Tricky Terminology That Can Make Or Break Your Bottom Line

The New Oil Investors Reference Bible:

Tricky Terminology That Can Make or Break Your Bottom Line
Whether you are new to the oil and gas scene, a veteran oil Size & Stream: Upstream, Midstream, Downstream,
and gas investor, or anything in between, the dynamic Independent & Integrated Oil and Gas
nature of this industry and the complexity of the market that
Lets start at the beginning by dening the playing eld.
governs its trade means that the rules of the game are
First, the oil and gas industry is divided into three chrono-
continually changing in subtle ways, and both current and
logical sectors with one additional component, while in
potential investors must maintain a high-level of vigilance.
terms of stocks, there are ve specic proles, so you have
The terminology dening the rules of this shape-shifting to know where you plan to start.
arena and determining the validity of an investment are not
The Sectors:
always straight-forward. Often real meaning is either misun-
derstood or manipulated to lure investors into the fold. Upstream: This is the Exploration & Production (E&P)
section covering everything in relation to searching for,
Todays oil-paved road to riches is lined with pedantic
recovering and producing oil and/or gas from under-
potholes. This special report goes to great length to dene
ground or underwater elds. This includes drilling and
what some of the more ambiguous terms actually mean,
operating wells and the entire process that is required to
how they are employed, and where current and potential
bring crude oil or raw gas to the surface. It also includes
investors may be misled or misinformed.
geological surveying and the obtaining of permits and
In the rst half of 2014, no one would have paid attention to licenses. This is the most complex, and certainly the
this. Investors were being lured in, purposefully confused most risky (but also potentially the most rewarding) of the
and ooded with catch phrases and buzz words that oil and three sectors.
gas companies like to use loosely to capture investment.
Midstream: This is the sector where produced hydrocar-
When oil prices started nose-diving in the summer of 2014,
bons are processed, stored, marketed and transported.
investorsparticularly those new to the scene who had
Essentially, this sector is the link between production and
been blindly captivated by all the money being made earlier
people, or producers and consumers, with the nal desti-
in the yearsuddenly realized that perhaps they didnt fully
nation being downstream, but there is generally a fair
understand some of the nuanced terminology sounded out
amount of overlap between midstream and downstream
by the pied pipers.
activities.
This report is a selection of nuanced terminology specic to
Downstream: This sector is where oil and gas are manu-
the oil and gas investment segment. What this terminology
factured, sold and distributed. In terms of rening, there
really means and how it is used by oil and gas companies
will be overlap with the midstream sector in many cases.
can make or break your bottom line. Be prepared. Your
Increasingly, the industry refers to only upstream and
investment can depend on something as seemingly innocu-
downstream, rolling midstream in with downstream due
ous as a four-letter wordor even a single letter.
to the natural overlap.

oilprice.com I 02
 Tricky Terminology That Can Make Or Break Your Bottom Line

Services: The additional component to this three-part Independent vs Integrated

sector is the oil and gas services industry. These are
Independent oil and gas companies exclusively produce
companies that provide support to the oil and gas indus-
oil and gas. They do not engage in any downstream (or
try but do not explore or produce themselves. The
midstream) activities. They are not reners. They are not
subcategories here are drilling and oileld services. Most
retailers. For the individual investorparticularly an inves-
drilling companies will be contractors hired for a specic
tor relatively new to the complicated oil and gas scenein-
period of time by an E&P company. Oileld services com-
dependent companies will be much easier to navigate and
panies complement the drillers by providing services
to ultimately understand. However, because there are
such as seismic imaging, advanced drilling technology,
hundreds of independent companies to choose from
hydraulic fracturing or transportation solutions, among
amongst those listed on US exchanges, the real difculty is
many other things.
determining which one is the best investment, which in
The Stock Proles: turn means a great deal of astute, comparative analysis.

Junior Companies: These are E&P companies with
production ranging from 0 to 10,000 boepd
Intermediate Companies: These are E&Ps with pro-
duction ranging from 10,001 to 100,000 boepd
Senior Companies: These are E&Ps with 100,000+
boepd of production
Integrated companies are the large and supermajor oil and
gas companies that have their hands in every aspect of the
industry, combining (integrating) upstream, midstream and
downstream. For individual investors, attempting to deter-
mine the primary driver of protability for these companies
is paramount, and valuation requires examining multiple
business segments.

