Nonproducing reserves are relatively cheap right now even as the gas-price strip climbs, reports Houston-based investment-banking and M&A advisory firm Weisser, Johnson & Co. The firm analyzed deals for producing and nonproducing reserves since 1988 and found that values for producing reserves continue to correspond neatly with the 12-month gas strip. The same was true for implied values of "total proved reserves," which include nonproducing reserves, through 2001. The correlation parted ways in 2002, however. Instead, average total proved reserve valuations have declined while the gas-price strip has risen. Since the implied deal value for proved reserves has grown during the years as the gas-price strip has grown, the study's results suggest the value of nonproducing reserves has been falling. "We believe a confluence of events has led to the caution and skepticism that these (results) reflect. Lower stock values, difficult access to new capital, reduced capital spending on reserve development, less-liquid hedging markets, and heightened skepticism and scrutiny of all forms of soft value or upside potential must all have some effect," the firm reports. The disconnect is not sustainable, however, Weisser Johnson adds. "It is either a correction of past over-valuations or is overly conservative discounting that will soon be corrected. Either way, market perception of future commodity prices, particularly gas, is a major driver of valuation. If gas prices remain near or above current levels, eventually a greater comfort with the sustainability of that price will grow." Meanwhile, producers who have been accumulating lower-price nonproducing reserves will do better when the value of their PUD assets returns to normal or as they develop the reserves, the firm adds. The firm's most recent analysis of M&A activity also finds that: • A long-standing premium for size has disappeared in the M&A market. For the analysis, the firm defined small deals as those of $10- to $99 million and medium-size deals as $100 million to $1 billion. "Since the late 1980s, larger transactions have received a 10- to 30-cent premium per thousand cubic feet of gas equivalent...The premium vanished in 2002. In fact it reverted slightly, with small deals trading for a slight premium." The reason may simply be a factor of supply and demand. "There have been so few deals available that buyers have, relatively speaking, paid up, even for smaller transactions." The premium for scale will return. "But it is a good time to be selling a small deal, especially if it is heavy with proved reserves." • Gas-weighted transactions command substantial premiums, while oil in the ground is cheap. Gas-denominated deals (those with 70% or more of total reserves being gas) have been more numerous each year since 1988 except in 1997, according to the firm's analysis, and have received better prices than predominantly oil deals since 1997. • Implied valuations across different basins have changed. Gulf of Mexico reserves continued in 2002 to be the most valuable for the third consecutive year, while Rockies reserves, which declined in value in 2000 and 2001, improved significantly in 2002, and Midcontinent reserves' value declined considerably in 2002. Shorter-life properties in the Gulf and on the Gulf Coast are getting relatively more expensive on the basis of reserves but cheaper on the basis of production, the firm explains. "The opposite is happening to longer-life Midcontinent and Rockies properties which have returned to their traditional relationships as cheapest on the basis of reserves but expensive on the basis of production." Overall, companies with more time to exploit their reserves may do well to accumulate longer-life properties with significant nonproducing reserves today, while they're cheap, the firm suggests. "As in past cycles, the progress you make during difficult times is the most likely to differentiate you from your competitors and ensure the long-term success of your organization. We see the coming year as a new springboard for many successful companies." -Nissa Darbonne

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