Evaluating the exploration efficiency of oil and gas firms using SFAS 69 supplemental disclosures

Abstract

Investors and other users of financial statements often analyze financial statement information to evaluate the exploration efficiency of oil and gas firms. One approach commonly employed is to calculate an average per-unit cost of finding and developing oil and gas reserves using data disclosed by oil and gas firms in the footnotes to their financial statements. These average finding costs ratios, while widely used, are by no means universally accepted as providing meaningful insight into the exploration efficiency and potential profitability of an oil and gas firm. In fact, a number of financial analysts who specialize in oil and gas firms have argued that these finding costs ratios in fact provide no useful insights into how well a company has done. The purpose of our paper is to evaluate the usefulness of these finding costs measures as indicators of exploration efficiency and potential profitability. Our approach involves comparing the statistical association between various finding costs measures to a benchmark measure of exploration efficiency derived from a Cobb-Douglas regression. We also compare these finding costs measures to two commonly used financial statement measures of profitability—return on sales and return on assets—to evaluate whether finding costs are useful as indicators of profitability. Our results indicate that finding costs ratios calculated from readily available financial statement data provide useful insight into both exploration efficiency and the potential profitability of an oil and gas firm. Our findings are important because they provide empirical evidence useful in resolving a debate within the financial analyst community concerning the utility of these finding costs ratios.