Oileld Services: These include companies that drill,

frack or rent oileld equipment etc.

Pipelines

oilprice.com I 03
 Tricky Terminology That Can Make Or Break Your Bottom Line
Oils & Condensate
Bitumen - A highly viscous form of crude oil, which
must be heated or combined with lighter hydrocarbons
to be produced.
Condensate - A mixture of hydrocarbons which are in
a gaseous state under reservoir conditions and, when
produced, become liquid under reduced temperature
and pressure.
Heavy oil - Crude oil with an API gravity less than 22.
Heavy oil generally does not ow easily due to its
elevated viscosity. It is closely related to natural
bitumen from oil sands. Heavy oil contains impurities
(waxes and other carbon residue), which must be
removed before rening. 'Extra Heavy Oil' has an API
gravity less than 10.
Oil sands - Also referred to as 'tar sands' or 'bituni-
mous sands'; geologic formations comprised predomi-
nantly of and grains and bitumen and are considered to
be unconventional petroleum deposits. They are highly
controversial due to their 'dirty' nature.
Shale - A very ne-grained sedimentary rock that is
formed by the consolidation of clay, mud or silt that
usually has a nely stratied or laminated structure that
often contains rich sources of oil and gas. Shale gas is
natural gas that is trapped within shale formations.
Shale oil is unconventional oil found in shale forma-
tions. This is not to be confused with 'Oil Shale'also
known as kerogenwhich is a substitute for conven-
tional crude oil. The last decade has ushered in new
technology such as advances in horizontal drilling and
hydraulic fracturing that have made extraction of oil
and gas from shale a revolutionary reality.
Gas Types
Coal bed methane (CBM) - Natural gas extracted
from coal beds.
Dry gas - Almost pure methane, occurring in the
absence of liquid hydrocarbons or by processing natu-
ral gas to remove liquid hydrocarbons and impurities.
Liqueed natural gas (LNG) - Natural gas that has
been converted into a liquid by refrigerating it to -260F.
Liquefying natural gas reduces the fuel's volume by
600 times, enabling it to be shipped economically from
distant producing areas to markets. LNG is destined to
become a massively signicant part of the global
energy equation over the coming years and decades.
Natural gas - Naturally occurring hydrocarbon gases
found in porous rock formations.
Natural gas liquids (NGLs) - A general term for
highly volatile liquid products separated from natural
gas in a gas processing plant. NGLs include ethane,
propane, butane and condensate.
Sour gas - Sour gas is natural gas or any other gas con-
taining signicant amounts of hydrogen sulde (H25).
Sweet gas - Natural gas that contains little or no
hydrogen sulde..
Tight gas - Natural gas produced from relatively
impermeable rock. Getting tight gas out usually
requires enhanced technology applications like
hydraulic fracturing. The term is generally used for
reservoirs other than shale.
Wet gas - Produced gas that contains natural gas
liquids.
oilprice.com I 04
 Tricky Terminology That Can Make Or Break Your Bottom Line
What to Invest in: Conventional and Unconventional Oil & Gas
Conventional Oil & Gas
Oil contained in rocks with relatively high matrix permeability,
and typically having a high recovery rate. Unlike bitumen,
conventional oil ows through a well without stimulation and
through a pipeline without processing or dilution.
Unconventional Oil & Gas
Reservoirs with permeability so low that the only way to
extract oil or gas is to employ a horizontal and hydraulic
fracturing or other advanced techniques. North Americas
shale reservoirs fall under this category.
What it means for an investor
The playing eld has changed dramatically over the past
decade, with revolutionary advancements in exploration,
Source: Energy Information Administration
drilling and production technology unlocking massive
reserves of hydrocarbons buried tightly within shale forma-
tions. As such, unconventional oil and gas has been all the
rage, while the tried and true conventional hydrocarbons
suddenly became less attractive. The shale boomspurred
along by the revolution in hydraulic fracturingwas highly
attractive to new investors who saw others making money
hand over foot.
The shale boom put paid to theories that Peak Oil was
upon us and it was game over for the industry. Seemingly
overnight, horizontal drilling combined with hydraulic fractur-
ing to get oil and gas out of shale and changed global
energy dynamics forever.
What investors have been looking for then, is whether the
Lower 48 States Shale Plays
oilprice.com I 05
 Tricky Terminology That Can Make Or Break Your Bottom Line

