By
Valuation of
Ralph E. Davis
Consultant, Houston, Tex.
and
Natural Gas Property
Dr. Eugene A. Stephenson
Professor Emeritus, University of Kansas
The appraisal of natural gas properties is a complex prob• What an Appraisal Is
lem affected by many non-engineering factors. Attention will
be brought here to the more important matters that influence
value of such properties, such as the necessity of competent
estimates of reserves, availability of the products and of mar•
ket outlets, the expected rate of recovery, the anticipated
prices of products and future costs, the effect of the graduated
An appraisal is an estimate of the value of a property. It
requires a study made by a person with knowledge of the
type of property to be appraised. The elements which are
important in evaluations of real property are: annual produc•
tion, expected prices and costs, risks, physical deterioration
and exhaustion of productivity. In the case of oil and natural
gas property, their appraisal is a relatively recent develop·
ment of the older art of appraising mining property. In both
cases the fundamental requirement is an estimate of the ulti·
mate production, the timing of this production, its costs and
income. The determination of these elements is based upon
geology and engineering.
income tax on profits which lead to greater value of
a property
to one owner than to another, and other items. To a degree,
in each appraisal the problems are unique in that the ap•
proach must be suited to the particular case.
During the past 30 years and more, many engineers and
geologists have accumulated considerable experience in the
problems of evaluating properties capable of producing oil
and natural gas. An extensive literature has developed out•
lining the principles and methods that govern appraisals.
is placed herein on the importance of careful analy•
sis of the various factors which should lead to a determina•
tion of value, and to point out the inadequacy of rather com•
mon engineering appraisals that frequently have little rela•
tion to what has been termed "fair market value." In a Dela•
ware court some years ago an engineer admitted freely on
cross-examination that his appraisal was "an engineering
valuation - not a determination of the fair market value.'
Such so-called "enl!;ineering appraisals" are perhaps interest•
ing, and occasionally may be of some use, but must not be
considered of fair value.
Some Aspects of "Value"
An appraisal results in a dollar value of the property in
question. What is this value? The appraised value may be
above or below the value of the property to its owner, or to a
particular prospective purchaser. It will probably differ from
the value as indicated by a recent sale for similar property.
The careful evaluator does not necessarily underwrite the
judgment of the principals who make a transaction. Rather.
the appraised value is an expression in dollars of the inter•
play of all the principal physical, economic and perhaps
political forces that affect the property now and perhaps in
the future.
I
An appraisal is a guide to busi.ess decisions, not their
determinant. The buyer, the seller, the lender, the borrower.
each views a property differently, because each one must con•
sider it in relation to his particular tax position.
Property may have value for a number of reasons. "Use
value" is a quality of consumer goods, such as houses' and
shoes. "Investment value" is based on earning power in the
form of future annual incomes which the property is expected
to produce. For example, the appraisal of a proved gas
property yields an investment evaluation. "Speculative value"
arises because of expected capital appreciation over present
value. Acreage which is probable or prospective for mineral
production has speculative value.
A fundamental economic difference is apparent between
proved and unproved acreage. The appraiser's estimate of
the investment value of proved acreage is a process that is
reducible largely to measurable quantities. The steps in the
process, other than judgment, are explicit. obiective and can
be substantially verified. The methods of valuing unproved
acreage are quite different. Hence, a clear distinction must be
drawn between what is proved and unproved. and the invest•
ment value ascribed to the proved acreage onlv.
. During the past few years the effect of the graduated in•
come tax has become especially important in the appraisal
of properties yielding income, and promises to continue to be
so far a long time. This tax places some corporations in the
52 per cent bracket and subjects individuals to rates that may
be as high as 85 to 90 per cent. To those institutions whose
income is not taxed, a property can be worth two or three
times as much as it may be to the individual in a high tax
bracket. Hence it is necessary to consider and determine the
fair value applicable to the tax situation of the prospective
purchaser. Government regulation of the buying and selling
price of gas also influences value. Examples are known where
a single property is owned in part by a gas company whose
earnings are regulated to, eay, 6 per cent and the other co•
owner is able to sell his gas even to his regulated partner at
price far above that permitted the latter for his own gas. The
result is that one part of the property a fair value in the
a
market place of several times that of the regulated share.
Appraisals are made for business purposes and although it
would seem illogical to find at a given time substantially
for a part!cular property, depending upon
'··the business purpose, it is clear that these factors just men-
'tilmed have produced precisely that situation.
This distinction is particularly important under current
business conditions. Our economy operates under
a
burden of
'SI:CTION 1
9
JOURNAL OF PETROLEUM TECHNOLOGY
July, 1953