Slugcatcher: "Where's the growth from the drill bit going to come from?"

RECORD profits, record dividends, record share buy backs. Oh, what a marvellous time to be in the oil industry – shame about the lack of discovery.

Without wishing to rain on anyone’s parade, Slugcatcher wonders whether anyone else out there has spotted the same glaring anomaly in the way the oil patch is working these days.

Once upon a time, record profits meant just one thing – funding for genuine wildcat exploration, and a push to expand reserves for a time when there wasn’t so much spare money floating around.

This boom is different – and it is deeply disturbing when looked at through the prism of the future.

Royal Dutch/Shell, which has faced a painful set of problems, is at the extreme end of the point being made by Slugcatcher, but sometimes it requires extremes to highlight the point.

Last year, from what Slugcatcher has read, Shell operated at a 45% reserve replacement ratio. In other words it failed, spectacularly, to replace by discovery or revaluation, the oil and gas it produced.

BP did better, but not significantly better. It managed a 106% replacement ratio. In other words, it just managed to scrape together a little bit more than it produced.

Said quickly, and it doesn’t seem to be such a problem. Looked at in the cold light of what happens to any mining or oil company that fails to find more of its primary product and you have a picture of a shrinking business.

Right now, that’s not a problem because the sky-high oil price has everyone awash in cash. If prices fall, and the reserve replacement ratio is still in negative territory, then there is a real problem.

It is at this point that the debate over reserve replacement, price and exploration becomes clouded and Slugcatcher admits that he’s not sure what forces are at work, or which way the situation will unfold.

From the perspective of an oil stock investor this is a terrific time because oil companies are returning their windfall profits in the form of high dividends and buybacks.

From the perspective of an oil company it’s a less thrilling time because it is supposed to be in the business of both production and exploration.

From the perspective of an oil consumer this is a dreadful time because he’s facing high prices, and the prospect of severe limitations on future supply because of the lack of exploration.

It is possible, if you believe in the law of finite resources, that we really have reached the end of the road when it comes to major new oil discoveries.

If that’s correct then perhaps we had better prepare ourselves for the big slowdown as oil production tops out, and even begins to slide, prices rise, and oil companies become rather dull managers of a portfolio of legacy assets because that’s what the financial markets want, and because exploration is considered too risky.

It is a stunning outlook. Imagine oil companies afraid to explore because it might damage their reputations as efficient managers of old oilfields?

But, that is a very real possibility – until we introduce another factor into the equation, even higher oil prices which crush global economic growth, and lead to a slowdown in oil demand, and price.

Tricky stuff, but well worth thinking about because unless the reserve replacement ratio is lifted, the world is in for a rocky ride.

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