The domestic oil industry
F_O_R_W_A_R_D_
The domestic oil industry has experienced a gigantic and
classic business cycle over the past 15 years. Exploratory
optimism evolved from the 1973 OPEC oil embargo and peaked in the
early 1980s. From the peak to present, the oil industry has
declined into a price induced depression, instilling fear in many
explorationists and investors alike. As in any other market,
late comers in the booming oil market were hurt badly by high
costs and declining prices. Conversely, early participants in a
new market cycle have the greatest potential to gain.
This paper is presented to refute misleading and erroneous
concepts regarding today's economics for oil exploration. Oil
price alone does not determine profitability in the domestic oil
industry. Exploration costs are an equally important factor.
Confusion and fear have arisen from the lack of factual
information regarding bottom line profitability.
OPEC has essentially now recouped its world market share of
oil, which was the original strategy. Information presented
herein is intended to help clear up much misconception
surrounding the domestic oil industry. The explorationist and
investor equipped with facts about bottom line profitability in
oil is best prepared for ultimate economic success.
James W. Cammack
CAMMACK AND CAMMACK
200 N. Harvey, Suite 410
Oklahoma City, Oklahoma 73102
Phone: (405)239-2031
T_H_E_ _B_E_S_T_ _O_F_ _T_I_M_E_S_
A_ _S_C_E_N_A_R_I_O_ _O_N_ _O_I_L_
(30 Year Historical Analysis)
I_N_T_R_O_D_U_C_T_I_O_N_
Today's economic climate offers an excellent investment
opportunity in the search for new domestic oil reserves. An
historical prospective of economics shows that oil exploration
has more potential for profitability than at any other time with-
in the past 30 years. The present romance in oil exploration is
revealed through the comparison of historical oil industry facts.
Successful investors must be concerned with price AND cost
when exploring for oil. Return On Investment, not just oil
price, is the major factor in determining potential profitabili-
ty.
E_C_O_N_O_M_I_C_S_
Primary indices that determine the economic feasibility of
oil exploration are: (A) Cost of drilling and completion, and
(B) Price of oil over the productive life of the project. Evalua-
tion costs, acquisition expense, operations, future value dis-
counting, etc. are other factors that must be formulated into
each venture.
The costs of drilling and completion are accurately deter-
mined by pricing through contractors and vendors. The future
price of oil over the life of a project is not known. Price is,
and always has been, a subjective quantity. Oil prices have
revolved around OPEC actions for the past 15 years (supply versus
world demand). No change in control is foreseeable.
Historical evaluation of the domestic industry requires that
certain criteria be used to normalize the variable effects of tax
and inflation on oil values and exploration costs.
1) A thirty year historical prospective is selected from
1959 through 1988. This time span includes the 15 year oil
price macro-cycle influenced by the OPEC Cartel plus the
previous 15 year period regulated by the Texas Railroad
Commission. Cost figures prior to 1959 are not readily
available.
2) The producer price index (PPI) discounts inflation and
establishes a constant dollar value base from which
historical comparisons are made.
3) The oil price is reduced by the amount of windfall profit
tax during it's effect on well head price.
Various industry statistics used are from The "Joint Associa-
tion Survey of the U.S. Oil and Gas Producing Industry" Annual,
American Petroleum Institute. The American Petroleum Institute,
and Joint Participants have compiled data from its sources.
OIL PRICE:
The price of oil is one factor in economic evaluation.
Annualized oil prices for domestic crude oil over a 30 year
period are shown in current and constant dollars on C_h_a_r_t_ _1_.
CURRENT PRICE is in inflated dollars. CONSTANT PRICE is
calculated in 1967 = 100 dollars. Prices are adjusted for
windfall profits taxes (Tier 3, New Oil) effective 1980 through
1985. The 1989 annual wellhead price is estimated at $18.00 in
current dollars and $5.28 in constant dollars. Constant price,
cost and windfall profit tax adjustment establish standardized
values for historical comparison and evaluation.
The 30 year price of oil in current dollars is illustrated
by F_i_g_._ _1_-_A_. This curve is deceptive when used for historical
price comparison. F_i_g_._ _1_-_B_ is corrected for inflation and wind-
fall profits tax. All oil prices are constant values relative to
the 1967 oil price.
