Valuation of undeveloped oil reserves with option pricing model ogel

A weekly update on issues important to the oil and gas industry How to Value Proven Undeveloped Reserves PUDs August 22, Valuation Issues One of the primary challenges for industry participants when valuing and pricing oil and gas reserves is addressing proven undeveloped reserves PUDs and unproven reserves. While the market approach can sometimes be used to understand the value of PUDs and unproven reserves, every transaction is unique. Additionally, many transactions that we see today are still a result of the crash in oil prices in ; and in some sales of non-core assets, PUDs and unproven reserves have been deemed worthless.

Valuation of undeveloped oil reserves with option pricing model ogel

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These techniques are generally accepted and understood in oil and gas circles to provide reasonable and accurate appraisals of hydrocarbon reserves. The reality of the marketplace, however, is often not so clear; sometimes it can be downright murky.

In the past, sophisticated acquirers accounted for PUDs upside and uncertainty by reducing expected returns from an industry weighted average cost of capital WACC or applying a judgmental reserve adjustments factor RAF to downward adjust reserves for risk.

At times, market conditions can require buyers and sellers to reconsider methods used to evaluate and price an asset differently than in the past.

In our opinion, such a time currently exists in the pricing cycle of oil reserves, in particular to PUDs and unproven reserves. Distressed Markets In the past, we have analyzed actual market transactions to show that buyers still pay for PUDs and unproven reserves despite a DCF that results in little or no value.

Is this transaction the best indication of fair market value or fair value? We believe there is a convincing argument to be made that the Samson transaction and a handful of other asset deals in the previous six months are not the best indication of asset value.

Significant decline and volatility in oil prices from 1 uncertain future demand and 2 current excess supply. Debt level pressures with 1 loan covenant requirements and 2 cash flow requirements. These factors indicate that some companies may feel pressure to lower their asking prices to levels that continuously attract bidders.

The market looks distressed.

Distressed Markets

When the marketplace is not distress-free, perhaps non-market methods should be utilized to estimate the real value of PUDs and unproven reserves. In these scenarios, one useful method to price these assets is the use of option theory.

Option Pricing If one solely relied on the market approach, it appears much of these unproven reserves would be deemed worthless. Why then, and under what circumstances, might the unproven reserves have significant value?

Valuation of undeveloped oil reserves with option pricing model ogel

In particular, if the acquirer has a long time to drill, one of two forces come into play: This optionality premium or valuation increment is typically most pronounced in unconventional resource play reserves, such as coal bed methane gas, heavy oil, or foreign reserves.

This is additionally pronounced when the PUDs and unproven reserves are held by production. These types of reserves do not require investment within a fixed short timeframe. The price level recovery for PUDs in was partly attributable to the recovery in the U. Five main factors have significantly increased the world supply of oil and driven down prices:Choosing the Right Relative Valuation Model Many analysts choose to value assets using relative valuation models.

premiums to reflect the same options. Consider, for instance, the undeveloped oil reserves owned by an oil company. While it is legitimate to value these reserves as relative valuation and option pricing models; and .

1 Option Valuation of Oil & Gas E&P Projects by Futures Term Structure Approach March 9, Hidetaka (Hugh) Nakaoka Former CIO & CCO of Itochu Oil Exploration Co., Ltd.

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Modern financial theories such as option theory are increasingly being used to evaluate the economic viability of oil and gas projects.

The stimulus for the use of this approach is the limitations of Discounted Cash Flow (DCF) methods such as NPV and IRR. These methods assume that the project is of a "now or never" nature.

ECONOMIC EVALUATION OF UNDEVELOPED RESERVES USING THE BINOMIAL TREE APPROACH. By: Benny Lubiantara ABSTRACT Modern financial theories such as option theory are increasingly being used to evaluate .

options, you should not add this value to a discounted cashflow valuation of the company, if your expected growth rate in the valuation is set higher because of the firm’s undeveloped reserves. One of the primary challenges for industry participants when valuing and pricing oil and gas reserves is addressing proven undeveloped reserves (PUDs) and unproven reserves.

While the market approach can sometimes be used to understand the value of PUDs and unproven reserves, every transaction is unique.

Bridging Valuation Gaps for Undeveloped and Unproven Reserves - Mercer Capital