With today’s low crude oil and natural gas prices, the survival of exploration and production companies depends on razor-thin margins. Lease operating expenses––the costs incurred by an operator to keep production flowing after the initial cost of drilling and completing a well have been incurred––are a go-to variable in assessing the financial health of E&Ps. But it’s not enough for investors and analysts to pull LOE line items from Securities and Exchange Commission filings to find the lowest cost producers, plays, or basins. More than ever we need to understand—really, truly, deeply—what LOEs are, why they matter, how they change with commodity prices, production volumes, and other factors, and how we should use them when comparing players and plays. Today we begin a series on a little-explored but important factor in assessing oil and gas production costs.
The slump in crude oil prices that started nearly two and a half years ago––and natural gas prices that, by and large, have remained lower than many had hoped––have put additional financial strain on many types of companies within the energy sector, E&Ps chief among them. Still, there’s been remarkable resilience; despite oil prices below $50/bbl and natural gas prices well south of $3/MMBtu, many E&Ps have significantly improved their drilling, completion and operating efficiencies; slashed their costs; divested properties with higher costs and focused on those with lower costs, all with the aim of surviving––even thriving––in tough times. In our ongoing analysis of upstream capital spending production trends (Been Down So Long; You Go Your Way, I’ll Go Mine; and Different Strokes by Different Folks) we’ve noted that while capital spending at most E&Ps is down sharply from where it was a couple of years ago, there’s been a new sense of optimism that by improving efficiencies, cutting costs and zeroing in on the very best production areas that an E&P can make a go of it even in an era of low oil and gas prices.
A key metric in assessing how well (or how poorly) E&Ps are doing on the cost side of the ledger is LOEs, which as we said are the costs incurred by an operator to keep production flowing after the initial cost of drilling and completing a well have been incurred. What’s included in the LOE “basket”? For one thing, the costs associated with employees known as “pumpers,” “well tenders,” or “lease operators,” who regularly monitor and maintain onshore wells. Their wages, vehicle expenses, gasoline costs, and any other expenses they have for items they use while tending to the wells (such as methanol for de-icing) are all LOEs. Other LOE elements come from operating and maintaining the on-site production equipment used to keep wells flowing and to process the hydrocarbons they produce so that they will be in a form suitable for transportation away from the lease. However, not all well costs are included in the LOE basket. For example, the initial cost to purchase and install the equipment is capitalized as part of the “producing property,” but the expenses for fuel used to power and maintain equipment at the lease site are included among LOEs.