4. Reserves replacement
Depletion and reserves growth
Any natural resource in the ground is physically limited, as has been stated above, which makes them “depletable”, in economic terms. In theory, this could mean that a project starts with a fixed level of resources which are then simply adjusted down by the amount of cumulative production. If a gold mine started with estimates of a million ounces, and produced 100,000 ounces a year, it would then have produced 500,000 ounces after five years and have 500,000 ounces remaining. But in practise, the level of knowledge about resources is constantly changing through the life of the project in a way which often leads to reserves growth.
There are two ways in which this could happen. First, continued exploration efforts could discover new resources in the same license area. In both mining and oil, companies are granted a license for a given geographical area. They then prospect, or explore across the area and if they find a resource which they deem commercial enough to be turned into reserves, they start production. But the production area is usually a sub-area of the original exploration area, and the physical extent of production facilities may itself be a sub-set of the allocated production area. Companies have an incentive to continue exploration because if it is already within their license area it might be that no separate negotiation process will be needed, and also the economics of any new discovery in that same area are likely to be more favourable, because certain significant categories of costs, such as infrastructure, may already be covered by the development of the first area.
Second, even without a new discovery, resources within the first area could be upgraded into reserves, meaning that the company has now declared the commercial intention to produce them.
Resources can be many times the stated reserves in a discovery. As production progresses, the company will be gaining new information all the time about how to maximise production.
Linked to reserves growth is the concept of recovery rates – how much of a resource a company will produce before operations become uneconomical and it closes the mine, or the field, even though it knows significant geological resources remain.
In the oil industry, for example, one definition of resources is called the Stock Tank Oil in Place (STOIP). Around the world currently production may typically only reach 30-35% of STOIP before a well is closed. Historically the figure has been even lower. There are estimates that since the oil industry began, collectively the recovery rate may have been no more than 25% - fully three quarters of the oil discovered has never been produced before the field was abandoned. In recent years the North Sea basin shared by the United Kingdom and Norway has seen intensive efforts at enhanced recovery, techniques designed to increase the percentage produced before abandonment, to over 50%, and the Norwegian state oil company Statoil announced it was even targeting 60% recovery in some fields. But such rates are announced because they are historically high. This is because oil does not exist in reservoirs in a pool of unbroken liquid, but in the cracks between dense rock structures. How much is extractable therefore depends on the porosity of the rock and the pressure forcing the oil out, and both of these can be highly variable through a single rock structure.
In mining, companies will plan to keep production going until they hit a cut-off grade in the quality of the ore. For example, production in a gold mine could start with ores which contain 2 grams of gold per tonne, and continue until the grade of ore had deteriorated to 1 gram a tonne, at which point it is no longer economic to continue.
In both cases the principle is the same. In any discovery the commercial viability of producing it is not a simple binary: yes, it is worthwhile to produce this resource of 100 million barrels of oil, or no it is not. The viability is actually on a sliding scale related to the quality of the resource and the ease of extraction.
The depletion rate of a natural resource leads companies into a constant search for reserves replacement. This can happen through reserves growth within existing assets, or by seeking to acquire new license areas and make new discoveries. Since a large part of the value of an oil or mining company depends on the resources it is entitled to produce, or “book” as it is known in the oil industry, companies often face great pressure to ensure that they replace at least the reserves they have produced in order to maintain their market value.
In 2004 the chairman of Shell oil company, Philip Watts, was forced to resign after the company was proved to have misstated reserves in order to reassure the market. ExxonMobil also courted controversy under former CEO Lee Raymond by insisting on declaring reserves in public communications in a way which differed from the formal regulations of the SEC, in order to emphasise shale oil and gas reserves it held.
In oil and gas, BP’s Statistical Review, published annually, is a widely used reference work which gives year on year reserves levels at a country level. Analysis shows that due to new discoveries and the kind of reserves growth within projects mentioned above, global reserves replacement is above 100%. In 1995 total proven reserves were estimated at 1.1 trillion barrels; in 2005 at 1.4 trillion barrels, and in 2015 at 1.7 trillion barrels.