Well Economics NPV IRR Formula

Well economics analysis evaluates the financial viability of drilling and completing oil and gas wells. The key metrics are Net Present Value (NPV), Internal Rate of Return (IRR), payout period, and breakeven commodity price. These metrics drive investment decisions for individual wells, development...

Overview

Theory

Cash flow analysis combines production forecasts (from decline curves) with commodity prices, operating costs, royalties, taxes, and capital expenditures to generate a time series of net cash flows. The time value of money is then applied through discounting to compute NPV.

Formulas

Net Revenue

Revenue_month = (q_oil * Price_oil * (1 - oil_diff) + q_gas * Price_gas + q_NGL * Price_NGL) * NRI

where NRI = Net Revenue Interest = WI * (1 - royalty rate).

Net Cash Flow (Monthly)

NCF = Revenue - LOE - Variable_OPEX - Taxes - CAPEX * WI
Taxes = (Revenue - LOE) * Tax_rate  (simplified)

Cumulative Cash Flow

CCF(t) = Σ NCF(1..t) - CAPEX (at t=0)

Net Present Value (NPV)

NPV = Σ [NCF_t / (1 + r/12)^t] - CAPEX

where r = annual discount rate, t = month number.

Internal Rate of Return (IRR)

IRR is the discount rate r* that makes NPV = 0:

0 = Σ [NCF_t / (1 + r*/12)^t] - CAPEX

Solved iteratively (bisection or Newton-Raphson).

Payout Period

Payout = month t where CCF(t) first becomes ≥ 0

Breakeven Price

The commodity price at which NPV = 0 (solved iteratively):

NPV(P_breakeven) = 0

Production Forecast (Arps Decline)

q(t) = qi / (1 + b * Di * t)^(1/b)

EUR (Estimated Ultimate Recovery)

EUR = Σ q(t) * Δt (summed until economic limit)

Economic limit: when monthly NCF < 0.

Profitability Index (PI)

PI = NPV / CAPEX

PI > 1 indicates value creation.

Worked Example

Given: qi, Di, and b from a decline-curve fit; P_oil from a public commodity benchmark such as EIA STEO or the World Bank Pink Sheet; CAPEX from AFE; LOE from lease records or a public textbook assumption; NRI from title; and discount rate from the investor's cost-of-capital policy. This example is illustrative methodology, not Petropt-calibrated basin guidance.

Month 1:

q_1 = qi / (1 + b * Di * 1)^(1/b)
Oil production_1 = q_1 * days_in_month
Revenue_1 = Oil production_1 * P_oil * NRI
NCF_1 = Revenue_1 - LOE_1 - Production_Taxes_1 - CAPEX_1

NPV (simplified, 60 months):

Cumulative undiscounted NCF = Sum of monthly NCF through economic limit.

NPV = Sum of discounted monthly NCF minus upfront CAPEX.

IRR is the discount rate that sets NPV to zero.

Payout is the first month where cumulative cash flow is non-negative.

Breakeven price is solved iteratively by finding the commodity price where NPV equals zero.

Need this calibrated to your asset?

For basin-specific type curves, LOE, CAPEX, and breakeven calibration, request an Asset Decision Pack.

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Valid Ranges

Parameter	Use in Screening
Discount rate	Use the investor's cost-of-capital policy or a clearly documented public textbook assumption
NPV > 0	Project is positive on the modeled assumptions
IRR vs hurdle rate	Compare against the investor's documented hurdle rate
Payout	Compare against the investor's liquidity and capital-recycling objective
PI > 1.0	Value-creating investment on the modeled assumptions
Breakeven price	Calculate from CAPEX/EUR, LOE per barrel, production taxes, DD&A, and NRI; public SEC Modernization guidance defines reserve-reporting context
Public references	SPE Petroleum Engineering Handbook, SPEE reserve guidance, SEC Final Rule 33-8995, and FASB ASC 932