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Page added on October 1, 2016
The Mysterious Case of Big Oil’s Disappearing Barrels
If you ever find yourself at a cocktail party with a bunch of oil executives, one phrase is a guaranteed mood-killer: “reserve replacement.”
Not merely awkward to say, it is the industry’s bogeyman. Because in a business chiefly concerned with getting stuff out of the ground, you need to replace that stuff pretty consistently unless you want to, well, eventually run out of stuff.
Last year, the stuff-gathering did not go so well. Not replacing your reserves can be due to several things, such as striking out on a big exploration prospect or simply dialing back investment in finding new fields.
It can also just be about those fickle little things called prices.
One of the things that makes proved reserves proved is a reasonable certainty they can be produced economically. A barrel of oil that costs more to get out of the ground than anyone is likely to pay for it isn’t, from any rational viewpoint, going to be produced. So, depending on the vagaries of the commodity markets, it can disappear from the books, even if it physically still lurks there beneath the ground.
A good example of how this works is what happened last year with Exxon Mobil, which suffered a serious reversal in its reserve replacement ratio:
The big hit came at home, as the collapse in U.S. natural gas prices forced Exxon to take some of those proved reserves off its books. It’s important to note this isn’t the same as a financial impairment, as a change in circumstances can see those reserves re-categorized as proved again.
Exxon certainly wasn’t alone in this regard. Surveying 11 U.S.-focused E&P companies’ filings for 2015, they collectively cut their proved reserves by a net 2.12 billion barrels of oil equivalent (before factoring in disposals). Gas accounted for almost 60 percent of the write-down.
Physically, of course, the gas still exists. So might the recent rally in gas prices help restore that existence to the accounting plane?
For now, it doesn’t seem like it. Under SEC rules, the average of the year’s month-end prices is used when assessing reserves. Looking at the market so far this year and using futures prices as a proxy for what will happen between now and New Year’s Eve, it’s looking like average U.S. gas prices will be within a few cents of 2015’s figure:
One comfort is that the low prices on their own shouldn’t lead to another savage round of cuts to proved gas reserves. That’s partly because companies took a kitchen-sink approach to this in 2015 in order not to suffer the indignity of doing it two years in a row. As Derek Ryder, a retired petroleum reservoir engineer, puts it: “If you’re going to take hits, take all the hits you’re going to take at once.”
Falling production costs in U.S. shale could also help by improving the economics of marginal reserves even at low prices. And even if average prices haven’t moved much, the outlook has improved: Futures prices for 2017 are now about 11 percent higher than at the start of this year, according to Bloomberg data.
OPEC’s sudden (and tentative) intervention in the market this week may also help on the oil side by encouraging a more bullish view of where prices are going, even if actual supply cuts are slow to materialize.
Big Oil will need the help. While their large portfolio of assets allows them to sanction new projects to help smooth out reserve replacement, they have been slashing investment to protect dividend payments to shareholders. According to a recent analysis by consultancy Wood Mackenzie, exploration spending by the major oil companies fell by more than 50 percent in 2015.
Some of that fall, similar to what has been seen in U.S. shale, represents beneficial things like cutting contractor fees and focusing on easier prospects rather than big, complex projects like Arctic drilling.
Even so, new megaprojects are out of favor. Looking ahead, Wood Mackenzie thinks only half of the majors’ production will be replaced by conventional exploration, necessitating a push into other options, such as unconventional resources like shale and, of course, acquisitions.
M&A has been conspicuous by its absence in this downturn. Potential targets haven’t wanted to sell out at the bottom, while the majors have held out for low oil prices to drag those targets to the negotiating table. On this front, OPEC’s shot of adrenaline to sentiment is less helpful.
Altogether, 2016 seems unlikely to be as bad as last year when it comes to reserve replacement but, equally, hardly deserving of a toast, either. In one sense, investors should applaud this: Favoring value over volume is a strategy the industry has often spoken of but failed to live by. Pursuing other avenues for profit that don’t prioritize booking reserves could be a useful exercise.
