Despite OPEC’s production cuts, crude oil prices are still hovering just below $50/bbl, and there are certainly no guarantees that they won’t fall back to $40 or lower (at least for a while). So the survival of many exploration and production companies continues to depend on razor-thin margins, meaning that E&Ps need to trim their capital and operating costs to the bone. Lease operating expenses—the costs incurred by an operator to keep production flowing after the initial cost of drilling and completion—are a go-to cost component in assessing the financial health of an E&P. But there’s a lot more to LOEs than meets the eye, and understanding them in detail is as important now as ever. Today we continue our series on the little-explored but important topic of lease operating expenses.
As we have noted in Been Down So Long, You Go Your Way, I’ll Go Mine, and Different Strokes by Different Folks, there has been a sharp decline in E&P capital spending over the past two years. But the decline in production during 2016 was nowhere near the magnitude of the capital-spending cut, and over the past few months U.S. production has been on the upswing. That’s in part because producers have improved their economics through enhancements in drilling and completion (D&C) efficiencies and a focus on production “sweet spots”. This has allowed many E&Ps to survive—and even thrive—during this period of lower prices (see Top 10 RBN Energy Prognostications for 2017, #8).
But capital spending is only one part of the story on costs. LOEs also play an essential role when it comes to assessing an E&P’s overall financial health. In Part 1 of this blog series, we covered the basics of what LOEs are (what’s in the LOEs “basket”), why they matter, and why reported LOEs should never be taken at face value. We also provided a clear definition of LOEs to guide us through the process of determining what should and shouldn’t be included in LOEs:
Lease operating expenses are the direct and indirect costs incurred to maintain the production of a well on the path (trajectory along decline curve) consistent with the capital investment history of the well.