I am studying for an interview with an energy group at a BB and see here that future cash flows are projected based on future production volume and current spot prices, and not the price that may prevail in the future. Why are spot prices used if that price is obviously going to change in the future? Sorry if this is an obvious question, I am just new to the energy space and trying to learn an industry in between my finals.
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Because nobody ever knows where oil/gas prices are ever going to end up. A lot of times people will use the NYMEX strip prices (future prices) as the base case and then run sensitivities at the different oil and gas prices. That way you can see in the model where the cash flow will be if oil drops down to 70, stays the same, or jumps to 100. Also, a lot of companies will hedge against price changes and sell futures to lock in a certain price, but this varies from company to company.
Long answer short: because nobody knows what oil prices will do in the future.
This is basically right. You want to value the equity and limit the impact of commodity price fluctuations to your valuation (though you still want to know what happens under different commodity price scenarios - i.e. do they hedge and how, if no hedging, how does it impact their costs/profits, etc.
If you had a specific view on oil prices that differed from the curve, you would just play the futures curve directly, removes company-specific risk. (Nobody may know for certain what oil prices will do in the future, but many people have beliefs in that regard and place bets accordingly - I am one of them, I have a small energy fund).
Note, sometimes the method you mentioned leads to screwing up valuations. People have gotten burned in nat gas equities this year because of some incorrect assumptions (too complicated to go into detail here).
I have my own projections as far as prices, and invest accordingly. That is not typically how it's done on the sell-side though.
hmm shots in the dark.. but maybe so that it can be in today's currency. Also, logically, spot pricing is a known/given price. A forward rate is anything but certain due to changes in interest rates, inflation etc.
Again, just guesses based on my finance knowledge
Nat gas is usually based on a nymex strip px plus an appropriate basis differential based on where you're selling. Firms like CERA and Wood Mac put out price projections over the next ~30 years which you can use as a guide and add an appropriate differential. The short answer though is that no one knows.
I really doubt you'll get asked this, but I second bcondon, you use the strip prices and run sensitivities off of that.
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