When an operator seeks financing of a venture, he generally provides information relating to his oil and gas reserves, as well as to his company's financial status. It is often left up to a bank, to a new venture partner or to a potential buyer to form his own opinion about the actual value of the reserves and the operator's ability to recover these. This paper will show how to bridge the gap between a conventional reserve estimate and the Fair Market Value of a property.

The paper first discusses the necessary reserve report as well as the often overlooked review of the operator's capabilities. The paper then discusses four different methods of determining the Fair Market Value of a property, and specifically point out sensitivities of the various assumptions used in the valuation methods. These appraisal methods include the following:

  1. Value per BOE. Gross recoverable barrels in the ground of both oil and oil-equivalent gas are determined through conventional reserve estimating. The barrels in the ground are multiplied by a dollar amount which reflects the risk and time period required to recover the oil (usually $7.00 per barrel). Non-producing reserves and proven, undeveloped reserves can be further discounted.

  2. Risked Present Worth. Present worth is first determined by an escalated future cash flow discounted back to present worth. Sources of risk include any lack of history of the producing formation, the operator's inexperience, and the time span over which the reserves will have to be recovered. A percentage in the 30 to 75% range is applied to the present worth of the property to account for these various risk factors.

  3. Three-year Cumulative Cash. The Fair Market Value can be determined by establishing a time criteria for payback of the acquisition price. The net cash flow is summed up from the present to the end of the selected time period (usually two-and-a-half to four years).

  4. Present Worth at 25%. A desired internal rate of return is targeted. The future net cash flow is discounted by this amount to establish a Fair Market Value. This method can also be adjusted to consider risk.

Cases are used to illustrate where the various methods are applicable and generally agree, as well as cases where pitfalls exist.

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