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Using the Altman z-score model to test bankruptcy in the Oil Industry

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 ABSTRACT

The purpose of this research is to evaluate whether company size is significant

in determining the potential for bankruptcy in the oil and gas industry. More

specifically, do larger independent oil and gas companies experience higher z-

scores, and therefore a lower risk of bankruptcy, than their smaller competitors?

The Altman z-score bankruptcy model is used as the statistical tool for

determination of bankruptcy in the sample of independent oil and gas

companies. It was found that for the most part, the larger companies did indeed

experience less risk of bankruptcy, but the findings were inconclusive.

Interestingly, certain smaller companies performed as well as, or in some

cases, better than the largest companies in the sample. There is potential for

the Altman z-score model to be adapted and tailored more specifically for the oil

and gas industry, which may lead to adoption of bankruptcy prediction models

as a performance indicator. Using the Altman z-score model does indeed

highlight influential characteristics in the determination of bankruptcy in the oil

and gas industry.

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 TABLE OF CONTENTS

CHAPTER ONE 1

INTRODUCTION 1

1.1 Background to the study 1

1.2 Characteristics of the oil industry 2

1.3 Aim and objective of the research 3

1.4 Research question 4

1.5 Motivation and significance of the study 4

1.6 Conduct of the study 6

1.7 Scope and limitations 7

1.8 Structure of the rest of the study 7

CHAPTER TWO 8

LITERATURE REVIEW 8

2.0 Introduction 8

2.1 The oil industry 8

2.1.1 Oil companies 10

2.2 Components of the annual report and ratios 11

2.2.1 Annual report 11

2.2.2 The balance sheet 11

2.2.3 The income statement 12

2.3 Bankruptcy 12

2.3.1 Implication of bankruptcy 13

2.3.2 when companies decide to use bankruptcy models 14

2.3.3 Reason for testing bankruptcy 15

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2.3.4 Factors which influence potential for bankruptcy 15

2.4 The Beaver Model 16

2.4.1 The Altman model 18

2.4.2 Updated studies based on original models 20

2.5 Choice of ratios 22

2.6 The z-score 24

2.7 Predictability of models 26

2.8 Conclusion 27

CHAPTER THREE 28

METHODOLOGY 28

3.0 Introduction 28

3.1 Research philosophy 29

3.1.1 Research paradigm 29

3.1.2 Research methodology 29

3.2 Software used for analysis 30

3.3 Rationale for using quantitative method of analysis 31

3.4 Sources and nature of data 32

3.5 Research design 33

3.5.1 Deductive nature of research 34

3.6 Categorising companies into bankrupt or non-bankrupt sectors 35

3.6.1 Use of methodology from previous study 35

3.7 Population and sample of the study 36

3.7.1 Sampling frame 37

3.7.2 Use of both FTSE indices 38

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3.7.3 Sample 39

3.8.1 Method for calculating the z-score 40

3.8.2 Working capital/total assets 41

3.8.3 Retained earnings/total assets 42

3.8.4 EBIT/total assets 42

3.8.5 The market value of equity/book value of debt 43

3.8.6 Sales/total assets 44

3.8.7 Exchange rate 45

3.9 Generalities 45

CHAPTER FOUR 46

DATA PRESENTATION AND ANALYSIS 46

4.0 Introduction 46

4.1 Descriptive analysis of data 46

4.2 Overview and analysis of the Altman z-score results 48

4.2.1 2008 z-score analysis 48

4.2.2 2009 z-score analysis 49

4.2.3 2010 z-score analysis 50

4.2.4 Unfavourable results for BP in 2010 51

4.2.5 2011 z-score analysis 53

4.2.6 2012 z-score analysis 54

4.2.7 Coastal Energy 55

4.3 Overview of large company results 56

4.4 Overview of Gulf Keystone 58

4.5 Conclusion 61

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CHAPTER FIVE 62

CONCLUSION AND RECOMMENDATIONS 62

5.1 Summary of main findings 62

5.2 Wider issues in the oil industry 63

5.3 A reconsideration of the objective set 63

5.4 Recommendations 64

5.5 Limitations of the dissertation project 66

5.6 Learning gained from doing the research 66

BIBLIOGRAPHY 68

APPENDICES 81

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 LIST OF TABLES

Table 3.1 Sample oil companies and their average total assets (in $ million) for

the research period, 2008-2012.

Table 4.1 z-scores for the sample oil companies.

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 LIST OF FIGURES

Figure 4.1 Altman z-scores for BP 2008-2012.

Figure 4.2 Altman z-scores for the small sized sample companies for 2012.

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 LIST OF ACRONYMS

BVD – Book value of debt.

EBIT – Earnings before interest and taxes.

FTSE – Financial Times and Stock Exchange.

IOC – Independent Oil Companies.

LSE – London Stock Exchange.

MDA – Multiple discriminant analysis.

MVE – Market value of equity.

NOC – National Oil Companies.

OECD - The Organisation for Economic Co-operation and Development.

OPEC - Organization of Petroleum Exporting Countries.

PLC – Public Limited Company.

RDS – Royal Dutch Shell.

RE – Retained earnings.

UK – United Kingdom.

US – United States.

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 CHAPTER ONE

INTRODUCTION

1.1 Background to the study

According to Li and Tang (2007), research has shown that larger companies

tend to outperform smaller companies when considering: profitability, growth of

share capacity, efficiency of operating practices and financial security. This

statement prompted the researcher to consider whether this is indeed true for

companies in the oil and gas industry. One method of testing performance of

companies is to assess their potential for bankruptcy.

The original research to test company performance by assessing bankruptcy

probability was conducted in the late 1960s: Beaver (1966) and Altman (1968).

Several modern studies have been completed using the pioneering statistical

models from the original research papers. One study in particular - Sena and

Williams’ “Using the Altman bankruptcy model to analyse the performance of oil

companies” - adopted the original statistical models to assess the influence of

company size on overall performance, and risk of bankruptcy. To the

knowledge of the researcher, no further studies have been conducted using a

bankruptcy model to test oil company performance. Therefore, the decision was

made to conduct a modern adaptation of the 1998 Sena and Williams’ study.

The influence company size has on potential for bankruptcy is ultimately the

proposed question of this dissertation.

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1.2 Characteristics of the oil industry

The oil and gas industry is associated with high risk, high level of investment

and the potential for vast returns (Wright and Gallun, 2008). Ward (1994)

suggests that cash flow from investment activities in the extractive industries

ought to be valuable in the prediction of bankruptcy, or financial distress, based

on the substantial investments in lasting tangible assets. If companies decide

not to invest in long-term assets (or are requiring to sell existing assets in order

to achieve cash flow equilibrium) it can be assumed that they will be more

susceptible to experience financial distress in times to come.

As one of the most important purposes of any business is to make money, it is

interesting to consider the oil and gas industry where money exchanged in

projects is vast (Wright and Gallun, 2008). It would be conceivable - based on

the Li and Tang (2007) research - to assume that major oil and gas companies

such as Royal Dutch Shell and BP, would perform better than smaller oil and

gas companies. Additionally, this could suggest that larger companies would

feel only minor pressure in the face of a global recession. However, since the

majority of economies, and companies, have been seen to be affected in some

way by the global economic crisis this may be an inappropriate stance to take

(Al-Khatib and Al-Horani, 2012). As the majority of world economies were

affected by the recession, conducting a study to assess how important

company size is in the face of financial adversity is possible, and should reveal

some interesting results.

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Past studies have used a bankruptcy model to test manufacturing and retail

businesses, since these industries are more susceptible to bankruptcy (Altman,

Haldeman and Narayanan, 1977). The oil industry has only been tested once

using bankruptcy as a performance indicator, so, as this industry becomes

increasingly important in the continuing development and expansion of the

emerging economies, such as China and India (BP, 2011) there is need to

adopt alternative criteria to assess performance. The steady, but increasing

demand for oil, has prompted demand and supply shocks on a global basis.

Supply shortages are a catalyst for oil price rises - such as the $147 per barrel

peak of late 2008 (Chen and Lee, 1993), which could not be managed over a

sustained period of time. It is therefore important to address the current

situation of the oil industry and whether there may be an imminent threat of

bankruptcy for companies related to size.

1.3 Aim and objective of the research

The comprehensive aim and objective of this research is to establish whether

independent oil company size is influential in the company’s ability to avoid

bankruptcy. To achieve this goal, the following objective will be followed.

To assess whether large independent oil and gas companies have better z-

scores than the smaller oil and gas companies, and consequently, less likely to

file for bankruptcy.

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1.4 Research question

In pursuance of achieving the aim and objective of this research, the following

research question is addressed:

Do large independent oil and gas companies have better z-scores than smaller

oil and gas companies?

To evaluate this question in an empirical manner, the aforementioned question

will be tested using a specific bankruptcy model. A thorough dissection of the

resulting z-scores will allow inferences to be made. Specifically, how important

company size is to survival in the oil and gas industry. Suggestions about the

state of the oil and gas industry can be drawn from the findings of the resultant

z-scores.

1.5 Motivation and significance of the study

The initial motivation of this research is to discover whether oil company

performance can be assessed through testing the potential for bankruptcy. As

the bankruptcy model includes ratios addressing key performance indicator

components of companies, assessing the threat of bankruptcy should indeed

show how well the companies are performing. As the oil and gas industry is key

to the global economy, determining whether performance of oil companies is

promising, or worrying, may highlight areas for improvement in practices.

Although only one study has been conducted to test the performance of oil

companies using a bankruptcy model, it is useful to discover how company size

affects a business’s operation and survival. The findings of this research would

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prove useful for the sample companies that are in a position of imminent

bankruptcy. It would then allow the management to take actions to avoid failure.

This research may supplement the existing body of work and will give scope for

future research to be conducted.

The ambition of this research is to assess the impact of company size and

continuing performance before, during and after the recent global financial

crisis. As the oil and gas industry is significantly important to the global

economy, it will similarly be interesting to understand how the companies react

and perform in unfavourable economic conditions.

The study is significant in the consideration of bankruptcy measurement as, to

the knowledge of the researcher, there is only one article which specifically

tests the petroleum industry using the Altman’s z-score model. This dissertation

should therefore build on the work of Sena and Williams (1998) but give a fresh

and updated perspective of the global oil and gas industry and the companies

involved.

The bankruptcy model uses ratios, and ratio analysis, to determine the overall

z-score of a company. The data required for the ratio calculations is found in

easily accessible company reports. The components of the ratios test key areas

of performance such as: profitability, liquidity, productivity, and the sales

generating ability of a company’s assets (Carstea et al., 2010; Sena and

Williams, 1998). When all these key performance indicators are combined, it

gives an overall score, which is used to determine the potential for bankruptcy.

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1.6 Conduct of the study

The methodology of the study will follow a similar structure to the one proposed

in the Sena and Williams’ (1998) study. The period of study was from 2008-

2012 as data before 2008 was not readily available. The sample includes

nineteen public limited companies listed on the London Stock Exchange with

total assets ranging from less than $1 billion to greater than $50 billion. The

data required for the ratio calculations was taken from the annual reports and

the London Stock Exchange. Once the data was collected, ratios of working

capital/total assets; retained earnings/total assets; earnings before interest and

taxes/total asset; market value of equity/book value of debt; and sales/total

assets were calculated. The resulting ratios are put into the following equation

and the z-score is found:

Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 0.999*X5

Where the values for each of the X components are as follows: X1 = working

capital/total assets X2 = retained earnings/total assets X3 = earnings before

interest and taxes/total assets X4 = market value of equity/book value of debt

X5 = sales/total assets (Carstea et al., 2010).

Once the z-scores were calculated for each sample company, over the five-year

research period, threshold ranges determine the potential for bankruptcy. A z-

score below 1.81 is the bankrupt sector, between 1.81 and 2.99 is the grey

sector, and above 2.99 is the non-bankrupt sector (Altman, 1968). Tables of the

z-scores were created, and conclusions drawn on the potential for bankruptcy,

and company size.

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1.7 Scope and limitations

Research on the topic of bankruptcy in the oil and gas industry is scant and

apparently overlooked in the body of literature available. Hence, the literature

reviewed gives a more general view of bankruptcy, and the bankruptcy model in

other industry sectors.

The findings of the importance of company size in corporate endurance are

discussed in the latter chapters of the research. Due to the time constraints of

the research (three months) it was not conceivable to cover a vast sample of

companies. In the future, further studies could be conducted with a larger

sample, or indeed the complete population of oil companies on the London

Stock Exchange.

The research does consider two important aspects of company performance:

size (based on total assets), and bankruptcy. The two aspects are important

considerations for every company and in the research time granted it is hoped

that results provide an insight into the risk of bankruptcy in the oil industry.

1.8 Structure of the rest of the study

The remainder of this dissertation will be structured as follows: Chapter two will

review the relevant literature of the topic. The literature covers conceptual and

investigative aspects of the subject matter. Chapter three will detail the

methodology used to conduct the research. Chapter four presents the data, and

a thorough analysis of the main findings is shown. Chapter five concludes, and

proposes recommendations for further research.

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 CHAPTER TWO

LITERATURE REVIEW

2.0 Introduction

This chapter begins with an overview of the oil and gas industry, specific

terminology, and fundamental knowledge deemed necessary for the reader.

This is followed by a thorough review of the previous research conducted into

the bankruptcy of companies, and highlights the theoretical foundation for

conducting this study. Accordingly, definitions of bankruptcy, past findings,

statistical models, and the accuracy of previous results are detailed. This

underlines the scope, and reasoning, behind the research topic of this study.

2.1 The oil industry

The oil industry is characterised by high-risk ventures in the extraction of

hydrocarbons (Suslick and Schiozer, 2004). The investments required in

exploration, appraisal, development and production phases of the oil industry

are vast, and extend over a long period of time. Therefore, there is a need to

assess the level of risk involved. According to Wright and Gallun (2005) there

are two sectors which oil and gas companies can be involved in: the upstream

and downstream. The upstream sector is concerned with exploration

(searching) and production (producing hydrocarbons) activities, whereas the

downstream sector is focused upon the transporting, refining, and marketing of

petroleum and petroleum based products (Wright and Gallun, 2005).

The reason the oil industry is so influential on the world economy is due to the

demand for oil on a global basis. The associated oil price can have a

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substantial effect on the economies that are heavily reliant on the revenues

generated by oil. The oil price, and other commodity prices have experienced

sharp rises and falls over the past sixty years. The first commodity boom was

particularly due to the build up of raw materials as a result of the war in Korea,

during 1950-51. The second commodity boom, occurring in 1973-74, was

driven by inconsistent crop yields and in OPEC’s mismanagement of oil

supplies, prompting the oil price to triple. The third boom began in 2004 and is

on-going. This can be attributed to the sustained, and aggressive economic

growth of China and India and their increasing demand for raw materials

(including oil) (Radetzki, 2006). In more recent times (late 2008), the oil price

soared to $147/barrel, but this peak did not last for long, and shortly after the

price fell drastically to $40/barrel causing major disruptions for all economies

and companies involved (Mohanty, Nandha and Bota, 2010; Pirog, 2012).

