OT30360 - Capital Gains

Valuation of Oil Assets (including shares). Methodology. 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 which were later disposed of as a mature fields; their later history has no bearing on the position at the earlier date - they should be valued as an exploration interests, if that is what they were at that date.

Interests in exploration blocks can be a significant element in a company valuation and they are worth considering in detail.

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 purchaser simply re-imburses the vendor's expenditure on the acreage. This is difficult to reconcile with the valuation principle that a block is worth less than the sunk costs expended by the vendor's up to that date. To accept a re-imbursement basis the inspector needs to be satisfied that the block had value in the first place, which again suggests that it is more that simple exploration acreage. It may, therefore, be worth asking whether that expenditure was abortive and, whether on a "stand in shoes" basis, the purchaser would be content to incur it if he were starting out as the original owner.

There are others, but there are two important caveats to the use or adoption of these methods bearing in mind inspectors are seeking to get to the price that would be paid by a purchaser in the open market.

First, they will probably automatically attribute value to a block or blocks. This is not relevant to exploration acreage, but if present, it is necessary to consider independently and by reference to facts whether such blocks have value, in which case is this more than just exploration acreage.

Secondly, it is important not to accept values simply because the methodology appears to address all the risk factors and concerns; the quantification and weighting of the risks may be even more significant.

Whatever methodology is adopted there must be support for any value proposed. What was known about the block at the time? Valuers can have a tendency to use hindsight if there is no contemporary information. In applying risk and probability factors they can also have a tendency to be too optimistic. They can also tend to take the upside perspective of the vendor rather than the cautious view of the purchaser. Inspectors need to form a view on the relationship between asset value (valuer's calculation) and market value, while taking a pragmatic approach to the issue. Contemporary deals and the state of the market offer some assistance here.