Cutoff estimation

Development of an oil or gas accumulation is unlikely to take place if the outlook for a PV Net Cash Surplus is gloomy. Usually only ultimate recoveries above a certain minimum economic limit are considered. This limit is called cutoff. Unfortunately a cutoff is a moving target or difficult to estimate for the following reasons:

Despite such problems a guesstimate has to be made in order to decide on the volume-above-cutoff or Mean Success Volume, that is used in the evaluation. I suggest the following relatively simple procedure for a single prospect.

  1. A range of plausible reserves is chosen. For instance 10, 50 and 100 mb.
  2. Cashflow calculations are made for these "trial" reserves. What is needed is the Present Value Net Cash Surplus (PVNCS).
  3. Plot the PVNCS versus the reserves. Draw a line through the three points. This is likely to be, but not necessarily, convex upward. Progressive taxation reduces the per barrel PVNCS, despite the economy of scale associated with the larger reserves. Note that the choice of reserves has to be so that the curve crosses the horizontal line PVNCS = 0.
  4. Read the volume at the point that PVNCS = 0. This is the economic cutoff.

Here is an example:

The points are plotted and the cutve drawn by hand, giving about 28 mb as a cutoff.

The economic cutoff can then be used to find a reasonable Mean Success Volume" that would be the amount of reserves for which a detailed cashflow calculation should be made. Some of the work for the three hypothetical reserves/cashflows can be used again. We could also quickly estimate the PVNCS for the MSV by going back to the above graph and reading the PVNCS associated with the MSV.

If the MSV was 84 mb in the case. With this value we arrive at a rough estimate of $ 55 million PVNCS.