I spent a lot of time in 2015 warning that at year-end we would see a huge decline in crude oil reserves. As I have explained in the past, the reason I expected this is because of the relationship between proved oil reserves and oil prices. This relationship is important for understanding oil reserves. Some articles that recently began making the rounds made certain conclusions from this paper — A global energy assessment — in which some subtleties about oil reserves have been lost. So let’s review.
An oil resource refers to the total amount of oil in place in particular area. Generally, most of a resource can’t be technically recovered, but the resource refers to the amount that could potentially be recovered. These estimates can go up and down, but the resource is what could be recovered at 100% recovery based on current estimates.
As an example, it is estimated that the Bakken Shale centered under North Dakota contains several hundred billion barrels (bbl) of oil (the resource). However, what is technically and economically recoverable in the Bakken has been estimated at less than 10 billion barrels (<10% of the resource).
The portion that is technically AND economically recoverable at prevailing oil prices may be classified as proved oil reserves. (The same concept applies for natural gas). This means that proved reserves are a function of prevailing oil prices. This qualifier is often misunderstood.
It was estimated that when oil was $100/bbl, there was a total of 1.7 trillion barrels of proved oil reserves globally. The aforementioned article argues that this estimate may be overstated by about 875 billion barrels. It may very well be, but that doesn’t mean the oil isn’t there. It just means that at $40/bbl, there aren’t 1.7 trillion barrels that can be economically produced. The inverse of this is why Venezuela’s proved reserves went from ~80 billion barrels in 2004 to nearly 300 billion barrels in 2014. Oil at $100 meant that more of Venezuela’s heavy oil was economical to produce, shifting it from the resource category into the proved reserves category (and of course it can be shifted right back out of the proved reserves category).
Each year, companies trading on U.S. exchanges must report the amount and estimated value of their oil and gas reserves. These estimates are done according to U.S. Securities and Exchange Commission (SEC) guidelines, and are provided in each company’s annual report.
The value of reserves is reported as a standard discounted cash flow (DCF), which is typically known as the standardized measure (SM). The SM is defined as the present value of the future cash flows from proved oil, natural gas liquids (NGLs), and natural gas reserves, minus development costs, income taxes and exploration costs, discounted at 10% annually.
Annual reports have now been filed, so the results are in. Of the 125 oil and gas companies in my database that reported proved reserves to the SEC, 92 reported declines in their proved oil reserves. The largest decline was reported by Royal Dutch Shell, which saw a decline of 827 million barrels in its proved oil reserves in 2015. Other large declines were recorded by Occidental (461 million barrels), Hess (246 million barrels), Apache (225 million barrels), and Anadarko (216 million barrels).
Cumulatively, these 92 oil companies reported a decline in reserves at the end of 2015 of about 3 billion barrels (11 billion barrels of oil equivalent if natural gas proved reserves are included). That’s a big number, but it only becomes truly impressive when the value of these reserves is tabulated.
Keep in mind that the Standardized Measure is based on both the overall amount of proved reserves — which declined — and also the value of reserves that remain on the books. The decline in commodity prices had an enormous impact on the latter.
At year-end 2014, the SM of companies reporting to the SEC was $1.4 trillion. At year-end 2015, that number was reported to be $560 billion — a year-over-year decline of $840 billion. Only three of the 125 companies in my database reported a year-over-year increase in the value of its reserves. The Energy Information Administration (EIA) recently tabulated that U.S. oil companies lost of total of $67 billion in 2015, but given the dramatically reduced value of reserves that’s a drop in the bucket compared to what it could be with an extended oil and gas bear market.
But, don’t expect a repeat in 2016. The nearly 80% gain in crude prices since the February lows make it likely that some of the write-down in 2015 will be recovered this year.