U.S. Based E&P Companies Valuation Trends 2007 – 2009: A Brief Assessment of Market Cap, EV, EBITDA and Production. Drawing from a sample of over 85 publicly traded U.S. based E&P firms, profiles were developed to gauge and assess trends in the sector between 2007 and 2009. The paper first establishes the over-arching trends in the U.S. E&P sector, discusses the key valuation drivers and then applies the analysis to establish a framework to estimate key valuation metrics for 2010. 2010 Marcus Wolters 1/1/2010
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U.S. Independent Oil & Gas Sector: 2010 Valuation Trends
U.S. Exploration & Production Sector Statistical Analysis. This is an assessment of the U.S. E&P sector from Q1 '07 through Q3 '09 and what the trends for the sector are moving into 2010. A range of key E&P valuation metrics for 2010 are estimated as the final stage in the analysis. The report draws from a comprehensive data assessment of 84 U.S. based Exploration & Production companies.
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U.S. Based E&P Companies Valuation Trends 2007 – 2009: A Brief Assessment of Market Cap, EV, EBITDA and Production. Drawing from a sample of over 85 publicly traded U.S. based E&P firms, profiles were developed to gauge and assess trends in the sector between 2007 and 2009. The paper first establishes the over-arching trends in the U.S. E&P sector, discusses the key valuation drivers and then applies the analysis to establish a framework to estimate key valuation metrics for 2010.
2010
Marcus Wolters
1/1/2010
DISCLAIMER
The information and opinions in this report were prepared by Marcus
Wolters. The information herein is believed to be accurate and reliable
and has been obtained exclusively from public sources believed to be
reliable. The author makes no representation as to the accuracy or
completeness of such information.
The material contained in this report is for information purposes only
and is not an offer or solicitation with respect to the sale or purchase of
Valuation Trends 2007 – 2009: A Brief Assessment of Market Cap, EV, EBITDA and Production.
Key Sector Trends: Q1 ’07 through Q3 ‘09 ....................................................................................................................................... 3
Market Capitalization Peaked in mid-2008 .................................................................................................................................. 3
Long-term Debt Grew Through 2008 ........................................................................................................................................... 3
Average Price Received Collapsed Rapidly Post Q2 ‘08 ............................................................................................................... 3
Reserves Re-valued at Lower Benchmark Prices at YE 2008 ........................................................................................................ 4
Market Cap and Enterprise Value Trend by Sub-Groups .................................................................................................................. 4
Production Groups ....................................................................................................................................................................... 4
Enterprise Value, Market Cap and Book Capitalization ............................................................................................................... 5
Enterprise Value to EBITDA ............................................................................................................................................................... 5
U.S. E&P Sector Overview ............................................................................................................................................................ 5
Key Valuation Considerations for 2010 ........................................................................................................................................ 5
Debt versus Reserves .............................................................................................................................................................. 5
Drilling and Production ........................................................................................................................................................... 6
WTI versus Henry Hub ............................................................................................................................................................. 6
New SEC Reserve Reporting Standards ................................................................................................................................... 7
Production Group Comparison of EV to EBITDA .......................................................................................................................... 7
Market Capitalization to Production ................................................................................................................................................. 8
U.S. E&P Sector Overview ............................................................................................................................................................ 8
Market Cap and Production Size .................................................................................................................................................. 8
What are the Objectives of Fundamentals Analysis? ................................................................................................................... 9
Mitigate the Price Effect and Focus on the Drivers ...................................................................................................................... 9
Identify the Key Drivers ................................................................................................................................................................ 9
Comparing Firms with Strong Fundamentals versus Firms with Weak Fundamentals .............................................................. 10
Translation into Other Metrics................................................................................................................................................... 10
How Fundamental E&P Drivers Translate into Market Valuations ............................................................................................ 11
Market Cap versus Daily Production ..................................................................................................................................... 11
Enterprise Value to EBITDA ................................................................................................................................................... 11
Valuation Trends 2007 – 2009: A Brief Assessment of Market Cap, EV, EBITDA and Production.
Price to CFPS (Trailing Twelve Months) ................................................................................................................................. 11
Two Scenarios for 2010 .................................................................................................................................................................. 12
Assessing the Value of Market Cap to Production ..................................................................................................................... 12
2010 Valuation Ranges - Production Groupings. ....................................................................................................................... 13
Final Comments ......................................................................................................................................................................... 13
Data Summary ................................................................................................................................................................................ 14
Data Collection and Management ............................................................................................................................................. 14
Production and Average Price Recap .................................................................................................................................... 16
Author’s Bio .................................................................................................................................................................................... 18
U.S. E&P Sector Enterprise Value as a % of Market Capitalization
Junior
Intermediate
Senior Super Independent
25%
30%
35%
40%
45%
50%
55%
60%
65%
Q1
'07
Q2
'07
Q3
'07
Q4
'07
Q1
'08
Q2
'08
Q3
'08
Q4
'08
Q1
'09
Q2
'09
Q3
'09
U.S. E&P Sector Debt to Capitalization (%) by Production Group
Junior
Intermediate
Senior
Super Independent
Enterprise Value, Market Cap and Book Capitalization
An intuitive way to see how Enterprise Value diverges from Market
Cap is to divide one into the other: the EV to MC measure, which
averaged 1.3 from Q1 ’07 to Q2 ’08, grew to 2.8 by Q2 ’09, implying
that debt comprised a much larger share of total Enterprise Value.
