Experience RS

Calculating Base Decline and Capital Efficiency

Capital efficiency is the amount spent to add an additional barrel a day of production to a company’s annual exit production. The lower the capital efficiency (lower costs), the better. It is calculated as:

Capital Efficiency = Capital Expenditures / Production Additions

Capital efficiency helps us look across a range of operators by benchmarking – Who’s efficient? Who’s not? – but also at individual operators. Using company-disclosed guidance, we can calculate an implied capital efficiency for the year. Comparing implied capital efficiency to what the company historically achieved indicates whether the guidance is realistic. Typically, this has been a revealing metric to help predict guidance revisions. 

This blog post will break down the components that make up capital efficiency, particularly production additions.

What are production additions? Let’s start with walking through Figure 1. It depicts production of a company through time, with each wedge representing the production of wells brought on in that year. Left of the black line shows historical production, while our forecast of production as the wells decline through time appears on the right.
 

FIGURE 1 | Typical RSEG Chart Showing Historical and Projected Production

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Suppose we are forecasting production for year three. We enter the year with production at point A – the same as production exiting year two – and we exit year three with production at point B. This is called exit production. Point C is the exit rate that would occur if no new wells were drilled during the 12 months.

An operator’s annual production is made up of two parts: production from existing wells (orange, pink, and gray wedges) and production from new wells (green) brought on that year. Production from new wells is added to the runway of existing, declining production to determine a firm’s exit rate. This is why base decline is so important: the steeper the decline, the more production will need to be added to just stay flat.

So, how does base decline tie back to capital efficiency? Recall the equation at the beginning of this piece with production additions as the denominator. Declines impact production additions, so operators with steep declines either require large capital programs or excellent capital efficiencies to grow.

Base declines and capital efficiency can also be used to explain growth and first-year capital returned as well as to calculate current production value (RSEG’s modified valuation of proved developed producing reserves). To learn more about our work on these subjects, contact marketing@rseg.com for more information about our Sept. 25 webinar on this topic or visit www.rseg.com/about/contact.


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