Valuing Oil and Gas Companies. A Guide to the Assessment and Evaluation of Assets, Performance and Prospects PDF
Preview Valuing Oil and Gas Companies. A Guide to the Assessment and Evaluation of Assets, Performance and Prospects
Valuing oil and gas companies A guide to the assessmen t and evaluatio n of assets, performanc e and prospect s Nick Antill and Robert Arnott WOODHEAD PUBLISHINGLIMITED Cambridge England ubiished by Woodhead Publishing Limited, Abington Hall, Granta Park, Ireat Abington, Cambridge CB21 6AH, England ww.woodheadpublishing.com irst published in 1994 by Woodhead Publishing Limited as Oil and gas equities: valuation and trading his edition published 2000, Woodhead Publishing Limited ) Woodhead Publishing Ltd, 1994, 2000 eprinted 2008 he authors have asserted their moral rights. his book contains information obtamed from authentic and highly regarded sources. :eprinted material is quoted with permission, and sources are indicated. Reasonable fforts have been made to publish reliable data and information, but the authors and the ubiishers cannot assume responsibility for the validity of all materials. Neither the uthors nor the publishers, nor anyone else associated with this publication, shall be liable )r any loss, damage or liability directly or indirectly caused or alleged to be caused by lis book. Neither this book nor any part may be reproduced or transmitted in any form or by any leans, electronic or mechanical, including photocopying, microfilming and recording, or y any information storage or retrieval system, without permission in writing from /oodhead Publishing Limited. The consent of Woodhead Publishing Limited does not extend to copying for general istribution, for promotion, for creating new works, or for resale. Specific permission must e obtained in writing from Woodhead Publishing Limited for such copying. rademark notice: Product or coφorate names may be trademarks or registered ademarks, and are used only for identification and explanation, without intent to 1 fringe. ritish Library Cataloguing in Publication Data . catalogue record for this book is available from the British Library. ibrary of Congress Cataloging in Publication Data . catalog record for this book is available from the Library of Congress. ^BN 978-1-85573-451-7 (book) 5BN 978-1-85573-899-7 (e-book) rimed in the United Kingdom by Lightning Source UK Ltd To Jenny and Michael, James and Samuel Preface to the first edition Equity markets value shares in companies by estabHshing the clearing price at which buying and selling interest is matched. They do this as part of their role as secondary markets, that is, markets in which existing shares change hands between investors. In addition to providing Uquidity, however, this role relates directly to the primary function of an equity market: it sets the price at which a company can raise new equity capital, or at which it can be acquired. Market value is thus set by investor behaviour. Economic theory suggests that in a liquid market (one with a large number of active and well informed buyers and sellers) the price which the market estabhshes will accurately reflect the balance of risks and returns which the share offers investors, in relation to those offered by alternative assets. If the equity market is efficient in this sense, it should be possible to relate the way in which the market prices assets to economic evaluation of the returns that they offer. All investment analysis is thus an exercise in appUed economics. The models used represent an attempt to explain and to predict the prices at which shares find a market equiUbrium. This book is an attempt to present the information and the theoretical knowledge required to analyse shares in oil and gas companies. Investment analysis is entirely concerned with the future, in that it is the future returns which will accrue to a shareholder as a result of his (or her) owning a share which will determine the price which he is prepared to pay for it now. Expectations for the future are formed by interpretations of past experience, however, and in practice a range of factors will influence the process of share price appraisal. These include assessments of a company's historical performance and of its apparent intentions for the future, appraisal of the prospects for its areas of operation, as well as simple evaluation of its assets as if they were about to ix χ Preface to the first edition be broken up and sold. Companies can and do add to or subtract from their value by management actions. This book begins with a brief description of the oil industry, its history and its ow^nership. It examines the external factors, notably of course the crude oil price, which combine to create the environment in which oil companies operate, and discusses the considerations which should underlie assumptions on which oil companies are evaluated. It discusses oil industry accounts, to highlight the main points of which the analyst needs to be aware when interpreting them. Finally, it discusses methodologies for evaluation of both exploration and production companies and integrated oil companieST The book is intended mainly for those involved with the equity market, whether as investors or in the treasury or planning department of oil companies. It may also be of interest to students of business studies or energy economics. In essence, it sets out to establish a series of benchmarks and performance indicators against which the market should (and does) evaluate shares in oil companies. There is thus no contradiction between the use of objective methods of valuation, on the one hand, and the recognition that value is a function of investor behaviour, on the other. It is necessary to remember, however, that the purpose of the models is to predict the behaviour of the market, not the other way around. As with all economic theory, techniques for share price evaluation are only as good as their predictive accuracy. Preface to this edition 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 secdon 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 iUustrations 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 iflustrate 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 xi xii Preface to this edition 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 impHcations 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 suppUers 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 Httle 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 Uquidation 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 of BP Amoco's excellent Annual Statistical Review of World Energy for source data on energy statistics for the charts in this book. We should Hke 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. Acknowledgements During the course of researching and writing this book the authors have benefited from conversations with a wide variety of individuals, including employees in the oil industry and in the investment community. Specific acknowledgement is due to help and advice received from Neil Atkinson, Peter Norris and Judith Parry, and for permission to reproduce material supplied by BP Amoco, Petroleos de Venezuela, the Royal Dutch/Shell group, Enterprise Oil, OMV, Petroleum Intelligence Weekly and the OPEC Secretariat. The new section on oil industry corporate finance was based on an article originally published by the Oxford Energy Institute. The authors are grateful to the Institute for permission to use this material. The authors remain, however, fully responsible for any errors which the book still contains. xiii List of abbreviations bcf billion (thousand million) cubic feet bcm billion (thousand million) cubic metres bc/d barrels of condensate per day boe barrels of oil equivalent boe/d barrels of oil equivalent per day bbl barrels of oil bbl/d barrels of oil per day btu British thermal unit LNG liquefied natural gas LPG liquefied petroleum gas mbbl thousand barrels of oil mbbl/d thousand barrels of oil per day mboe/d thousand barrels of oil equivalent per day mscf thousand standard cubic feet mmscf million standard cubic feet mmscf/d million standard cubic feet per day mmbbl million barrels of oil mmboe million barrels of oil equivalent Sm^ standard cubic metre 000 mmbbl billion (thousand million) barrels of oil 000 mmboe billion (thousand million) barrels of oil equivalent xiv CHAPTER 1 The development of the oil industry It is not the intention of this book to cover in any great depth the development of the oil industry since many good texts on the subject exist already. However, for the analyst or new entrant coming into the sector for the first time it is useful to have at hand a very brief resume of the history of the industry. This chapter is therefore divided into four main sections: a brief history of the oil market, the origins of the major companies, a review of the worldwide occurrence and ownership of hydrocarbons, and a summary of the state of the oil and gas industry today. OIL INDUSTRY HISTORY The history of the oil industry is not only Hnked to each major technological invention but is also intimately linked with major political events. Briefly, the history can be subdivided into three main periods: • The early history, lasting until Drake's oil discovery weU in Pennsylvania in 1859. • The period from 1859 to 1955, during which time more than half of the world's crude oil production came from the USA. • The recent history from 1955 and the emergence of the OPEC period, when oil prices were dominated by a single cartel.
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