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Discounted cash flow method

Under the DCF methodology a project's future cash inflows and outflows are forecast to establish the project's future net cash flow. A discount rate is then applied to the net cash flows to derive a value of the project at a specific date. In the case of the extended PRRT the specific valuation date is 1 May 2010.

The DCF method is a commonly used market accepted method for valuing petroleum project interests in development and production, given the finite life of a field and the well-established market for petroleum commodities. The DCF method is also used for earlier stage projects where the valuer has reasonable grounds for the forward looking information used in the method.

The ATO understands that the DCF method is used to estimate the market value of development projects and producing fields for the following reasons:

  • these types of projects typically form part of an ongoing concern
  • the depletion of reserves and resources over the life of the field, as well as the expected addition to reserves and resources due to successful near-field exploration, can be modelled over time
  • the DCF method allows explicit judgments to be made regarding matters specific to the project (for example, forecast production and commodity prices, operating expenditure, capital investment and new project development)
  • there are sufficient market measures by which to estimate an appropriate discount rate
  • many such projects are long-dated and the DCF method gives recognition to the 'time value of money'.

DCF calculations are sensitive to the input variables used. DCF calculations for the market value of the resource are particularly sensitive to the forecast commodity price variable. After consultation with industry, tax professionals, Treasury and the Department of Resources, Energy and Tourism, the ATO will consider publishing, where possible and practicable, a set of safe harbour reference variables that the taxpayer could input into their DCF calculation in order to arrive at a total value for a petroleum project. By providing taxpayers with safe harbour reference variables to input into the DCF calculation, the ATO aims to increase taxpayers' level of confidence in relation to their compliance obligations, as well as an opportunity to reduce the risk of a market valuation review or audit.

    Last modified: 03 Jul 2012QC 25073