What Is a Recycle Ratio?
A recycle ratio is a key profitability measure of the oil and gas industry. The ratio is calculated by dividing the profit per barrel of oil by the cost of finding and developing that barrel of oil. The profit per barrel is known in industry terminology as "netback," and finding and development costs are abbreviated to "F&D." The higher the ratio, the better, with a sustained ratio over 1x a necessary condition for an oil and gas producer to stay in business.
- A recycle ratio is a profitability ratio that measures the profit per barrel of oil to the cost of finding and developing that barrel of oil.
- The profit per barrel is known as "netback" whereas the cost of finding and developing it is known as "F&D" or "FD&A" when costs of acquisition are added.
- The recycle ratio for an energy company should be at 1x or above for it to remain in business.
- Recycle ratios are provided for internal and external analysis but netback and FD costs are not accounting measures under International Financial Reporting Standards (IFRS) or generally accepted accounting principles (GAAP).
Understanding a Recycle Ratio
Netback, or operating netback (to be more precise), is equivalent to revenues minus production expenses, transportation expenses, and royalties on a per barrel of oil equivalent (BOE) basis. Finding and development costs in their most basic form are equivalent to exploration and development costs per BOE of proved reserves added during the year. FD&A, another number often reported in conjunction with F&D, adds costs of acquisition.
The F&D number indicates whether an oil and gas company is adding reserves at a low or reasonable cost. If an energy firm generates an operating netback of $50 per barrel and its F&D costs were $25 per barrel, its recycle ratio would be 2x.
Both netback and F&D costs are non-International Financial Reporting Standards (IFRS) and non-generally accepted accounting principles (GAAP) measures given mainly by Canadian producers and some U.S. producers to provide investors and analysts information to assess their profitability per barrel relative to the field cost of replacing that barrel. The recycle ratios are tracked through cycles and used for peer comparisons.
Oil and gas companies have control only in certain components of the recycle ratio. For example, the price at which they sell a barrel of oil is for the most part out of their hands as they cannot control oil prices. An oil and gas company can control its costs of finding and developing oil, such as providing accurate information to geologists, reducing frack stages, and implementing more consistent well-to-well placement.
The recycle ratio is subject to variations to the simplified version above. Canadian Natural Resources Limited reported 2018 recycle ratios of 8.7x and 11.8x for proved reserves and proved plus probable reserves. The denominator was FD&A, excluding changes in future development costs (FDC).
Added to the set of recycle ratios was FD&A including the change in FDC. With FDC changes, the recycle ratios were 2.9x for proved reserves and 2.5x for proved plus probable reserves. This shows that there may be numerous recycle ratios in the industry. To make performance comparisons across these oil and gas companies, it is essential that the components for the ratio are identical.