Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Six – The awkward squad
the interest charge that attaches to the PBO of a pension scheme, discussed in
Chapter four, or the movement in the embedded value of a life insurance
company, to be discussed in a later section of this chapter.)
The solution is to adjust both numbers. We want our profit to reflect not merely
that which has been realised but also the movement in the value of our reserves,
adjusted for costs capitalised during the year. These comprise costs incurred
minus exploration costs expensed directly. And we want our return to be
calculated by dividing profit by the opportunity cost of our reserves at the start
of the year, for which we shall take the SEC discounted value as a proxy. The
point is that we could in theory sell our reserves at this value. If we keep them
and run the company as a going concern, then it is presumably because we can
earn an acceptable return on the fair value of the capital.
The adjustments are shown on page four, and the result is that our capital is now
valued at $99 billion, and that the return made during 2003 on the opening figure
of $97 billion drops to 7.8 per cent. In fairness, this was after an unrealised loss
of $7 billion, because capitalised costs exceeded increase in the value of the
reserves by $7 billion. Movements in reserve values are very volatile, and it is
probably not realistic to assume that a well-managed company will continue on
average to generate negative net present values when it invests.
Pursuing this analysis would require us to take a longer term view of Exxon’s
historical performance and to make explicit assumptions about future value
added that go beyond the space that we can allocate here. For the reasons
discussed earlier, the SEC valuation of Exxon’s reserves will be substantially
below a fair market value, because of the restrictiveness of the reserve definition,
and the high discount rate applied to forecast cash flows. Suffice it to say that
analysing Exxon’s upstream assets with a base assumption that they are worth
some $100 billion, plus whatever adjustment for conservatism is deemed
reasonable, but that the company earns close to its cost of capital on its
incremental investments, is a much better set of working assumptions than that
its assets are worth only $50 billion and that it is generating almost 30 per cent
returns on incremental capital. If the latter were the case then its slow growth and
large returns of capital to its investors would be unintelligible. They are not.
2.6 Some further thoughts on accounting issues in
extractive and energy sectors
The advent of IFRS has produced significant interest in accounting issues for a
variety of sectors, including oil, gas and mining. Interestingly there is a large
IASB project in progress on this industry. In general terms the project group has
made it clear that:
1. The primary financial statements of an extractive industries enterprise
should be based on historical costs, not on estimated reserve values.
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