Primitive Energy owns several coal seam gas reserves in south-west Queensland. As a relatively minor player in the Queensland Liquefied Natural Gas (LNG) market, Primitive does not have the capacity to transfer and process the gas for sale to domestic or international buyers. Instead, Primitive simply extracts the gas and then sells it immediately (at the well-head, which is at the surface) to one of the major gas companies operating in the area. Recently, Primitive entered into a contract to sell gas from one of its reserves for the fixed price of $4.45 per gigajoule (GJ) for the life of the reserve.

With this contract in place, Primitive's management are currently trying to determinewhether they should extract the gas throughconventional 'Vertical' drilling or the recently developed'Horizontal'drilling. As indicated in Figure 1, the Vertical drilling approach drills to the coal seam while the Horizontal approach drills down to and then across the coal seam.

Vertical:Smaller capital outlay, however, more wells are generally required due to smaller drainage area (the portion of the reserve that a well can access).

Preliminary designs indicate project requires 100 Vertical wells.

Higher capital outlay given length of drilling, technology and difficulty. Greater access to gas reserves and larger spacing between wells, which

means fewer wells required. Preliminary designs indicate that project requires 50 Horizontal wells.

Specific detail on each of the well types including: capital outlay, production, maintenance, depreciation, state royalties, well drilling and capping schedule.

general information

total reserve size 250000000

state royalties: 0.1

tax:0.3

required rate off return:0.11

vertical well drilling

capital expenditure (per well): 3,000,000

Well life: 10

well salvage: _

well capping and rehabilitation: 300,000

well depreciation method: straight-line

well operating costs: 1

working capital:_

Wells drilled in given years and their operating life_

well production profile: 517,231 (Yr1), 744,250(Yr2), 486,064(Yr3), 288770(Yr4), 156,061(Yr5), 76772(Yr6), 34311(Yr7), 13958(Yr8), 5165(Yr9), 1739(Yr10)

wells drilled at the beginning of yr 1 : 20

wells drilled at the beginning of yr 2 : 20

wells drilled at the beginning of yr 3: 20

wells drilled at the beginning of yr 4: 20

wells drilled at the beginning of yr 5: 20

wells in operation: 20,40,60,80,100,100,100,100,100,100,100,80k,60,40,20

total production per well: 2324271

times the total number of wells(100): 232427071.69

Horizontal well drilling

capital expenditure (per well): 5,000,000

Well life: 17

well salvage: _

well capping and rehabilitation: 300,000

well depreciation method: straight-line

well operating costs: 1

working capital:_

Wells drilled in given years and their operating life: _

Well production profile: 680,922(Yr1),1,136,692(Yr2),1068150(Yr3), 731671(Yr4), 463,089(Yr5), 288,688(Yr6), 181,135(Yr7), 115,289(Yr8),74630(yr9), 49154(Yr10), 32923(Yr11), 22406(Yr12), 15477(Yr13), 10840(Yr14), 7691(yr15), 5523(Yr16), 4010(Yr17)

wells in operation: 10,20,30,40,50,50,50,50,50,50,50,50,50,40,30,20,10

Total production per well: 4888290

Times the number of wells (50): 244,414,502.05

extra information

^1 Contract specifies that this is a fixed price of gas at the wellhead over the life of project.^2 in a given year, State Royalties ($) = State Royalties (%) x (Revenue - Allowed Extraction Costs). Allowable Extraction Costs include operating expenses and depreciation but exlcudes the well capping and rehibilitation expense.^3 State Royalties are tax deductible.^4 Tax is paid in the year of income. Note that it is assumed that any tax loses in any year will offset tax gains within the Primitive Energy tax consolidated group.^5 Capital expenditure on wells is recorded at the start of year in which the well is drilled.^6 Wells must operate for stated life to ensure well pressure is sufficiently low for well capping.^7 All revenues and operating expenses are assumed to occur at the end of given year.^8 Straight Line depreciation method (depreciating down to zero over the life of the well).^9 Wages and other operating expenses are all captured by the operating cost per GJ.^10 Given the nature of the project, supply and servicing contracts, project has no working capital requirements.^11 Wells drilled in years as indicated. Capital expenditure recorded at the beginning of the year. For example, the beginning of Year 1 corresponds to the 0 column.