What Was Producers' Break-Even Oil Price for 2008?

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Includes: OIL, USO
by: Oil and Gas Investments Bulletin

The breakeven price for oil and gas companies in 2008 was US$87.24 per barrel of oil equivalent (boe), BMO Nesbitt Burns said in its annual Global Cost Study released July 21.

The three year average for the industry’s breakeven price is US$73.60. They estimate the 2009 breakeven price will fall roughly 20% to close to US$70. It has risen steadily since 1999 when it was $16.96

BMO Nesbitt Burns is one of the largest Canadian brokerage firms. Its survey included 118 companies that produced 19 million barrels of oil per day (bopd) and 85 billion cubic feet of gas per day (bcf/d). These numbers encompass all costs, or what the industry calls full cycle costs, and include a 10% return on capital for the producer.

(This is an important distinction as many investors get confused on costs. When companies report break-even costs on wells or production, they are often referring to operating costs, or what the industry calls half-cycle costs. Energy companies can say they can produce oil or gas at $X, but that may be on an operating basis, and not include items like land acquisition (this is especially true for the new shale gas plays).)

BMO says the rise in the breakeven price is caused by two factors:

  1. Operating costs have gone from US$4.50 per boe in 1999 to almost $16 in 2008
  2. Rising Finding & Development Costs (F&D). This is the big jump - from US$3.88 in 1999 to $23.16 in 2008. This is the cost for replacing reserves. If a company has 10 million boe in reserves in Year 1, but produced 1 million boe that year, it now only has 9 million boe in reserves. The cost of replenishing that 1 million boe lost to production has increased dramatically.

I’ll highlight several points that I think investors would find interesting:

F&D costs in 2008 rose 56%, a huge jump. BMO said this was because many companies actually showed negative reserve growth in 2008, despite $323 billion being spent on exploration by these 118 companies.

This is because costs were still reflecting the highly inflated cost structure of 2005-2008, while the year end oil price collapsed. Companies must report their reserves based on the year end oil price. They spent their exploration money throughout the year finding oil reserves based on $100 oil, but it ended up just over $44.

In North America, BMO reports reserve additions cost more than US$41/boe, almost double their global average. (However, North American accounting provisions could just be tougher - but I’m not sure about that.)

Return on capital for energy producers has decreased since 2005, as government has taken a larger chunk of the profits, and the quality of crude has declined. So profit per barrel has declined and the cost of finding a barrel has increased, despite over $1.2 trillion spent on exploration in the last five years, BMO reports.

There are a couple issues that would indicate higher oil prices are here to stay:

  • Historically, there is still a small surplus capacity in the global system, even with the global recession. BMO’s charts show it to be under 5 million boe, vs. over 20 million in the 1980s and early 1990s.
  • A shortage in skilled labour within the industry remains - geologists, engineers etc.

BMO also reports that previously when there was surplus capacity, the industry was also able to discover large low cost reserves in the world that helped bring costs down. They don’t see that on the horizon right now. The oil sands, a new unconventional source of oil, might be able to get to all in cost of US$50.

They do point to shale gas as one such possibility. Natural gas could potentially find a breakeven price of US$5/mcf, down from $9.28. However, I have written before how the financial statements of these companies are not yet showing any significant decrease in their finding costs, as is shown on the line item “Depreciation, Depletion & Acquisition”, or DD&A.

Lastly, and this is important for the many thousands of retail investors who own the Canadian natural gas stocks, is that costs to find gas in Canada is 50% higher than in the US - >US$10/mcf vs. US$7.09. The reason for this is that Canadian companies built up production as fast as they could over the last few years, with the hopes of being bought out by a royalty trust, and that game is now gone, or much reduced.

The Canadian producers just did not need to be as efficient in their growth as their US counterparts. (Having said that, their success rate in drilling is still very high.) But this has resulted in high debt levels for the Canadian companies during a time of low commodity prices. Much if not all of their cash flow growth over the coming years will be used to reduce debt, and will not flow to investors. This means investors need to be very choosy in deciding which if any gas weighted juniors or intermediate producers.