One the the primary obstacles for sector participants as soon as valuing and pricing oil and also gas reserves is addressing proven undeveloped make reservation (PUDs) and also unproven reserves. If the market strategy can occasionally be provided to know the worth of PUDs and also unproven reserves, every transaction is unique. Additionally, numerous transactions that we see today are still a result of the crash in oil prices in 2014; and also in some sales that non-core assets, PUDs and unproven reserves have been considered worthless. Why then, and also under what circumstances, can the PUDs and also unproven to make reservation have far-reaching value?

Optionality Value

The answer lies in ~ the optionality the a property’s future DCF values. In particular, if the acquirer has actually a lengthy time to drill, one of two pressures come right into play: one of two people the PUDs potential for advancement can be altered by fluctuations in the current price outlook for a resource, or, together seen with the rise of hydraulic fracturing, drilling technology can adjust driving far-reaching increases in the DCF value of the unproven reserves.

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This optionality premium or valuation increment is often most pronounce in unconventional resource play reserves, such as coal bed methane gas, hefty oil, or international reserves. This is furthermore pronounced once the PUDs and also unproven to make reservation are organized by production. These species of reserves do not call for investment within a fixed brief timeframe.

PUDs are typically valued utilizing the same discounted cash circulation (DCF) model as proven creating reserves after adding in an calculation for the funding costs (capital expenditures) to drill. Climate the pricing level is changed for the incremental risk and also the hesitation of drilling “success,” i.e., advertising volumes, life and also risk of too much water volumes, etc. This incremental risk can be accounted for through either a greater discount rate in the DCF, a RAF or a haircut. Historically, in reduced oil price environments like we face today, a raw DCF would suggest small to no worth for PUDs or unproven reserves in a number of plays and also basins.

In practice, undeveloped acreage ownership attributes as an choice for to make reservation owners; they have the right to hold the asset and wait until the market improves to start production. Therefore an choice pricing model deserve to be a realistic means to guide a prospective acquirer or valuation skilled to the ideal segment of market pricing because that undeveloped acreage.

Adaptation of black color Scholes option Model

The PUD and also unproved valuation version is commonly seen as an adaptation the the black Scholes alternative model. The black Scholes option model is a extensively used version used to develop the worth of European-style options. The adaptation is many accurate and useful when the owners of the PUDs have the opportunity, yet not the requirement, to drill the PUD and unproven wells and also the time durations are long, (i.e. 5 to 10 years). The value of the PUDs thus consists of both a DCF value, if applicable, add to the optionality that the upside pushed by potentially higher future commodity prices and also other factors. The comparative inputs, regarded as a real option, are displayed in the table below.


When these inputs are provided in an choice pricing version the resulting worth of the PUDs reflects the unpredictable nature that the oil and gas market. This application of alternative modeling becomes many relevant near the lower finish of historical cycles for a commodity. In a high oil price environment, including this factor to consider to a DCF will certainly have little impact as advance is booked for the near future and the chances for future fluctuations have small impact top top the time of cash flows. At low points, top top the various other hand, PUDs and also unproved reserves might not generate confident returns and, thus, will certainly not be exploited immediately.

If the ideal to drill can be postponed for an extended period of time, (i.e. Five to ten years), those reserves still have value based upon the likelihood lock will come to be positive investments when the sector shifts at some allude in the future. In the language that options, the moment value of the out-of-the-money drilling opportunities can have far-reaching worth. This worth is not strictly theoretical either, or just applicable to reorganization negotiations. Market transactions with small or no proven producing reserves have actually demonstrated far-reaching value attributable to non-producing reserves, demonstrating the acknowledgment by the swimming pool of buyers the this optionality upside.


We caution, however, the there can be constraints in the model’s effectiveness, together we describe in Bridging Valuation Gaps, component 3. Specific and cautious applications of assumptions are needed, and even then black Sholes’ inputs perform not constantly capture several of the inherent threats that have to be thought about in suitable valuation efforts. Nevertheless, alternative pricing deserve to be a valuable tool if wielded with knowledge, skill, and good information, providing secondary lens to peer right into a periodically murky marketplace.

Today’s marketplace is an especially murky, and also a high quality appraisal is very valuable, because establishing reasonable and also supportable proof for PUD, probable and possible reserve worths may help in a reorganization process that identify the survival of a company, or the return profile because that a potential investment, or merely standing approximately third-party scrutiny. Given these conditions we feel the the benefits of using option pricing much outweigh that challenges.

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Mercer capital has far-reaching experience valuing assets and also companies in the energy industry, mostly oil and gas, bio fuels and also other minerals. Call a Mercer resources professional today to discuss your valuation requirements in confidence.