Case Study 3 Little Judson ProspectOctober 15 was another beaut.docx

Case Study 3: Little Judson Prospect
October 15 was another beautiful, blue-sky day in western
Albany County, Wyoming. Mick McMurry could see some cattle
grazing the fields on the high- plains dessert out in front of him.
He was grateful for the bucolic setting and his generous
circumstances which were made possible by his doing very well
with some of his investments, one of which now required some
concentration. Mick was the founder and President of Nerd Gas
Company. The decision at hand was whether to drill an oil well
known internally as the Little Judson Prospect or not, in his
effort to try to chaset he Niobrara shale oil play.
The Company
Founded by Mick McMurry in 1996, Nerd Gas Company, LLC is
a private, Wyoming-based energy investment company whose
primary focus is on the efficient and responsible exploration of
hydrocarbons in Wyoming and the northern Rocky Mountain
region. Nerd Gas Company is one of Wyoming’s leading
entrepreneurs in energy projects in a state recognized for the
depth and breadth of its extensive mineral resources.
Nerd is currently involved in conventional oil and gas
exploration projects in the Wyoming-Utah Over- thrust Belt and
the Rocky Mountain region. Zones of interest are primarily
traditional oil or gas-bearing Cretaceous sand reservoirs,
traditional carbonate reservoirs and both structural and
stratigraphic traps. Nerd is also currently invested in other
potential energy-producing projects in Wyoming, including a
“pure play” uranium exploration project in the Powder River
Basin.
Nerd Gas Company is proud of its talented group of
professionals on staff that have spent the majority of their
careers focusing on Rocky Mountain reservoirs and solving
energy production challenges. Profession- al expertise includes
land management, drilling and extraction, completions and
production, and in-house energy financial analysis. The

combination of strong capital, seasoned professionals and the
owner’s entre- preneurial spirit allows Nerd Gas to take
advantage of rapidly developing opportunities. In 2007, Nerd
Gas Company was awarded the Torch Award for Business
Ethics by the Rocky Mountain Region Better Business
Bureau and was the state of Wyoming’s first-ever recipient of
the award.
In 2008, Nerd Gas Company contracted with the Idaho National
Laboratory (INL) to conduct a feasibility study investigating the
technical and economic viability of locating a natural gas-to-
liquids (GTL) facility in the state of Wyoming. Initial feedback
delivered by INL suggested Nerd continue to advance the
project. Nerd has been working with technology providers and
the state of Wyoming in a proposed, modular-designed GTL
project located in central Wyoming.
In 2011, Nerd Gas, along with three local partners possessing
significant geologic and exploration expertise, formed
Stakeholder Energy, LLC. Stakeholder was formed to pursue
large-scale uranium exploration in Converse County, Wyoming.
Stakeholder has leased significant acreage ideally positioned
between a uranium processing facility and the uranium mine
sites.
The list of Nerd Gas affiliated companies included: High
Country Fabrication, Jonah Bank, M&N Field Services, Nerd
Technology, and Stakeholder Energy. In 2013, McMurry-related
companies employed over 225 people.
Another extension of these companies was the very generous
McMurry foundation, which has given out $49 million dollars to
charitable causes in the State of Wyoming since it started in
1998. Among the many beneficiaries of their kindness is the
University of Wyoming (UW). The foundation had given
millions of dollars each to the Wyoming Technology Business
Incubator, the Jonah field at War Memorial Stadium, the
College of Business, and most recently the new Gateway
Center.
NERD’s Entry into Oil & Natural Gas