So much for aspirations. In the here and now, investors, like oil executives, tend to look at depleting reserves with mounting dread. OPEC or not, it will be surprising indeed if 2017 turns out to be another year where Big Oil holds off on cutting big deals.
14 Comments on "The Mysterious Case of Big Oil’s Disappearing Barrels"
rockman on Sat, 1st Oct 2016 9:18 pm
“reserve replacement.” Thank Dog!!! Someone finally tags “PO” as the oil patch has always characterized that dynamic. LOL.
But some horrible misinformation needs to be corrected to understand the subject at hand: no US public oil company has ever booked a number for “proved reserves”. And never will: that metric only exists in the world of the uneducated.
Numerous “proved” catergories of reserves exist. For brevity I’ll focus on just the 2 more critical metrics. They are PDP (Proved Developed Producing) and PUD (Proved Un-Developed). The combination of the two typically make up the majority of a pubco’s reserves reported under SEC regs.
Both PDP and PUD metrics are a function of price as well as physical existence. Even with the huge decrease in oil prices the PDP category will decrease very little: as long as the LOE (Lease Operating Expense) is less then the NET revenue from a well the reserve value doesn’t decrease. The LOE of oil wells varies greatly: $2/bbl to $25/bbl. No one has a good weighted average but a reasonable number would be between $8 and $18 per bbl. So as long as the NET revenue (gross daily production rate – royalty – production taxes) is greater then the well’s LOE it is profitable and its reserve value remains unchanged. And this is still true if the well is a money losing investment…such as costing $6 million and netting only a total of $4 million over its life.
Of course PUD reserves are very effected by oil prices. If a company has 100 undrilled shale locations that a few years ago had a total PUD reserve of 30 million bbls but would require a cost of $55/bbl to be economic to drill then the PUD would drop from 30 mm bo to -0- bo if a $45/bbl price is used. And companies don’t get to pick that price…the SEC regs do. Search on your own for those details. Likewise the rules for how the SEC defines PUD leases has greatly changed in recent years.
Again all I can offer are these generalization. They are good representations of the reality but just way too much tech details to explain it all here.
But also understand that while some pubcos are lossing huge chunks of PUD reserves as a result of the price collapse others are adding huge chunks of PDP reserves cheaper then they been able to for at least the last 10 years. They are buying PDP reserves for $15-$20 per bbl from the pubcos that have been crippled by low oil prices. Throughout the entire history of the oil patch the reserves that eventually provided the best profits were those acquired during the busts. And some of the worst were generated during drilling booms brought on by TEMPORARY high oil prices. The last 6 years stand as testament to that reality.
Stabilizer on Sun, 2nd Oct 2016 9:30 am
Ignore the majors. Majors mostly replace reserves by purchasing smaller companies. They do drill, but usually it’s cheaper to wait for the cyclical downturn and buy companies – essentially they spend their cash where it provides the highest return. The planet as a whole has found less oil than we’ve extracted for about 40 years. We keep draining the meg-elephants found in the 1930s, as they are still cheaper to extract than new, smaller, more expensive reservoirs. Two of the elderly giants failed in the last 5 years, and all are declining. In a few decades, we will have a permanent oil shortage, unless it’s replaced by other energy sources, which is exactly what is happening. So we do need to promote solar, wind, hydrogen, methanol, and every other source. Once we have 25 industries each supplying 4% of energy need, prices will stabilize for everyone. It’s a few years off and we can’t force it, and no, we don’t need government help other than subsidize new energy sources for a few years with tax incentives to help them get started.
tahoe1780 on Sun, 2nd Oct 2016 10:32 am
Came across this the other day. https://drive.google.com/file/d/0Bze7GXvI3ywrSGxYWDVXM3hVUm8/view Lots of talk about carbon taxing in the local senate races.
Jerry McManus on Sun, 2nd Oct 2016 10:37 am
Rockman tells it like it is.
