Slowly but surely, methods of publicly disclosing oil and gas reserves are improving. That’s how they should improve: slowly but surely.
This week’s special report, Corporate Reserves Issues, beginning on p. 20, describes the issues and progress so far. The complexity and the difficulty are apparent. They’re the reasons not to rush improvement.
Reserves reporting must navigate a treacherous channel between the often-conflicting ideals of certitude and full disclosure. In the US, current requirements, enforced by the Securities and Exchange Commission, call for estimates of proved reserves and of values calculated on the basis of projected production and prices, discounted at 10%. The estimates are reported with but are not integral to financial statements. Asset accounts associated with reserves on company balance sheets reflect only accumulated costs, which are diminished as production advances through depletion charges on income statements.
SEC’s conservatism
In the interest of comparability among companies, the SEC and Financial Accounting Standards Board traditionally lean toward certitude even as they yearn for disclosure. SEC regulations and FASB standards focus on proved reserves, narrowly defined. While the conservatism is judicious, several broad problems with the current approach have come to light.
One is that specific elements of current regulations are obsolete. The use of yearend oil and gas prices in reserves assessments, for example, doesn’t suit the price volatility of modern oil and gas markets. Price averages or projections based on late-year trends would be better. Producers shouldn’t have to make major reserves adjustments just because prices ended a year at the extreme end of a price swing. It happened last year for producers of heavy oil.
In another area needing modernization, SEC has begun to act. Last year it allowed the use of techniques other than production tests for reserves assessments in the deepwater Gulf of Mexico. Producers continue to urge it to embrace other new technology in lieu of flow tests for reserves estimates. Because few new technologies work in all reservoirs and because production testing remains necessary for many, progress in this area will have to be case by case.
A broader and more difficult problem is that current standards force investors into a cramped view that differs from the perspectives of most company managers. In judgments about companies’ future production, proved reserves seldom tell the whole story. Growth prospects of a company with proved but little probable and possible reserves differ greatly, for example, from those of a company with equivalent proved but much larger estimates in the less certain categories. Indeed, Canada allows formal disclosure of probable reserves. UK regulators also allow reporting of probable reserves and give producers more flexibility than their US counterparts do in the “proved” category. What broadens disclosure, however, can detract from certitude. Many “reserves” reported as probable and possible have been awaiting development for many years.
Furthermore, as large downgrades last year showed, quantities better described as probable or possible sometimes creep into the proved category. Companies differ in their practices for estimating and reporting reserves. Engineers differ within companies. Regulatory conservatism can’t screen out all these discrepancies. For that reason, proposals to require independent assessments by certified reserves evaluators have merit.
Beyond the US, the United Nations has created a framework for global classification of mineral reserves. The Society of Petroleum Engineers, American Association of Petroleum Geologists, and World Petroleum Council also have worked on global standardization of reserves reporting. The work addresses a range of problems. At present, variation of definitions and regulations confounds comparisons of reserves estimates among companies and even within companies with production in many countries.
Ambition vs. practicality
These and other attempts to improve the corporate reporting of oil and gas reserves are welcome and important. In a nice departure from the usual pattern, moreover, pressure for change comes from producers and their investors rather than from regulators.
Hope must be realistic, however. Not all of the efforts under way to improve reserves disclosure will produce results. Ambition in this area has yielded to practicality in the past-as in the failed experiment with reserves recognition accounting. The central aim is to express geophysical interpretation in accounting terms. Wisdom in reserves disclosure begins with an appreciation for the compromises of precision essential to that process.