Here’s Why Big Oil Companies Are Unable To Increase Reserves To Counter Declining Production

According to the quarterly results announced during the past few weeks, major oil companies have reported a mediocre performance for last year, as far as exploration and production of crude oil and natural gas reserves is concerned. At the same time, companies have also reduced their capital spending budgets for this year, which might exacerbate their lower production problem.

Over the last decade, some of the biggest oil companies have seen their production drop and their growth of reserves stutter, even though oil price was going up for the most part. Royal Dutch Shell plc (ADR) (NYSE:RDS.A), BP plc (ADR) (NYSE:BP), ConocoPhillips (NYSE:COP), Exxon Mobil Corporation (NYSE:XOM), and Chevron Corporation (NYSE:CVX) are five of the biggest global oil and gas companies, which saw their production drop 3.25% year-over-year (YoY) on average last year, while failing to replace the crude oil and natural gas – they extracted last year – with new reserves

As oil price has crashed over the last six months, concerns have been growing about cash flow preservation. After trading over $100 per barrel last summer, crude oil price has halved now. West Texas Intermediate crude oil futures for March delivery are trading at $51.69 per barrel, while Brent crude oil futures are currently trading at $57.80 per barrel.

In attempts to grapple with the low oil price and maintain dividends, companies all over the world have reduced their capital expenditure (capex) budgets significantly. It raises further questions about how the falling production will be increased.

Analysts and industry experts believe that the capex cuts may prove too extreme in some cases, and may hurt the companies in the long term. Some view capex reductions as elongating the problem and not essentially solving it.

ConocoPhillips slashed its capex by 33% YoY, while BP and Chevron have lowered their capital spending budgets by 13% YoY. Shell has not announced a reduction yet, but the company did scrap off a $6.5 billion petrochemicals megaproject in Qatar, where it had a 20% stake.

As the US experienced the shale oil boom, reserve replacement was not much of a concern. North American oil producers were pumping up so much oil that it lead to a supply glut on a global level. However, oil and natural gas extraction from shale reserves is far more costly than that of conventional reserves. In the current low-price environment, companies will find it difficult to derive any significant profits from the shale operations.

According to Jim Chanos, the US shale revolution was uneconomic to begin with. He believes major oil producers will run into deeper troubles as their entire business models stand challenged. In his interview with CNBC last month, Mr. Chanos boldly said: “Days of finding cheap oil is over.”

Oil companies believe the concerns about oil sector’s health are premature, claiming that lower production reflects the companies’ efforts to become lean and focused on profits. However, certain executives do admit that the reductions in capital spending can come back to haunt the sector in the long term. Attractive investment opportunities may be missed, as oil firms restrict their capital budgets.

Another concern is the acceleration in the depletion rates of current oil resources. According to Reuters, oilfields deplete on average by 15% each year. But companies manage to reduce the depletion rates to as low as 3% by using techniques that require significant expenditure. As firms reduce their spending budgets, depletion rates could rise much higher than 3%. A single percentage point increase in depletion rates can reduce oil production by millions of barrels per month.

Companies face a growing need to increase their reserves, which can come from acquisitions or significant capital spending.

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