How do you value an oil and gas company? Finding and development costs are critical.

New Orleans-headquartered Global Hunter Securities recently released its 2011 Finding and Development Cost Study of 100 of the largest domestic public companies. Senior analyst Michael Bodino says the firm's mantra is to focus on PV-I, or the amount of present value added per dollar of investment.

"It levels the playing field," he says. "Over time, the correlation with equity returns is very high."

The study found drillbit and acquisition costs on both absolute and per-unit bases are edging upward. Also, future production and development costs per unit (barrel of oil equivalent, or BOE) rose substantially from 2009 to 2010. The average 2010 commodity pricing was $75.38 for West Texas Intermediate and $4.43 for gas at Henry Hub.

Oil reserve growth will soon surpass gas reserve growth. Surveying the equivalent of 91 billion barrels of oil equivalent, Bodino notes the flat oil reserve growth of the past five years versus gas is beginning to flip flop. "As the acreage capture period of the gas cycle recedes, companies are moving to capture acreage and resources on the oil side. We are also seeing a continued divergence between costs on the oil and gas sides."

The group's average drillbit F&D cost is on the rise. It was $29.17 per BOE in 2008, fell to $13.02 in 2009, but surged to $18.27 this past year—mirroring 2006's $18.32. The five companies with the lowest drillbit F&D cost in 2010 were NGAS Resources Inc. ($1.08); Panhandle Oil & Gas Inc. ($1.82), EQT Corp. ($2.81), Exco Resources Inc. ($3.22) and Carrizo Oil & Gas Inc. ($3.55).

"We expect 2011 to look more like 2007, particularly with the shift to drilling for oil, which is more expensive than gas," says Bodino.

"What will be really interesting to see as a general trend is how bad the numbers will look this year. With capital spending, the bang for the buck will not be as robust in the next couple of years.

"On unconventional oil projects, the number that keeps coming up is $30 per BOE to find and develop. In 2008 it was $22, including acreage and drilling costs; last year it was $17, so it's on the rise, and dollars aren't going as far. We're getting back to the 2007-2008 squeeze in returns on the lower-margin-type projects."

On a per-BOE basis, with all-sources F&D costs of $17.05, future production costs of $15.83 and future development costs of $15.74, at least $32 per BOE is spent on each unit of reserves, on average. Given the average cash flow per unit of $29.12 per BOE, a fully-loaded margin of just $12.07 is generated once subtracting the all-sources F&D cost.

"It certainly highlights how difficult this business is and the need for high commodity prices for energy producers to be self-sufficient," he says.

"Looking at severance and ad valorem taxes and other costs for future production, the cost is moving into the range of $18 to $20, so you're throwing another $20 on top of that $30. When you look at reserve data, the notable thing is it doesn't include corporate costs—there's no G&A, no interest or cost of capital or return on capital, or corporate taxes. There are other costs sitting out there. Smaller companies don't have the reserves to amortize those costs.

"That's why we've seen a movement of the large, multinational companies into the unconventional resource plays. They don't have to make the incremental overhead additions; and they have a lower cost of capital."

Winners in the five-year full-cycle returns group are independent oil companies like Concho, Continental, Brigham, and Whiting Petroleum, says Bodino. "The other group that's done well in full-cycle returns is the E&P MLPs. These are companies—like Legacy, Linn Energy, EnerVest—that were aggregating oil properties when prices were lower, when everyone else was chasing gas."

All-sources F&D costs for the industry, which peaked in 2008 at $25.92 per BOE and then dropped to $12.18 per BOE in 2009, rebounded to $17.05 in 2010, just ahead of 2006 levels of $16.76. Companies with the lowest all-sources F&D costs were Panhandle Oil & Gas ($1.35); PostRock Energy Corp. ($1.91); Range Resources Corp. ($3.67); Double Eagle Petroleum Corp. ($4.04); and Crimson Exploration Inc. ($4.08).

Future production costs projected by the companies climbed from $11.61 in 2008 to $14.39 in 2009 and to $15.83 per BOE in 2010, due to the shift to liquids and push for oil reserves, which are more costly to produce on average.