EV/2P Ratio

What Is the EV/2P Ratio?

The EV/2P ratio is a ratio used to value oil and gas companies. It comprises of the enterprise value (EV) divided by the proven and probable (2P) reserves. The enterprise value reflects the company's total value. Proven and probable (2P) refers to energy reserves, for example, oil, that are likely to be recovered.

The Formula for the EV/2P Ratio Is

$\begin &\text{EV/2P} = \frac{ \text }{ \text{2P Reserves} } \ &\textbf \ &\text{2P Reserves} = \text \ &\text = \text + \text - \text \ &\text = \text \ &\text = \text \ \end$
2P reserves are the total of proven and probable reserves. Proved reserves are likely to be recovered, whereas probable reserves are less likely to be recovered than proved reserves. The sum of proved and probable reserves is represented by 2P.

Instructions to Calculate the EV/2P Ratio

Acquire or calculate the enterprise value of the company. The EV is often calculated for investors however on the off chance that not, add the market capitalization and total debt together and take away out cash.
Plug the EV value in the numerator.
Plug the 2P reserves value into the denominator and divide it into EV.

What Does the EV/2P Ratio Tell You?

Enterprise value compared to proven and probable reserves is a metric that helps analysts understand how well a company's resources will support its operations and growth. Ideally, the EV/2P ratio ought not be used in disengagement, as not all reserves are the same. However, it can in any case be an important metric in the event that little is had some significant awareness of the company's cash flow.

Reserves can be proven, probable, or possible reserves. The proven reserves are typically known as 1P, with numerous analysts referring to it as P90, or having a 90% probability of being produced. Probable reserves are referred to as P50 or having a half certainty of being produced. When used related to one another, it is referred to as 2P.

When the EV/2P multiple is high, it means the company is trading at a premium for a given amount of oil in the ground. Conversely, a low value would suggest a potentially undervalued company.

The EV/2P ratio is comparable to other more common ratios used in valuation, for example, enterprise value or P/E ratios. These ratios express a company's value as a multiple of earnings or assets.

It's important to compare a company's EV/2P ratio with those of comparative companies and with the historical values of the ratio. Utilizing historical and industry comparisons can help investors determine on the off chance that a company is undervalued, overvalued, or genuinely valued.

Example of the EV/2P Ratio

Let us assume that an oil company has an enterprise value of $2 billion and proven and probable reserves of 100 million barrels:
$\begin &\text{EV/2P} = \frac{ $2 \text }{ $100 \text } = 20 \ \end$
The EV/2P ratio = 20 or the company has a 20 multiple. In other words, the company is valued at 20 times its enterprise value to 2P reserves.

Whether the 20 multiple is high, low, or genuinely valued depends on other oil companies inside the same industry.

The Difference Between the EV/2P Ratio and EV/EBITDA

Enterprise value compared to earnings before interest, tax, depreciation, and amortization is likewise referred to as the enterprise multiple. The EV/EBITDA ratio compares the oil and gas business, free of debt, to EBITDA. This is an important metric as oil and gas firms typically have a great deal of debt and the EV includes the cost of paying it off. By stripping out debt, analysts can see how well the company is valued.

The EV/2P ratio then again likewise uses enterprise value in its formula, yet instead of utilizing EBITDA, the ratio includes proven and probable (2P) reserves. The EV/2P ratio is important when passing judgment on the potential or possible growth of an oil company since proven and probable (2P) reserves are likely to be recovered.

Limitations of the EV/2P Ratio

As mentioned earlier, the EV/2P ratio includes total debt in its calculation because enterprise value likewise includes total debt. Oil companies typically carry critical amounts of debt on their balance sheets, which is normal for the industry. Debt is used to top finance oil apparatuses, equipment, and the cost of exploration.

As a result, the extra debt would put the EV of oil companies at a lot higher valuation than most other industries that carry less debt. Investors ought to be aware of the unique capital structures of oil and gas companies when utilizing any valuation metric including the EV/2P ratio.

Highlights

It's important to compare a company's EV/2P ratio with those of comparative companies and with the historical values of the ratio.
Enterprise value compared to proven and probable reserves is a metric that helps analysts understand how well a company's resources will support its operations and growth.
The EV/2P ratio is a ratio used to value oil and gas companies. It comprises of the enterprise value (EV) divided by the proven and probable (2P) reserves.