Capital gains: valuation of oil assets including shares: methodology of valuing prospects
Prospects and DCFs
DCFs can be used for valuing prospects when the figures are meaningful, that is when the figure for reserves has a degree of credibility and there is some contemporary support for the production profile and for development and operating costs. When all or most of the figures have to be estimated retrospectively it is doubtful whether any DCF can be relied upon at all. In such a situation a prospective purchaser will seek a much higher discount rate in any DCF to be used - they may even go as far as insisting that the result is itself discounted, thus a notional NPV might be $25m and the result discounted to $5m to give the open market value. Alternatively, it may mean that a prospective purchaser could not have produced a DCF and any attempt is meaningless. A different method valuation must be used. The question of ‘commerciality’ is likely therefore to feature more.
‘Per barrel basis of valuation’
There may be little benefit in attempting to set up a cash flow model given the lack of hard facts for a prospect and a value for the prospect may be made by reference to other similar fields, either real or hypothetical. Then a present value may be assigned on a ‘per barrel’ basis.
A number of points arise about the ‘per barrel’ approach:
The field chosen as a guide, hypothetical or real, should have similar characteristics to the project being developed.
- When calculating the per barrel value of the field chosen as a guide it is safest to use only total value per barrel and ignore any figure for the remaining value per barrel.
- There are other factors such as a company’s specific tax position, which could affect the value calculated.
- Given that the average size of discovery is probably still declining, even the most recent fields may not provide a satisfactory guide to valuing new reserves.
- Is the prospect reasonably viewed as commercial at the date of valuation? If not, this fact must feature strongly in any assessment of value.
In practice the ‘per barrel’ approach may support other methods of valuations, but is unlikely to fully reflect a market value.