How to value an energy business, especially the upstream? The two key components to be considered are oil reserves and oil prices.
While we do not have control over oil prices, it is possible for the companies to manipulate their oil reserves, thus misleading the investors.
Oil reserves are the total volume of oil in the oil reservoir. However, it is not possible to extract all oil that is there in the reservoir. Much of it depends on the reservoir characteristics and technology used. The simpler the reservoir characteristics and the more advanced the technology used to extract, the higher the possibility of more oil to be extracted.
Thus the reserves can be classified as:
1) Proven (1P or P90) reserves - have very high (at least 90%) possibility of recovery.
2) Unproven reserves - have lower possibility of recovery:
a) Probable (P50) reserves - have reasonable (about 50%) chance of recovery.
2P reserves represent proven plus probable reserves.
b) Possible (P10) reserves - have very low (at least 10%) chance of recovery.
3P reserves represent proven plus probable plus possible reserves.
Under these circumstances, the company is best advised to disclose only proven reserves to the investors.
It is not certain that the company will be able to recover its proven reserves in full in the first place since these are all estimates.
If unproven (probable or possible) reserves are disclosed, it will only complicate matters and mislead the investors. Market participants are ready to sniff anything that is given to them. Lest they go astray, it is well advised that the company does not go any farther than its proven reserves.
Estimates of unproven reserves should be an internal matter for the management for its decision-making regarding capital allocation.
If you attempt to value the business considering its reserves that are not yet proven, do it at your own peril.
While we do not have control over oil prices, it is possible for the companies to manipulate their oil reserves, thus misleading the investors.
Oil reserves are the total volume of oil in the oil reservoir. However, it is not possible to extract all oil that is there in the reservoir. Much of it depends on the reservoir characteristics and technology used. The simpler the reservoir characteristics and the more advanced the technology used to extract, the higher the possibility of more oil to be extracted.
Thus the reserves can be classified as:
1) Proven (1P or P90) reserves - have very high (at least 90%) possibility of recovery.
2) Unproven reserves - have lower possibility of recovery:
a) Probable (P50) reserves - have reasonable (about 50%) chance of recovery.
2P reserves represent proven plus probable reserves.
b) Possible (P10) reserves - have very low (at least 10%) chance of recovery.
3P reserves represent proven plus probable plus possible reserves.
Under these circumstances, the company is best advised to disclose only proven reserves to the investors.
It is not certain that the company will be able to recover its proven reserves in full in the first place since these are all estimates.
If unproven (probable or possible) reserves are disclosed, it will only complicate matters and mislead the investors. Market participants are ready to sniff anything that is given to them. Lest they go astray, it is well advised that the company does not go any farther than its proven reserves.
Estimates of unproven reserves should be an internal matter for the management for its decision-making regarding capital allocation.
If you attempt to value the business considering its reserves that are not yet proven, do it at your own peril.
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