Analyzing Profitability

This paper was prepared for the 40th Annual California Regional Meeting of the Society of Petroleum Engineers of AIME, to be held in San Francisco, Calif., Nov. 6–7, 1969. Permission to copy is restricted to an abstract of not more than 300 words. Illustrations may not be copied. The abstract should contain conspicuous acknowledgment of where and by whom the paper is presented. Publication elsewhere after publication in the JOURNAL OF PETROLEUM TECHNOLOGY or the SOCIETY OF publication in the JOURNAL OF PETROLEUM TECHNOLOGY or the SOCIETY OF PETROLEUM ENGINEERS JOURNAL is usually granted upon request to the Editor PETROLEUM ENGINEERS JOURNAL is usually granted upon request to the Editor of the appropriate journal provided agreement to give proper credit is made. Discussion of this paper is invited. Three copies of any discussion should be sent to the Society of Petroleum Engineers office. Such discussion may be presented at the above meeting and, with the paper, may be considered for publication in one of the two SPE magazines. Abstract Profitability analyses are made by engineers according to ground rules laid down by managements. The analyses produce yardstick numbers to aid in decision making; these yardstick numbers describe ventures in an imperfect numerical shorthand. Why do we use this particular shorthand? Just what do we mean by particular shorthand? Just what do we mean by profitability? By profit? This paper attempts profitability? By profit? This paper attempts to define these questions, so that the reader can develop his own satisfactory answers. Introduction Every paper has a purpose. At technical society meetings, the purpose is usually to inform; to present a result or a technique or an experience. This paper has a purpose also, but it is different from the ones above: it is to make the reader [or the listener] take time out and think about a subject with which he is already familiar - in this case, profitability analysis. You have all taken time out from your normal routine of "doing" to come to this meeting to recharge your batteries in one way or another - either by attending the sessions or just by meeting with and talking with old friends - exchanging experiences; looking at the new products; deciding to pick up a set of preprints - which you promise yourselves you preprints - which you promise yourselves you will read later - and often never do because once you get back to your desks., it is the same old rat race again. Well, you do not have to read further in this preprint to get at least some of the message that I bring you. Just think along with me for the next half hour or so. The end product of our thinking is to be a better understanding of the significance of profitability analysis; you can call it profitability analysis; you can call it economic analysis or venture analysis if you like. In other words, why profitability analysis? There are numerous papers and books on how profitability is currently measured; I doubt if profitability is currently measured; I doubt if I could add much to your knowledge there, so that except for passing references during this talk, I shall not even try. All of us here know how to make a profitability analysis - in fact, just about everyone does, from the kid who figures out the advantage of paying a quarter for six packages of gum as against a nickel a package, all the way to the Secretary of Defense package, all the way to the Secretary of Defense who is charged with the analysis of the cost/ effectiveness of some $78 billion of expenditures every year. If we have competent management, then it will tell us very clearly and precisely and in no uncertain terms just how it wants us to analyze the profitability of ventures - all the techniques and yardsticks should be supplied. But we need to ask ourselves, and management does not always tell us, why we should analyze profitability; why we cannot just send a description of the project upstairs and let it go at that.