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| Also known as Exploration & Production, or E&P, companies, they focus on finding and extracting minerals and resources from the ground. |
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| They focus on transporting oil, gas, and other commodities to companies that will sell them. This is mostly done via “pipelines” that carry these commodities over great distances. |
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| They refine and market commodities (hence the “R&M” name for them), turn them into something useful – AKA jet fuel, automobile gasoline, diesel, and so on – and then sell them to customers. |
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| They don’t find, transport, or sell oil & gas, but instead provide services to companies that do. They might maintain their oil fields, repair broken spots, upgrade the technology, or even provide security for workers. |
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Definition
perform upstream, midstream, downstrem, and oil field services.
Think BP and Exxon Mobil. These companies do everything above, just in different proportions. The most common combination is to focus on upstream and downstream, and then leave the rest to dedicated specialists. |
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| upstream companies are most different from "normal companies" |
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| Difference One Between O&G Modeling and Traditional? |
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| Can't control prices (and thus revenue) |
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| E&P Companies are balance sheet centric |
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Definition
| Just like banks or insurance firms, an E&P company is far more dependent on its balance sheet than, say, a technology or consumer retail company. The balance sheet contains its most important asset: the reserves that will generate future revenue and profit. |
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| 2 types of accounting for E&P |
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Definition
| "full cost" and "successful efforts" |
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Definition
Versus full cost accounting.
These methods differ in the treatment of specific operating expenses relating to exploration costs (as opposed to acquisition or devel- opment costs, which are capitalized in both methods).
The successful efforts method capitalizes only those exploration costs associated with successfully locating new reserves. For unsuccessful (or dry hole) results, the associated explora- tion costs are immediately expensed. |
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Definition
| The full cost method capitalizes all exploration spending regardless of the outcome. |
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| As company grows and earns revenue, |
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its ASSETS DECLINE
(because the reserves are being used up) |
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| oil and gas companies market value can be cyclical |
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and follow commodity pRice cycles
Investing in an energy or mining company is almost like investing in the underlying commodity, which means you have to be comfortable with giant price swings. |
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Term
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Definition
Oil--barrels (42 gallons in a barrel)
nat gas -- cubic feet (Bcf = billion cubic feet)
mining--whatever makes sense
(tonnes, carats, ounces depending on the mineral we are referring to) |
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| Shown on balance sheet, is how much of the resource company has READY to EXTRACT, PRODUCE, SELL |
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| When you project nat resource company's statmeents, begin by PROJECTING PRODUCTION BY SEGMENT based on RESERVES, HISTORICAL PATTERNS |
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Definition
Production-linked expenses--which you estimate on a dollar per barrel of oil or per cubic foot of gas basis
Non-production-linked expenses--such as stock-based compensation and smaller, miscellaneous items. |
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| E&P firms are unique in that their primary asset base is depleting and therefore must be continually replaced through either drilling activities or acquisition. |
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Definition
Refers to a form of investment in oil and gas drilling operations in which the investor is directly liable for a portion of the ongoing costs associated with exploration, drilling and production. In a similar fashion, working interest owners also fully participate in the profits of any successful wells. This stands in contrast to royalty interests, in which an investor's cost is usually limited to their initial investment, also resulting in a lower potential for large profits.
Read more: http://www.investopedia.com/terms/w/working-interests.asp#ixzz262Cl0qyw |
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Definition
| In the oil and gas industry this refers to ownership of a portion of the resource or revenue that is produced. A company or person that owns a royalty interest does not bear any of the costs of the operations needed to produce the resource, yet the person or company still owns a portion of resource of revenue produced.Read more: http://www.investopedia.com/terms/r/royalty-interest.asp#ixzz262CrZry3 |
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| Overriding royalty interests |
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Definition
| Like mineral and royalty owners, the owner of overriding royalty interests receives a portion of the income from the production of oil and gas. The main difference is that the owner of an overriding royalty does not own the minerals under the ground, only proceeds from the production of minerals. Once the lease has expired and production has ceased, the overriding royalty interest expires. Conversely, the owners of minerals and royalties maintain their ownership after production ceases. |
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| Working interests can be classified as: |
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Definition
operating working interests--Operating interests are basically controlling interests. has the right to collect standard overhead charges (known as COPAS charges) from other working interest holders that can be beneficial to the operator.
