With the bar continually raised on the estimated ultimate recoveries (EUR) from wells drilled in U.S. shale gas plays, determining how to value unconventional acreage is proving to be a diverse, complicated process, according to a new report.
Seenu Akunuri, a principal in PwC's transaction services valuation practice, recently completed "Valuing the Great Shale Play" to help guide companies preparing to buy and sell shale gas assets. He has more than 14 years on his resume valuing structuring, buy-side, sell-side, tax and financial reporting purchases, but he told NGI's Shale Daily that valuing assets in unconventional plays has proved to be an intricate and risk-laden process.
"I have worked on conventional and unconventional sales but it's shale that is on everybody's mind," he said. Determining a shale play's value, however, has proved to be a daunting task.
"We're still working on ways to value the shale reserves because it's time consuming to determine what the ultimate recoveries will be," he said. Conventional plays, for instance, have "reliable extraction methods" but because of hydraulic fracturing techniques combined with horizontal drilling the "enhanced recovery is much faster in shales and unconventionals...and you have to link them up with the accretive value...and that plays into how it is valued overall."
The discount rates in the shale plays vary depending on which plays have been proven to perform, he explained. For example, with 10-plus production years of data available, the Barnett Shale has become a more reliable area to evaluate. Determining the worth of the Utica Shale, still in its early days, is much more risky.
"You have to keep in mind the nuances to properly determine fair value," said Akunuri. "Oftentimes, when companies announce a deal, they have the price forecast, the announced closing date. But prices change...and micro, macro factors change...and there are other important factors" involved on the financial accounting end.
"The focal point is to start early...don't get caught off guard," Akunuri said. "If your company is eager to join in the 'shale rush,' you have to make certain you take steps to ensure that acquired reserves are properly fair valued for financial reporting purposes."
The "major component of most shale deals, or any upstream acquisition, is reserves [and] the fair value of the acquired reserves is critical to the overall financial statement impact of the acquisition. While companies are eager to enter shale plays and sometimes are willing to pay a premium to do so, the market price of natural gas is at a five-year low with new production coming online regularly."
This price gap could lead to a big difference in the actual value of the deal for financial reporting purposes, Akunuri said. Another factor skewing value adjustments is "the timing of cash flows and the inability to obtain capital to fund production due to lower gas prices."
Because of the chasm between "strategic value" and "fair value," it's critical that the transaction team meets early with the financial and tax teams to avoid significant value adjustments as the deal is consummated, he said. A particular focus should be on the transaction pricing date versus transaction close date; commodity prices; risking of reserves; income taxes, the discount rates and other assets and liabilities.
"Changes in stock prices themselves may have a significant impact upon the potential level of goodwill or bargain purchase that may be realized once the deal closes," Akunuri said. In any case, due diligence has to be done "up front," long before the purchase agreement is finalized.