Reserves definitions and reserves reporting standards are designed to help protect investors, but the US regulatory process sometimes actually constrains the amount of available public information, an analyst with IHS Energy said.
Royal Dutch/Shell Group announced Jan. 9 that it had overestimated its proved oil and natural gas reserves by 3.9 billion boe, or 20% (OGJ Online, Jan. 9, 2004).
The reporting of reserves helps investors evaluate a company's assets and compare various companies' financial performance, said Kenneth Chew, IHS Energy vice-president, industry performance and strategy.
"However, this works only if all companies report reserves to the same standards, and this is where industry regulators enter the picture. Financial accounting rules (and thereby reserves reporting) vary from country to country," Chew said.
US regulators' reserves definition and guidelines establish standardized criteria to evaluate "what otherwise would be a fairly subjective item," he said.
"While this may be the best solution as far as the protection of the public and the average investor is concerned, the need for standardization and the inbuilt conservatism result in a significant loss of information that could be of significant value to an informed and experienced analyst," he noted.
FASB, SEC regulations
All companies trading on the New York Stock Exchange are subject to oil and gas reporting standards established by the US Financial Accounting Standards Board. FASB 69 provides the reporting and accounting rules and reporting formats for:
- Proved oil and gas reserve quantities.
- Capitalized costs relating to oil and gas producing activities.
- Costs incurred for property acquisition, exploration, and development activities.
- Results of operations for oil and gas producing activities.
- A standardized measure of discounted future net cash flows relating to proved oil and gas reserves quantities.
"The fifth item is one of the most contentious because it requires future cash inflows to be calculated by applying yearend oil and gas prices (no matter how atypical they may be) to yearend reserves and bases future costs on yearend costs and the assumed continuation of existing economic conditions," Chew said.
In the case of the Shell reserves revision, a company news release noted, "The information so calculated does not provide a reliable measure of future cash flows from proved reserves."
Although FASB made the rules, company reports are filed with the US Securities and Exchange Commission, and the SEC defined various terms incorporated into FASB 69.
Those definitions were published in 1978 and remain essentially unchanged, although slight modifications have been made.
Technology
But reserves estimators say problems are created because exploration and production technology has advanced since 1978 (OGJ, Jan. 19, 2004, p. 28).
For instance, current computing power enables petroleum engineers to make reservoir simulations and probabilistic calculation methods with "far greater precision in establishing in-place and recoverable hydrocarbon volumes than was possible a quarter of a century ago," Chew said.
Consequently, SEC engineers have issued guidance documents to assist companies in compiling regulatory filings. "It should be noted that such documents are generally accompanied by a header disclaiming responsibility on the part of the SEC for the views of its staff," Chew said.
SEC engineers acknowledge that "it is difficult, if not impossible, to write reserves definitions that easily cover all possible situations," Chew said.
Proved reserves
Nevertheless, the thrust of the SEC proved reserves definition remains that companies may "disclose only proved reserves that a company has demonstrated by actual production or conclusive formation tests to be economically and legally producible under existing economic and operating conditions."
The interpretation of "conclusive formation tests" is an issue in deepwater Gulf of Mexico, where companies are reluctant to conduct drillstem and production tests because of the expense and environmental permitting requirements. Instead, companies prefer log analysis, wireline formation tests, and cores."
Internationally, the widespread use of the production-sharing contract also has had an impact on what a company can report as "owned" proved reserves.
"Given the fundamental uncertainty that exists about all reserves estimates (they are just estimates) and the varying possible interpretations that can be placed upon terms such as 'reasonable certainty' and 'conclusive,' it should not be thought surprising that there can be a considerable variety of opinion on what constitutes 'proved reserves,'" Chew said.
SEC is conservative regarding frontier-area developments, and it requires evidence that the reserves will be developed. The evidence can be in the form of signed sales contracts or a commitment to develop the necessary production and transportation infrastructure.
"It is probably on these grounds that Shell had to recategorize the resources associated with the supergiant Gorgon gas-condensate fields on Australia's North West Shelf," Chew noted.
While the SEC has not specified a confidence level for the certainty of proved reserves, the Society of Petroleum Engineers has specified a 90% confidence level for proved reserves.
Russian oil company OAO Yukos reported to SEC proved liquid reserves of 10.45 billion bbl as of Dec. 31, 2002, and SPE proved liquid reserves of 13.73 billion bbl.
"In other words, the SEC reserves definition was even more conservative than the SPE's 90% confidence level in this instance," Chew said.
Probable, possible reserves
The SEC does not allow probable and possible reserves to be reported in filings.
Oil recoverable from oil sands operations also must be excluded from disclosures about oil and gas producing activities. SEC considers oil sands recovery as mining.
"The absence of data on probable reserves is a serious loss of valuable information," Chew said. Canadian standards for reserves reporting require a statement of probable reserves and permits a statement of possible reserves (OGJ, Jan. 19, 2004, p. 30).
"The Shell situation highlights this problem. While Shell's SEC proved reserves have diminished by 20%, the chances are that Shells' resource base—the total inventory of Shell's discovered hydrocarbon resources that are likely to be developed at some future time—has changed very little if at all," Chew said.
The company's recategorized reserves were shifted between categories and are likely to be shifted back again, he said. Meanwhile, investors want to know a company's assessment of its total resources.
"ExxonMobil [Corp.] gets around this difficulty by reporting its resource base and annual resource base additions in a 'Financial and Operating Review' that does not have to be filed with the SEC. The 2002 review makes for interesting reading," Chew said.
While ExxonMobil's SEC proved reserves as of Dec. 31, 2002, were 21.1 billion boe, the company's discovered resource base was 72 billion boe, reflecting that only 29% of resources were reported as proved.
Chew noted that ExxonMobil's 2.2 billion bbl of new-field resource additions and acquisitions tells what the company actually accomplished in 2002.
"By contrast, the 1.2 billion bbl of discoveries and extensions reported in 'proved reserves' additions give no indication of how ExxonMobil performed as an explorer in 2002. It is quite possible for not a single barrel reported to the SEC as discovery and extension additions in 2002 to have been drilled in 2002," Chew said.
Discoveries and extensions reported in 2002 might simply reflect discoveries actually made in earlier years but that only now conform to SEC proved reserves criteria so that those reserves can be booked, he said.
Shell example
Another Shell example demonstrates this situation. In September 2001, the UK Department of Trade and Industry authorized development of the Penguin group of fields in the northern North Sea.
Shell's share of the proved resources appeared in its 2002 SEC filing.
"The first Penguin discovery well was completed in November 1974. But because the fields were not viable until advances in development technology took place (including a 65 km subsea tieback), they first appeared as 'discoveries' almost 30 years after the initial discovery was made," Chew noted.
So while the SEC's conservative proved reserves definition protects the investor, it also has "the effect of depriving analysts and investors of much valuable information," he noted.