ArrowHead Solutions – Probabilistic Resource Cost Quantification

ArrowHead Solution Helps Clients Understand Exploration Opportunities and Competition with First Ever Comprehensive Geological Resource Analysis Coupled with Costs

The Problem

Oil produced from low-permeability reservoirs such as the Bakken and Three Forks Formations in North Dakota and Montana, the Eagle Ford formation in Texas, and the Monterey diatomites in California provides a large marginal source of supply that is already changing the energy outlook in the United States and the world. As economists know, the marginal source of supply sets the price, and thus it is absolutely crucial to understand the cost and volume of the marginal source. Production of such “unconventional” resources is shifting global supply and petroleum pricing and will continue to do so in the future.

Future petroleum production will be influenced greatly by the degree to which United States and worldwide production of accumulations of “light tight oil” can be developed, expanded, and maintained. Over the last several years production has increased rapidly in certain parts of the United States. Projecting future impact requires a careful understanding of not only the quantities but also the associated costs of light tight oil available for future production, i.e., a “resource cost curve” that is accurate, credible, and descriptive of both the resources and their production costs. This understanding is essential in order to evaluate:

What other (competing) producers and regions are likely to do Where, what, and when are the best opportunities for you Whether present and future crude prices are likely to be soft or firm

The Need

Oil and gas companies (IOCs, NOCs, and independents), governments, and other investors are striving to understand the impact of unconventional oil (as well as conventional oil and gas and unconventional gas) on prices, quantities, and reserve additions. Prior to this solution, all that has been available are widely varying estimates about in-place volumes put forth by “experts” with varying levels of understanding about the critical variables (geology, cost, reservoir parameters, and production costs). Such volumetric estimates are simply not sufficient to address the foregoing questions. Before this solution, unconventional resources typically have been characterized in terms of large deterministic estimates of original oil in place coupled with projected high well counts and optimistic estimates of ultimate per well production volumes based on initial production rates in selected wells. The belief that large in-place volumes from homogeneous reservoirs (viewed as “containers”) coupled with massive drilling equals a high oil flow rate and therefore soft prices has led to widespread misconception and consequent complacency about the resource base—a pervasive bias toward soon-to-be-low prices and an erroneous belief that resources of light tight oil are available in virtually limitless quantities at prevailing costs. It has led to optimistic estimates of production, export, and potential for energy independence. Policy makers have embraced this view, arguing there is “no problem” because of the surfeit of supply. Such perspective, while widely held, is not correct.

In contrast to this prevalent view, the unconventional resources representing the potential marginal supply of the future, in fact, display a wide range of geological characteristics, well performance, and economic disparity. The resource base and production costs are anything but homogeneous. In reality, cost and rates of production, and therefore the economic competitiveness of various sources, are destined to vary significantly from basin to basin, play to play, and even assessment unit (AU) to assessment unit. You cannot address the foregoing policies and decisions without knowing the explicit costs and geological characteristics of these resources, which will be provided with this solution for the first time.

Examples

As an example, a recent USGS study done in collaboration with various industry operators (meaning it had substantial industry input related to geology and resources) estimated between 4.4 to 11.4 billion barrels of undiscovered and undeveloped technically recoverable oil in Bakken and Three Forks reservoirs, assuming application of current best practice technology. This potential is distributed among six geographically defined areas (assessment units or AUs) in Montana and North Dakota. The estimated mean ultimate recovery per well (EUR) is different for each AU, ranging from 431 thousand barrels/well in sweet spots of the Eastern Transitional Continuous Oil AU to 55 thousand barrels/well in non-sweet spots of the Northwest Transitional Continuous Oil AU. This can hardly be considered a homogeneous, constant-cost resource base. This can hardly be considered a flat supply curve as far as the eye can see. Quite the contrary, it is a supply curve with significant “shape” to it.

Such findings indicate that, although recoverable resources in Bakken and Three Forks reservoirs are indeed extremely large, quality and exploration and production (E&P) costs vary widely across the resource base. The large resource is clearly not all available at today’s production cost. Analyses that treat this resource as a single, huge tranche are flawed and misleading. Not only that, the recoverable volumes themselves are highly uncertain and will only be available at a wide range of costs, from less than $30 to $130/barrel or even higher, assuming current well costs.

As another example, two EIA reports estimated that low permeability reservoirs of the “Monterey Shale” contain 15.4 and 13.7 billion barrels of technically recoverable oil, respectively. No cost was associated, merely a “vat” of oil of that magnitude there for the taking. However, a recent revision from EIA decreased the initial estimates to 600 million barrels of recoverable oil in the same “Monterey Shale.” According to this revision, the “vat” is practically empty! None of these estimates has intrinsic economic or decision-making value. This solution circumvents that.

