EVALUATING AN OIL AND GAS PROJECTION
 By Leslie A. Murphy, CPA
 Plante & Moran, LLP

PART THREE: "BUT HOW DO I FARE?" CONVERTING THE PROJECTIONS FOR A WELL TO THE SPECIFICS OF YOUR PROGRAM: ESTIMATING "PAYOUT"

Editor's Note: In the November and December, 1996, issues, Leslie Murphy discussed several aspects of analyzing Oil & Gas Projections: the significance of the assumptions underlying such projections; how to evaluate the major variables in the projection; and the importance of the structure of the Program. In this third partof her article, Ms. Murphy begins a discussion of how to convert data provided you concerning the expected results of the wells to be drilled by your Program to information that takes into account

 the specifics of Your Particular Program. This Part Three focuses on the critical issue of determining "Payout."

CONVERT THE ECONOMIC PROJECTION FOR THE WELLS TO YOUR PROGRAM SPECIFICS

 After you have identified all your program specifics, it is time to apply the specifics of your program to the projected cash flow analysis of the wells. Consider the following basic assumptions:

 Chart 3 presents a basic cash flow for the proposed program that begins with gross revenue from oil and gas sales. The revenue is first reduced for royalty interest payments. Be certain that management's cash flow has all royalty interest payments considered. Oftentimes, their analysis includes only landowner royalty payments because the other royalty arrangements arose during the syndication process.

 Gross revenue to working interest owners is further reduced for operating expenses. Be certain that operating expenses include annual expenses like program monitor costs, program administration charges, and outside accounting expenses or determine that these are considered elsewhere in the projection. The initial spreadsheet of projected well revenues and expenses seldom considers these costs as they are also determined at the time of syndication.

 CHART 3:

PROPOSED OIL AND GAS INVESTMENT
 SCHEDULE OF NET CASH TO WORKING INTEREST OWNERS
(IN THOUSANDS)

Chart 4 begins with net cash to working interest owners and calculates net cash distributions to the limited and general partners according to the revenue sharing formula. For this example, we have defined "payout" as cash on cash return and, as you will note, it occurs during the fifth year. The calculation of payout can vary substantially based on how it is defined, as illustrated below:

 Payout defined as:

As you can see from our example, the definition of payout affects total return to the limited partners over the life of the investment. Nearly all programs increase distributions to the general partner after payout is achieved, and the earlier the change occurs, the greater the return to the general partner. You should also be aware that most cash flow projections do not take the reversion point (the point in time that the general partners increase their revenue sharing percentage) into account because these cash flow statements are often prepared before the final structure is determined.

 CHART 4:

PROPOSED OIL AND GAS INVESTMENT
 SCHEDULE OF PROJECTED CASH DISTRIBUTIONS
(IN THOUSANDS)

Additional considerations that should be included in your objective analysis of projected cash flow include:

 1. Review for incentive payment arrangements to the operator, general partners, etc.

 2. Develop a feel for the sensitivity of the assumptions. Try a "what would happen if . . ." analysis to determine how much a price change or cost increase could influence your satisfaction with the program.

 3. Determine if the projected cash flow statements include production from secondary recovery techniques, additional drilling sites, and up hole production. Any projected benefit would require an additional investment of capital and this expenditure should be considered in the projection.

 Coming next month: Taking into Account Taxes and the Time Value of Money

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