What is the reserve-to-production ratio?
The reserve-to-production ratio is an estimate of the number of years that a natural resource site will continue to be productive at current production rates.
The ratio is used to predict many business factors such as the total income one can expect to derive from the source and the number of employees needed over its working life. It is also a key factor in determining whether further exploration is needed to identify new sources of natural resources.
The reserve-to-production ratio is often abbreviated as RPR or R/P.
Key points to remember
- The supply-to-production ratio measures the number of years a natural resource will last if consumption rates remain the same.
- It is calculated by dividing the amount of the reserve by the rate at which it is mined per year.
- The ratio is an estimate and cannot take into account new discoveries, technical advances and changing consumption patterns.
Understanding the reserve-to-production ratio
The reserves-to-production ratio is used to estimate the productive life of a particular site, such as an oil field. Alternatively, it can be used to project national or global availability of a natural resource.
The reserves-to-production ratio can be relevant to any business that relies on natural resources, whether it’s gravel or gold. However, it is mainly used in the oil and gas industry.
The ratio is derived from two numbers:
- The amount of a resource that is known to exist and that can be recovered from the measured site.
- The amount of production that the site is currently producing on an annual basis.
Divide the first number by the second and you get the number of years that today’s reserves would last if the rate of consumption did not change.
Defining natural resources
Natural resources are by definition Earth materials that are useful but available in finite quantities. Finding them becomes increasingly difficult and expensive until they are completely exhausted. The natural process of restoring them takes forever.
Meanwhile, we rely on them to feed us, get us from point A to point B, and build many of the things we rely on.
How investors read the ratio
If a resource-producing company has a low supply-to-production ratio, it usually signals that it is about to run out of material it relies on to make money.
Unless she locates more of this resource, she will go bankrupt.
Economists as well as investors calculate reserve-to-production ratios for entire nations. If Botswana were considered to have a low reserve-to-production ratio for its diamond industry, it would mean that the country lacks one of the natural resources that contribute most to its national economy.
Example of reserve-to-production ratio
The reserves-to-production ratio is commonly used to estimate how many years a company or country has in oil. If a country has 10 million barrels of proven oil reserves, for example, and produces 250,000 barrels per year, then the RPR, or reserve life, is 10,000,000 / 250,000 = 40 years.
In 2019, British oil company bp plc estimated that the world had about 1.73 trillion barrels of oil reserves, which would be enough to meet about 47 years of global production at 2019 consumption levels.
The reserve/production ratio is imperfect. Estimates from 40 years ago showed that the world still had 30 years of proven oil reserves, which means we should be out of it by now. Then, 20 years later, the revised ratio concluded that we had 40 years of this critical energy resource to extract.
The long-term unreliability of the reserves-to-production ratio can be attributed to several factors.
New sources of supply
Oil and gas explorers and other extractors are constantly identifying new natural resources to extract. These discoveries drastically change the ratio, extending the estimated time we have left before they run out.
New technologies can disrupt the ratio. Newer tools allow the extraction of oil that was previously considered unobtainable at practical cost. This effectively changed the number of global reserves and the value of the ratio.
Another example is 3D seismic imaging. This breakthrough technology helps scientists see miles below the seabed, identifying new proven reserves at sea.
Offshore drilling can reach a depth of 25,000 feet, a significant increase from the 5,000 foot limits of the 1950s.
Displacement of consumption
Another factor that the ratio does not take into account is the continuous increase request for natural resources as the world’s population grows and new economic powers emerge. As long as this trend continues, estimates of how many years we have left are likely to be overly generous.
At the same time, environmental concerns have led to a serious effort to find and develop alternative fuel sources. A lesser appetite for some dirtier raw materials should lead to a drop in their consumption rate, impacting production rates and, with them, current ratios.