Discount Cash Flow Valuation of Upstream Oil and Gas Investments

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Accounting for Uncertainty in Discounted Cash Flow Valuation of Upstream Oil and Gas Investments∗ by William H. Knull, III, Scott T. Jones, Timothy J. Tyler & Richard D. Deutsch∗∗ Valuing future income streams from the production of oil and gas is a welldeveloped discipline within the industry and among sophisticated investors. Valuations drive companies’ investment decisions and market transactions every day. In the context of resolving disputes, especially international ones, arbitral tribunals are frequently called on to perform a similar exercise: to determine a lump-sum damages award to compensate for the loss of an income-producing asset. Both the arbitrators’ decision and the industry’s evaluation entail converting projected…show more content…
E.g. Marboe, supra, at 72526 (asserting that “in certain cases the use of one term [compensation or damages] might be more appropriate than the other” based on the legality of the actions underlying the dispute). This paper does not consider the legality of the actions underlying the dispute. See infra text accompanying note 2. The two terms are thus synonymous for the purposes of this paper and are used interchangeably. 2 subjectivity with respect to an issue that, in some instances, could have effects measured in hundreds of millions of dollars. In order to focus on the single issue of determining the equivalence between present and projected future values in the face of uncertainty, we will address only the question of how to convert projected lost revenues as of a certain date to an equivalent, lump-sum cash award. This starting point necessarily presumes only the involuntary loss of a contract or property or rights. We do not consider the legal nature of the wrong occasioning that loss or other potential components of damages.2 The mathematical models for determining the present value equivalent to projected future revenues derive from economic and financial considerations, not from the legal principles determining a claimant’s right to compensation for loss of those revenues. ASWATH DAMODARAN,

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