Economic evaluation of the petroleum prospect is founded upon ostensibly objective cash-flow modeling of the visualized new field. Many corporate cash flow analyses are in fact deeply flawed by biased estimates (conservative as well as optimistic) and invalid financial concepts and applications. In addition most corporations do not calibrate the accuracy of their project cash flow analyses by systematically comparing predicted parameters against actual outcomes.

As a professional prospector you should expect any prospective buyer to construct a cash flow model for your submitted prospect that utilizes conservative valves and parameters, thus reducing your prospect's present value. This may arise from ignorance or caution, but sometimes it is a purposeful and effective negotiating ploy. Examples of such conservative biases include 1) increased costs, discount rate, and development time, 2) reduced reserves, flow-rates, well-head prices, and project life, and 3) omission of ancillary values arising from project success.

In addition, some common economic measures are commonly misunderstood and therefore misused, especially Discounted Cash Flow Rate of Return, Payout, and Profit to Investment Ratio. Moreover, because the links between prospect reserves, chance of geologic success, and chance of commercial success are often misunderstood, prospects are sometimes “double-risked”, severely impacting their Expected Values.

The solution is simple but demanding: prospectors must become knowledgeable about the concepts and intricacies of petroleum economics. As an integral part of their professional business they must carry out complete economic analyses of their own prospects, so as to be able to justify their estimates of the critical variables that effect the value of their prospects.

AAPG Search and Discovery Article #90937©1998 AAPG Annual Convention and Exhibition, Salt Lake City, Utah