Oil & Gas Valuation

Analysis and valuation in the energy sector is complicated by its division into three main segments – upstream exploration and production (E&P), ‘midstream’ gathering and transmission, and ‘downstream’ refining and marketing. The sector also has unique and highly industry-specific ‘metrics’ for performance measurement and valuation. Finally, substantial changes in organizational forms – especially the division of E&P from midstream and downstream assets, and the further organization of ‘pure-play’ gathering/transmission assets – are a further challenge. In appraising potential E&P investments, IPO opportunities, or M&A situations, a familiarity with reserve modeling is critical. Cash flows must be modeled so as to reflect the differing natures of developed vs. non-developed, producing vs. non-producing, and proven vs. probable and possible reserves. Non-production ‘hard assets’ and unexplored production acreage also need to be included in any valuation. Cash flow models reflecting these differing assets, and which break down value into ‘going concern’ vs. ‘liquidation scenarios’, are invaluable in making analytical judgments. Moreover, the breadth of the sector requires an understanding of the valuation of ‘midstream’ and ‘downstream’ assets. Investors are increasingly expressing strong preferences for ‘pure-play’ exposures, and such assets can have very attractive sustainable cashflow characteristics, which can be utilized to fund “upstream” activities. Comparable firm and comparable transaction analysis is critical in this area. The course will: Provide practical exposure to reserve DCF modeling techniques, and contrast the different categories of reserves, both in 'going concern' and liquidation scenarios, and how these are modelled Review methodologies for valuing non-reserve hard assets, as well as midstream and downstream activities Define key industry-specific metrics, such as BOE, MMCFE, DACF, EBITDAX, distribution yields, etc. Highlight public market valuation of upstream, midstream, downstream, and integrated assets, as well as explore structures such as royalty trusts and gathering/transmission MLPs Illustrate these techniques in the M&A context, while exploring credit issues and the financing of energy firms Who should attend? Energy investment bankers Sell-side securities analysts Buy-side portfolio managers Sovereign wealth and pension fund analysts Corporate planners and strategists Credit analysts Accountants and lawyers working with energy clients and transactions
Day 1 Upstream Assets: Analysis and Valuation of Reserves and E&P Companies Using DCF and NAV Firms and investors need to deploy intrinsic or absolute approaches when analyzing and valuing upstream assets – oil and gas reserve bases. Discounted cash flow methodology is the most common tool when valuing such exploration and production (E&P) assets, resulting in an estimated Net Asset Value (NAV) for an upstream resource. But such analysis involves many assumptions about future oil and gas pricing, production levels, extraction costs, capital expenditure, reserve lives, residual values, and discount rates. Energy assets: upstream vs. Midstream vs. Downstream Gassy vs. oily assets Definitions: proven producing vs. proven not producing vs. probable vs. possible reserves Production level assumptions Extraction cost assumptions Output price assumptions Capital expenditure assumptions Depletion and depreciation Determining the discount rate Estimating a residual or terminal value Liquidation or blow down approach to DCF modeling and valuation Reserve replacement approach to DCF modeling and valuation Possible reserves as real options A key question: how much of a reserve base should an E&P company maintain? A rule-of-thumb with theoretical justification Case firms AMOCO Sale of MW Petroleum to Apache Excel Model of MW Petroleum Reserves Valuation Day 2 Upstream Assets: Analysis and Valuation of Reserves and E&P Companies Using Comparable Firm Metrics and Operational Metrics Firms and investors also need to deploy relative approaches when analyzing and valuing upstream assets. DCF methodology is most common for a developer/owner/operator of a reserve, but even privately-held operators have to raise capital from non-operator investors. Such investors are very focused on public market benchmarks for production assets, and hence peer group or comparable company analysis is vital. A third alternative, operational metrics such as enterprise value per barrel of oil equivalent (EV/BOE), provide a very commonly-used rule-of-thumb approach E&P firms - Finding costs, success rates - Measuring returns to capital: ROIC vs. CFROI Nature of the reserves and impacts on valuation: gassy firms vs. oily firms and the impact of the relative prices of oil and natural gas Identifying the peer group: dimensions of comparability