companies they are interested in are in the top shale-pro-
ducing region. This means understanding the dynamics of
the key shale plays. Not all shale plays are equalnor is
every part of a shale play as promising. And now the boom
is all about improving further on the revolutionary technolo-
gies that made it happenimprovements that hope to get
even more oil and gas out of shale.
In the meantime, however, investors would do well to
remember that conventional oil and gas has its lure, and in
trying times of slumping oil prices, producing conventional
oil and gas is cheaper.
The trick for the investor is to nd the best t for the prevailing
market. Unconventional drilling is highly productivebut
very expensive. Many US shale projects are unprotable
unless oil prices are at $80 per barrel at least. At the same
time, there are some conventional drillers out there who can
produce oil at $20 per barrel. Even with oil prices at under
$50/per barrel, investors can make great returns.
From June 2014 to February 2015, the collapse of oil prices
cost North American investors an estimated $390 billion.
Investors also make the mistake of focusing strictly on geog-
raphy. Its not just about whether a company is operating in
one of the hot US shale plays; its about their strategy going
forward and their future potential. Investors must examine
what a companys potential is beyond proved reserves (see
more below). New technology allows E&P companies to get
oil and gas out of the shale quickly, but depletion of the well
is also faster.
The investor must also ask what a companys re-
serves-to-production ratio is. Knowing how much oil and
gas they have access to is not enough; How much are
they actually producing in proportion to what they have
access to?
Finally, while no one has come close to the US in getting a
shale boom off the ground, investors should consider
looking to places like Argentina which has become a particu-
larly attractive prospect since oil prices began to plummet.
Why? Because Argentinas prices are pegged at $76/$77, a
fact which has prompted a urry of drilling activity and a
number of massive discoveries of late.

What is API Gravity? Not All Oils Are Equal API Gravity
This is the specic gravity of a crude oil expressed in terms of API degrees, and it
45.4
is estimated with the following ratio: API = Sg 141.5 131.5.
This is the standard used by the American Petroleum LIGHT OIL

31.1
Institute (API), from which it derives its name., to express the weight of oil. It is a
30.2
statistic used to compare a petroleum liquid's density to water. Typically, the upper
MEDIUM
limit for heavy oil is 22 API gravity with a viscosity of 100 cp (centipoise). This is a 22.3
statistic 21.5

Heavy oil are usually not recoverable in their natural state through a well and require HEAVY

heat or dilution to ow into a well or through a pipeline. As such, API Gravity is 10.0
something an investor needs to understand and consider in terms of economics. 6.5
EXTRA-HEAVY
0.1

