There are oil and gas assets for sale-and some of their greatest value may be free! One would have to sit on them for 15 or so years, and the investment premise requires buying into the peak-oil theory. Yet, they pay a quarterly cash distribution now. Did someone say MLP? It's not, but buying into an upstream master limited partnership is one way to invest in this one-off idea.

Traditionally, oil- and gas-producing assets are purchased for present value (PV) that is discounted some percent. The PV is in relation to the asset's reserve/production (R/P) profile. Steep-decline assets go for a discount of maybe 20%. Shallow-water Gulf of Mexico properties can often take this kind of valuation, for example. The shorthand would be PV-20. This means the asset's cash flow beyond five years (if there is any) is discounted to nearly zero, meaning that if there is still any, the owner got it for free.

An example of less-steep-decline assets would be types in the Midcontinent, for example, that carry a PV of 15. A bid on this type of asset would be based on a risk that the asset won't produce any cash flow after an eight-year run if it is operated in a mostly do-nothing or failure-to-improve mode.

And then, there are longer-life oil reserves, such as Encore Acquisition Co.'s Elk and Permian basin assets, and those in the Spraberry Trend held by Pioneer Natural Resources. They carry PVs of 10 or so. They are expected to produce many years, with relatively little geologic risk or cost, such as new exploration and diligent exploitation.

The PV assigned to the asset package usually places little or no value on the probable or possible reserves that do need some diligent exploration and exploitation to surface unless it's a premium resource play. The key premise in developing bids for oil-producing properties is what oil prices might be in five or 15 years. What type of cash flow can be expected during the term of the loan that will be used to pay the seller?

Enter peak-oil theory. This suggests the world's oil reserves can be produced for only another 15 years or so at prices that are affordable to most consumers. If this theory proves true, the value of the asset's remaining oil reserves will be exponentially greater in 15 years than today.

This is counter to the banker's point of view, a convention developed in the 20th century when the threat of tight oil supply was largely temporary and political. Today, there is a geologic risk-running out of economic oil.

Asset-valuation truths should hold dear. But there is a new fact that must be considered when investing in the oil industry today: The average age of today's upstream leadership is estimated at 50 years or older. Meanwhile two other key facts remain: equity investors are usually looking for returns that are nearer-term than 15 years, and commercial-debt providers are bound to value only what's producible as far forward as the futures markets allow.

Thus anyone capitalizing on a peak-oil theory today is left to do so from his own, and his fellow venture capitalists', pockets. Or, buy units in the new upstream MLPs, at least the oily ones. (There is a peak-gas theory, but it is less founded right now than peak-oil theory.) It could be a way to bet both on super-future and near-month oil prices-unit-holders collect quarterly cash distributions that reflect current-month prices, and they hold a stake in an asset that may potentially be worth much more 15 years from now and requires little reinvestment capital.

For a primer on how the new upstream MLPs work, see "Upstream MLP 101" in this issue.

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