Energy Sector Valuation & Interview Questions for Finance

Oil & gas companies are usually valued with a Net Asset Value (NAV) approach that models each field’s cash flows, adjusted for debt and corporate items. Generic methods like DCF or multiples are used as cross-checks but are less reliable on their own due to price volatility.

• NAV: Forecast production, deduct operating costs and capex, discount cash flows, subtract net debt, and divide by shares to get NAV per share
• Cross-checks: Apply a DCF or generic multiples like EV/EBITDA and P/E, especially for midstream or integrated players with steadier cash flows
• Key difference: NAV ties directly to reserves and commodity pricing, which are central in energy

A fall in oil prices reduces revenues almost one-to-one, which puts pressure on margins, cash flow, and ultimately valuation. The impact shows up across all three financial statements.

• Income statement: Revenue declines, margins compress since many costs are fixed, and impairments may be recorded
• Cash flow statement: Operating cash flow falls, which limits capex flexibility and debt repayment capacity
• Balance sheet: Leverage ratios worsen because debt stays constant while EBITDA falls
• Valuation: Equity value usually falls more than the commodity price because of operating and financial leverage

Each segment of the energy value chain has different risk profiles and cash flow stability, so valuation methods must be adapted accordingly.

• Upstream (exploration & production): Best valued with NAV since reserves and commodity exposure drive value
• Midstream (pipelines, storage, LNG): Stable, fee-based contracts make DCF or EV/EBITDA appropriate
• Downstream (refining, petrochemicals): Valued like industrials, using EV/EBITDA or P/E multiples with refining margins as key drivers

Reserves represent the future production base of an oil & gas company and are classified by the probability of being economically recoverable.

• 1P (proved): >90% certainty of recovery
• 2P (proved + probable): around 50% certainty
• 3P (proved + probable + possible): around 10% certainty
• Valuation link: Higher levels of proved reserves increase NAV certainty and reduce perceived risk for investors and lenders

Generic multiples like EV/EBITDA are used, but they miss sector-specific drivers. Energy relies more on measures tied to reserves and production.

• EV/DACF: Enterprise Value / Debt-Adjusted Cash Flow, reflects cash flow available to all capital providers
• EV/BOE/D: Enterprise Value / Barrels of Oil Equivalent per Day, a production-based metric
• P/NAV: Price / Net Asset Value per share, compares market price to underlying reserves
• EV/EBITDA and P/E: Still used, but heavily cycle-dependent and less reliable on their own

ESG concerns and the shift toward renewables change both investor sentiment and the cost of capital for energy companies.

• Cost of capital: Fossil fuel companies face higher discount rates due to perceived risk and reduced investor appetite
• Stranded assets: Carbon-intensive reserves may never be produced, lowering NAV
• Valuation premium: Renewable assets often trade at higher multiples thanks to stable, long-term contracts
• Investor base: More capital flows into renewables, while hydrocarbons experience divestment pressure

LNG projects are more capital-intensive and have different risk and cash flow profiles than typical oilfields.

• Capex profile: High upfront investment with long construction timelines
• Revenue model: Often based on long-term offtake contracts rather than spot prices
• Operating risk: Lower commodity exposure once contracts are in place, but higher project execution risk
• Valuation method: DCF is more appropriate since cash flows are contracted and predictable

• Integrated majors are the world’s largest oil companies (e.g., ExxonMobil, Shell, BP, Chevron, TotalEnergies) that operate across the entire value chain upstream (exploration & production), midstream (transport/storage), and downstream (refining, petrochemicals, retail).
• Pure-play E&Ps are companies focused mainly on exploration and production of oil and gas, without significant midstream or downstream operations. Examples include ConocoPhillips, Apache, and many shale-focused independents.

Integrated oil companies combine upstream, midstream, and downstream operations, which changes their risk profile and valuation relative to pure-play producers.

• Diversification: Downstream and midstream provide more stable cash flows, reducing earnings volatility
• Hedging effect: Refining margins can offset upstream price declines, smoothing results
• Capital intensity: Larger balance sheets and integrated models support lower discount rates
• Investor perception: Viewed as lower risk but with less upside, leading to lower multiples compared to E&Ps

Decommissioning liabilities (often called Asset Retirement Obligations (AROs)) are the future costs an oil & gas company is legally required to pay when shutting down operations.

Decommissioning liabilities need to be factored into NAV and cash flow models.

• Balance sheet: Recorded as a liability with a corresponding asset, then accreted over time
• Cash flow impact: Actual decommissioning cash outflows reduce free cash flow in later years
• Valuation treatment: Subtract AROs or their present value from NAV to reflect the company’s true equity value
• Risk factor: Larger AROs increase leverage and reduce financial flexibility