The growth of oil producers is often tracked by a measurement known as the reserve replacement ratio. This compares the proven reserves of oil and gas to actual levels produced. If producers are unable to keep this percentage above 100 percent then they typically realize a loss in share price. To be considered “proven” producers need to be 90 percent positive these resources exist and are extractable. The catch with proven reserves is that they cannot be accounted for if it doesn’t make financial sense to recover the oil or gas. In the past year, this caveat has begun creating issues for producers.
According to EY records, 11 exploration and production companies in the United States realized a collective loss of over 2.12 billion barrels of oil in proved reserves for 2015. The majority of this figure was contributed by natural gas, a market seriously oversupplied. Because of the shale boom, natural gas prices have fallen to $2.5 per mmbtu, much less than the $4.2 per mmbtu figure recorded in 2014. Producers are struggling to pump gas out of the ground at a price that makes economic sense.
Proven reserves are predicted to be assets and are recorded as such. As of 2010, the SEC expects producers to pump the oil within five years as proof. Many shale companies were on board for this decision because it meant they could show shareholders extra inventory. Oil drillers are now failing to deliver evidence of these proven reserves and are losing them as assets. Chesapeake Energy Corp. had to remove 1.1 billion barrels from their proven reserves last year, over 45 percent of their inventory.
It’s not that these resources were incorrectly measured, they are very much still there. If oil producers are able to find the means to pump the oil and gas out of the ground at a reasonable cost once more, then proven reserves could reappear on company balance sheets. An alternative to waiting for prices to rebound is producers could find a way to extract resources at a cheaper price. Shale extraction is becoming more efficient, increasing this possibility.
A report by Haynes and Boone notes that as of September 7th 58 oil producers in North America have filed for bankruptcy. This accounts for more than $67 billion in debt. Ultra Petroleum was one of these companies with $3.9 billion in debt and Penn Virginia leaving another $1.2 billion on the table. In 2012, Penn Virginia claimed it was no longer interested in pumping certain natural gas reserves but it allowed these undeveloped fields to appear on their report to the SEC months later, accounting for more than 40 percent of their reserves.
With OPEC’s announcement that they will be cutting production, the oil market has recovered slightly. If oil prices hold steady or continue to rise, producers in the United States could gain the motivation to claim their costly resources.
There are growing concerns for whether producers are ever going to recover these resources. The SEC will continue to remove proven reserves from producer’s assets resulting in the notional supply of oil and natural gas decreasing. Investors will likely see a slight increase in the respective futures markets with the next release of company’s annual 10 k reports. Shale producers, however, will be disappointing investors if they show a decrease in reserve replacements.
By Michael McDonald of Oilprice.com
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