How to Read a Cash Flow Statement in a Reserve Report

Warning

This article and series is specifically targeted for anyone involved or interested in oil and gas reserves reporting guidelines, methods, issues, calculations and pitfalls. Proceed at your own risk!

Introduction

Reserve reports typically present the lifetime oil and gas reserves and expected cash flows for a commercial entity that has ownership in a specific set of properties. The report could involve only one well, or possibly tens of thousands of wells spread out in numerous productive basins targeting different reservoirs and involving various operators. Any proper reserve report should describe the entity, the purpose for the report and detail any complexities so the reader can be fully informed. Most importantly, summary cash flow tables are the “main event” of the reserve report effort, where reserves and values are shown in one very detailed page. It should be pointed out, however, that reserves and cash flows shown in reserve reports DO NOT take into account interest payments, debt service or federal income taxes unless specifically noted. Herein, we will take a brief tour of a reserves-based cash flow page and explain some of its nuances, leave you with an explanatory reference guide, and throw in a bonus rate-versus-time graph to drive home how forecasted production is converted to dollars and discounted cash flow.

Summary Cash Flow Statement

Please refer to the summary cash flow page below (Figure 1), which presents the Total Proved reserves and economics for Example Exploration, LLC’s ownership in certain oil and gas assets in Texas. The first thing to notice is the titles, which clues you in to exactly what this page reveals… reserves and economics, the ownership entity, asset description, reserve classification and development status, and the effective date of the valuation. A quick glance at the bottom of the page indicates that this valuation used SEC pricing for year-end 2019, which coincides with the effective date of December 31, 2019.

Before diving into the numbers shown on the cash flow page, let’s take a high level look at what items this composite page presents. These items are summarized below and annotated on Figure 1.

• Time Frames (usually annual periods are shown at left)
• Gross Production (at the wellhead)
• Net Production (Sales, considering revenue interest and gas shrinkage)
• Average Product Prices (Benchmark prices less differentials)
• Revenues (for hydrocarbons, and other sources if applicable)
• Taxes (State Production Severance and Ad Valorem taxes, typically a % of revenue)
• Operating Costs (Fixed and variable costs, and other appropriate expenses)
• Investments (Capital deployed for remediation, drilling and/or abandonment)
• Cash Flow (Revenue less taxes, expenses, and investments)
• Discounted Cash Flow (“DCF” – cash flow discounted for “time value of money”)

Explanatory Comments Guide

In every reserve report that we publish, we provide an explanatory guide that describes the detail in a summary cash flow page. This guide is very important to include so that we can be sure that any reader of our report will have all the tools needed to better understand the reserves and cash flows. Please refer to the “Explanatory Comments for Summary Cash Flow Tables” page below in Figure 2 when reviewing the elements in the cash flow page in Figure 1.

A closer look at Figure 2 reveals the details in each cash flow page. Not only does it describe what information is contained with each of the 31 columns, it also describes the math that goes into calculating each set of numbers. Furthermore, Figure 2 lists the various components that go into each calculation, such as “Other Deductions” which typically represents variable operating expenses like compression or gathering expenses, transportation costs, and/or water disposal costs.

One nuance that I can point out in the cash flow statement (Figure 1) above is that you should notice that net product sales are shown for oil, gas and natural gas liquids (NGLs). This is a clear signal that at least SOME of the natural gas flows through a processing plant where residue gas (net gas sales) and NGL’s (net NGL sales) are sold at the tailgate. If the Net NGL Production (column 7) was zero, then that is a signal that natural gas sales in the reserve report were modeled as wet gas sales (unprocessed).

Without going into every detail about cash flow statements in this article, we have provided Figure 2 below for your reference and education.

Production Rate vs Time Graph (Semilog)

Reserve reports will often present graphical “rate versus time” figures to show a visual representation of historical and forecasted oil and gas production. In Figure 3 below, we have included a Summary Plot that is related to the Total Proved summary reserves and economics statement in Figure 1. In this case, GROSS historical oil/gas production and well count are shown prior to the December 31, 2019 effective date, and GROSS forecasted values are shown after this date. In addition, our plots include summary production, reserves and economics values at top right that match the cash flow page.

Note that this graph shows logarithmic rate versus linear time (semilog), which is very common in the energy industry due to the declining production behavior of oil and gas wells. In fact, for this particular evaluation individual well rate versus time plots were utilized for decline curve analysis (DCA) to forecast future production. These individual forecasts were rolled up into this Total Proved composite rate versus time plot, which actually is made up of 24 producing wells (PDP), 3 behind-pipe wells (PDNP) and one drill (PUD). These details would have been revealed in a full reserve report, but you can still glean a significant amount of detail from just a summary cash flow page and summary rate-time plot.

Closing

This was a brief tour of the most important page in a reserve report… summary cash flow for proved reserves. The rest of the reserve report (report letter, table of contents, individual well analysis, reserve definitions, etc) all serve to support the summary cash flow. But, be aware that reserve reports can be very complex and do not always show every detail that went into the valuation. We encourage you to read the report letter in full so you can understand the reason for the valuation and assumptions applied to prepare cash flows and determine value. We can help you with that, so feel free to reach out here or contact a CG&A professional at the links below. Thanks for reading!

Contact CG&A about Reserves: [email protected]

Check Out Our Website: www.cgaus.com

Special thanks to @Jeffrey Wilson PE, @Jonathan Schmit, PE and @Shelby Loskorn for their efforts in publishing this series.