how organic reserve replacement works
organic reserve replacement is a relevant metric to those needing to evaluate an oil or gas company these evaluations would generally include a review of the reserve replacement ratio the reserve replacement ratio expresses the amount of proved reserves added to a company s reserve base during the year as compared to the amount of oil and gas produced a company s reserve replacement ratio should be at least 100 for the company to be profitable and viable long term investors and industry analysts worry when they see an oil company with a less than 100 reserve replacement ratio lower reserves indicate the company is depleting its reserves and if that trend continues will eventually run out of supply exploration of organic reservessmall and intermediate sized oil and gas companies may use a company that specializes in exploration and production e p to find organic reserves in larger integrated corporations such as exxon and british petroleum an arm of the business may handle these duties the term finding and development f d also refers to the process and costs incurred when a company researches and develops or purchases property to establish commodity reserves in the oil and gas industry exploration finding and developing are know as the upstream functions usually exploration begins in an area with high potential to hold a resource generally due to the local geology and known nearby petroleum deposits a geophysical and geochemical analysis is done using techniques including induced polarization ip surveys drilling assaying seismologic sounding and the use of electrical currents after locating a promising area the company will drill a deep test hole known as an exploratory well to gather more detailed geological data on rock and fluid properties most current exploration today is offshore where a single exploratory well can cost 150 million and the success rate is around one in five it typically takes several years before an exploratory well comes into production organic reserve to determine financial healthduring the exploration or finding and developing stage some companies use the full cost accounting fc approach and capitalize all their operating expenses regardless of whether they found any commercially viable reserves or not this accounting method inflates the balance sheet by treating costs as assets and makes the company look more profitable than it is in comparison the successful efforts se accounting method is more conservative it only allows those expenses associated with successfully locating new oil and natural gas reserves to be capitalized oil quantity is usually measured in barrels and gas uses a cubic feet measurement calculation of a company s costs to find a new source comes from the entire exploration process funds spent to locate the new organic reserve replacement is totaled and then divided by the estimated additional quantity discovered investors looking at the financial strength of oil and gas companies should consider a company s organic replacement when evaluating its reserve replacement ratio the organic replacement portion is a significant part of that formula and can be relevant to those wanting to assess the company s health from an economic standpoint as an essential metric of overall business health and viability the ratio indicates the company s upstream and proactive efforts the results offer a perception of the results gained from expenditures in drilling and exploration and may give insight into future profitability 