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April 7, 2013 5:56 pm
When a car runs out of petrol, it soon sputters to a halt. Ditto if an oil and gas company runs out of oil and gas. The reserve replacement ratio tells investors the extent to which companies are replacing the oil they produce with new reserves. If it is persistently under 100 per cent, it spells long-term trouble. The number can vary widely among the majors. Shell’s replacement rate was 85 per cent in 2012, ExxonMobil’s was 115 per cent, Chevron’s 112 per cent, and Total’s 93 per cent. The variety is interesting. The number’s underlying message is even more so.
Although there is no escaping the logic of the RRR, it is important to take the long view. Despite the dip in 2012, Shell’s RRR over the past three years is 112 per cent. Over five years, Chevron’s is 112 per cent. Over 10 years, ExxonMobil’s is 121 per cent. BP’s is 109 per cent, even allowing for its “abnormally low” 77 per cent rate last year. These numbers look comfortable, though there is an important distinction between organic and acquired RRRs.
Yet the numbers also tell some tales. The supermajors have gone through a phase of under-investment in exploration, which may be the last legacy of the mid-1990s merger boom. That has created a lumpy scenario for so-called FIDs – final investment decisions that bring projects into production. From discovery to production can take 15 years. BP says the timing of its FID schedule played a part in its RRR in 2012. Investors should expect accelerated FIDs to be a feature of 2013 as companies revive the production momentum lacking in the sector’s 2012 operating performance.
The RRR matters in another way: it shows the relationship between production and reserves. According to RBC Capital Markets, 2 per cent production growth requires an RRR of 118 per cent to maintain reserve life. That means either finding new reserves (organic RRR) or buying them. Neither is cheap. But it is no wonder that chief executives want to get back in the exploration game.
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