Economic Evaluations of Oil and Gas Development
What does it cost to implement best management practices? Some of the time, labor, and material costs of oil and gas development are “baseline costs”– those costs which are incurred in the essential functions of developing and producing oil and gas regardless of government regulation or the operator’s environmental or social ethic. Evaluating the costs of implementing BMPs, means calculating the incremental costs -- costs above and beyond the baseline. For example, what is the cost of:
- Using thermal distillation to treat produced water? See BMP 6207
- Modifying reserve pits to protect soils and water quality? See BMP 6289
- Installing plunger lift systems to minimize methane emissions that degrade air quality? See BMP 4460
- Using ultrasound to identify leaks to minimize and stop hard to find gas leaks? See BMP 4921
- Using oak mats for roads to speed the process of visual recovery and reduce reclamation costs? See BMP 5033
Calculating the incremental costs of environmentally friendly development is problematic. Difficulties include:
- Defining “baseline” – What is the standard industry procedure before adding environmentally friendly BMPs? Practices that were once innovative “extras” are now considered industry standards. This phenomenon of “BMP creep” is good for the environment, but can make it difficult to evaluate costs.
- Failure to compile Information – Operators are not required to compile financial information – either the expenses or the income generated from implementation of practices. It can be time consuming and tedious to isolate and calculate these costs.
- Poor communications – Even if operators have the foresight to compile this information, they have not generally shared it beyond their management circles.
Spend it Now to Save it Later?
To evaluate the true cost of development, we must consider costs during all phases of development:
- Planning/Environmental Review
Especially when BMPs are implemented, spending time and money during an early phase of development can help minimize expenditures during other phases.
- Time/money spent in carefully siting and constructing the well pad and roads can save on maintenance costs during operations
- Protection of topsoil during construction may reduce costs of reclamation.
- Installation of specialized equipment during construction/drilling can eliminate gas leaks and yield higher gas production to offset equipment costs
Time is Money?
Evaluations must also consider all categories of expenses, including labor, equipment, fuel, and other supplies. Increasing expenses in one category can reduce them in others:
- Building a pipeline to move and reuse well completion fluids from a central location can save on fuel and maintenance for water trucks and may also conserve water (see Anadarko’s Completion Transport System).
- Spending more on high quality revegetation materials (seed, mulch, erosion control blanket) can minimize the need for workers returning to the site for weed control or replanting (see Encana and the Lifespan Planning Approach)
Cost Information in the BMP Database
The Intermountain BMP Database contains over 7000 entries from our five-state region, but, currently, less than 100 of these entries include cost or cost savings information. The information, in the “Cost/Benefit Analysis” panel of the BMP record, ranges from very general and qualitative to quite specific and quantitative. On one extreme, the authors of BMP 5168, recommending secondary containment and leak detection for below-ground tanks, simply opine that the BMP reduces or eliminates soil contamination and thereby reduces remediation costs. Other BMPs include much more specific cost information. For example BMP 4462, installation of flash-tank separators, includes estimates of equipment costs, operation and maintenance costs, gas savings, and a payback period.
BMPs with cost information are available in the database for several resource categories including:
- air quality (45%),
- water quality (22%), and
- land surface disturbance, vegetation/soil reclamation, grazing/agriculture, and other (33%)
The majority of BMPs with cost information pertain to drilling and production phases of development (specifically water management and air emissions controls), with a few related to exploration, planning, siting, construction, and reclamation.
To access cost information within the BMP database, go to the Advanced Search page. After you choose your search criteria, c hoose “Cost-Benefit Analysis” and any other display criteria of your choice from the “Extra Fields to Display” section.
Methods of Economic Evaluation
Economic evaluations – whether they are for full-field development, individual wells, or specific practices for protecting the environment -- can be either qualitative (descriptive) or quantitative evaluations. We include both in the database both because so little information of either kind is currently available and because both types of evaluations can be useful if provided by a reliable/reputable source.
Whether they are qualitative or quantitative, economic evaluations of BMPs compare the costs of implementing BMPs with the incremental additional value of the resource produced or with the cost or cost-savings that results from using the BMP. In either case, if evaluating use of a BMP shows a net economic profit (total revenue minus total costs), then the operator would financially benefit from implementing the BMP.
Viewed simply from the operator’s standpoint, a cost-effective BMP might be shown by either:
- an increase in production of oil or gas that offsets the cost of the BMP, or
- a reduction in costs of development.
Production increases from BMPs often stem from reducing waste and unwanted emissions to the atmosphere. Development costs can be reduced by either reducing the cost of necessary materials (for example, by reusing water or roadbase) or reducing labor costs by making the development process more efficient.
Examples from the BMP Database
Increasing Production: BMP 4460: Installing a plunger lift systems in mature gas wells can decrease the accumulation of fluids in the well tubing that increases unwanted methane emissions. If the operator applies this BMP, it can reduce unwanted emissions and increase profits by selling methane that is no longer wasted.
Reducing Development Costs: BMP 6289: Use of a V-shaped pit can reduce construction time, water costs and pit liner costs while reducing water consumption and surface disturbance compared to using a traditional pit design.
BMPs can also save money by “getting it right” the first time -- minimizing cleanup costs, for example, cleanup of soils or water contaminated in accidents (BMP 5168) or reclaiming areas unnecessarily disturbed during development. (See Encana and the Lifespan Planning Approach). If environmental precautions are addressed throughout well siting, drilling, and production, the costs of cleanup can be minimized or eliminated. Of course, this can only be considered a “cost savings” if we assume that the cleanup is a necessary baseline cost of operations.
