Finding new oil gets ever more expensive

Updated: A new study by research firm IHS Herold illustrates why there are fears of a supply crunch: oil is getting much more expensive to find, but investment in finding new oil is falling this year.

Exploration spending by listed oil companies rose 21 per cent and development spending 23 per cent in 2008 – but total reserves fell 3 per cent, according to the study. Much of this was due to some existing reserves becoming uneconomic: there was a a 5.2 billion barrel decline in revisions “due to the steep drop in commodity prices”. It’s not the first time total reserves have fallen, but it makes us wonder what this year, when capital investment is set to fall further, will bring.

Meanwhile the average cost of replacing a barrel of oil equivalent rose 70 per cent to $23.44 in 2008.  Here’s how finding and development costs weigh up against reserve replacement:

IHS Herold

Source: IHS Herold

The study culled data from the filings of 232 companies with the SEC “and other similar agencies worldwide”, so some of the really big national oil companies such as Saudi Aramco aren’t in there. Petrobras and Pemex are represented, however, along with the big Russian and Chinese companies.

One significant finding of the study: in the US, replacement costs more than doubled.

On the bright side, it notes that some of the pre-salt reserves in South America are yet to be booked.

So what does IHS Herold believe the future holds for the supply/demand balance? Well, it could become very tight indeed – although not be as bad as today’s prices might suggest:

Over the last three years, investment of more than $750 billion in development capital has resulted in no change in crude oil reserves and production. Recent deepwater discoveries provide hope that future results may be better, but meaningful output from those new projects will be more than five years into the future. Aside from OPEC curtailments, the world has virtually no excess capacity to meet demand growth that could result from synchronous economic expansions. Crude markets could tighten appreciably in a few years time, but current prices seem to be prematurely high.

Here are the bullet points from the IHS Herold press release:

Overall Findings
The 2009 Global Upstream Performance Review, IHS Herold’s 42st annual study of 232 oil and gas companies based on publicly available data filed with the U.S. Securities and Exchange Commission (SEC) and other similar agencies worldwide, measured industry performance in a number of key areas:
• Prices & Revenues – Worldwide revenues increased by $293 billion, implying an average realized price of $61.91 per barrel, a 30 percent increase from 2007.
• Cash Flow & Capital Spending – Cash flow per boe increased 35 percent to $29.66 per barrel.  For the second consecutive year, cash flow exceeded investment.
• Exploration & Development – Development spending increased 23 percent, accounting for 63 percent of total investment, about the same 2007.  Exploration spending increased 21 percent and has doubled since 2005 total.
• Mergers & Acquisitions – Proved acquisition spending dropped 30 percent to $44 billion as the M&A collapsed in the last five months of 2008, particularly in North America.  Competition for unconventional resources was up sharply, led by the US region, with global spending for unproved acquisitions more than doubling to $62 billion.
• Production & Reserves – Oil reserves declined nearly 3 percent, primarily due to a 5.2 billion barrel decline in revisions due to the steep drop in commodity prices. Natural gas reserves grew at the 3 percent rate of the past five years, but production accelerated nearly 5 percent to 44.2 Tcf.
• Reserve Replacement – Reserve replacement and finding and development costs surge 70 percent and 66 percent to $23.44/boe and $25.50/boe, respectively, due to a sharp drop-off in positive reserve revisions. Reserve additions, both from all sources and via the drill-bit, were down over 20 percent.
• Profits – Net income per boe was rose 24 percent to $16.07/boe, but margins were lower for the fourth consecutive year.

Update:

Gregor makes an excellent point in the comments below about an aspect of the report we failed to highlight initially: reserve revisions are in part due to “economic factors” (along with new information from development and production itself).  The report actually says such revisions affected the US and Russian and Caspian regions most sharply. However some reserves were added in the Middle East and Africa because of production-sharing agreements  that actually increase reserves when oil and gas prices fall. We’re not sure why that would be – perhaps it takes into account those falling prices charged by oil service companies – but it obviously wasn’t enough to offset the downward revisions in the US and Russia.

Another point worth noting: the industry saw record revenues last year (although profitability declined slightly). But despite capital investment increasing last year, the proportion of cashflow invested back into reserve replacement remained static.

Herold says:

Although the industry had record cash generation, it plowed back fully 75% of the funds into finding and development projects. The reinvestment ratio is nearly unchanged over the last few years, despite rapidly rising prices, while reserve and production growth rates have remained disturbingly low.

More here, for Long Room members.

Related links:

Demand to recover in 2012, says CERA (FT Energy Source, 09/08/09)
World oil reserves fall just a little in 2008 (FT Energy Source, 10/06/09)
Delaying investment projects: Who’s doing it, and why (FT Energy Source, 13/03/09)

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