I have posted before on the breakeven oil price for some North Sea developments and then in this follow-up post I extended that analysis to make rough and ready estimates of how the net present value per barrel varied with oil price for most of those projects.
I found that a jolly interesting exercise, but we all know it doesn't matter what intricate calculations say the net present value of an asset is, what matters is what someone is actually prepared to pay for the oilfield. That is what tells you its real worth.
So let's look back at the history of some North Sea deals. As before, I have focussed in on undeveloped discoveries, and managed to find information on twenty asset deals and two corporate acquisitions dating back to the end of 2008. Then I added in the market capitalisations of three development focussed North Sea companies, Xcite, Hurricane and Independent Oil & Gas.
So here is the list, in graphical form. I have tried to make the deals as consistent as possible; where the arrangement involves a carry of development costs, I worked out the tax saving from that arrangement, and reduced the price by 80% of that benefit; some of the deals included tax losses, in those cases I reduced the cost to the buyer by 50% of the available tax losses. The Solan deal is the trickiest to normalise, as a big part of that deal was a loan to Chrysaor from Premier, so my estimate of the value of that is not much better than speculation. Other deals included contingent payments so I added those in at 50% of their value. Why 50% – well it doesn't seem right to ignore them and it doesn't seem right to include them at full value, so two half rights might not be wrong. All of the above is somewhat arbitrary so please don't over analyse the individual deals as presented here, over-analysing is my job.
The wide green bars are the reserves in each deal (though Xcite and Hurricane are both off the scale). The narrow bars are my estimates of the value paid per bbl; the orange bars apply in the cases where the field development plan had been approved and the project was underway; the purple bars are for assets that did not have completed field development plans; and the blue bars are for companies rather than assets. Gas fields are shown as pale versions of the rest, they are included for completeness, but gas is different from oil.
The asset market, that is the market for oilfields traded between oil companies, seems to value discovered oilfields, without a firm and financed plan, at between $1 and $3/bbl; though there are some spectacular outliers, such is the premium for control or a strategic acquisition.
Today, in the middle of March 2015, the stock market values the two undeveloped oilfields in quoted companies at between 50¢ and 90¢ per bbl. Though of course these valuations were quite a bit higher in the summer when oil prices were a tad better – both Hurricane and Xcite were valued at about $1.50 per bbl back then.
On the other hand, the average value per bbl for oil projects, with all the approvals and finance in place, comes to about $7.5/bbl. Although this value is so much higher, that is still a small discount to the calculated NPV, based on the oil price at the time; on the few deals I can analyse it looks like the discount is about 15% to 20%, the red squares on the chart are the ratio of deal value per bbl to calculated NPV per bbl.
So the value of a discovered oilfield, that still needs work, where the jigsaw pieces of DECC and partner approval, financing and contracts have yet to coalesce, is only about a quarter of the value of a development project all ready to go. That is a pretty substantial re-rating for getting everything together, but it is a lot of work and more complex, time consuming and difficult than most people realise. In a sense this value gap explains why if an exploration company's share price soars towards the NPV on a new field being discovered, not long thereafter the share price sags as everyone realises how much work is left to do.
This discount, which is just another way of describing an impending re-rating, explains, to a significant extent, the gap between the calculated NPV's and the market capitalisation for companies like Xcite and Hurricane.
If we accept the analysis above then we can say that the fair value for an undeveloped field, with all the necessary finance, contracts and approvals in place, is 80% of the calculated NPV, but that before everything is in place the market value for an undeveloped field is just a quarter of that, or 20% of the calculated NPV. Let me try these calculations out on Lancaster and Bentley.
The first tricky part is deciding what oil price to use - for the sake of argument let's pick $80/bbl, that is the price I settled on as a decent long run oil price expectation in my very first post, and nothing that has happened since has changed my mind. Using my rough and ready reckoner that gives me a calculated NPV per bbl for Bentley of $3.20/bbl and for Lancaster of $4.20/bbl. Which would imply, using the 20% rule of thumb above, an expected market value of 64¢/bbl for Bentley and 84¢/bbl for Lancaster. The market currently values Lancaster (if we assume all Hurricane's value is in Lancaster) at c. 50¢/bbl and Bentley at 90¢/bbl. On that basis one might conclude that the market has the companies the wrong way round but Xcite's higher valuation does make sense as Xcite is apparently well on the road to delivering the Bentley FDP and coalescing all the pieces of the jigsaw, so applying a full 80% discount to the calculated NPV would be quite harsh.
So what is the upside in the Xcite and Hurricane share prices when the field development plans come together? Well, that is where I am going to let you down, because there are two big unknowns; firstly, just how much capital the companies will need to raise to get DECC approval and pay contractors, and secondly the extent to which the current shareholders will be diluted. That applies whether the new capital comes from the stock market or from another oil company.
I have some idea of the answer to the first question, but literally no idea whatsoever on the second. I am sure the market will revalue Bentley and Lancaster when development approval comes, but whether the current shareholders, new shareholders or new partners will reap the benefit I just don't know.