The constant oil price curve exhibits four distinct periods
of change. 1959-1973 reflects a relatively "S_T_A_B_L_E_" period for
oil prices under the Texas Railroad Commission. A "P_L_A_T_E_A_U_" is
seen for 1974-1979. This period marks the beginning of OPEC
Cartel price control. The "B_O_O_M_" of 1980-1985 was caused by an
imbalance in world oil supply with OPEC controlling prices. A
double "B_O_T_T_O_M_" period in 1986-1988 was caused by OPEC regaining
quota through price reduction. "T_O_D_A_Y_", OPEC has regained domi-
nance and oil prices are recovering.
WELL COMPLETION COST:
The cost of drilling and completion to produce oil is
another factor in economic evaluation. Annualized per foot
completion costs are listed in current and constant dollars
(C_h_a_r_t_ _2_). Costs for 1988 and 1989 are extrapolated.
The 30 year per foot costs for completion are illustrated by
F_i_g_._ _2_-_A_ and 2_-_B_ in current and constant dollars, respectively.
The constant dollar curve (F_i_g_._ _2_-_B_) shows costs peaking at
$26.00 in 1982 and declining to an estimated $12.77 in 1989.
Completion costs have reached a new 22 year low in 1989.
OIL WELL PAYOUT:
The Return on Investment is a function of price and cost.
The historical relationship between oil prices and completion
costs is a standard measure for relative profitability.
The completed oil well cost and oil price graphs have simi-
lar profiles. A comparison of oil well completion cost to oil
price shows that the cost peak of 1982 lagged the price peak by
approximately one year. A reverse lag of lower cost versus
higher price is now apparent.
A comparison of constant dollar oil prices and constant
dollar completed oil well costs are listed on C_h_a_r_t_ _3_. PAYOUT is
defined as the yield in barrels of oil per foot that is required
to pay for the cost of a completed oil well. Barrels of oil per
foot for payout (BO/ft-payout) is the completion cost divided by
the oil price. Less BO/ft-payout equates to better potential
Return on Investment.
F_i_g_._ _3_ illustrates BO/ft-payout over the past 30 years. The
30 year average for payout is 4.01 BO/ft. Payout varies from a
maximum of 5.17 BO/ft in 1972 to a minimum of 2.46 BO/ft in
1984. Today's figure is at a 31 year low of 2.42 BO/ft. The
pre-OPEC (Texas Railroad Commission) period had an average payout
of 4.49 BO/ft compared to 3.53 BO/ft under OPEC control, reflect-
ing a 21% improvement between the former and latter periods.
The BO/ft-payout assumes 100% success and stable oil price
during payout. In practical application, risk must be calculat-
ed. Other costs such as acquisition, operations, and future
value discounting must also be included. Ultimate potential
Return On Investment is related to all of the above.
A relative cost, price and payout rate comparison of the
various periods is illustrated on C_h_a_r_t_ _3_.
COMPOSITE PRICE-COST-PAYOUT:
F_i_g_._ _4_ and C_h_a_r_t_ _4_-_A_ and 4_-_B_ depict the status of oil price,
drilling and completion cost and BO/ft-payout for the "Stable",
"Plateau", "Boom", "Bottom" and "Today" periods. This composite
of domestic oil industry economics shows "Today" to be superior
to the other periods. COST, PRICE AND BO/FT-PAYOUT RELATIONSHIPS
ARE CENTRAL TO UNDERSTANDING TODAY'S ECONOMIC MERITS.
M_I_S_C_E_L_L_A_N_E_O_U_S_
OIL WELL FOOTAGE:
C_h_a_r_t_ _5_ and F_i_g_._ _5_ show the total annual footage drilled for
oil. Data includes completions and dry holes. The footage
drilled for oil in 1988 is at a 14 year low. The 1986-1988
"Bottom" average footage is at a 30 year low compared to the
other periods.
TAX EXPENSE:
Taxation has an important bearing on economics. C_h_a_r_t_ _6_ is
a comparison of taxes (excluding income taxes) versus total esti-
mated U.S. exploration, development and producing expenses.
