?For the first time in 25 years, the SEC has approved new reserve-reporting rules meant to help investors better evaluate an E&P company’s assets. Under consideration for more than a year, these revisions apply to year-end 2009 reserves.
Oil and gas companies and groups, such as the Society of Petroleum Engineers, have long lobbied for the changes, which the SPE and Canadian securities-regulation authorities adopted in 2007. They cited new technologies in use since 1982 that enable E&P companies to estimate their reserves far more precisely, thus limiting the usefulness of the old disclosure rules.
The SEC says data from 3-D seismic amplitudes, numeric reservoir simulation and horizontal drilling can now be included when companies estimate their proved reserves (1P), in addition to using actual well logs, pressure tests or production tests as required before.
Another big change: The SEC will allow (not require) companies to disclose probable (2P) and possible (3P) reserves, which until now could not be included in formal filings to the SEC.
“While conservatism is appropriate in accounting, limiting a company to disclosure of proved reserves made it difficult for management to explain why it was investing company funds in a particular project, and why investors should invest their funds in a company,” says securities partner Bill Nelson with law firm Haynes and Boone LLP.
“We’ll get transparency and consistency, but any investor thinking that booked reserves are about to skyrocket is going to be disappointed,” report the analysts with investment-banking firm Tudor Pickering, Holt & Co. “We’re guessing that the new guidelines will result in slightly higher reserves—due to PUDs and technology—but we would be shocked if this was more than 10% in aggregate for the publicly traded E&P universe.
“Remember: This is for 2009 reserves, so 2008 will be done under current rules.”

PUDs and offsets
Under the new definitions, E&Ps are allowed to formally disclose probable and possible reserves in their filings.
“They were already doing this informally in investor presentations, but it takes on more weight/importance when it is in an SEC document where the penalties for exaggeration are more meaningful,” the TPH analysts add.
“Investors should warm to the disclosure of probable and possible reserves, as this provides greater transparency and an idea of upside opportunity within a company’s asset base. Even though these reserves are significantly more risky and less certain than proved reserves, we’re guessing that it won’t take long for investors to focus on changes up/down in these categories.”
Estimating probable and possible reserves can be extremely labor-intensive. Growth companies, in which 2P and 3P reserves make up a majority of likely value, especially in so-called resource or shale plays, will make the effort.
Gone are the days of only booking proved reserves if they are adjacent to, or one offset location away from, producing wells, Haynes and Boone’s Nelson adds. The SEC rule is now that companies will be able to include reserves beyond the immediate vicinity of existing wells, so long as they use technology demonstrated to be reliable in establishing reserves in the area. This includes proprietary technology, points out Chris Kulander, an oil and gas attorney with Haynes and Boone and a former geophysicist.

Commodity-price deck
For reserves to be considered proved, the E&P company must be reasonably certain they can be produced economically at a certain commodity price. One of the most-welcome features of the new rules is that E&Ps will be able to use the unweighted average of the month-end price of the 12 months in the reporting period—versus currently being limited to using fiscal-year-end price, commonly December 31.
“The old requirement that proved estimates be made using only prices as of the date of the report, held constant, created large swings in reserve quantities based on short-term, seasonal changes in prices,” Kulander adds.
In their press releases and investor presentations, independent E&Ps commonly disclose 2P and 3P reserve numbers. Because these do not include the same level of disclosure or uniformity as SEC filings, there was a risk that publicly available information on nonproved reserves would not include the balance required by SEC filings.
Pritchard Capital Partners’ analysts report that using average prices will smooth out the data and make numbers more comparable company to company. “This helps stocks that have gotten killed because of price-related revisions risk, such as Exco Resources Inc., Pioneer Natural Resources Co. and Berry Petroleum Co.
“It should also help companies with big 3P reserves relative to 1P, such as Petrohawk Energy Corp., GMX Resources Inc., PetroQuest Energy Inc. and Chesapeake Energy Corp.”
The TPH analysts also like this change—with a caveat. “We believe that allowing average prices is a generally positive upgrade to the reserve rules—the whim of the markets on 12 days—each month’s end—is probably more accurate than one day…However, this approach can still distort estimates in periods of rapidly changing prices.
“For example, using the month-end approach for 2008 would yield a price of $98 per barrel (while the year-end price was below $50). Long-term prices of about $98 may be reasonable, but it is hard to argue they are representative of the current environment. There is an added complexity to using average prices, since existing accounting standards require end-of-period prices for ceiling test and DD&A calculations. This implies that companies would need to maintain two sets of reserve estimates.”

Unconventional resources
The new rules may allow previously excluded resources like bitumen or tar sands to be classified as oil reserves. Since these resources are already booked as mining reserves, the net effect of reclassification would have little impact on asset values.
Although the definition of “resource” was added to the SEC regulations, a company’s resources will not be permitted to be disclosed in SEC filings unless they fall into a reserve category. Thus, resource size and undiscovered reserves will continue to be disclosed in press releases and at investor presentations.
As the new rules go into effect January 1, 2010, the SEC has specifically reported that early compliance is not permitted, warns Nelson.

Comments