Structured Transaction White Paper
Embedded Derivatives in Structured Transaction Energy ContractsPhillip Green, Senior Business Analyst, Consultant
Derivatives Trading Desk©®™
STRUCTURED TRANSACTION ENERGY TRADINGCONTRACT
Assessment of Structured Transaction for energy trading contracts. This analysis sets outto answer the following questions regarding a structured energy trading contract betweenan energy trading firm, the originator, and an operating company. The fictional company,let’s call it Aramaco, has concerns that the transaction may require FAS 133 accountingtreatment. The analysis will briefly discuss the economic projection
and todetermine if there is an
inherent in the hostcontract:Is the forecast reliable?Is there a notional on the contract?Is there an embedded derivative in the host contract?
Economic projection forecast background
The forecast is based upon geological formations and gas and oil history of the area.Technology has been developed and is widely used to both quantify the amount of gaswithin the shales, and also the permeability of the shale. Companies like Schlumberger and Halliburton are pioneers in this field. Aramaco provides the forecasts to prospectivelease purchasers and use them as valuation of lease agreement terms.The forecast is a tool utilized by prospective gas well lease purchasers to assess potentialextraction capacities and inherent revenue from oil and natural gas extractions. Theselease purchase are normally one to ten years in tenor. Purchasers are either bullish or bearish on their view of whether the wells or new drillings will actually deliver theextraction projections. They are willing to pay a premium for land leases with projected positive returns or history of successful transactions (piggy-backing); and seek to attaindiscounts with lease purchases deemed “wildcatting”, (an oil or natural-gas well drilledspeculatively in an area not known to be productive).Economic projection gas prices are based upon NYMEX strip prices (average of the dailysettlement price of the next 12 months futures contracts) and constant cost parameters.
1. Is the forecast reliable?
The economic projection forecasts are mainly used in the industry for the valuation of selling properties, i.e., land leases in reservoirs, oil and natural gas fields.