OT30333 - Capital Gains

Valuation of Oil Assets (including shares). Methodology. Fields. Discounted Cash Flow. Inputs.

Oil Price

Where necessary, Wood MacKenzie estimates can be used as in the past. If companies use different figures, a view will have to be taken on whether they are reasonable. We would not expect their view to be substantially different, at least not substantially more optimistic, but a purchaser might need to be more cautious than Wood MacKenzie.

Development and Operating Costs

Ideally these should be taken from contemporary plans. If there are none, it may be questionable whether the field or prospect justifies being valued by a DCF.

Part of the operating costs will be fixed, part variable and related to production. You may consider that you need to adjust the costs particularly for the period of decline.

Taxes

For the North Sea, up to five different duties or taxes are to be taken into account: royalty, supplementary petroleum duty, petroleum revenue tax, advance petroleum revenue tax and corporation tax, depending on the date of valuation (for 31 March 1982 it should be assumed that all fields are subject to royalty). For non-UK assets you will need to be satisfied that the relevant taxes are reasonably covered in the assumptions and cash flows.

DCFs are calculated on a paid rather than accrued basis. On occasion it may be important to eliminate "tax overhang" i.e. tax due, but which will not be paid until after the valuation date, and which may therefore fall into the DCF. With a company valuation, it may be reasonable to leave the entries in; they are after all ongoing liabilities of the company. However they should not be left in if they are also taken into account as balance sheet adjustments. With an asset valuation tax for the prior period is unlikely to be a relevant deduction. The tax overhang adjustment will enhance the value of the asset.

Purchasers Assumptions

The DCF should reflect the purchaser’s assumptions. A purchaser would probably take the field data from the vendor. He would however bring to bear his own views on the variables of discount rate, foreign exchange rate and oil price. He would also be more conservative than the vendor. Subject to a fixed “in house rate”, he would use a higher discount rate than a vendor would.

Variations

It is sometimes thought that differences in variables and other inputs in the DCFs produce dramatic results. This is not necessarily the case. A decrease in sales value may be offset partially by a reduction in tax; less opex may mean more tax. Anticipation of income may also mean anticipation of expenditure.

In worthwhile cases inspectors should ask companies to provide sensitivities of DCFs based on differing assumptions and inputs as appropriate. Companies will certainly hold DCFs based on alternative assumptions. It is a useful exercise, helping to highlight the points of difference. It allows the inspector to identify the inputs that matter. It can also show that a large change in the production profile may, contrary to expectations, produce a small change in the NPV.

It is also important, at the end to consider whether the asset would be a commercial project on a stand alone or on an incremental basis.

For example, in 1982 it was suggested within the industry that developments under 80m barrels would not be commercial. The drop in oil price had reduced the number of projects which were considered commercial at the time. This phenomenon was repeated in 1998 when the oil price fell to $10 a barrel. It follows, therefore, that if at the date of valuation known reserves are below such a threshold, the open market value should not be attributed on the basis of NPV alone. It should be looked at afresh in the light of that fact. These comments should be more relevant for prospects than fields, but the oil price can call into question the commerciality of producing fields.