The change in the percentage of taxes to total expenses is shown
on F_i_g_._ _6_. The percentage of tax to total expense more than
doubled in years 1981 through 1985, reflecting the effect of
windfall profits taxes on expenses. 1986 shows a pre-windfall
tax norm of 9%.
In the past 30 years the maximum Federal income tax bracket
has been decreased from 90% to 33%. reflecting a 63% rate reduc-
tion. The Federal depletion allowance is still intact but reduced
from 27% to 15%. Various other tax allowances have been revised
over time. Each investment entity must make its own evaluation
for after-tax return. The after-tax net Return On Investment can
then be determined.
S_U_M_M_A_R_Y_
Renunciation of certain generally accepted truisms regarding
today's economics of domestic oil is appropriate. Current
economic opportunities do abound in oil!
Oil well payout rate today is at a 30 year high, and 11%
better than the 1980-1985 "Boom" average. Footage drilled is
lower than any previous period in 30 years. Today's constant
price of oil, excluding the 1980-1985 anomaly, is at a 30 year
high and drilling-completion cost is lower than any other period
in 30 years. Oil price today is 17% better than the 1974-1979
"Plateau" price while payout rate between these periods is up
33%. The windfall profits tax no longer exists. Income taxes
vary among taxpayers, but the maximum bracket tax rate has de-
creased 63% on income. Oil still has a 15% depletion allowable.
Oil prices are competitive with total U.S. industry (PPI)
prices. The real (constant) price received for oil in 1989 is
about 78% higher than total U.S. product prices since 1959.
This is THE BEST OF TIMES, not the worst of times, FOR PROS-
PERITY in the oil industry. Oil price phobia has diminished
exploration activity (and exploration costs) to a depressive
level. The golden opportunity for profits in oil exploration
today has not been surpassed in several decades!
C_H_A_R_T_ _1_
AVERAGE ANNUAL WELLHEAD PRICE OF U.S. CRUDE OIL
IN CURRENT AND CONSTANT DOLLARS
After Producer After
WFPT Price Index Price WFPT
Price in Tier 3 All Commodities in Tier 3 Period
Y_e_a_r_ C_u_r_r_e_n_t_ _$_ N_e_w_ _o_i_l_ _(_1_9_6_7_ _=_ _1_0_0_)_ _ _ C_o_n_s_t_a_n_t_ _$_ N_e_w_ _o_i_l_ _A_v_g_._ _
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
1959 2.90 94.8 3.06
60 2.88 94.9 3.03
61 2.89 94.5 3.06
62 2.90 94.8 3.06
63 2.89 94.5 3.06
1964 2.88 94.7 3.04
65 2.86 96.6 2.96 S_t_a_b_l_e_
66 2.88 99.8 2.89 $2.96
67 2.92 100.0 2.92
68 2.94 102.5 2.87
1969 3.09 106.5 2.90
70 3.18 110.4 2.88
71 3.39 113.9 2.98
72 3.39 119.1 2.85
73 3.89 134.7 _2_._8_9_ _ _ _ _ _ _ _ _ _ _ _
1974 6.74 160.1 4.21
75 7.56 174.9 4.32
76 8.14 182.9 4.45 P_l_a_t_e_a_u_
77 8.57 194.2 4.41 $4.50
78 8.96 209.3 4.28
1979 12.51 235.6 _5_._3_1_ _ _ _ _ _ _ _ _ _ _ _
80 21.59 20.35 268.7 8.03 7.57
81 31.77 27,96 293.4 10.83 9.53
82 28.52 25.92 299.3 9.53 8.66 B_o_o_m_
83 26.19 24.26 303.1 8.64 8.00 $8.17
1984 25.88 24.19 310.3 8.34 7.80
85 24.09 23.03 308.8 _7_._8_0_ _ _ _ _ _ _7_._4_6_ _
86 12.51 300.9 4.16 B_o_t_t_o_m_
87 15.41 307.7 5.01 $4.34
88 12.57 324.7 _3_._8_7_ _ _ _ _ _ _ _ _ _ _ _
1989 18.00* 340.9** 5.28* T_o_d_a_y_
$5.28*
* Estimated average oil price.
