Finding and Development Costs (F&D Costs)

Finding and Development Costs (or F&D Costs) is a crucial performance metric used primarily in the Oil and Gas industry. Think of it as the price tag for restocking the shelves. Oil and gas companies are in the business of finding, extracting, and selling a finite resource. Every barrel they sell depletes their inventory. F&D costs measure how much money an exploration and production (E&P) company spends to add one new barrel of oil (or equivalent in natural gas) to its proven reserves. These costs include everything from geological surveys and exploratory drilling (the 'finding' part) to drilling production wells and building the necessary infrastructure to get the oil out of the ground (the 'development' part). A lower F&D cost is a sign of efficiency and a powerful indicator of a company's long-term health and profitability.

For an E&P company, its reserves are its lifeblood. Without finding new sources of oil and gas to replace what's being produced and sold, the company will eventually run out of business. F&D costs cut right to the heart of this challenge, telling you how effectively and economically a company is managing its core business. Imagine two corner stores. Both sell a can of soda for $1. Store A gets its cans from a wholesaler for $0.30 each, while Store B, due to poor logistics, pays $0.60. It’s obvious which store is the better business. In the oil patch, F&D costs are that wholesale price. A company with a consistently low F&D cost per barrel has a massive Competitive Moat. It can weather downturns in commodity prices better than its rivals and generate far superior profits when prices are high. Conversely, a company with rising F&D costs is a red flag; it may be struggling to find new oil, operating in high-cost regions, or simply being managed inefficiently.

While the concept is straightforward, the calculation requires a bit of detective work in a company's financial statements.

The most common way to calculate F&D costs is on a per-unit basis, typically per Barrel of Oil Equivalent (BOE), which standardizes oil and natural gas into a single unit. The simplified formula is:

• F&D Cost per BOE = Total Exploration & Development Costs / Total Proved Reserves Added

You can find the “Total Exploration & Development Costs” in the company's financial reports, often detailed within the discussion of Capital Expenditures (CapEx). The “Total Proved Reserves Added” is found in the supplemental oil and gas information, usually tucked away in the footnotes of the Annual Report (10-K).

• Use a Multi-Year Average: Oil and gas exploration is lumpy. A company might spend heavily for two years before a huge discovery is officially booked in the third year. This would make the first two years look terribly inefficient and the third year look miraculous. To smooth this out, analysts almost always use a three-year rolling average for both costs and reserve additions.
• All-in Costs: The basic formula looks at organic growth. However, companies also add reserves by acquiring other companies. A more comprehensive metric, sometimes called “full-cycle cost,” includes the cost of acquisitions. A company might look great on organic F&D but be overpaying massively for acquisitions.
• Revisions Matter: Reserves aren't just added; they can also be revised up or down based on new data or changes in commodity prices. A company that consistently has large upward revisions is likely employing conservative and high-quality geological analysis—a very good sign.

For a value investor, F&D cost isn't just a number; it's a window into the quality of the business and its management.

Consistently low F&D costs are a hallmark of a disciplined and skilled management team. It shows they are excellent capital allocators, selecting the best projects and executing them efficiently. They aren't just throwing money at any hole in the ground; they are making smart, high-return investments with shareholder money.

The core of Value Investing is buying assets for less than their intrinsic value, creating a Margin of Safety. For an E&P company, the margin is created between the cost to get a barrel of oil out of the ground and the price it sells for. F&D is the largest and most important part of that cost. Let's say Company X has a three-year average F&D cost of $15 per barrel and its production cost is $10 per barrel. Its total “all-in” cost is $25.

• If oil is trading at $80, the company is printing money.
• If oil crashes to $30, the company can still survive and even make a small profit.

Now consider Company Y, with an F&D cost of $30 and the same production cost, for a total of $40. At $30 oil, this company is losing money on every new barrel it develops, putting its survival at risk. The value investor will always favor Company X for its superior resilience and long-term earning power. When analyzing an E&P company, comparing its F&D cost to the price of the underlying commodity is one of the most powerful analytical tools you have.