Oil and gas analysts use many different metrics to explain and compare the value of an oil and gas company, specifically an exploration and production (E&P) company. The most popular metrics (at least according to our eyeballs) include EV/Production, EV/Reserves, EV/Acreage, and EV/EBITDA(X). In this post, we will dive into the EV/Production metric, and explore its most popular uses.

Definition

EV/Production is a commonly used valuation multiple in the oil and gas industry which measures the value of a company as a function of the average number of barrels of oil equivalent (BOE), or thousand cubic feet of natural gas equivalent (MCFE) equivalent, produced per day over a period of time. Whether BOE or MCFE is used as the measure is arbitrary and generally follows whether the company primarily produces oil or liquids (BOE) or natural gas (MCFE). When using this multiple, it is important to remember that it does not explicitly account for future production or undeveloped fields.

Common Uses

Let’s investigate deeper into some of the common uses of the multiple:

1. BOE or MCFE. BOE or MCFE is a way to to consolidate different energy sources into a single, comparable figure. This is useful when reporting to investors or drawing comparisons across companies. These measures roughly equivocate energy content between these production types. The most prevalent conversion ratio is 6 mcf of natural gas:1 bbl of oil. Sometimes liquids are reported in gallons. 1 barrel is equal to 42 gallons in volume.
2. Premium or Discount. If the multiple is higher compared to its peers, it only appears to trade at a premium, but it does not mean the market value of the company is at a premium or more expensive than its peers. If it trades at a discount to its peers, the same is also true; it does not automatically mean the value of a company is cheaper than its peers. To draw that conclusion, one assumes each of its peers has the exact same future production outlook, the exact same well locations and the exact same management team, just to name a few. Making this assumption in isolation is in error. Instead, analysis should be performed to understand the why behind a perceived “premium” or “discount.”
3. Current or Future Production. The metric uses current production as an indication of value for the company. When using this metric, it could be assumed that (1) the current oil/gas/natural gas liquids mix will stay the same; (2) the current production level will continue on its previously experienced decline rate; and (3) the equivalency formula to translate gas production into oil production will not change. This metric fails to account for visibility into future production. When analyzing an E&P company, future production should always be considered.

Experience

While this multiple is useful, it also has its shortfalls. As with all multiples, it should not be used as the sole consideration in assessing value. As an example, using this multiple in isolation would give zero value for an E&P flush with acreage and no production.

Other shortfalls include not accounting for realized price differentials and production types, often implying discounted multiples for gas producers. Production multiples don’t reflect the actual prices producers receive, which vary by hydrocarbon quality, transport costs, and other factors. The standard 6 mcf:1 bbl conversion also overstates gas’s value—at current prices, 6 mcf of gas (about $20.5) is far below a barrel of oil ($67.3). Similarly, other hydrocarbon liquids like natural gas liquids and condensate sell for a fraction of crude oil prices. That’s why these characteristics are important to keep in mind when making comparisons between companies.

Conclusion

Multiples such as EV/Production can provide context for market pricing in the form of a range. Relying solely on a single market multiple as an indication of value can be limiting, especially when valuing a privately held company.

Ideally, market multiples should be used as one of many value indicators during analysis. While there may be facts and circumstances that prohibit the use of multiple value indicators, it is always advisable to (1) understand the implications of using a specific multiple; (2) understand its weaknesses; and (3) use other value indications together.

When observing the EV/Production multiple, reconcile the observations with other valuation multiples and valuation indications for a reasonable analysis.

For assistance in the process or other valuation analysis for an energy company, contact a member of our oil and gas team to discuss your needs in confidence.