How Accurate are SEC Oil and Gas Reserves for Analysis? | Russell T. Rudy Energy LLC
The July/August issue of A Shot of Texas Magazine has an excellent piece by renowned energy expert Daniel Yergin, “How Much Oil Is Really Down There?”. The article deals with calculating oil and gas reserves, and is summarized below.
In response to the Arab Oil Embargo of 1973, the U. S. Congress instructed the Securities and Exchange Commission (SEC) to develop a process for determining how much domestic oil and gas were still “in the ground”. The intent was to come up with “proved reserves”, an objective estimate which could be used for strategic planning as well as a tool for investors in evaluating oil companies.
Under any set of circumstances this would have been a tall order. “Proved reserves” are an estimate of the size, shape and content of geologic formations thousands of feet below the earth’s surface. Understandably, the SEC turned to the Society of Petroleum Engineers (SPE), the key technical and professional group composed of experts from industry and academia. Terms, practices and terminology in use at the time were incorporated into what has come to be known as the “1978 System”, which is still in use today.
One of the problems with the system is that since its inception, the SPE has revised its definitions three times, and is in the process of doing so yet again. These revisions are a response to major advances in reservoir measurement since the ‘70’s.
The current system is not only challenged by the intrinsic inaccuracy of estimating the dimensions and contents of a subsurface structure, but also by the fact that “proved reserves” must be based on the “reasonable certainty” that the hydrocarbons can be economically recovered. To make this determination, a price must be assumed, and the SEC mandated those in effect at the end of each year be used. Given the fluctuations in oil and gas prices, those at year end may or may not be an accurate reflection of prices over the preceding year, much less an indication of what can be expected in the future. Consequently, when prices fall, reserves have to be taken off the books, and when they rise, reserves added. In no way does this reflect the subsurface reality, even if it could be precisely determined.
Conversely, in countries that require oil companies operate under production sharing agreements, rising prices can have the opposite effect. Currently, more than 80% of the “proved reserves” of oil companies are in countries that require production sharing agreements. In these cases the oil companies are entitled to recover their costs. When prices rise, the companies are entitled to fewer cost recovery barrels and their reserves are downgraded accordingly.
Currently, oil companies are investing billions of dollars to exploit reserves that are clearly anticipated, but not counted under the current reporting process. These opportunities should be an indication of the long term viability of the enterprise. However, this would be overlooked in an analysis based solely on “proved reserves”. Yergin concludes that a major overhaul of SEC reserves reporting is not only justified, but imperative if “proved reserves” are going to be a meaningful yardstick for planners and investors.
To read the entire article, please go to http://design2pro.com/ashotoftexas/2014/060814/#/16/.
