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Oil and Gas Reserves and Shareholder Value

COP 21 represents the first formal squeeze on the global carbon budget – and, as time goes by, the grip is set to tighten.  What does this mean for shareholders of oil and gas companies?

Part – the biggest part – of the answer to this question is the link between market capitalizations of oil and gas companies and their fossil fuel reserves – this being nearly perfect. In numbers: r=0.98.

Proven developed and undeveloped reserves are the most important determinant of the equity value of oil and gas exploration and production companies.  These are the oil and gas deposits that have been discovered or judged to have a reasonable certainty of existing and which are either being extracted or can be viably extracted (refer to SEC’s full definition).

Over the past year crude oil prices have plummeted and, with them, shareholder value in oil and gas companies.  Shareholders in the largest 23 oil and gas companies in the US have lost a combined 22% of their equity value since March 2015 – a total $218bn.[1]  On average, these companies lost 40% of what they were worth just ten months ago, compared to around 2 percent loss combined across all other S&P 500 companies.

Notwithstanding r=0.98 held across this period (as measured against 2014 year-end reserves data published in 2015 annual reports).  There are some nuances to this correlation: smaller companies among the group of 23 fared slightly worse – possibly seen as riskier bets in view of challenges imposed by threatened investments.  The balance between developed and undeveloped proven reserves may have a slight mediating effect on the relationship – although, counter-intuitively, percent in undeveloped reserves appears slightly negatively associated with losses.

International commitment to constrain GHG emissions expressed in COP21 member states’ Intended Nationally Determined Contributions (INDCs) threaten the market value assigned to fossil fuel reserves – coal, oil and natural gas.

With ExxonMobil[2] under investigation by the Attorneys General of two states[3] for potentially misrepresenting to investors the threat that climate change poses to its business, investors and, hopefully, the SEC (which has come under pressure from investors to improve climate disclosure oversight) will be pressing other fossil fuel companies for more straight talk using language that recognises the vulnerability of reserves under carbon constrained scenarios.  Where, up to now, these companies have ignored the potential impact on their reserves valuations of an international agreement to limit global warming, it will be difficult to avoid this issue in 2016 annual reports to shareholders.

 

 

[1] Using market capitalizations as of 7 January 2016.

[2] Exxon holds almost of a third of total reserves of this group and accounts for around 41% of the combined market capitalization of the 23 largest US oil and gas exploration and production companies.

[3] New York and California.