# Fair Market Valuation Methodology

BOEM determines the resource economic value of a tract offered for lease by calculating the amount of economically recoverable resources through a discounted cash flow analysis. This process includes developing a complete geological and geophysical interpretation of the subsurface; evaluating relevant engineering parameters such as recovery factors and production profiles; and modeling the exploration and development activities, including the scheduling of capital expenses and operating costs. BOEM uses a stochastic simulation model to assess the resource economic value of certain OCS tracts offered for lease by the Federal Government.

Much of the geologic and engineering data (e.g., areal extent and thickness of the hydrocarbon pay zone, porosity, initial water saturation, recovery factors, production rates, product prices, costs, etc.) used to evaluate a tract are known with varying degrees of uncertainty. BOEM recognizes these uncertainties by utilizing a Monte Carlo (or range-of-values) modeling technique. This method provides a means to mitigate a series of subjective judgments about each individual variable. This method explicitly recognizes the probabilistic nature of all variables affecting the evaluation through the use of multiple trials and calculates possible outcomes based on sampling from input probability distributions.

The Monte Carlo simulation method can be described as a four-step process.

Step 1: Estimate the range and distribution of values for each variable that will affect the ultimate outcome of the venture.

Step 2: Select, at random, one value from the distribution of each variable. Compute the net present value (NPV) of the tract using this combination of selected values. This determines one point in the final distribution of possible tract values. Select, at random, a second value from the distribution of each of the variables. Again compute the resulting NPV. This is the second point in the distribution of possible tract values. The random selection is statistically done in such a way that, if a large number of random selections are made (1,000 or more), the distribution of the randomly selected values closely resembles the distribution that was read in.

Step 3: Repeat the process 1,000-10,000 (or more) times, each time with a set of values selected at random from the distribution of each variable. For each trial (1 of the 1,000 or more repetitions) the tract’s NPV is determined from the combination of sample outcomes from each variable.

Step 4: Calculate the mean of the range of values (MROV) commonly referred to as the Government’s reservation price. The MROV is the mean of a tract’s value for a given number of iterations in the Monte Carlo simulation. It is computed using the probability of success multiplied by NPV of productive wells plus the probability of failure multiplied by the NPV of non-productive wells.

This stochastic approach allows BOEM to account for the uncertainty of the input parameters as well as to quantify the risk associated with exploration and production of hydrocarbons.