Valuing Oil and Gas Companies
A Guide to thr assessment and
evaluation of assets, performance and prospects
In preparing the new edition
of this book we have aimed to update but not to alter the original. It was originally
conceived and written as a practical handbook, not a thesis or a history of the oil
industry. It did and does contain some indications of our expectations for the future, but
these are there to illustrate how conclusions follow from analysis of historical
performance; the conclusions are not the primary objective.
The most material change that
we have made in this edition is to widen the emphasis from that of an investor to include
that of a corporate planner. The new section on corporate activity, while relevant to the
investor, is really aimed at explaining how the competitive structure of the industry has
influenced company performance and how this in turn does and should influence corporate
conduct. Throughout the book, we have added comments which address the concerns of the
industry planner, rather than merely the industry investment analyst on whichever
side of the fence.
Much of the updating of
examples has been of no methodological significance; it simply implies that the
illustrations may be more topical to readers. Some of it has had more far-reaching
consequences, where the conclusions that follow from recent structural changes do seem to
be different from those drawn five years ago. Perhaps the best way to illustrate this is
to comment on some of the changes to our conclusions which have resulted.
In the first edition, we
concluded that the best prospects seemed to lie with the larger and better-financed
companies, and that the greatest challenges were faced by the niche operators, especially
upstream. That conclusion has not changed; it has merely been reinforced by the drive to
create 'supermajors'. Secondly, we argued that the two biggest strategic issues were how
to re-enter the lower-cost but politically difficult regions of the Middle East, the FSU
and Latin America; and how to manage an investment strategy in the refining industry,
given the conflicting pressures of environmental controls and inadequate returns. These
are still two of the key issues for the industry.
In this edition, we have
placed greater emphasis on the implications of gas and power liberalisation on both sides
of the Atlantic. These have created the opportunity, and perhaps the need, to integrate in
one of two directions: vertically, to the customer, either in gas or via power; or
horizontally, across the fuel mix. For example, one could conceive of an oil company
marketing gas and power but acquiring options on generation capacity without owning
generation plant. Our general conclusion is that the direction in which companies move
will vary from market to market, a function of how many alternative suppliers and how much
infrastructure there is. The less competitive the markets, the greater the tendency to
vertical integration.
Both editions are open to the
charge that we have made too little of environmental factors which might revolutionise the
oil industry, rather than merely affecting it. These could include hydrogen fuel cells,
more draconian restrictions on greenhouse gases, etc. We plead guilty. Most of these
issues are currently imponderable. They should be mentioned; they cannot be quantified.
This is a book about quantifying valuations of oil companies, and these issues may well
become quantifiable in future years, but are not currently.
Regarding valuation
methodology, we have made two changes from that of the first edition. For exploration and
production companies, we have put more emphasis on the relationship between their
performance and the rating that the market will apply to their liquidation values. This
point was discussed in the first edition; it is illustrated more fully in this one.
Secondly, for the integrated oil companies, we have shifted from the use of a dividend
discount approach to a discounted cash flow model. This maintains a clearer continuity
with the section on exploration companies and is methodologically more satisfactory. The
crucial distinction between the liquidation value approach used for exploration companies
and the going concern approach used for integrated companies is inevitable, and remains
unchanged between editions.
As with the previous edition,
the authors have made extensive use ofBP Amoco's excellent Annual Statistical Review of
World Energy for source data on energy statistics for the charts in this book. We should
like to thank the company for its permission to use this information. We are also grateful
to OMV for permission to use an updated flow chart of its Schwechat refinery, and to
Enterprise Oil for the use of two charts analysing changes in oil price expectations and
the distribution of actual oil prices.
Contents
1.The development of the oil
industry
Oil industry history
The companies
Reserves and production
Future potential
The oil industry today
2.Economic assumptions
A non-renewable resource
Oil market demand
The 1997 Asian crisis
Ex-Communist countries
Environmentalism
Non-OPEC supply
The economics and politics
of OPEC
The short term
Price
Refining margins
Natural gas markets
3.Oil industry accounts
Accounts and economics
Oil company consolidated
accounts
Oil industry accounting
conventions
Exploration
Accounting for value
International accounting
comparisons
4. Exploration and production
companies
The industry method of asset
valuation
Exploration acreage
Asset value sensitivities
Asset value growth
Company performance
Equity market valuation
5.Integrated oil companies
Activities and structure
Exploration and production
Downstream oil
Refining
Marketing
Downstream profitability
Comparative analysis
Petrochemicals
Finance
Share price rating
Strategy
Absolute evaluation
6. Oil industry corporate
finance
Theoretical background
One world, regional variety
Exploration and production
companies: a special case
Oil industry financing
Conclusion
7. The future
Industry background
E and P companies
Integrated companies
Equity market behaviour
Challenges for the future
282 pages