I had a friend who was in charge of buying and selling producing properties for our company.
He was very pleased with his success and pointed out that each year he had sold properties for more than they were worth, and replaced them by buying properties for less than their real worth.
Is this a great business, or what?
Perhaps this true story illustrates some of the problems with valuing producing properties. Either my friend was dealing with a large population of fools, or he was valuing his sale properties too low and his acquired properties too highly. Fools are hard to find in our business.
At some time or another, most geologists will be involved in the valuation of properties. I would like to spend a minute looking at the problem of assessing value from the particular point of view of the seller.
Do properties have a "true" value that can be determined by proper analysis of production history, proper forecasting of oil prices, operating costs and cost of capital?
There are approaches that will improve analysis of production forecasts, but accurate prediction of crude oil price and operating cost remain elusive. And, are these improvements in analysis procedure what we need to establish the "real" value of the property we want to sell?
If we have an absolutely perfect method for establishing the present value of a producing property, does that tell us how much to sell the property for?
No!
Let me explain.
We do not want to sell to others at what we might agree is a fair or adequate price; we want to sell the property for the highest possible price. We have little interest in selling at an acceptable price, if someone will happily pay much more for the property.
What we need to worry about is not value, but venue.
Instead of worrying whether we have correctly calculated the present value of a property we wish to sell, more helpfully, we need to find a venue in which maximum price will be paid for our property. We want to have the property sold at some sort of auction, hopefully with numerous bidders.
The theory of competitive bidding points out that when numerous bidders vie for the same property, the winner almost certainly pays too much. As the seller of the property, you benefit when the "winning" bidder pays too much, pays more than your careful analysis of true value.
If you are charged with providing a valuation for a seller of a producing property, worry less about calculated value; worry more about placing the property in a venue that will maximize return to the seller.
Let a competitive market set maximum value for the seller.
Bargaining (negotiations between two parties) is another well-established way to bring buyers and sellers together to value goods.
I had a marvelous opportunity to observe a real negotiator at work; I was visiting our Doula office, and was taken to an outdoor market by our local manager, a Cameroonian.
He watched my feeble efforts to bargain in French, and then asked if he could take over the negotiations. He told me to go sit in our nearby car.
He picked up five or six of the native necklaces and strode back to our car, closely followed by two nervous merchants. He got in the car, closed and locked the doors, rolled down the window an inch and proceeded to bargain, from inside the car, with the necklaces in his hands.
They made him a great deal!
I remember giving advice to our young and eager negotiators as they left for meetings with foreign government representatives to discuss contract terms. I said:
"You have no chance to out-negotiate the government representatives; they have spent their lives in bargaining every decision, every day of their lives; your advantage is of a different sort; you know what the contract is worth to us and when to stop negotiating."