Oil prices may have weakened recently, but they're up strongly from lows just a few years back. Few executives, however, at the world's integrated oil giants have been talking about ramping up spending.
That raises a big question: Can companies keep a lid on spending and keep the crude flowing?
The oil business works like a treadmill. To maintain production levels, companies have to keep approving new projects and finding, or buying new, untapped deposits. In the industry, this is called replacing reserves. To guarantee output growth, firms have historically tried to at least replace every barrel they take out of the ground and sell.
As companies throttle back spending, though, that becomes harder to do. Last year was the first time since 2013 that the five biggest Western energy companies — Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), Royal Dutch Shell PLC (RDS/A), BP PLC (BP) and Total SA (TOT) — managed to do that as a group.
What happened? A sharp oil price decline in 2014 forced companies to cut back on costly exploration, push back big new projects, and sell off unwanted assets.
The trade-off: a decline in the industry's reserves of untapped oil. While new discoveries are only part of the mix in replacing reserves, the industry has long struggled to find enough new oil, as output increases.
Last year, the big five companies' average "proven reserves life" fell to its lowest level in a decade. What does this mean? Shell, for instance, can only keep up its current production for about another nine years, based on its current tally of reserves in the ground. In the past, investors watched reserve replacement closely as a measure of growth potential, and regulators maintain strict accounting rules about what constitutes proven reserves. Shell has emphasized that it expects growth to continue in the coming years, and that Securities and Exchange Commission rules governing what can be included in reserves don't necessarily fully reflect the opportunities available to the company.
But these days, investors have been less concerned about dwindling reserves, and much more focused on spending discipline. In some cases, investors have rewarded companies that are shrinking in terms of reserves. They have punished those seen as spending too much to sustain growth. Take Exxon, which has ramped up spending recently to bulk up, and ConocoPhillips (COP), which has been selling off assets to focus on the most profitable projects, dramatically shrinking its reserves in the process.
Investors have made clear which they prefer. Exxon's shares are roughly unchanged in the past 12 months, including reinvested dividends, while ConocoPhillips's is up about 25%. Exxon has said it plans to focus on "value over volume" in the coming years.
That has forced big oil companies to re-evaluate their business models.
"Pre-oil-price-crash, finding reserves was considered…the most important strategic activity," said Andy Brogan, global oil-and-gas transactions leader at consultancy EY. "Postcrash, developing known reserves in an economic way is considered the most important strategic activity of an oil company."
The industry's new Holy Grail is low-cost production. That churns out the cash flow investors have come to covet. For now, protecting that is more important than double-digit reserves life.
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