Fitch Reviews Oil & Gas Operations and Reserves

Fitch Ratings is out with a statistical review of operational metrics at a number of oil & gas companies. The review notes a handful of emerging trends:

• Finding, development, and acquisition (FD&A) costs are rising.
• Reserves are growing.
• Proved, developed reserves are shrinking.
• Reserve additions are not well matched to production.
• Liquids are in every E&P company’s sights.

To even out the changes a bit, Fitch computed a three-year average as well as a year-over-year average change.

FD&A costs for the entire group of companies fell by an average of -14% over three years, but the variation was large. The three-year average cost of a barrel in 2008 was $20.76, falling to $16.46 in 2011. Exxon Mobil Corp. (NYSE: XOM) posted an increase of 45% in FD&A costs over three years, while Chevron Corp. (NYSE: CVX) lowered its costs by -41% and ConocoPhillips lowered its costs by -36%. Occidental Petroleum Corp. (NYSE: OXY) showed a 1% increase in FD&A costs over the three years and Hess Corp. (NYSE: HES) paid 60% more per barrel in FD&A costs. FD&A costs for SandRidge Energy Corp. (NYSE: SD) rose 42%, while the largest drop in costs came at Range Resources Inc. (NYSE: RRC), at -65%.

Total proved reserves posted median gains of 4.8% year-over-year and 24% since 2008. Some of the largest reserves gains came from additions of natural gas, which drove up the reserve equivalent barrels count, but weighed on valuations due to the low prices for natural gas. Among the bigger companies, Exxon increased its reserves by 14.1% over the three-year span, while Chevron’s reserves grew by just 0.4% and Conoco’s fell by -18%.

Proved, developed reserves declined for all the companies in the sample by -3.5% over the three-year period. Fitch defined proved, developed reserves as “proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods, or through relatively minor expenditures.” Essentially that means that the companies are increasing production from existing wells and driving down the amount that’s left to get out of a producing well. As a percentage of total reserves, proved, developed reserves rose the most at Marathon Oil Corp. (NYSE: MRO), a total of 8% in the three-year period. Proved, developed reserves fell the most at Plains Exploration & Production Co. (NYSE: PXP), a total of -16.4%.

The mismatch between production and reserves replacement is described as “lumpy” by Fitch. The problem is mainly one of timing. A project with a long startup cycle, like Chevron’s liquefied natural gas project offshore of Australia, delays reserves booking well past the time the company spent billions of dollars to develop the project. This effect will become a bigger issue as new projects are developed in ultra-deepwater and other difficult environments by smaller companies.

Finally, the push to develop liquids production has been well-documented over the past couple of years. With natural gas prices near historic lows, liquids development is critically important to companies that once focussed almost exclusively on dry natural gas. The largest three-year average gain in liquids reserves was 40% at SandRidge, followed by 12% gains at Pioneer Natural Resources Co. (NYSE: PXD) and Newfield Exploration Co. (NYSE: NFX). Chesapeake Energy Corp. (NYSE: CHK) grew its liquids reserves by 11% over the three years.

Fitch notes that what it calls ‘efficiency’ — which is essentially the sum of all the factors it looked at in this operational review — “helps determine the relative credit quality and competitiveness of a firm when indexed against its peers … [B]eing a low-cost, efficient producer remains a key credit protection in the event of lower oil prices.”

The full report from FitchRatings is available here.

Paul Ausick