According to Mohanty, Nandha and Bota (2010) many factors influenced the

volatile oil price over the previous decade (2000-2010). The staggering growth

of emerging economies such as China and India occurred at a time when

production had plateaued causing oil demand shocks. There were also issues

in the supply of oil with the U.S. war on terror in Iraq. The recession in the U.S.

and other OECD economies of late 2008 exacerbated the oil price rises

resulting from the global financial crisis and the demise of the Lehman Brothers

in 2008 (Mohanty, Nandha and Bota, 2010). During the period between August

2008 and March 2010, the global financial crisis had an undesirable effect on

the prices of commodities as well as equity values of companies in the oil and

gas industry and global stocks.

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2.1.1 Oil companies

Independent oil companies (IOCs) have the incentive to maximise shareholder

wealth, and if the companies do not provide a better rate of return than the

market, money must be returned to shareholders (Stevens, 2008). According to

Villalonga (2000) IOCs possess certain features, such as: private ownership (in

the form of tradable shares), takeover threats and the potential for bankruptcy,

which helps these companies to align their interests with the shareholders. On

the other hand, National Oil Companies (NOCs) are more likely to be driven by

the personal or political goals of the country of ownership (Eller, Hartley and

Medlock, 2007; Bernard and Weiner, 1996). These can include: national

employment; public infrastructure, and a number of other goals, not stringently

associated with fundamental oil sector activities (Victor, 2007). NOCs do not

usually possess tradable shares and are reluctant to publish information on

their financial performance. The reason IOCs were considered in this study is

that information on their financial statements is readily available, there are

tradable shares - a necessary requirement for one of the calculations in the

study - and the information published is audited, giving a certain level of

reliability.

Independent oil companies can experience substantial unpredictability in their

profit and cash flows. This is because they are subject to fluctuations in

commodity prices and the significant investments required to aid the

replacement of reserves (DBRS, 2011). There are issues concerning

independent oil companies accessing reserves. The majority of the world’s oil

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reserves are located in the Middle East and Africa where frequent political

disturbances can have a detrimental impact on the global supply and demand

of commodities. This can also affect the global oil prices underlining the

influence of political processes contributing to instability in the oil and gas

industry (DBRS, 2011).

2.2 Components of the annual report and ratios

2.2.1 Annual Report

All independent oil companies record their yearly results in an annual report

(Walton, 2000). When assessing a company, it is useful to consider the

components of the annual report and financial statements. Ratio analysis is a

technique used to highlight the performance of a company where ratios are

calculated from important records in the annual reports namely: the income

statement and the balance sheet (Walton, 2000; Atrill and McLaney, 2008;

Dunn, 2010). The income statement is sometimes referred to as the profit and

loss account; and the balance sheet, the statement of financial position (Walton,

2000; Atrill and McLaney, 2008; Dunn, 2010).

2.2.2 The balance sheet

The purpose of the balance sheet is simple, “to set out the financial position of a

business at a particular moment in time” (Atrill and McLaney, 2008). This will

usually be at the end of the year - the 31st of December (Walton, 2000; Gibson,

2009). There are two specific categories on the balance sheet: assets of the

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business, and claims against the business (Atrill and McLaney, 2008).

2.2.3 The income statement

The income statement records how much profit, or loss, the business has made

over a specific period of time. It is a summary of the revenues and expenses of

a business (Gibson, 2009). To measure the profit generated requires a record

of the total revenue - total number of goods and services sold to customers

(Gibson, 2009). The revenue (expenses) can be defined as the incoming

(outgoing) flows of economic benefits as a result of the normal activities of a

business. The income statement reports the total revenue generated and

deducts the total expenses in generating that revenue. If the total revenue is

greater (less) than the total expenses, there will be a profit (loss) for the

business (Atrill and McLaney, 2008).

2.3 Bankruptcy

According to Chen and Lee (1993) bankruptcy (financial distress) occurs when

a company is unable to fulfil its financial commitments. In an operational sense,

a company will be deemed in financial difficulty once one of the ensuing

proceedings, the first to affect the business, has happened: “1 filing for

protection under Chapter 11 of the U.S. Bankruptcy Code or, for Canadian

firms, going into receivership; 2 Defaulting on the payment of principal or

interest; Suspending preferred stock dividends” (Chen and Lee, 1993). This

definition is very similar to the one observed in the Beaver (1966) study, where

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he signals failure events as: “bankruptcy; bond default; an overdrawn bank

account; or non-payment of a preferred stock dividend” (Beaver, 1966). Other

studies define a company as failing when it enters into procedures of

bankruptcy or discussions with the financers to help minimise the debts of the

company (Edmister, 1972; Blum, 1969; Altman, 1968). Deakin (1972) deems

failure to include only companies that experience “bankruptcy, insolvency, or

were otherwise liquidated for the benefit of creditors” (Deakin, 1972). The

aforementioned are United States based definitions. According to

PricewaterhouseCoopers UK bankruptcy is defined as “a company becomes

insolvent if it does not have enough assets to cover its debts and/or it cannot

pay its debts on the due dates” (PricewaterhouseCoopers, 2009).

2.3.1 Implication of bankruptcy

Deakin (1972) and Doukas (1986) note the effect failure can have on a

company, specifically the considerable losses experienced by owners of the

business (stockholders and other investors). Barbuta-Misu (2011) reports that

using bankruptcy risk as a means of assessing the financial health of a

company is justified, as a company with a minimal probability of failure is

deemed efficient in financial standings. As the failure of a business has

significant implications for shareholders, and the reputations of the company

representatives, the prediction of bankruptcy can help managers take steps to

avoid failure such as: consideration of merger or divestment, revaluation of

financial structure, and how to improve efficiency in their respective industry

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(Ohlson, 1980; Agarwal and Taffler, 2007). The severity of bankruptcy, and

corporate failure was recognised by Beaver (1966) and Altman (1968). Both

researchers deemed the risk worthy to develop models to predict failure based

on the annual and financial reports of the companies concerned (Deakin, 1972).

If models could be developed with the predictive power to observe initial signs

of failure up to five years prior to bankruptcy, then it would allow managers to

initiate proceedings to evade failure, thus, allowing the company to continue

operations and keep the shareholders happy.

2.3.2 when companies decide to use bankruptcy models

Most studies after the original Beaver (1966) and Altman (1968) models were

conducted when economies, and/or companies were faced with adversity.

Shirata (1999) reports that after the economic distress of 1990, the Japanese

economy experienced a period of financial turmoil and many companies

succumbed to bankruptcy. He suggests the need for the development of a new

Japanese model of bankruptcy predictability as only a small number of studies

to assess Japanese company bankruptcy had been conducted and due to the

small sample sizes, generalities could not be made. Also, the accuracy in past

Japanese bankruptcy prediction models was lower than desired, whereas the

newer Shirata model boasts more than 86.14% accuracy (Shirata, 1999).

Additionally Doukas (1986) observed that following the recession of 1980-82 a

substantial number of studies were conducted into the forecast of failure. It

seems that as long as companies are making a profit and not facing adverse

conditions then there is no need to determine the risk of bankruptcy.

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2.3.3 Reason for testing bankruptcy

Chen and Lee (1993) set the initial measuring time in the survival period of oil

and gas companies at December 1981. This was due to the oil price reaching a

peak in mid-1981. Likewise, 2008 was chosen as the beginning point of the

study for this research due to the high oil price of $147 in that year. Al-Khatib

and Al-Horani (2012) noted that even in today’s economy, studies of bankruptcy

prediction hold value, as companies are still susceptible to the detrimental

effects of a financial crisis on their ability to survive. The vast majority of the

world’s economies were affected by the global financial crisis of 2008, and

many public limited companies fell victim to bankruptcy in the United States,

Europe, Asia and other countries (Al-Khatib and Al-Horani, 2012; Carstea et al.,

2010). In light of these events, many analysts, economists and academics have

questioned companies’ ability to endure a recession. This led to substantial

curiosity into the paramount methods and indicators, which can aid in the

forecasting of financial failure in companies. In light of the events at the turn of

the century where Enron and WorldCom met their demise, this acted as a

catalyst for global economies to take more care and prompted rehabilitated

concern for credit risk assessment (Aziz and Humayon, 2006; Agarwal and

Taffler, 2007).

2.3.4 Factors which influence potential for bankruptcy

In line with Li and Tang (2007), research shows that companies of a greater

magnitude (based on total assets or market capitalization for instance) tend to

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outperform their smaller counterparts when considering: profitability, growth of

share capacity, efficiency of operating practices and financial security.

Corporate endurance can vary vastly from company to company, depending on

a number of factors: the capital structure of a company; size of company;

efficiency of operational practices; and industry sector (Ohlson, 1980, Chen and

Lee, 1993, Shirata, 1999). For the extractive industries it is: size, age of entity,

and successful exploration that are key determinants in the endurance of

companies. As stated by Ohlson (1980) there are four main factors, which affect

a company’s likelihood of failure these are: “1 - size of company, 2 - a

measure(s) of the structure, 3 - a measure(s) of performance, 4 - a measure(s)

of current liquidity” (Ohlson, 1980). In this dissertation the focus is on the size of

company but due to the independent variables included in the z-score model

each of the above factors will be assessed indirectly.

2.4 The Beaver Model

Beaver used univariant discriminant analysis, meaning he tested one variable at

a time, in the determination of bankruptcy (Barbuta-Misu, 2011). The variables

used in his study were specific key financial ratios. The study was based on the

earlier investigative work of Patrick (1932) on the usefulness of ratios. The

result of Patrick’s study showed that indeed ratios, and associated analytical

methods, could be used as powerful instruments of assessment. According to

Barnes (1987), financial ratios are used for a wide variety of purposes: by

accountants for forecasting future financial performance and more recently by

researchers in statistical models (z-score) to determine bankruptcy, credit rating

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and the valuation of risk. Beaver (1966) used this study to develop a model for

assessing companies’ risk of bankruptcy through ratio analysis (Abor and

Appiah, 2009). In the 1930s it had been discovered that companies

experiencing financial turmoil display substantial differences in the measured

ratios compared with firms experiencing strong financial performance (Altman,

1968). The Beaver model not only based predictions of financial distress on

bankruptcy but also compared distressed and non-distressed companies. This

research concurs with the later exploratory works of Giroux and Wiggings

(1984) and DeAngelo and DeAngelo (1990) (Ward, 1994). According to Platt

and Platt (1990) there is an abundance of literature based upon the original

framework set by Beaver in 1966 using the univariant methodology to predict

failure. Deakin (1972) argues that while the Beaver model is unquestionable in

the predictive ability of its results, the later Altman model has greater perceptive

uses, and popularity (Deakin, 1972).

Beaver (1966) defines a financial ratio as a “quotient of two numbers, where

both numbers consist of financial statement items” (Beaver, 1966). This is a

very succinct definition. The aim of his study was not only to create a model for

the prediction of failure but also to ultimately examine the worth of ratios and

the accounting data used in their calculation. It is suggested that further

research could be done using multiratio analysis, where numerous ratios are

used to determine the potential of bankruptcy in companies. Beaver thought this

might prove more useful and even better than using single ratios (Beaver,

1966). This suggestion paved the way for Edward Altman to develop his

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bankruptcy prediction model. However, the Beaver model is still recognised as

a pioneering work, with its greatest addition being the development of a method

to evaluate accounting data for any use, not only for corporate endurance

(Beaver, 1966).

2.4.1 The Altman model

The Altman bankruptcy model is regarded by many as the pioneering research

into the development of a model to predict the probability of failure in corporate

entities (Abor and Appiah, 2009; Platt and Platt, 1990; Chen and Lee, 1993;

Sena and Williams, 1998; Barbuta-Misu, 2011; Deakin, 1972; Doukas, 1986;

Carstea et al., 2010). In Doukas’ (1986) opinion, the Altman model of 1968 has

progressed and is “deemed as the yardstick of predictability models because of

its straightforwardness of understanding and pertinence” (Doukas, 1986). This

is in a similar vein to Moyer (1977) who states that further studies have not

provided adequately improved results to render the Altman model obsolete and

in need of adaptations. Since its conception, the z-score model has been tried

and tested in various academic works. The outcomes show that the original

model is precise and dependable, and is still widely utilised to determine

financial distress, in spite of developments throughout the past thirty years

(Agarwal and Taffler, 2007; Carstea et al., 2010). Edmister (1972) reports the

interesting predictive power of ratios is cumulative – the predictive ability

increases with successive additions of other ratios. The additional ratios will

only add to the predictive power if they are indeed relevant, significant, and do

not overlap other ratios. He also notes that some ratios are not actually

! xxviii!
significant predictors of bankruptcy by themselves but aid the improved

discriminant capability when included in the z-score function (Edmister, 1972).

Altman drew on the suggestions made in the 1966 paper, that it may be

possible to achieve greater accuracy in bankruptcy prediction should a variety

of ratio be used at one time – multivariate analysis. Although Altman recognised

that the Beaver study showed irrefutable evidence that using ratios in analysis

can indeed predict potential failure of firms, he wanted to mould the model to

give greater accuracy. The Beaver study prompted Altman to develop a

statistical technique to test companies known to have failed against those which

have not – Multiple Discriminant Analysis (MDA). According to Altman (1968),

the possible principal advantage of multiple discriminant analysis in determining

issues of classification (into bankrupt and non-bankruptcy companies) is the

ability to evaluate an absolute set of variables simultaneously, as opposed to

consecutively examining singular features of the test subject (Altman, 1968).

Altman attempted to assess the quality of ratio analysis as an analytical tool in

predicting bankruptcy of firms ranging in size from $0.7 million to $25.9 million

in assets. His sample was from a population of the manufacturing industry and

consisted of thirty-three companies declaring bankruptcy under Chapter X over

the period 1946-1965. He paired the bankrupt companies with a sample of

thirty-three firms not declaring bankruptcy. From an original list of twenty-two

ratios based on earlier research (notably Beaver 1966), Altman selected the five

ratios he deemed most appropriate in the prediction of bankruptcy. These five

ratios were as follows: working capital/total assets, retained earnings/total

assets, earnings before interest and taxes/total assets, market value of

! xxix!
equity/book value of debt, and sales/total assets (Altman, 1968; Edmister, 1972;

Chen and Shimerda, 1981; Sena and Williams, 1998; and Carstea et al., 2010).

