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HMRC internal manual

Oil Taxation Manual

HM Revenue & Customs
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Capital gains: valuation of oil assets including shares: methodology of valuing exploration acreage

Exploration acreage covers a wide spectrum - from blocks with no (even negative) value to interests which might include probable reserves, but for which development plans had not crystallised at the valuation date. Some blocks may have contained considerable potential at the valuation date and the distinction between them and prospects may be artificial. It may be necessary to value exploration interests that were later disposed of as a mature field; their later history has no bearing on the position at the earlier date - they should be valued as an exploration interest, if that is what they were at that date.

Interests in exploration blocks can be a significant element in a company valuation.

There is no single established method for valuing these blocks. Alternatives might consist of:

  • Expected Monetary Value Approach - a form of heavily discounted DCF analysis.
  • Re-imbursement of Expenditure - this is where the value reflects a simple reimbursement of the vendor’s expenditure on the acreage. This is difficult to reconcile with the expectation that an exploration block is worth less than the sunk costs expended by the vendors up to that date (in the absence of any change in view of potential reserves, and so on). The re-imbursement basis requires that the block had value in the first place, which again suggests that it is more that simple exploration acreage. In considering this method, HMRC may consider whether expenditure was abortive and whether on a ‘stand in shoes’ basis the purchaser would be content to incur it if they were starting out as the original owner.

There are other methods, but in arriving at the price that would be paid by a purchaser in the open market any method that simply attributes value to a block or blocks will not be relevant to exploration acreage. All blocks need to be checked to see if they actually have a value, and whilst a methodology may address all the risk factors, the quantification and weighting of the risks will still be significant.

Whichever methodology is adopted the value will reflect what was known about the block at the time and there will be a consideration of any difference between the asset value on the valuer’s calculation and the market value.