global oil produc-tion or U.S. gas output turns out to be higherthan forecast, or higher than demand, creat-ing a supply glut. The amount of oil or gas instorage keeps rising, outpacing demand andcreating a glut that takes time to be absorbed

by the market.Unexpected production increases occur

due to more drilling, or more success perwell drilled because of technology advances.Or, more companies enter the industry andstart drilling. As oil prices rise, unaccounted-for inventories surface, curtailing the pricerise.

Geopolitically, OPEC meetings or pro-nouncements spook oil markets and traders.State or federal regulations, legislation or taxchanges suddenly make drilling and produc-tion less attractive.

FACTORS AFFECTING PRICES



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the paper profit or loss.If delivery is taken of the product, oil must be

delivered at Cushing, Oklahoma, where manymajor oil pipelines intersect and there are morethan 21 million barrels of storage capacity. Gasmust be delivered at the Henry Hub, a gaspipeline intersection near Erath, Louisiana.

Typical daily Nymex oil-trading volume ex-ceeds the equivalent of 100 million barrels ofoil, more than that physically produced eachday. Nearly 1,000 traders may be franticallysignaling buy and sell orders on a 25,000-

square-foot floor that is dedicated to energy atthe 133-year-old Nymex in lower Manhattan.Nymex handles about 75% of the daily tradingin all energy futures contracts around the world.

The number of oil and gas contracts tradeddaily during the first nine months of 2005 aver-aged 242,609 and 78,139, respectively. In astudy Nymex conducted in late 2004, the ex-change found that hedge funds accounted for3% of the volume of crude oil trades on the ex-change and 9% of the natural gas trades.

Leslie Haines

They call it black gold, but it isnt al-ways black and the amount of gold itputs in a producers pocket varies

greatly. In addition to global and nationalsupply, demand and storage trends, Nymexprices, and the cost of transporting oil from

wellhead to refinery gate, the physical at-tributes of the crude itself matter.

These attributes include the oils viscosity,gravity (density as compared with water),and its sulphur, water and salt content. Crudegravity and volume vary with temperature.

Gravity refers to the density of the crude,expressed in a scale originated by the Amer-ican Petroleum Institute. In the scale, waterhas a gravity of 10 degrees API. Liquidslighter than water (most crudes) typicallyhave gravities numerically greater than 10,up to about 40. Hydrocarbons greater than

40-degree gravity may be condensates.Some crudes, such as those found in parts

of Oklahoma, Alberta and British Columbia,flow freely from the wellhead withoutpumps, and are so light in color and viscos-ity, they resemble white wine. They are al-

most ready to use in a combustion engine.These crudes command top dollar. Other

crudes, such as some found in California andVenezuelas Orinoco Basin, are so black,heavy and putty-like, they cannot be pouredonce they reach the surface. Water, gas,steam, carbon dioxide, nitrogen, polymers orother chemicals must be injected into thewell first, to get the oil to the surface andthrough the pipeline. These oils commandless money per barrel since they requiremore sophisticated and costly refining pro-cesses.

Lighter oils lend themselves to refining ormanufacture of higher-priced products suchas gasoline, jet fuel and kerosene. Heavieroils are refined into lower-priced productssuch as bunker fuel and asphalt.

CRUDE LA CARTE


A different pricefor crude isreceived basedon its physicalqualities anddistance from thepipeline.(Photo by NickDeSciose)

The numberof oil and gascontractstraded dailyduring thefirst ninemonths of2005averaged242,609 and78,139,respectively.

Myriad Crude Oil Prices ($/Bbl)

West Texas Intermediate: $59.55Louisiana Light Sweet: 60.39Eugene Island: 57.17Mars: 53.94Poseidon: 53.95

HLS: 58.49

West Texas Sour: 54.50Wyoming Sweet: 53.81Basrah Light: 50.47Bonito: 57.39

Alaska North Slope (California): 56.61Canadian Lloyd Blend: 34.36Canadian Mixed Sweet: 60.36Canadian Light Sour Blend: 54.26Canadian Condensates: 68.36

Terra Nova: 55.73Hibernia: 56.68Source: Platts North American Crude Wire, Nov. 8, 2005


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How much is an oil and gas companyworth? Measures such as cash flowgrowth, earnings per share (EPS) and

return on capital employed (ROCE) tell onlypart of the story. What about the underlying as-sets themselvesthe oil and gas reserves in theground?

The current status and future potential of acompany also are measured by the amount ofreserves that are recoverable, the nature ofthose reserves, and the cost of finding and pro-ducing them. Some investors in oil and gascompanies may be surprised to learn that howmuch oil and gas the company continues toown below the surface may change from yearto yearnot due to any change in how muchoil or gas is actually there.

Through complex petroleum engineer-ing studies and actual productionhistory, a company grows more

confident about the discoveriesit has made. The more wells itdrills in a given field or area, thegreater its knowledge of the phys-ical characteristics of the sub-surface reservoir. Theengineers can then de-termine which tech-nologies to applyto maximizeproduction in ac o s t - e f f i c i e n tmanner.