** Estimated average Producer Price Index.
Source:
Price in Current Dollars, "J_o_i_n_t_ _A_s_s_o_c_i_a_t_i_o_n_ _S_u_r_v_e_y_ _o_f_ _t_h_e_ _U_._S_._ _
P_r_o_d_u_c_i_n_g_ _I_n_d_u_s_t_r_y_ _A_n_n_u_a_l_" American Petroleum Institute, U.S.
Energy Information Administration.
Producer Price Index, U.S. Bureau of Labor Statistics.
Price in Constant Dollars, Period Avg. and After Windfall Profit
Tax (Tier 3, New Oil) after M_i_l_l_e_r_s_ _O_i_l_ _&_ _G_a_s_ _F_e_d_e_r_a_l_ _I_n_c_o_m_e_ _
T_a_x_a_t_i_o_n_ computed by James W. Cammack.
C_H_A_R_T_ _2_
ESTIMATED OIL WELL DRILLING AND COMPLETION COSTS
(ONSHORE U.S.)
IN CURRENT AND CONSTANT DOLLARS
Producer Average
Avg. Depth Avg. Cost Price Index Cost
Per Well Per Foot All Commodities Per Foot Period
Y_e_a_r_ _(_f_t_._)_ _ _ _ _ C_u_r_r_e_n_t_ _$_ _(_1_9_6_7_ _=_ _1_0_0_)_ _ _ C_o_n_s_t_a_n_t_ _$_ _A_v_g_._ _
_ _ _ _ _ _ _ _
1959 3753 13.07 94.8 13.79
60 3878 11.26 94.9 11.87
61 3821 12.18 94.5 12.89
62 4146 12.52 94.8 13.21
63 3812 12.15 94.5 12.86
1964 3719 11.77 94.7 12.43
65 4062 11.71 96.6 12.12 S_t_a_b_l_e_
66 3925 12.40 99.8 12.42 $13.28
67 3781 12.89 100.0 12.89
68 3984 13.49 102.5 13.16
1969 4276 14.99 106.5 14.08
70 4306 15.59 110.4 14.12
71 4116 16.01 113.9 14.06
72 4330 17.56 119.1 14.74
73 4462 19.65 134.7 _1_4_._5_9_ _ _
1974 3874 25.59 160.1 15.98
75 3979 31.49 174.9 18.00
76 3953 33.93 182.9 18.55 P_l_a_t_e_a_u_
77 4052 36.82 194.2 18.96 $19.09
78 4093 44.10 209.3 21.07
1979 4076 51.73 235.6 _2_1_._9_6_ _ _
80 4045 60.62 268.7 22.56
81 4138 75.38 293.4 25.69
82 3958 77.81 299.3 26.00 B_o_o_m_
83 3831 63.27 303.1 20.87 $22.23
1984 3888 59.42 310.3 19.15
85 3993 59.00 308.8 _1_9_._1_1_ _ _
86 4070 56.98 300.9 18.93 B_o_t_t_o_m_
87 4134 49.23 307.7 16.00 $16.36
88 4134 45.96* 324.7 _1_4_._1_5_*_ _
1989 4134 43.54* 340.9** 12.77* T_o_d_a_y_
$12.77*
* Estimated drilling and completion costs.
** Estimated average Producer Price Index.
Source:
Average Depth and Average Cost per Foot in Current Dollars,
"J_o_i_n_t_ _A_s_s_o_c_i_a_t_i_o_n_ _S_u_r_v_e_y_ _o_f_ _t_h_e_ _U_._S_._ _P_r_o_d_u_c_i_n_g_ _I_n_d_u_s_t_r_y_ _A_n_n_u_a_l_",
American Petroleum Institute.
Producer Price Index, U.S. Bureau of Labor Statistics.
Average Cost Per Foot Constant Dollars and Period Avg. computed
by James W. Cammack.
