Charting a Course for High Quality Oil and Gas Appraisals: A Review of Best Practices Bob Adair
Daron Fredrickson Director, Indirect Tax
Phillips 66 Company
Chesapeake Energy Corporation
Director, Property Tax
Houston, Texas
[email protected]
Oklahoma City, Oklahoma
[email protected]
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IPT Annual Conference * San Diego, California
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Learning Objectives • Identify new developments in state valuation regulations and contrast methodologies for oil and gas property appraisal across the country. • Evaluate whether or not excess operating costs are being properly quantified in upstream discounted cash flow appraisals. • Verify that external economic obsolescence for midstream and downstream properties is being recognized.
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Oil & Gas Assets
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Oil & Gas Well Valuation (Upstream)
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Oil & Gas Well Appraisal Basics There are two primary methodologies used to value oil & gas wells, the Cost Approach and the Income Approach. Though the Market Approach is a useful measurement of the accuracy of assessments, it is rarely used as a primary methodology.
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The Income Approach Though many parameters go into the Income Approach calculations for valuing wells, there are four primary drivers. • • • •
Operating costs Product price Start rate / production Decline rate
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Example of a Typical Income Approach Gray Area – Production Yellow Area – Price Green Area – Operating Cost Blue Area – Expected Value
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The Income Approach It is important to fully understand what personal property is represented in the Income Approach assessments. Other than salvage value, any equipment addition is potentially a double assessment. In the current market, the actual salvage value could be less than zero. It is important to review any salvage value for equipment that is included in the assessment. 8 June 28 - July 1, 2015
IPT Annual Conference * San Diego, California
The Cost Approach The Cost Approach is used less frequently to value wells than the Income Approach. In some states both are applied to the same wells. There are two very important issues when considering the Cost Approach assessments. • The source data (schedules or actual cost) • Understanding the equipment included in the valuation (what is taxable by law) 9 June 28 - July 1, 2015
IPT Annual Conference * San Diego, California
The Approaches to Value Used in Four Example States • Texas – Income Approach with some consideration for equipment • Kansas – Scheduled Income Approach with some consideration for equipment • Louisiana – Cost Approach with minerals exempted • Wyoming – Income Approach on the minerals from the state and a Cost Approach on the personal property from the county.
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Texas Appraisal Firm Valuation Example
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Example Kansas Rendition Form
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Example Louisiana Rendition Form
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Example Wyoming Annual Report Form
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Example Wyoming County Rendition Form
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IPT Annual Conference * San Diego, California
Current Issues Related to Well Valuations Lower Oil & Gas Prices are Creating Significant Issues for Taxing Jurisdictions & Companies • Jurisdictions reliant on oil & gas values will be greatly impacted in 2015 • Reductions in assessed value will have to be made up in the M&O Rate or services will have to be reduced • Tax Rates to service bonds will increase (I&S Rate) • Companies forced to seek lowest possible market value reflective of current conditions • Some appraisers are disallowing portions of operating expenses and altering pricing scenarios to offset losses 16 June 28 - July 1, 2015
IPT Annual Conference * San Diego, California
Pipeline Valuation (Downstream)
Amounts and calculations are for demonstration purposes only and are not intended to be similar to actual properties.
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Basic Concept in Unit Valuation Value entire company (the “unit”) Apportion unit value to states Allocate state value to jurisdictions Apportionment for state income taxes is usually based on one or more of property, payroll and sales. For property taxes, apportionment and allocation are usually based on one or more of book cost, net book value, miles of pipe and income.
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Basic Data for Pipeline Unit Appraisals FERC Form 6 financial statements (previous 3-5 years) Information by category for value adjustments (technological deficiencies, intangibles, explanations of planned significant changes, functional obsolescence cures, income shortfall, etc.) System capacity and throughputs by segment (previous 3-5 years and forecast) 19 June 28 - July 1, 2015
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Income Approach to Value Determine “normalized” cash flow as a reasonable expectation for future years. Use direct capitalization rate with market capital structure and cost of debt and equity. IRV: Income / Rate = Value
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Example Calculation of Income Approach to Value
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Example Calculation of Cost Approach to Value
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Reconciliation of Value
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Refinery Valuation (Downstream)
Amounts and calculations are for demonstration purposes only and are not intended to be similar to actual properties.
