What it means
Drilling an oil or gas well is a staged process, and spudding is the first physical step. Before this, the company has to secure the land rights, obtain permits, hire a rig and crew, and arrange the finance for the work.
Once drilling begins the clock starts. Rigs are rented at a daily rate, so each day of drilling costs money, and the total depends on how deep the well is and how smoothly the work goes.
The spud date is a milestone that investors, lenders and joint venture partners watch. Exploration companies often announce it in their reports, and many loan agreements and partnership agreements contain conditions that must be met by a certain date, such as starting drilling within a set period.
For the accountants, spudding also matters. Costs incurred before drilling, such as seismic surveys and permits, and costs after drilling begins are often treated differently, depending on the accounting method the company uses for oil and gas exploration, and these methods can change reported profit significantly.
Spudding does not mean the well will produce oil or gas. Many exploration wells find nothing commercial, so a spud date marks the start of spending and risk, not of income.
Investors therefore treat it as a starting gun rather than a result. A well can also be spudded and then abandoned if problems occur.
The expenditure to that point must be dealt with in the accounts according to the company's policy, which is why finance teams track the status of every well from spud to completion.
In practice
Real-world examples.
Example
A small exploration company announces that it has spudded its first well. Its share price moves as investors wait for news about whether the well has found oil.
Example
A lender to an oil project has a condition that drilling must begin within six months of signing the loan. The company spuds the well with a week to spare, avoiding a default. The finance director records the spud date in the covenant tracker so that future deadlines are never missed. He also shares the tracker with the board each quarter, so everyone can see which obligations are coming up.
Example
A joint venture partner owning 25% of a well receives notice of the spud date. It must now pay its share of the daily costs, which means paying 25% of each day's rig rate and other expenses. On a $60,000 daily rate, that is 0.25 x 60,000 = $15,000 a day for the partner.
Formula
Calculation
Estimated drilling cost = (number of days x daily rig rate) + other well costs
A company plans a well that will take 30 days to drill. The rig costs $60,000 per day, and other costs such as casing, fluids and services are estimated at $700,000. Drilling cost = (30 x 60,000) + 700,000 = 1,800,000 + 700,000 = $2,500,000. If the well takes 40 days instead, the cost rises to (40 x 60,000) + 700,000 = $3,100,000.Case study
Seen in the real world.
Redfern Petroleum is an illustrative, fictional exploration company that planned to spud its first well by the end of March to satisfy a licence condition. The finance team had budgeted $4,000,000 for the well and arranged a loan facility of $3,000,000 plus $1,000,000 of its own cash. The plan assumed a rig rate of $70,000 a day.
A delay in delivering the rig pushed the spud date back by three weeks. The company had to negotiate an extension of the licence deadline and paid a fee of $50,000 to the licence authority.
Once drilling began, the well took 35 days instead of the planned 30, adding 5 x $70,000 = $350,000 to the cost. The illustrative lesson is that the budget should include a contingency for delays, and Redfern added a 15% margin to all future well budgets. It also began to report spud dates and costs to its lenders every month, so they could see progress and the cost trend.
Watch out
Common mistakes.
- Assuming that a spud date means the well has found oil or gas, when it marks only the start of drilling.
- Budgeting for the planned number of drilling days without allowing for delays and overruns.
- Overlooking the accounting treatment of costs before and after spudding, which can change the reported profit.
Questions
People also ask.
What does it mean to spud in?
It means to begin drilling a well, as the drill bit first penetrates the ground.
Why do investors follow the spud date?
It shows that the project has moved from planning to action, and it sets the timetable for results, which can move a company's share price.
Who pays for a well?
The operator and its partners share the costs in proportion to their ownership stakes, with each partner paying its percentage of the spending.
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