oilprice.com I 06
 Tricky Terminology That Can Make Or Break Your Bottom Line
Sweet & Sour Investments
Investors must also understand the difference between
sweet and sour oil before taking the plunge. Sulfur
content is the key to this determination, and the bench-
mark is 0.5% sulfur content. Sour oil has a total sulfur
level greater than half a percent. Sweet oil has a sulfur
level of less than 0.5%. Sour crude is more prevalent
and is produced largely in Canada, the Gulf of Mexico,
South America and the Middle East. Sweet, light crude
primarily comes from the central part of the US,
Europe's North Sea, Africa and the Asia Pacic region.
For an investor, it's easier to ofoad sweet crude
because it requires less processing to remove impuri-
ties. Sour, heavy crude trades at a bigger discount.
THE THREE Ps: PROVED, PROBABLE, POSSIBLE
The three Ps are probably some of the most misunderstood
terms in the industry. They have changed and evolved, and
they can often be the downfall of a new investor. Oil and gas
reserves and resources are volumes of oil and gas that can
be commercially recovered in the FUTURE. For potential
investors attempting to determine the present and future
value of an oil and gas companys reserves, the 3Ps are the
pieces to the puzzle; and quite simply, they categorize the
level of certainty of commercial extraction. Reserves are
merely estimates based on the evaluation of data showing
evidence of the amount of oil and gas present in under-
ground reservoirs.
According to the Society of Petroleum Engineers (SPE),
there are ve classications of commerciality for oil and gas
resources:
Production: Oil and gas that has already been recovered,
so recovery is demonstrable;
Reserves: proven, probable and possible (the 3Ps);
Contingent Reserves: These are potentially recoverable
reserves that may not yet be mature enough to commer-
cially extract, or that may intuit some technological com-
plications;
Prospective Resources: These are resources that have
not yet been discovered, and whose presence and
volume is estimated based on indirect evidence and no
drilling;
Unrecoverable Petroleum: These are resources that are
not recoverable currently due to geological/technological
reasons.
Under this classication system, the least risk for investors is
associated with Reserves, which carry some degree of
certainty regarding future commercial extraction; while
Contingent Reserves are discovered but considered
sub-commercial, and Prospective Reserves are a pure
gamble and as yet undiscovered.
Under the category of Reserves, 3Ps are dened as
follows:
Proved Reserves: Reserves with 90% certainty of com-
mercial extraction
Probable Reserves: Reserves with 50% certainty of com-
mercial extraction
Possible Reserves: Reserves with 10% certainty of com-
mercial extraction
oilprice.com I 07
 Tricky Terminology That Can Make Or Break Your Bottom Line
When companies attempt to dene their reserves as 1P, they
are referring to the highest category of certainty: Proved
Reserves. When companies dene their reserves as 2P, they
are combining the sum of Proved and Probable Reserves.
Thus, when companies dene their reserves as 3P, they are
denoting Proved + Probable + Possible. According to the
SPE, the best estimate of recovery from committed projects
is generally considered to be the 2P sum of proved and
probable reserves.
Proved, probable and possible reserves, farming-in and
farming-out ... this is all just the tip of the iceberg for oil & gas
investors. Stick with us because our next report takes you
deeper into the complicated world of oil and gas recovery.
We detail the three phases of recovery--primary, secondary
and tertiary--what they mean and where investors tend to
make their rst, major mistake. This is a game-changing
report for your bottom line, so be sure not to miss it.
Copyright 2015, all rights reserved by Oilprice.com. No
portion of this report may be published or reused in any way
without the explicit consent of Oilprice.com.
The 3P Conundrum
Not all companies report 3P reserves; 1P and 2P are much
more common. The decision to report 3P reserves is based
entirely on a companys determination from an investment
standpoint whether this is benecial or not. At the same time,
where law allows, some companies will report only 3P
reserves when it is benecial from a selling standpoint, which
would also mean that 1P and 2P reserves would appear less
attractive to potential investors. Junior oil and gas compa-
nies are increasingly adopting the 3P reserve denition. This
is largely because junior companieswhose typical aim is to
explore, discover and then develop assets that will be sold to
a larger companydo not usually have the nancing to pay
for massive exploration that could denote proved or proba-
ble reserves. For these smaller companies, 3P reserves are
a much easier way to denote potential for investors. But
investors must be aware that this means we are talking
about Possible Reserves, with only a 10% certainty of com-
mercial extraction in the future. Many companies reporting
3P reserves are found on the AIM (London) and TSX-V (Can-
ada) exchange.
What is the difference between
'reserves' & 'resources'?
The difference between 'reserves' and 'resources' is
largely a question of commercial viability plus time
and reality. While there is some certainty the reserves
can be commercially recovered in the present time,
resources are less mature: They are potentially recov-
erable, but not ready for commercial development.
Resources exist, but for now they are staying in the
ground, either because of political, social or market
reasons, or because the technology to recover them
is not yet fully developed.
In January 2010, the US Securities and Exchange Commis-
sion (SEC) changed the regulations covering reserve disclo-
sures in lings. Before that, companies were only allowed to
report 1P (Proved Reserves) to investors. Now companies
are allowed to declare 2P reserves (the sum of Proved and
Probable), but there must be substantiating documentation.
Companies are also now allowed to declare 3P (Possible
Reserves), but evaluations of such must be veried by quali-
ed, independent consultants. There are specic regulations
governing reports from 3P independent petroleum
engineers.
oilprice.com I 08
 Tricky Terminology That Can Make Or Break Your Bottom Line

