When it comes to raw materials, especially for fossil fuels, it’s essential to evaluate existing and potential production capabilities for such companies. Using the EV\/2P Ratio is a powerful tool when evaluating fossil fuel-related companies.<\/p>\n
This ratio is calculated by dividing a business’ enterprise value into the company’s reserves. It provides financial analysts, investors and internal business stakeholders with a snapshot of a company’s reserves and the business’ likelihood of preserving operation growth. This standardizes valuations, thereby allowing analysts to compare company-to-company financials.<\/p>\n
Enterprise Value (EV) \/ Total 2P Reserves<\/p>\n
Defined as: Enterprise Value = Equity (open market price) + Debt (open market price) – Cash and Cash Equivalents<\/p>\n
2P = Proven and Probable Reserves<\/p>\n
If a company’s capitalization is $300 million and debt consisting of $225 million, along with $30 million for proven reserve value, $20 million in probable reserves, and $25 million in possible reserves, the company’s resulting enterprise value becomes:<\/p>\n
$300 million + $225 million = $525 million<\/p>\n
The 2P reserves is:<\/p>\n
$30 million + $20 million = $50 million<\/p>\n
Plugging the numbers into the original formula, it’s: $525 million \/ $50 million = 10.5x (multiple)<\/p>\n
Based on the resulting 10.5 multiple, this ratio provides a current valuation that translates to for every $1 in 2P reserves equals $10.50 of a market valuation.<\/p>\n
Reserves are how internal\/external stakeholders value the production\/growth potential of oil\/gas companies. It’s broken down into two categories:<\/p>\n
1.) P1 are proven reserves, which are the highest caliber reserves. There’s at least a 9 in 10 percent likelihood (or more) of recoverable reserves. It’s also known as P90.<\/p>\n
2.) Probable reserve (also known as P50) has an even chance of either non-recoverability or realized recoverability. This is the next best, but a lesser grade than P1.<\/p>\n
These two resource categories are referred to as 2P.<\/p>\n
Depending on the company’s calculated EV\/2P Ratio, the business owner or investor can determine a course of action to take.<\/p>\n
If it’s higher, it’s more highly valued than its competitors based on the same level of 2P reserves; therefore, the company’s shares are more expensive against its peers. This can give investors pause because other undervalued stocks are more attractive due to a higher likelihood they’ll appreciate.<\/p>\n
However, if a company is valued higher, but the company is more efficient or a higher performer, investors also may be interested because its production and earnings justify the higher valuation. That’s why looking at the metric in a silo is not effective.<\/p>\n
When it comes to debt and analyzing this ratio, fossil fuel businesses are often highly levered since they use massive sums of debt for research and development and continued operations.<\/p>\n
Since the EV value looks at debt and equity concurrently, analyzing a company’s capital structure is essential when comparing companies’ valuations. Essentially, if a company has too much debt and if interest rates suddenly increase or it can’t service debt if the price of crude plummets, it may run into debt servicing issues.<\/p>\n
While this ratio is effective in providing a level playing field for analytical uses, it’s important to remember that it needs to be used in conjunction with comprehensive financial analysis.<\/p>\n
Version 6<\/p>\n","protected":false},"excerpt":{"rendered":"
When it comes to raw materials, especially for fossil fuels, it’s essential to evaluate existing and potential production capabilities for such companies. Using the EV\/2P Ratio is a powerful tool when evaluating fossil fuel-related companies. Defining the Ratio This ratio…<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false,"footnotes":""},"categories":[4,11],"tags":[],"class_list":["post-846","post","type-post","status-publish","format-standard","hentry","category-blog","category-general-business-news"],"acf":[],"yoast_head":"\n