C_H_A_R_T_ _3_
BARRELS OF OIL PER FOOT DRILLED
TO PAY OUT AN OIL WELL
(Drilling and Completion only)
Well Costs* Payout
Oil Price* (Onshore, U.S.) in Bbls. Oil
Constant $ Constant $ Per Ft. Drilled Period
Y_e_a_r_ (_1_9_6_7_ _=_ _1_0_0_)_ (_1_9_6_7_ _=_ _1_0_0_)_ (_D_r_l_g_._ _&_ _C_o_m_p_._)_ _A_v_g_._ _
_ _ _ _ _ _ _ _ _ _
1959 3.06 13.79 4.51
60 3.03 11.87 3.92
61 3.06 12.89 4.21
62 3.06 13.21 4.32
63 3.06 12.86 4.20
1964 3.04 12.43 4.09
65 2.96 12.12 4.09
S_t_a_b_l_e_
66 2.89 12.42 4.30 4.49
67 2.92 12.89 4.41
68 2.87 13.16 4.59
1969 2.90 14.08 4.86
70 2.88 14.12 4.90
71 2.98 14.06 4.72
72 2.85 14.74 5.17
73 2.89 14.59 _5_._0_5_ _ _ _ _ _
1974 4.21 15.98 3.80
75 4.32 18.00 4.17
76 4.45 18.55 4.17 P_l_a_t_e_a_u_
77 4.41 18.96 4.30 4.24
78 4.28 21.07 4.92
1979 5.31 21.96 _4_._1_4_ _ _ _ _ _
80 7.57 22.56 2.98
81 9.53 25.69 2.70
82 8.66 26.00 3.00 B_o_o_m_
83 8.00 20.87 2.61 2.72
1984 7.80 19.15 2.46
85 7.46 19.11 _2_._5_6_ _ _ _ _ _
86 4.16 18.94 4.55 B_o_t_t_o_m_
87 5.01 16.00 3.19 3.77
88 3.87 14.15 _3_._6_6_ _ _ _ _ _
1989 5.28 12.77 2.42 T_o_d_a_y_
2.42
* Oil Price and Well Cost (with estimates) from
Charts 1 and 2.
Source:
Payout in Bbls. Oil Per Ft. Drilled and Period Avg. computed by
James W. Cammack.
C_H_A_R_T_ _4_-_A_
PRICE, COST AND PAYOUT RATE COMPARISON
OVER 30 YEARS
Constant Constant
Oil Comp. BO/ft.
P_e_r_i_o_d_ P_r_i_c_e_ C_o_s_t_ P_a_y_o_u_t_
Stable 2.96 $13.28 4.49
Plateau $4.50 $19.09 4.24
Boom $8.17 $22.23 2.72
Bottom $4.34 $16.36 3.77
Today $5.28 $12.77 2.42
C_H_A_R_T_ _4_-_B_
PRICE, COST AND PAYOUT RATE TODAY
COMPARED TO THE OTHER PERIODS
(Percentage of Change)
| Today's Today's Today's
Comparison | Oil Comp. BO/ft.
P_e_r_i_o_d_ | P_r_i_c_e_ C_o_s_t_ P_a_y_o_u_t_
|
Stable | 78% higher 4% less 46% better
|
Plateau | 17% higher 33% less 43% better
|
Boom | <35% lower> 43% less 11% better
|
Bottom | 22% higher 22% less 36% better
|
Source:
Price, Cost and Payout Rate compiled from Charts 1, 2 and 3.
Chart 4-B computed by James W. Cammack.
C_H_A_R_T_ _5_
TOTAL ANNUAL FOOTAGE DRILLED FOR OIL
COMPLETIONS AND DRY HOLES
(millions of feet)
Total Footage Period
Y_e_a_r_ _ _ _f_o_r_ _O_i_l_ _ _ _ _A_v_g_._ _
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
1959 174.1
60 152.7
61 151.4
62 155.6
63 148.7
1964 152.6
65 145.7 S_t_a_b_l_e_
66 122.8 129.1
67 111.3
68 112.0
1969 115.8
70 105.6
71 95.5
72 99.1
73 _ _9_3_._9_ _ _ _ _ _ _ _ _ _ _ _ _
1974 108.0
75 127.2
76 128.9 P_l_a_t_e_a_u_
77 142.4 134.9
78 150.3
1979 _1_5_2_._4_ _ _ _ _ _ _ _ _ _ _ _ _
80 202.1
81 279.3
82 251.9 B_o_o_m_
83 219.0 239.8
1984 257.5
85 _2_2_9_._2_ _ _ _ _ _ _ _ _ _ _ _ _
86 127.9 B_o_t_t_o_m_
87 111.9 116.2
88 _1_0_8_._9_*_ _ _ _ _ _ _ _ _ _ _ _
1989 (Data not available) Today
*Petroleum Information Quarterly Reports
Source:
"J_o_i_n_t_ _A_s_s_o_c_i_a_t_i_o_n_ _S_u_r_v_e_y_ _o_f_ _t_h_e_ _U_._S_._ _o_i_l_ _a_n_d_ _G_a_s_ _P_r_o_d_u_c_i_n_g_ _I_n_d_u_s_-
t_r_y_ _A_n_n_u_a_l_"_, American Petroleum Institute, Independent Petroleum
Association of America, Mid-Continent Oil and Gas Association.