As for fantasies of windmills and solar panels, any idiot with half a brain can see that those things are 100% dependent on massive quantities of fossil fuels for their very existence. Or hadn’t anyone noticed that?
Cloggie on Sun, 2nd Oct 2016 11:35 am
As for fantasies of windmills and solar panels, any idiot with half a brain can see that those things are 100% dependent on massive quantities of fossil fuels for their very existence. Or hadn’t anyone noticed that?
It shouldn’t be to difficult for a person like you who apparently has still his two halves of a brain to explain why this can’t exist:
https://www.youtube.com/watch?v=iODg_uRLUjo
Windmills of Kinderdijk build by hand, in 1740, that is more than a century before the discovery and grand-scale application of oil in America.
https://en.wikipedia.org/wiki/Kinderdijk
Thousands of similar windmills were build since the Middle Ages and without them the Netherlands wouldn’t exist in its present shape. Besides to get rid of unwanted water, they were also used to saw wood to build ships and colonize desolate oversees parts of the world.
Oldest windmill in the Netherlands was build before 1441 and still exists and works:
https://en.wikipedia.org/wiki/Grafelijke_Korenmolen,_Zeddam
Now where are the “massive quantities of oil necessary for these devices to exist”?
There aren’t any.
It is absolutely a figment of imagination, rampant on this site, that you need kwh’s from oil to build a modern windturbine, where in reality any kwh’s will do: from cow dung, from hydro, from biofuel, from solar panels, from coal, from windturbines build earlier with oil, anything will do.
A kwh is a kwh. We are not going to discriminate here and engage in kwh-racism.lol!
Apneaman on Sun, 2nd Oct 2016 11:47 am
Cloggie what percentage of the Netherlands total electrical consumption is generated with those made by hand windmills?
Cloggie on Sun, 2nd Oct 2016 11:53 am
You know the answer yourself. Your point?
/off-topic, news just in, Hungarians voted 80+% against asylum tourists:
http://www.telegraph.co.uk/news/2016/10/02/hungary-votes-no-to-migrant-quotas-polls-suggest—but-what-does/
Hungary is a democratic country, unlike the “free West”
peakyeast on Sun, 2nd Oct 2016 12:26 pm
Cloggie: Did you know that all of europe was once filled with natural resources – for example timber and salmon?
How much forest is there now % compared to just before the windmills were built – in europe?
How much was the european population back then?
My belief is: At the time when the windmills were built Europe seemed EMPTY and untouched compared to today and even more in the future.
Please think about that difference
Cloggie on Sun, 2nd Oct 2016 12:38 pm
peakyeast, that is all true.
But what has it got to do with the question of whether a solar panels and wind turbines infrastructure can exist without oil?
Ignoring that we are going to have thousands of years worth of fossil fuel left for niche applications like wind turbine building, assuming that this couldn’t be done with energy from wind turbines and solar panels. Which is rubbish, you can very well build new renewable energy devices using energy generated by other renewable energy devices.
Apneaman on Sun, 2nd Oct 2016 1:15 pm
Cloggie, can you mine and smelt the metals and extract the rare earth metals with solar and wind? Show me!!!!
Inside the Resolution Copper Mine, 1.3 Miles Underground
https://www.youtube.com/watch?v=tEgDPPLC_eQ
Old dutch, do you know why they need to drill 1.3 miles into the earth and in many cases deeper?
That’s because of that “low hanging fruit” principle your buddy Heinburg keeps telling you about that you refuse to believe.
Guess what? None of this mining is done with solar power.
Copper Mining and Smelter Refinery Plant Bor brownfield investment projects
https://www.youtube.com/watch?v=jsMq3ERy3UM
Apneaman on Sun, 2nd Oct 2016 1:56 pm
Old dutch, here’s your go to Brit rag with it’s typical bar room rhetoric, but not untrue.