What investors really need to know

While 3P reserve indicators clearly come along with risk,

this does not mean that P1 and P2 reserves are risk-free.
Investors should be aware that this data can sometimes be
unreliable. How we determine reservesor how we deter-
mine commercial extractionhas changed signicantly in
the short time since the shale boom and hydraulic fractur-
ing revolution swept through North America. With the new
technological momentum of horizontal drilling and the
rampant use of fracking for extraction, oil and gas produc-
tion has become something more akin to manufacturing.
Because of the process--which has rendered exploration
much less signicantinvestors will nd that future drilling
locations are included in 2P reserve reports. Only 1P
reserves are guaranteed to be fully funded, so when an
investor is looking at 2P reserve reports, he or she is proba-
bly looking at future drilling locations that may be stellar but
may not be funded, and in many cases, the company in
question may not even have the nancial capacity to fund
their development.

Exploration & Production: The Drilling Ins and Outs
Massive reserves of oil and gas locked deep beneath the
rock surfaces are accessible for the rst time in American
history, ushering in a shale revolution on the back of
tremendous advances in drilling and extraction technology.
A combination of new horizontal drilling and hydraulic
fracturing, or fracking, has rendered the United States the
worlds biggest oil producer, overtaking Saudi Arabia and
Russia. But its not quite as black and white as this.
In order to understand what you should be investing in
under current market conditions, you need to understand
not only WHAT is being drilled, but HOW it is being drilled,
WHY and what the COST difference is. There are basically
two types of drillingDirectional and Vertical, with Horizon-
tal drilling, which helped spawn the shale boom, is a type of
Directional drilling.
Directional Drilling
Around since the 1920s but signicantly advanced over the
past decade, directional drilling is the process of drilling oil
and gas wells at an angle. This enables producers to more
easily reach oil and gas deposits under the surface. At the
same time, production from directional drilling has been
massively popular because it also allows for the drilling of
multiple wells from the same well bore, reducing expenses

oilprice.com I 09
 Tricky Terminology That Can Make Or Break Your Bottom Line

for producers and resulting in less surface destruction and
thus a lower environmental impact.
The technology enabling directional drilling has seen some
very important advancements in the past decade; speci-
cally, real-time technologies (sensors and global position-
ing technology) that allow for high-accuracy targeting of the
drill bit. With this technology, reserves that are miles away
from the well bore or even a mile below the surface can be
tapped into. Directional drilling allows for not only drilling at
an angle, but at an angle that can be continually re-direct-
ed, or bent.
bending at a certain depth, thus enabling it to reach a wider
area of rock and tap the resources within. The point at
which the vertical well bends to become horizontal is the
kickoff point. Unconventional oil and gas reserves are
extracted using directional drilling techniques. It is also
important to note that 10% of the world's crude oil and 32%
of natural gas comes from shale formationsunconven-
tional oil and gas.
Vertical Drilling
Traditional vertical drilling is used to tap into conventional oil
and gas. Vertical drilling is much less complicated and less
expensive than horizontal drilling, but the range is limited so
this process is generally less productive. Vertical wells can
only access the oil and gas that is directly below. However,
it is important to keep in mind that there are plenty of
conventional oil and gas plays that do not require horizontal
drilling to be productive. This also means that these plays
are less expensive to produce and that when oil prices are
too low to support the massive costs of extracting from the
prolic shale plays, conventional plays that need only verti-
cal drilling can still promise investors attractive returns.

