Since the presentation in 1984 of the author's paper on "Comparison of Methods for Determining Fair Market Values," (SPE Preprint 13769), the authors have had an opportunity to evaluate the risk analysis methods used both by industry as well as by their own firm in over thirty appraisal cases. The industry cases were further analyzed as part of the class work in the University of Tulsa-sponsored seminar on "Appraisal of Oil and Gas Properties," where critical review by many market sector representatives was applied. With these data as a base, a study has been made of the adequacy (or lack thereof) of the risk analysis in oil and gas property appraisals. It has been found that of the four methods generally used by industry for fair market value determination, only one adequately addresses risk analysis and allows numerical treatment of the subjective part of the appraisal. We term this method the Risked Present Worth method, while the other three are generally known as the Β0Ε method, the Cumulative Cash method and the Targeted ROR method. None of these latter three methods, while frequently used, allows for a systematic approach to risk analysis.
In contrast, the Risked Present Worth method provides for a distinction between the effects of time-value-of-money and the mechanical, operator and market-related risks. In the continuing development of this method over the last four years, it has become possible to develop checklists for subjective assessment of the various types of risk toward determination of a single risk factor which subsequently can be multiplied into the unrisked present worth of the future cash flow and yield an acceptable fair market value. These checklists are designed to allow risk analysis by appraisers of varying levels of skill or experience. They are also designed to provide default values where some details about an oil or gas property may be unavailable. The method currently defaults (if absolutely no information is available) at a risk factor of 0.73 for proved developed producing properties as of fall, 1988. Additional market data evaluations performed during the preparation of this paper show a slight downward trend toward 71%. The detailed risk analysis, which can be performed on the basis of additional property information, may increase or decrease the risk factor. Under current economic conditions (winter, 1988), the present worth at 10% would be used as a base for the unrisked present worth, but could be accurately adjusted to reflect the prevailing interest rates.