At the time of its founding, Nerd Gas Company was a successful
working interest partner in the discovery and nine-year
development of both the prolific Jo- nah and Pinedale
Anticline Fields in Sublette County, Wyoming. These fields
presented geological challenges which required new drilling and
hydraulic fracturing technology in order to successfully extract
natural gas in these areas. Jonah Field, which was one of the
largest on-shore natural gas discoveries in the USA in the
early 1990s with 10.5 trillion cubic feet of gas, was sold to
Alberta Energy (later changed its name to EnCana) in June
2000, and the Anticline Field was sold in November 2001 to
Shell Oil.
Mick had wanted the company to find some investment
opportunities and became convinced that the company could
enjoy higher potential returns (30-40% after tax) from natural
resource exploration than from other investment opportunities,
including real estate, which were yielding 8-10%. Although
natural resource exploration was clearly riskier, Mick felt the
risk could be lessened by drilling only sites that were part of
existing natural resource plays, like the Bakken shale in North
Dakota and the Niobrara shale in southeastern Wyoming.
Nerd Gas (NG) had drilled four wells recently. It had not been
difficult operationally to drill the four wells, but it had been
challenging to find enough high-quality investment
opportunities. Mick considered wells to be “good” if they met
all the following criteria: (1) payback of initial cash investment
in 36 months or less, (2) at least 25% internal rate of return
(IRR) on an after-tax basis, and (3) a positive Net Present Value
(NPV).
In the first five months of production, one of the wells had
already paid back 52% of its initial investment--well ahead of
its target 36-month payout. The other wells were also doing
well, and most of them were at least on schedule for meeting
their targeted return on investment. Even though things had
gone favorably for Mick so far, he knew the pressure was still
on him to make good decisions because NG was planning to

drill four more in the coming year.
Investment Strategy
NG acted as the operating partner in the oil and gas drilling
ventures it formed, which gave it full responsibility for
choosing sites and managing the well if oil were found. NG
gathered information from the states of Wyoming, Utah and
Colorado and from other companies drilling in the vicinity of a
well (if they were willing to engage in “information trading”).
Mick would then put together a lease package for drilling 10, up
to 50 wells that he considered good investments based on all the
information he had gathered. The total initial investment for a
typical package would be around $6 million up to $30 million.
NG would retain about 25% ownership and sell the rest to
several other working interest partners.
As project operator, NG was responsible for hiring
a general contractor who would actually hire a firm to do the
drilling, and NG’s engineer Joe Nicholas, who also had an MBA
degree from UW, would determine whether there really was
enough oil to make it worth completing a well. If the decision
was to go ahead, the operator would also be in charge of the
day-to-day operations of a well. NG had entered into a joint
venture with Allen and Crouch Petroleum (A&C) of Casper,
Wyoming, in which they agreed that A&C would act as the
general contractor for all the wells on which NG acted as
managing general partner.
The first-year production level varied significantly from well to
well. Joe found the uncertainty could be described with a
lognormal probability distribution with a mean of 30 barrels of
oil per day (BOPD), a standard deviation of 14 BOPD and a
minimum value of zero, of course.
Drilling and Developing a Well
The most common drilling rig in operation was the rotary rig
composed of five major components-the drill string and bit, the
fluid-circulating system, the hoisting system, the power plant,
and the blowout-prevention system. To facilitate the drilling
process, generally a fluid known as drilling mud (composed of

water and special chemicals) was circulated around the hole
being drilled. In some cases, such as the Little Judson, air was
used as the “drilling mud.” The major purpose of the drilling
mud was to lubricate the drill bit and to carry to the surface the
cuttings that could otherwise remain in the hole and clog it.
In the case of the Little Judson, the drilling procedure was
divided into 3 stages. The first 300 feet of hole was drilled with
a 12-1/4” bit, before running 8-5/8” diameter metal pipe,
referred to as casing into the wellbore. The casing was then
cemented in place, stabilizing the first section of the hole. The
second stage of the well was similar to the first, except a 7-7/8”
drill bit was used to drill down to 2700 feet, before running
another casing string (production casing) into the hole. After
cementing the production casing in place NG would be ready to
test the well. Because NG was worried about the drilling fluids
causing formation damage, they planned to drill into the
productive Niobrara formation using air. If the well was found
to be productive, the producing zone would be left as an ‘open
hole completion’ without any casing supporting the productive
zone. This would allow oil to flow
through the open hole completion and up through the production
casing to the surface. The cost to drill an “average” well in
Albany County, Wyoming, location of the Little Judson
Prospect, was $625,000. There was some uncertainty, however,
in the cost from well to well because of such factors as differing
depths of wells and different types of terrain that had to be
drilled. Experts in the local area said that there was a 95%
chance that the cost for any given well would be within $62,500
of the average cost, assuming a normal distribution.
The “Little Judson” Prospect
Nerd had originally leased the rights to drill on 32, 400 acres
in Albany County, Wyoming back in early 2009. They later split
the project into two—called the Big Judson and the Little
Judson. The Big Judson (28,000 acres) was farmed out to a third
party operator, with Nerd Gas just carrying a small working

