What it means
Oil and gas companies own reserves, which are volumes of oil and gas in the ground that can be recovered in future. These reserves will produce income over many years, but money received later is worth less than money received today.
Present value is the way of expressing future cash in today's terms. PV10 follows a standard approach.
Engineers estimate how much oil and gas will be produced from proved reserves, then work out the revenue, subtract operating costs, taxes and development costs, and discount each year's net cash flow at 10%. The sum is the PV10.
Because every company uses the same discount rate, PV10 makes comparisons easier. A lender can compare the reserve value of two borrowers without having to guess which discount rate each should use.
It is also used in annual reports and in reserve-based lending, where a bank decides how much it will lend against the value of the reserves. PV10 is not the same as market value or fair value.
It uses prices and cost assumptions that follow set rules, often based on an average of past prices rather than a forecast. The result can therefore be well above or below what a buyer would actually pay for the reserves.
Lenders typically lend only a fraction of PV10, often well below 100%, to allow for price falls and operating problems. If prices drop, the reserves' PV10 falls and the borrowing limit may be reduced.
Companies must therefore watch it closely. A nuance is that PV10 may be shown before tax or after tax.
The pre-tax version is often quoted in the industry because it avoids the effects of different company tax positions, while the after-tax version is closer to the reported accounting measure. Readers should check which one is being quoted before comparing figures.
In practice
Real-world examples.
Example
A small oil producer wants a credit line from its bank. The bank asks for a reserve report showing a PV10 of $30,000,000 and agrees to lend up to 50% of it, or $15,000,000. The borrowing base is reviewed again when prices change.
Example
An investor compares two listed gas producers. One has a PV10 of $200 million and debt of $150 million, and the other has a PV10 of $200 million and debt of $50 million. The second has much more headroom between its reserve value and its borrowing.
Example
A company considering buying another producer uses PV10 as a starting point for a price. The target's PV10 is $80,000,000, but the buyer adjusts it for expected price changes and unproven reserves. The final offer is based on those adjustments, not the PV10 alone.
Formula
Calculation
PV10 = sum of [net cash flow in year t / (1.10) ^ t] for each year of production
Suppose a field is expected to generate net cash flows of $1,100,000 in year 1, $1,210,000 in year 2 and $1,331,000 in year 3. The present values are 1,100,000 / 1.10 = $1,000,000, 1,210,000 / 1.21 = $1,000,000 and 1,331,000 / 1.331 = $1,000,000. PV10 = 1,000,000 + 1,000,000 + 1,000,000 = $3,000,000, even though the undiscounted total is $3,641,000.Case study
Seen in the real world.
Ridgeline Petroleum is an illustrative, fictional exploration company with proved reserves reported at a PV10 of $120,000,000 and bank debt of $50,000,000. The bank's rule was that debt should not exceed 50% of PV10, which left $10,000,000 of headroom, since 50% of 120,000,000 is $60,000,000.
Oil prices then fell sharply, and the new reserve report showed a PV10 of $70,000,000. The bank's limit dropped to $35,000,000, below the existing debt of $50,000,000. Ridgeline had a borrowing base deficiency of $15,000,000 and had to repay or find extra security within a set time.
The company sold a non-core property for $12,000,000 and negotiated an extension for the rest. The illustrative lesson was that PV10 is not static, and lending limits move with commodity prices.
Watch out
Common mistakes.
- Treating PV10 as the market value of the reserves, when it follows fixed rules and a fixed discount rate.
- Comparing a pre-tax PV10 from one company with an after-tax figure from another.
- Assuming lenders will lend 100% of PV10, when they usually lend only a fraction to allow for a margin of safety.
Questions
People also ask.
Why is the discount rate fixed at 10%?
It is an industry convention that makes figures comparable between companies, even though no company's true cost of capital is exactly 10%.
Does PV10 include probable and possible reserves?
Usually it covers only proved reserves, although some companies also show values for other categories separately and clearly labelled.
How often is PV10 updated?
Companies normally update it at least annually in a reserve report, and lenders may require updates more often when commodity prices move sharply.
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