nonoperating interests--are like minority and noncontrolling interests. |
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| A royalty takes preference over all other payments from lease revenue. They represent payments to mineral owners to drill on their property and typically represent a one-fourth to one- eighth interest in gross revenues after taxes. Royalties are similar to a triple-net lease. |
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Definition
| Overriding royalty interests (ORRI) are like royalty interests except these expire once the lease has become uneconomic. |
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Definition
| Exploration costs are costs relating to carrying and retain- ing undeveloped properties, costs of the collection and analysis of geophysical and seismic data, and costs incurred with drilling an exploratory well |
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| Production volumes can be expressed as |
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Definition
barrels of oil equivalent (boe)
thousands of cubic feet equivalent (mcfe) |
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| As opposed to industrial companies, the quantitative measures of E&P performance are based primarily on the ability to replace and grow resources at a favorable cost. This is in contrast to profit margins and growth. |
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Term
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| Rather than EBITDA (earnings before depreciation, interest, taxes, and depreciation and amortization), ana- lysts usually consider EBITDAX a primary pricing metric for E&P companies. EBITDAX represents EBITDA before exploration costs for successful efforts companies. For full cost firms, exploration costs are embedded in depreciation and depletion (since in full cost alL exploring costs are capitalized and thus depreicatied), so EBITDAX equalizes both accounting types. |
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| In addition, other noncash expenses such as impairments, accretion of asset retirement obligation, and deferred taxes should be added back in calculating EBITDAX. |
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Definition
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| Proved Reserves (Part of PPE) |
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Definition
As opposed to probable reserves.
Proved reserves are quantities (volumes) of oil or natural gas that are recoverable in future years from known reservoirs under existing economic and operating conditions.
Proved Reserves have a 90%+ chance of being recovered |
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| Probable Reserves (Part of PPE) |
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Definition
As opposed to proved.
Probable reserves (referred to as 2P reserves when aggregated with proved reserves) have a 50% chance that reserves quantities will be higher than estimated and a 50% chance that the reserves will be smaller in accor- dance with the engineering definition of the American Petroleum Institute.
Probable is between 50% and 90% chance of being recovered |
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| Possible Reserves (part of PPE) |
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Definition
As opposed to both proven and probable.
Possible reserves (referred to as 3P reserves when aggregated with proved and probable reserves) reserves have a 10% chance that reserves are greater than estimated and a 90% chance that reserves will be smaller.
<50% chance of being recovered |
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| Different types of PROVED Reserves (PDP Reserves) |
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Definition
| Proved Developed Producing (PDP) reserves--are expected to be recovered from completion intervals (oil- and gas-producing sands or zones) that are open and producing at the time of the estimate. PDPs are the only reserve class generating current cash flow or EBITDAX. are the least risky and therefore most valuable reserve class. |
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| Different types of PROVED Reserves (PDNP Reserves) |
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Proved Developed Non-producing (PDNP) reserves-- include shut-in and behind-pipe reserves. Shut-in reserves are expected to be recovered from completion intervals (zones) that WERE open at the time of the reserve estimate but are NOT producing. Behind pipe reserves are expected to be recovered from completion intervals not yet open but still behind casing in existing wells.
Such wells are usually producing, but from another completion interval.
Additional completion work is needed before these reserves are produced. |
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| Different types of PROVED Reserves (PUD Reserves) |
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Definition
Proved undeveloped (PUD) reserves--expected to be recovered from (1) new wells on undrilled acreage or (2) existing wells requiring major expenditure.
Typically not counted (or booked) UNTIL IT IS CLEAR that the well or major expenditure will be funded and completed in the near term. |
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Definition
| operating income + depreciation, depletion and amortization + exploration expenses + dry hole, abandonment, and/or impairment expenses + accretion of asset retirement obigation + deferred taxes |
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| can actually show up everywhere – current assets, long-term assets, current liabilities, and long-term liabilities. Energy companies use hedging to protect themselves from falling commodity prices, and these “derivatives” consist of contracts that say, for example, “Even if oil prices fall to $50 per barrel, I can still buy oil from you at $60 per barrel.” Derivatives on the assets side represent long positions and on the liabilities side they represent short positions. |
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| Asset Retirement Obligation |
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Definition
A liabilty representing future cost associated with shutting down oil wells and gas fields.
you add to it over time by adding in the future cost of shutting down each new well or field you develop (reflected in the "accretion of the asset retirement obligation discount" expense on the income statement). |
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| Depreciation, Depletion & Amortization |
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Definition
| --MASSIVE for O&G companies. Sometimes even bigger than their net income. |
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Definition
| That “dry hole expense” I mentioned above is another name for unsuccessful exploration, and some companies actually add it back on their cash flow statements (long story, but essentially they are using a mix of both standards). |
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Definition
CapEx is massive for natural resource companies, once again often exceeding their net income.
Asset sales are also very common. These companies spend a huge amount exploring and buying assets, and also receive a good chunk of change for selling assets like individual oil fields and gas wells. |
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| Financing Activities: Since oil & gas companies are constantly buying assets and spending a small fortune to find more assets and since they deal with volatile commodity prices, they have huge financing needs. So you see massive amounts of debt being raised and paid off, along with equity financing in some cases. |
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| This section seeks to provide some basic understanding of the reserve report.Unlike third-party appraisal reports, many petroleum (or reservoir) engineers do not determine the fair market value of reserves. Rather, they provide gross quantities expected to be produced from wells, net such quantities to the subject company’s ownership interest, and make estimates of future prices, operating expenses, and capital expenditures. Essentially the reserve report is a discounted cash flow (DCF) model for the subject company’s reserves, on a pre-income tax basis. |
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| c Oil-to-gas conversion ratio: 6 mcf = 1 bbl. |
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| Where to find comparable energy companies? |
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| Master Limited Partnership (MLP) |
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Definition
A type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP's cash flow, whereas the general partner is the party responsible for managing the MLP's affairs and receives compensation that is linked to the performance of the venture.
