An oft quoted adage is, "You get what you measure." This is certainly true when it comes to proven reserves reported to the United States Securities and Exchange Commission (SEC).

When I asked my network of email sources what they thought caused problems in reserves determinations, two often cited drivers were the SEC rules for reporting reserves and associated company reward systems.

• "In most upstream oil company operations, reserve replacement is a goal, and a very important goal. If it is on your performance appraisal, it is probably on your boss's appraisal and so on up the line. Everyone wants to look good."

• "Aggressive bookings were probably due to the linkage of bonuses for staff and management to reserves additions, and the SEC was not routinely challenging the practices. So folks kept pushing the envelope."

The SEC defines "proven oil and gas reserves" as "the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions..."
As one expert told me, "The sole focus on proven reserves is an example of 'irrational objectivity' - detailed systematic reporting of a small part of an uncertain picture...allowing (or requiring) companies to effectively report the entire probabilistic distribution of their reserves would provide a better comparative yardstick than proved reserves alone."

Another expert added, "Some countries, like Canada, require disclosure of both 'proved' and 'proved and probable' estimates. This gives investors a better idea of the ultimate production expected."

People in my network described several ways in which companies try to work around the SEC definition to get recognition from the financial community for the portions of their portfolio that aren't really proved reserves. For example, "Many operators have focused on a best estimate recoverable volume and discount it a bit to arrive at their proved estimate. This would be closer to a proved plus probable estimate under SPE (Society of Petroleum Engineers) guidance, but since the SEC does not recognize probabilistics, folks try to jam it all into proved."

To facilitate consistency, in 1997, SPE and the World Petroleum Congress (WPC) approved a joint set of reserves definitions. In addition to a more precise definition of proved reserves than that provided by the SEC, the SPE and WPC provide definitions for two categories of unproven reserves, probable and possible.

In 2000, the American Association of Petroleum Geologists (AAPG) joined the SPE and WPC in endorsing a petroleum resources classification system and definitions. This system expands on the 1997 definitions supplementing the reserves categories with contingent and prospective resources.

Despite the widespread enthusiasm in the technical community for the SPE/WPC/AAPG classification system, it is not being used for public reporting. Disclosure using this classification system is not prohibited, but companies are hesitant to use it.

One of the reasons for this reluctance is concern that investors would be confused by the differences between the SEC reporting requirements and the more comprehensive SPE/WPC/AAPG system.
Companies could address this concern by providing tutorials and briefing sessions to supplement the detailed descriptions, which are publicly available on the SPE Web site.

With the spotlight on the deficiencies of the SEC reporting system, let's seize the opportunity to implement the superior SPE/WPC/AAPG system as a supplement. Carpe diem!

Eve Sprunt, evesprunt@aol.com, is an oil industry executive. Responses in quotes come from her broad network of contacts in the industry who respond to her e-mail surveys.

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