The Rise Of Technology In Energy: What It Means For Valuation

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Over the last few years, technology has become increasingly more prominent in the extraction and production of oil and natural gas and associated byproducts. Before the global COVID-19 pandemic, oilfield service and drilling providers were already working to develop greater technological advancements that have added to the efficiency and cost-effectiveness of extraction and production activities. As an example, many oil and gas companies and related services providers have embraced digital technologies (read: Big Data) to become more efficient in their operations.

More recently, there’s been an even greater focus not only on digital technologies but also on low-carbon technologies. This has occurred as more companies in the energy industry have committed to reducing their carbon footprint as part of their overall environmental, social, and governance (ESG) initiatives. Examples of low-carbon technologies include bioenergy, carbon capture, and negative emissions technologies, among many others.

READ MORE: 3 Reasons Why ESG Is Here To Stay In The Oil & Gas Industry

Now and going forward, this enhanced focus on operational efficiency and environmental sustainability will have an impact on the types of assets that are valued for energy companies for a variety of purposes, including (but certainly not limited to) the following:

When performing an intangible asset valuation in the energy industry, particularly within services companies, contractual and non-contractual customer relationships have typically been the primary intangible asset being acquired. However, recent years have seen more transactions throughout the energy space in which either internally developed technology, in-process research, and development (IPR&D), or know-how is the primary driver behind the transaction. As a result, these are the primary assets being acquired, and as such, the appropriate valuation of these assets is receiving greater attention.

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Typically, the multi-period excess earnings method, a form of discounted cash flow analysis, is utilized to estimate the value of the primary intangible asset being acquired in a purchase price allocation. When valuing customer relationship assets under this method, a key input is the assumed customer attrition rate; documentation and support for this input has recently received greater scrutiny from auditors and regulatory bodies, including the Public Company Accounting Oversight Board (PCAOB).

However, when performing a valuation of technology-based intangible assets, more variables can be introduced into the excess earnings analysis and care should be taken to provide adequate support for these various inputs. There may also be instances where alternative valuation techniques, such as the relief from royalty method, should be considered in estimating the value of an acquired technology asset.

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Key inputs in the valuation of technology-based intangibles and IPR&D include the following:

  • Annual obsolescence factor.
  • Total research and development (R&D) spend necessary to bring the IPR&D to commercialization.
  • Estimated maintenance R&D spend.
  • Time expected to bring the IPR&D to commercialization.
  • If utilizing the relief from royalty method, an appropriate market-based royalty rate.

Energy companies and related service providers have made fiscal discipline and environmental sustainability a top priority over the last several years. This means that investments in cost-saving and environmentally focused technology can be expected to continue. Just as customer-based asset valuations have recently received greater regulatory scrutiny and as technology has become more commonplace in the energy industry, companies and valuation providers could expect technology valuations to become more of an exam and enforcement focus in the coming years.

Therefore, companies making technology-based acquisitions, or those who require a technology-based asset valuation for other purposes, should be prepared with defensible, supportable valuation analyses that can stand up to scrutiny.

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