An interesting example of the power of MDA is with the sales to total asset ratio.

This ratio exemplifies a company’s ability to generate sales. When considered

on an individual basis, it is the least significant, and would have been omitted

from the study. However, due to the unique interaction it has with other ratios in

the z-score model, it actually is positioned second in its influence on the overall

predictability of the model. Altman suggested that the ratio of market value of

equity/book value of debt, gave a market approach to his predictive model

rather than relying solely on the reported figures in the financial statements.

Interestingly, Altman’s model is only really useful in predicting the likelihood of

bankruptcy in public limited companies (due to the need for the market value of

equity ratio component). When Doukas (1986) conducted his study involving

privately owned firms only, the information required to calculate the market

value of equity was unavailable and this ratio was omitted from his research. He

instead used the book value of equity. This shows the limitations of ratios and

the availability of data in conducting studies.

2.4.2 Updated studies based on original models

According to Aziz and Humayon (2006) the most common statistical method

used in failure prediction is ratio analysis. It was discovered that, of the eighty-

nine empirical past bankruptcy prediction studies, sixty per cent reportedly used

financial ratios. As reported by Abor and Appiah (2009) there are a substantial

! xxx!
number of bankruptcy models present today, all adopting slightly different

methods. However, it must be recognised that the majority, if not all models are

based, in some way or another, upon the originally conceived study of Altman in

1968 (Abor and Appiah, 2009). These models adopted similar methods to

Altman but are modified in such a way to suit their specific needs. The models

include: Deakin (1972); Altman et al. (1977); Keasey and Watson (1986);

Gentry et al. (1987); Balwin and Glezen (1992) and Aly et al. (1992). As stated

by Barbuta-Misu (2011) there is a substantial number of studies based on the

original papers of Beaver and Altman in the development of bankruptcy risk

models. Specific to bankruptcy prediction are, for example: Edmister (1972), the

Diamond model (1976), Deakin probabilistic model (1977), Springate model

(1978), the Ohlson model (1982), and the Fulmer model (1984) (Barbuta-Misu,

2011). It should be noted that, to the knowledge of the researcher, there are few

research studies developing bankruptcy models in the 2000s. A possible reason

is that the original models (and aforementioned updated studies), are

adequately addressing the bankruptcy issues of the 21st century. This is the

notion of Aziz and Humayon in their 2006 study, who indicate that due to

prominent use of multiple discriminant analysis in past studies, it is the most

appropriate method to use for their study (Aziz and Humayon, 2006).

There is an interesting study conducted by Shirata (1999) on the prediction of

failure in Japan. The model Shirata constructed was loosely based on the

Altman model but chose to omit ratios of profitability and liquidity. The reason

why profitability was omitted is due to the fact that even if a Japanese company

experiences a decrease in profitability, it can still have an abundance of

! xxxi!
cumulative profitability, and subsequently may not go bankrupt (Shirata, 1999).

Therefore profitability is not a significant determinant of bankruptcy in Japanese

firms. A notable outcome of this study was that the model used is a universal

model and not heavily influenced by size of company or the business sector it

operates. As the research of this dissertation is concerned with the influence

size of company has on corporate endurance, the Shirata model would not be

appropriate to use. However it is worth mentioning for any researchers wishing

to pursue further research on companies regardless of industry sector or

company size.

2.5 Choice of ratios

According to Horrigan (1968) the state of ratio analysis at the time of his paper

was missing an unambiguous speculative structure to adhere to. As a result the

researcher conducting the analysis has to rely on the worthiness of a writer’s

experience in the field. Hence, ratio analysis is made up of unproven

declarations regarding which ratios to use, alongside the expected relations

between ratios. From the Chen and Shirmerda (1981) study, it was identified

that considering a sample of twenty-six separate studies, sixty-five financial

accounting ratios appeared. From this sample, forty-one of the ratios were

deemed significant for the researchers. Provided with such a substantial and

varied collection of financial ratios, researchers conducting studies may find it

difficult to select ratios most useful to address their research objective(s). In this

research, it was deemed appropriate to follow the methods adopted by Sena

and Williams (1998) using the five ratios considered most effective by Altman

! xxxii!
(1968). This bestows a certain level of trust in the aforementioned studies and

following the methodology and framework of the Sena and Williams study,

alleviated bias towards the choice of ratios. This made it easier to decide on

using only five ratios and not consider all forty-one. As the Sena and Williams

study is the only one found which uses the Altman model for oil and gas

company performance, it is sensible to adopt a similar approach.

Another method of selecting ratios is to look at overlaps in the financial data

used in the calculations. In Deakin (1972), the univariant study calculated 28

separate ratios respectively, however this was made up of only ten different

quantifiable items of data. Similarly the later study by Elam (1975) used 18

separate data elements in the calculation of twenty-eight ratios. Observing any

overlapping data would help eliminate less useful ratios and allow the

construction of a set of consistent useful financial ratios (Chen and Shirmerda,

1981). The main concern with overlapping in ratios is the presence of

mutlicollinearity – where two separate ratios have a very strong relationship with

one another, rendering their contribution to the model substantially less

significant. In a similar vein, Altman utilised this method of overlapping to

cleanse his list of twenty-two ratios to a selection of five he regarded as the

most powerful in their relevance and predictive ability in the determination of

failure. Edmister (1972) recognised that conducting analysis using ratios can be

exceedingly perceptive to “either or both the purpose of the analysis and the

population studied” (Edmister, 1972).

! xxxiii!
2.6 The z-score

The z-score function takes the following form: Z = vixi + v2x2+…+vnxn, where vi,

v2,… vn = discriminant coefficients, xi, x2,… xn = independent variables. The

discriminant coefficients are the factors each independent variable is multiplied

by. The independent variables are the ratios: working capital/total assets,

retained earnings/total assets, retained earnings before profit and taxation,

market value of equity/book value of debt, and sales/total assets (Altman, 1968;

Sena and Williams, 1998; Carstea et al., 2010). The lower the resultant z-score

a company receives, the greater the potential for bankruptcy. If the model is

created in a systematic and intelligent manner, the independent variables

(ratios) characteristically address essential aspects of business performance

(profitability, liquidity, efficiency, sales ability among others) (Agarwal and

Taffler, 2007).

As stated in Agarwal and Taffler (2007) the definition of the standard z-score is

given as “the distillation into a single measure of a number of appropriately

chosen financial ratios, weighted and added” (Agarwal and Taffler, 2007). This

allows the researcher to not only test the predictive value of one ratio, but

several at once. Carstea et al. (2010) suggests z-scores are extremely useful in

allowing the financial health of a company to be determined by a single figure

depending on the thresholds of bankruptcy or non-bankruptcy. This is the

premise for using discriminant analysis as it allows several different influential

constituents to be amalgamated to form one single determinant score. Taffler

(1977) used multiple discriminant analysis to construct a model for failed and

! xxxiv!
non-failed companies in the United Kingdom (Abor and Appiah, 2009). The

major impact of his research was the expansion of a specific z-score model for

bankruptcy prediction in the United Kingdom.

There are three categories that companies can be separated into, based on

their z-score: bankrupt or distressed zone; the grey area – inconclusive zone,

and the non-bankrupt or safe zone. The bankrupt zone includes any company

that reports a z-score of below 1.81; the grey area includes any company

reporting a z-score between 1.81 and 2.99; and any company reporting a z-

score above 2.99 is in the “safe zone” (Altman, 1968, Carstea et al., 2010; Sena

and Williams, 1998). These threshold values were determined by the firm’s

resultant z-scores in Altman’s original study.

As reported by Deakin (1972), observing the resultant scores of firms and

classifying them based on thresholds is a sufficient method of failure prediction,

yet it may omit certain relative scores from the study, hence misclassifying

some of the companies. He refers to the studies of Altman (1968), Frishkoff

(1970) and Frank and Weygandt (1971) as examples of this method. In the

Sena and Williams (1998) study it was discovered that of their sample, two

companies were in the bankrupt zone, six were in the safe zone, and the

majority (eighteen companies) were situated in the grey zone. Companies

falling into the grey zone are susceptible to errors in classification whether there

is an imminent threat of bankruptcy or not. This is a limitation of the model and it

may be useful to revise the thresholds, which determine the predictability of

failure. With the time limitations of this study, calculating new threshold z-scores

is beyond the scope of the research, but could be an option for future studies.

! xxxv!
The study of Agarwal and Taffler (2007) illustrates the predictive abilities of the

z-score model, in comparison with supplementary prediction models. This study

also emphasises that using published financial accounts gives a certain level of

reliability and validity in the ratios, and therefore the overall z-score.

2.7 Predictability of models

The Taffler (1977) model, adopting MDA, can provide a significant level of

accuracy in prediction of failure in a business, not only in the year prior to

bankruptcy but also in two or three years before. Deakin (1972) reports that the

original work of Altman was over 90% effective in the selection of future

bankruptcy in firms in the years prior to bankruptcy (Chen and Shimerda, 1981).

To emphasise how accurate his predictions were, it is noted that the firms

Altman predicted to fail, did so, on average, “seven and one-half months after

the close of the last fiscal year for which reports were prepared” (Deakin, 1972).

It has been discovered that the predictive power of these models can highlight

potential for bankruptcy up to three years prior to failure, with a high level of

accuracy, thus allowing managers to take steps to avoid looming failure. The

later revised study of Altman (1968) by Altman, Haldeman and Narayanan

(1977) argued that using the z-score method could categorise companies as

bankrupt up to five years prior to failure. This paper also suggested an accuracy

of 92.8% determination of bankruptcy in companies in the year prior to financial

distress (Al-Kahtib and Al-Horani, 2012).

! xxxvi!
2.8 Conclusion

This chapter has provided an overview of the oil and gas industry, bankruptcy

and associated issues, and has shown the power and predictive ability of

bankruptcy models. The literature review revealed how past studies have

analysed and emphasised the importance of bankruptcy prediction for

businesses. A dissection of the z-score model and ratio components is

explained and analysed. Furthermore, the original and pioneering studies of

Altman and Beaver have been discussed in detail to provide the reader with a

thorough account of the basis of future research. By building on the methods

and theories developed in the previous studies, the researcher will utilise the

bankruptcy model to determine the performance of independent oil companies.

! xxxvii!
 CHAPTER THREE

METHODOLOGY

3.0 Introduction

Firstly, this chapter opens with a discussion and reasons why the study was

chosen, followed by an overview of the research paradigm, research philosophy

and the methodology used. Secondly, information on the nature of the research

and the data will be presented. Thirdly, the sample and population are

addressed including explanations of the ratios utilised in the calculations. The

final section considers how the research was conducted, highlighting any issues

arising and how these were overcome.

To the knowledge of the researcher there are no articles after the Sena and

Williams’ study which use the Altman bankruptcy model to assess the

performance of oil companies (Sena and Williams, 1998). Since the 1998 study

was based on a sample of oil companies between 1986-1995, it was feasible to

adopt a similar methodology over a different longitudinal time frame. This

dissertation considers the performance of oil companies between 2008 and

2012 using the Altman z-score model. This period allowed conclusions to be

drawn on the impact of company size relative to overall performance and

potential for bankruptcy. In addition, it allowed consideration of the reasons

behind companies of a similar size, experiencing better performances than

others. A thorough discussion of the results and findings is addressed in

Chapter four.

! xxxviii!
3.1 Research philosophy

Lewis, Saunders and Thornhill (2012) describe a research philosophy as an all-

encompassing phrase related to “the development of knowledge and the nature

of that knowledge” (Lewis, Sanders and Thornhill, 2012). In other words, the

process of a study is to increase understanding of a specific topic. In this

dissertation, the purpose, and ambition of addressing a modest, yet important

problem for a specific population has indeed shown a development of

knowledge.

3.1.1 Research paradigm

The paradigm adopted was positivism, described by Bryman and Bell (2011) as

“an epistemological position that advocates the application of the methods of

the natural sciences to the study of social reality and beyond” (Bryman and Bell,

2011). There is no single conclusive definition of positivism and many authors

will discuss it in similar fashion of either a paradigm or philosophy (Collis and

Hussey, 2009 p. 56; Lewis, Saunders and Thornhill, 2012 p. 134; Jankowicz,

2005 p. 110; Bryman and Bell, 2011 p. 15) but the general concept and nature

is the same.

3.1.2 Research methodology

According to Lewis, Saunders and Thornhill (2011), the methodology is the

research strategy for how the researcher will conduct the study and answer the

research question (or questions) proposed. According to Denzin and Lincoln

(2005) cited in Lewis, Saunders and Thornhill (2011) p. 173, the research

! xxxix!
strategy is the connection amidst the research philosophy and the ensuing

decision of how to gather and examine the data. The structure of the

methodology will include: clearly defined objectives fashioned from the research

question(s); an outline of precisely where the data will be gathered from; how

the researcher suggests to gather and examine the data; discussions of any

ethical concerns; and the limitations of the research such as availability of data,

time constraint and financing the project (Lewis, Saunders and Thornhill, 2011).

3.2 Software used for analysis

The Microsoft Excel programme was used to input, and analyse all the data

collected. One workbook was used, where each company had a separate

worksheet for the respective data. Once the ratio component figures for working

capital, total assets, market value of equity, book value of debt, sales, retained

earnings, and the earnings before interest and taxes were found, or calculated,

they were entered into the worksheet. The aforementioned figures were found

for each year of the study for all nineteen sample companies. This took

considerable time due to the number of companies and five-year study period.

Thorough checks were completed to make sure the information included in the

worksheets was consistent, accurate, and reliable. Independent auditors

audited the complete sample financial reports. Having an independent audit

gives a level of validity, and reliability, in the reported figures. The companies

used for the audit were major accounting firms such as: Deloitte LLP, Ernst and

Young, and PricewaterhouseCoopers LLP.

! xl!
Once all the data had been calculated and input in separate worksheets in

EXCEL, the z-scores were calculated. This was done by taking each ratio

component for the first company (Afren) in 2008 and multiplying them by the

specific factor proposed in the z-score model. Once the z-score had been

calculated for 2008, the 2009 results were calculated, and so on. This method

of calculation was replicated for the entire sample of the study. Once all the z-

scores were calculated, a table was constructed for the results of each year.

The mean yearly value and mean company value was calculated in EXCEL.

Although the Sena and Williams’ study used the mean z-score values to assess

the performance of the companies, it was not possible to replicate, as the

timeframe of this dissertation was not sufficiently long. It proved more applicable

to look for trends in each company’s z-score over the five-year period, or

alternatively to compare companies with other companies’ yearly z-score in the

sample. Full details of the z-score calculations and results can be found in the

appendices section (Appendix A). As the main question raised is concerned

with company size, analysis of each group (small, medium and large

companies) was made. It was discovered that some companies significantly

outperformed others in their size grouping or even in other grouping categories.

