When you mentioned that the PV_10 of PBR at $74/bbl price is $120B based on your linear plot, you should the present value with its EV, which is around $111B (MC of $74b plus net debt of $37B).
I believe the NPVs published by Wall Street firms significantly underestimate the asset of many commodity companies. The primary reason is they tend to use a flat or even declining future commodity price. The 3P (proven, probably and possible) reserves of some Canadian oil sands companies (such as CNQ, CVE, MEG and SU) can last 30 to 60 years. But at a flat oil price and 10% discount rate, the CFs after 25 years makes negligible contribution to the NPV. Since the CFs in distant future years receives little credit and it takes a lot of money to convert resources into reserves., many IOCs just try to keep their reserve life index to around 8-10 years.
The problem with discounted cash flow model is best illustrated by this scenario. Suppose that you bought 1 Oz of gold from me (a gold miner) at around $250 in 2000. At that time, I also had another Oz of gold that had not been mined and I decided to keep in underground too. Because my net profit margin of mining was 33%, the value of my 1Oz gold in the ground was $82.5. As you treated your gold as saving, you dug a hole in your backyard and store it underground. Then we both went to a Wall Street analyst to him to estimate the NPV for your and my gold in 2023 at discount rate of 10%. The analyst would likely have told us that your underground gold worthy $250 (assuming no storage and maintenance fees) while my ground gold would just be around $10. (82.5/1.1^22) (also assuming not maintaining fee of the mine). Both numbers were in the year 2000 dollar.
In 2023, the 10% discount rate actually works out pretty well for your underground gold, as $250 x 1.1^22 gives $2035 in the 2023 dollar, which is very close to Friday's gold spot price of $2011. However, if I use the same ratio to convert year 2000 NPV of my underground gold, it will give me only a value of ~$82 today. which significantly underestimates the present value. Even if my net mining profit margin has dropped in 22 years, say. to 25% today, my 1Oz underground gold should still be valued at ~$500. (The ASIC of many gold miners today is around $1200/Oz)
My conclusion is that the values of long duration commodity assets are often grossly underestimated.
Enterprise value is best for comparing companies together. Since Petrobras' debt level is now conservative, and I am looking at a time series, I think it's fine to look at market cap alone. For Equinor, EV is advantageous because of their net cash position. If EQNR had net debt, I would have presented PV-10 versus market cap (assuming leverage was low).
The PV-10 data I used come from the producers, not Wall Street estimates. PV-10 is based on SEC guidelines which only include proved reserves. And it does not account for the value of non-reserves assets, such as marketing. It's a useful model but it's not flawless. I like that it's conservative. I don't want to pay the full price; I want a bargain.
If a company has decades of reserves left, it's nice but it does not really matter. It's the production that comes out of the ground during a bull market that counts. A short payback period is better (more certain) than a long payback period (less certain). The discount rate is a way to price that risk, even though the commodity may hold its value.
Thank you. I worry that it's just confirmation bias at this point. The first article was about risk/reward. The second was looking at history and sentiment. The third was identifying strategic attributes (i.e. oil). I probably could have stopped writing about the company after. But it's dangerous to look at a single variable or period. The analysis is complete now.
Thanks for another excellent column on PBR.
When you mentioned that the PV_10 of PBR at $74/bbl price is $120B based on your linear plot, you should the present value with its EV, which is around $111B (MC of $74b plus net debt of $37B).
I believe the NPVs published by Wall Street firms significantly underestimate the asset of many commodity companies. The primary reason is they tend to use a flat or even declining future commodity price. The 3P (proven, probably and possible) reserves of some Canadian oil sands companies (such as CNQ, CVE, MEG and SU) can last 30 to 60 years. But at a flat oil price and 10% discount rate, the CFs after 25 years makes negligible contribution to the NPV. Since the CFs in distant future years receives little credit and it takes a lot of money to convert resources into reserves., many IOCs just try to keep their reserve life index to around 8-10 years.
The problem with discounted cash flow model is best illustrated by this scenario. Suppose that you bought 1 Oz of gold from me (a gold miner) at around $250 in 2000. At that time, I also had another Oz of gold that had not been mined and I decided to keep in underground too. Because my net profit margin of mining was 33%, the value of my 1Oz gold in the ground was $82.5. As you treated your gold as saving, you dug a hole in your backyard and store it underground. Then we both went to a Wall Street analyst to him to estimate the NPV for your and my gold in 2023 at discount rate of 10%. The analyst would likely have told us that your underground gold worthy $250 (assuming no storage and maintenance fees) while my ground gold would just be around $10. (82.5/1.1^22) (also assuming not maintaining fee of the mine). Both numbers were in the year 2000 dollar.
In 2023, the 10% discount rate actually works out pretty well for your underground gold, as $250 x 1.1^22 gives $2035 in the 2023 dollar, which is very close to Friday's gold spot price of $2011. However, if I use the same ratio to convert year 2000 NPV of my underground gold, it will give me only a value of ~$82 today. which significantly underestimates the present value. Even if my net mining profit margin has dropped in 22 years, say. to 25% today, my 1Oz underground gold should still be valued at ~$500. (The ASIC of many gold miners today is around $1200/Oz)
My conclusion is that the values of long duration commodity assets are often grossly underestimated.
Enterprise value is best for comparing companies together. Since Petrobras' debt level is now conservative, and I am looking at a time series, I think it's fine to look at market cap alone. For Equinor, EV is advantageous because of their net cash position. If EQNR had net debt, I would have presented PV-10 versus market cap (assuming leverage was low).
The PV-10 data I used come from the producers, not Wall Street estimates. PV-10 is based on SEC guidelines which only include proved reserves. And it does not account for the value of non-reserves assets, such as marketing. It's a useful model but it's not flawless. I like that it's conservative. I don't want to pay the full price; I want a bargain.
If a company has decades of reserves left, it's nice but it does not really matter. It's the production that comes out of the ground during a bull market that counts. A short payback period is better (more certain) than a long payback period (less certain). The discount rate is a way to price that risk, even though the commodity may hold its value.
Well done Sir. Thank You! I enjoy reading your thoughts on PBR vs whomever basically haha. Im Biased I guess.
Thank you. I worry that it's just confirmation bias at this point. The first article was about risk/reward. The second was looking at history and sentiment. The third was identifying strategic attributes (i.e. oil). I probably could have stopped writing about the company after. But it's dangerous to look at a single variable or period. The analysis is complete now.