The figure to the right shows that as the production size increased,
market cap was less and less affected.
But it is no coincidence smaller producers experienced the largest divergence. It can be shown historically that the variance in share price risk/return of smaller producers is much wider than larger production groups to begin with. And since 2007, smaller producers added debt at a much faster rate than larger producers, causing wide mismatches in capital structure. In the span of just over 2 ½ years the average debt to cap increased from 35% at Q1 ’07 to 58% at Q2 ’09, and this served to make the impact of the fall in share price even more pronounced.
The question remains: how long will it take for this highly-leveraged
sector to return to normal? It is clear the credit risk profile for the
entire sector has already been in decline even prior to 2007, but the
negative price shock that occurred so swiftly in 2008 (the brunt of it in
six months) only compounded the problem. Moving into 2010, the
capital structure of the E&P sector has fundamentally shifted; this will
take a significant amount of time to correct itself.
Enterprise Value to EBITDA
U.S. E&P Sector Overview
From 2002 through 2007 the average EV to EBITDA multiple for the
U.S. E&P sector ranged between 5.5 and 12.5, averaging 8.9 Times.
This “norm” so to speak has been broken both on the upside and the
downside beginning in 2008. Corresponding with the trend in crude
oil prices, the metric peaked in Q2 ’08 but rapidly collapsed to lows
not seen this decade.
Even with a crude oil price recovery (WTI has more than doubled
since Q1 ’09) this widely used metric will have a difficult time in 2010
stabilizing within bounds that once were considered appropriate.
There are a number of solid reasons for that, as described below.
Key Valuation Considerations for 2010
Revenue Structure: Gas prices will likely remain flat, demand will be
stable, and the E&P sector is heavily weighted to natural gas
production. In the short-term, inventory levels moving into winter
are at record levels and per-capita usage is down slightly. For the
long-term, unless there is a more serious initiative to move
structurally away from coal-fired electricity generation to natural gas
fired generation, demand growth will be mitigated.
Debt versus Reserves: From 2004 the relationship between debt and
reserves has been deteriorating. While Debt per BOE reserves has
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
20
02
20
03
20
04
20
05
20
06
20
07
Q1
'08
Q2
'08
Q3
'08
Q4
'08
Q1
'09
Q2
'09
Q3
'09
U.S. E&P Sector
Enterprise Value to EBITDA Multiple
Quarterly Multiples based onTrailing Twelve Months (TTM) EBITDA
4.6
5.6 5.5 5.4
7.0
3.8
7.4
4.6
8.5
2.0
Debt to PDR SEC PV10 to debt
2004
2005
2006
2007
2008
U.S. E&P Sector Debt to Proved Developed Reserves, PV10 to Debt
2. For 2010, gas- in- storage volumes are at record levels. Unless the winter heating season is consistently colder (much
colder), winter season prices will be suppressed.
3. Fuel switching capabilities: For many years, fuel switching between natural gas and residual fuel oil kept natural gas prices
closely aligned with those for crude oil. More recently, however, the number of U.S. facilities able to switch between
natural gas and residual fuel oil has declined, and over the past five years, U.S. natural gas prices have been on an upward
trend with crude oil prices but with considerable independent movement.
New SEC Reserve Reporting Standards: From www.sec.gov: On June 26th
, 2008 the SEC announced that it has proposed revised
oil and gas company reporting requirements to help provide investors with a more accurate and useful picture of the oil and
gas reserves that a company holds. The new reporting standards become effective January 1, 2010. The rule proposal reflects
the significant changes that have taken place in the oil and gas industry since the adoption of the original reporting
requirements more than 25 years ago. The proposed rule changes incorporate improved technologies and alternative
extraction methods, and enable oil and gas companies to provide investors with additional information about their reserves.
The more that precise, first-hand information from oil and gas companies is available to investors and the marketplace, the less
that the marketplace is forced to rely solely upon information provided by speculators.
The enhanced reporting standards will add a broader aspect of valuation with respect to reserves on a standardized basis.
Some the key changes include:
Permitting use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes.
Enabling companies to additionally disclose their probable and possible reserves to investors. Current rules limit disclosure to only proved reserves.
Allowing previously excluded resources, such as oil sands, to be classified as oil and gas reserves. Currently these resources are considered to be mining reserves.
Requiring companies to report the independence and qualifications of a preparer or auditor, based on current Society of Petroleum Engineers criteria.
