Integrity questions spur action on reserves accounting, analyst says

Dec. 1, 2004
Unprecedented reserves writedowns in 2004 have brought unwelcome attention to the oil and gas industry, leading to questions about the integrity of its participants, said Ron Harrell, chairman and CEO of Ryder Scott Co. LP, at a Nov. 18 meeting in Houston.

Judy Clark
Associate Editor

HOUSTON, Dec. 1 -- Unprecedented reserves writedowns in 2004 have brought unwelcome attention to the oil and gas industry, leading to questions about the integrity of its participants, said Ron Harrell, chairman and CEO of Ryder Scott Co. LP, at a Nov. 18 SPE meeting in Houston.

Harrell, whose Houston-based company conducts reservoir evaluations, urged the industry to support establishment of a certification program for reservoir engineers before the government mandates the reserves audits increasingly demanded by investors (OGJ, Mar. 15, 2004, p. 24).

The US Securities and Exchange Commission (SEC), the US Department of Justice, and other official bodies are investigating the reserves issue, Harrell noted. And inquiries by national legislators "who are not considered friends of the industry" have been conducted.

"This is the first time I've seen Congress get involved," Harrell said.

Although mandates for reserves audits are possible, Harrell does not expect them soon.

"First of all, there are not enough of us—third party engineers and geologists—to do that," he said, adding that it would take about 4 years to have enough competent people to perform mandatory audits for all the companies that report to SEC.

Harrell said, however, that the Alberta Securities Commission (ASC) has had good results—"better than expected"—with its National Instrument 51-101 (NI 51-101) standard for disclosure of oil and gas reserves, which went into effect in 2003. NI 51-101 requires the annual public filing of certain estimates and other information pertaining to oil and gas activities, and it specifies responsibilities of corporate directors.

"ASC requires the reporting of proved and probable reserves and allows the reporting of possible reserves under different pricing scenarios; it's a much broader. . .view of company reserves," Harrell said. "The level of compliance has been good. The concerns that they were holding out have not materialized. It's a learning experience that seems to be working." ASC received some 300 different reports under the measure, he said.

Other regulatory action
Regulatory activity affecting reserves reporting is increasing outside the US and Canada as well, Harrell said. New regulations will appear in January from the International Accounting Standards Board of Europe—comparable to the US Financial Accounting Standards Board—that will govern reporting by European Union companies along with those from Australia "plus another country or two." Although it isn't yet known what the regulations will cover, Harrell said that "people who are knowledgeable" think these regulations will address more than crude oil reserves.

He said the International Energy Agency in Paris (IEA), which has 26 member countries, also has called for better reporting.

"IEA can point out that about 80% of the world's reserves are not publicized," he said, "particularly in the Middle East."

The nine-member international reserves committee of the Society of Petroleum Engineers (SPE), attuned to concerns around the world, is trying to harmonize the definitions of two documents—the 1997 "reserves" definition and the Year 2000 "resource" definition—in a single cohesive document, Harrell said.

The United Nations also is seeking to develop a framework for putting all energy definitions under one umbrella, using a complex, three-dimensional model to define reservoirs and reserves.

In addition, Daniel Yergin, chairman of Cambridge Energy Research Associates (CERA), Cambridge, Mass., began leading a commercial effort in September in which a group of companies is discussing SEC reporting requirements, along with "how we got into this situation with the SEC," current challenges, and improvements to the system of reporting, Harrell said.

Supermajors such as ExxonMobil Corp., ChevronTexaco, and BP PLC, are taking part in the discussions with the intention of drafting recommendations for Congress, he said. "But it hasn't worked out quite that way because they cannot reach a consensus about how this should be done."

Push for certification
Harrell said it is important that an accreditation program be established to certify petroleum reserves evaluators and auditors as specialists, just as lawyers and other professionals are board-certified, because "our credibility has been questioned." He also said that without a certification program, "the long-term answer is Sarbanes-Oxley [Act of 2002]—somewhere down the line." The law doesn't require certification now, but it could in the future, he added.

Current qualifications for reserves auditors, as established through SPE standards published in 1977 and partially updated in 2001, are "graduation from an accredited university, 3 years of experience in the oil and gas business, and at least 1 year of experience estimating reserves," Harrell said. "That might have worked in 1977, but it is not enough today; rather, it is something to build on."

Harrell said that reserves consultants must be state-licensed petroleum engineers and that some companies have established internal guidelines and excellent training and standards for their reserves evaluators. But he qualified that by saying "sometimes" and noted that internal company training may not always be adequate.

"We looked at some 61 companies last year that reported reserves to the SEC. I don't want to cast aspersions on anybody, but I have observed some things that are pretty frightening. If you don't start with a good geological foundation, nothing will ever work."

Steps to date
Certification relates to the professionalism of engineers and geoscientists who, Harrell said, have a responsibility "to ourselves, our employers, shareholders, and the public." He said, "Certification as we see it is about people, not companies," although companies can be the beneficiaries.

There currently are no national or international standards specifically addressing accreditation, but exploratory efforts toward a certification program are under way, Harrell said. The American Association of Petroleum Geologists (AAPG), which has certification experience, and the Society of Petroleum Evaluation Engineers (SPEE), which holds its evaluators to a high standard to qualify for membership, have agreed to investigate this initiative.

They are using input from bankers, oil company representatives, internal documents, and reserves manuals from 20 companies to determine entry-level qualifications and to identify best practices and training that could serve as a basis for certification. Some of the other elements they will consider are reserves definitions and ethics considerations. SPE said it also would cooperate in allowing use of its library and other materials, although it will not be a sponsor.

"There are about 35 people involved in this—all volunteers," Harrell said. The certification program could receive approvals by sponsors in early 2005, and processing of candidates could begin in late 2005. Certification will be voluntary, although eventually it could become mandatory, he added. He said he saw no liability consequences for SPEE and AAPG, as the certification just says an evaluator has completed a course of study and passed an exam. "Certification won't get you any powers, but it will now empower you."

In the push for accreditation, the goal is for reserves reports to be more accurate.

"They will never be totally accurate, but we can improve [the reliability of reporting]," Harrell said. "There needs to be more than just a big enough computer."

Contact Judy Clark at [email protected]