How an Oil & Gas Exploration & Production Company Operates

Introduction

THIS BOOK FOCUSES ON the activities of an oil and gas exploration and production company from the viewpoint of the mineral owner or the land administration professional, and with the oil and gas lease in mind. Many books are available informing readers on drilling and production procedures and practices, but this is not one of them. Those books target investors and oil industry professionals such as geologists and petroleum engineers. This book concentrates on the oil and gas lease and the steps that an oil and gas exploration company takes to make that lease productive and to pay all owners entitled to a share of that production. Production, when sold, generates royalty payments for the mineral owners, the primary audience for this book.

The reader will find in-depth discussions of the various actions taken by various company employees and contractors throughout the life of the lease. Specific delegation of tasks and the workflow procedures generated by those tasks will differ from company to company based on size and other factors, but all domestic U.S. petroleum exploration and production (called E&P) companies operate in substantially the same way, by generating and handling oil and gas leases. This book unveils the fundamental but universal business model with detail sufficient to give insight into the complexity, expense, and expertise required to obtain oil and gas from the ground generating royalty revenues. Substantial effort and risk is required to grow and maintain an exploration and production company engaged in drilling and producing oil and gas in the domestic United States.

There are two ways to acquire oil and gas producing properties, but the organic method through the drill bit is of main interest in this book. The organic method creates producing oil and gas properties by leasing the land and then drilling on it. In the industry, this is called exploration. Once the land is drilled and a successful oil or gas well is completed, the well and the acreage around it is more likely to be sold and traded with other oil companies. A price-per-barrel equivalent is negotiated for the oil and gas still underground in the reservoir waiting to be produced out. In the industry, this process of selling and buying oil and gas properties is called acquisition and divestiture, or A&D for short. After acquiring already-producing properties, and company is likely to continue drilling more wells on the same land, to fully develop its production potential. This phase of drilling generally has lower financial risk associated with it, since the petroleum reservoir is now known. The industry refers to this as exploitation.

Imagine that! America is the only nation in the world that allows private ownership of natural resources that makes our system of domestic exploration and exploitation possible. Canada and Australia are two nations that also did in the past, but no longer allow it. The government controls oil and gas rights in all other countries, which issues licenses or concessions to companies wishing to drill for those natural resources. The government receives all royalties for oil and gas produced in its country.

Chapter 1: The Organic Prospect

Three Types of Oil and Gas Companies

BEFORE A MEANINGFUL discussion of how an oil and gas exploration and production company operates can begin, it is necessary to explain that this type of oil and gas company is only one of the three types of oil companies in this industry that mineral and royalty owners deal with routinely. An oil and gas exploration and production company is the type of company that acquires new leases from landowners. It is the type that oversees all of the processes and steps necessary to drill a successful well, and then holds the responsibility of making certain all royalty owners are paid (as well as all other owners in the well who are not royalty owners). This type of oil and gas company is called an operator.

The second type of oil and gas company is called simply a producer. This company also acquires leases, new or existing, but does not take the responsibility of drilling a well. It seeks to partner with operators who oversee the processes causing a well to be drilled; therefore, it is called a non-operator. However, this type of company can, and often does, sell its share of the production to its own purchaser and receives directly the money from the sale each month. We in the industry call this taking in kind. A non-operator taking in kind is responsible for paying its royalty owners out of the money paid over to it by the purchaser.

The third type of oil and gas company is the purchaser. A purchaser is the company that buys the production for the sole purpose of either refining it or selling it to a refinery, or end user. A single oil and gas company can function as an operator, a producer, and a purchaser, but this is the exception and not the norm.

Now that the groundwork is laid for understanding the role and processes of an oil and gas exploration and production company, the real discussion can begin.

Geological Idea

EXPLORATION FOR OIL or gas begins with a geological idea. In other words, based on extensive research and review of existing historical seismic surveys, drilling, and completion data, much of which is available to the public, a skilled geologist identifies a target area. The geologist locates an area that he or she believes contains an amount of oil or gas sufficient to warrant the financial and environmental risk of exploring for it. If the targeted geological formation has not been drilled before—which is common these days given the advancements in our industry technologies—the first well will be a wildcat well. A wildcat well is a well drilled where there is no other well near it that is currently producing from the target formation. Or, another wellbore (vertical or directional) drilled through that formation before being completed above or below it. Only after successful completion of the first wildcat are all subsequent wells in the field categorized as development wells.

Oil and gas in the ground resides in underground hydrocarbon reservoirs, labeled as oil and gas reserves. Reserves are the quantity of oil or gas still in the ground waiting to be produced. Before the wildcat well is drilled, the reservoir of oil or gas that the geologist believes is there, but doesn’t know for sure yet, are labeled unproven reserves, probable reserves, or undiscovered petroleum initially-in-place. These reserves have no direct value until a successful wildcat well is drilled. In addition, a true wildcat well might not have any pipeline available near it, so a pipeline is built to get the production to the nearest gathering pipeline or to the nearest trunk pipeline. Commonly, the operator drills two or three producing wells before pipeline work begins. In the case of oil, it is trucked. For a gas well, it is shut-in and the royalty owners are paid a shut-in royalty according to the terms of their lease until a pipeline is constructed.

