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Well before you jump out and make a quick decision, let’s analyze this opportunity using probabilistic economic modeling with software such as Crystal Ball, a simple add-in to your Microsoft Excel software.
To ascertain how much the bonus might be worth, you need to know more about the new company's financials to better determine the value of the net profits. Hypothetically, let's look at the financial information of the new company, comparing three likely scenarios.
Income Most Likely Worst Case Best Case Yearly Gas Production 1,500,000 1,200,000 1,800,000 Current Gas Price $4.55/mcf $3.00/mcf $6.00/mcf Total Annual Income $6,825,000 $3,600,000 $10,800,000 Expenses Royalty Expenses $1,706,250 $ 900,000 $2,700,000 Production Taxes $ 546,000 $ 288,000 $ 864,000 LOE Expenses $2,559,375 $2,559,375 $2,943,281 G&A Expenses $1,235,000 $1,235,000 $1,500,000 Total Annual Expenses $6,046,625 $4,982,375 $8,007,281 Gross Profit $ 778,375 -$1,382,375 $2,792,719 Income Taxes $ 311,350 $-0- $1,117,088 Net Profit $ 467,025 -$1,382,375 $1,675,631 3% of Net Profits $ 14,011 $-0- $ 50,269The worst case scenario column assumes production continues to decline at 20%, with nothing done to improve production - a produce out case. The downside case also assumes gas price could drop as low as $3.00/mcf. The upside case assumes something can be done to improve production beyond its normal decline, to a level of 20% above the most-likely case, which is, in effect, 50% above the produce out case.
It
also assumes gas price could go as high as $6.00/mcf. Let's assume
that with your current position at your current company you make $120,000
+ $12,000 = $132,000. Using the Most Likely Scenario on the hypothetical
financials above, your prospective position apparently is offering
$126,000 + $14,011 = $140,011. At first blush, it looks like you would
make a little more money with the new company initially but, if you
could help improve production and reduce expenses in the new company,
you might be able to increase your salary even more. Which job opportunity
sounds best to you ~ stay where you are, with an assured base salary
but limited upside, or move to a new position with a new company with
the potential to greatly improve your financial freedom? Companies
and individuals make decisions using this kind of information every
day. But running an economic model, using a software program like
Crystal Ball, might give you a more accurate comparison of the two
job choices. If you were to run the economic model, the probability distribution would show a 75% chance of making some bonus (>$0) with the new opportunity, and a 59% chance of making at least what your current position pays (>$6000).
And the last analysis indicates a 12% probability of making a $25,000
bonus. So what appears on the surface to be a better opportunity at
the new company may in fact be a coin-toss as to whether you will
make the same amount of take home pay, and there is a pretty low probability
of making substantially more than your current salary. This example,
while somewhat unrealistic from a personal standpoint, is very representative
of the day-to-day decisions that oil and gas executives and project
managers make for their respective companies when they analyze oil
and gas properties. If we simply rely on a basic, single point evaluation, we may be led to believe a more optimistic picture in spite of our best effort to portray an accurate and realistic scenario of an opportunity. If we look at the sensitivity analysis of the example listed below, we see gas price and production are the two most critical components that will have the greatest effect on determining whether you get paid a bonus or not.
You
obviously will have limited opportunity to influence the gas price
by very much, but can perhaps affect the production rate if you are
successful at growing production above and beyond its natural decline
rate. So by performing this 10 minute analysis, you are at least more
informed that, if you were to take this new opportunity, you will
need to focus all of your efforts and the company’s resources
towards growing production. If the decline rate of the existing production
is very steep, and the company’s financial resources are very
limited, and/or gas price goes down, you have relatively little chance
of being successful. This is exactly why your company’s executives
are so keenly focused on production growth. If the company sells off
some of its properties, what are the real prospects of replacing that
production by the next quarter, and at what cost, whether it is a
finding or acquisition cost. If you are unfamiliar with Crystal Ball, I encourage you to buy a copy yourself, and improve your analytical skills and begin to experience the evaluation capability that exists when you move beyond simple economic analysis to probabilistic assessment of investment opportunities. If you are an excel user, learning and using Crystal Ball is a piece of cake. This is just another example of some of the typical industry software that is available, that can provide tremendous analytical capability for today's engineers and geoscientists. Let's get inspired and get ahead of the curve!
Back to December 2003 Newsletter
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