A pump jack sits in an oil field in Texas on January 21, 2016. Introduction and summary As of 2017, nearly 26 million acres of federal land were under lease to oil and gas developers in the United States. But according to the Bureau of Land Management (BLM), which oversees the federal government’s onshore subsurface mineral estate, not all of these leases are poised for future production. In fact, in 2017, less than half of the nearly 26 million acres were producing any oil and gas. 3 But why would developers invest in acquiring these leases if only to sit idly on reserves and stall production? Companies point to a variety of possible factors that contribute to this stay in production on federal land: uncertainty in subsurface mineral deposits, shifts in commodity prices, high exploration costs, and the perception of endless government red tape that the industry blames for delays in development. […]
But some public land advocates and lawmakers have suggested there might exist a more perverse incentive for companies to sit on undeveloped federal land.5 Once a company acquires a lease, it then carries those subsurface reserves as assets on its balance sheet. By doing this, a company can immediately improve its overall financial health, boost its attractiveness to shareholders and investors, and even increase its ability to borrow on favorable terms. While industry leaders have suggested it was “absurd” to think companies would continue to shell out millions of dollars in rental fees and lease acquisitions solely to pad their balance sheets,6 the relatively low cost of federal land nonetheless provides a strong incentive for companies to do just that. Because of this, companies have the potential to directly benefit from amassing these undeveloped reserves through federal land leases, while the U.S. taxpayer loses out on revenue that could—and should—be generated from wells actually producing oil and gas products. Meanwhile, these undeveloped leases tie up land that the federal government would otherwise manage for conservation, recreation, or other beneficial uses as required under the BLM’s multiple-use mandate.
This report explores these possible financial motivations for oil and gas companies to acquire and hold undeveloped federal leases as a means to bolster their bottom line and improve their financial health. By analyzing financial reports for publicly traded oil and gas companies from 2006 through 2017, the author determined that changes in Securities and Exchange Commission (SEC) reporting policies have allowed oil and gas companies to increase their booked reserves over time. This is thanks to an expansion of acceptable reporting standards for proved undeveloped (PUD) reserves—assets that have yet to be drilled for production. While the impact of acquiring PUD reserves on a company’s valuation or stock returns has been downplayed by some industry analysts who point to the high exploration and development costs for moving these undeveloped reserves to market,7 this report shows that booked undeveloped reserves do serve as a statistically reliable indicator of a company’s overall market value. In fact, immediately following the 2008 change in SEC reporting standards, the companies included in this study saw a marked increase in their booked PUD reserve levels and yet another increase in the correlation between these PUD reserves and overall market value. Though the global drop in oil prices in 2014 saw this trend reverse temporarily, the recent market rebound has resulted in a return to these high correlation measures between undeveloped reserves and market valuation. Overall, the author’s results suggest that this link provides adequate incentive for oil and gas companies to acquire federal leases with the purpose of increasing their booked reserves and bolstering their overall financial health, rather than bringing those leases into production.
Researching oil and gas financial reporting
While there has been no shortage of research and studies from the federal perspective examining the current trends in oil and gas leasing practices, little understanding or analysis exists that explores the industry side of this equation. This gap in current oil and gas analysis is almost certainly due to two major research obstacles: the lack of financial data available for companies that are not publicly traded and the wide diversity of businesses within the oil and gas industry. Financial accounting in the commodities market is a complex system that must account for a wide variety of external variables, including different valuation methods and guidance for companies depending on their business models and risk management strategies. All of this is to say that reporting on the financial incentives at play in acquiring federal land leases presents an array of challenges—not all of which are addressed within this report. Importantly, this report does not distinguish between upstream, or exploration and production (E&P), companies and fully integrated conglomerates. While reserve levels and reporting play an integral role in determining the fair market valuation of companies that fall into both these categories, integrated companies have far more external variables that could affect their total market capitalization or share price. This report does not include midstream and downstream companies, though reserve levels could potentially affect their business practices as well.
What is explored here are three primary scenarios under which a company may have sufficient financial incentives to acquire federal land leases as a means to increase reserves on their balance sheet. The first scenario is when a company benefits financially—either in the form of a rise in stock price value or market capitalization8—by increasing their booked undeveloped reserves, or those reserves reported on annually either publicly or to a company’s shareholders and investors. The second scenario is when companies pursue potential acquisition or merger options with another company. In this situation, the theory suggests that companies could obtain a higher acquisition price by demonstrating a high value of undeveloped reserves on their balance sheet. Finally, the author explores the practice of reserves-based lending to understand the degree to which undeveloped acreage can better position companies to ensure more favorable lending terms on long-term loans.
Not all of these scenarios apply to companies equally—each depends on the size, financial health, and business model of a particular entity. That said, all of these possible outcomes could provide companies—regardless of size—with sufficient incentive to acquire federal land in the hopes of bolstering their bottom line and pulling in additional investment.