THE ECONOMICS OF OIL & GAS

Understand the numbers behind an oil & gas investment and the terms used to evaluate its economics.

From revenue and operating costs to IRR, MOIC, cash flow, and tax considerations, these core concepts provide a foundation for understanding how an investment may perform and what to look for when reviewing an opportunity.

1. HOW DOES THE OIL & GAS WELL GENERATE REVENUE?

Revenue The value generated from selling produced oil and natural gas, before deducting operating expenses, taxes, transportation, and other costs.

Cash Flow

The cash generated by an investment after applicable operating costs and other cash expenses. Understanding the timing of cash flow is just as important as the total amount.

2. WHAT DOES IT COST TO PRODUCE?

Lease Operating Expenses (LOE)

The ongoing costs required to operate and maintain producing wells, such as labor, repairs, utilities, and field services.

Gathering & Transportation

Costs associated with moving produced oil and natural gas from the well or lease to processing facilities, pipelines, or sales points.

Production Taxes

Taxes imposed by states or other jurisdictions on the production or value of oil and natural gas.

Authorization for Expenditure (AFE)

A formal estimate of expected costs for a planned operation, such as drilling, completion, or significant work on a well.

3. HOW MUCH RESOURCE IS THERE?

Estimated Ultimate Recovery (EUR)

An estimate of the total amount of oil or natural gas expected to be recovered from a well or reservoir over its productive life.

Reserves

Quantities of oil and natural gas estimated to be recoverable under defined economic and operating conditions. Reserve classifications can vary based on the level of certainty and economic assumptions.

Decline Curve

A model used to estimate how production from a well is expected to change over time. Production typically declines after the initial production period, although the shape and rate of decline vary by well and reservoir.

4. HOW ARE THE INVESTMENT ECONOMICS MEASURED?

Internal Rate of Return (IRR)

A return measure that considers both the amount and timing of an investment's cash flows. It is commonly used to evaluate projects with multiple cash inflows and outflows.

Multiple on Invested Capital (MOIC)

The total value or cash returned from an investment relative to the original capital invested. A 2.0x MOIC means $1 of invested capital generated $2 of total value or distributions.

Cash-on-Cash Return

Cash received over a specified period relative to the amount of capital invested. It helps illustrate the income-producing characteristics of an investment.

Payback Period

The amount of time required for cumulative cash flows to recover the initial investment. It is one measure of capital recovery, but does not capture the full economics or risk of an investment.

5. WHERE DO TAXES FIT?

Intangible Drilling Costs (IDC)

Certain costs associated with drilling and completing an oil or gas well may qualify for current deduction under U.S. tax rules, subject to applicable requirements.

Tangible Drilling Costs (TDC)

Costs associated with tangible equipment and property used in drilling and production. Tax treatment generally differs from qualifying intangible costs.

Depletion

A tax deduction intended to account for the reduction of a mineral property's economic interest as oil or gas is produced. Depending on the circumstances, depletion may be calculated using cost depletion or percentage depletion.

This article is for general educational purposes only and does not constitute investment, tax, legal, or financial advice. Tax treatment varies based on the investment structure and individual circumstances. Investors should consult their own qualified advisors regarding their specific situation.