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The average private investor can find it most confusing trying to assess a company’s share price when looking at its resource base. This isn’t helped by wild claims by some junior resource stocks (which I won’t name) on billion barrel discoveries. So I’ll briefly explain each of the internationally approved reserve classifications to assist understanding.
We can also look at some of the more popular oil company’s enterprise values versus their resource base to illustrate how you can start playing with figures and building this into your appraisal of stocks.
The below summarises the Petroleum Resources Management System, and the different classifications of reserves:
Reserves
Hydrocarbons that are either already on production, approved for development or justified for development, i.e. commercial reserves. The most common way of assessing a company’s resources is using 2P reserves, i.e. reserves that are already on production and those reserves where a board FID case has been passed. As the reserves should be commercial in order to be recognised then this gives the investor some confidence of a viable production business. Note – commercial is a broad term though, Afren went into administration with 200mm Boe of 2P reserves!
Contingent Resources
These are resources that are discoveries, but development potential is on hold. This could because of sub commerciality or it could be the project is viable but further work is needed to get this to a FID. i.e. there are contingencies which need to be solved before they can be booked as reserves.
Prospective Resources
Exploration Plays, Prospects or Leads. Typically undrilled or not sufficiently appraised to move to contingent resources.
How are companies able to book reserves?
To stop companies quoting utter codswallop in their reserves, a Competent Person Report is required (CPR) before a company can recognise these reserves in its financial reports.
So let’s take a look at the bulletin boards favourite companies…
I’ve looked at Gulf Keystone, Genel Energy, UK Oil and Gas, 88 Energy and Sound Energy. I’m not going to analyse these companies in detail but just make brief comments about what the results show us.
Genel
Very low value assigned to each barrel. The overall OPEX Boe is low, however all contracts relate to Production Share Agreements which are less lucrative. That said this is potentially an attractive valuation and could be a buy signal.
Gulf Keystone
Very low value assigned to each barrel. The overall OPEX Boe is higher than Genel as its transport is through trucking rather than pipeline. Significant CAPEX also likely required to maintain production and access these reserves.
BP
Included as Benchmark, it is hard to value BP on this basis as it only publishes a 1P figure, it also as downstream and trading operations so the figure is likely lower than illustrated above when these factors are adjusted for.
UKOG
The favourite stock of the Bulletin Board. Based on its 2P reserves UK Oil and Gas appears hugely overvalued, with its 2P reserves valued at $60 a barrel this is well in excess of current oil price and thus the current valuation must be expecting material upgrades to reserves from its exploration plays. Let’s look at that next…
The above chart combines reserves, contingent resources and prospective resources so low valuations here could indicate a buy signal and represent significant growth upside.
Genel and GKP
Both have lots of potential resource which could make them good longer term growth plays. Both operate in low CAPEX/OPEX environments, any oil price rise and the KRG payment situation sorted could help significantly. However, high risk too given where they operate. However, here is where you need to be cautious, I would though not buy GKP due to the distressed financial situation it finds itself in (I wrote about this here), this highlights the importance of using analysis like this as part of your research, not basing investment decisions solely on this analysis.
88E
A one trick pony company but with some promise. A recent CPR estimates 768m barrels net. It is also looking at conventional prospects expecting results of seismic soon, this could upgrade its resource bookings further. Again a good speculative play, close to infrastructure and planning permission unlikely to be an issue unlike UK Oil and Gas.
UKOG
Despite lots of media attention with its ‘Gatwick Gusher’ UKOG is unattractive to me. The Gatwick Gusher aka Horse Hill lead is not included in the reserves or resources classifications as it is too immature, and this is confirmed by its own RNS.
UKOG does talk about 3.6bn barrels of OIP, however this is total oil in place and with today’s technology only a fraction will be recoverable. Taking a conservative recovery factor of 20% this gives 730m barrels, which granted if were to be included as prospective resources then it’s $ per Boe would be below that of Genel Energy, which I believe is a value stock. It is not clear to me when UK Oil and Gas will be able to firm up this lead to prospective resources and have a CPR on the figures though so I am very cautious.
Ultimately, for me I would not be considering an investment here until I see a clear timeline towards a booking resources or reserves on Horse Hill. To me one major bottleneck will be building the onshore facilities needed to extract the oil, this discovery with where it is located I cannot see extensive facilities gaining planning permission, at least without a lengthy process. Just look at how close we are at getting a third runway in the south east, extracting 700m barrels of oil in Sussex will be equally as protracted in my opinion.
Sound Energy
I have not included this company on the chart above as it is so far off the chart, its current resources are priced in at $586 per Boe! However, none of its recent discovery in Morocco is included in prospective resources or contingent resources, again I would be looking to understand when work can be done to move this discovery into these categories before jumping in here. Watch closely but not a BUY in my opinion.
Summary
You should never only look at Enterprise Value vs Reserves & Resources when making investing decisions but this screening method can identify over and undervalued companies, as long as you are prepared to understand what additional factors which may be behind valuations.
Disclaimer – I have a position equal to 2% of my net assets in Genel Energy. I have no further positions in any of the other stocks mentioned and to my knowledge nor do any close family, friends nor associates.
This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.
