casemark/modeling-resource-depletion-economics

Modeling Resource Depletion Economics

Builds depletion models with production decline, reserve replacement economics, and terminal value analysis for finite-life assets.

When To Use

• Valuing oil & gas properties, mining concessions, or timber tracts where asset life is bounded by extractable reserves
• Forecasting production revenue streams under hyperbolic, exponential, or harmonic decline assumptions
• Evaluating reserve replacement economics — whether infill drilling, secondary recovery, or exploration capex extends economic life at acceptable returns
• Calculating terminal/salvage value and asset retirement obligations (ARO) for finite-life assets
• Stress-testing resource investments against commodity price, decline rate, and cost escalation scenarios

Inputs To Gather

• Reserve estimates: Proved (1P), proved + probable (2P), and contingent resource volumes with classification basis (SEC, PRMS, NI 51-101) [VERIFY classification standard used]
• Current production rates: Recent monthly/quarterly production data (BOE/d, tons/month, MBF/year as applicable)
• Decline curve parameters: Initial decline rate (Di), b-factor (hyperbolic exponent), and minimum decline rate (Dmin) if using modified hyperbolic
• Commodity pricing: Strip pricing, flat-price assumptions, or escalation model; specify real vs. nominal terms
• Operating costs: LOE/per-unit lifting costs, royalties/overriding royalties, severance/ad valorem taxes [VERIFY applicable fiscal regime]
• Capital program: Maintenance capex, development capex schedule, and reserve replacement investment plan
• Discount rate / WACC: Risk-adjusted rate appropriate to resource type and jurisdiction
• ARO / reclamation costs: Plugging & abandonment, mine closure, or reforestation obligations with timing estimates

Workflow

1. Establish reserve base and production profile

   • Classify reserves by category (PDP, PDNP, PUD, probable, possible)
   • Fit decline curves to historical production; select decline model (exponential for mature assets, hyperbolic for unconventional, harmonic where warranted)
   • Set economic limit — production rate at which net revenue equals operating cost

2. Build revenue forecast

   • Apply production volumes to commodity price deck on a per-period basis
   • Account for product mix (oil/gas/NGL ratios, ore grade variation over mine life)
   • Incorporate hedging or contract pricing if applicable

3. Layer in cost structure

   • Fixed vs. variable opex separation; apply per-unit variable costs to production schedule
   • Schedule development capex tied to reserve category conversion (PUD → PDP)
   • Include royalty burdens, production taxes, and income tax modeling [VERIFY royalty/tax rates by jurisdiction]

4. Model reserve replacement economics

   • For each tranche of replacement capex, calculate incremental reserves added, F&D cost ($/BOE or $/ton), and recycle ratio (netback ÷ F&D)
   • Compare recycle ratios against hurdle (typically >1.5× for conventional, >2.0× for unconventional) [VERIFY current market benchmarks]
   • Determine whether reserve additions extend asset life beyond base decline or merely slow decline rate

5. Calculate terminal value and ARO

   • Terminal value = salvage value of surface equipment + land residual − ARO obligation (discounted)
   • For mining: include reclamation bonding costs and post-closure monitoring
   • If perpetual tail production exists (e.g., low-rate stripper wells), capitalize at economic limit or apply a terminal multiple

6. Run depletion and valuation

   • Compute unit-of-production depletion for each period: (period production ÷ remaining reserves) × depletable basis
   • Generate PV-10 (undiscounted and at 10% per SEC convention) and NPV at project WACC
   • Calculate reserve life index (RLI = reserves ÷ annual production) at each forecast point

7. Sensitivity and scenario analysis

   • Vary commodity price (±20%, ±40%), decline rate (b-factor ±0.2), and opex escalation (CPI vs. oilfield-specific indices)
   • Run breakeven analysis: minimum commodity price to achieve target IRR or positive NPV
   • Tornado chart of top-5 value drivers ranked by impact on PV-10

Output

The completed model should include:

• Production forecast table: Annual volumes by reserve category with cumulative depletion percentage
• Cash flow waterfall: Revenue → royalties → opex → capex → taxes → net cash flow, per period
• Depletion schedule: Unit-of-production depletion by period with remaining depletable basis
• Reserve replacement summary: F&D cost, recycle ratio, and incremental RLI per capex tranche
• Valuation summary: PV-10, NPV at WACC, IRR, and payback period
• Sensitivity outputs: Tornado chart, breakeven price, and scenario comparison table
• Assumptions log: Every key input with source, date, and [VERIFY] flags where data is uncertain

Quality Checks

• Confirm cumulative production in forecast does not exceed total recoverable reserves (1P or 2P as specified)
• Verify decline curve fit against at least 12 months of historical production — flag assets with insufficient history
• Check that economic limit is correctly applied: no periods should show negative net operating income unless explicitly modeling pre-production or development phases
• Ensure depletion basis ties to acquisition/development cost less accumulated depletion and impairment
• Validate that PV-10 calculation uses pre-tax, pre-financing cash flows per SEC methodology when presented as PV-10 (vs. post-tax NPV)
• Cross-check RLI trajectory — if RLI is increasing while production declines, confirm reserve additions are the driver
• Confirm ARO timing is consistent with expected plug/abandonment or closure schedule, not artificially deferred