Read more: http://www.investopedia.com/terms/m/mlp.asp#ixzz262IwzZvZ |
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| Screening criteria for comps of energy companies? |
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Definition
We believe some of the most important screening criteria include
(1) size (in market capitalization or reserve volumes),
(2) gas/oil mix (the percentage of reserves or production represented by natural gas verses oil),
(3) reserve life (proved reserves divided by last or current year’s production and known as the r/p ratio),
(4) the PUD to total proved reserve ratio (this indicates how much of the reserve base is currently generating EBITDAX),
(5) areas/basins of operation (i.e., onshore versus offshore activities). |
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Definition
| Proved reserves / Last or current year's production |
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| Common multiples in modeling energy companies |
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•EV/proved reserve quantities
• EV/daily production
• EV/EBITDAX. |
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Remember how I said above that oil & gas companies use “different” accounting?
Revenue recognition is straightforward, but the expenses get tricky. You always capitalize acquisitions and development (actually constructing the field or well), and you always expense production.
But exploration costs are more subtle: it seems obvious that you’d capitalize successful explorations, i.e. if you go out into the fields and actually find oil, but what about unsuccessful explorations?
Under the successful efforts methodology, you expense them, and under the full cost methodology you capitalize them and add that CapEx to the PP&E on your balance sheet. |
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| Large companies tend to use successful efforts because they can afford the hit to their net income, while smaller companies tend to use the full cost method to boost their earnings. |
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| One downside of ful cost accounting for exploration expense |
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| One downside of the full cost method is that you need to test the PP&E balance every so often and apply write-downs if the book value gets out of line with the market value – so write-down and impairment charges are common on full cost companies’ income statements. |
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| Why P/E multiples USELESS for energy modeling |
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Definition
| P/E is not terribly useful because many energy companies have odd tax situations, huge depreciation numbers, and lots of impairment charges and write-downs |
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| Why revenue multiples USELESS for energy modeling |
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Definition
| revenue multiples are useless because oil & gas companies have limited control over their revenue due to their dependence on commodity prices. |
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| EBITDAX, not EBITDA: The “X” stands for Exploration Expense, and we add back it to EBITDA when working with E&P companies because of the issue with successful efforts vs. full cost accounting above: we’re normalizing the metric. |
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| Investments in E&P companies are essentially com- modity plays. Their market prices are highly correlated to the price expectations of the commodities they sell. The analysis therefore is based heavily on reserve life and the ability to replace production. PUDs are the reserves that will fuel future reserve replacement. |
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| Note also that the asset retirement obligation should be treated as debt and subtracted from EV to calculate equity value. |
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| NAV (net asset value) model |
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Definition
The NAV model flips the traditional DCF on its head because you no longer assume perpetual growth.Instead, you assume that the company adds nothing to its reserves and that it produces 100% of its reserves until it runs out of natural resources completely.
1. Set Up Columns to Track Each Commodity, Revenue, Expenses, and Cash Flows.
2. Assume Production Decline Rates and Calculate Revenue Until the Reserves Run Out.
3. Project (Some) Expenses.
4. Calculate and Discount After-Tax Cash Flows
5. Add in Other Assets and Business Segments |
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Term
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Definition
popular valuation model for energy.
For cases where the company is highly diversified – think Exxon Mobil – you need to value its upstream, midstream, downstream, and other segments separately and add up the values at the end.So you might, for example, use traditional multiples like EBITDA for the midstream and downstream segments, and then use Proved Reserves or Production multiples for the upstream segment and add them together to arrive at the final value. |
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| In a merger, merger paid with... |
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Definition
| Stock tends to be very common because oil & gas companies are often highly leveraged (little capacity to raise additional debt) and also don’t have much cash available. |
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| Synergies in a merger between E&P |
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Definition
You generally assume no revenue synergies because they just don’t make sense – remember that commodities companies cannot control their “product” prices.
You might assume expense synergies based on reducing production costs on a per Barrel / Cubic Foot / Tonne / Ounce basis. |
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| The most important point about Oil & Gas LBO models, ironically, is that oil & gas leveraged buyouts rarely happen. |
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WHY?
Extremely Unstable and Unpredictable Cash Flows: If oil, gas, or gold prices swing one or the other, your returns may be hosed.
High CapEx: This makes it much harder to repay additional debt.
Already Highly Leveraged: This makes it difficult for the private equity firm to use a lot of new debt to acquire the company. |
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