Introduction to Valuation Of Upstream Oil And Gas Assets

What is Asset Valuation? Why in the world do I need it for?

Asset valuation is the process of determining the fair market or present value of assets. Now the assets might be tangible assets like buildings and equipment; or intangible assets such as brands, patents, and trademarks. In order to stick to our agenda and make our complex world less complex, we will talk about just the tangible assets

Asset-based valuation allows us to calculate a business's net worth by adding up the current value of its assets less the value of its liabilities. Basically allowing us to value what we currently have if we take it to the market.

How can I value these Assets?

Valuing fixed assets can be done using various methods, a few of them being

• Net Asset Value (NAV) also known as net tangible assets – is the book value of tangible assets on the balance sheet?
• Absolute Valuation Methods value assets based only on the characteristics of that asset. These models are known as discounted cash flow (DCF) models, and value assets like stocks, bonds, and real estate, based on their future cash flows and the opportunity cost of capital
• Relative Valuation & Comparable Transactions determine the value based on the observation of market prices of similar assets. We all might have come across this when determining the fair value of your favorite toy or gadget to compare it with a similar option in the market.

When are we going to talk about Oil and Gas?

Right about now, now you might be thinking what's the big fuss about valuing an Oil and Gas asset. Well for starters, you cannot for sure say the money it's going to generate as value is correlated to constantly changing commodity prices. Valuing oil and gas assets, which comprise a depleting asset base where value is correlated to historical production trends, demands a thorough understanding of the technical details included in a company’s reserve database. The complex interplay of macroeconomic, technical, and geopolitical assumptions can have a profound effect on perceptions of risk and value associate with those assets, particularly for the longer time horizons in which oil and gas investments operate.

At the end of the day, it's the risk-reward ratio, that we are trying to ascertain related to that entity. Thus a valuation often relies as much on unique assumptions of the institutions and upstream operators they work for as it does on the technical aspects of the valuation and therefore needs professionals who fully understand the technical aspects of performing a valuation analysis on oil and gas assets, and who can also apply their experience in valuing these types of assets in order to tailor their assumptions and inputs to the unique characteristics of the specific assets associated.

When you're valuing an E&P (Exploration & Production) company, the Net Asset Value (NAV) Model is the key methodology. Unlike in a DCF, where cash flow growth is assumed into infinity, in a NAV model you assume the company's cash flows go to $0 eventually as it completely produces all of its reserves and has nothing left. A granular NAV model is complex, but it comes down to modeling the company's existing production from wells it already has... and assume a decline rate for the annual production each year, also assuming commodity prices to determine revenue, and linking operating expenses to production, and calculating cash flow like that. Woh that was a lot. Don't worry, next will talk about the general outline that might help tie together the overall structure

How to go about it?

While the roads might be different but the process is often fundamentally the same

• Hydrocarbon Volumes Associated: those making an investment decision want to know how much hydrocarbon is present in a project, how much can be recovered, at what cost, and how much it’s going to sell for, and for that you need Data. This data may come from company Annual reports, nearby Offset Wells, or third-party data aggregators

• The What If Scenario's: Here the base-case view identified is used as starting point for adjusted price assumptions, performs sensitivity analysis, and asks “what if…?” across any number of variables – What if operating costs could be reduced by 3%? What if crude prices increase by 5%? And so on. This is when valuations can diverge significantly due to differing views on factors such as above-ground and subsurface risk – we adjust asset valuations to reflect our own realities or point of view.
• The Final Showdown with Standard Indicators: here we make like-for-like comparisons of assets and their forecast performance. Standard indicators (the big guns) are brought in to include net present value (which is a fancy way of saying projected cash flow translated into today’s dollar value), the breakeven price (you all know it, the price where you have recovered your invested money with zero profit or loss) and the rate of return (money it going bring to you each year) to compare with alternate opportunities.

?It helps us answer some important questions along the line of

• Basic view of various scenarios and their effect on the asset for risk or strategy planning to make advanced portfolio planning and optimization decisions like one happening Inn markets now where companies are divesting/investing to strengthen their portfolio
• Which assets have created/can create the most value for us (on paper)?
• Buying under-capitalized assets and exploiting upside by selling back in the market to leverage the fair price gap ie buy low sell high

That's it for today, everyone, hope you guys found it useful. In case you have any follow-up questions reach out to me or leave out your comment below. In the next post, we can talk more about the use of Data Analytics coupled with efficient integrated reservoir (including Hydrocarbon Saturation, Formation Volume Factor) and well performance reviews, to dive deeper into an asset’s value.