What Is PV10?
PV10 is a calculation of the present value of estimated future oil and gas revenues, net of estimated direct expenses and discounted at an annual rate of 10%.
This figure is used in the energy industry to estimate the value of a corporation’s proven oil and gas reserves.
- PV10 is a method of estimating an energy company's potential future earnings based on its proven reserves of oil and gas, using a 10% discount rate.
- It is based on engineers' reports of the estimated costs and revenues that each oil deposit or reserve may produce.
- PV10 is widely used by stock analysts and investors as a measure of an energy company's market value.
In general, it is difficult to place a value on oil and gas reserves, and that makes it difficult to estimate an oil company's future earnings. The PV10 metric is useful in determining an approximate value in an industry that is arguably one of the most difficult for investors to understand and evaluate accurately.
Analysts rely on reservoir engineers for the information used to calculate PV10. The engineer creates a reserve report for existing wells and proven but undeveloped well locations. This takes into account each well’s present production rate, production costs, expenses for reserve development, and its forecast decline rate. Future gross revenues are estimated by using prevailing energy prices or applying a suitable escalation rate.
Only direct expenses are counted in the report. Indirect expenses that are not factored in may include debt service, depletion, amortization, and administrative overhead as well as expenses not related to property.
The PV10 calculation is widely used by investors and market analysts, but it is not a financial metric calculated in accordance with generally accepted accounting principles (GAAP). That is, PV10 does not factor in the effect income taxes will have on future earnings.
PV10 and Enterprise Value
The PV10 calculation is often reported as the EV/PV10 calculation. Enterprise value (EV) is a measure of the market value of the company, inclusive of its equity and debt. The total is calculated by adding together the firm's market capitalization, preferred stock, and debt, and then subtracting cash and cash equivalents.
Essentially, EV can be thought of as a hypothetical takeover price. If the company was purchased, the acquiring company would assume the company’s debt and retains its cash.
If a company’s PV10 value is higher than its EV, the stock is apparently priced below the value it will generate over time. That makes the company’s stock appealing to investors.
If a company’s PV10 value is higher than its enterprise value, investors will see its stock as a long-term buying opportunity.
Example of PV10 Calculation
Consider the hypothetical case of a major international oil company. The company's EV is $449 billion.
The company has 25 billion oil-equivalent barrels of guaranteed reserves. The company expects to replace all of its yearly production with new reserves. That means this figure should remain constant from year to year.
Based on these figures, the oil company's EV/reserve is $17.80, which indicates that its value is about 18 times its proven barrels of oil reserves. The company's PV10 would thus be $176 billion.