Should Big Oil Shareholder Worry About Declining Reserve Replacement Rates?

In 2015, most of the world's major oil companies replaced on average only 75% of their reserves, and 2016 isn't looking much better.

In this segment from the Industry Focus: Energy podcast, Motley Fool analysts Sean O'Reilly and Tyler Crowe explain where this fits into the companies' strategies, and why the move is not as alarming as it might initially sound.

A transcript follows the video.

This podcast was recorded on March 31, 2016. 

Sean O'Reilly: We have to talk about this, because it's a big deal. You'll explain why in a minute. Bottom line, the world's oil companies, particularly the majors, only replaced last year's 75% of their reserves. How long has it been since that happened? Ever?

Tyler Crowe: It's been like a decade. I think the last time, there was a post in The Wall Street Journal basically talking about companies not replacing their reserves at a 100% clip, and I think the last time that -- well, all the companies all at once, I think it was some time like 2004, 2005. So it's been close to a decade. Or, a little more than a decade.

O'Reilly: Did they just say, the entire energy industry? Or did they take the top 20 firms and say 75% of them?

Crowe: Did not specify, but I think kind of the overall discussion was on the big players who spend all the money doing it. The Royal Dutch Shells (RDS.A) (RDS.B), the ExxonMobils (XOM 0.23%), the Chevrons of the world. ExxonMobil replaced about somewhere between 67%-75% of their reserves last year, Royal Dutch Shell right around 75%, and the truth is, they're just not... it's kind of a combination of, it's getting a little harder to find very large reserve replacements, and a little bit of less exploration spending here and there is going to tend to do that.

O'Reilly: It's not like they have an incentive, too, with oil at $30-$40 a barrel. Do you think... obviously, long-term, this is a trend that can't remain if we're going to keep using oil. Is this something that'll reverse itself this year? What were these oil companies thinking when they cut these budgets so much that they weren't even replacing their own reserves? Were they just like, "We'll just make up for it, and then some, when oil recovers?"

Crowe: They were cutting their exploration budgets this much because they wanted to keep the lights on. I mean, if you look at cash flows for these companies and their ability to pay their dividends, which is the primary reason why somebody is going to invest in a big oil company anyways, is stability and a dividend. You're not buying them for double, triple stock price growth. So, when you're not spending any money on exploration, it's just not going to happen. And, a lot of these guys have the cushion to do it, if you look at their five, 10-year reserve replacement rates, it's 15%-20% greater than what they produced.

So, they've been building up a little bit of cushion in the event that something like this happens. You look at ExxonMobil, they have proved reserves of more than 20 billion barrels, and then what they call their resource base, which is stuff that they're evaluating, and has been discovered in years prior and they think they can get, is up to 90 billion barrels, which is something on the range of--

O'Reilly: Absurd amount, yeah.

Crowe: --on the range of 40-50 years of production at today's constant rates. So, it's not like the alarms should be going off and everybody's heads, "Oh my God this is an absolute crisis!" It's a one-year thing. If you look over a five-year reserve replacement rate, they're still above 100%. And sometimes, these bad years are going to happen. And chances are that 2016 is going to be another really bad year, because they're not spending any money on it.