Two key issues - Political risk: geographic location of reserves? - Economic risk: cost and feasibility of extraction? How to measure performance and valuation: valuation metrics - Energy sector highlight: depletion and depreciation - Full-cost vs. successful efforts accounting Cash flow metrics - Price/cash earnings - EV/DACF - EV/EBITDA - EV/EBITDAX - Dividend, DACF, and EDITDA yields Price/NAV An alternative: operational metrics - EV/proven producing reserves - EV/proven producing and proven non-producing reserves - EV/proven producing, proven non-producing, and probable reserves EV/proven producing, proven non-producing, probable, and possible reserves - EV/barrel vs. EV/MCFE vs. EV/BOE Conventions for valuing associated fixed assets Sum-of-the-parts analysis Capital-sourcing for E&P firms Credit issues for E&P assets Case firms A typical mid-size E&P Firm: St. Mary’s Oil and Gas An interesting option: Islamic Sukuk bond financing of Gulf of Mexico E&P play Day 3 Midstream Assets: Analysis and Valuation of Gathering and Transmission Assets and Firms Many integrated oil and gas firms have assets beyond production reserves – such as pipeline gathering and transmission networks, known as midstream assets. A worldwide revolution toward the creation of numerous pure-play companies in this sector has resulted in enormous capital-raising and M&A activity among pipeline master limited partnerships. The pipeline master limited partnership revolution The role of leverage in MLPs Cash flow metrics - Distribution yield - Price/earnings - Price/cash earnings - Price/distributable cash flow - EV/EBITDA Price/book value Transmission assets as infrastructure private equity – inflation hedges Partnerships structures: GPs vs. LPs, incentive agreements Capital-sourcing for MLPs Credit issues for MLP assets Case firms The Kinder Morgan MLP Complex: Kinder-Morgan Partners, Kinder Morgan Inc., and Kinder Morgan Management Downstream Assets: Analysis and Valuation of Refining and Marketing Assets and Firms Just as many integrated oil and gas firms have midstream assets, many also have downstream assets, such as refineries and petrol station networks. Many firms historically have been pure-play refining and marketing (R&M) firms. But a second worldwide revolution among integrated companies has been there disposal, via spinoffs, of their R&M assets as pure-play companies. Once again, this revolution has resulted in enormous capital-raising and M&A activity. Traditional pure play refiners and marketers The break-up wave: marathon, Conoco, Hess, occidental petroleum Cash flow metrics - Price/earnings - Price/cash earnings - EV/EBITDA Price/book value Sum-of-the-parts analysis Refining and marketing assets as infrastructure private equity – inflation hedges Environmental rectification liabilities: a big potential headache for R&Ms Case firms China’s big R&M firm: Sinopec Esso Oil (Thailand) Initial Public Offering Exxon sale of Japanese R&M assets Marathon Petroleum: Now an R&M pure play Break-up of Conoco into Conoco and Phillips 66 Sum-of-the parts valuation of big integrates Day 4 Back to the Upstream: Upstream MLPs and Royalty Trusts In disposing of R&M networks via spin-offs, many previously integrated firms have become essentially upstream assets. A traditional way to finance upstream activities has been to segregate proven producing properties into separate firms, organized as royalty trusts or production master limited partnerships, which then can be monetized to provide capital for additional exploration. Once again, the creation of such royalty trusts and production MLPs has resulted in enormous capital-raising and M&A activity. No replacement: upstream assts as wasting assets Royalty trusts vs. production master limited partnerships Fire-and-forget production assets as yield plays Cash flow metrics - Distribution yield - Price/earnings - Price/cash earnings - Price/distributable cash flow - EV/EBITDA Price/book value Residual values Case firms Prudhoe Bay Royalty Trust LINE Energy Bringing it all together: M&A in the Energy Sector The centrality of energy to modern life, the scale of the sector, its capital intensity, and its inherent risks have all made it a fertile area for capital-raising and consolidation activity. The range of asset types – upstream, midstream, downstream – as well as corporate forms – corporations, trusts, master limited partnerships – add to this richness. E&P vs. midstream vs. R&M assets Sum-of-the-parts analysis DCF valuation in M&A Comparable firm analysis in M&A Comparable transaction analysis in M&A Operational metrics in M&A Accretion and dilution and credit/funding issues Case firms Union Pacific Resources takeover of Norcen Energy Excel model of Norcen Energy Reserves: Blow down scenario Excel model of Norcen Energy Reserves: Growth scenario Course summary and close