Here's a Little Help Placing a Value on Oil and Gas Producers

The business of oil and gas can be lucrative, but it is also hard to understand. What's more, oil and gas companies can be difficult to value, even for the most experienced analysts as no one knows how much oil is in the ground and at what price said oil will be extracted and sold for. However, using data supplied by company engineers as well as financial metrics, it can be easy to put together a rough valuation. To show you how, I'm going to work through some examples with ExxonMobil (NYSE: XOM  ) , Chevron (NYSE: CVX  ) , and EOG Resources (NYSE: EOG  ) .

Before we get started...
But before we get to number crunching, let me explain a key metric: enterprise value. Enterprise value, or EV as it is commonly abbreviated, is defined by Investopedia below:

EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value... Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents...Think of enterprise value as the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash...

So, by using EV as a way of placing a value on a company, we get a more accurate representation of true value. When combined with other metrics, EV can give us some great numbers that are really helpful in comparing the different valuations of energy companies and discovering how some businesses are undervalued in comparison to others.

Two key metrics
There are two key ways you can use EV in valuations. Firstly, EV/reserves, which is simply the company in question's enterprise value dividend by the number of oil equivalent barrels the company has in reserve. This gives a value to every barrel of oil equivalent the company has.

The other method is the EV/PV-10 calculation. Now I know, that looks daunting, but it is in fact fairly simple. The PV-10 calculation is the present value of the company's current oil reserves -- or to put it another way, the value of the company's oil reserves once extracted from the ground, net of expenses, minus 10% per year. If the company's enterprise value is currently lower than its PV-10 value, then in theory the stock is worth less than the value that it's going to generate over time -- in other words, the stock is cheap. You don't need to worry about computing this figure; it's usually done by the company and can be found within annual reports.

Some examples
So, as an example let's take a look at ExxonMobil. At the time of this writing, ExxonMobil's enterprise value is $449 billion. Based on year-end 2012 numbers, the company had 25.2 billion oil-equivalent barrels of proven reserves. The company aims to replace 100% of yearly production with new reserves, so we can state that this figure has remained constant. Based on these numbers, ExxonMobil's EV/reserve figure is $17.80, implying that ExxonMobil is valued at $17.80 for every barrel of oil the company has proved to be in its reserve base. Based on full-year 2012 numbers, ExxonMobil's PV-10 Figure was $176 billion.

Meanwhile, ExxonMobil's close peer Chevron actually looks slightly expensive compared to the industry leader. At the end of 2012, Chevron's net proved reserves were 11.3 billion barrels of oil equivalent, and the company's current enterprise value is $229 billion. That's an EV/reserve figure of $20.30. Additionally, the company's PV-10 figure at Dec. 31, 2012 was $155.5 billion. At this point I should state that these figures are only guides; they exclude other important figures like operational efficiency and could be misleading, but they act as a good guide. Certainty, it's strange to see ExxonMobil trading at a discount to Chevron, its smaller peer.

Still, one thing to note is that each company's enterprise value is almost double its PV-10 value. This is a prevalent trend within the industry.

U.S. oil boom
Putting together these figures leads me to one conclusion: Domestic oil and gas companies within the United States, which have ridden the shale-oil boom, are expensive. For example, EOG Resources currently has 1.8 billion barrels of proven resources, but the company has an enterprise value of $51 billion and an EV/reserve value of $28 per barrel, nearly double ExxonMobil's valuation . EOG's PV-10 value is $17 billion.

Foolish summary
Taking these figures into account, EOG does look to be more expensive than its international peers, but remember, these valuations are only a rough estimate. In addition, we need to consider the fact that EOG's production is still growing while output at Chevron and ExxonMobil is falling. What's more, I should also mention that the EV's of major oil companies such as Chevron and Exxon will look different to pure-play exploration and production companies like EOG, as major players have other interests, such as chemicals production and downstream assets. Still, this diversification implies to me that Exxon and Chevron should trade at a premium to pure-play peers. 

So overall, oil and gas companies are hard to value, but the EV/reserves and PV-10 metrics really help place a value on an industry that is notoriously hard to understand.

Take advantage of surging oil and gas spending
The oil and gas industry can be difficult to evaluate. But what if you could invest in a company that rents a very specific and valuable piece of machinery to that industry for $41,000... per hour (that's almost as much as the average American makes in a year!). On top of that, Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2824340, ~/Articles/ArticleHandler.aspx, 10/31/2014 4:12:11 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement