What is the Reserve-Replacement Ratio
The reserve-replacement ratio is a metric used by investors to judge the operating performance of an oil and gas exploration and production company. The reserve-replacement ratio measures the amount of proved reserves added to a company's reserve base during the year relative to the amount of oil and gas produced. During stable demand condition environments a company's reserve-replacement ratio must be at least 100% for the company to stay in business long-term; otherwise, it will eventually run out of oil.
BREAKING DOWN Reserve-Replacement Ratio
The reserve-replacement ratio is just one method investors should use to get an accurate picture of how well an oil company is performing. The reserve-replacement ratio should only be looked at in the context of other operating metrics such as the reserve-life index, enterprise value to debt-adjusted cash flow ratio, enterprise value to daily production ratio, and total capital expenditure (CAPEX) spending. Capex spending is what an oil company expends to find and develop additional reserves. Capex spending varies from period to period and can be affected by new technologies, supply and demand, and the price of oil. A high reserve-replacement ratio achieved through organic replacement is considered better than a high reserve-replacement ratio achieved through purchasing proved reserves.