Horizontal drilling is a type of directional drilling which has

been employed to realize the shale boom in the US.
Horizontal drilling has proven to increase production by as
much as 20% over traditional vertical drilling. A wellbore
that is drilled at an angle of 80 degrees or more is horizon-
tal. Horizontal drilling is used to extract hydrocarbons from
a sourcesuch as a layer of shale rockthat is running
through the ground horizontally. A horizontal well is also
vertical at the outset, forming a J as it goes deeper and

oilprice.com I 10
 Tricky Terminology That Can Make Or Break Your Bottom Line

Hydraulic Fracturing

Once a well is drilled, hydraulic fracturing enters the fray in

some of the tougher geological venues. Hydraulic fractur-
ing is part of the production process, not the drilling
process. It employs the use of uids and other materials to
create small fractures in a formation with the goal of stimu-
lating production from an oil or gas well. The fracturing
creates a path that can exponentially increase the rate of
ow of oil and gas through the well. In the US, fracking is
used in 9 out of 10 natural gas wells. However, for the
individual investor, it is important to understand that frack-
ing is very expensive and can become uneconomical when
oil prices are under $90 per barrel.

Exploration & Production Terminology

Borehole - Also referred to as a 'wellbore', a borehole is a hole in the earth made by a drilling rig.

Casing - A casing is a thick-walled steel pipe the drillers place in wells in order to isolate the uids that form during drilling
and to prevent the borehole from collapsing in on itself.

Completion - Completion denotes the process of rendering an oil or gas well ready to begin production. During this
time, operators install permanent equipment, including the wellhead. Hydraulic fracturing may also be considered part of
the completion process.

Development well - Development wells are wells drilled within an area of proved oil or gas. These wells are drilled to
productive depth.

Drilling rig - The machine used to drill a wellbore.

Dry hole - Dry holes are wells that cannot economically produce commercially viable volumes of oil or gas.

Exploratory well - A well drilled to nd a new eld or to nd a new reservoir in a eld previously found to be productive
of oil or gas in another reservoir.

Flaring - The burning of natural gas for safety reasons or when there is no way to transport the gas to market or use the
gas for other benecial purposes (such as FOR or reservoir pressure maintenance). The practice of aring is being steadily
reduced as pipelines are completed and in response to environmental concerns.

Hydraulic fracturing uids - Mixture of water and proppants along with minor amounts of chemical additives used to
hydraulically fracture low permeability formations. sufcient quantities to justify commercial exploitation.

oilprice.com I 11
 Tricky Terminology That Can Make Or Break Your Bottom Line

Productive well - A well that is capable of producing hydrocarbons in sufcient quantities to justify commercial
exploitation.

Proppant - Sand or man-made, sand-sized particles pumped into a formation during a hydraulic fracturing treatment to
keep fractures open so that oil and natural gas can ow through the fractures to the wellbore.

Recompletion - The process of entering an existing wellbore and performing work designed to establish production
from a new zone.

Spacing - The distance between wells producing from the same reservoir; generally expressed in terms of acres.

Getting Into The Game: Farm-In, Farm-Out What motivates sellers and buyers

What it really means
A farm-in is a process of one company joining another
company or joint venture in a specic oil and gas license
area. The company that is farming in to the business
purchases a working interest in the license with cash,
through exploration or other commitments. Most common-
ly, the company farming-in to the lease is required to drill
wells in order to earn its interest in the acreage. The differ-
ence between Farm-in and Farm-out is this: The interest
received by the assignee is the farm-in, while the interest
transferred by the assignor is the farm-out.
More to the point, a farm-in is really an alternative means of
nancing exploration activities, typically when the company
that owns the lease cannot raise enough capital to fund
exploration through corporate lending due to high interest
rates or due to the higher-risk associated with the endeav-
or. This risk may be associated with the geology of the land
or the political stability of the host country. Regardless,
farm-ins have become an extremely popular tool for nanc-
ing exploration activities and managing risk in the oil and
gas industry. At the end of the day, this is one of the most
prevalent forms of oil and gas agreements.
While the most common reason for farming-out acreage is
as an alternative means of nancing, there may be other
motivational factors for the seller here:
The sellerthe party farming-outmay want to divest
acreage that is peripheral to its main exploration or
production area. This is particularly common after a
company change in management, which often produces
a change in strategy. New management may seek to
consolidate a diverse portfolio;
The seller may also have only a small equity holding in
the acreage in question, and deem it not worth the man-
agement time.
Farm-in agreements are extremely popular among junior oil
and gas players, who look for bigger companies to come
on board as partners and then handle production while the
smaller company focuses on new exploration projects.
Where to nd farm-in/farm-out opportunities
Short of googling farm-out opportunities, there are really
only two ways nd whats out there.
1) The Petroleum Listing Service (PLS), launched in 1987,

