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Oil Well Amortization

The well will be amortized over its estimated production on a per m^3 of production. The estimated production was calculated at the auction and made known to all financiers. This value will be divided into the market value of the oil well to get a $/m3 amortization rate.

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Let's assume that an oil well with a total estimated production of 10,000 m3 is put up for auction. The winning financier bid $450,000 for that well. The second highest bid was $400,000. The market value is $400,000 (and $50,000 is put in the financier's loss schedule of that province). The amortization rate is $40/m3 ($400,000 ÷ 10,000 m3). This value will be used until the well is fully amortized or is abandoned.

As the well is produced, the amortization will be listed as an expense in the income statements and an account called “accumulated amortization” will increase by this amount. The original value of the well minus the accumulated amortization is the “book value” of the well.

Taking our example on its first day of production, its initial flow rate is 200 m3/OF Day. Therefore the amortization expense for that well on its first day of production is $8,000 (200 x $40). The accumulated amortization is now $8,000, which means the well's book value is now $392,000 ($400,000 - $8,000).

Taking our example one more OF Day, its decline is 1%. So the production for the second day is 198 m3, giving an amortization expense of $7,920 (198 x $40). The accumulated amortization is $15,920. The book value of the well is now reduced to $384,080 ($400,000 - $15,920).

Most wells in OilFinancier will be fully amortized before they are abandoned. After being fully amortized, there are no further amortization expenses. When an oil well has been fully amortized, this means its book value (initial purchase price minus accumulated amortization) is now zero and no further amortization expense is incurred. When an oil well has zero book value and is yet still earning a small profit, it will create a positive leverage on the share price.

When the well is suspended, there is no amortization expense. This expense resumes when the well is operating again.

The amortization expense is not used as a valid expense in the tax calculations. Instead Capital Cost Expense is used for calculating taxes to account for the asset which is being consumed over time.

Remember that amortization is a reasonable estimate of how the assets (oil wells) are being used up.

 
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