In China, the true cost of Britain’s clean, green wind power experiment: Pollution on a disastrous scale
“This toxic lake poisons Chinese farmers, their children and their land. It is what’s left behind after making the magnets for Britain’s latest wind turbines… and, as a special Live investigation reveals, is merely one of a multitude of environmental sins committed in the name of our new green Jerusalem”
http://www.dailymail.co.uk/home/moslive/article-1350811/In-China-true-cost-Britains-clean-green-wind-power-experiment-Pollution-disastrous-scale.html
Establishment Brit.
The dystopian lake filled by the world’s tech lust
Hidden in an unknown corner of Inner Mongolia is a toxic, nightmarish lake created by our thirst for smartphones, consumer gadgets and green tech, discovers Tim Maughan
http://www.bbc.com/future/story/20150402-the-worst-place-on-earth
The Age of Humans
The Burning Truth Behind an E-Waste Dump in Africa
Ending the toxic smoke rising from an iconic dump in Ghana will take more than curbing Western waste
http://www.smithsonianmag.com/science-nature/burning-truth-behind-e-waste-dump-africa-180957597/?no-ist
Old dutch, seems to me all these pseudo Green dreams have a dark side. Very dark. Seems like just one more White, over privileged, consumer fantasy. Again it’s the poorest non whites far far away from the sanitized suburbs who pay the costs while spoiled self righteous cunts like you enjoy all the benefits – guilt and pollution free. It’s a global NIMBY project. Old dutch are you still enjoying your nes $900 34″ curved screen computer monitor with the uber high DPI? That consumer dopamine hit still flowing? What was the old monitor? A primitive 24″? The horror! Where is it now? Probable in some toxic African e-waste dump being picked apart by a couple of cancer riddled 6 year olds so they can eat for the first time in 3 days. Who fucking cares about the externalities on both ends as long as white people have an unbroken chain of ever better (and greener;) tech products. The electronic communication toys/fashion statement are especially important since without them we can’t go online and yell at each other about how super fucking green and clean alt energy is and how much WE deserve it. Tell yourself. Holy fuck are the humans ever full of shit!
peakyeast on Sun, 2nd Oct 2016 3:08 pm
cloggie: I can see you havent connected the 2-3 dots. But please do try. Give it a few days. No disrespect intended.
Please remember other things you have been told – dont compartmentalise your knowledge.
I can see apeman is helping you with some of the aspects, but hardly all.
Remember: It is death by “a 1000” cuts. Not 1 or 2 or 100.
shortonoil on Mon, 3rd Oct 2016 10:40 am
This certainly doesn’t come as a surprise to us; the world has already extracted 86% of the all the oil that it will ever be removed. The last 14% will be much more difficult, and expensive to produce than was the first 14%. The world’s petroleum producers have taken the very best of what remained for the last 158 years. As they have the quality of the remaining reserve continually declined. Most of what remains has degraded to a level that the economy will not buy it. Producers are finding it ever more difficult to command a price that justifies oil’s extraction costs. Their annual revenue has fallen by $1.7 trillion as a result
Declining revenue has led to declining exploration, and development, which has led to a reduction of new oil coming onto the market:
https://assets.bwbx.io/images/users/iqjWHBFdfxIU/icbkDFACM4iA/v2/-1x-1.png
There are no “missing” barrels! The industry has carefully gone over most of the planet with a fine toothed comb for over a century and a half in search of the black gold. Almost every barrel remaining has been identified, categorized , and counted. Little dribs and drabs may be found from time to time, but they will amount to nothing compared to the 34 billion barrels a year now being pumped. In 2015 the world’s producers discovered 6% of what they extracted.
There can now be little doubt as to the future of petroleum. King Oil will be demoted to poor Peter; a mere shadow of its once omnipotent presence. Although many say that the world can not live without oil, depletion is telling us that we don’t have much of a voice in the matter. Nature is now knocking at the door, we can listen very carefully to Her poignant statements, or perish in our own sea of self inflicted denial.
http://www.thehillsgroup.org/
george on Tue, 4th Oct 2016 8:16 am
windmills – lmao
lots of hot air
tip them over , put 18 wheels under them and presto , another fantasy.