oilprice.com I 12
 Tricky Terminology That Can Make Or Break Your Bottom Line

provides operators and investors with various listings and
proprietary databases, and also hosts property expos and
brokers while directly marketing properties, prospects,
overrides and midstream assets for sellers. Because over
2,000 independent companies subscribe to this service, it
is a good place to start the search for farm-ins.
2) Engage an independent industry expert to hunt for
farm-in opportunities, vet opportunities through high-level
reviews and facilitate introductions and negotiations for
you. This option, while more expensive, is generally more
likely to produce positive results as it is an all-inclusive
service that is managed from start to nish by experts. (See
OP Tactical for more information about these services).

Royalties V. Working Interest

A royalty is an interest in a natural gas and oil lease that gives the owner of the interest the right to receive a portion of
the production from the leased acreage (or of the proceeds of the sale thereof). Royalty interests do not require the
owner to foot the bill for any of the costs of drilling or operating the wells. Royalties may be either landowner's royalties,
which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalties, which
are usually reserved by an owner of the leasehold in connection with a transfer to a subsequent owner.

A working interest, on the other hand, means you pay a percentage of the bills but also receive a proportional percent-
age of the prots. It's higher risk, with higher reward. If you acquire a 50% working interest in an oil and gas project, you
will also be responsible for paying 50% of the costs. But you will also be entitled to net revenue interesta percentage
of the income generated from the project. In this case it is best to view the 'working interest' as the expenses and the
net revenue interest as the prot.

One Comparative Scenario: Let us say that a landowner owns the mineral rights to a certain oil and gas property and
signs a lease with an E&P company that gives him a 20% royalty. What this means is that the E&P company owns 100%
interest in the project, while the landowner owns 20% net revenue interest. The E&P company has to foot the bill for
100% of the costs, while it earns 80% of the net revenue interest when it produces. If another investor buys a 50% inter-
est in this project, then they will be buying into a 40% net revenue interest.

oilprice.com I 13
 Tricky Terminology That Can Make Or Break Your Bottom Line

Acreage & Ownership Terms

Acreage Land - leased for oil and gas exploration and/or land for which a company owns the mineral rights.

Net acres - The percentage that a company owns in an acreage position with multiple owners. For example, a compa-
ny that has a 50% interest in a lease covering 10,000 acres owns 5,000 net acres.

Joint operating agreement (JOA) - An agreement governing the rights and obligations of co-owners in a eld or
undeveloped acreage, which denes, amongst other things, how costs and revenues are to be shared among the
parties and who is the operator.

Lease - A legal document executed between a mineral owner and a company or individual that conveys the right to
explore for and develop hydrocarbons and/or other products for a specied period of time over a given area.

Operator - This is the entity responsible for managing all operations in an oil or gas eld or within undeveloped acreage.
More specically, the Operator is responsible for the exploration, development and production of an oil or gas well or
lease, and is usually the company who has engaged the drilling contractor.

Production sharing contract (PSC) - An agreement between a host government and the owners (or co-owners) of
a well or eld regarding the percentage of production each party will receive after the parties have recovered a specied
amount of capital and operational expenses

Undeveloped acreage - Acreage on which wells have not been drilled or completed to a point that would permit the
production of commercial quantities of oil and gas regardless of whether or not the acreage contains proved reserves.

Unit - The joining of interests in a reservoir or eld to provide for development and operations without regard to separate
property interests. Also, the area covered by a unitization agreement.