interest of 20% in the two wells that were drilled by the third
party. Upon drilling, they found hydrocarbon but the wells were
considered “uneconomic,” so nothing else was done with the
Big Judson. Now, the drilling leases are about to expire on the
Little Judson. Below is a picture of the actual potential drilling
site, along with representatives from Nerd Gas and the UW
football team, that was taken for the cover of the football pro-
gram for a Fall 2013 game.
NG has the opportunity to drill and/or renew the leases for $40
per acre. They reviewed an offsetting well in the area, drilled in
the 1970s, and the geologist noticed a high reading on the
resistivity log, which normally indicated hydrocarbons were
present. He further felt that there was a high probability of
being able to use ‘natural’ fracturing to obtain the oil, rather
than having to use the more expensive ‘hydraulic’ fracturing.
Exhibit 1 shows the spreadsheet (LittleJudson.xlsx) that Joe had
developed to analyze the one well, called the Little Judson
Prospect (LJP), as a potential member of the package of 10
wells he was currently putting together for Mick and his
investors (years 12-25 are not shown). As Joe thought about the
realization of this one well, he knew the LJP had other
producing wells in the region (Niobrara Shale region). It was
therefore about a 25% chance that NG would hit the formation
and decide to complete the well, but there was a much larger,
75% chance that either they would hit a dry hole, or have an
operational failure that would cause zero production. In either
of these cases, the pretax loss would be $625K. In the optimistic
case, there would be oil produced and Joe would then find out
how much the well would produce in the first and sub- sequent
years. He would also learn what gravity the oil was, which
would affect the total revenue generated by the well.
Revenues and Expenses. The spreadsheet was basically an
income statement over the well’s life. The price per barrel was
calculated from the market value of West Texas Intermediate at

Cushing, Oklahoma, which today was $104.25. The production
in barrels of oil per day (BOPD) was then estimated for the
first year and calculated for each succeeding year based on the
percentage decline value given in the assumptions. The gross
revenue was just the product of the price per barrel times the
barrels of oil produced in a given year. Out of the gross revenue
came a 17% royalty payment to the owner of the mineral rights,
leaving net revenue. Several expenses were deducted from net
revenue to arrive at the profit before tax:
1. Monthly operating costs of $500 were paid to contract
operators in addition to a budgeted amount of $12,000 for other
operating expenses that might occur on an annual basis. These
costs were increased annually by the inflation factor.
2. Local taxes of 6.4% times the NG gross revenue (after
royalties) were paid to the county and a severance tax of 6%
times the gross revenue (after royalties) was paid to the state of
Wyoming.
3. Depreciation expense for year 0 equaled the in- tangible
drilling cost, which was 72.5% of the total well cost. The
remainder of the initial drilling cost was depreciated on a
straight-line basis over seven years.
To compute profit after tax, the following equations applied:
Profit after tax = Profit before tax - Depletion - Federal Income
Tax
Where: Depletion = minimum of .5 * (Profit before tax)
or .15 * (Net revenue) Federal Income Tax = Federal tax rate *
(Profit before
tax - Depletion)
Initial Results and Investment Considerations.
To find the net present value (NPV), Joe added back the
depreciation and depletion to the profit after tax to come up
with the yearly cash flows. These flows were then discounted at
the company’s hurdle rate of 25% for projects of this risk (see
Exhibit 2 for a listing of rates of return for investments of
varying maturities and degrees of risk) to calculate the NPV
through any given year of the well’s life. His pro forma analysis

indicated the project had an amazing IRR of 113% and an NPV
of $1.13 million.
Joe was feeling good about the LJP, even though he knew he
had made many assumptions. He’d used an API (American
Petroleum Institute) gravity index of 40 to estimate the density
of the oil because it was the expected (mean) value, when in
reality he knew it could be as low as 33 or as high as 43, with
the most likely value (mode) being 41. The density of the oil
affected the price that NG could sell the oil at. An API gravity
reading of 43 degrees commanded the highest price. Below 43,
the molecular chains become larger and less valuable to the
refineries. It was safe to assume that you should deduct
$0.015/barrel from the price for every 1/10 degree that the oil’s
reading was below 43. For example, oil with an API reading of
40 would cause a deduction of $0.45/barrel in the price sold
i.e., it would move the price sold from $100 down to $99.55).
He also guessed that inflation, as measured by the Gross
National Product (GNP) Deflator (a measure similar to the
Consumer Price Index or CPI), would average 2.5% over the 25-
year project life, but he thought he ought to check a couple of
forecasts and look at the historical trends.
Exhibit 1
Little Judson ProspectBase Case Spreadsheet
See Exhibit 3 for historical oil prices and both forecasts of
GNP Deflator values as well as historical GNP Deflator values.
Joe’s idea was to use the GNP Deflator to forecast oil prices
after their four-year contract expired.
Further Questions and Uncertainties. When Joe showed the
results to Mick and Dick Bratton, a potential partner of Mick’s,
Dick was impressed with the “expected” scenario but asked,
“What is the downside on an investment such as this?” Joe had
done his homework and produced Exhibits 4 and 5 together
(again years 12-25 are not shown). Exhibit 4 showed the results
if there was not enough oil to develop. Exhibit 5 showed what

