Over the past couple of issues, I have been covering some of the important metrics for investing in oil and gas companies. While these companies are sometimes accused of exaggerating their resource base to prospective investors, the U.S. Securities and Exchange Commission (SEC) has specific requirements for the way some information is calculated and reported. One of these important pieces of information concerns the proved reserves of a company. We covered this in the previous two issues, but there are specific rules in place in order for a company to claim proved reserves. In this way, we can have confidence that Company A’s proved reserves can be compared with those of Company B.

In the previous issue we discussed the PV10, which is the present value of estimated future oil and gas revenues based on proved reserves (developed and undeveloped) minus estimated direct expenses, discounted at an annual discount rate of 10%. But the PV10 is a non-GAAP measure, and so there can be differences in how different companies arrive at their conclusions. Company A’s PV10 might not be comparable to Company B’s unless they use the same calculation methodology.

Enter the Standardized Measure (SM), which must be calculated according to specific guidelines set by the SEC. The SM is the present value of the future cash flows from proved oil, natural gas liquids (NGLs), and natural gas reserves, minus development costs, income taxes and existing exploration costs, discounted at 10%. All oil and gas firms traded on a US exchange must provide the Standardized Measure in their filings with the SEC.

Companies often report a PV10 as well, and then reconcile that number to the SM. In most cases, the only difference between the two is that the SM accounts for the expected taxes that will have to be paid. Thus, the SM will always be smaller than the PV10, but it should also be consistent across companies.

Like the PV10, the SM is calculated according to the average prices received over the past 12 months for oil, NGLs, and natural gas. Most companies calculated SMs at the end of last year based on oil prices around $100/bbl. This year’s SMs will be calculated at a lower oil price, so those companies that derive a high percentage of their reserves from oil will see their SMs reduced from last year — unless they added enough reserves during the year to compensate for the decline in price.

I wanted to compare a number of the smaller oil and gas producers using the SM metric. Note that the SM is simply an estimate of future cash flows based on the proved reserves estimates. This calculation is sensitive to commodity price, as well as changes in reserves. So it is not a measure of the absolute value of an oil or gas company, but gives us rather a consistent basis for comparison.

In the table below, I show the ratio of Enterprise Value (EV)/Standardized Measure (SM). But if a company has historically been better than others at finding and replacing reserves, they may warrant a higher ratio. I have listed the companies in descending order according to EV, ranging from $5.3 billion down to $360 million.

Reserves = “Proved Reserves” in billions of barrels at year end 2013
EV = Enterprise Value in billion dollars on 11/25/2014
SM = “Standardized Measure”, also sometimes called “Standard Measure”, “Net Future Cash Flow”, or “Future Net Cash Flow” in billion dollars
CR = Total Current Assets for the most recent quarter divided by Total Current Liabilities for the same period
Oil = percentage of the proved reserves estimated to be oil
PD = percentage of reserves that are “Proved Developed”
RG = percentage proved reserves growth from 12/31/12 to 12/31/13
Decline = decline in share price since July 30, 2014

I included the common EV/EBITDA metric as well, and added the Current Ratio to give an idea of relative debt levels (the higher the Current Ratio, the less relative debt). I included the percentage of oil in the reserves because low oil prices are going to make the biggest difference in this year’s calculations. Keep in mind that natural gas prices have mostly been higher this year than last year, so a company with predominantly natural gas reserves isn’t likely to see a big drop in its SM at year end.

I included the Proved Developed percentage, as these are the most secure reserves. The higher the PD percentage, the lower the risk. The year-over-year reserves growth is there just to give an idea of how adept these companies have been at finding new reserves. Finally, I have included the decline in share price since July 30, which is the last time the price of West Texas Intermediate (WTI) was above $100/bbl.

A couple of things stand out from the chart. The first is that Diamondback Energy (NASDAQ: FANG) appears to be significantly overvalued by several metrics relative to its peers. Its EV/EBITDA and EV/SM are both well above the average for all companies compared (6.54 average for EV/EBITDA and 1.92 average for EV/SM). Its Proved Developed percentage is just above the average of 44% for the group. Likewise, its reserve replacement is just above the 54% group average. The company has certainly held up better during the recent decline, tying for the smallest drop (-22%) within the group. But there isn’t anything in these metrics that would suggest that such a premium for Diamondback is warranted.

Swift Energy (NYSE: SFY), Northern Oil and Gas (NYSE: NOG), Penn Virginia (NYSE: PVA), and Oasis (NYSE; OAS) are all relatively cheap according to the EV/SM metric. However, note that Swift Energy has a low Proved Developed percentage, while Northern Oil and Gas and Oasis both have very high oil percentages in their reserves. Typically, this is highly desirable as margins for oil are usually higher, but with the steep decline in the price of crude we may see significant downward movements in the year end SM.  

My objective for 2015 is to develop a large database for oil and gas companies that contains all of the important metrics, updated automatically each time I refresh the spreadsheet. The SM will be a one-time entry and tedious to extract, because it has to be pulled individually from each company’s SEC 10-K filing. But once that has been done, I can utilize it for comparative purposes for the rest of the year.

Conclusions

As with the previous issue, the purpose of this exercise was to identify companies that appear to be trading higher or lower than their peers based on certain metrics. In this issue I used the Standard Measure required at year end by the SEC. The SM is sensitive to commodity pricing and the absolute value of reserves, and can change a lot from year to year. Further, some companies may justify a higher multiple of the SM if they have demonstrated a knack for growing their reserves.

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