'Northoil' pid='74658' datel Wrote:Nice piece of work. Thanks. I have one question and a comment: How do you get the "implied probability" of any A7 outcome?
Comment: You may wish to consider the time value of money. Esssentially, you have to put up $49 now. I'm not sure when we get the $45 in Exxon stock, but definitely months. The resource payment could be a long time coming - you have to drill A7, then certify. Certainly could be a year from today, or longer. Drilling and coring there is not easy. What if they lose the well, need to sidetrack, get stuck, etc.? Alternately, you can sell the stock today, get $49 and invest in something else. An opportunity cost, if you will.
Still, good analysis and presentation.
Thanks! First, let me say that my calculations don't account for the time value of money. Theoretically, one should make an adjustment, but we are talking only 1 year of time value and interest rates are low, so I decided to keep the analysis simple and ignore that aspect.
That said, the implied probability is calculated by dividing the "Implied Option Value (aka CVP payment)" by the "Additional Payment" for any particular resource scenario. For example, let's use the 7.2 Tcfe scenario. If we knew with 100% certainty that the certification could result in 7.2 Tcfe of resource (no more and no less), the market should theoretically value the Option Value (or CVP) at $7.07 per share. And IOC should be trading at $52.07 per share today...
But IOC is not trading at $52.07 per share today. It's only trading at $49.20. So that means that the market is only ascribing $4.20 of value to the Option Value (= $49.20 - $45 base payment). And because $4.20 is less than $7.07 (the 100% certain scenario above), we know that the market is pricing in a probability that is less than 100%. To figure out the exact probability, we divide $4.20 by $7.07 and get 59%. Hope that helps!