These solutions avoid the mistake of assuming that the entire volume of a play will be available at a single low cost, or worse, making arbitrary guesses about how the resource might be distributed either volumetrically or by cost across a play, AU, or basin. Far too many unguided, non-geological, and quite arbitrary guesses have been issued by individuals or organizations that have not had the depth or sophistication, which misleads decision makers and policy makers.

How We Can Help

To make good business decisions, corporate planners, investors, economists, and upstream developers need a sophisticated and nuanced understanding of the distribution, properties, geological characteristics, recoverable volumes, and production costs of light tight oil resources in the United States. Development and delivery of such understanding is the objective of this solution.

Make no mistake; this solution is not just another “volumetric guess” at barrels of tight oil in place, akin to what we have seen in other studies (or “studies of studies”) in the past three decades. This solution is a thorough and accurate quantification of resource cost curves for unconventional oil across the various petroleum basins in the United States based on detailed probabilistic geological information and production cost and engineering fundamentals. Without such probabilistic quantification, you cannot understand the resource base, its production schedule, or costs and instead must rely on estimates with little economic or geological basis.

In this solution, using geological, production cost, and other stochastic information we are able to generate a full, complete probability density functions (pdf) over volumes to be produced in each AU coupled with the full cost to produce them (capital and operating cost). The assessment and calculation are depicted in Figure 1. Notice that we will probabilistically assess the full range of geological, well, reservoir, and production cost parameters for all light, tight oil formations and basins in the United States. The simulation is a fully probabilistic “mixing” of all the geological and cost parameters to create a joint probability distribution over producible volume in every AU and its associated production cost, as indicated on the right in Figure 1.

Figure 1: Geological Data and Cost/Volume Simulator

The output on the right, the joint pdf over producible volume and production cost, is a sophisticated joint representation of all possible cost-volume pairs for resource in each AU. It fully characterizes geological, volumetric, and cost realities and uncertainties. Figure 2 shows such a pdf (for a different basin) and evidences what the complete range of volumes and production costs within the AU weighted by their probability of occurrence looks like. (This solution generates such a pdf for every light tight oil location in the United States.) Note that the results in this case cluster the cost/volume pairs against the origin corner, i.e., the 0 volume, 0 production cost corner, but it is the specific shape of the pdf that really matters.

Figure 2: Joint Probability Density Function over Production Cost and Producible Volume

Based on the joint density in Figure 2, we use Bayesian methods to calculate the conditional probability distribution of producible volumes given the cost for each level of production. That conditional probability distribution (volume conditional on cost) appears in Figure 3.

Figure 3: Probability Distribution over Producible Volume Given Production Cost

Once we have the conditional probability distribution over volume given production cost, we can use fractile methods to calculate the probability distribution over the supply curves themselves, as shown in the Greenland example produced by Dr. Gautier and his colleagues in Figure 4. The probabilistic resource cost curve in in Figure 4, developed by Don Gautier and Red White for undiscovered oil resources in the Arctic (White and Gautier 2011), is similar to what we will develop and deliver for every light tight oil play in the United States during this project. All the probabilistic estimates and calculations will be developed as summarized here. Such a resource cost curve indicates the cumulative oil volume deliverable to the wellhead oil market for each level of production cost (Capex plus Opex) at various probabilities. Providing similar resource curves for existing and prospective light tight oil plays in the United States is the objective of this solution.

