How does the Market Value Undeveloped North Sea Reserves

This is a question close to my heart as in The Steam Oil Production Company we have a good few barrels of undeveloped reserves, so I do pay attention to how the AIM market seems to value undeveloped barrels in the ground, especially those in the UK & Ireland. I also pay attention to the industry transaction values for those same kind of barrels, but recently there haven't been too many transactions to follow, not where anyone is paying cash upfront at least.

It is a far cry from the heady days of 2011 when Premier and Taqa carved up Encore for values per barrel that lay in the high teens. Then in 2012, Cairn bought Nautical for about $5/bbl and sold a part of the Catcher field to Dyas for about $10/bbl. The oil price collapse has a lot to do with the lack of activity as while companies are busy cancelling development projects on fields they already own, the appetite just isn't there to buy assets which will only be put in the cupboard to await sunnier days. Although that would be a good contrarian strategy the buyers all think "what's to be lost by waiting, sure the price might get even lower."

So we won't get many clues as to the market value of undeveloped oilfields from the industry. But for those companies that are listed, the stock exchange values their assets every minute of every day, so we can look to that market to derive a valuation.

Here are the companies I follow, they are Providence and Lansdowne who are partners in the Barryroe discovery offshore Cork, Independent Oil & Gas whose main project is the Skipper heavy oil field, Hurricane with its Lancaster & Whirlwind discoveries, Xcite with Bentley and Parkmead whose main undeveloped reserves lie in the Perth, Dolphin & Lowlander fields. 

I have tried to be consistent in the way I calculate the market value of the assets and the barrels in the ground. But all the companies are different and it is sometimes tricky to be confident that you have captured all the ins and outs of the balance sheet, so I recommend you do your own calculations if you want something you can rely upon. 

To calculate the enterprise value I take the market capitalisation as posted on the London Stock Exchange website, and to that I add the net debt. I calculate net debt by taking the long term debt adding to it the current liabilities and my estimate of how much money has been spent since the last financial report, finally from that I subtract the current assets. If that turns out negative then that the company has net cash. Only two of the companies are in the fortunate position of having net cash, all the rest have debts or other liabilities on their books. Xcite has a very ominous looking bond liability looming in June 2016, clearing that will be an essential part of any refinancing package to take the Bentley project forward.

Green dots are Enterprise Value divided by 2P + 2C resources, bars to the right of the centre line represent the Enterprise Value split into value of shares and the value of the net debt position, net cash is represented by the bars to the left of the centre line.

Green dots are Enterprise Value divided by 2P + 2C resources, bars to the right of the centre line represent the Enterprise Value split into value of shares and the value of the net debt position, net cash is represented by the bars to the left of the centre line.

When all is said and done the values per barrel lie in a range from 18¢ to 83¢, well down on the valuations of eighteen months ago, which reflects concerns that right now some of the projects might not attract finance or worse still just wouldn't make a profit. However undeveloped barrels do have an option value that persists even if the development project might not quite work at today's oil price. The one thing that is for sure about the oil price is that it will be different tomorrow and tomorrow that project might work really well, so it is rare that an undeveloped field will actually have no value. That isn't to say that the share price of some of these companies isn't at risk of going to zero, that could happen to any of the companies with net debt rather than net cash on their balance sheet.

Nevertheless, I think it is probably the case that a number of potential development projects are now only being valued as options to develop the field at some point in the future rather than at a discount to the calculated net present value of the development projects. My conclusion from looking at these values is that the option value of a barrel of undeveloped reserves is somewhere between 15¢ and 20¢. As a comparison, in one of the few recent transactions MOL paid 15¢/bbl for 600 mmbbls of unrisked prospective resources in Norway. That's 15¢/bbl for something that hasn't actually been found, in fact MOL would be delighted if they eventually found a half or a third of those 600 mmbbls, and which will be taxed at 78%. Of course MOL will only have to spend 22% of the cost of the wells to find these barrels but that deal reflects the fact that oil companies will pay for the possibility of finding oil.

However, if the market thinks (or hopes) that the project might actually go ahead the value stands a chance of heading towards $1/bbl; and I would expect that if any of these projects were funded and the field development plan blessed by OGA then the market value per barrel would be even higher than that, say between $2/bbl and $5/bbl. Unfortunately none of the companies that I follow are as yet in that position.

So today you can buy hundreds of millions of barrels of reserves for quite a lot less than a dollar per barrel. That is an awful lot less than the average finding cost for reserves pretty much anywhere in the world; and in the North Sea exploration costs came out at about $8/bbl for the period from 2005 to 2013. It really is cheaper drilling for oil on the AIM market than in the treacherous waters of the North Sea.

Bob Clark Transocean, The Transocean semi-submersible drilling rig the Sedco 706, photographed from the Dunbar platform in the Northern North Sea during some inclement weather.

Bob Clark Transocean, The Transocean semi-submersible drilling rig the Sedco 706, photographed from the Dunbar platform in the Northern North Sea during some inclement weather.