Finding and Development Costs
In the oil and gas industry it is common to refer to “Finding and Development Costs”
F&D costs or sometimes just finding costs. F&D costs are: (a) the costs to purchase
properties or acquire leases that might contain oil & gas and the cost of exploring for
oil and gas reserves on these properties – the finding component; and (b) the
development component – the cost of developing reserves of oil and gas; e.g.,
drilling and facilities costs. F&D costs are typically expressed on a per-unit basis,
either boe or Mcfe.
One has to be very careful in using the F&D methodology. It may be OK for
relative comparison at a single point in time and when accompanied with other
more robust measures of financial performance; however it is of little benefit in
informing go-forward investment decisions.
F&D cost methodology inflates current cost by asymmetrically treating costs and
reserve additions that result from new investment. This occurs because costs are
reported in the year in which they occur; whereas, reserves are credited to the year
of the original pool discovery. This situation is less pronounced for a new
exploration area and more pronounced for a basin that has significant development
activity such as onshore North America, where roughly 75% of the total wells drilled
are allocated to development. Although these development activities create value on
mature fields, the reserves added through development are credited back to the
year that the pool is discovered. This lowers historical F&D cost and inflates current
F&D costs. Consider the following illustration and the accompanying Table C.3.1.
Assume that only one well is drilled in 1995 at a cost of $40. This well discovers a
pool with reserves of 100. This results in an F&D cost of $40/100 = $0.40. Now,
further assume that in 2005 two wells are drilled at a cost of $40 each. One of these
wells discovers a new pool with reserves of 100 and the other is into the pool
discovered in 1995 adding 100 to that pool. The F&D cost for 1995 is now reported
as $40/200 = $0.20 and the F&D cost for 2005 is $80/100 = $0.80.
Table C.3.1: F & D Costs Calculation and Reserves Allocation
ILLUSTRATION OF RESERVES
ALLOCATION AND F&D COSTS
1990 Discovery
2005 Discovery
Prior to
2005
2005
2005
Well Costs
40
40
80 = 2 X 40
Reserves
Discovered
100
200
100
F&D Costs
40/100 =
0.40
40/(100+100) = 0.20
80/(200-100) =
0.80
Further illustration: Forest Oil (NYSE:FST), for example, reported 2008 all-sources
finding, development and acquisition costs of $2.61 per Mcfe excluding revisions.
This is calculated by dividing the company's total capital expenditures by its total
reserve additions from all sources – meaning reserves the company purchased and
reserves it added using the "drillbit". See Table C.3.2.
Forest Oil also reported 2008 organic finding and development costs of $2.54 per
Mcfe excluding revisions. "Organic" is the key word here, and it refers to reserves
found just with the drillbit. The calculations are the same as above except the
denominator excludes reserves that were purchased; the numerator excludes the
cost of those acquisitions.
Table C.3.2: Finding & Development Cost Example
Exploration and development
$1,356
Reserve discoveries and extensions
533 Bcfe
Organic FD costs per Mcfe
$2.54
Total costs from all capital activities
$2,725
Total reserve additions
1,044 Bcfe
All sources' FDA costs per Mcfe
$2.61
Further Reading …
http://www.investopedia.com/stock-analysis/2009/take-finding-and-development-costswith-a-grain-of-salt-bp-fst-upl0219.aspx#ixzz2DLyEXBLM
Securities and Exchange Commission: To underscore the pitfalls of the F&D
methodology for valuing a given company or investment prospect, the Securities
and Exchange Commission (SEC) prescribes how F&D costs are to be calculated. SEC
document – National Instrument 51-101 Standards of Disclosure for Oil and Gas
Activities contains the following:
Finding and Development Costs - If written disclosure is made of finding and development costs:
(a) those costs must be calculated using the following two methods, in each case after
eliminating the effects of acquisitions and dispositions:
Method 1: (a+b+c) / x; and,
Method 2: (a+b+d) / y
Where:
a = exploration costs incurred in the most recent financial year
b = development costs incurred in the most recent financial year
c = the change during the most recent financial year in estimated future development
costs relating to proved reserves
d = the change during the most recent financial year in estimated future
development costs relating to proved reserves and probable reserves
x = additions to proved reserves during the most recent financial year, expressed in
BOEs or other unit of equivalency
y = additions to proved reserves and probable reserves during the most recent
financial year, expressed in BOEs or other unit of equivalency
(b) the disclosure must include:
(i) the results of both methods of calculation under paragraph (a) and a description of
those methods;
(ii) if the disclosure also includes a result derived using any other method of
calculation, a description of that method and the reason for its use;
(iii) for each result, comparative information for the most recent financial year, the
second most recent financial year and the averages for the three most recent financial
years;
(iv) a cautionary statement to the effect that: "The aggregate of the exploration and
development costs incurred in the most recent financial year and the change during
that year in estimated future development costs generally will not reflect total finding
and development costs related to reserves additions for that year"; and
(v) the cautionary statement required under paragraph 5.14(d): "BOEs [or 'McfGEs'
or other applicable units of equivalency] may be misleading, particularly if used in
isolation. A BOE conversion ratio of 6 Mcf: 1 bbl [or 'An McfGE conversion ratio of 1
bbl: 6 Mcf'] is based on an energy equivalency conversion method primarily applicable
at the burner tip and does not represent a value equivalency at the wellhead".