Exploration vs. acquisition of oil and gas reserves: Effect on stock returns

Abstract

This paper examines how oil and gas companies’ reserves growth affects their share price returns. In particular we examine three issues affecting the relation between reserves changes and oil and gas firm returns. First, we examine if investors value reserves replacement as a result of exploration activities differently to reserves growth through acquisitions. In the second analysis, we test if reserves replacement of oil reserves impacts stock returns differently than changes in gas reserves do. Third, we examine the impact of the Shale gas revolution and the subsequent oil and gas price divergence on the association between returns and replacement of oil versus gas reserves. The results suggest that investors seem to be indifferent to reserves replacement strategy (exploration or acquisition). However, we find that changes in oil reserves impact oil and gas company returns differently than changes in gas reserves does. Moreover, we find that there has been a structural shift in the relation between returns and changes in gas reserves (but not changes in oil reserves) after 2008, coinciding with the Shale gas revolution and the break in the oil-gas price link. This latter result can be relevant for understanding the impact of the recent fall in oil prices on investor valuation of oil and gas reserves.

Keywords:

• oil and gas reserves
• reserves replacement
• stock returns
• acquisition
• oil company
• oil and gas company
• exploration

Public Interest Statement

Oil and gas reserves are the most important assets that oil and gas companies have, and represent their main source of revenues. The main objective of holding petroleum reserves is to generate future cash flows when they are extracted from oil and gas reservoirs and subsequently monetized. Replacing reserves as they are produced is crucial for the sustainability of their business model, and therefore an aspect of the industry that is followed closely by financial markets. Oil companies can pursue two main strategies for reserves replacement. They can either engage in risky exploration activities or purchase reserves from other agents. An interesting research question is how additions from organic growth through discoveries compare to reserve replacement through acquisition activities in terms of effects on security returns. On a risk-adjusted basis, an investor should be indifferent between organic growth and acquisitions. In this study, we address this issue and empirically examine if this is the case.

Notes

1. Royal Dutch Shell plc announced that they downgraded their reserves from proved to probable.

2. There is also a strand of research in the literature that investigate the impact on oil company valuation multiples from fundamentals such as profitability and operational information on reserves and production (see e.g. Asche & Misund, 2016; Misund, 2016, 2017; Osmundsen, Asche, Misund, & Mohn, 2006; Osmundsen, Mohn, Misund, & Asche, 2007; Quirin, Berry, & O’Bryan, 2000).

3. It is worth noting that Kretzschmar and Kirchner (2009) and Misund, Mohn, and Sikveland (2017) examine additional risk factors such as geographical location of oil and gas reserves, as well as exploration risks.

4. The momentum effect was originally identified by Jegadeesh and Titman (1993).

Additional information

Notes on contributors

Bård Misund

Bård Misund is an associate professor of Accounting and Finance at UiS Business School at the University of Stavanger. He has more than 10 years of industry experience from commodities companies. Before joining academia, he worked as an economic analyst, and later as an advisor to the Norwegian oil and gas company Statoil ASA.

His research covers several fields including accounting, finance, and economics, mostly covering topics related to commodity markets. Misund’s research interests include commodity price behavior, volatility transmission, the relationship between spot and futures prices, price formation in spot and futures markets, determinants of commodity firm stock returns, financial statement analysis, and valuation of oil and gas firms. He has published more than 25 papers in international peer-reviewed journals in economics, finance, and accounting.