What Is the Reserves-to-Production Ratio?
The reserves-to-production ratio is an estimate of the number of years that the site of a natural resource will continue to be productive based on current production rates.
The ratio is used to forecast many business factors such as the total income that can be expected to be earned from the source and the number of employees needed over its active lifespan. It also is a key factor in determining whether further exploration is needed to identify new sources of the natural resource.
The reserves-to-production ratio is often abbreviated as RPR or R/P.
- The reserves-to-production ratio measures the number of years a natural resource will last if consumption rates stay the same.
- It is calculated by dividing the amount of the reserve by the rate at which it is extracted per year.
- Investors use the ratio to better understand when resources may run out.
- The ratio is an estimate and can't account for new discoveries, technical advances, and changing consumption patterns.
- For this reason, the reserves-to-production may widely swing from one period to another.
Understanding the Reserves-to-Production Ratio
The reserves-to-production ratio is used to estimate the productive life of a particular site, such as an oil field. Alternatively, it may be used to project national or global availability of a natural resource.
The reserves-to-production ratio can be relevant to any business that relies on natural resources, whether it is gravel or gold. However, it is primarily used in the oil and gas industry.
The ratio is derived from two numbers:
- The amount of a resource that is known to exist and that can feasibly be retrieved in the site being measured.
- The amount of production that the site is currently yielding on an annual basis.
Divide the first number by the second number and you get the number of years that today's reserves would last if the rate of consumption doesn’t change.
Defining Natural Resources
Natural resources by definition are materials from the Earth that are useful but are available in finite quantities. Finding them gets steadily more difficult and more expensive until they are tapped out completely. The natural process of restoring them takes eons.
Meanwhile, we are relying on them to feed us, get us from point A to point B, and build many of the things that we have come to rely upon.
How Investors Read the Ratio
If a company that is in the business of producing resources has a low reserves-to-production ratio it generally signals that it is about to run out of the material it relies on to make money. Unless it locates more of that resource, it will be out of business.
Economists as well as investors calculate reserves-to-production ratios for whole nations. If Botswana was seen as having a low reserves-to-production ratio for its diamond industry, it would mean that the nation is running short on one of the natural resources that contribute most to its national economy.
Example of Reserves-to-Production Ratio
The reserves-to-production ratio is commonly used to estimate how many years' worth of oil a company or a country has. If a country has 10 million barrels of proven oil reserves, for example, and is producing 250,000 barrels a year, then the RPR, or life of the reserves, is 10,000,000 / 250,000 = 40 years.
According to Oil & Gas Journal, the world's proven oil reserves were just under 1.8 billion barrels of crude oil.
The reserves-to-production ratio may be flawed as it requires estimates that may not prove to be fact. For example, pretend an estimate from 40 years ago showed the world as having 30 years of proven oil reserves left (meaning we should have run out by now). Then, 20 years later, a revised ratio could conclude that we had 40 years of this critical energy resource left to extract. Because the estimated number of barrels is simply a guess, the reverses-to-production ratio is subject to broad swings.
The lack of long-term reliability of the reserves-to-production ratio can be attributed to several factors.
New Supply Sources
Oil and gas explorers and other extractors are constantly identifying new natural resources to dig up. These discoveries dramatically change the ratio, prolonging the estimated time we have left before they run out.
New technology can throw the ratio out of whack. Newer tools allow the extraction of oil that was previously considered impossible to get at a practical cost. That effectively changed the global reserves number and the value of the ratio.
Another example is 3D seismic imaging. This technology breakthrough helps scientists see miles below the seabed floor, identifying newly proven reserves at sea.
Offshore drilling can reach a depth of 25,000 feet, a significant increase from the 5,000 feet limits of the 1950s.
Another factor that the ratio fails to account for is the continually increasing demand for natural resources as the global population grows and new economic powerhouses emerge. As long as that trend continues, estimates of how much we have left in terms of years are likely to be overly generous.
At the same time, concerns about the environment have led to an earnest effort to find and develop alternative fuel sources. Less appetite for some dirtier raw materials should lead their consumption rates to drop, impacting production rates and, with them, current ratios.
Is a High Reserves-to-Production Ratio Good?
In general, a high ratio indicates that reserves may be substantially high, meaning there is a long runway to extract assets. For individuals or countries concerned about future production, a high ratio is favorable.
On the other hand, a high ratio may be an indicator of low production. In this case, a high ratio is unfavorable as it may be signaling longer-term problems relating to the demand for energy or economic growth.
Who Are the Top Oil Producing Countries?
In 2021, the top five crude oil producers in the world were the United States, Russia, Saudi Arabia, Canada, and Iraq. In 2021, these five countries accounted for roughly half of the world's total crude oil production.
How Many Barrels of Oil Does the U.S. Produce Each Day?
The United States usually produces an average of over 11 million barrels per day of crude oil. In 2020, the U.S. averaged 11.2 million barrels per day, with this figure increasing to 11.6 million in 2021. The U.S. Energy Information Agency noted this increase was due to higher demand for crude oil and higher investments/implementations of mining rigs.
The Bottom Line
The reserves-to-production ratio is a measurement of how many years of natural resources are left in reserves. Investors can use this information to better understand the long-term implications of what assets are on hand for a company. Though the reserves-to-production ratio can provide long-term insights, it is also limited by shifting technologies, unpredictable demand, and reliance on estimates.