SRC Energy (SRCI:NYSE) – Valuing Oil & Gas Companies

Whilst I’m not a huge fan of investing in commodities like Oil & Gas, base metals, and etc., I thought it’d still be interesting to make today’s article and video about this topic, and will be using SRC Energy as an example company on how you may want to approach valuing Oil & Gas equities.

Reasons why I dislike commodity equities:

  • Not only do you need to know your company, you also need to be fully across macro economics and socio-political factors – this will mean you’ll be at a significant disadvantage if you’re not an industry insider;
  • Oil & Gas reserves are based on technical reports and analysis by “competent persons” – nobody can ever be 100% sure how much Oil & Gas is underneath the ground, hence the inherent nature of these equities are higher risk;

What are reserves?

There are 3 types of reserves:

  • Proven – 90% of commercial feasibility to extract
  • Probable – 50% of commercial feasibility to extract
  • Possible (inferred/indicated) – 10% feasibility to extract

As mentioned above, this is measured by “competent persons” and is their best educated guess, based on various techniques and methods – it’s uneconomical to dig up an entire patch of ground or a seabed to make 100% certain, hence there is always room for human error.

There are also “resources”, which happens to be measured by the same group of “competent persons” – these are not classified as reserves because they’re less confident about these, hence why they’re classed as “resources” – all of this seems highly anecdotal to me, which is why as an average retail investor, I think it’s safer to discount the potential value of these “resources” (unless you’re well versed in reading 150+ page technical reports, drilling, fracking, engineering, geology, etc.)…

What are SRCI’s reserves worth?

I’m unsure how to insert tables into forum posts, but in my video analysis, I’ve calculated a range of possible values for SRCI’s Oil, NG, and NGL reserves, using a spot price range of ~$45 – $70; I’ve also calculated their historic realised operating and net margins, along with how effectively they hedge and deliver into the spot market (realised vs. spot price) for the last 10 quarters.

Based on proven reserves, SRCI appears to be trading at fair value, at an Enterprise Value of ~$1.87 billion.

Other factors to consider:

  • The next oil bear and bull market – how long these will last for;
  • What are the geo-political uncertainties e.g.: Libya, Iran, overproduction, undersupply, manipulation by OPEC, etc.;
  • How American Oil & Gas companies can remain competitive, if they need to ship their exports across an entire ocean vs. Gazprom being able to deliver it directly via it’s pipeline network

Conclusion

Whilst these equities can be very lucrative if you get it right, I believe it’s more prudent for average retail investors stick to something easier to understand – more often than not, even many industry insiders get it wrong than right…

 

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