Flood still not optimized? The opportunity cost is high.
Deciding where to invest? Optimizing floods provides the best return in the basin. Optimizing floods is a much cheaper way to increase production than drilling. If you ignore flood optimization you face a huge opportunity cost.
Opportunity cost is the rate of return of the next most attractive alternative.
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One operator chose to drill a well in a costly, restricted area because he expected a large prize -- even on a risked basis. The opportunity cost was the smaller return of drilling wells in an easier locale. So he decided to drill this expensive critically sour well in a recreational area taking all the extra environmental care and bearing the extra cost.
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Losing cash flow by not optimizing a flood: Opportunity cost
For every month an operator puts off optimizing her flood she forfeits the opportunity cost of half a million dollars or 300 bopd.
|If an operator chooses not to optimize a flood, the opportunity cost is $500k/month|
|$6,000||k cf/y||Incr cash flow|
|$500||k cf/mo||Incr cash flow|
|$500||k cf/mo||Opportunity cost|
The opportunity cost is the lost cash flow from deciding not to optimize a flood. How many months are you willing to pay this opportunity cost?
Charles Koch said, “A good businessman doesn’t use fixed costs, nor does he use incremental costs. He uses real costs and he thinks about what that means.”
If your flood has not been optimized for years, the technical debt may also robbing you of cash flow.
But you are not alone. Alberta operators are losing $10 billion per year from unoptimized floods.
What is opportunity cost?
Opportunity cost is the benefit of the next most attractive alternative. It is the cost of choosing one alternative compared to the benefit what you could have chosen.
For example, let us consider two investment alternatives: Drilling well A or well B.
Well A costs $1 million to drill and provides income of $3.5 million.
Well B also costs $1 million to drill but provides income of $6 million.
You would naturally choose to drill Well B. The opportunity cost is the $3.5 million -- return of Well A. Well B is $2.5 million better than Well A.
The cost of choosing is leaving behind another choice.
Benefit is a Cost?
It is easy to get confused when one hears that opportunity cost of one choice
is a benefit from another choice.
How can a benefit of one alternative be the cost of another?
When you choose an investment, it should be better than any other alternative. The next best alternative defines the opportunity cost. Opportunity cost is the alternative you forego.
Even if you could afford to choose all alternatives, you would naturally start with the best one. If you chose anything but the best, the cost of leaving it behind is too high.
Flood optimization is more economic than most other common investments in the oil and gas business.
Flood optimization is more economic than other investments
|Investment Metric||Optimize Flood||Replace an ESP||Drill a Hz Well|
Opportunity cost applied to discounted cash flow
The benefit of investing in risk-free Canadian T-Bills is about 1% return. Any other alternative investment must have a better benefit than this risk free return.
If an alternative investment won't make better than 1% return, why not invest in T-Bills?
The opportunity cost of investing becomes the cost of capital or discount rate.
But oil and gas operators believe drilling wells is a more risky investment than T-Bills. They demand a higher rate of return to offset that risk.
Opportunity cost must be adjusted for risk. Canadian government thirty-year bonds have a return of 4% because they are more volatile and therefore more risky than a T-Bill.
Oil and gas operators are currently using a weighted average cost of capital (opportunity cost) between 6 and 20%.
Opportunity cost applied to oil and gas field investments
Consider drilling a well: The well must provide a better return than other investments. If not, why drill it?
But drilling a well is risky. Its risked benefit should provide a better return than other investments with similar risk.
Consider a well workover: The operation must provide a better return than other investments. If not, why perform the workover?
A well workover has less risk than drilling. Compared to drilling, if a workover risk is lower and the rate of return is higher, wouldn't you perform a workover first?
Flood optimization has a large benefit and a low cost. Optimizing a flood can provide a better return than either a workover or drilling a well.
Tags: Flood, Cut costs
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