The purpose of this study is to develop a methodology to value oil and gas assets to complement traditional Discounted Cash Flow (DCF) valuations. A new methodology is required to overcome some of the shortcomings and biases inherent in DCF analysis and to present results in a way readily acceptable to industry. Such valuation methodology will make use of Real Option calculations and derive the necessary parameters from the evaluation of farm in/out agreements and from the stock exchange performance of junior, oil and gas companies.

Discounted Cash Flow (DCF) valuation derives from a simple adaptation of Fisher’s (1907) model of valuation under assumed certainty. Notwithstanding that various weaknesses have been associated with it, for the last fifty years it has remained the most common valuation tool used in the oil and gas exploration industry.

Various methodologies that address its weaknesses have been developed but none has emerged as a complete replacement to DCF analysis. Developments in financial theory like the Capital Asset Pricing Method, Portfolio Theory, and Option Valuation have so far had the best results at complementing Fisher’s model. Modern Asset Pricing (MAP), the simplest of the Real Option Valuation (ROV) methodologies, is the tool that has better adapted the latest developments in financial theory specifically to the valuation of oil and gas projects. MAP separates and neutralises the individual risk of the revenue and cost functions of the financial model of project making use of information derived from the futures exchange markets.

This study intends to show that there is a lot more information that can be derived from the exchange markets to be used in the ROV valuation of oil and gas exploration projects.