Some of the difficulties involved in valuing oil companies are because the company is always developing along the trajectory from 'we think there's oil there' to 'we know there's oil there and we can prove it'. As an investor, you're looking for the extra value - which might not be what the reserves are worth now, but what you think they'll be worth if three out of the next five wells hit oil.
Remember that reserve values can grow in two ways. First, the reserve can be increased if the company actually finds oil. But secondly, it can be increased if the certainty of the reserve (technically, the probability of extracting the oil - and that's where P1, P2, P3 come in) becomes greater.
So as an investor, you're looking forward to see if you can guess what's going to happen to those numbers. And you then have just the same problem as any other investor of working out what the market is discounting - for instance if your oil company has a one in ten chance of success, but the market is valuing it as if has a one in five chance, you're sunk. If the market reckons it has a one in twenty chance, you could do all right - though if it drills all duds, you're sunk unless you sold the stock first!
The easiest way to value a company is to look at 'oil in the ground'. That's really quite a rough figure as it doesn't account for how costly the oil will be to get out, and you have no idea sometimes how much of the total oil will be recoverable. However, what you do is to look at other companies at the same stage of development, and take the same valuation. You might decide to reduce it a bit if you think there's more risk. Conventionally that's quite often been three bucks a barrel - though that probably undershoots the value of oil these days by a considerable margin.
Oil analysts do a lot more work. They generally work out what the field might produce in future, building into their model specific flow rates, the decline in production after the field passes its peak, development costs and appropriate oil price forecasts. Then they discount this back to get a net present value for…