3.3 Rationale for using quantitative method of analysis

The study is concerned with the size of independent oil companies, based on

total assets. The use of numeric data in the ratio calculations means it is

sensible to follow a quantitative method of analysis. Quantitative refers to any

data that has been enumerated (numeric data). This analysis allows ratios to be

! xli!
calculated from audited financial statements, providing reliability in the figures.

A qualitative method (concerning non-numeric data) using a questionnaire, or

survey for instance, could have been adopted to gain the opinion of the

management of the companies in the sample. This would have provided an

interesting insight into the opinion of management on bankruptcy issues in the

oil and gas industry, however, due to the time limitation (three months) and lack

of contacts in the positions required, this method could not be fulfilled.

3.4 Sources and nature of data

According to Lewis, Saunders and Thornhill (2011) data are “facts, opinions and

statistics that have been collected together and recorded for references or for

analysis” (Lewis, Saunders and Thornhill, 2011). Data can be divided into two

broad groups: primary data and secondary data. Primary data is any data,

which has been gathered explicitly for the study being conducted. This data is

new, and is collected by the researcher, through the use of questionnaires,

surveys, interviews, and focus groups (Collis and Hussey, 2009). Contrarily,

secondary are data originally gathered for a different intention to the specific

purpose of the research in this study. The data can be subject to additional

analysis to postulate further and deeper knowledge of a topic. It may also allow

the researcher to draw conclusions. Sources of secondary data include any

information already gathered and reported, examples such as: journals;

publications; databases and company’s annual reports; and other company

documents (Collis and Hussey, 2009). The main advantage of secondary data

is that it is already available, and in abundance, thus alleviating issues of time

! xlii!
and monetary constraints, apparent in some researchers’ academic studies

(Ghauri and Grønhaug, 2010 cited in Lewis, Saunders and Thornhill, 2012).

Secondary data will also allow the analysis of a much larger sample, providing

the researcher with the option of making generalities about the wider subject

area. It will also allow for longitudinal studies to be conducted, that is, a study

conducted over a specific period of time. There are however, disadvantages in

secondary data, most prevalently that the data was not collected for the specific

purpose of the researcher’s study. Also, there is no guarantee that the data

gathered is of high quality and reliable.

The data from the companies’ annual reports was used for the components of

the ratio calculations. The ratios used considered liquidity; profitability;

productivity of assets; solvency; and sales generating ability of assets. There

are indeed limitations to using ratio analysis: there is no universally accepted

set of ratios to use for assessment; a single ratio doesn’t provide enough

information to make a thorough assessment and ratios are only as reliable as

the source of data they have been retrieved and calculated from (Atrill and

McLaney, 2011).

3.5 Research design

It was decided that a positivist philosophy, involving experimental research, was

the most appropriate for the research. The reason for choosing a positivist

study is because the research is based on the collection, and analysis, of

secondary quantitative data and adopts, as far as applicable, a value neutral

! xliii!
approach to the research. Value neutral means that the researcher was

independent of the research subject (Collis and Hussey, 2009). The researcher

has aimed to follow this approach as closely as possible, but there are some

limitations in adopting this mentality such as: the choice of issues addressed;

the aims of the research; and which data to collect and analyse. Therefore the

approach cannot be fully value neutral. This approach involves the collection of

data about a reality deemed observable and the pursuit of consistencies and

contributory associations in the data to establish generalities similar to those

fashioned by scientists (Gill and Johnson, 2010).

3.5.1 Deductive nature of research

The research was conducted in a deductive manner, because it is concerned

with the use of data to test a theory or question(s). Deductive research is most

common to scientific experiments and the natural sciences, where theories are

put through substantial tests to predict the reliability of validity of the theory.

As the study proposed an association between size and potential for bankruptcy

to form a conclusion it follows the nature of deductive research. Other research

approaches, such as inductive and abductive, could have been used but were

analysed and subsequently rejected. Inductive research begins with the

collection of data to investigate an occurrence, and then theories are built from

the findings – quite frequently in the development of a “conceptual framework”

(Lewis, Saunders and Thornhill, 2011). The abductive approach to research

uses data to investigate an occurrence, recognise similarities and repetitions, to

allow the generation of a new, or adapt a current theory further tested using

! xliv!
additional data. As neither of these alternative approaches was applicable, the

approach was indeed deductive.

3.6 Categorising companies into bankrupt or non-bankrupt sectors

Z-score values, as recommended in the Altman study of 1968, were proposed

to assess companies’ probability of bankruptcy. The categories are as follows: a

z-score equal or greater than 2.99 means a company fits into the non-bankrupt

sector; a z-score equalling between 1.81 but less than 2.99 is in the “grey area”

and a company with a z-score less than 1.81 is in the bankrupt sector. The grey

area is the section where a company’s potential for bankruptcy is undetermined.

It must be made clear that the z-score is merely a performance indicator and

does not provide an absolute guarantee that companies will ultimately go

bankrupt or not, if they report scores below 1.81 (bankrupt) or above 2.99 (non-

bankrupt).

3.6.1 Use of methodology from previous study

The Altman z-scores for the sample of oil companies were calculated, and are

documented in figure 4.1, found in Chapter four. The originally proposed period

of study for this dissertation considered a time frame over a ten-year period

between 2003 and 2012. This was later revised, and shortened, to a study from

2008 to 2012 due to lack of available data from all sample companies

concerned. If a researcher had full access to historic company accounts, then

the originally proposed ten-year study period could be possible. The chosen

five-year period allowed a sufficient analysis of oil companies of varying size,

! xlv!
based on their average total assets. The reason for choosing this period was to

evaluate company size and the potential for bankruptcy in independent oil

companies. This may also help to highlight the effect the global financial crisis

and oil price shocks of late 2008 had upon independent oil companies.

Choosing independent oil companies with varying size: large (with average total

assets >$50 billion), medium sized (between $1 billion and $50 billion average

total assets) and small (below $1 billion total assets) allowed comparisons to be

drawn on the potential for bankruptcy relative to company size.

The data was then used to compare the sample over the five-year period using

Altman’s arrangement and modelling technique. This technique involved the

calculation of the five specific ratios: working capital/total assets; retained

earnings/total assets; earnings before interest and taxes/total assets; market

value of equity/book value of debt; and sales/total assets, for each company in

the sample. The ratios were then multiplied by a specific factor and combined to

provide an overall z-score. The z-score is the determination of the probability of

bankruptcy within a company. The value for these ratios can be found in

summarised form, of annual and company results, in the appendices section

(Appendix A).

3.7 Population and sample of the study

The population of a study is defined in slightly different ways by academics.

Bryman and Bell (2011) describe it as “the universe of units from which a

sample is to be selected”; Lewis, Saunders and Thornhill (2012) describe it as

! xlvi!
“the complete set of cases or group members” (Bryman and Bell, 2011; Lewis,

Saunders and Thornhill, 2012). Although these definitions vary slightly, the

general idea of a population is the complete group of the test subject (for

example: retail stores, oil and gas companies, banks and others).

It would not be possible, given the time allotted (three months), to analyse the

complete population of all independent oil companies. Thus, a sample is

selected from the population. A sample is a smaller “sub-group or part of a

larger population” (Lewis, Saunders and Thornhill, 2012). This alleviates the

impracticability of testing a population of hundreds of companies in the limited

time available. An appropriate sample was selected to represent the population.

This was prepared under the associated method of probability (or

representative) sampling, whereby implications need to be made from the

selected sample, about the population. The sample is prepared in order to

address, and answer, the question(s) set by the researcher and ultimately

achieve the objective(s) set.

3.7.1 Sampling frame

To allow a sample to be selected, the sampling frame was established. The

sampling frame is a “complete list of all the cases in the population from which

your sample will be drawn” (Lewis, Saunders and Thornhill, 2012). To allow

generalities to be drawn from the sample, about the population as a whole,

companies needed to be varied in size from small, medium, to large. Initially the

sample was chosen using a method of only including companies on the London

stock exchange with a market capitalisation of greater than £100 million as it

! xlvii!
helped to reduce the companies which were too small for the study. It was

discovered that the majority of companies with a market capitalisation of less

than £100 million were oil investment companies, not independent oil

companies as required for the research. If these companies were included in

the sample, the mean values would be erroneous and inconsistent and the

overall sample results would be unreliable. Considering the total number of oil

companies listed on the London Stock Exchange (FTSE all share Index and

FTSE AIM all Share Index) gave a population of 115 companies (ninety-seven

from the FTSE AIM all share and eighteen from the FTSE all share).

3.7.2 Use of both FTSE indices

The reason for considering both FTSE indices is that large and medium sized

companies are listed on the all share index, and smaller companies are listed

on the AIM index, thus providing an ample range of companies of varying size

to assess potential for bankruptcy. The initial sample included thirty-five

companies, nineteen from the FTSE AIM all share index and sixteen from the

FTSE all share index. The average total assets of each company were

calculated (over 2008-2012) to give an indication of relative size. This was

consistent with the past study of Sena and Williams, which based the sample of

company size on total assets. Once the average total assets had been

calculated from the initial sample, a further nine companies were subsequently

omitted, when it was discovered that the historic annual reports did not go back

to 2008 as required. Another reason for omitting the nine companies was that

the figures were quoted on the 31st of March. As the vast majority of companies

! xlviii!
report their figures on the 31st of December, any company reporting financial

results on another date was omitted, to ensure the results were consistent. The

annual reports were sourced through the companies’ websites and

http://www.northcote.co.uk - a database of historical annual reports. The latter

source was used only when the annual reports could not be sourced directly

from the companies’ website. Data required for the market value of equity (the

share price) was gathered from the London Stock Exchange website.

3.7.3 Sample

The companies in the initial sample were: Afren, Amerisur Resources, BG

Group, BP, Cairn Energy, Circle Oil, Coastal Energy, Exillion Energy, Faroe

Petroleum, Geopark, Gulf Keystone, Heritage Oil, Igas Energy, Iofina, Ithaca

Energy, JKX, Ophir Energy, Petroceltic International, Premier Oil, Providence

Resources, Royal Dutch Shell, Salamander Energy, San Leon, Soco

International, Tullow Oil and Xcite Energy. Unfortunately, data from: Amerisur

Resources, Exillion Energy, Igas Energy, Iofina, Providence Resources, San

Leon and Xcite Energy was not available, or consistent with the rest of the

sample, hence they were subsequently removed. There was no share price

information before February 2009 for Providence Resources meaning the

market value of equity could not be calculated. Amerisur Resources’ annual

report was for a period ending on the 31st of March. A similar inconsistency

issue arose with Igas Energy where the annual reports were given for the year

ending on the 31st of March. Similar inconsistences, or lack of available data

were the reason the abovementioned companies were omitted.

! xlix!
The final sample size consisted of nineteen companies, listed below in Table

3.1. The company size was based on the samples’ average total assets ($

millions). It can be observed that this sample is indeed an accurate

exemplification of the population as it contains oil majors (BP and Royal Dutch

Shell), and a mix of medium-sized companies and smaller, less well-known oil

and gas companies.

Company Name Total Assets Company Name Total Assets

($m) ($m)
Afren 1,997 Heritage Oil 1,405
BG Group 71,217 Ithaca Energy 593
BP 265,946 JKX 525
Cairn Energy 4,893 Ophir Energy 637
Circle Oil 186 Petroceltic International 383
Coastal Energy 482 Premier Oil 3,150
Faroe Petroleum 440 Royal Dutch Shell 320,545
Geopark 336 Salamander Energy 1,029
Gulf Keystone 470 Soco International 1,186
Tullow 10,794
Table 3.1: sample oil companies and their average total assets (in $ million)* for

the research period, 2008-2012 (Source: Annual accounts of companies

concerned 2008-2012).

*Companies with total assets greater than $50 billion, 3; between $1 and 50

billion, 7; and less than $1 billion, 9.

3.8.1 Method for calculating the z-score

To calculate the z-score, the formula originally proposed by Altman (1968) was

used. This formula was used primarily for the manufacturing industry, and after

a thorough search of literature and past studies an oil industry specific z-score

model could not be found. The z-score formula is as follows:

! l!
 Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 0.999*X5

The values for each of the X components are as follows:

X1 = Working capital/total assets

X2 = Retained earnings/total assets

X3 = Earnings before interest and taxes/total assets

X4 = Market value of equity/book value of debt

X5 = Sales/total assets

3.8.2 Working capital/total assets

The working capital was calculated by taking the total current assets and

subtracting the total current liabilities. This calculation was completed for each

sample company for each year. The figures for the current assets and current

liabilities were clearly located and retrieved from the companies’ balance sheet.

When the working capital is divided by the total assets, the result gives a

measure of the liquidity of the business. According to Atrill and McLaney (2008),

liquidity is a measure of how many liquid resources (money) a company has

available in order to pay what they owe (Atrill and McLaney, 2008). There are

two other commonly used ratios for measuring the liquidity of a company: the

current ratio (current assets/current liabilities) and the quick ratio (current assets

less stocks/current liabilities), however both alternatives were discovered to be

less statistically significant than the working capital/total assets.

! li!
3.8.3 Retained earnings/total assets

The retained earnings (or accumulated losses) are a measure of the profitability

and are a major foundation of finance for the majority of businesses (Atrill and

McLaney, 2008). If earnings are retained by the business, as opposed to

releasing to the shareholders in a dividend (share of a companies profits paid to

owners quarterly), the available funds for the business are improved. The

retained earnings figure is located on the balance sheet under the heading of

equity.

3.8.4 EBIT/total assets

Earnings before interest and taxes (also know as EBIT) is a measure of how

efficient the business is utilising its assets. The continuation of a business is

built on the earning ability of its assets. In this study the operating profit was

used for the figure of EBIT, as this is the wealth generated during a specific

period from regular activities carried out by the business. In the case of

bankruptcy, insolvency can occur when the total liabilities exceed the

businesses’ total assets (the earning ability of the assets). As many of the

companies reported very different forms of interest values, it proved consistent

to use operating profit for the EBIT component of the ratio as all companies

reported the it clearly in the income statement. The ratio of earnings before

interest and taxes/total assets carries the highest contribution and inclusive

determinant ability of bankruptcy prediction in the model.

! lii!
3.8.5 The market value of equity/book value of debt

The book value of debt was calculated by summing all the liabilities on the

companies’ balance sheet (both current and long-term). The market value of

equity is also referred to as the market capitalisation of the company. This is

calculated by taking the total number of outstanding shares of the company and

multiplying by the share price for the date the accounts are reported (31st

December). This value took a considerable period of time to calculate as the

historic share price was required for each company, found on the London Stock

Exchange website. As this information is from the LSE, the share price is

quoted in British pence. All the other figures are reported in US Dollars ($),

therefore the share price had to be converted from Pounds (£) to Dollars ($).

