# Presentation: 237430

## Looking into the Future: The Case of Oil & Gas

- Dr. Jon A. Rasmussen
- Energy Information Administration
- February 2000

## Cost and Value in Oil and Gas Production

**Cost and Value in Oil and Gas Production**

- The development of financial and operating data** **disclosures for oil and gas producers was a key development in the late 1970’s.
- Why single out oil and gas producers?

## Setting and Issues I

**Setting and Issues I**

- The value of an oil-producing company is primarily a function of the company’s reserve quantities and the price of oil.
- For financial reporting purposes generally, assets on the balance sheet are carried at original cost adjusted for depreciation.
- Oil reserves for the most part are not purchased and their original cost consists mainly of the costs of lease acquisitions and drilling

## Settings and Issues II

**Settings and Issues II**

- Original cost provides a reasonable estimate of asset value when oil prices are stable, as they were until late 1973.
- With rising or volatile oil prices, the value of reserves and, thus shareholder value, is fluctuating.
- Fluctuations in reserve value are not reflected in financial statements, which are based on original costs.
- Oil prices began rising sharply in late 1973

## Valuing Reserves

**Valuing Reserves**

- The prime movers in developing special reporting standards for oil and gas producers were the pillars of financial reporting in the United States :
- The Securities and Exchange Commission (Federal government)
- AICPA (professional association), and
- The Financial Accounting Standards Board (corporate self-regulating body).
- Other stakeholders were involved, including the Department of Energy and its Financial Reporting System.

## Two Opposing Points of View:

**Two Opposing Points of View:**

- Keep the status quo and do nothing, or
- Disclose only the value of oil and gas producers’ reserves.
- Value of reserves = present value of future net cash flows yielded by production from the reserves.

## Estimating the Value of Reserves I

**Estimating the Value of Reserves I**

- To make an estimate of the value of reserves one needs:
- 1.  A credible estimate of reserves
- 2.  Future production path
- 3.  Future oil prices
- 4.  Future cost of extraction (lifting costs)
- 5.  Future cost of developing undeveloped reserves
- 6.  Future tax payments
- 7.  Salvage value after abandonment
- 8.  Discount rate/cost of capital

## Estimating the Value of Reserves II

**Estimating the Value of Reserves II**

- Difficulties include
- Uncertainties about future values,
- subjectivity,
- potential misrepresentation, and
- comparability with other industries’ financial statements.

## Required Oil and Gas Disclosures

**Required Oil and Gas Disclosures**

- Reserve quantities
- Capitalized costs
- Costs incurred
- Results of operations
- Standardized measure of discounted future net cash flows
- Wells drilled
- Oil and gas acreage
- Average prices and lifting costs

## Additional FRS Requirements

**Additional FRS Requirements**

- Exact and detailed geographic separation of reserves, costs incurred (exploration and development expenditures), and lifting costs.
- Functional detail on expenditures and lifting costs.

## Unocal’s Present Value of Net Cash Flow 

- Unocal’s Present Value of Net Cash Flow

## Slide 12

## Slide 13

## Looking into the Future: The Investor Side

- Many approaches to valuing a company
- All methodologies must contain expectations about future earnings
- In practice, the FRS staff has found the Market-to-Book ratio (M) useful
- M = Market Value of Common       Shares / Stockholders’ Equity

## Investor Side (cont.)

- M = (Market Value/Earnings) x (Earnings/Stockholders’ Equity)
- M = (Share Price/Earnings per Share) x (Earnings/Stockholders’ Equity)
- M = Price-Earnings Ratio x Return on Equity
- M = (P/E) x ROE