Calculating Differentials

The data, opinions, interpretations, and guidance provided herein are for general information purposes only. NSAI accepts no responsibility for the accuracy of any such information or for any reliance made on it. The precision of estimated differentials depends on a number of factors, including the data available, the experience and judgment of the evaluators, and the methodology used.

Terminology

Benchmark or Index Price – Reference price of oil or gas, chosen because it is both familiar in the industry and relevant to the properties being evaluated.

Spot Price – “The price for a one-time open market transaction for immediate delivery of a specific quantity of product at a specific location where the commodity is purchased ‘on the spot’ at current market rates.” [EIA]

Posted Price – An established price for which a buyer is willing to purchase oil or gas for a period of time, usually at a major oil or gas pipeline interconnect location or at a refinery.

Futures Price – A price established on a futures exchange based on trading of contracts to buy/sell oil or gas for delivery at a future date; generally refers to the “near-month” futures price.  The “Futures Strip Price” is the price of futures in sequential delivery months, e.g., a 12-month strip price is the average futures price over the next 12 months.

Field Price or Realized Price – The price actually received for oil or gas sold from a given lease or field (sometimes referred to as the “wellhead price”).

Price Differential – The difference in price between an established benchmark and what is actually received at the lease or field (inclusive of adjustments for quality, energy content, transportation fees, and regional/local differentials).

Common Industry Benchmarks

Calculating Differentials Compliant with SEC Regulations

It is our understanding that the SEC’s intent is for the prices used in an evaluation to be the prices the Company could have received if it marketed/sold its gas/oil on the first day of each month within the 12-month period prior to the end of the reporting period.

Data Used

• Gas/oil sales and transportation contracts (or summaries of contract terms) that cover the 12-month period.
• Monthly lease operating statements (LOS) showing prices and revenue, by production month, for the 12-month period.
• The previous 12 months of monthly index prices. The monthly index prices are different than the first-day-of-the-month SEC prices.
• The 12-month unweighted average of first-day-of-the-month prices for the appropriate regional index.

Shown below is an example of both monthly index prices and first-day-of-the-month prices for the most commonly used indices.

Methodology

It is the SEC’s intent, although it is difficult in practice, for the prices used in an evaluation to be the prices the Company could have received at the well or field if it marketed/sold its gas/oil on the first day of each month. Said another way, what happens in February or later should not affect the well- or field-level SEC price for January 1st. In practice, there are a few different methods to determine this price, including but not limited to:

1. Obtain gas/oil sales and transportation contracts that cover the 12-month period prior to the end of the reporting period and use the differentials set out in those contracts with the appropriate regional hub spot/posted price index.
   • Recognize it is not always possible, or practical, to get contracts for every property.
   • Assumes that month-to-month contract terms are representative of the “price the Company could receive”.
   • Note that often times not all of the contractual arrangements that affect the net price received are well known or documented (which is why it is best practice to validate contract data with actual LOS).
2. Use the monthly index prices and the monthly LOS to determine the average differential to the indices and then apply that average differential to the 12-month average SEC index price (average of first-day-of-the-month prices).
   • Assumes that the 12 months of the monthly differential is a close approximation of the differential in effect on the first day of each of the 12 months.
   • Used to verify contracts/contract terms or as a proxy or in lieu of obtaining month-to-month gas/oil sales contracts.
   • Recognize that LOS data over the same period as the SEC pricing indices may not be available, so you may be limited to using the average for the first 9 or 10 months rather than the 12-month average. The evaluator should use good judgment to determine the appropriate differential, reflecting his/her estimate for the missing months.

Example

Cautionary Notes

1. Be careful to use the appropriate index prices when determining differentials for your price case.
   • The above example uses WTI posted oil prices. If using a WTI NYMEX or spot price forecast for a non-SEC report, be sure to factor in the difference between NYMEX and posted prices. For example, if you use the Bloomberg spot oil price with differentials determined from comparing historical received oil prices to posted oil prices, you will calculate a price that is too high. For 2015, the NYMEX vs. posted delta is $3.45 ($48.80 – $45.35).
   • Note that the difference between first-day-of-the-month prices and monthly index prices can make a difference in the differential calculation. For instance, for 2015 the average Plains WTI Posting oil price was $45.35, whereas the first-day-of-the-month average price for 2015 was $46.79, which if used incorrectly could lead to using a SEC wellhead/lease price that is $1.44 too high.
2. Gas is typically sold on a $/MMBTU basis, so the example above assumes the BTU factor is known and is factored in before the differential is calculated. In some cases, where the BTU factor is not known, gas differentials are expressed as a % (or multiplier) of the index price rather than a $/MCF difference.
3. The example shows differential calculations for the 12 prior months where LOS data are available at the time the estimates are made; some estimators limit the differentials to just the current calendar year and some estimators use the current year plus estimate the differentials for the missing months. For SEC reports, the estimators use their judgment to determine which differential best represents the full 12 months prior to the as-of date. For non-SEC reports, the estimators use their judgment to determine which differential best represents the expected future differential.