The conversion was achieved by taking the share price in pence, dividing it by

100 to get the value in Pounds, then converted to Dollars using the middle (+/-

0%) rate from the www.oanda.com website. For each year (2008-2012) the

exchange figures were as follows: 1.44727; 1.59257; 1.54679; 1.54261 and

1.61533 respectively. The figures from 2008, 2009, 2010 and 2012 are for the

31st of December. The 2011 figure is for the 30th of December as there is no

share price quoted for the 31st of December as this fell on a Saturday, when the

stock exchange was closed.

By including the market value of equity to book value of debt ratio, it gave a

market value aspect to the overall z-score model. The outstanding shares figure

is found under the ‘share-based payments’ section in the annual reports. This

details the outstanding shares at the beginning and end of each year. The latter

! liii!
value is required for the market value of equity calculation. A similar, more

common ratio (book value of net worth/book value of total debt) could have

been used, but it was deemed that including the market value dimension was

more influential in bankruptcy prediction (Sena and Williams, 1998). There was

only one company, which posed an issue when calculating the market value of

equity – Royal Dutch Shell. As RDS possesses class ‘A’ and class ‘B’ shares,

investigation was done to find out which class of share would be most

appropriate. It was discovered that dividends paid on class ‘A’ shares follow a

Dutch tax regime. Class ‘B’ shares, on the other hand, receive dividends from a

dividend access mechanism. Any dividends paid through this mechanism will

have a UK source for both Dutch and UK taxes. Hence, the class ‘B’ share price

and number of outstanding shares was used in the calculation for market value

of equity for RDS (Shell, 2013).

3.8.6 Sales/total assets

The sales (also known as turnover or revenue) of a company are known as a

measure of the inflow of capital from the ordinary operating activities of a

business (Atrill and McLaney, 2008). The sales to total assets ratio highlights

the sales creation capability of the company’s assets. This is a common

accounting ratio, deemed appropriate to measure the aptitude of the

management’s ability to deal with competitive market environments (Edmister,

1972; Sena and Williams, 1998).

! liv!
3.8.7 Exchange rate

Three of the companies in the sample (BG Group, Faroe Petroleum and Tullow

Oil) reported all their figures in British Pounds, hence the OandA website was

used to convert the figures to US Dollars. This was achieved using the middle

(+/- 0) exchange rate. The exchange rates in 2008, 2009, 2010, 2011 and 2012

(1.44727; 1.59257; 1.54679; 1.54531; 1.61533 respectively) were used for this

conversion. Once the z-scores for each company were calculated the

information was collated into one table. This table included all the z-scores, a

yearly mean and company mean for each of the sample companies.

3.9 Generalities

It is important to note that any generalities made from the sample findings are

only concerned with companies listed on the London Stock Exchange.

Inferences cannot be made about all independent oil and gas companies on a

global basis unless the number of companies assessed was a higher proportion

of the population and was based on a sample from all listed independent oil and

gas companies globally.

! lv!
 CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.0 Introduction

The proposed aim of this chapter is to report and evaluate the data collected in

the study. Initially, the findings will be presented in a table of the overall z-

scores for the sample companies over each year. This will give values for the

company mean and yearly mean allowing further analysis to be conducted. By

presenting the figures for each company in a table allows easy to understand

results and trends to be analysed. The second section of this chapter will delve

into the analysis of the findings and provide guidelines on the reasons why the

trends are occurring and ultimately enable the research question to be

addressed, and answered. Generalities about the population will be proposed in

the conclusion of this chapter.

4.1 Descriptive analysis of data

The data from the study is collected and amalgamated into a table to highlight

the trends in the figures for each company over the period studied. The

companies are detailed in alphabetical order, as it would not be possible to

arrange them according to z-score as each year’s results differ substantially. As

it was not possible to address the companies over a longer period of time, the

trends are over a five-year period. This however gives a good range of results

and allows for a thorough analysis.

Table 4.1 below gives a full table of all companies and their associated z scores

over the research period.

! lvi!
 Mean
2008 z 2009 z 2010 z 2011 z 2012 z company
Company score score score score score z score
2008 2009 2010 2011 2012
Afren -0.352 0.481 0.326 0.443 1.190 0.417
BG Group 1.381 1.010 0.833 0.903 0.770 0.980
BP 3.289 2.859 2.094 2.798 2.630 2.734
Cairn Energy 1.187 0.757 1.649 1.516 1.247 1.271
Circle Oil -0.229 0.620 1.362 0.977 1.381 0.816
Coastal Energy 0.110 2.379 2.320 1.474 2.684 1.793
Faroe Petroleum -0.742 -0.076 0.345 0.948 0.506 0.196
Geopark 1.394 2.023 2.420 1.585 1.521 1.789
Gulf Keystone -1.803 -6.962 0.778 -0.263 -0.300 -1.219
Heritage Oil -0.370 0.225 1.439 1.300 0.091 0.537
Ithaca Energy -0.237 1.130 3.742 1.406 1.287 1.466
JKX 2.635 2.400 1.485 1.683 1.331 1.907
Ophir Energy -1.491 0.170 -0.557 0.616 -0.236 -0.300
Petroceltic
International 2.081 -0.287 0.324 -0.133 1.724 0.742
Premier Oil 1.704 0.923 0.810 0.665 0.932 1.007
Royal Dutch Shell 3.158 2.154 2.470 2.970 2.853 2.721
Salamander
Energy -0.135 0.130 -0.426 0.510 0.138 0.043
Soco International 1.423 1.379 1.330 1.743 2.664 1.708
Tullow Oil 0.749 0.697 0.705 0.993 1.285 0.886
Yearly Mean 0.722 0.632 1.234 1.345 1.389
Table 4.1: z-scores for the sample oil companies (Annual accounts of
companies concerned, 2008-2012; London Stock Exchange, 2013).

Based on the company mean z-scores in all years, it can be observed that

100% of the sample is either categorised in the grey or bankrupt sectors. From

these findings it suggests that the oil and gas industry (for the companies listed

on the London Stock Exchange) was in an unfavourable position of financial

health. This could be due to the fact that the global recession affected every

industry, even one as lucrative and expansive as oil and gas.

! lvii!
4.2 Overview and analysis of the Altman z-score results

4.2.1 2008 z-score analysis

It proved more beneficial to assess the financial health of the industry year by

year to evaluate trends. This also showed that in some cases, companies were

in the non-bankrupt sector, when if the mean value was observed, the

companies would appear to be in the grey or bankrupt sectors. From the 2008

z-scores, two companies were in the non-bankrupt sector, two in the “grey”

sector and fifteen in the bankrupt sector. This shows a majority (79%) of

companies in the bankrupt sector – emphasising that the oil and gas industry

was not in a good financial position. Of the companies in the bankrupt sector,

eight reported negative z-scores (Afren, Circle Oil, Faroe Petroleum, Gulf

Keystone, Heritage Oil, Ithaca Energy, Ophir Energy and Salamander Energy).

This was a very worrying situation for these companies to be in but can be

explained as a result of negative retained earnings and negative earnings

before interest and taxes reported for that year. Circle Oil also reported zero

sales in 2008; further enhancing the less favourable reported results, and

overall z-score. It was interesting to note that seven of the eight companies

reporting negative z-scores, have total assets less than $1 billion, categorising

them as small sized companies. One company (Salamander Energy) is a

medium sized company, giving an indication that even slightly larger companies

still face precarious results.

! lviii!
4.2.2 2009 z-score analysis

With the recession taking hold in late 2009, the resultant z-scores for all

companies would be expected to decrease accordingly, as the financial

environment was inauspicious. This is indeed the case, and no single company

appears in the non-bankrupt zone with a z-score of 2.99 or greater. Royal Dutch

Shell, in fact, experienced a decrease in z-score of over 1.000, from 3.158 to

2.154 in the space of one year. Five companies fall into the grey sector, with a

decrease in the percentage of companies in the bankrupt sector by 5%. Of

these five companies, only three reported negative figures - an improvement on

the 2008 results. The companies, which reported negative z-scores, are again

small sized companies with total assets below $1 billion (Faroe Petroleum, Gulf

Keystone and Petroceltic International). The reason for this is due to the

negative retained earnings and negative earnings before interest and taxes for

all three companies. Petroceltic International experienced a loss of $6.1 million

as a result of higher administration costs, largely due to broadening all areas of

the company’s operations (Petroceltic International, 2009). Faroe Petroleum

recorded a loss of £6.0 million in 2009, largely as a result of lower than

predicted reserves in the Topaz gas field after drilling of the well earlier that

year (Faroe Petroleum, 2009). Gulf Keystone reported a severe negative z-

score in 2009 of -6.962 mainly due to the working capital value of -$221.23

million. This was possibly due to a diversification of the assets in Kurdistan, to

allow the company to gain exposure not only to exploration opportunities but,

production, appraisal and development (London South East 2013). A decision

was made by the management to restrict investment in Algeria and begin a

! lix!
tactical withdrawal from the country. This contributed heavily in the company’s

2009 loss of $96.3 million, where the financial charges involved in the Group’s

exit from Algeria were $73.9 million. Algeria had been a key area of exploration

and success for Gulf Keystone for many years but the investments required to

develop projects had increased significantly. This makes development projects

in Algeria only applicable to larger oil companies with an abundance of financial

resources (Gulf Keystone, 2009).

4.2.3 2010 z-score analysis

A surprising result occurred in the 2010 reports with one company (Ithaca

Energy) rising into the non-bankrupt sector with a score of 3.742, the highest

reported z-score over the period of this research. From the annual reports, and

individual ratio calculations, Ithaca Energy experienced a large rise in the

number of outstanding shares (from 162,361,975 in 2009 to 255,789,464 in

2010); this was coupled with an end of year share price of $1.97. The increased

number of outstanding shares of the company could be attributed to a UK

private placement (Ithaca Energy, 2010). A private placement is adopted by

smaller companies and involves the issue of shares to a select, and

sophisticated group of investors, in order to raise capital (Sherman, 1991). The

company issued over 90 million shares in the private placement, generating

$153.2 million (Ithaca Energy, 2010). When the market value of equity was

calculated, from the aforementioned figures, and divided by the book value of

debt, the result was large, having a substantial influence on the increased

overall z-score. The working capital (current assets less current liabilities) for

! lx!
Ithaca Energy in 2010 also increased, nearly four times the value reported in

2009. Of the $224.9 working capital value, $195.6 million was free cash balance

meaning this money was available immediately, if required. From the Ithaca

Energy ‘Management’s Discussion and Analysis’ report for 2010, the improved

results could be attributed to the increased production in the Beatrice and Jacky

fields (Ithaca Energy, 2011). Repairs and modifications were made in early

2010, which allowed the facilities to run at higher capacity, and subsequently

increase production. A higher oil price in 2010, compared with 2009 also helped

Ithaca Energy report a highly successful year. The overall picture for the

industry was improved from 2009, with one company in the non-bankrupt zone,

four in the grey zone and fourteen in the bankrupt zone. Of all the companies,

only two reported negative z-scores.

4.2.4 Unfavourable results for BP in 2010

The results of BP were interesting to consider as the z-score changed from one

of the highest in the study (2.859 in 2009) dropping by 0.765 to a low of 2.094 in

2010. Even though BP did not score low enough to be in the bankrupt sector at

any point, this change is noteworthy. The low score was substantial and the

trend for BP’s z-score results needs mentioning. The trend can be observed in

Figure 4.1 below:

! lxi!
 BP'Z)scores'2008)2012'
3.500!
3.289!
3.000!
2.859! 2.798!
2.630!
2.500!
Altman'z)score'

2.000! 2.094!

1.500!

1.000!

0.500!

0.000!
2008! 2009! 2010! 2011! 2012!
Year'

Figure 4.1 Altman z-scores for BP 2008-2012 (BP, 2008-2012; London Stock
Exchange, 2013).

The significant decrease experienced in 2010 can be mainly attributed to the

Deepwater Horizon oil spill occurring in the Gulf of Mexico on the 20th of April

2010. The incident involved a failure of the equipment used to maintain the

integrity of the well. Following this breakdown, the equipment used to control

the flow of hydrocarbons from the well failed and hydrocarbons leaked into the

Gulf of Mexico (BP, 2013). BP reports that on the 31st December 2012, over

$14 billion has been spent on activities to rectify the damage caused. This has

involved close engagement with governments, indigenous people, company

shareholders, BP employees, the oil industry as a whole and the media (BP,

2013). According to a recent Financial Times report, the compensation

payments continue for BP. Although it states that since the accident, BP has

paid $11 billion to remedy the damage caused, it entered a settlement whereby

! lxii!
billions more are to be paid to businesses and indigenous people located in the

five states on the Gulf of Mexico (Financial Times, 2013c). Although, BP’s z-

score in 2011, returned to a figure nearing the results of 2009, it is unclear how

dramatic the effect of the on-going settlements will have on the overall results

for BP in the future.

4.2.5 2011 z-score analysis

The 2011 z-scores highlight the worst yearly overall performance of all

companies with a staggering 89.5 per cent of companies falling into the

bankrupt sector. The only exceptions were the two largest companies – BP and

Royal Dutch Shell – even then these companies were in the grey zone, and not

the non-bankrupt zone. This year saw a high in the oil prices with the spot price

of Brent crude averaging a value of $111.26 per barrel, an increase of forty per

cent for the previous year (U.S. EIA, 2012; BP, 2012). This average was the

highest oil price reported since 2008. It can be explained by significant events

occurring during 2011. The civil war in Libya broke in February, which caused a

decrease in the supply of oil from Libya to the world oil markets (1.5 million

barrels per day in exports). This forced the oil price to rise and relied on the

input of OPEC to increase supply to the world markets. The oil price peaked in

April of 2011 as a result of the disruptions in Libya and ensuing loss of supply of

exports (BP, 2012). This, coupled with the continuing increased demand from

the emerging economies, such as China and India, put strain on the major oil

exporting countries and the price of oil. China’s share of global energy

consumption in 2011 was at a staggering 20.3 per cent, emphasising the

! lxiii!
demand for oil in emerging economies (BP, 2011). As the focus of this research

is on companies listed on the London Stock Exchange, a major factor in the

results may be characterised somewhat by the debt crisis in Europe. This crisis

had an impact on not only the European markets but also the global economy

as a whole. In particular, stunted growth of the organisation for economic co-

operation and development (OECD) countries was observed (U.S. EIA, 2011).

