5 Oil Companies Building Assets the Best

There are hundreds of ways to evaluate oil companies, and each of them will give you a different result as who is the best. As investors, we can't rely on one metric alone, but instead we need to understand a multitude of ways to look at these companies to make better decisions.

Today, let's look at one of the lesser used metrics and decide what oil companies are the best based on it.

Buying the future at a discount
Whenever an oil company produces oil, it depletes its reserves. So for a company to continue its growth, it needs to replace these reserves through either exploration of new fields or by acquiring someone else's assets. The price a company pays to replace that barrel of oil it just produced are known as reserve replacement costs, and they can be a strong indicator of how a company will perform in the future. 

In 2012, we saw reserve replacement costs jump to levels we haven't seen since 2008, and some of the integrated majors, the biggest producers in the U.S., have well above average reserve replacement costs. Ultimately, high reserve replacement costs can lead to two things: more money dedicated to operational cash flow, and higher prices for consumers on the final products. 

Who's doing it the best?
It can be pretty handy to evaluate the entire industry on how efficiently it's replacing reserves, but reserve replacement costs can be more effective in evaluating individual companies. The lower the costs, the better it is. According to Ernst & Young, the most effective company at controlling reserve replacement costs is private company Antero Resources, with a three-year average reserve replacement cost of about $2.88 per barrel of oil equivalent. Antero, and four of the other top five companies on Ernst & Young's list, are almost pure natural gas plays. If we've learned one thing over the past couple of years, it's that oil reserves and natural gas reserves are two totally different things when it comes to value. The five following companies have more than 50% liquids on their reserves and had the lowest reserve replacement costs for 2012.

Company % Liquids in Portfolio Oil Production Replacement Rate (3 Years) Reserve Replacement Costs (3-Year Average) Per boe
Rosetta Resources  (NASDAQ: ROSE  ) 57% 846% $6.99
Continental Resources  (NYSE: CLR  ) 72% 827% $12.61
Laredo Petroleum  (NYSE: LPI  ) 52% 1,042% $13.51
SM Energy  (NYSE: SM  ) 53% 392% $14.67
SandRidge Energy  (NYSE: SD  ) 58% 704% $14.85

Sources: Ernst & Young and S&P Capital IQ; author's calculations.

On the surface, there isn't much that these companies have in common. None of them operates in the same part of the country. Over these past few years, SandRidge, Continental, and SM have been relatively active in terms of buying and selling assets, but Laredo and Rosetta have remained pretty quiet on this front up until the past couple of months.

So what ties these companies all together? They're all very close to being one-trick ponies as energy plays. 

Company

Primary Location of Assets  % of Production
Rosetta Resources  Eagle Ford >90%
Continental Resources Bakken 88%
Laredo Petroleum Permian Basin 72%
SM Energy Eagle Ford 60%
SandRidge Energy Mississippian Lime >50%

Source: Investor Presentations.

In the case of SandRidge, it's a bit of a long shot to call it a pure Mississippian Lime play when just 50% production comes from there. Based on its capital expenditure plan, though, it's pretty clear that it plans to move in that direction. The company plans to spend just over $1 billion in the Mississippian Lime in 2013, versus only $160 million on its other assets in the Gulf of Mexico.

By focusing efforts in a single play, these companies are able to leverage their operational expertise in these regions to restock their reserves at a price much less than others that have assets spread out over multiple plays. For investors looking at energy investments, these five companies could prove to be much more successful than their competitors down the road if they can maintain these low reserve replacement costs.

What a Fool believes
Nobody makes an investment decision on a single metric, nor should you. You certainly wouldn't purchase a house based on the quality of the bathroom alone, and the same should hold true when investing in companies. Think of a metric as one color of paint on your investor palette: It will take a multitude of these metrics blended together to paint your investment masterpiece.

Investors were startled after SandRidge plummeted when natural gas prices reached 10-year lows, but with the company focusing on growing liquids production, the future looks optimistic. If you're unsure about the future of this emerging oil and gas junior and are looking to find out more about its strengths and weaknesses, then check out The Motley Fool's premium research report detailing SandRidge's game plan and what to expect from the company going forward. To get started, simply click here now!


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