Determining Oil & Gas Valuations
Determining Oil &Gas Valuations
by admin on
(ashorter version of this story appeared in the Financial Post TradingDesk online edition on January 6)
How do valuations get setfor oil and gas companies? I ask because I’m seeing very fast-risingvaluations in the junior and intermediate oil sector that I cover. Ihave seen junior oil producers valued at $200,000 per flowing barrelrecently – more than triple the peer group average.
Industrystatistics concur. A December 24th report by Peters &Co., a Calgary-based securities firm that is an oil and gas boutique,showed that the average purchase/sale price for oil weighted productionin Q4 2009 was $100,000 per flowing barrel.
This is up more than50% from the Q3 valuation of just over $60,000. (Oil and gas equivalentis the way the industry puts the two commodities into one valuation,usually at 6:1 ratio of gas-to-oil).
The report showed thatvaluations for natural gas weighted purchases also jumped up more than50% in Q4, from $35,000 per flowing boe to $54,700. These numbers havean immediate impact on junior and intermediate stocks across the board,as you’ll read.
(There areseveral ways to value oil and gas companies, but I find the price perflowing barrel to be the simplest. It’s easily calculated: market cap +debt (or minus cash) divided by the daily production level of thecompany, in barrels per day.)
What is driving these fast risingvaluations? It’s
1) an increasing oil price and
2)improving technology – especially multi-stage fracking – that isallowing producers to retrieve more oil and gas, more quickly, in eachwell. This increases cash flow which increases stock prices.
3)Lower risk oil reservoirs—especially with the new “tight” oil and gasplays—drilling success rate is often 95%-100% now.
The marketfollows these transaction prices closely, and then transfers thoseindividual transaction valuations over to company wide valuations (thestock price). They have a huge – and immediate – impact on stockprices.
Research analysts would quickly calculate thevaluation of all the producers in those areas based on the price of themost recent sale, and decide who is undervalued or overvalued.
Themarket saw a perfect example of that this week when Berens Energy(BEN-TSX) was bought by Petrobakken (PBN-TSX) for $90,000 per flowingboe, for their Cardium oil production and land package in Alberta. Overthe next two days the market re-rated (upwards) many of the otherjuniors in the Cardium (see my story on this:https://tinyurl.com/yfkmag6)to be much closer to that valuation. It meant a 20-30% movefor some stocks in a couple days.
So I really wanted to understand– when two companies sit down to sell production and land package, howdo they decide on a price? I spoke with Neil Roszell, CEO of WildStream Exploration Inc. (WSX-TSX) to give me a valuation analysis insimple terms:
“Overall, a buyer would pay 90-100% of the baseindependent engineering value of an asset,” he told me, “subject tointernal review that agrees with the numbers, and then evaluate therisked upside of the undeveloped reserves not in the engineering reportand pay some portion thereof.”
As an example, he said to assumethat base production in a hypothetical North American oilfield is worth$60,000-$80,000/boepd.
So if Company Xhas 500 boepd of production with reserves, the independent report mightsay it’s worth $35 million (500 x $70,000/boe).
Plus, they have afurther 10,000 net acres of undeveloped land. To decide on the upsideevaluation of that undeveloped land, the buyer would decide how much ofit is prospective, and divide that by 640 to get the number of sections(or 1 square mile – there are 640 acres in 1 section or 1 square mile)times (x) the number of wells per section times (x) the Net PresentValue (NPV) of each well.
Here is the math arranged like a gradeschool sum:
Base production value
+(Raw acreage x prospective %
/ 640 x wells persection
x NPV per well
=Valuation per flowing boe
Then, the buyer and sellersplit that number – the buyer will pay a portion, or an agreedpercentage, of that undeveloped land upside, from the seller.
Forthis example, we’ll say 70% of the land is prospective for horizontaldrilling, after the buyer’s technical review.
So 10,000 acres x70% /640 = 11 net sections x 4 well per section = 44 net possiblewells. The potential value of the drilling is 44 x $3,000,000 NPV/well =$132 million.
That would make the total possiblevalue of the deal worth $167 million ($35 million for base production +$132 million for undeveloped land), or $335,000 per flowing boe($167M/500 boepd).
Roszell said a likely bid would be topay the $35 million + some percentage of the $132 million. If the twoparties agreed at 25%, (which equals $33 million) then the deal wouldlook like this: $35 million + 33 million = $68 million or $136,000per flowing boe ($68 M/500 boepd).
The buyer is lookingto turn the $68 million paid into $150-$170 million of value, therebygiving their investors a longer term double.
To recap, besides theincreasing oil price, the market is seeing these significantly highervaluations because the NPV of these wells has been increasing,especially as improvement in technology – specifically multi-stagefracking – has greatly improved economics. Plus the high IP rates inthe new tight oil and gas plays heavily increase NPV.
And as I’vementioned in several stories, the industry is still finding ways toincrease recoveries, cash flows and NPVs. It’s an exciting time to beinvesting in the energy sector.
Another reason for high valuationsis that these unconventional plays are geologically quite consistent, sothe seller is wanting – and getting – more of that near-certain futurecash flow. The probability of the buyer producing the maximumtheoretical potential of that land is very high. With consistentgeology and 3D seismic, buyers have nowhere near the risk they did indeals done a decade ago.
That’s why I’m seeing transactions doneas high as $175,000 and $200,000 per flowing boe. And it’s having animmediate, positive, impact on junior and intermediate oil stocks inCanada.