Companies can perform their own economic evaluations of BMP implementation or can rely on data provided by others. Using the BMP example above of installing plunger lift systems, data would be collected from companies that have and have not installed plunger lift systems. Factors that would be evaluated:
- cost of plunger lift system,
- cost of installing plunger lift systems,
- costs of maintaining plunger lift systems,
- methane emission losses over multiple periods,
- market value of methane during each period.
In this instance the profit from implementing the BMP would be the value of the methane emissions saved by companies that installed the systems minus the cost of installing them compared with the costs and values from those that did not install the systems.
Payback Period Analysis
A payback period analysis goes one step further and evaluates how long it takes to recover the costs of investment in the BMP and begin to make a profit. An investment with a shorter payback period is considered less risky and is therefor a better investment. Though BMPs incur costs to implement, often times they can shorten the payback period for total project costs (compared to the baseline cost of development) either through increased production of gas or by reducing the operating costs. In the example above, a payback period analysis could determine how long it would take an operator to recover the costs of installing and maintaining a plunger lift system by the money saved from reducing fugitive methane emissions and selling the additional gas.
The EPA Natural Gas STAR program uses payback period analysis where possible to evaluate BMPs.
The Bigger Economic Picture
While we focus on the incremental costs of implementing BMPs, there are a variety of other economic factors to consider in the bigger economic picture of oil and gas development. Economists use a variety of methods to evaluate development. Some of the most common are:
Input – Output model (IMPLAN):
This economic technique describes commodity flows from producers to intermediate and final consumers. It evaluates how much output will generally result from increasing inputs (purchases made to develop whatever good/service is being produced) by $1.
Benefits Transfer method
This monetization technique involves reviewing available valuation estimates to identify those that most closely resemble the resource, impact, and/or location being valued. Estimates are available in peer-reviewed literature for the monetary value of preserving some lands from development, protecting various species, and avoiding or remediating groundwater contamination. This data is presented in ranges of values to reflect the uncertainty and variation in the estimates.
This is a method to estimate the value of goods and services that are not commonly bought and sold in markets. Nonmarket valuation determines a value for environmental outputs, such as a healthier ecosystem, an underwater reef viewshed, or a fish population that is less likely to become extinct, that can be factored into traditional economic cost-benefit analyses. Specific economic tools can be used to estimate the economic value of environmental outputs. These tools include
- Using surveys designed to help respondents assign values to nonmarket goods or services (e.g., contingent valuation method)
- Studying market transactions that are influenced by the environmental good or service of interest.
Ecological economics is a policy perspective that addresses the interdependence and coevolution between human economies and their natural ecosystems. Interest in this area has been prompted by concerns for the adverse impacts of human economic growth processes on natural systems.
Multi-Criteria Decision Analysis
Decision-making in environmental projects is typically a complex and confusing exercise, characterized by trade-offs between socio-political, environmental, and economic impacts. Cost-benefit analyses are often used, occasionally in concert with comparative risk assessment, to choose between competing project alternatives. The selection of appropriate remedial and abatement policies for contaminated sites, landuse planning and other regulatory decision-making problems for contaminated sites involves multiple criteria such as cost, benefit, environmental impact, safety, and risk. Considerable research in the area of multi criteria decision analysis (MCDA) has made available practical methods for applying scientific decision theoretical approaches to multi-criteria problems
Revenue from oil and gas production differs state to state but some general taxes are applicable to oil and gas development. The industry pays taxes and royalties to federal, state and local governments that are derived directly from the extraction of oil, natural gas, and coal. The majority of energy revenue comes from production taxes (including severance), property taxes, and state and federal royalties, each linked directly to the production value of energy resources.
Royalties are “production” taxes paid to the land owner, including federal and state governments, Indian tribes, and private individuals. federal royalties are paid to the U.S. Treasury. Roughly half of federal royalties are returned to the state where drilling takes place. State royalties range from 12.5 percent in Colorado to 16.7 percent in Wyoming. Royalty figures include bonuses paid through the competitive leasing process (a premium paid by a company to win a leasing contract to drill in a specific area) and fees or rents paid to maintain a lease. (Source: Headwaters)
This tax becomes payable only when minerals are producing (as opposed to non producing), and are billed and collected once per year. For this tax, mineral interests are classified as real property, and are taxed based on the appraised fair market value. In its simplest form, fair market value is the price a willing buyer from the open market will pay for a mineral interest within the currently prevailing market conditions. (Source: MineralWeb)
Severance taxes are an excise tax on natural resources "severed" from the earth. They are measured by the quantity or value of the resource removed or produced. In the majority of states, the taxes are applied to specific industries such as coal or iron mining and natural gas or oil production. They are usually payable by the severer or producer, although in a few states payment is made by the first purchaser. The taxes usually are imposed at a flat rate per unit of measure, with oil production taxes on a per barrel basis, and gas production taxes on a per foot basis, although the rates may be graduated based on volume of production or value of the products. "Value" may mean market value in some states and gross value in others. Taxable net value or net proceeds are determined by deducting certain items from the gross value or gross proceeds. Examples of deductions include production costs, ad valorem taxes and royalties paid. Evaporation for gas wells also might qualify as a deduction.”
(Source: National Conference of State Legislatures)