Finding and Development (F&D) Costs are a crucial performance metric used primarily in the `Oil and Gas Industry`. Think of an oil company like a tub of water with the drain constantly open; the oil it sells is flowing out, and it must find and add new water (oil reserves) just to keep the level from dropping. F&D cost is the price tag on refilling the tub. It measures the total cost an `Upstream` (exploration and production) company spends to add one new `barrel of oil equivalent (BOE)` to its inventory of `proved reserves`. This isn't just the cost of a single drill bit; it encompasses all `capital expenditures (CapEx)` on exploration activities—like seismic surveys and exploratory drilling—and development activities, which involve drilling production wells and building the infrastructure to get the oil or gas out of the ground. In essence, it's the all-in cost of replacing the reserves the company produces each year. A low and stable F&D cost is the hallmark of an efficient, well-run oil and gas operator.
For a `value investing` enthusiast, F&D cost is more than just industry jargon; it’s a window into a company's operational excellence and long-term viability. Since oil and gas are finite resources, a company's ability to replace them cheaply is fundamental to its survival and profitability.
A low F&D cost is a powerful indicator of a company's competitive advantage, or `moat`. A company that can replenish its reserves for $10 per barrel while its competitors are spending $20 has a massive structural advantage. This efficiency translates directly into higher potential profit margins, stronger `free cash flow`, and a superior `Return on Capital Employed (ROCE)`. It tells you whether management is skilled at finding valuable assets (`geological expertise`) and developing them cost-effectively (`project management skill`). A company that consistently posts industry-leading F&D costs is demonstrating a durable skill that is difficult for rivals to replicate.
It's crucial not to judge a company based on a single year's F&D cost. The figure can be notoriously “lumpy.” A company might spend heavily on exploration for several years with little to show for it, and then make one giant, low-cost discovery that makes the F&D cost for that year look spectacularly low. Conversely, a year with high spending but no major discoveries can make an excellent operator look inefficient. The smart investor smooths out this volatility by looking at a 3-year or 5-year rolling average. This approach provides a much clearer picture of the company's true, underlying efficiency and helps you spot a genuine trend rather than reacting to a one-off event.
While the concept is straightforward, the calculation can have its nuances. The basic formula is: F&D Cost = Total Exploration & Development Costs / Total New Reserves Added Let's break down the two parts.
This is the total capital spent on finding and developing new reserves within a period. It primarily includes:
Some companies also include the cost of buying reserves from other companies (`acquisition costs`) in their calculation. This creates a different metric, often called “Finding, Development, and Acquisition (FD&A) Cost.” It's vital to read the company's annual report to understand exactly what is included in their reported figure.
This is the total volume of new proved reserves added during the year, measured in BOE. These additions come from three sources:
This number is closely related to another key metric, the `Reserve Replacement Ratio (RRR)`, which measures if a company is adding more reserves than it produces.
When analyzing a company's F&D costs, keep these practical points in mind: