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NATIONAL OIL EXPLORATION

COMPANY

In September 2006 Mr. R. Hashim, VP of National Oil Exploration


Company (NOEC), was deciding what to do with NOEC’s lease 4783. The
lease gave the NOEC exclusive rights to explore for oil and gas on 20
hectares of land owned by a Mr. Swadi. It was purchased by NOEC from
Swadi in July 2002 for $ 40,000, and NOEC paid Swadi annual rentals in
advance of $ 4,000 since 2002. The lease provided that if oil and gas were
found, Mr. Swadi would receive one-eighth (12.5 %) of the gross production
from the well, with the other seven-eighths (87.5%) to go to NOEC. All costs
of drilling and operating the well would be paid by NOEC.

In 2006 NOEC had yet to drill 4783 because it had other attractive
investments, and because its cash flow was limited at the time. Because the
lease would be automatically cancelled if NOEC did not start drilling by 2007,
Hashim had to decide on several options.

He could assign or sell the lease to another oil company. Because the
lease was located in an oil field containing existing, commercially viable oil
and gas deposits, NOEC believed it could sell the lease for $ 150,000.

Hashim could drill for oil or gas on lease 4783. In the 1,000 hectares
of “Sandusky” oil field around lease 4783, 70 wildcat wells had been
completed by 23 other operators: an oil industry association reported that
21 of the wells were dry holes, 28 were gas wells, 14 were combination oil
and gas, and 7 were oil wells. In addition, 18 wildcat dry holes were drilled
outside the field. Lease 4783, however, was conveniently located in the
middle of the productive Sandusky area.

Hashim determined that the NOEC could expect total lifetime operating
profits (net present value) of $ 1.5 million for a gas well, $ 2 million for a
combination well, and $ 3 million for an oil well. These amounts were net of

____________________________________________________________________________________
This case was written by Prof. Ricardo Lim, Asian Institute of Management. All case materials are prepared solely for the
purpose of class discussion. They are neither designed nor intended to illustrate the correct or incorrect management of
problems or issues contained in the case. Copyright 2016, Asian Institute of Management, Makati City, Philippines,
http://www.aim.edu. No part of this publication may be reproduced or stored without the consent of the Asian Institute of
Management.
National Oil Exploration Company 2

royalties to lease owner Swadi, and net of operating expenses, but before
deducting an estimated $ 1 million cost of drilling a well.

Several oil companies had been active in exploring Sandusky. Some


had conducted seismic tests to determine the subsurface formations beneath
the drill site. In the last 30 seismic tests in Sandusky, 12 “A,” 15 “B,” and 3
“C” formations were detected.

“A” tests were regarded by geologists as bad formations, i.e. dry


holes. Because of this, only 4 of the 12 “A” tests were actually drilled: of the
4 drills, three were dry and one produced gas. “B” tests, on the other
hand, were known to produce gas wells. Of the 15 “B” tests drilled, 9
actually produced gas, and six produced combination oil and gas. “C” tests
were the most desirable, because they almost always produced oil: all three
“C” sites were drilled and produced commercial grade oil.

Hashim could easily sell the lease to another operator. Or, he could
gamble and drill, without a proper seismic test. Or, he could commission a
seismic test for Lease 4783 for $300,000. Because NOEC was financially
constrained, the cost of the test was unattractive to NOEC management,
moreso if it yielded an “A” formation: an “A” test would basically kill any
chance that NOEC could sell lease 4783 to another operator. What will
Hashim do?

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Asian Institute of Management Copyright 2016

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