A company can replace its oil and gas reserves by successful exploration and drilling, whereby formerly untapped deposits are added to productive capacity, or by outright purchase of proven reserves from another reserve owner. Since either method can be employed, measuring the costs to the company should account for both. One such measure that has been employed frequently within the oil and gas industry (see endnote 22) is termed reserve replacement costs. For a company, reserve replacement costs are measured by the ratio of expenditures (for unproved lease acquisitions, acquisition of proven reserves, exploration, and development) to barrels of oil and gas reserves (on a COE basis) added to the company's books (through extensions, discoveries, improved recovery, revisions of previous estimates, and purchase of proven reserves from other companies).

Since there can be lags between expenditures and associated reserve additions, reserve replacement costs are measured as three-year weighted averages. Reserve replacement costs are measured before tax effects. The overall effect of taxes on reserve replacement costs has been found to differ little between majors and nonmajors (see endnote 23). For the purposes of comparison, reserve replacement costs are computed for four categories of U.S. oil and gas producers: the majors (represented by the FRS companies), surviving independents (i.e., specialized companies that produced oil and/or gas in 1993), nonsurviving independents (i.e., specialized companies that produced U.S. oil and/or gas sometime prior to 1993 but did not exist in 1993), and other producers (refiners, pipelines, utilities, Canadian-based companies, and diversified companies).

In the 1990's, U.S. reserve replacement costs of the majors and surviving independents were nearly equal at about $5 per barrel of added reserves (in 1993 dollars) (Figure 9). Even in the late 1980's, reserve replacement costs of the two groups differed by only a few cents per barrel. Reserve replacement costs for independents that exited the industry were slightly higher at about the time of the oil price collapse. Thereafter, the costs for nonsurviving independents compared to surviving independents continued to grow, and by 1990-1992 were nearly $4 per barrel higher. Other producers (such as diversified companies) also incurred higher reserve replacement costs.

These results reinforce the view that the market forces to which U.S. oil and gas producers have been subject forced efficiency in resource development. That is, as the industry adjusted to the lower level of prices following the oil price collapse of the mid-1980's, the companies that competed successfully tended to incur lower costs of adding to their reserve bases than those companies that reduced or withdrew their asset commitments to U.S. oil and gas production.