If the wildcat is classified by the regulatory agency as an oil well, one or more big, round tanks will be brought onto the drill site so the well can flow into the tanks and tanker trucks can come to the battery site, load up and haul the oil to market while a pipeline is built. This method of transportation is very expensive, especially for large production volumes. If the wildcat is a gas well, often it is shut-in until the pipeline is completed and the gas can begin flowing from the wellhead into the pipeline. It is not feasible to store gas safely in tanks at well sites. Often, an oil well initially will also produce a small amount of gas when it begins producing, called a gas cap in the reservoir.

Small amounts of gas, or gas with very low pressure at the wellhead, are uneconomical because they do not warrant building a gas pipeline from the well to connect it into the purchaser’s pipeline. Commonly, the operator flares this gas. Flaring means the operator installs a hollow stack at the well site, then gas flows into the gas stack and burns like a huge candle. It is quite a sight to see dozens of wells with burning flare stacks at once, such as out in West Texas near Midland where this practice is common. The royalty owners must be paid royalties on the value of the flared gas only if their lease pays royalties on all gas produced. Most leases pay royalties on all gas produced and saved. Since the gas burns at the wellhead, the gas is not saved; therefore, royalties typically are not due.

After drilling a successful wildcat well, the geologist, geophysicist and reservoir engineer analyze the myriad of drilling logs and other sub-surface tests available from the drilling process. This team decides how large the reservoir likely might be. Based on that, they can estimate how many barrels of oil and thousand-cubic-feet of gas might be in the reservoir, and the name of the reserves changes to proven, undeveloped reserves, possible reserves, or discovered petroleum initially-in-place. Generally, only the estimated amount of oil or gas directly around the wildcat wellbore will be given value, as little as 30% of the current oil or gas sales price in the area up to as much as 60% based on the quality of the production already produced. This valuation will allow the wildcatter oil company to sell pieces of ownership in the entire field, the wildcat well included, using these low percentages. The company reinvests the capital raised from the sale in another project elsewhere, depending on the selling company’s business model.

Ideally, the operator drills additional wells strategically distanced from the first well, to try to find out where the edges of the reservoir are. For this phase of reservoir development, wildcatters that do not already have partners contributing to the cost will want to attract some. These strategic wells are called step-out wells. Step-out wells are similar to playing the computer game of Minesweeper. Several vertical or horizontal dry hole wells could be drilled attempting to find the edges of the productive reservoir. Sharing the risk of dry holes with other companies, as partners, helps to make those high-risk losses palatable. Once the operating company locates the likely edges of the reservoir, potential drill sites are selected inside those boundaries. These sites are considered the hottest spots. The reservoir is then said to contain what are called proven, developed reserves, or known reserves, or total petroleum initially-in-place.

A prospect area potentially holding one or more reservoirs can be as large as several thousands of acres (called a field), or as small as a few dozen acres. Today, most of the new prospects generated by geologists will fall in between these two extremes, for several reasons. One reason is that it most often is too costly to go out and lease several thousands of acres before the wildcat is successful, risking losing the leases near the wildcat if they begin expiring before drilling rigs can be scheduled. It’s prudent to acquire a reasonable amount of acreage within the hottest center of the prospect so that outside-competitor companies cannot jump in and take leases close to the wildcat well if it turns out to be a gusher—a very high-volume producing well. All of this requires a very delicate balance between risk, available capital funds, and maintaining competitive advantage.

Imagine that! The North America Prospect Expo, better known as NAPE, is the world's largest E&P (upstream) expo. NAPE Expo provides a marketplace for the buying, selling and trading of oil and gas prospects and producing properties via exhibit booths. NAPE is the premier E&P networking venue - where one can see what's going on throughout the entire oil patch in two days. http://www.napeexpo.com/about-nape

Receive Management Approvals

THE GEOLOGIST MUST sell the geological idea in order to get funding for it. If the geologist is an employee of an E&P company, he or she must sell the geological idea to management. An independent consultant does this same amount of work with the expectation of selling the prospect to an E&P company for cash. Either way, the geological idea must be sold in order to acquire the funding necessary to begin exploring it. Typically, a tremendous amount of work goes into the process of preparing a geological idea for presentation to company executives who hold the purse strings. Presentations can range from highly detailed PowerPoint presentations with well organized but less than glossy handouts, to a video presentation with professionally published glossy booklets for each of the executives.

The job of the geologist is to present his geologic idea to the audience with the power to drill the prospect area and sell it. If he or she successfully sells the project, plans to drill it can begin. The company whose executives have