Why BP plc’s Reserve Replacement Has Skyrocketed


In the popular imagination, the oil business is a licence to pump moneY. Stick a pipe down a well, extract the black gold and sell all the barrels of the lucrative gloop you can. It sure beats trying to be the next Apple, right?

Of course, things are not so easy — especially not if you’re one of the largest oil companies in the world like BP (LSE: BP) (NYSE: BP.US).

Prospecting for future profits

For the record, things were once that easy. Canada’s first commercial oil well, for example, struck the good stuff in 1858 after digging down just four metres. The businessman behind it had reportedly extracted 1.5 million litres of crude oil by 1860.

Most easy pickings were depleted a long time ago, however. There remain some easier to extract reserves in neglected (or frightening!) places, such as in Kurdistan, where the ex-boss of BP Tony Hayward seems unable to stick a shovel into the ground without hitting oil with Genel.

But in the main, extracting oil is only getting more difficult. Britain’s oil boom took place offshore in the North Sea for instance — and it was a significant engineering feat to get that oil out from under the waves in the 1970s.

By modern standards, though, the relatively shallow waters of the North Sea, situated close to likely end markets, are a doddle.

The companies looking to extract oil off the coast of Brazil don’t just have to negotiate the mere ocean — in most cases, they then need to drill through a two mile deep layer of salt before they’ll strike anything like a gusher.

In many parts of the world it’s not much easier onshore these days, either.

America is enjoying an oil production renaissance because companies have developed new ways to extract hitherto inaccessible reserves — such as multi-directional drilling, and the ever-controversial tactic known as fracking — not because they’ve found vast virgin oil fields.

Keep up!

All this matters because oil is self-evidently not a renewable source. Once an oil company has drained a reserve dry, there’s nothing much left except a hole in the ground.

This means that an oil company like BP is usually expected to find at least as much oil over time as it produces and sells.

If it fails to at least replace the oil it’s extracting then its reserves will dwindle, which obviously threatens its business, and more pertinently those lovely dividend payouts that tend to attract investors to the likes of it and Royal Dutch Shell.

The figure that captures this in the company’s annual reports is known as the ‘replacement ratio’. A number below 100% tells you that reserves shrank. A figure over 100% means the company added more to reserves than it used up in production.

A few decades ago it was easy to keep the reserves ratio strong. Big oil discoveries were two a penny, as the oil majors brought every corner of the world online for oil. And what they didn’t discover themselves they could acquire via takeovers or mergers. The most successful companies grew rapidly to achieve today’s huge scale.

However we’ve as discussed, oil is harder to get now and very few finds move the reserves dial for the likes of BP and Royal Dutch Shell.

It’s a similar story with acquisitions. The assets of the majority of the junior oil companies barely amount to a drop in the ocean for the majors.

Finally, shareholders in big oil companies are increasingly suspicious of expensive and uncertain oil prospecting. They want their companies to steward their capital, rather than punting it on mega-projects, almost irrespective of the risks.

This need to watch the pennies is yet another factor making it hard for oil majors to keep their replacement ratios up.

BP’s reserves boom

All of which makes BP’s latest reserve replacement figures for its past full-year remarkable.

At the group level, BP has booked a reserves replacement of 129% in 2013, excluding certain disposals and assets. That’s clearly way above the level required for it to make up for the oil it pumped.

Include all BP’s activities and deals and the number soars even higher, to a barnstorming 199%!

A couple of years ago, BP reported a ratio of just 77% — way down on its average of over 100% for most of the past 20 years.

What on earth is happening?

Well, reserve replacements tend to be lumpy, as big finds and transformative deals don’t come along like clockwork. And BP had two in 2013 that have substantially reshaped the company, as well as boosting its reserves.

From Mexico to Moscow

Firstly BP has actually made one of those rare big discoveries, this time in the Gulf of Mexio — yes, the same place region where the fatal Deepwater oil rig disaster in 2010 set in motion events that led to that unusually low ratio of 2012, as well as a host of other problems for the company. The company has also increased volumes in Angola and the North Sea.

Secondly, BP has rejigged its portfolio of Russian assets, selling its TNK-BP division (long the major source of BP’s reserves top-ups) to Russia’s State-owned giant Rosneft and picked up 20% of the latter in the process. It’s this that causes the replacement ratio to surge up to 199% when the Russian assets are included.

BP has been a very controversial company in recent years, and both its moves in Russia and the prospect of it pumping yet more oil from the Gulf will fill some onlookers with dread.

If you’re a BP shareholder, however, the good news from a reserves point of view is that the deals have worked.

Of course there’s more to evaluating an oil company than simply eyeballing one figure in isolation. To this end, the Motley Fool has produced a unique guide to finding great oil and gas companies to profit from. 

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> Owain owns shares in Genel and Royal Dutch Shell.