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The cost of acquiring natural gas reserves is about $1.60/Mcf [ClearOnMoney]
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The cost of acquiring natural gas reserves is about $1.60/Mcf

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Commentary

The cost of acquiring natural gas reserves is about $1.60/Mcf

26 Dec 2012 by Jim Fickett.

Oil and gas company valuations are closely related to their reserves, so it helps to know how much it costs to acquire those reserves. Ernst & Young provide reserve acquisition costs for the top 50 US exploration and production companies in the oil and gas sector. Taking an average for 9 companies with large gas and small oil reserves gives an average reserve acquisition cost of $1.60 per thousand cubic feet of gas.

Yesterday I came across a June 2012 benchmarking study from Ernst & Young on the US oil and gas exploration and production industry. If you are interested in the oil and gas sector, this study provides considerable background information on the top companies that you will have a hard time finding anywhere else.

I am in the process of updating some of my analysis on Encana, and am particularly interested to know what it costs, on average, across the industry, to acquire new reserves. Ernst & Young have excellent data, breaking down total reserve acquisitions into two categories – existing proved reserves that were purchased, and reserves that were acquired by exploring new land.

A limitation of the Ernst & Young study is that their combined average statistics mix oil and gas, two markets that have greatly diverged in recent years. However it is possible to get around this limitation because E&Y give separate results on each of the 50 top companies.

There are 9 companies analyzed (a) that have gas reserves of at least 3 trillion cubic feet (Tcf) and (b) for which gas is at least 75% of total reserves. Below are three year average performance measures for (1) purchase costs, (2) finding and development costs (strictly defined, not including purchases), and (3) reserve replacement costs (total capital expenditure divided by additions to reserves, combining 1 and 2). The unit in all three case is dollars per thousand cubic feet equivalent (Mcfe; a barrel of liquid is considered as equivalent to 6000 cubic feet of gas; this is based on heat value).

Company Purchase F&D RRC
Chesapeake 2.30 2.21 2.21
Consol 1.65 1.68 1.65
Encana 0.89 1.81 1.79
EQT 3.08 1.10 1.13
Petrohawk 1.50 1.89 1.88
Range Resources 1.05 0.87 0.87
Southwestern 2.43 1.05 1.05
Talisman 11.03 1.88 2.00
Ultra 1.83 1.83
Average 2.99 1.59 1.60

This list of companies is an interesting starting point for further research, if you believe, as I do, that the gas sector is unreasonably depressed right now.

As a side note, I had wondered in the past whether there was any significant distortion in calculations like the above from capital costs not directly related to reserves – for example new office buildings or gas processing plants. E&Y provide a breakdown of all capital costs in the whole sector, and it is clear that costs not directly related to acquiring reserves are negligible.

The bottom line is that, averaged across these 9 companies, the cost of adding new reserves was about $1.60/Mcf. It follows that this is a lower bound for valuing gas company reserves, on average.