Table Of ContentValuing 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.
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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
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^BN 978-1-85573-451-7 (book)
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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.
