Profitability of Capital Expenditures for Development Drilling and Producing Property Appraisal
- J.J. Arps (The British-American Oil Producing Co.)
- Document ID
- Society of Petroleum Engineers
- Journal of Petroleum Technology
- Publication Date
- July 1958
- Document Type
- Journal Paper
- 13 - 20
- 1958. Original copyright American Institute of Mining, Metallurgical, and Petroleum Engineers, Inc. Copyright has expired.
- 4.3.4 Scale, 4.1.5 Processing Equipment, 1.6 Drilling Operations, 5.7 Reserves Evaluation, 4.1.2 Separation and Treating
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The appraisal of producing properties and profitability analysis of a proposed capital expenditure are based on the same principles. In both problems a projection of future cash income is compared to one or more capital expenditures. Several different methods have been in use either to compute a price to obtain a given earning power on the investment or to compute the earning power which will result from a given capital expenditure. One of these, the "Average Annual Rate of Return" method, computes in a simple manner the ratio of the present value of the future earnings after amortization to the present value of the undepreciated balances of the investment over the life of a project. This method, not well known generally, appears to have some rather unique advantages in reducing the computation work required, eliminating trial-and-error solutions, and providing a more accurate answer when applied to oil industry investments subject to the unit-of-production basis of amortization. Its derivation is given and its versatility demonstrated in the solution of certain everyday investment problems. A number of charts, useful in applying this method to profitability analysis and appraisal work, are provided. The current trend in the market values of producing properties is shown.
Making sound capital expenditure decisions requires an objective means of measuring the productivity of individual investment proposals. Since the best measure of the economic worth of such proposals is their ability to produce profits, it is common practice to grade proposed capital expenditures according to their annual earning power as a percentage of the outstanding capital. The same principles which govern the determination of the rate of return of proposed capital expenditures also apply generally to the problem of determining the appraisal value or purchase price of income-producing oil and gas properties.
Both problems are of prime importance in the producing phase of the oil business, where management is faced daily with decisions to drill or not to drill certain development wells, or with the determination of the appraisal value of producing properties.
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