Working interest - The right granted to the lessee of a property to explore for, produce and own oil, gas or other miner-
als. The working interest owners share the costs of exploration, development and operating. The share of production to
which a working interest is entitled will be smaller than the share of costs that the working interest owner is required to
bear to the extent of any royalty burden.

Valuating a Potential Investment

EV/2P Ratio
Oil and gas companies are particularly challenging for
investors in terms of measuring valuation due to the uncer-
tainty surrounding their reserves, which requires about as
much assumption as it does actual math.
The EV (enterprise value) 2P (proved plus probable
reserves) ratio is a way to valuate oil and gas companies.
The ratio is calculated by taking the EVwhich reects the
companys total value--and dividing it by the 2P reserves.
This demonstrates the multiples at which the company is
trading and is a very important tool for investors. Keep in

oilprice.com I 14
 Tricky Terminology That Can Make Or Break Your Bottom Line

mind that this is a highly dynamic value; however, if the NPV(10)

valuation is low, it is possible that the company is underval-
ued and a good deal for investors.
What you need to know is this: When you are researching
an oil and gas investment, and trying to compare compa-
nies, EV/2P helps you to determine which company has the
cheapest 2P (proven plus probable) reserves of oil and/or
gas. Importantly, this value measurement takes into
account how much cash and debt a company has in addi-
tion to its market capitalization. This is an important metric
as oil and gas rms typically have a lot of debt and the EV
includes the cost of paying it off.
Net present value (NPV) is the present value of estimated
FUTURE oil and gas reserves, net of estimated direct
expenses and discounted at an annual rate of 10%. It is a
calculation used to estimate the value of a companys
PROVED oil and gas reserves (P1). Reservoir engineers
create reserve reports for each well and each proved unde-
veloped well location for this calculation. Each well report
considers the current production rate and forecast decline
rate, plus unique production costs or developmental
expenses. Non-property-related costs or indirect expenses
are not included.

Units of Measurement
BBL = Barrel of oil; approximately 42 US gallons.

BBL/D (also BPD, BD, B/D) = Barrels per day; to measure daily production and consumption.

BOE = Barrel of oil equivalent; a unit of energy based on burning one barrel (or 42 gallons US) of crude oil. For gas
companies, this combines all reserves and production into one unit of measurement.

BOEPD or BOE/D = Barrels of oil equivalent per day; with one barrel equally 6,000 cubic feet of natural gas.

BCF = One billion cubic feet of natural gas

BTU = British thermal unit, a unit of energy used to determine the quality of the resource when burned; the heat
required to raise the temperature of a one-pound mass of water by one degree Fahrenheit.

MBBL = One thousand barrels of crude oil, bitumen, condensate or natural gas liquids

MBD = One thousand barrels per day

MBOE = One thousand barrels of oil equivalent

MCF = One thousand standard cubic feet of natural gas

MMBBL = One million barrels of crude oil, bitumen, condensate or natural gas liquids

MMBOE = One million barrels of oil equivalent

MMBTU = One million British thermal units

MMCF = One million standard cubic feet of natural gas

MTPA = Millions of tons per annum TCF = One trillion cubic feet of natural gas

TOE = Ton of oil equivalent (approximately 6,841 BBOE)

oilprice.com I 15
 Tricky Terminology That Can Make Or Break Your Bottom Line

Remember Proved, probable and possible reserves, farming-in and

Oil and gas companies need your money to drill, and
they are not always forthright about how much is
actually in the ground and how this compares to
what can feasibly be recovered. After youve got the
basics of the industry down, understanding the
nuances of the three classications of reserve esti-
mates is the key to protecting your investment and
your bottom line.
farming-out ... this is all just the tip of the iceberg for oil &
gas investors. Stick with us because our next report takes
you deeper into the complicated world of oil and gas recov-
ery. We detail the three phases of recovery--primary,
secondary and tertiary--what they mean and where inves-
tors tend to make their rst, major mistake. This is a
game-changing report for your bottom line, so be sure not
to miss it.

Copyright 2015, all rights reserved by Oilprice.com. No portion of this report may be published or reused in any way
without the explicit consent of Oilprice.com.

oilprice.com I 16