Important bankruptcy ruling on how to value oil and gas assets

BVWireIssue #189-3
June 20, 2018

bankruptcy
discount rate, expert testimony, fair market value (FMV), going concern, net asset value approach (NAV), oil and gas interests, reorganization, solvency, precedent transactions analysis, creditor, debtor, cash flow projections

Valuing oil and gas assets requires special expertise, as is evident from a recent bankruptcy ruling that includes a thorough examination of the parties’ valuation evidence. Practitioners may find the court’s discussion of the experts’ net asset value analyses particularly instructive.

Four critical analytical factors: The debtor, Breitburn, was a group of affiliated oil and gas exploration and production companies with two types of assets. The “Legacy assets” were spread across large parts of the country and included thousands of individual wells with long-life production from proven developed oil and gas reserves. The “Permian assets” consisted of undeveloped, unconventional acreage in the Permian Midland Basin of west Texas. Breitburn filed for Chapter 11 bankruptcy in May 2016. As of the petition date, it had secured and unsecured debt of approximately $3 billion.

The debtor asked the Bankruptcy Court for confirmation of its latest reorganization plan. The court held a four-day evidentiary hearing that focused largely on the debtor’s valuation. Both the debtor’s expert and the equity committee’s expert valued the Legacy assets under the NAV approach and the Permian assets under a precedent transaction analysis. The debtor’s expert found the combined value of the assets was about $1.6 billion. The equity committee’s expert arrived at a value of $3.8 billion.

The court approved of both valuation methods. But it found the analyses by the debtor’s expert were more credible. Regarding the NAV calculations, the court noted that four analytical factors—pricing, forecasting future prices, risking reserves, and projecting costs—explained the sizable value gap. Assumptions concerning pricing had the greatest impact on the experts’ valuations, the court said. The debtor’s expert used strip pricing, whereas equity’s expert used consensus pricing. The court, favoring strip pricing and referencing the debtor’s expert, said this approach reflected the views of willing buyers and sellers, each with access to all available information who “puts his money where his mouth is.” The court further pointed out that this was the method “used to value assets in every large, confirmed chapter 11 E&P case since 2015.”

The equity committee’s expert developed a consensus price that was problematic, the court found. For one, the expert chose 10 price sources, but two of those sources already reflected the consensus of a great number of individual price forecasts. By failing to account for this fact, the expert inflated the consensus price, the court said.

Slightly modifying the debtor’s analyses, the court arrived at a combined worth of $1.8 billion. Consequently, the debtor was hopelessly insolvent. However, the court declined to confirm the debtor’s plan, finding it unfairly discriminated against a class of unsecured claims.

A detailed discussion of In re Breitburn Energy Partners LP, 2018 Bank. LEXIS 691 (March 9, 2018), and the court’s opinion, are available at BVLaw.

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