What Is a Recycle Ratio?
The recycle ratio is a profitability metric that calculates the profit earned per barrel of oil against the cost incurred in finding and developing that same barrel of oil. The profit earned for each barrel is called the "netback." On the other hand, the cost of discovering and developing the barrel is called "F&D" or "FD&A" when acquisition costs are included. An energy company should aim for a recycle ratio of 1x or higher to remain profitable. Recycle ratios are used for both internal and external analysis, but it's important to note that netback and FD costs are not accounting measures recognized by International Financial Reporting Standards (IFRS) or generally accepted accounting principles (GAAP).
The recycle ratio is a vital metric for gauging profitability in the oil and gas sector. This ratio, often denoted as "netback," is computed by dividing the profit earned per barrel of oil by the total expenditure associated with discovering and developing that barrel, abbreviated as "F&D." To remain solvent, oil and gas companies must maintain a recycle ratio exceeding 1x. A higher ratio signifies superior financial health and sustainability in this industry.
Deciphering the Recycle Ratio: A Financial Analysis
Netback, specifically operating netback, denotes revenues minus production expenses, transportation costs, and royalties per barrel of oil equivalent (BOE). Basic finding and development (F&D) costs represent exploration and development expenses per BOE of proved reserves added within a year. The FD&A metric, often linked with F&D, adds acquisition costs.
The F&D figure serves as an indicator of whether an energy company is augmenting reserves at an economical rate. For instance, if an energy firm generates an operating netback of $50 per barrel and incurs F&D costs of $25 per barrel, the resulting recycle ratio would be 2x.
Both netback and F&D expenses are non-international Financial Reporting Standards (IFRS) and non-generally accepted accounting principles (GAAP) measures. They are primarily provided by Canadian and some U.S. producers to offer investors and analysts insights into their profitability per barrel compared to the cost of replacing that barrel. Recycle ratios are continuously monitored throughout industry cycles and serve as a basis for peer comparisons.
In the realm of the recycle ratio, oil and gas companies possess control over specific elements. For instance, the sale price of a barrel of oil is largely beyond their influence, as oil prices are beyond their reach. However, companies can manage their expenses in finding and developing oil by supplying accurate data to geologists, reducing frack stages, and ensuring consistent well-to-well placement.
Diverse Recycle Ratios Examples
The concept of the recycle ratio offers various interpretations beyond the simplified model outlined earlier. Canadian Natural Resources Limited, in its 2018 report, disclosed recycle ratios of 8.7x and 11.8x for proved and proved plus probable reserves, respectively. These figures employed FD&A as the denominator, excluding changes in future development costs (FDC).
Expanding the range of recycle ratios, they presented another set considering FD&A along with FDC changes, resulting in 2.9x for proved reserves and 2.5x for proved plus probable reserves.
This multifaceted landscape highlights the existence of multiple recycle ratios within the industry. To facilitate meaningful performance comparisons among oil and gas companies, it is imperative that the components used in calculating these ratios remain consistent.
The recycle ratio serves as a vital profitability metric in the oil and gas sector, gauging the profit per barrel against the costs of discovery and development. The "netback" represents earnings, while "F&D" or "FD&A" includes associated expenses. Maintaining a recycle ratio above 1x is crucial for financial stability. It's worth noting that these metrics, not conforming to International Financial Reporting Standards (IFRS) or generally accepted accounting principles (GAAP), provide valuable insights for investors and analysts.
The diverse landscape of recycle ratios, exemplified by Canadian Natural Resources Limited, underscores the need for consistent comparisons among oil and gas companies. While certain factors are beyond a company's control, efficient management of discovery and development expenses remains a key driver of success in this dynamic industry.