would happen if there was enough oil, but all other uncertain
quantities were set at their 1 chance in 10 worst levels. Dick
was some- what disturbed by what he saw but said, “Hey, Mick,
we’re businessmen. We’re here to take risks; that’s how we
make money. What we really want to know is the likelihood of
these sorts of outcomes.”
Joe realized he had not thought enough about the probabilities
associated with potential risks that a project of this kind
involved. He also put his mind to work thinking about whether
he had considered all the things he had seen that could change
significantly from one project to another. The only additional
uncertainty he generated was the yearly production decline,
which could vary significantly for a given well. He had used
what he considered the expected value in this case (12% per
year), but now he realized he ought to multiply it by some
uncertain quantity, with a most likely value of 1.0, a low of
0.67, and a high of 1.67, to allow for the kind of fluctuation he
had seen.
Joe wondered what would be the most effective way to
incorporate all six of the uncertainties (total well cost, whether
the well produced oil or not, first-year production of oil, the
API gravity, rate of production decline, and the average
inflation over the next 25 years) into his investment analysis.
He remembered doing “what if ” tables with spreadsheets back
in business school (the old College of Commerce and Indus-
try or C&I), but he had never heard of a six-way table. As he
skimmed back through his decision science book, he saw a
chapter on Monte Carlo simulation and read enough to be
convinced that this method was ideally suited to his current
situation.
When Joe told Mick about this new method of evaluation he was
contemplating, his boss laughed and said, “Come on, it can’t be
that hard. What you’re talking about sounds like something
they’d teach brand-new MBAs. You and I have been doing this
type of investing for years. Can’t we just figure it out on the
back of an envelope?” When Joe tried to estimate the

probability of his worst-case scenario, it came out to .001%--not
very likely! There was no way he was going to waste any more
time trying to figure out the expected NPV by hand based on all
the uncertainties, regardless of how intuitive his boss thought it
should be. Consequently, Joe thought a little more about how
Monte Carlo simulation would work with this decision.
In his current method of evaluating projects, he had used the
three criteria mentioned earlier (< 36-month payback of initial
cash investment, > 25% IRR on after-tax basis, and a positive
NPV). He could see that calculating the average IRR after
several Monte Carlo trials wouldn’t be very meaningful,
especially since there was a 75% chance that you would spend
$625K on a pretax basis and get no return! It would be im-
possible to find an IRR on that particular scenario. He did feel
he could calculate an average NPV after several trials and
even find out how many years it would take until the NPV
became positive. As he settled into his chair to finish reading
the chapter, which looked vaguely familiar, he looked up briefly
at the arid land and wondered for a moment what resources were
under that land.
Questions
1. Based on the base case scenario and the two alternative
downside possibilities, is this investment economically
attractive?
2. What benefit can Monte Carlo simulation add to Joe and
Mick’s understanding of the economic benefits of the Little
Judson Prospect?
3. Incorporate uncertainties into the spreadsheet using Crystal
Ball. What do the Monte Carlo results reveal? What is the
probability that the NPV will be greater than zero? How
sensitive is the NPV to the different inputs?
4. Think about the proper discount rate—should it be adjusted
now that much of the risk has been modeled explicitly with
Crystal Ball? Should Mick invest?
Exhibit 2
US Treasury and Corporate Bond Yields

Exhibit 3
Historical and Forecast Data
Exhibit 3
(continued)
Exhibit 4
Spreadsheet with No Oil Produced
Exhibit 5
Spreadsheet with Oil Found but All Other Uncertainties Set at 1
Chance in 10 Worst Level
Retail Management
BA 446/546
Week 2: A
Picking Up Where We Left Off:
Reminder About Grading & Classroom Etiquette
This Thursday’s Assignment (Upper Div – Current Affairs)
#gratitude