Of the seven medium sized companies in the sample, Premier Oil is the third

largest in terms of total assets. In 2011, the reported z-score was 0.665, similar

to the results of smaller medium sized companies. According to the Financial

Times report, Premier Oil was experiencing some operational issues with the

Huntington field in the North Sea. The repercussions of this was a lower level of

production than was originally expected. This led to a decrease in the pre-tax

profit from $111.6 million to $32.5 million over the course of the first two

quarters of 2011. Premier Oil’s share price dropped by twenty-two per cent in

August 2011, unusual for a company listed on the main FTSE index (Financial

Times, 2011).

4.2.6 2012 z-score analysis

There were four companies listed in the grey zone and fifteen in the bankrupt

zone in 2012. Coastal Energy experienced a high z-score result in 2012, higher

than that of its much larger counterpart, BP. With a z-score result of 2.684, it

was the second highest in 2012, behind Royal Dutch Shell. Coastal Energy is

categorised as a small company so the results were remarkable when

! lxiv!
compared with the other small companies in the sample. The results are shown

below in figure 4.2:

Small'sized'companies'Altman'z)scores'for'
2012'
3.000!
2.500!
Altman'z)scores'

2.000!
1.500!
1.000!
0.500!
0.000!
10.500!

Companies'

2012!Altman!z1scores!for!small!size!companies.!

Figure 4.2 Altman z-scores for the small sized sample companies for 2012*
(Annual accounts of companies concerned, 2012; London Stock Exchange,
2013).

*Full details of the Altman z-score results for the small sized sample over the
entire research period can be found in Appendix B (App 21).

4.2.7 Coastal Energy

From the annual report and financial statements Coastal Energy recorded a

fantastic year of results. The total assets increased from $518.731 million to

$894.193 million during 2011 and 2012. The sales revenue generated was

remarkable and increased over two times in the space of one year from

$297.104 million to $666.902 million. The most staggering result observed in

! lxv!
the results is for the retained earnings increasing over ten times in 2012

($193.88 million) compared with the 2011 results ($17.63 million). The earnings

before interest and taxes increased over four times from 2011 to 2012 (Coastal

Energy, 2012). This was mainly driven by higher production levels - averaging

20,000 barrels of oil per day - together with increased global commodity prices

(The Wall Street Journal, 2013). Increased reserve bases also assisted in the

momentous results for Coastal Energy. The production and cash flow for

Coastal Energy was strong for the fourth-year running, represented in the vast

financial statement results (Financial Times, 2013b). The future looks bright for

Coastal Energy with the signing of a contract to develop reservoirs in Malaysia.

Coastal Energy has committed to the hire of a rig for a daily rate of $145,000 for

this project. It is proposed, by Investec, that this commitment should result in

the sales increasing to $936 million in 2013 (Financial Times, 2012). Coastal

Energy’s CEO Randy L. Bartley reports projected expansion in the future and

has the opportunity to work as the operator on fields owned by PETRONAS in

Malaysia (Coastal Energy, 2013). Even in their short history their results should

give investors the confidence to continue to support the business’s operations.

For a company of Coastal Energy’s size to report a better z-score than a major

company – such as BP – shows that larger companies do not necessarily

perform better than their smaller counterparts.

4.3 Overview of large company results

Of the three large sample companies - BG Group, BP, and Royal Dutch Shell –

BG Group reported low z-scores across the entirety of the study. Given the size

! lxvi!
and diversity of these companies’ global operations, one would expect all to

report large earnings, generation of sales revenue and z-score. However, the

BG Group results give a different picture. Although BG Group is around twenty-

two per cent and twenty-seven per cent of the size of BP and Royal Dutch Shell

respectively, and significantly larger than other companies in the sample, the z-

scores reported are worrying. The yearly z-scores for BG Group were 1.381,

1.010, 0.833, 0.903, and 0.770, which places them in the bankrupt sector for

the entirety of the study. The z-score for 2008 is not a major concern with the

development of large Brazilian oil fields, coupled with sizeable profits from

liquefied natural gas (LNG) projects increasing four-fold. However, the share

price decreased due to the speculation of a higher price required for the

acquisition of the Australian based company, Origin Energy (Financial Times,

2008). According to a report by The Guardian, in the following year, a discovery

of the Guara field in the Santos basin off Brazil possesses the opportunity for

BG to make substantial cash flow and increase production levels for years to

come (The Guardian, 2009). The main reason for the lower z-score results is

attributed to the low market value of equity based on the shares outstanding

being only 45.0 million for 2009 compared with its larger counterpart BP that

had 18,732 million shares outstanding for the same year. This may highlight

that share price has a significant impact on the overall z-score value. If time

permitted, a thorough investigation would be conducted into the correlation

between share price and z-score.

Of all the years, BG Group reported its lowest z-score in 2012 of 0.770. This

could mainly be down to the announcement of no production increase for 2012.

! lxvii!
This led to a drop in BG shares by greater than eighteen per cent. Several

issues limited its ability to meet the production targets set, such as the halt on

operations on the Elgin/Franklin field in the North Sea, experiencing a large leak

– meaning no production would take place until some point in 2013. In addition,

the expected start date in production of the Jasmine field was delayed from the

original date of late 2012, to now begin in 2013. Operations in Egypt contributed

to the less favourable performance of BG Group in 2012, where reservoir

decline had lowered the production levels. The strategy implemented to halt the

decline was less effective than planned and production levels still remained low.

Additionally, the continuing political and social unrest with the presidential and

parliamentary elections made project execution more difficult (BG Group, 2012).

Despite the abovementioned issues, the future looks good for BG Group, with

large projects in both Brazil and Australia expected to increase cash flow and

production levels in 2014 and 2015 (BG Group, 2012). Also, a twenty-year deal

agreed with the Chinese oil giant CNOOC to supply LNG from a project in

Australia, supports this notion (The Telegraph, 2012). Although BG Group

reported low z-scores for each year, it is clear that the company does not look

as if it will go bankrupt in the near future. Thus, emphasising that z-scores are

merely an indicator of potential bankruptcy and not an absolute guarantee that

bankruptcy is immanent for companies reporting a z-score lower than 1.81.

4.4 Overview of Gulf Keystone

It must be noted that some companies reported negative z-score values,

emphasising a severe threat of bankruptcy might be immanent. It would not be

! lxviii!
useful to assess the companies solely on the mean company score, as this is

not a fair reflection of the overall performance of the companies over the five-

year study. Due to the high risks, and vast investments involved in oil and gas

projects, companies may report a significant loss in the retained earnings due to

the large project investment in a particular year. There may be times where a

company has invested a significant portion of their revenue into a project initially

deemed profitable (where reserves exist) but during the exploration phase it is

discovered that the well is dry. Hence, the company will abandon the project,

and the investment is lost. It is more useful, and beneficial, to look at the trends

in the companies’ z-score as having one unfavourable year could result in a

negative overall mean z-score. Companies could also report low or even no

sales (revenue) generation for a particular year, which results in an extremely

low or negative z-score for that year. Examples of this are Cairn energy (0.00

revenue in 2011 and 2012); Gulf Keystone (0.000 in 2009); Ophir Energy (0.533

in 2010); and Petroceltic International (0.210, 0.270 and 0.00 in 2009, 2010 and

2011 respectively). An extreme example of the impact of having no sales

generation can be observed in the 2009 z-score for Gulf Keystone of -6.962, the

lowest score reported in the sample. This was attributable to zero sales,

coupled with retained earnings of -$186,292,000 and earnings before interest

and taxes of -$95,123,000. Gulf Keystone reported the worst overall results

across all years where, four out of five years were negative z-scores. If a

company does not generate revenue, then its retained earnings and EBIT will

suffer. The lack of revenue generating ability can have a significant impact on

the overall performance of a company, not only in the reported year of zero

! lxix!
sales but also in subsequent future years. This is the case with Gulf Keystone

and explains why the overall mean z-score is negative. One reason for their

poor performance, specifically in 2009, could be due to the fact that it did not

possess any proven reserves at the time. In August 2009, Gulf Keystone did

make a discovery in Kurdistan attributing to a sharp rise in their share price from

27p to a high of 193p in November of that year (SPE, 2013; Financial Times,

2010). This may be the reason the performance, and z-score improved

drastically from 2009 to 2010. The poor performance in 2011 and 2012 could be

attributed to the court case filed against Gulf Keystone by Excalibur. In a report

conducted by the Telegraph (2011) Excalibur was suing Gulf Keystone over the

discovery in Kurdistan. The court case was heard in London in October 2012.

On-going speculation and lawsuits give the company a less favourable

reputation and could be the reason for the lower z-scores reported (The

Telegraph, 2011). This case was only settled on the 10th September 2013, with

a victory for Gulf Keystone over the legal possession of acreage in Kurdistan.

The outcome saw share prices soar by twenty-five per cent when trading

restarted on the Tuesday morning (Financial Times, 2013a). Although time

does not permit research to conduct a study of the 2013 results, further

research could show the impact a court case has on company results - such as

Gulf Keystone.

! lxx!
4.5 Conclusion

In general, the larger companies (Royal Dutch Shell and BP) did perform better

over the entire period of the study. However, there were several smaller

companies exhibiting especially good results in certain years. Therefore no

generalities can be made about the entire sample of companies’ z-score results

for each size category. Nor is it therefore possible to make inferences about the

entire population of oil and gas companies listed on the London Stock

Exchange. It is clear that using z-scores as an indicator of financial performance

does not give any guarantee that a company will go bankrupt if it reports z-

scores below 1.81 over an extended period of time. Nor does it give a company

reporting a z-score higher than 2.99 certainty of non-bankruptcy. Therefore the

z-score may not be a useful indicator in bankruptcy prediction in the oil and gas

industry in a practical context.

! lxxi!
 CHAPTER FIVE

CONCLUSION AND RECOMMENDATIONS

5.1 Summary of main findings

The findings were inconclusive for the entire sample, however in general, the

larger companies did experience greater z-scores than their small equivalents.

The two largest companies in the sample (Royal Dutch Shell and BP)

experienced the greatest z-scores for the entirety of the study period, therefore

answering the research question. Certain smaller companies did perform well,

and even surpassed the z-scores of the two largest companies in particular

years. Specifically, Coastal Energy experiencing positive z-scores during the

entire research period, including a greater z-score than BP in 2012. Ithaca

Energy – a small sized company - reported the highest z-score of the entire

sample in 2010. Thus, it is not possible to provide generalities about all small,

medium and large sized companies, due to exceptions mentioned above. If

more time were available, the study would have been conducted with a larger

sample size over a greater timespan in the hope that generalities could be

found about the population of all independent oil and gas companies on the

London Stock Exchange.

Using a bankruptcy model in a research capacity does provide interesting

results, however the practical uses are untested for oil and gas companies.

Therefore, in practice, the bankruptcy model may not be the suitable means of

testing oil company performance at the moment. However, it may prove vital in

! lxxii!
the future, depending on the implications of increasing demand for oil from the

emerging economies such as China.

5.2 Wider issues in the oil industry

Testing oil company performance using a bankruptcy model only considers a

small proportion of issues in the oil and gas industry. Although oil reserves

depleting is not a major concern in the immediate future, reserves will run out at

some point, and substitute energy sources will need to be sourced. Alternatively

the development of advanced technologies and enhanced oil recovery

techniques may grant access to reserves previously deemed unreachable and

not economically viable. Exploration in more diverse locations such as the

Arctic and Greenland is currently taking place in search of new oil reserves and

sources of energy. With the majority of oil reserves situated in National Oil

Company countries, the independent oil companies are finding it more difficult

to gain access to oil reserves, due to political risks and a need for participating

in joint venture projects with the National Oil Companies. In addition to issues of

bankruptcy in the oil industry, the abovementioned concerns could also be

tested to add value to the findings of the Altman z-scores.

5.3 A reconsideration of the objective set

The aim, and question set in Chapter One was: Do large independent oil and

gas companies have better z-scores than smaller oil and gas companies?

It is clear that some of the larger independent oil and gas companies did report

higher z-scores than the small and medium sized companies. Though it can be

! lxxiii!
observed in Chapter Four, that in some cases (BG Group and Premier Oil for

instance), being a larger company does not necessarily merit greater z-scores

and less risk of bankruptcy. This result should prompt companies to adopt

bankruptcy models to fit alongside the list of ratios more commonly used to test

performance. The objective set was somewhat achieved with the exceptional

performances of smaller companies recognised and discussed. Consideration

of the exceptional z-scores in the sample highlights where companies (of a

similar size) could alter their practices to improve performance.

5.4 Recommendations

If the reader wishes to conduct further research, the development of an oil and

gas industry specific bankruptcy model would be a valuable objective. Time

constraints, and limited knowledge in the construction of theoretical bankruptcy

models, meant the author of this work was unable to pursue this in the

dissertation. To construct an oil and gas industry specific bankruptcy model

would require a thorough evaluation of the discriminant coefficients and

independent variables of the current z-score model.

Conducting the research over a longer timeframe would allow inferences to be

based on the mean values rather than trends. The hope is that generalities

could be made about the population and would be more significant. This

recommended research is only applicable if access to historic annual reports of

independent oil companies was available.

If the research time had been longer, an examination into the correlation

between z-score and share price would have been conducted. This may show

! lxxiv!
that the share price is significant in influencing the overall z-score. Therefore, if

companies are experiencing worse z-scores than their counterparts, increasing

the number of shares, or aiming to increase the share price could help lessen

the potential for bankruptcy.

It was noticed that the volatility of z-scores for larger companies differed to

small companies. There was not time to go into sufficient depth and evaluate

the relationship between company size and volatility in the results (see

Appendix C, App 23). However, it seems possible from the sample period

results, to propose that the larger the company, the less volatile the z-score

results. Nonetheless, further research with a larger sample size needs be done

to investigate if this relationship exists.

A line graph of the results of all companies’ z-scores for 2008 and 2012 was

constructed (found in Appendix B, App 22). This was done to show the

favourable and similar results in the trends for these years specifically. These

trends may suggest that the oil industry was affected most by the recession in

2009, 2010, and 2011. As time did not allow a thorough assessment to be

conducted, further research to evaluate the health of the oil industry, and effect

of the recession over this period could be made.

Using the z-score model only evaluates a small segment of the oil industry and

the influences behind the performance of independent oil companies. Further

research could be conducted on a global basis to include companies from other

stock exchanges such as New York and Shanghai, to give a country

comparison. This would allow a greater sample to be tested, and more diverse

population.

! lxxv!
5.5 Limitations of the dissertation project

If time permitted, more companies would have been included in the sample, in

the hope that generalities could be proposed and a longer research timespan

would have been used. Additionally, primary data in the form of semi-structured

interviews with the sample companies’ management would have added value to

the findings. Unfortunately, limited access to contacts in the industry meant this

was not applicable. Further research could be conducted through using a larger

sample size; conduct interviews as mentioned above; or development of a new

bankruptcy model specifically tailored for the oil and gas industry. With the

majority of companies in the grey area and unable to be classified as bankrupt

or non-bankrupt means there are errors in classification, thus a revision of the z-

score thresholds might be useful to further research.