Figure 4

Knowing how keen and broad the need, we have focused a powerful combination of geological knowledge and analytical expertise on the problem of unconventional oil resources in the United States. In this solution we analyze and quantify the inherent geological uncertainties, exploration and development costs, and well production characteristics to provide subscribers with a unique, comprehensive and nuanced understanding of resource/cost relationships among current and yet-to-be developed unconventional oil resources that span the United States. There is no substitute for an understanding of this information. Lacking this information, decision makers are relegated to drawing unsubstantiated conclusions based on nothing but resource-in-place estimates whose basis is not clear (and probably naïve or incorrect because they are not based on sound analytical techniques). Deliverables Following are the deliverables for the first offering in this solution (United States light tight oil): A detailed description for each major resource play, including: A Reference Map showing the geographic distribution of major unconventional oil resource plays in the United States. A document containing geological and geographic descriptions of each major resource play (for example the Bakken/Three Forks Play in the Williston Basin), keyed to the Reference Map (a) with identification and description of major geological and geographic subdivisions (AUs) that substantially affect the resource/cost curves A tabulation that includes quantities of resources, numbers of wells required for full development, and ranges of expected well performance (well success ratio, estimated ultimate recovery per well, and well spacing) as well as probabilistic estimates of yet-to-be-developed resources in each resource play, subdivided into AUs A pdf containing probabilistic resource/cost curves, including: Probabilistic resource/cost curves for each AU in each shale oil play, showing quantities and costs of resources available at various probabilities (similar to Figure 1 above) Aggregate resource/cost curves at various probabilities for resources combined at the basin or province level, also in a format similar to that shown in Figure 1 Presentation and discussion of the results: A kickoff meeting . A briefing (WebEx or equivalent) that sets the stage for all the subscribers and informs them about what will transpire. Presentation of preliminary results and findings . There will be a mid-project meeting (held via WebEx or equivalent), which will present and discuss many aspects of the offering, including the geographic and geological descriptions of the plays; the methodology and approach used; and interim results. Presentation of final results and findings . There will be a final meeting (held via WebEx), which will present and discuss many aspects of the offering, including the geographic and geological descriptions of the plays; the methodology and approach used; and the final results. Final document : The study will conclude with a final report and overview to be delivered online. It will complement the datasets, which will also be made available in the delivery medium. The primary function of the final report will be to present salient findings and accomplishments in summary form and to document how to access the data set. A Unique Solution This solution provides an integrated understanding of the geological uncertainties inherent in the unconventional oil resources that everyone is trying to understand, and explicitly links them to the costs required to develop and deliver the resources to market. The work product represents a powerful volume-cost combination that advances understanding of the unconventional resources while providing subscribers with a distinctive geological-production-cost-economic perspective that should lead to advantaged understanding of their businesses. No comparable analysis to our knowledge has ever been attempted commercially. Our team uniquely has the experience, expertise, and knowledge to credibly accomplish this analysis. We bring a unique perspective that melds keen and current knowledge of petroleum geology and the uncertainties and opportunities inherent in unconventional oil resources in the United States with a powerful capability in resource assessment methodology, statistical analysis, and resource economics. It overcomes the disadvantages of the available volumetric analyses that are, as we have emphasized, not useful for economic analysis, opportunity analysis, or decision-making. The currently and previously available volumetric analyses have provided only volumetric numbers (often unrealistically inflated and often assuming low production cost). Our solution redefines and closely examines the geological state of nature in the relevant petroleum basins and assigns scientifically-based supply curves to each of them. This helps subscribers understand the true nature of the resource in each region, what it will cost to get it out of the ground, and how (and if) it might affect reserve additions, market prices, and produced quantities. This is essential information to making key decisions and answering the three essential questions with which this prospectus started. In addition, this solution is an essential precursor to oil or gas economic analysis, i.e., any oil or gas model. Particularly with regard to oil refining, products, and product consumption inside and outside the transportation sector, no model without this type of input can be considered to have any realistic predictive power. Price, production, or consumption projections in the absence of this type of information are suspect. Use of the work product as a basis for analytic modeling is amplified in the Appendix. Our Core Team The majority of work will be performed by and under the direct oversight and management of Dr. Donald Gautier, one of the premier hydrocarbon geologists in the world. Indeed, that is one of the huge benefits of this offering. He is particularly and uniquely qualified to lead this effort because he created and led the team at USGS that developed the breakthrough methodology used for assessment of unconventional resources such as shale oil and has assessed most of the hydrocarbon basins in the world. The methodology links geological analyses with technologies used for their development and thus provides the possibility of connecting resource uncertainty with development costs. Don has now completed that work in the private sector, creating breakthrough techniques that link costs to quantities of technically recoverable oil resources, thus making resource analyses more useful for company decision makers. Phases for the First Offering (United States Light Tight Oil) Each offering is to be delivered in three phases with specific subsets of the United States included in each phase: Phase One : Williston basin, Montana and North Dakota Phase Two : Rocky Mountain basins Phase 3 : Alaska, Mid-Continent, Appalachian, and Gulf Coast basins

Each phase will have the same methodology and deliverables as described above. Phase 1 will be completed first. When Phase 1 has been completed, including all tasks and deliverables, Phase 2 will begin. When Phase 2 has been completed, including all its tasks and deliverables, Phase 3 will begin. For more detailed information on each phase, please contact us. Optional ArrowHead can work with individual subscribers to make the valuable information provided in this offering even more useful by providing customized market analysis to more completely address crucial policies and decisions. For such analysis, ArrowHead uses our unique Global Oil and Global Gas Models to combine the unique resource/cost analyses of this offering with the world’s best supply/demand models producing authentic probability distribution over price and quantity. For additional details, please contact us for a more detailed prospectus. Additional Arrowhead Resource Cost Quantifications ArrowHead is offering the following other probabilistic resource cost quantifications: