The Treatment of Capital in Estimating Fair Market Value of Oil and Gas Properties

Fair market value has its origin in law and is defined as that price that a willing buyer will pay and a willing seller will sell at some point in time, with neither the buyer nor the seller under any compulsion to buy or sell, aid both having equal and reasonable knowledge of the facts. In reality, a perfect sale probably never occurs in which a willing buyer and a willing seller are under no compulsion to buy or sell and both are equally familiar with all the facts. Nonetheless, it is necessary to prepare fair market value estimates for oil and gas properties for the purpose of gift taxes, estate taxes, condemnation cases, mergers and divorce settlements. For the estimation of the fair market value of oil and gas properties, there are basically two approaches; namely, the income approach and the market data approach. The income approach requires the estimation of reserves, identification of their categories (proved, probable and possible), a detailed cash flow projection and the proper application of risk factors. The market data approach utilizes the comparable sales of properties The comparable sales approach is preferred, but for producing oil and gas properties it is difficult tomore » identify sales comparable in net reserves, product prices, location, operating expenses, operator expertise, etc. Consequently, for proved, probable and possible reserves, the income approach has been accepted by the courts and is more generally applied. For nonproducing mineral interests the comparable sales approach is applied using multiples of lease bonuses in the area.« less