Total footage For Oil and Period Avg. computed by James W.
Cammack.
C_H_A_R_T_ _6_
U.S. ESTIMATED EXPENDITURES FOR EXPLORATION
VERSUS TAXES PAID
Total
Taxes* Expenditures Tax / Total
Y_e_a_r_ (_M_i_l_l_i_o_n_s_ _$_)_ (_M_i_l_l_i_o_n_s_ _$_)_ (_P_e_r_c_e_n_t_a_g_e_)_
1972 (Data not available prior to 1973)
73 924.6 12,694.2 7.3
74 1,534.1 18,706.1 8.2
75 1,746.1 18,558.7 10.6
76 1,897.9 22,558.7 8.4
1977 2,098.9 25,725.1 8.2
78 2,379.0 30,373.2 7.8
79 2,750.4 44,686.4 6.2
80 4,564.9 62,655.0 7.3
81 20,557.5 98,635.7 20.8
1982 14,008.3 91,784.3 15.3
83 16,860.0 81,923.0 20.6
84 14,895.0 81,965.0 18.1
85 11,426.0 77,784.0 14.7
86 4,317.0 48,040.0 9.0
1987 (Data not available after 1986)
*excludes income tax.
Source:
Taxes and Total Expenditures, "J_o_i_n_t_ _A_s_s_o_c_i_a_t_i_o_n_ _S_u_r_v_e_y_ _o_f_ _t_h_e_ _
U_._S_,_ _O_i_l_ _a_n_d_ _G_a_s_ _P_r_o_d_u_c_i_n_g_ _I_n_d_u_s_t_r_y_ _A_n_n_u_a_l_", American Petroleum
Institute, U.S. Department of Commerce, Bureau of Census: Annual
Survey of Oil and Gas.
Tax / Total Percentage computed by James W. Cammack.
REFERENCES
American Petroleum Institute. May, 1989. Basic Petroleum Data
Book. Petroleum Industry Statistics. Vol. IX-No.2: Section III-
Table 9-9a, Section V-Table 10-10a, Section VI-Table 1-1a.
Houghton, James L., and others. 1981. Millers Oil & Gas Federal
Income Taxation. Commerce Clearing House, Inc., Nineteenth Edi-
tion: 32-1 through 32-17.
ACKNOWLEDGMENTS
Appreciation is expressed to Mr. John A. Taylor, ComQuest
Expl. Co., Oklahoma City, Oklahoma for his help in editing of
manuscript. Thanks are extended to Mr. A. R. Tiehen, Arbor Petro-
leum Corp, Oklahoma City, Oklahoma for helpful comments and
suggestions. Special acknowledgment goes to my wife Laurie
Cammack, for her encouragement and moral support.
ABOUT THE AUTHOR
Mr. James W. Cammack has a long and varied career, mostly in
the petroleum industry. After seven years as a development and
exploration geologist with TEXACO, INC. in Oklahoma and Ohio, he
joined the Arkansas Public Schools in ElDorado Arkansas as a
school administrator for four years.
In 1969 Mr. Cammack joined Southern Union Production Co.
(SUPRON), Dallas, Texas, and served as District and Division
Geologist over the Mid-Continent region.
Since 1977 Mr. Cammack has been a successful independent
businessman practicing geology in Oklahoma City, Oklahoma,
specializing in oil and gas exploration.
Mr. Cammack graduated with a master's degree in geology from
the University of Arkansas, Fayetteville. He also has a strong
background in education, psychology and investment strategies.
The author is professionally affiliated with the American
Association of Petroleum Geologists, the Oklahoma City Geological
Society and the Society of Independent Professional Earth
Scientists.
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