David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Shareholders relieved that Woodside Petroleum has canceled its $40 billion Browse liquefied natural gas project should keep an eye on how it's spending the rest of their money.

The Australian company's reserve replacement costs are the highest of any oil company with more than $5 billion of annual revenue, according to data compiled by Bloomberg. Its $3.7 billion acquisition of stakes in the Wheatstone and Kitimat LNG projects from Apache last year lifted its replacement costs to $104 per barrel of oil equivalent. Oil hasn't been at those levels in more than 18 months, and Brent crude traded at about $41.35 Wednesday.

Spending a Lot To Get a Little
Reserve replacement costs of major oil companies, $/barrel
Source: Bloomberg data

Such deals may be pricey, but they have to be done. An oil company that doesn't replenish reserves will eventually see its wells run dry, and levels in Woodside's gas tank have been trending down for a decade now. In the absence of organic growth from exploration, petroleum companies have to buy other people's discoveries instead.

Life Expectancy
Woodside's average reserve life has been trending downwards for a decade
Source: Bloomberg data

Now is probably not as good a time to go shopping as you'd think. While the S&P 500's sub-index of oil explorers and producers hit its lowest level since 2009 last month, forecast earnings have fallen even further and debt isn't going away. As a result, the enterprise value of the index is near a record high relative to expected profits:

Poor Value
The enterprise value of the S&P 500 exploration and production sub-index looks too rich
Source: Bloomberg data

Still, there are gems to be had even in a rough market, and canceling Browse -- a remote, deepwater resource with high carbon-dioxide content and huge capital costs -- gives Woodside some firepower.

What options are out there? Top of the list must be Oil Search, the Papua New Guinea-based company that's developed the country's largest LNG project with Exxon Mobil. Woodside offered some $8 billion for the business in September but was rebuffed, and walked away in December without seeking to improve the bid. Despite all the gyrations in the oil market since then, Oil Search has ultimately traded sideways, down just 0.5 percent since the eve of Woodside's proposal. 

Papua New Guinea is the most obvious location for Woodside to be looking due to its ``abundant gas resources and low development costs", Neil Beveridge, an analyst at Sanford C. Bernstein in Hong Kong, wrote in a note to clients Wednesday. InterOil, which is developing the country's Elk-Antelope LNG export project with Total, would be another option, Beveridge said.

Closer to home, there's even Santos, which shipped its first LNG cargoes from the Australian port of Gladstone last October and fended off a takeover bid from a consortium of Middle Eastern and Asian investors while Woodside was still looking at Oil Search. Its shares have fallen 17 percent since that bid was lodged and, measured by the implied cost of its petroleum reserves, the company is one of the cheapest players on the Australian equities market.

Cheap Gas
Implied valuation of oil and gas reserves in Australian-listed exploration and production companies
Source: Bloomberg data
Note: Calculated by dividing share price by barrels of oil equivalent-per share measure.

Much though such deals may excite M&A bankers, Chief Executive Officer Peter Coleman doesn't sound in the mood for anything so ambitious. The company has ``headroom" now that Browse has been canceled, and low prices will drive companies with weak cash flows to part with their assets to stave off creditors, he told Bloomberg News Wednesday. Such small acquisitions are likely to be the order of the day, he said.

Coleman had better get a move on. Those declining reserves won't replace themselves, and petroleum companies are like sharks. If they don't keep moving forward, they'll die.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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David Fickling in Sydney at

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