In this technical yet accessible episode, we demystify decline curve analysis (DCA), the proven scientific method that oil companies have used for over 80 years to predict the amount of oil and gas a well will produce over its lifetime. This episode is helpful if you have ever wondered why your royalty checks keep dropping each month or if you would like to know how to predict what they will be in the future.
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Key Takeaways
What is Decline Curve Analysis?
Decline curve analysis is a mathematical process that uses historical production data to forecast future well performance. The method works by fitting curves to production data and using basic mathematical equations to predict what a well will produce in the future. This isn’t guesswork – it’s the same established methodology that major oil companies use to value their reserves and that engineers have refined since 1945.
Why Mineral Owners Should Care About This Process
Understanding decline curve analysis helps mineral owners make informed decisions about their property. The analysis provides month-by-month projections of future royalty income, which proves invaluable for budgeting purposes and quarterly tax planning. Many mineral owners don’t realize this level of detailed forecasting is possible, often thinking their royalty checks are unpredictable when there’s actually substantial data available to project future payments.
The Three Phases of Well Production
Most oil and gas wells go through predictable phases that explain why royalty checks change over time. Right after the well is drilled, it usually delivers the highest initial production for the first few months where the production grows until it peaks (this is usually when you receive the largest royalty checks). Next, the “transient phase” shows declining but somewhat steady production as reservoir pressure begins to drop. Finally, once things have stabilized, most modern wells experience an exponential decline phase ( think “slow, steady decline”) that can last decades, especially for horizontal wells. This pattern happens because of natural reservoir energy depletion, not because anything is wrong with the well.
Of course, there are times when the well will stop producing due to a maintenance issue or due to curtailment due to an upset in the export pipeline or for other reasons. The decline curve does not predict when these unforseen events will occur. Assuming there is no damage to the well, most will resume production at or near the original decline curve once production resumes, although every well is somewhat unique.
Different Types of Decline Curves Match Different Well Behaviors
Engineers use different mathematical curves depending on how wells perform. Most modern horizontal wells follow a “hyperbolic decline” initially, where production drops steeply at first but the decline rate slows over time. Eventually, wells transition to an “exponential decline” with a constant percentage decline each year. The specific curve parameters depend on the reservoir characteristics and can be predicted based on similar wells in the area.
Building Forecasts for New Wells Using Type Curves
When companies want to predict how a new, undrilled well will perform, they create “type curves” by analyzing production data from similar existing wells in the area. Engineers normalize this data for factors like horizontal well length and completion techniques, then average the results to create a representative forecast. This process allows accurate predictions for wells that don’t exist yet, enabling better planning and investment decisions.
The Importance of Clean Production Data
Reliable production forecasts require at least 12 to 24 months of unrestricted production data (ideally), although if you are familiar with an established area you may be able to accurately forecast a well with less data. Wells that are constrained by pipeline capacity, subject to enhanced recovery methods, or curtailed for market reasons can’t be accurately modeled using standard decline curve analysis. The method works best during primary production when wells flow naturally under reservoir pressure without artificial constraints.
Oil and Gas Prices Remain the Biggest Variable
While engineers can forecast production volumes quite accurately, commodity prices introduce the greatest uncertainty in value calculations. Professionals use various methods to estimate future prices, including futures market data, bank price forecasts, or SEC-approved historical averaging methods. Since the relationship between price and value is mostly linear, forecasts can be easily adjusted up or down based on different price assumptions.
When to Do This Analysis Yourself vs Hiring Professionals
Mineral owners can perform basic decline curve analysis using software tools and online resources, with simple forecasts taking just a few minutes for wells with adequate production history. In fact, I recorded a video that shows you how to do just that using a paid WellDatabase account (not a sponsor of the show, I just use their service in my consulting practice).
However, professional valuations or appraisals become essential for significant financial decisions like for estate or tax planning, for determining the fair market value of your interests to help with negotiating a sale, or situations requiring IRS-defensible valuations (like when you want to establish a step-up in basis for capital gains tax purposes). The cost of professional analysis often pays for itself, especially when establishing stepped-up basis for inherited properties.
Practical Applications Beyond Just Knowing the Numbers
This analysis serves multiple practical purposes for mineral owners. It helps distinguish between normal production decline and actual well problems. It enables accurate quarterly estimated tax payments, avoiding penalties or overpayments. For inheritance situations, it can establish higher tax basis values that reduce capital gains taxes when properties are eventually sold. The analysis also provides mineral owners with confidence in understanding their assets rather than simply hoping their checks continue.
Limitations and Realistic Expectations
While decline curve analysis is highly reliable for short-term forecasts with good data, uncertainty increases for longer time periods and newer wells. Type curves represent averages, meaning individual wells will perform above or below predictions about half the time. The methodology requires expertise to apply correctly, and mineral owners should understand both its capabilities and limitations before making major financial decisions based on the results.
Hopefully, this episode transformed Decline Curve Analysis (DCA) from intimidating engineering jargon into practical knowledge that you can use to better understand and manage your assets.
Resources Mentioned in this Episode
- My YouTube Video showing How To Forecast Your Own Royalty Payments
- WellDatabase (You will need to purchase one month of the “Essential” plan to be able to forecast production and export the resulting data to a spreadsheet like I show in the video).
Mineral Rights Education
- Mineral Management Basics Online Course
- National Association of Royalty Owners (For a limited time, use coupon code “MRPODCAST” for $25 off an Introductory Membership. Good only for first-time members).
- While you are at the NARO website, check out the free letter in lieu of division order template that you can use instead of returning a division order (*depending on the state where your minerals are located).
- 1-on-1 Coaching with Matt
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Disclaimer: This episode and accompanying show notes are provided for general information purposes and should not be construed as financial, legal, or investment advice. For guidance specific to your situation, please consult with qualified legal and financial professionals.
