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The reserve-replacement ratio

A deep oil-price decline is reshaping the oil industry's priorities. The current oil glut has forced companies to cut spending wherever they can so they have pulled back on exploratory drilling and spending on new projects. As a result, big oil companies are draining their oil reserves faster than they are replacing them.

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For the first time in more than twenty years, the gauge has stopped short of the top of the Exxon oil tanks. It isn’t a mere drop or two short either. The Texas-based company reported it had only put back 67% of its 2015 output.

It wasn’t alone. According to marketwatch.com “..seven of the biggest publicly traded Western energy corporations including Royal Dutch Shell PLC, replaced just 75% of the oil and natural gas they pumped” This is, judging by data obtained by the Wall Street Journal, the largest decrease in inventory reported by companies in at least ten years.

Yet it isn’t an indication of end of the world fears – far from it. Exxon has sufficient reserves that would enable it to last until 2032 at this production rate. Instead Rex Tillerson, the company’s CEO, told analysts that this move was calculated to ensure value would be retained for shareholders.

That’s because, despite votes and talks and crises meetings, the oil price remains troublingly low for many producers. It is “less important” to put back supplies says Luca Bertelli from Eni SpA. The Chief Exploration Officer points to how they’re already moving from chance taking in new sites to certain returns from already tapped fields. As Allianz Global Investors fund manager Christopher Wheaton put it, “When the house is burning you’re not worrying if you need to paint the outside.”

That move by Exxon and others like it worked. Last week the Baker Hughes oil rig count reported it had dropped by 15 to 372. That’s the fewest number of operational rigs since November 2009. This week oil prices rallied.

“One week does not make a trend, but hopefully we’ll see this continue and finally see this excess inventory worked off,” said Chip Hodge, senior managing director at John Hancock Financial Services, who oversees about $7 billion in oil and natural gas-related investments. “That will enable prices to rebound.”

Naturally, not everyone sees it like that. Resourceinvestor.com says this is disturbing. “It seems that the movement by big oil to not replace reserves means that we are laying the groundwork for a price spike in the future. When oil companies fail to replace reserves, they almost always over compensate for short term drop in oil prices.”

However there are those who find it easier to produce cheap oil – and could do so with an eye less on immediate financial returns and more on long-term goals. Iran’s Oil Minister Bijan Zanganeh has bullishly told state news the country planned to continue upping production and export until it reaches the market position it held before the imposition of sanctions. That will further scupper the faltering deal between Saudi Arabia and Russia to put a hold on production levels.

That meeting is due in Doha later this month but analysts are not hopeful. “It’s not very strange to see a wave of profit-taking and some unwinding of long positions,” said ABN Amro’s chief energy economist, Hans van Cleef. He added ominously, “Some people are even saying they could reposition for a move towards lower prices.” All we can do is wait and watch.