Say a company shows in a presentation that wells cost $10 million to drill and complete and the calculated PV10 is $5 million. What does that mean in simple terms? I understand time value of money and what present value is (PV), but just what are they saying? What, exactly, does this $5 million value represent? Does it mean that each so-called proved location is worth $5 million today?
One source for your answer would be the footnotes of a (public) company's disclosure statements, such as a 10-K. I believe there is a prescribed SEC formula for calculating the PV10. Normally, this footnote would be labeled "Reserves" or somesuch.
Generally, the PV10 would be the algebraic sum of Drilling & Completion Costs (a negative number) plus the sum, discounted at 10%, of the expected revenue of the well, less some costs, in each period over the expected life of the well. IIRC, the footnotes disclosing the calculation would give the assumed commodity price into the future (I think the SEC methodology dictates unescalated pricing, but in company presentations I suppose they may escalate). There would also have to be incorporated an assumed decline curve for the commodity production which I think is not normally set forth explicitly in the footnote.
James, let me put it this way. I have assumed that it means that the projected discounted cashflow for each location they attribute this value, using their well-engineered decline curve, is the same as having $5 million cash in hand? Is this correct?
So, if they had 200 locations of such, it's like having $1 billion of value?
So, if they were to sell this block of leases, they're selling $1 billion, but, obviously, the buyer is not going to give a billion, because the buyer has to make a profit, else, why buy it. Plus, there is real world risk. It's not liquid, they don't really have a billion dollars, they just have (according to their hype lol) that much calculated value waiting to be had.
You have now gone into the difference between regulatory filings and negotiating a sale.
My take on it would be this: The PV-10 calculation in an SEC filing is prescribed in a certain way for balance sheet reserves. That is for a different purpose, but certainly figures into, discussions about sale of the reserves, or production if post-drilling. My sense is, and I could well be wrong, that in today's interest-rate environment 10% is on the high side, but it is some kind of standard.
Sellers and buyers are not constrained by the assumptions going into a regulatory PV-10 calculation.
A seller, in confidential discussions with a prospective buyer, would no doubt offer the reserves and value them with a calculation much more favorable than PV-10. The seller would escalate commodity prices, would probably discount at a lower rate (after all, the "risk-free" 10-year Treasury is now yielding about 2.85%. I don't know what risk premiums are in the Oil Patch for any given play), and may have "forum-shopped" among engineering firms for the most favorable decline curves, etc.
A buyer would no doubt counter with a value based upon non-escalated (or less escalated) commodity pricing, a more pessimistic decline curve and lower EUR, would argue for a discount factor greatly in excess of that in the seller's calculation, skepticism about adjoining "control wells," etc. Some buyers might be happy to pay PV-10 if they believe commodity prices will escalate, interest rates will remain low, more optimistic about EUR and decline curve, drilling costs, etc. Or if they have some kind of strategic non-financially-driven purpose, such as the Red Chinese buying production or reserves.
As the old sports reporter Charlie Eckman on Baltimore radio WBAL used to say, it takes a difference of opinion to make a horse race.
But you're right: The buyer would want to make a profit by buying as inexpensively as possible. If a sale actually ensues, he would be buying at a price that would give him comfort about making a profit based upon his own assumptions which may or may not be the same as those forming the basis of the PV-10 calculation.
Not being an economist or planner, I won't try to dive into the details as to PV and deep down meanings. But I do know as a historical buyer of producing and prospective properties that the PV numbers are various discounted rates (e.g. PV 15) are used to determine bids for various properties.
Much of the key in using these numbers is to have a very good set of projections for production (both present and future) as well as capital expenditures needed to drill new wells. Plus a confident O&G and NGL pricing projection.
Hale and Marcus Aurelius,
Here is an excellent article about the difference between SEC PV-10 and Fair Market Value.
And, Mark, thanks for pointing out that you, as a buyer, would discount at say 15%. My guesstimate that 10% might be steep is an indication that I'd overpay for production. LOL.
Thanks for the article - will read it over later but it is things like this that are at the root of the differences in business models between public companies governed by SEC regulations and guidelines and non public companies (many of which are private equity supported with 8-10% capital injections). Then add in the business model for companies that are either internally funded or funding by non private equity investors who have a whole different set of financial metrics.
Roll these differences into a play (e.g. Permian Basin) and analyze how each area / company is making their respective plays.
In thinking, this would be a great research project / paper - but not for me to delve into! LOL
Switching back to acquisition concepts, usually you have a combination of producing developed properties (PDP) where you have cash flow projections (and a certain PV) plus infill proved undeveloped producing (PUD) properties with a certain PV) plus undrilled locations with varying degrees of risk / confidence (with a range of PV's).
This is where financial planners and analysts make their money.
But it still comes down to a management team and related series of beliefs and concepts that are taking all this data and saying "let's to it".
I know of one company (not named here) that took all this data years ago when oil prices were diving to the $30 and lower range and opted to do a mega deal based on the belief that "things will get better" (which was based on some educated analysis).
Things did get better and this group eventually sold their assets after drilling a few great wells and "crushed it" for themselves and their investors.
But there are other stories where management teams made what they thought were educated decisions who are now looking for new positions after losing everything.
The oil patch - biggest casino game on earth!!! IMO
Cool, thanks, I really appreciate you finding that. It does have some insight regarding SEC PV10 and real world basis.