Bitter Cost of Replacing Oil Reserves

Imagine an urn filled with good, strong coffee. As you pour cup after cup from the tap at the bottom, you simultaneously refill it at the top with weak, watery stuff. After a while, your supply is as full as ever, but it just doesn’t deliver quite the same kick.

The oil majors face a similar problem, underlined by talk of more cost-cutting from the likes of Royal Dutch Shell amid dreadful quarterly results.
Overall, the sector has struggled over the past decade to replace crude-oil and natural-gas reserves depleted by production. Shareholders were prepared to overlook this as long as high energy prices funded big cash distributions.

The added twist, says Neil McMahon of Sanford Bernstein, is that not all barrels in the ground are the same. Overall, the majors have been pumping out high-margin oil from mature fields in areas like the North Sea. The majority of those barrels have been replaced with expensive, highly taxed reserves in regions like Russia.

Average cash flow per barrel divided by finding and development costs — a ratio measuring whether oil companies can cover the cost of replacing reserves organically — has dropped from about 200% at the start of the decade to about 150%. That cash flow also has to fund big dividends.

Wall Street Journal, through Google News.