Abstract

Many independent Nigerian oil & gas companies have emerged over the last decade out of divestments of ageing petroleum assets by multinational oil companies. These transactions are marked by pervasive cases of overvaluation and huge gaps in offers that lead to unnecessarily high acquisition costs.

Petroleum analysts around the world adopt the Discounted Cashflow Analysis (DCF) method in estimating present value of future oil production revenues. Unfortunately, project economics using the conventional DCF evaluation does not de-risk the reserves components appropriately or account for the excess risk premiums. As such their valuation is not commensurate with the risk involved. Usually, even when analysts apply optimistic discount rates of say 10% or 15% when deriving Net Present Value (NPV), they face the dilemma of extracting an offer price from that NPV. Some base their offer on 50% of NPV believing to be conservative, while others throw in all the NPV in a scheme to win the bid at all cost. There are also buyers who sometimes start by plugging in a guesstimated amount as acquisition value using a rule of thumb and then place an offer based on NPV that is left behind. The decision to pay a given percentage of the NPV is entirely subjective and varies amongst investors and as such does not depict a logical perception of market value.

Furthermore, the conventional DCF process also excludes political risk which is most crucial for upstream petroleum investments. And in most cases, these buyers adopt different reserve bases that compound the problem, thus arriving at NPVs that are few and far between each other. The reserves are usually un-risked ‘proved plus probable’ (2P) reserves, which is highly speculative and unrealistic, thus leading to overpricing as seen in most petroleum transactions in Nigeria. The cumulative effect is a huge gap in offers made by different buyers on the same asset and of course, the highest bidder wins. This trend has persisted exposing end-life operators, their investors and financial institutions to potential funding risk and liquidity challenges. Therefore, a change in approach is necessary to inspire a more investment friendly climate and promote policies that can help to mitigate political risks.

For the first time, these concerns of high purchase price and offer gaps have been debugged by addressing above questions using a new Risk-Based Valuation model that is based on a modified Discounted Cashflow (DCF) model. In an extensive research, past stand-alone Nigerian transactions were independently analysed using two approaches, namely, the conventional project economic evaluation method and the new Risk-Based approach. The study concludes that income approach using a Risk-Based DCF model is a preferable technique for determining the Fair Market Value of Nigeria petroleum assets and more suitable than the market approach or asset approach due to obvious reasons explained in this work. The study also introduces the concept of Perceived Market Value to capture an upside premium.

Furthermore, the study was able to establish that buyers are paying on average 4 times the value of these assets with huge offer gaps tending from hundreds of millions to sometimes a billion dollars depending on the deal size. Thus, Risk-Based DCF technique can help prevent over-pricing or under-pricing of Nigerian assets, minimize offer gaps in the market as well as account for the impact of political risks (or their mitigation thereof) in valuation.