Why Do My Monthly Checks Fluctuate So Much?
Another month passes, and this time your check is down a thousand dollars. Last month it was up by $600. Every month’s different. Why? Are you being treated fairly? Are you being paid correctly?
Let’s take a high level look at how to calculate what you should be getting paid, to better understand this. First, here’s a rudimentary equation for how your share of the oil is calculated.
The Equation is:
Quantity of product produced from the well x Commodity price of the product x Division of interest = Revenue before taxes.
Here’s an example with real numbers: If 1,000 barrels of oil is produced and the price of oil is $51.02/Bbls, and you have a .01523 division of interest in the unit, simply put the correct variables in their respective spots, then do the math.
1,000/bbls X $51.02 X .01523 = $777.03
Quantity X Commodity Price x DOI = Revenue
Understand that many operators include more factors in their agreements. For example, taxes,marketing, transportation, and commodity differentials are all left out of the above equation. Our goal is to focus on the two variables that cause the most fluctuation in your checks: Quantity produced, and Commodity Price.Your Division of Interest will generally stay the same, unless unitization changes. For this reason, we will not discuss Division of interest in depth.
Quantity produced each month – Wells are constantly in a state of decline, from the first barrel of oil or cubic foot of gas produced.The below graphic shows actual wells in the Eagle Ford and the number of barrels they produced over time:
As you see in the above graphic, shale well declines are very strong, as indicated by the steep decline in the first year. Eventually,the well is no longer economic. The money produced from pumping is less than the cost to maintain the well. This is called the Economic Limit, or ECL.
What does this mean for you? In the beginning, your checks will be very high but will quickly decline. Eventually you’ll hit a point where you no longer receive royalties. We’ll investigate how price effects the Economic Limit next.
Commodity Price – Commodity price is the next key factor. Sometimes, even though your well’s production has declined, your monthly check may be close to where it was the previous month. As an example,let’s look at what would happen if you owned 1 NMA leased at 25% in the Clapton well, in Karnes County.
In the above illustration we ran three scenarios.
· The first scenario (in blue on the chart) assumes you are paid $50/bbls consistently for the life of the well. The total sum of all payments received is $4,789.09.
· The second scenario (in orange on the chart) is what happens under a NYMEX strip scenario. The NYMEX strip,or “12-month strip” is the average of the daily settlement prices of the next 12 months' futures contracts, and is a good indicator of where oil prices are for the next 24 months. The total sum of all payments received in this scenario is $8,075.13.
· Finally, we inverted the NYMEX strip (in gray on the chart)to show the outcome if a well was brought on in a lower commodity price environment and gained an uplift from increased commodity prices over the life of the well. The total sum of all payments received is $5,987.99.
The takeaway from the above graphic is that commodity price has a tremendous effect on how much you earn and can often be misleading. Look closely at the Gray and the Orange lines. You’ll see a convergence around month 20. The well is still declining but the increase in commodity prices is greater than the decline of the well. You might assume that the well isn’t declining,but it is. At points from months 67 to months 69 the gray line exceeds both the Orange and the Blue. However, as noted above, you’d still be better off if the well came online in a higher price environment. The high IP (Initial Potential), paired with a higher commodity price yields $2,087.14 more for the life of the well.
So, I’m sure you’re thinking “this is all well and good, but when will the well stop producing?” This is very difficult to pinpoint. As you see above, higher prices can help lift revenue on a well not just for you but for the operator. If the price increases to a point at which profit outweigh the cost, the well may continue to produce. The price uplift needed varies by well and by operator.
We hope our attempt to take a high-level approach to check fluctuations sheds light on the main two factors driving the changes, as well as shows how looking at only the dollar amount of your check can be misleading.There are other factors we listed above but failed to go into detail on, such as marketing, transportation, taxes, commodity differentials, etc. We are always happy to talk through these factors, or other variables, when convenient for you.