Analysis: Shale Boom, Independents Drive U.S. Reserves, Capital Spending

The U.S. shale oil and gas drilling boom boosted U.S. oil and gas reserve growth to a five-year high in 2010, while upstream spending more than doubled from 2009 to 2010 largely due to producers' acquisitions of shale properties, according to Ernst & Young's fourth annual U.S. E&P Benchmark Study.

The survey of the 50 largest oil and gas companies by end-of-year reserves found that end-of-year oil reserves grew 11 percent from 16.1 billion barrels in 2009 to 17.8 billion barrels in 2010, and natural gas reserve grew 12 percent from 156.2 Tcf in 2009 to 174.3 Tcf in 2010, the strongest combined annual growth posted from 2006 to 2010.

Analysis: Shale Boom, Independents Drive U.S. Reserves, Capital Spending
Shale Rock

The oil production replacement rate for U.S. oil reserves from all sources, including extensions and discoveries, improved recovery, revisions, purchases and sales of proved reserves, was 234 percent in 2010, compared with a 158 percent replacement rate in 2009. The U.S. natural gas production replacement rate from all sources was 252 percent last year, compared with 156 percent in 2009.

Production replacement rates for 2010 that excluded purchases and sales were 205 percent for oil, 249 percent for gas, and 232 percent on a combined BOE basis.

The study found that independent oil and gas producers led in terms of oil production replacement rates for 2010, with independents replacing 601 percent of oil production from all sources last year and, excluding purchases and sales, replacing 433 percent of oil production.

Large independents replaced 241 percent of production from all sources, and 290 percent of production from sources other than purchases and sales. Meanwhile, integrated oil and gas companies replaced 141 percent of oil production from all sources, and 111 percent of production from sources excluding purchases and sales.

Integrated companies had a gas production replacement rate of 436 percent from all sources; however, this replacement rate reflects ExxonMobil's acquisition of XTO Energy, which was completed in June 2010. When purchases and sales were excluded, integrated companies had a gas production replacement rate of 111 percent.

Independents replaced 408 percent of gas production from all sources in 2010, or 375 percent when purchases and sales were excluded. Large independents recorded a negative gas production replacement rate of 34 percent, largely due to the ExxonMobil/XTO transaction, as XTO is classified as a large independent. Excluding purchases and sales, large independents had a gas production replacement rate of 263 percent in 2010.

Reserve replacement costs on a total basis, including proved property acquisitions, were up once again, increasing to $15.26 per BOE in 2010 from $12.78 per BOE in 2009. Reserve replacement costs on a finding and development basis, excluding proved property acquisitions, increased to $17.84 per BOE, up from $13.01 per BOE in 2009.

Upstream spending more than doubled from $72.8 billion in 2009 to $177.9 billion in 2010. ExxonMobil's acquisition of XTO Energy accounted for 51 percent of proved property acquisition costs of $42.2 billion and 40 percent of unproved property acquisition costs of $59.3 billion in 2010. Apache Corp.'s acquisition of Mariner Energy and assets from Devon Energy and BP contributed significantly to proved and unproved property acquisition costs, as did acquisitions by Chesapeake Energy and Denbury Resources.

Exploration costs increased eight percent from $14.3 billion in 2009 to $15.5 billion in 2010, while development spending increased 36 percent from $44.8 billion in 2009 to $60.8 billion in 2010, primarily due to shale oil and gas development. The increase in exploration and development spending was primarily driven by ExxonMobil, Chesapeake Energy and EOG Resources. Of the 50 companies surveyed, only four decreased their exploration and development spending in 2010 – BP, ConocoPhillips, Loews and Plains Exploration & Production.

The companies' plowback percentage, or total upstream spending as a percentage of netback, increased to 170 percent in 2010, the highest of the five-year period from 2006 to 2010, as companies reinvest in shale activity. In 2006, the plowback percentage reached 121 percent as a result of an increase in investment activity driven by a relatively high priced commodity environment.

ExxonMobil's acquisition of XTO and similar deals are part of the trend of major oil and gas companies following the lead of independent oil and gas companies, who were first movers in North American shale plays. This trend is occurring as integrated majors are finding it difficult to replace reserves organically. The rise of national oil companies overseas has made it more difficult for the companies to access foreign reserves, as have restrictions placed U.S. offshore drilling. U.S. independents and oil service companies have been at leading edge of technology, including developments in horizontal drilling, which have changed the oil and gas industry.

Strong oil prices and weak, but stable, gas prices in 2010 encouraged investment in shale exploration efforts and production technology. The shift from gas to oil-focused drilling has created a drilling renaissance in the Permian Basin that has operators looking at plays nobody thought was possible.

However, consistency in commodity prices, as well as companies' abilities to find enough skilled employees and addressing issues surrounding hydraulic fracturing, are needed to allow companies to capitalize on shale properties. Despite controversy over hydraulic fracturing, the practice will likely continue, said Marcela Donadio, Americas Oil & Gas Leader for Ernst & Young, noting that companies are taking efforts to conduce fracing responsibly.


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