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Oil majors fail to replace reserves

OXFORD ANALYTICA

Monday, April 28, 2008

EVENT: Crude oil hit a record $119.90 (U.S.) dollars per barrel, as Saudi Arabia warned of “limited capacity” in global oil production.

SIGNIFICANCE: Major oil companies need to replace their reserves. Yet alternative reserves reporting standards present very different pictures of their position. Poor organic reserves replacement reflects a more competitive investment environment.

ANALYSIS: Reduced oil stocks provide a smaller buffer against short-term supply shocks, increasing price volatility. Saudi Arabian Oil Minister Ali Naimi yesterday said that lack of spare oil production capacity globally threatened energy security and ever-higher prices. International oil companies (IOCs) are naturally keen to replace oil and natural gas liquids reserves. They can do so through: acquisition – buying companies and assimilating their proved reserves; or organic growth – including revisions to existing reserves estimates based on new information, extensions to existing reserves, new discoveries and improved oil recovery rates.

Yet with the exception of BP, IOCs in 2007 failed to replace reserves, according to U.S. Securities and Exchange Commission definitions of proved reserves: ExxonMobil. ExxonMobil ended 2007 with proved reserves totalling 22.7 billion barrels of oil equivalent (boe, a unit of energy companies use to combine oil and natural gas reserves).

For crude oil and natural gas liquids, proved developed and undeveloped reserves amounted to 10.380 billion barrels, down 470 million barrels from end-2006.

For the company's consolidated subsidiaries (representing three-quarters of reserves), organic growth accounted for 786 million new barrels – 545 million barrels from revisions, 186 million from extensions and discoveries.

Production accounted for 801 million barrels.

Assets sales, relating primarily to the company's forced exit from Venezuela, accounted for reduction by 435 million barrels.

BP. BP had proved oil reserves of 10.073 billion barrels at end-2007, up from 9.781 billion barrels at the start of the year: Organic growth accounted for 1.217 billion barrels added, 758 million coming from revisions to previous estimates in its equity-accounted entities, principally TNK-BP.

It divested 66 million barrels of proved reserves and produced 859 million barrels.

BP's equity-accounted investments notably outperformed direct subsidiaries; reserves grew by a net 693 million barrels in the former, but fell by a net 401 million barrels in the latter.

BP's proved gas reserves fell 2.24 per cent to 44.900 billion cubic feet (bcf), with organic growth replacing two-thirds of production.

Shell. In 2007, Shell's total net proved oil and gas reserves fell from 11.942 billion boe to 11.920 billion boe: Proved developed and undeveloped oil reserves from Shell subsidiaries and equity-accounted investments fell from 4.197 billion barrels to 3.776 billion – about a 10 per cent reduction.

While production totalled 663 million barrels, organic growth accounted for an additional 448 million barrels.

Sales of minerals, including divestment of 27.5 per cent in the Sakhalin II project to Gazprom, accounted for 206 million barrels of oil.

Chevron. Chevron's net proved oil and gas reserves at end-2007 for consolidated and affiliated companies were 10.777 billion boe, down 7.25 per cent from 2006: Of this, liquids fell 722 million barrels to 7.087 billion barrels.

Organic liquids reserves growth accounted for 37 million barrels, owing to large downward reserves revisions in Nigeria and Indonesia.

Production amounted to 641 million barrels, while extensions and discoveries added 60 million barrels.

Sales outweighed acquisitions to account for reduction by 115 million barrels.

The revision of the company's status in its Venezuelan Hamaca equity affiliate saw a net loss of 116 million barrels.

Total. France's Total saw proved oil and gas reserves fall 6 per cent in 2007, as it replaced only 23 per cent of production: Total's proved reserves were 10.449 billion boe at end-2007, down from 11.120 billion boe in 2006.

Excluding assets sales, particularly 16.7 per cent of the Sincor project in Venezuela to state oil company PDVSA, the reserve replacement ratio would have been 78 per cent.

ConocoPhillips. ConocoPhillips had proved crude oil reserves of 5.502 billion barrels at end-2007, including consolidated operations and affiliates, down 388 million from 5.890 billion in 2006: Overall, ConocoPhillips replaced 29 per cent of its oil and gas production in 2007, proved oil and gas reserves falling to 10.559 billion boe from 11.168 billion at end-2006.

The 1.028-billion-barrel reduction as a result of asset sales was due to loss of the company's Venezuelan assets.

Organic growth accounted for 732 million barrels of additions, compared with production of 452 million barrels.

Revisions accounted for 202 million barrels and mainly were attributable to ConocoPhillips's investment in Lukoil.

Sales and acquisitions accounted for a 666-million-barrel net reduction.

Replacement trends. Majors' SEC filings indicate that: their loss of reserves in Venezuela and Russia, and more generally through greater competition for access to resources, has hit them hard; except BP and Chevron, organic growth is failing to match production levels, even for firms that produced less in 2007 than 2006; Chevron and BP's Russian interests were critical in achieving organic growth above production levels; and improving replacement ratios will require higher levels of future investment, implying less shareholder return.

SEC reporting standards. However, SEC measures do not accurately illustrate companies' resource bases, due to stringent definitions:

'Proved'. The SEC requires companies to report only proved developed and undeveloped reserves and bars them from including other reserves. It defines ‘proved' as those geological and engineering data indicate can be produced with “reasonable certainty” from known reservoirs based on costs and prices when the estimate is made.

Economic condition. Economic condition means that they cannot be sold for less than they cost to extract and transport to market. No transport means reserves cannot be booked, so stranded assets are excluded. If prices rise, reserves grow, as more oil in existing reserves becomes economic to recover. However, higher prices also impact some production sharing contracts, which reduces companies' reserves.

Undeveloped. Conditions for proved undeveloped reserves are even more stringent. Reserves established due to new seismic technologies are not accepted, as there has been no direct contact with the reservoir. Unconventional resources, such as oil sands, also are excluded as these were considered mining operations when SEC regulations were formulated in 1978.

Different measures. Following recent consultation, changes to standards are expected, which should see the SEC come closer to other bodies' measurement standards. For example, if presenting to investors, companies generally use the Society of Petroleum Engineers classification system for reserve estimates. These produce a markedly different picture:

Shell. According to Shell's non-SEC reports, the company added 1.5 billion boe of reserves in 2007: This takes organic reserves replacement to 124 per cent, contrasting an SEC reserve replacement ratio of 17 per cent.

Shell estimated its resource base at 66 billion boe, which includes 20 billion barrels of oil sands and heavy oil resources in Canada.

ExxonMobil. ExxonMobil also presents a different picture from SEC data, including oil sands reserves of 694 million barrels at end-2007: Using year-end prices, ExxonMobil said total proved reserves additions were 1.2 billion boe, a 76 per cent reserve replacement ratio.

However, the company said the SEC's single pricing date skewed results, and its ten-year average reserves replacement rate was 112 per cent, 104 per cent for liquids and 124 per cent gas.

ExxonMobil estimates its total oil and gas resource base at 72 billion boe, to which it added 2.0 billion boe in 2007, more than replacing production.

CONCLUSION: While changes to SEC reserve reporting standards will expand companies' reserves, this adds little new market information. Returning a higher proportion of cash flow for investment is required to turn large resource bases into production, thus bolstering reserves and expanding capacity.

From the Oxford Analytica Daily Brief

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