5.6 Learning gained from doing the research

Conducting research has allowed the researcher to extensively work

independently on a chosen research subject. The research has shown

development from little knowledge of bankruptcy prediction to a broad and well-

rounded understanding of the subject area. The purpose of a research study is:

to establish a problem; address and analyse that problem; and provide

conclusions, whilst developing knowledge of the topic. At the culmination of the

dissertation, the researcher has increased their knowledge of the subject matter

and met the aims proposed.

! lxxvi!
Studying the MSc Oil and Gas Accounting programme has been character

building. The yearlong course has been met with: both highs and lows, but

allowed the researcher to gain an academic, and practical experience of Oil and

Gas Accounting. Not only has the programme developed the researchers’

academic abilities, but has provided the opportunity to meet some exceptional

people, and friends for life, to which the researcher owes a debt of gratitude to

the University of Abertay.

! lxxvii!
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! xc!
 APPENDICES

Appendix A

Tables of all company ratio components, ratio calculations and z-scores.

*All ratio components quoted in $ million.

Ratio&components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( .40.787( 158.400( .86.787( .254.766( 81.600(
Total(Assets( 921.698( 1,099.982( 1,446.488( 2,930.505( 3,584.400(
Retained(Earnings( .122.991( .129.895( .77.868( 64.795( 272.900(
Book(value(of(debt( 571.195( 441.734( 587.773( 1,723.200( 2,157.000(
Earning(before(interest(and(
taxes( .44.500( 45.791( 88.988( 268.151( 675.400(
Sales( 42.501( 335.818( 319.447( 596.663( 1,498.800(
Market(Value(of(Equity( 10.358( 22.697( 48.655( 31.403( 58.670(

(
Ratio&Calculations& ( ( ( ( (
Working(capital/Total(Assets( (
.0.044( (
0.144( (
.0.060( (
.0.087( (
0.023(
Sales/Total(Assets( 0.046( 0.305( 0.221( 0.204( 0.418(
RE/Total(assets( .0.133( .0.118( .0.054( 0.022( 0.076(
EBIT/Total(Assets( .0.048( 0.042( 0.062( 0.092( 0.188(
MVE/BVD( 0.018( 0.051( 0.083( 0.018( 0.027(

(
z.scores( (
.0.342( (
0.481( (
0.326( (
0.443( (
1.190(
App 1: Afren ratio components, ratios calculations and yearly z-scores (Afren,
2008-2012; London Stock Exchange, 2013).

! xci!
 Ratio&components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 509.439( 101.924( 1668.986( 4838.366( 5789.343(
Total(Assets( 36175.961( 41855.925( 77801.990( 94854.218( 105395.437(
Retained(Earnings( 4476.406( 3605.578( 5413.765( 6668.013( 7451.517(
Book(value(of(debt( 17218.171( 19289.208( 49044.071( 36492.496( 51937.705(
Earnings(before(interest(
and(taxes( 7389.761( 6008.767( 8603.246( 11375.027( 10000.508(
Sales( 18186.395( 16264.917( 26552.197( 32564.318( 30583.043(
Market(Value(of(Equity( 421.040( 804.150( 346.865( 280.236( 165.135(

(Ratio&Calculations& ( ( ( ( (
Working(capital/Total( ( ( ( ( (
Assets( 0.014( 0.002( 0.021( 0.051( 0.055(
Sales/Total(Assets( 0.503( 0.389( 0.341( 0.343( 0.290(
RE/Total(assets( 0.124( 0.086( 0.070( 0.070( 0.071(
EBIT/Total(Assets( 0.204( 0.144( 0.111( 0.120( 0.095(
MVE/BVD( 0.024( 0.042( 0.007( 0.008( 0.003(

(
z.scores( ( 1.381( ( 1.010( ( 0.833( ( 0.903( ( 0.770(
App 2: BG Group ratio components, ratio calculations and yearly z-scores (BG
Group, 2008-2012; London Stock Exchange, 2013).

Ratio&components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( .3,409( 8,333( 12,974( 13,266( 33,395(
Total(Assets( 228,238( 235,968( 272,262( 293,068( 300,193(
Retained(Earnings( 91,303( 101,613( 94,987( 111,465( 118,414(
Book(value(of(debt( 136,129( 133,855( 176,371( 180,586( 180,573(
Earnings(before(interest(and(
taxes( 35,239( 26,426( .3,702( 39,817( 19,733(
Sales( 367,053( 246,138( 308,928( 386,463( 388,285(
Market(Value(of(Equity( 143,000( 179,000( 135,000( 134,000( 131,000(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( .0.015( ( 0.035( ( 0.048( ( 0.045( ( 0.111(
Sales/Total(Assets( 1.608( 1.043( 1.135( 1.319( 1.293(
RE/Total(assets( 0.400( 0.431( 0.349( 0.380( 0.394(
EBIT/Total(Assets( 0.154( 0.112( .0.014( 0.136( 0.066(
MVE/BVD( 1.050( 1.337( 0.765( 0.742( 0.725(

(z.scores( ( 3.289( ( 2.859( ( 2.094( ( 2.798( ( 2.630(

App 3: BP ratio components, ratio calculations and yearly z-scores (BP, 2008-
2012; London Stock Exchange, 2013).

! xcii!
 Ratio&Components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 1365.200( 1174.100( 146.500( 4600.600( 1573.900(
Total(Assets( 3620.400( 3863.800( 5280.800( 7370.600( 4327.700(
Retained(Earnings( 1433.700( 1495.000( 2317.600( 6472.100( 2980.700(
Book(value(of(debt( 1341.700( 1176.800( 1442.400( 4773.000( 686.000(
Earnings(before(interest(and(
taxes( 42.700( .240.100( 1089.000( .1136.300( .247.300(
Sales( 299.300( 169.900( 1601.300( 0.000( 0.000(
Market(Value(of(Equity( 130.000( 232.000( 439.000( 368.000( 399.000(

(Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.377( ( 0.304( ( 0.028( ( 0.624( ( 0.364(
Sales/Total(Assets( 0.083( 0.044( 0.303( 0.000( 0.000(
RE/Total(assets( 0.396( 0.387( 0.439( 0.878( 0.689(
EBIT/Total(Assets( 0.012( .0.062( 0.206( .0.154( .0.057(
MVE/BVD( 0.097( 0.197( 0.304( 0.077( 0.582(

(z.scores( ( 1.187( ( 0.863( ( 1.814( ( 1.516( ( 1.561(

App 4: Cairn Energy ratio components, ratio calculations and yearly z-scores
(Cairn Energy, 2008-2012; London Stock Exchange, 2013).

Ratio&Components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 22.956( 21.416( 59.109( 8.119( 43.871(
Total(Assets( 99.728( 132.156( 203.866( 234.065( 260.913(
Retained(Earnings( .20.621( .34.118( .22.958( 2.648( 27.891(
Book(value(of(debt( 33.974( 51.209( 44.999( 49.592( 44.938(
Earnings(before(interest(and(
taxes( .16.385( .0.344( 12.583( 19.969( 28.189(
Sales( .3.006( 15.093( 44.391( 57.950( 73.270(
Market(Value(of(Equity( 18.500( 58.200( 56.300( 32.300( 29.400(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.230( ( 0.162( ( 0.290( ( 0.035( ( 0.168(
Sales/Total(Assets( .0.030( 0.114( 0.218( 0.248( 0.281(
RE/Total(assets( .0.207( .0.258( .0.113( 0.011( 0.107(
EBIT/Total(Assets( .0.164( .0.003( 0.062( 0.085( 0.108(
MVE/BVD( 0.545( 1.137( 1.251( 0.651( 0.654(

(
z.scores( ( .0.259( ( 0.620( ( 1.362( ( 0.977( ( 1.381(
App 5: Circle Oil ratio components, ratio calculations and z-scores (Circle Oil,
2008-2012; London Stock Exchange, 2013).

! xciii!
 Ratio&Components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( .43.232( .32.782( .55.814( .48.848( .70.350(
Total(Assets( 258.463( 325.609( 413.090( 518.731( 894.193(
Retained(Earnings( .16.587( .16.702( .11.848( 17.630( 193.877(
Book(value(of(debt( 114.887( 124.641( 201.105( 267.864( 463.664(
Earnings(before(interest(and(
taxes( .14.799( .7.966( 11.009( 92.130( 387.823(
Sales( 3.884( 78.530( 159.064( 297.104( 666.902(
Market(Value(of(Equity( 110.000( 501.000( 687.000( 170.000( 231.000(

(Ratio&Calculations& ( ( ( ( (
Working(capital/Total(Assets( ( .0.167( ( .0.101( ( .0.135( ( .0.094( ( .0.079(
Sales/Total(Assets( 0.015( 0.241( 0.385( 0.573( 0.746(
RE/Total(assets( .0.064( .0.051( .0.029( 0.034( 0.217(
EBIT/Total(Assets( .0.057( .0.024( 0.027( 0.178( 0.434(
MVE/BVD( 0.957( 4.020( 3.416( 0.635( 0.498(

(z.scores( ( 0.1100( ( 2.3793( ( 2.3200( ( 1.4737( ( 2.6844(

App 6: Coastal Energy ratio components, ratio calculations and z-scores
(Coastal Energy, 2008-2012; London Stock Exchange, 2013).

Ratio&Components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 24.185( 43.904( 20.087( 19.427( 14.288(
Total(Assets( 205.656( 225.312( 434.469( 588.011( 744.485(
Retained(Earnings( .40.263( .53.541( .80.906( .2.638( .5.788(
Book(value(of(debt( 90.786( 107.153( 154.288( 231.331( 370.219(
Earnings(before(interest(and(
taxes( .43.160( .17.378( .38.956( 24.356( .41.325(
Sales( 3.304( 11.156( 23.336( 123.985( 256.501(
Market(Value(of(Equity( 7.040( 25.600( 48.700( 52.400( 48.000(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.1176( ( 0.1949( ( 0.0462( ( 0.0330( ( 0.0192(
Sales/Total(Assets( 0.0161( 0.0495( 0.0537( 0.2109( 0.3445(
RE/Total(assets( .0.1958( .0.2376( .0.1862( .0.0045( .0.0078(
EBIT/Total(Assets( .0.2099( .0.0771( .0.0897( 0.0414( .0.0555(
MVE/BVD( 0.0775( 0.2389( 0.3156( 0.2265( 0.1297(

(
z.scores( ( .0.763( ( .0.161( ( .0.258( ( 0.517( ( 0.251(
App 7: Faroe Petroleum ratio components, ratio calculations and z-scores
(Faroe Petroleum, 2008-2012; London Stock Exchange, 2013).

! xciv!
 Ratio&components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( .5.847( 11.835( 79.973( 173.841( 30.189(
Total(Assets( 129.807( 162.285( 285.763( 472.269( 628.017(
Retained(Earnings( .19.207( .26.034( .19.527( .18.549( .5.860(
Book(value(of(debt( 69.310( 76.803( 193.471( 221.617( 315.931(
Earnings(before(interest(and(
taxes( 7.182( .3.768( 13.224( 25.784( 40.747(
Sales( 38.376( 44.847( 79.550( 111.580( 250.478(
Market(Value(of(Equity( 136.000( 251.000( 564.000( 289.000( 455.000(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( .0.045( ( 0.073( ( 0.280( ( 0.368( ( 0.048(
Sales/Total(Assets( 0.296( 0.276( 0.278( 0.236( 0.399(
RE/Total(assets( .0.148( .0.160( .0.068( .0.039( .0.009(
EBIT/Total(Assets( 0.055( .0.023( 0.046( 0.055( 0.065(
MVE/BVD( 1.962( 3.268( 2.915( 1.304( 1.440(

(
z.scores( ( 1.394( ( 2.023( ( 2.420( ( 1.585( ( 1.521(
App 8: Geopark ratio components, ratio calculations and z-scores (Geopark,
2008-2012; London Stock Exchange, 2013).

Ratio&components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 28.870( .221.230( 201.208( 241.867( 274.920(
Total(Assets( 158.618( 117.393( 472.663( 673.413( 925.899(
Retained(Earnings( .89.990( .186.292( .193.414( .225.492( .276.849(
Book(value(of(debt( 36.218( 48.299( 45.822( 67.339( 348.208(
Earnings(before(interest(and(
taxes( .61.096( .95.123( .32.595( .70.350( .82.137(
Sales( 0.999( 0.000( 0.808( 6.919( 32.190(
Market(Value(of(Equity( 2.280( 15.700( 81.400( 12.300( 12.000(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.182( ( .1.885( ( 0.426( ( 0.359( ( 0.297(
Sales/Total(Assets( 0.006( 0.000( 0.002( 0.010( 0.035(
RE/Total(assets( .0.567( .1.587( .0.409( .0.335( .0.299(
EBIT/Total(Assets( .0.385( .0.810( .0.069( .0.104( .0.089(
MVE/BVD( 0.063( 0.325( 1.776( 0.183( 0.034(

(
z.scores( ( .1.803( ( .6.962( ( 0.778( ( .0.263( ( .0.300(
App 9: Gulf Keystone ratio components, ratio calculations and z-scores (Gulf
Keystone, 2008-2012; London Stock Exchange, 2013).

! xcv!
 Ratio&components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 43.235( 337.841( 969.262( 550.156( .17.745(
Total(Assets( 401.298( 556.024( 1311.905( 1112.027( 3643.159(
. .
Retained(Earnings( 113.817( 153.164( 575.867( 507.196( 535.813(
Book(value(of(debt( 211.677( 166.361( 189.080( 175.823( 267.661(
Earnings(before(interest(and(
taxes( .37.593( .30.756( .46.752( .44.375( .137.629(
Sales( 5.096( 2.705( 5.015( 9.030( 8.834(
Market(Value(of(Equity( 68.400( 16.400( 16.400( 56.100( 57.900(

(Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.108( ( 0.608( ( 0.739( ( 0.495( ( .0.005(
Sales/Total(Assets( 0.013( 0.005( 0.004( 0.008( 0.002(
RE/Total(assets( .0.284( .0.275( 0.439( 0.456( 0.147(
EBIT/Total(Assets( .0.094( .0.055( .0.036( .0.040( .0.038(
MVE/BVD( 0.323( 0.099( 0.087( 0.319( 0.216(

(
z.scores( ( .0.370( ( 0.225( ( 1.439( ( 1.300( ( 0.208(
App 10: Heritage Oil ratio components, ratio calculations and z-scores (Heritage
Oil, 2008-2012; London Stock Exchange, 2013).

