A recent U.S. Securities and Exchange Commission comment letter has prompted oil and gas companies with horizontal drilling operations to closely review proved undeveloped (PUD) reserves-booking practices.

Public companies preparing year-end 2007 financials are especially concerned that if the SEC universally applies what is viewed as an arbitrary guideline on the number of PUD well offsets, the rippling effect will chip away at year-end booked asset values on horizontally drilled properties worldwide.

The SEC letter to Parallel Petroleum Corp. last year stated that “areas offsetting a horizontal well that are reasonably certain of production would generally be limited to (two) direct parallel offsets to an existing horizontal well.” The two-location maximum is viewed as overly restrictive by an industry that uses a combination of geological and engineering data to justify from one to eight drainage locations offsetting a proved developed producing (PDP) well.

Frequently, producers use a “checkerboard” vertical-well spacing pattern to plot two horizontal and six vertical offsets to the horizontal producer. Then they assign PUDs to offsetting locations intersected by the proposed heel-to-toe lateral, including now-“suspect” vertical-well locations. The SEC is concerned that if producers book reserves for verticals when, in fact, they intend to drill horizontals, then those companies are not following their own development plans but rather attempting to put reserves on the books.

Originally, Midland-based Parallel had designated 31 horizontal PUD locations as offsets in the New Mexico Wolfcamp carbonate trend, but eight of those locations fell outside of the SEC parameter. Parallel removed those locations from the PUD category and said that the resulting downward reserves revision was “immaterial” and resulted in a 2.6% reduction of its year-end 2006 reserves.

The regulator’s stance is that comment letters are case-specific, not policy statements to be broadly interpreted and applied. However, the SEC used the term “generally” to refer to its view on horizontal offsets, which helped fuel industry concern.

North American gas producers in the Permian Basin, Barnett shale and other onshore provinces are boosting production and reserves through horizontal drilling, which accounts for 25% of current domestic drilling operations. International operating companies that report to U.S. markets are horizontally drilling through “continuous” reservoirs worldwide in major projects in Venezuela, Oman, United Arab Emirates, Nigeria and elsewhere.

The “balancing act” for these companies is to carry full values for proved reserves to justify horizontal drilling and completion operations while being in full compliance with regulatory interpretations. In response to SEC comments, Parallel attempted to technically substantiate continuity of production and horizontal PUD locations based on what it said were horizontal well geometries tighter than vertical well geometries and flowback data and mudlog gas shows from 100 times more reservoir rock than typically encountered in vertical drilling.

The company also said it defined trend boundaries with mudlogs and openhole logs from productive vertical wells, commenting that the play is “stratigraphic in nature with little structure of significance.”

Parallel said that cross-sections and gross-pay isopach maps show the productive interval to be continuous. The SEC countered, saying that “geological presentations of isopach maps and cross-sections are not sufficient to demonstrate continuity of production.”

The SEC added that, for wells offsetting a productive well by more than one location away, continuity of production should be demonstrated by pressure communication.

Parallel said some of the “decline curves validate a continuous productive interval and show no sign of reserve acceleration,” adding that “actual production is a more definitive indication of continuity of production than pressure communication.”

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