The Valuation of Oil Reserves

Abstract

The decision to make investments in oil or gas reserves is determined by the relationship between the value of a barrel in-ground and the cost of creating a new one. Wide disparities between these two values will result in investment or disinvestment until the in ground value is equal to the cost of replacement. Over the past few years there have been several mergers and acquisitions in the domestic oil and gas industry. Some of these mergers have include the purchase of large quantities of proven reserves at prices that were deemed to be low in relation to the development cost of the reserves. This is evidenced in the oft-repeated saying that "it is cheaper to buy oil on Wall Street than by drilling". If so, the price of the asset oil in the ground is much less than its cost. It is difficult to see why sellers insist on giving away assets, year after year. The implication is that the capital market is inefficient, a proposition worth testing. In this paper we examine the market value of reserves to test this proposition.

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“…3 and No. This experience has been supplemented by numerous interviews and a survey of individuals active in the acquisition areas.…”