Original oil and/or

gas in place is the total,finite amount in theearth regardless ofwhether or not it can betechnically or economi-cally recovered. Recoveryis a function of technologyand market prices. Most oilwells recover only10% to 35% of theoil and/or gas thatis in place, withoutadditional stimula-

tion or special

equipment. Gas wells do much better; it is notuncommon to recover 80% of the gas in place.

Proved oil and gas reserves represent the sumof two sub-classifications.

Proved developed reserves can be recov-ered from known reservoirs in existing wells attodays prices and technology, using existing

facilities. Sub-categories include proved devel-oped producing (PDP) and proved developednonproducing (PDNP).

Proved undeveloped (PUD) reserves areexpected to be recovered from new wells onpreviously undrilled leases, or from existingwells where a relatively major expenditure isneeded to recomplete a well in a different zone.

There are two additional categories of re-serves, after proved reserves. Theseare probable and possible reserves.Among U.S.-reporting companies,these are not considered in evaluat-

ing a companys worth bySEC definition. AmongCanadian-reporting compa-

nies, probable reservesare part of the cal-

culation. Else-where in the

world, variousrules apply.

The combina-tion of the threereserve types in

reporting total re-serves is commonly

abbreviated at 3P.The combination of

proved and probablereserves would be re-

ported as 2P.While engineers may

debate the finer points ofcategorizing reserves,bankers loan money to

companies based on a per-centage of the value of

their proved reserves,specifically the PDP re-

serves and sometimes a small

RESERVES ANDWRITE-DOWNSThe amount of oil and gas a company claims as itsown can change due to commodity prices as muchas by geological and technical factors.

ASSET EVALUATION


ILLUSTRATIONBYMARKSHAVER


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portion of the PUD reserves.Lower and/or slower production rates reduce

the economic value of reserves, in terms of thetime value of money. Higher costs also reducevalue. The option value of undeveloped, proba-ble and possible reserves is sensitive to a com-panys ability to find the needed capital, applythe right technology at reasonable cost, and in-stall the right infrastructure to get the oil and/orgas to the surface and to marketsurface orsubsurface production facilities, processing or

treating facilities, gathering lines and pipelines.Each year, companies formalize this re-

serves-calculation process when they hire third-party engineering firms to audit their reservenumbers and revise them, based on a host offactors:

Technology and infrastructure How manyof those barrels or cubic feet can be economi-cally extracted now, using todays technologythat is affordable to this particular company,and how much can be recovered in the future?What is affordable to an oil company that en-

joys a good credit rating and thus access to low-interest debt may not be affordable to a small

company that doesnt have the leverage andhistory to get low-cost capital.

What is the scope of the companys technicaltalent and access to the latest production sci-ence? It is more likely that ExxonMobil willsuccessfully develop an ultra-deepwater Gulf ofMexico discovery in 10,000 feet of water andanother 25,000 feet below the seabed that is100 miles from the nearest existing pipeline in-frastructure than the odds of a small oil and gascompany doing so. In this case, the smaller oilcompany is usually a partner with ExxonMobil,and gets credit for its share of the reserves.

Are the new wells near existing gatheringlines and pipelines, or many miles away? Forexample, zero credit would be given for gas re-serves found in central Africa, where there islittle market for the gas and infrastructure to getthe gas to a thirsty market via a liquefied natu-ral gas (LNG) terminal and tankers.

Do the wells require expensive fracturing orother stimulation before they can produce? Re-serves associated with wells that may easily

produce 10 million cubic feet of gas per day inSouth Louisiana would likely get full credit;waxy oil reserves in Utah that produce withgreat prodding would get less credit.

Commodity price What is the price of oiland gas now, and what might it be three yearsfrom now? Decisions based on oil prices of $60per barrel look economic but they appear fool-hardy if oil drops to $25 per barrel. The sameholds when natural gas falls from $12 per thou-sand cubic feet to $4.

On the other hand, when oil and gas pricesrise, the backlog of high-potential projectsbased on good science, but had to be shelveduntil better times, can finally be undertaken.

Can the company afford to fully develop thereserves using its own cash flow, or must it bor-row, or bring in partners and trade away a per-cent of the total? Is this well uneconomic toproduce now, or if oil or gas prices rise, will itbe economic later?

Future cash flows are estimated based on fu-ture production volume and current spot prices,not the price that may actually prevail in the fu-ture.

Unless a company has an unusually high tol-erance for risk, or deep pockets, it will postpone

high-risk, high-cost wildcat wells in a low-priceenvironment until the economics improve.

Economics may improve in four main ways:the price of the commodity rises, a new tech-nology reduces finding, development or pro-ducing costs, the cost of capital falls orcorporate overhead declines. Occasionally,state or federal tax relief may temporarily makedrilling economics more attractive, which maycause a company to drill a well that was placedon the back burner.

Quality of reserves What percent of the re-serves are now producing? If a high number,say 60% to 90%, a company is essentially liqui-


A roughneckcleans the floorof a drilling rig.Shown is thehole, throughwhich the well isdrilled, anddrilling mud.

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