The theory and art of asset valuation: Building a case for change
Applying to the oil and gas industry what finance has learned
SPE Workshop Banff, Alberta, Canada 15-17 Sept 2003
Steering Committee Chair: Dr. David Laughton
Available in .pdf here
For several years, many executives and managers in the upstream petroleum
industry have been looking for better processes to generate and evaluate alternative proposals
for the creation and management of assets. As a result of this overall effort, many have come
to believe that a better understanding of potential asset value, its components and
determinants, is necessary if they are to be able to make better decisions and create more
value for their organisations.
The Society of Petroleum Engineers (SPE) had two technical fora, in July
2000 and 2002, that dealt in part with issues of project evaluation. Participants in these
fora requested a workshop on topics in "advanced" economic analysis, including probabilistic
DCF analysis, decision tree analysis, and real options analysis.
The SPE responded to part of that request by asking me to organise a
workshop, which gathered together a small group of executives, managers and technical experts
who focus on valuation issues in the industry, with the following structure.
Workshop participants explored what steps might be taken next by organisations in the
industry to improve the part of the overall asset evaluation process that has to do with
the estimation of asset value under different alternatives for asset management.
To achieve this, there were plenary sessions to bring participants up to date on the latest
developments in, and insights about, current and potential methods for value estimation.
There was also hands-on small group work in using these tools.
Workshop participants discussed the software, consulting, training and other infrastructure
needs of the industry if various types of changes are to be facilitated.
The workshop was designed to help participants to determine:
- if there is a case to be made either for change, or for putting resources into
exploring possible changes, in the industry, in their own organisations, or among
their customers; and, if so,
- what that change is, or which possible changes should be explored, and how to make
the case in the best way possible.
By "value", we meant the price at which the asset would be sold/bought in a
free and deep market for the asset. Such markets involve the trade of economic resources over
time. This is why lessons from finance come into play.
The workshop focussed on potential advances in value estimation based on:
improvements in the DCF methods currently used; and
the "no transactions costs" approximation for price estimation in financial markets,
used by Black, Scholes and Merton, and the people who have followed them, to help
transform financial markets since 1970. (We called this "market-based" valuation for
short. Some people refer to this as "real options analysis", for reasons that were made
clear at the workshop.)
Moreover, the focus was on asset and project valuation rather than
corporate-level issues. Therefore, little time was spent on corporate governance and internal
incentive structures, enterprise risk management or portfolio management. Nevertheless, these
corporate issues formed a backdrop for the asset-level considerations.
Workshop Agenda: Summary
The first day of the workshop and part of the second morning provided
background material needed for the discussion. The rest of the second day was spent in small
teams in a case study (distributed with other materials before the workshop) using various
methods to estimate the value of an asset or project. The third morning was a discussion of
whether there was case to be made for change or to explore possible changes, and, if so, how
to make it.
The small teams were carefully constructed to have the knowledge and
experience needed to accomplish their task.
- David Laughton (University of Alberta), Chair
- Steve Begg (University of Adelaide, 2000 Forum co-chair, (formerly with Landmark and BP)
- Ellen Coopersmith (DecisionFrameworks, formerly with Conoco)
- Mike Grandin (Fording Coal, Encana, formerly with Sceptre)
- Frank Koch (ChevronTexaco)
- Glen Koller (BP)
- Steve Letros (Shell Canada)
- Bob Ligon (Unocal, 2002 Forum chair)
- Morten Lund (Statoil)
- John Parsons (Charles River Associates)
- Gardner Walkup, Jr. (Strategic Decisions Group, formerly with Chevron)
This group included:
- the former CEO and CFO of two leading independent oil and gas producers
- a senior manager in a major division of a large operating company
- people who, as managers, have been responsible for rolling out new evaluation processes in several large operating companies
- people who act, or have acted, as internal evaluation consultants at several large operating companies
- practice leaders at prominent economics, decision analysis and strategy consulting firms
- a former senior manager at a major industry software supplier
- leading financial economists who have consulted on valuation to the industry.
Workshop Agenda: Detailed
Sunday 14 Sept 2003
1830-2000 Opening Reception
Monday 15 Sept 2003
0800-0910 Introductions and a quick review of where we've been,
where we are, where we might go
- The role of value estimation in the decision process
- The role of theory and art in valuation
- A brief review of modern finance
- Strategic, organisational and technical issues involved in revising the valuation methods used in an organisation
0915-1145 Assumptions behind & limitations of DCF, including decision
trees & simulation
- Improving the use of DCF (including how to avoid some common errors)
1200-1300 Small group formation over lunch
1315-1700 The basis for, and examples of, market-based approaches to
1715-1830 Small group Q&A and discussion
Tuesday 16 Sept 2003
0800-0930 Preparing for the case study
- Review of value estimation methods
- Modelling economic uncertainty, using oil and gas price uncertainty as an example
- Learning models of geological and project-level technical uncertainty
0945-1745 Small group case study
Wednesday 17 Sept 2003
0900-1145 The case for change & implementation
- Is there a compelling story for change, or for exploring possible changes?
- If so, What is your desired implementation end state?
- What is the story for change?
- When, where, by/to whom, how should story be told?
- How can I practically implement this "back at the ranch"?
- Doing, presenting, commitment to action, follow through
- Simple take-aways for quick improvements
- What infrastructure support is needed for change?
- How will it get done? (role of OPCOs, service companies, others)
Preference was given to potential participants who:
- were responsible for determining the valuation methods that are to be used in their
organisations, especially if they had past or current experience in managing a programme
to introduce new techniques of probabilistic economic analysis;
- were internal valuation experts in their organisations, especially if they were using
probabilistic economic analysis methods in that capacity; or
- had demonstrable leading-edge expertise as consultants in probabilistic economic analysis
for clients in the industry.
Some Comments by Workshop Participants
"I came away with a much more clear understanding of market-based
valuation and a better way to 'show' the value of legacy assets."
"I obtained a better understanding of some of the theory underlying
market-based valuation and how it differs from that commonly used in traditional valuation
"I learned a great deal. This was a very worthwhile conference."
"The meeting provided a clarification of different valuation techniques.
Market-based valuation is a significant advance but there remain issues of communication with
senior management. David Laughton is exceptionally knowledgeable."
"Of the many SPE activities I have helped to organise, the valuation workshop led by David Laughton is the one that I have enjoyed the most. For a change, I actually got as much as, if not more than, I gave. Some of the concepts we discussed are inherently difficult. There is no way around it. It takes several exposures over a period of time for them to sink in. But it is definitely worth the time and effort."
The photograph was taken by Dr. Laughton looking south from Sentinel Pass, Banff National Park.