Nothing impacts our industry’s activity level more than the price actually paid for oil and gas. After enjoying a period of relative stability for oil in the range of $95 to $105 per barrel (bbl) since January 2013, oil prices have recently seen a significant downward adjustment into the low $80s, and might experience even further price degradation in the months to come.

Given the geopolitical and religious unrest the world is experiencing, particularly in certain key producing countries, one might expect that prices would remain in the $100/bbl range for much longer, but many experts believe a downward price adjustment is long overdue and that oil prices have been inflated for some time.

However, a culmination of present-day events is driving the softening of oil prices, including slower growth in many of the European and Asian economies; the potential for a global viral epidemic and the negative impact it might have on affected economies; unprecedented domestic U.S. production growth; the return of production supply from key producers in war-torn parts of North Africa and the Middle East; and the strengthening of the U.S. dollar.

On the other hand, gas is not a global commodity, and it is solely affected by supply and demand in North America. Gas prices have remained in a band of $3 to $4 per thousand cubic feet (Mcf) since third-quarter 2012, with the exception of a most enjoyable but brief spike above $4/Mcf in 2014. At least for now, Nymex gas futures are on an upward forecast. Figure 1 shows the average yearly settlement prices for both oil and gas at press time.

Comparing metrics

During volatile price periods, buyers of producing assets struggle to find meaningful comparable metrics when deciding what to pay for new acquisitions. Standard metrics used include the present value of future reserves and production, multiples of forecasted cash flow, the price paid per net producing barrel of oil equivalent per day and the price paid per barrel of oil equivalent for total proved reserves in the ground.

Buyer discount rate hurdles and reserve risking criteria, as well as cash flow multiples, basically remain the same in all price environments. However, the actual price paid will increase or decrease depending on the current five-year Nymex strip. The barrel of oil equivalent per day price paid has become a less dependable metric to use if the asset has a significant percentage of gas production in its production stream. This is due to the decoupling of gas prices compared to oil, and the wide variances of the ratio of gas-to-oil in the last few years.

An interesting, but less frequently used, means of valuing total proved reserves in the ground is by calculating the implied price paid as a percentage of ­­spot prices at the time of the transaction. Figure 2 is an analysis of publicly reported oil transactions from second-quarter 2009 through second-quarter 2014. The green plotted line reflects the spot price posted vs. the lower plot, which reflects the implied price paid at any given time. Generally speaking, the industry pays about 20% of the spot price for oil transactions.

Figure 3 is a similar plot of spot prices vs. the implied price historically paid for gas transactions for the same time period. This graph reflects much more volatility in both spot prices and the implied price paid for assets. However, it indicates that the implied price being paid for gas transactions is about 40% of the spot price.

Effectively, the industry pays 40% of the spot price for gas transactions compared to only 20% for oil. This is partly because lifting and operating costs for oil assets are much higher than for gas assets. When evaluating assets with a strong component of both oil and gas, it is advisable in today’s market to run separate evaluations of both the oil and gas streams, applying individual price decks for each.

During the course of a reserve and economic evaluation and assuming adequate data is available, it is important to analyze all four of these producing metrics for consistency. If one metric stands out compared to the others, then further analysis is warranted to determine the reason and to make any appropriate adjustments to the risk assessments or other assumptions built into the evaluation.

—Kenneth R. Olive Jr., The Oil & Gas Asset Clearinghouse LLC, 281-873-4600, kolive@ogclearinghouse.com