Requiring the filing of reports for companies that rely on a third party to prepare reserves estimates or conduct a reserves audit.
Requiring companies to report oil and gas reserves using an average price based upon the prior 12-month period-rather than year-end prices, to maximize the comparability of reserve estimates among companies and mitigate the distortion of the estimates that arises when using a single pricing date.
In addition to the SEC working paper there are several very good opinion papers on the proposed reserve reporting standards.
Production Group Comparison of EV to EBITDA
Assessing the EV/EBITDA in smaller parts shows unique characteristics based on production size. Historically, Junior producers
have had valuations roughly twice that of the largest producers, and this relationship held through the market upswing,
downswing and now in the current more stable period:
Table 2: Enterprise Value to EBITDA: Trend by Production Group
2010 Valuation Range Possibilities - Production Groupings.
The table below details the ranges of three metrics based on the two scenarios, arranged by production groups. EV to EBITDA is approximated based on an historical relationship between the two ratios. See endnote ii for a table of production ranges for each group. Metrics for Q3 2009 are calculated on actual results.
Table 7: Market Cap to Daily BOE Production: 2010 Outlook by Production Group
Production Group Q3 2009 (Actual) 2010 High Price Case 2010 Low Price Case
Junior $54,000 per BOEQ $104,000 per BOEQ $54,300 per BOEQ
Intermediate 56,530 76,200 39,100
Senior 52,450 69,200 37,000
Super Independent 48,920 59,500 34,900
Table 8: Enterprise Value to EBITDA: 2010 Outlook by Production Group
Production Group Q3 2009 (Actual) 2010 High Price Case 2010 Low Price Case
Junior 9.5x 11.3x 8.2x
Intermediate 9.1 8.8 5.4
Senior 9.4 8.2 5.2
Super Independent 7.2 7.3 5.0
Table 9: Average Market Capitalization ($USD) Outlook by Production Group
Production Group Q3 2009 (Actual) 2010 High Price Case 2010 Low Price Case
Junior $258 Million $370 $167
Intermediate $2.4 Billion 3.2 1.6
Senior $6.5 Billion 8.6 4.6
Super Independent $25.1 Billion 30.6 17.9
Final Comments
The U.S. E&P sector has clearly come off its early 2009 lows and the outlook for 2010 appears to be more robust. But several
questions will remain on the table which will affect valuations. For example:
Will the continental gas oversupply subside? In the short term, the main factor will be weather related and if North
America will experience a colder than normal temperatures in winter and/or the summer season will be warmer.
How will new government/environmental policies translate into reduced energy consumption? This is a longer-term
consideration, but valuations will be effected nonetheless.
i The U.S. universe comprises 84 publicly traded American based E&P’s. For the full detailed list, please see the section “Companies Surveyed.” Throughout the report, outliers and extreme values were removed from the analysis where it was deemed appropriate. Unless otherwise stated, all analysis was developed in-house. All data was obtained from its original source: the United States Securities and Exchange Commission (www.sec.gov). Share prices obtained from Yahoo! Finance. Presentations, news releases, outlooks and other relevant operational information obtained from company websites. Institutional ownership data obtained from Thomson-Reuters. ii The sample of 84 U.S. E&P firms was divided into four production sub-groups: Junior, Intermediate, Senior and Super
Independent. This widely accepted approach is very useful in examining many aspects of the E&P sector, from financial analysis to operations. The production sizes are tabled below:
iii The “Oil 10” and “Gas 10” E&P companies were determined by ranking the universe of 84 publicly traded E&P companies on
the basis of oil production and gas production, not revenue weighted and indifferent to the size of the firm or any performance considerations: Oil Focus Companies % Oil Gas Focus Companies % Gas
Arena Resources, Inc. ARD 83% Atlas Energy Resources, LLC ATN 97%
Continental Resources, Inc. CLR 74% Cabot Oil & Gas Corporation COG 95%
Evolution Petroleum Corporation EPM 55% CNX Gas Corporation CXG 100%
Performance measurement: Junior producers are not included in these types of performance assessments. The 2008 “P5” and “L5” E&P firms are tabled below:
P5 – Strong Fundamentals Group L5 – Weak Fundamentals Group
CNX Gas Corporation CXG ATP Oil & Gas Corporation ATPG
EOG Resources EOG Clayton Williams Energy CWEI
Range Resources Corp. RRC Stone Energy Corporation SGY
Southwestern Energy Company SWN Swift Energy Company SFY
Ultra Petroleum Corp. UPL W&T Offshore, Inc. WTI
v Key industry measures are assessed from first principles through to valuation measures: Input Metrics look at the drivers of
what defines the E&P sector: the efficient management of oil & gas resources and the efficient exploitation of reserves. Corporate Metrics provide guidance as to how the sector (as well as the individual company) manages its capital, asset and manpower requirements to give working strength to the reserve base. Output Metrics provide the tools which place a value on the individual company and the sector - trend analysis becomes an essential component in market valuations, returns and margins.