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Crack Spreads
Source: Scotia Howard Weil, 5/22/2015 27 June 28 - July 1, 2015
IPT Annual Conference * San Diego, California
Primary Principles of Value Anticipation – “Value is the present worth of all the anticipated future benefits to be derived from a property. The benefits, in the form of an income stream or amenities, are those benefits anticipated by the market … Prior sales and prior income streams are important only when they parallel the current actions of buyers, thus providing an indication of what may be expected in the future.” This is the Income Approach to value. Substitution – “A property’s market value tends to be set by the cost of acquiring an equally desirable and valuable substitute property, assuming that no costly delay is encountered in making the substitution.” Contribution – “The value of a component of property depends upon its contribution to the whole. In other words, the cost of the component does not necessarily equal the value the component adds to the property.” I.e., the value of new capital investment may be close to its cost … but not necessarily. It’s also a primary reason for adjustments to Sales. Source: Property Assessment Valuation, International Association of Assessing Officers
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Property Information – Refinery Crude Capacity: 250,000 barrels per day Nelson Complexity: 11:3 Equivalent Distillation Capacity: 2,834,000 bpd Physical Factors Generally maintained consistent with industry average.
Functional (Internal) Factors Built in 1940s. Less than optimum general layout. Greater operating cost and less efficient production yields compared to current generation technology.
External Factors Current and anticipated refining economics below prior normal highs, volatile crude cost, domestic demand declining. Significant environmental demands, capital and operating. 29 June 28 - July 1, 2015
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Nelson Complexity Factor
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Sales Comparison Approach
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Income Approach
(thousands, unless otherwise indicated)
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Cost Approach Measuring External Obsolescence (IAAO) Capitalize the income loss attributable to the negative influence (similar to incurable functional obsolescence). Compare comparable sales of similar properties, some exposed to the negative influence and others not. Note: This method is preferable, but often impractical.
Source: Property Assessment Valuation, page 173, International Association of Assessing Officers 33 June 28 - July 1, 2015
IPT Annual Conference * San Diego, California
Cost Approach Measuring External Obsolescence (ASA) Inutility (lower than optimal utilization) Excess Operating Cost Income loss attributable to the negative factor Industry returns versus alternative investments Gross margin trend Stock price/net book value ratios (industry versus general market)
Other – evidence of changes in use, idle or shutdown plants within the industry Sales transactions of comparable properties Source: Valuing Machinery and Equipment, page s 96-102, American Society of Appraisers 34 June 28 - July 1, 2015
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Cost Approach
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Reconciliation of Value
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Exceptions to Previous Examples • California – Proposition 13 and current attempt to reinstate State Board of Equalization Rule 474 for refineries only. • Montana – A 2011 MT Supreme Court decision concluded the Department of Revenue: (1) may use their earnings-to-price ratios in a direct capitalization approach; and (2) may assume the depreciation in the annual FERC filing includes all depreciation unless evidence suggests additional obsolescence. • Oklahoma – Intangible value has been exempt since 1/1/2013. 37 June 28 - July 1, 2015
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Refinery Appraisal Resources • HowStuffWorks.com – How Oil Refining Works • OSHA Technical Manual – Section IV: Chapter 2 – Refining Processes • Introduction to Crack Spreads (CME Group) • Refining Complexity (Johnson, Oil & Gas Journal, 1996) • Appraising an Oil Refinery in the 21st Century (Remsha, American Appraisal, 2011) • Downstream Glossary (DownstreamToday.com) 38 June 28 - July 1, 2015
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