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OIL & GAS COMPANY VALUATION
Purpose of Valuation
Purpose of Valuation
Purpose of Valuation
Oil & Gas Company: Merger & Acquisitions, Financial Modelling, Asset Project Valuation, Feasibility Study
Financial Institutions & Investment Firms: FASB Financial Reporting, Financing
Legal & Tax: Economic Damages, Bankruptcy & Restructuring, Litigation Support, IRS Compliance Tax Reporting for Donation, Estate, Gift
Government: Eminent Domain, Federal & State Land Appraisal
Mineral Rights Owner: Royalty Rate, Estate, Gift, Trust Planning
Upstream Sector
Purpose of Valuation
Purpose of Valuation
Valuations for Oil and Gas Company Exploration and Production (E&P) is highly specialized. Significant scientific and technical issues are involved in the evaluation of information, due diligence, and nomenclature. Activities within the upstream sector include searching for potential underground or underwater oil and gas fields, drilling exploratory wells, and drilling and operating wells that recover and bring to the surface crude oil, natural gas and related liquids. E&P firms represent the “upstream” aspect of the energy industry. Pipeline and marketing firms are known as “midstream” companies, and refiners and petrochemical companies are considered “downstream” participants.
The primary assets of an E&P company are its oil and gas reserves, that is, hydrocarbons below the surface that have not yet been produced and are economically viable to extract. E&P firms are unique in that their primary asset base is depleting and therefore must be continually replaced through either drilling activities or acquisition. Ownership interests related to reserves can be held in a variety of forms including working interests, royalty (or mineral) interests, and overriding royalty interests.
When analyzing historical financial statements, it is useful to include historical production volumes as well as the average hydrocarbon prices received for the periods in question. Since hydrocarbons are a commodity, the physical volumes indicate whether the company is producing more or less, regardless of revenue increases resulting from price increases. Rather than EBITDA (earnings before depreciation, interest, taxes, and depreciation and amortization), analysts usually consider EBITDAX a primary pricing metric for E&P companies. EBITDAX represents EBITDA before exploration costs for successful efforts companies.
A forward or current year indication of reserves, production, and EBIDAX should be utilized because of the frequency of reserve acquisitions and divestitures among the publicly traded E&P companies that could distort valuation indications.
Midstream Sector
The midstream sector starts at the gathering system, which collects oil and gas from the wellheads. Gathering systems range in size from small systems that process gas close to the wellhead, to large systems consisting of thousands of miles of pipes that collect from hundreds of wells. At the processing plant, various products (for example, natural gas liquids like ethane and butane) are separated from the oil and gas.
Conventional variations of the Income and Market approaches (e.g., DCF and EBITDA based multiples) may be appropriate in valuing midstream E&P companies, which are frequently incorporated as master limited partnerships (“MLPs”).
An MLP is a limited partnership that is publicly traded on a stock exchange qualifying under Section 7704 of the Internal Revenue Code. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. MLPs traditionally pay out almost all available cash flow on a regular basis. They generally offer higher yields, stemming from their legal and tax structures as well as from the underlying companies’ operating business.
Most publicly traded companies are structured as C corporations that pay entity-level corporate taxes, but MLPs pass through their taxable income to their unit holders rather than incur taxes at the entity level. As a result — and in contrast to C corporations, which must pay corporate income taxes, and whose shareholders are subject to taxes on any dividends received — MLPs avoid double taxation and offer higher distributions and yields to investors. Traditionally, MLPs have provided distribution growth by increasing the volume of products processed on existing assets, reducing costs through improved operations and scale, making accretive acquisitions, developing new assets, and capitalizing on new trends.
Downstream Sector
Companies in the downstream sector are involved in refining crude oil and in selling and distributing natural gas and crude oil derived products such as liquefied petroleum gas, gasoline/petrol, jet fuel, diesel oil, other fuel oils, asphalt, and petroleum coke. The downstream sector includes refineries, petrochemical plants, petroleum product distribution companies, retail outlets, and natural gas distribution companies.
Conventional variations of the Income and Market approaches (e.g., DCF and EBITD Abased multiples) may be appropriate in valuing downstream companies. Although lower oil and gas commodity prices adversely impact the valuation of E&P companies, the valuation of downstream companies, such as refiners, often benefits from lower prices of the commodity feedstock.
The crude oil that E&P companies produce serves as a primary feedstock for downstream companies, and lower feedstock prices may result in higher crack spreads for downstream companies. Crack spread is the differential between the price of crude oil and the price of petroleum products extracted from it — that is, the profit margin a refinery can expect when it “cracks” crude oil. As a result, in the current oil and gas industry environment, downstream companies are expected to benefit from higher crack spreads in the near term, thus increasing their valuations. Another important factor affecting the crack spread is the relative proportion of various petroleum products produced by a refinery.