Recoverable Reserves

Definition

The term recoverable reserves is used in the natural resource industry to describe assets considered economically and technically feasible to extract.  The process of estimating recoverable reserves relies on the expertise of subject matter experts, and estimates will change as processes become more sophisticated.

Explanation

The term recoverable reserves is associated with assets that are considered natural resources.  This includes timber, mineral ores, oil and natural gas deposits.  Unlike assets such as property, plant and equipment, which are depreciated, natural resources are subject to depletion.  The capitalized costs associated with assets that are natural resource, falls into three categories: acquisition, exploration and development.

Recoverable reserves are those natural resources that are economically and technically practicable to extract or harvest.  Once valued, these reserves are reduced on the balance sheet using a contra asset account known as accumulated depletion.

Oftentimes, the estimate of recoverable reserves will change as new technologies are developed, processes are improved, or the value of the natural resource changes the profitability of an extraction process.  When an estimate changes, companies must revise the depletion rate on a prospective basis.

Example

Company A paid $100,000,000 to obtain rights to natural gas reserves held within the Marcellus Shale region.  The rights to these natural gas reserves are expected to have a residual value of $1,000,000.  Exploration and development costs were $10,000,000, and the original estimate of extractable reserves was 1 billion cubic feet of natural gas.

Company A expects to extract 50,000,000 cubic feet of natural gas from the ground annually.  The depletion expense per unit for Company A was originally calculated to be:

= ($100,000,000 + $10,000,000 - $1,000,000) / 1,000,000,000
= $109,000,000 / 1,000,000,000, or $0.109 per unit

And the depletion expense for Company A was:

= $0.109 per unit x 50,000,000 units, or $5,450,000

New fracturing technology allows Company A to extract 2 billion cubic feet of natural gas from the original reserves.  Company A also expects to extract 100,000,000 cubic feet of natural gas annually.  The new depletion expense for Company A is:

= ($100,000,000 + $10,000,000 - $1,000,000) / 2,000,000,000
= $109,000,000 / 2,000,000,000, or $0.0545 per unit

The depletion expense for Company A is now:

= $0.0545 per unit x 100,000,000 units, or $5,450,000

Related Terms

assets, depreciation expense, amortization, depletion expense, discovery value accounting, depletion base