Ratio&components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 19.689( 59.304( 224.923( 108.508( 23.819(
Total(Assets( 357.670( 309.140( 561.851( 804.674( 933.505(
Retained(Earnings( .38.287( .30.431( 24.723( 60.591( 153.990(
Book(value(of(debt( 113.802( 54.684( 126.607( 297.263( 327.857(
Earnings(before(interest(and( .
taxes( .33.381( 102.874( 97.190( 38.201( 33.947(
Sales( 3.282( 110.812( 135.233( 129.059( 170.477(
Market(Value(of(Equity( 27.700( 162.000( 504.000( 407.000( 395.000(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.055( ( 0.192( ( 0.400( ( 0.135( ( 0.026(
Sales/Total(Assets( 0.009( 0.358( 0.241( 0.160( 0.183(
RE/Total(assets( .0.107( .0.098( 0.044( 0.075( 0.165(
EBIT/Total(Assets( .0.093( .0.333( 0.173( 0.047( 0.036(
MVE/BVD( 0.243( 2.962( 3.981( 1.369( 1.205(

(
z.scores( ( .0.237( ( 1.130( ( 3.742( ( 1.406( ( 1.287(
App 11: Ithaca Energy ratio components, ratio calculations and z-scores (Ithaca
Energy, 2008-2012; London Stock Exchange, 2013).

! xcvi!
 Ratio&components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 26.688( 63.087( 26.795( .32.413( 8.036(
Total(Assets( 392.338( 484.320( 549.538( 614.023( 586.882(
Retained(Earnings( 256.535( 329.572( 337.569( 389.499( 378.164(
Book(value(of(debt( 58.181( 79.996( 80.872( 107.248( 74.983(
Earnings(before(interest(and(
taxes( 125.393( 119.591( 20.367( 82.014( 5.769(
Sales( 207.047( 196.508( 192.879( 236.854( 202.858(
Market(Value(of(Equity( 5.420( 9.450( 12.600( 5.790( 4.380(

(Ratio&calculations&
Working(capital/Total(Assets(
Sales/Total(Assets(
RE/Total(assets(
EBIT/Total(Assets(
MVE/BVD(
( ( ( ( (
( 0.0680( ( 0.1303( ( 0.0488( (.0.0528( ( 0.0137(
0.5277( 0.4057( 0.3510( 0.3857( 0.3457(
0.6539( 0.6805( 0.6143( 0.6343( 0.6444(
0.3196( 0.2469( 0.0371( 0.1336( 0.0098(
0.0932( 0.1181( 0.1558( 0.0540( 0.0584(

(z.scores( ( 2.635( ( 2.400( ( 1.485( ( 1.683( ( 1.331(

App 12: JKX ratio components, ratio calculations and z-scores (JKX, 2008-
2012; London Stock Exchange, 2013).

Ratio&calculations& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 70.647( 133.561( 84.070( 383.509( 129.805(
1281.97
Total(Assets( 355.827( 388.331( 416.894( 741.968( 2(
. . . .
Retained(Earnings( 185.493( 228.759( 248.037( 267.112( .307.721(
Book(value(of(debt( 49.327( 13.983( 60.648( 28.908( 177.522(
Earnings(before(interest(and( .
taxes( 132.348( .43.266( .19.278( .19.075( .40.943(
Sales( 5.470( 0.616( 0.533( 14.678( 1.021(
Market(Value(of(Equity( 17.500( 22.100( 18.700( 27.200( 24.600(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.199( ( 0.344( ( 0.202( ( 0.517( ( 0.101(
Sales/Total(Assets( 0.015( 0.002( 0.001( 0.020( 0.001(
RE/Total(assets( .0.521( .0.589( .0.595( .0.360( .0.240(
EBIT/Total(Assets( .0.372( .0.111( .0.046( .0.026( .0.032(
MVE/BVD( 0.355( 1.580( 0.308( 0.941( 0.139(

(
z.scores( ( .1.491( ( 0.170( ( .0.557( ( 0.616( ( .0.236(
App 13: Ophir Energy ratio components, ratio calculations and z-scores (Ophir
Energy, 2008-2012; London Stock Exchange, 2013).

! xcvii!
 Ratio&calculations& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 43.425( 3.250( 72.754( 9.214( 145.156(
Total(Assets( 123.236( 191.923( 281.751( 371.533( 946.029(
Retained(Earnings( .81.551( .83.903( .94.699( .101.791( .130.631(
Book(value(of(debt( 1.191( 33.086( 15.703( 53.758( 14.101(
Earnings(before(interest(and(
taxes( .4.812( .7.972( .14.475( .9.723( .3.078(
Sales( 0.962( 0.210( 0.270( 0.000( 59.435(
Market(Value(of(Equity( 5.370( 24.300( 17.100( 27.400( 39.500(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.352( ( 0.017( ( 0.258( ( 0.025( ( 0.153(
Sales/Total(Assets( 0.008( 0.001( 0.001( 0.000( 0.063(
RE/Total(assets( .0.662( .0.437( .0.336( .0.274( .0.138(
EBIT/Total(Assets( .0.039( .0.042( .0.051( .0.026( .0.003(
MVE/BVD( 4.509( 0.734( 1.089( 0.510( 2.801(

(
z.scores( ( 2.081( ( .0.287( ( 0.324( ( .0.134( ( 1.724(
App 14: Petroceltic International ratio components, ratio calculations and z-
scores (Petroceltic International, 2008-2012; London Stock Exchange, 2013).

Ratio&calculations& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 242.900( 265.400( 193.800( .94.400( .7.300(
Total(Assets( 1450.600( 2539.800( 3025.900( 3889.400( 4843.600(
Retained(Earnings( 472.900( 603.200( 738.700( 922.900( 1150.100(
Book(value(of(debt( 851.700( 1568.500( 1392.500( 2565.800( 2890.100(
Earnings(before(interest(and(
taxes( 261.700( 169.700( 127.700( 175.600( 455.200(
Sales( 655.200( 621.100( 763.600( 826.800( 1408.700(
Market(Value(of(Equity( 0.552( 0.768( 0.789( 2.018( 2.190(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.1674( ( 0.1045( ( 0.0640( ( .0.0243( ( .0.0015(
Sales/Total(Assets( 0.4517( 0.2445( 0.2524( 0.2126( 0.2908(
RE/Total(assets( 0.3260( 0.2375( 0.2441( 0.2373( 0.2374(
EBIT/Total(Assets( 0.1804( 0.0668( 0.0422( 0.0451( 0.0940(
MVE/BVD( 0.0006( 0.0005( 0.0006( 0.0008( 0.0008(

(
z.scores( ( 1.704( ( 0.923( ( 0.810( ( 0.665( ( 0.932(
App 15: Premier Oil ratio components, ratio calculations and z-scores (Premier
Oil, 2008-2012; London Stock Exchange, 2013).

! xcviii!
 Ratio&components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 11041( 11668( 12342( 17118( 17755(
Total(Assets( 282401( 292181( 322560( 345257( 360325(
Retained(Earnings( 125447( 127633( 140179( 162987( 180218(
Book(value(of(debt( 153535( 154046( 172780( 174254( 170398(
Earnings(before(interest(and(
taxes( 52001( 21562( 36340( 57033( 52046(
Sales( 458361( 278188( 368056( 470171( 467153(
Market(Value(of(Equity( 66590( 76990( 87470( 99930( 91320(

(Ratio&calculations&
Working(capital/Total(Assets(
Sales/Total(Assets(
RE/Total(assets(
EBIT/Total(Assets(
MVE/BVD(
( ( ( ( (
( 0.039( ( 0.040( ( 0.038( ( 0.050( ( 0.049(
1.623( 0.952( 1.141( 1.362( 1.296(
0.444( 0.437( 0.435( 0.472( 0.500(
0.184( 0.074( 0.113( 0.165( 0.144(
0.434( 0.500( 0.506( 0.573( 0.536(

(z.scores( ( 3.158( ( 2.154( ( 2.470( ( 2.970( ( 2.853(

App 16: Royal Dutch Shell ratio components, ratio calculations and z-scores
(Royal Dutch Shell, 2008-2012; London Stock Exchange, 2013).

Ratio&components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( 112.298( 13.242( .51.655( 34.233( 124.849(
Total(Assets( 939.812( 961.977( 995.480( 971.830( 1273.637(
Retained(Earnings( .70.945( .84.476( .253.994( .299.456( .361.746(
Book(value(of(debt( 357.709( 389.971( 576.089( 592.857( 753.329(
Earnings(before(interest(and(
taxes( .81.897( 13.179( .105.960( 136.925( 44.321(
Sales( 100.753( 157.148( 323.374( 408.000( 367.987(
Market(Value(of(Equity( 4.507( 18.259( 19.801( 14.590( 18.148(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.1195( ( 0.0138( ( .0.0519( ( 0.0352( ( 0.0980(
Sales/Total(Assets( 0.1072( 0.1634( 0.3248( 0.4198( 0.2889(
RE/Total(assets( .0.0755( .0.0878( .0.2551( .0.3081( .0.2840(
EBIT/Total(Assets( .0.0871( 0.0137( .0.1064( 0.1409( 0.0348(
MVE/BVD( 0.0126( 0.0468( 0.0344( 0.0246( 0.0241(

(
z.scores( ( .0.135( ( 0.130( ( .0.426( ( 0.510( ( 0.138(
App 17: Salamander Energy ratio components, ratio calculations and z-scores
(Salamander Energy, 2008-2012; London Stock Exchange, 2013).

! xcix!
 Ratio&components& 2008& 2009& 2010& 2011& 2012&
Working(Capital( 315.044( 84.542( 253.670( 187.623( 274.200(
Total(Assets( 974.418( 1064.067( 1176.237( 1277.915( 1437.100(
Retained(Earnings( 600.998( 656.423( 763.856( 857.034( 970.500(
Book(value(of(debt( 264.032( 300.799( 163.020( 179.869( 260.500(
Earnings(before(interest(and(
taxes( 30.172( 90.451( 29.137( 156.945( 448.200(
Sales( 55.340( 131.013( 48.390( 234.156( 621.600(
Market(Value(of(Equity( 5.672( 8.130( 10.656( 11.911( 12.120(

(Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( 0.323( ( 0.079( ( 0.216( ( 0.147( ( 0.191(
Sales/Total(Assets( 0.057( 0.123( 0.041( 0.183( 0.433(
RE/Total(assets( 0.617( 0.617( 0.649( 0.671( 0.675(
EBIT/Total(Assets( 0.031( 0.085( 0.025( 0.123( 0.312(
MVE/BVD( 0.021( 0.027( 0.065( 0.066( 0.047(

(z.scores( ( 1.423( ( 1.379( ( 1.330( ( 1.743( ( 2.664(

App 18: Soco International ratio components, ratio calculations and z-scores
(Soco International, 2008-2012; London Stock Exchange, 2013).

Ratio&components& 2008& 2009& 2010& 2011& 2012&

Working(Capital( .213.762( 121.035( .232.328( .556.621( 105.643(
Total(Assets( 4243.685( 5124.890( 13012.371( 16432.981( 15154.703(
Retained(Earnings( 676.888( 1311.800( 4444.856( 5317.875( 6350.185(
Book(value(of(debt( 2348.919( 2694.788( 4676.565( 9068.034( 6558.563(
Earnings(before(interest(and(
taxes( 433.747( 151.453( 405.104( 1749.291( 1914.489(
Sales( 1001.077( 927.354( 1685.692( 3560.703( 3786.495(
Market(Value(of(Equity( 36.448( 89.081( 80.028( 126.698( 159.450(

(
Ratio&calculations& ( ( ( ( (
Working(capital/Total(Assets( ( .0.0504( ( 0.0236( ( .0.0179( ( .0.0339( ( 0.0070(
Sales/Total(Assets( 0.2359( 0.1810( 0.1295( 0.2167( 0.2499(
RE/Total(assets( 0.1595( 0.2560( 0.3416( 0.3236( 0.4190(
EBIT/Total(Assets( 0.1022( 0.0296( 0.0311( 0.1065( 0.1263(
MVE/BVD( 0.0155( 0.0331( 0.0171( 0.0140( 0.0243(

(
z.scores( ( 0.745( ( 0.685( ( 0.699( ( 0.989( ( 1.276(
App 19: Tullow Oil ratio components, ratio calculations and z-scores (Tullow Oil,
2008-2012; London Stock Exchange, 2013).

! c!
 Appendix B

Full Altman z-score results for: all sample companies; small sized

companies from 2008-2012; and all companies for 2008 and 2012 only.

Altman'Z)scores'for'all'sample'companies'
from'2008)2012'
6.000!

4.000!

2.000!
Altman'Z)scores'

0.000!

12.000!

14.000!

16.000!

18.000!
Company'

2008!z1score! 2009!z1scores! 2010!z1scores! 2011!z1scores! 2012!z1scores!

App 20: Altman z-scores for all sample companies 2008-2012 (Annual accounts
of companies concerned, 2008-2012; London Stock Exchange, 2013).

! ci!
 Altman'z)scores'for'small'sized'companies'
2008)2012'
6.000!

4.000!

2.000!
Altman'Z)scores'

0.000!

12.000!

14.000!

16.000!

18.000!
Company'

2008!z1score! 2009!z1score! 2010!z1score! 2011!z1score! 2012!z1score!

!App 21: Altman z-scores for small sized companies 2008-2012 (Annual
accounts of companies concerned, 2008-2012; London Stock Exchange, 2013).

! cii!
 Altman'z)scores'for'all'companies'for'2008'
and'2012'
4.000!

3.000!

2.000!
Altman'z)scores'

1.000!

0.000!

11.000!

12.000!

13.000!
Company'

2008!z1scores! 2012!z1scores!

App 22: Altman z-scores for all companies in 2008 and 2012 (Annual accounts
for companies concerned, 2008; annual accounts for companies concerned,
2012; London Stock Exchange, 2013).

! ciii!
 Appendix C

Volatility in z-scores based on company size

It can be observed in figure App 23 below, that smaller sample companies

exhibit more volatile changes in z-scores over the research period.

Altman'z)scores'for'Petroceltic'
International'and'Royal'Dutch'Shell'
2008)2012'
3.500!

3.000!

2.500!
Altman'z)score'

2.000!

1.500!

1.000!

0.500!

0.000!
2008! 2009! 2010! 2011! 2012!
10.500!
Year'

Petroceltic!International! Royal!Dutch!Shell!

App 23: Altman z-scores for Petroceltic and Royal Dutch Shell 2008-2012

(Petroceltic International, 2008-2012; Royal Dutch Shell, 2008-2012; London

Stock Exchange, 2013).

! civ!

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