NEWS
Omnichannel: AmazonGo + Amazon
Staffing Holiday Season
Omnichannel Diminutive Storefronts
Relationship Retailing (p. 16-17)
“The best retailers know it is in their interest to engage in
relationship retailing, whereby they seek to establish and
maintain long-term bonds with customers, rather than act as if
each sales transaction is a completely new customer.” #oldnavy
Firms must keep 2 Points in mind (para. 9+) <group>
Review Figure 1-11 “A Customer Respect Checklist” (p. 17)
Chapter 2:
Building & Sustaining Relationships
Value
“To prosper, a retailer must properly apply the concepts of
value and relationships so (1) customers strongly believe the
firm offers a good value for the money and (2) both customers
and channel members want to do business with that retailer” (p.
25).
p. 25 <group>
Gamestop Logo Source: https://www.gamestop.com/

Building & Sustaining Relationships Cont. (p. 25)
Berman, Evens, and Chatterdee contend that “consumers expect
more for less, especially from their stores than from their online
or mobile shopping experience,” adding that “time budget-
constrained consumers will spend less time shopping, make
fewer trips, visit fewer stores, and shop more purposefully.
Different strokes for different folks.”
Supermarkets of Ol’ (few options at play)
Keeping in Mind
Key: “Consumers will shop for different formats for a variety of
needs. Specifically, they will split the commodity shopping trip
from the value-added shopping trip.”
Ex’s: #dollarstore #apple #thinkgeek
What else? <group>
Value Added Chain (p. 26)
What is the “Value Chain”? <group>
“From the perspective of the manufacturer; the wholesaler, and
retailer, value is embodied by a series of activities and
processes—a value chain—that provides a certain value for the
consumer,” adding that “[from] the customer’s perspective,
value is the perception a shopper has of a value chain.”
KEY:
“Value is the perceived benefits received verses the price paid.”

Retailer Relationships
“whereby retailers seek to form and maintain long-term bonds
with customers, rather than act as if each sales transaction is a
new encounter with them.”
SEE: Figure 2.2 - A Value-Oriented Retailing Checklist
Too, customer relationships matter in retail. They “are the
backbone of a business. Thus, it is important that retailers retain
their loyal customers through repeated sales in a trusted
Wholefoods]
Trusted = <group>
Shifting Currents
Aging population[s]/population trends
Generational Shifts
[builder>boomers>GenX>Mill./Y>PostMill/Z...]
Increasing Diversity
IN THE NEWS: Millennials – “Diminutive Storefronts” – The
Holidays
“It is worth more to nurture relationships with some shoppers
than with others [cp. Tommy Bahama,
Tech in Retailing (p. 39-42)
“In each firm, the roles of technology and “human” must be
clear and consistent with the goals and style of that business”
electronic banking #mobility/lean
Credit/Debit, ATMs, Apps, etc. [cp. artisan markets]

Customer Exchange
Gift Cards = $1 billion annually
Smart Kiosks accounting for over $1.2 billion annually (ex: Red
Robin [Seattle], Buffalo Wild Wings [NC], Airlines, McD’s,
vending, Costco, etc)
Ethics in Retailing
Coercion, manipulation, and control...
Dee Figure 1.1 on pg. 43
Newport Cigs and coal in Oakland (plus LAFB)
Go over list at the bottom of page 42 and top of 43
Chapter 3:
Strategic Planning (Final Project Cpt.)
Good/service, Name, etc.
Establish a “mission statement” (p. 53-54)
Type of Business (sole proprietorship, partnership, or
corporation)
...the PLAN
Figures 3-2, 3-3, and 3-5 (pgs. 56-58)
3-2: A Checklist to Consider When Starting a New Retail
Business <group>
3-3: A Checklist for Purchasing an Existing Retail Business
<group>
3-5: Selected Kinds of Retail Goods and Services

Establishments
Building a Plan
Some Stories
Women’s Success #trending
Stroll
Away Luggage
Mented Cosmetics
Ben & Jerry’s
Bread Euphoria Café
Jansport
Retail Management
BA 446/546
Week 2: B

Case Study 3 Little Judson ProspectOctober 15 was another beaut.docx

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