CHAPTER 8 

 VALUATION AND SUBSURFACE GEOLOGY 



JOHN D. TODD 



The art of valuing producing petroleum properties (and it is more 

 of an art than a science) has grown up in the oil business contemporane- 

 ously with the maturing of subsurface geological knowledge. Of course, 

 both started in Colonel Drake's time from zero, and during the past ninety 

 years, valuation has at times out-distanced geology. In other decades 

 geological knowledge has grown faster than knowledge of valuation. 



When Professor Wright investigated the oil business at the close, of 

 the Civil War, he found that subsurface geology was a maze of supersti- 

 tions and that valuation attempts were dominated by promotion. As 

 thousands of wells were drilled and millions of barrels of oil were yearly 

 produced, many things were learned about oil reservoirs — both in the 

 drilling of new wells and in the performance of the old wells. Wright 

 found that the average life of a well was eighteen months in 1865, whereas 

 shortly thereafter wells were being sold on twice that payout period. 



One of the earliest standards of valuation was the "days of payout," 

 on which much Allegheny production was sold. It was common custom 

 in early Pennsylvanian days to value net daily barrels of settled-oil pro- 

 duction at one thousand times the price of oil. For instance, a property 

 producing 1,000 net barrels per day would be worth $3,000,000 if oil was 

 selling at $3.00 per barrel. Although this method gave no consideration 

 to subsurface geology (and properly so, since almost nothing was known 

 about it) , it represented a composite of oil men's opinions on operating 

 costs, probable rate of decline, and expected profits. Even today, the 

 net daily barrels produced is used as a yardstick in evaluating some 

 properties. 



As the oil industry grew, some systematic operators began to keep 

 charts on the wells and to draw curves on their production. As every well 

 was always produced at its maximum rate, these charts recorded not only 

 the decline of daily production but also the decline of daily capacity. As 

 none of the wells ever increased, these curves became known as "decline 

 curves." From the study of many of these curves, it became apparent 

 that in many fields, the decline followed a certain pattern. Observers 

 found that they could draw an average curve of all the wells, and could 

 fit any well curve into a portion of a master curve — and that, properly 

 placed, the future performance of that well followed the master curve. 

 From this fact evolved the Law of Equal Expectations expressed as: "If 

 two wells under similar conditions produce equal amounts during any 

 given year, the amounts they will produce thereafter, on the average, will 



