Reserves Estimation in Accounting and Reporting: Oklahoma State University Oil & Gas Accounting Conference
Reserves Estimation in Accounting and Reporting: Oklahoma State University Oil & Gas Accounting Conference
Reserves Estimation in Accounting and Reporting: Oklahoma State University Oil & Gas Accounting Conference
Discussion Outline
SEC Compliant Report Validating a Reserve Report SEC Comment Letters SEC Hot Button Issues
The information presented herein represents informed opinions about U.S. SEC reserves reporting regulations but does not purport to be identical to advice to be obtained from the SEC.
What does the United States Securities and Exchange Commission (SEC) expect in a 10-K Reserves filing?
RESERVES DEFINITIONS
SEC 1978 Proved oil and gas reserves are 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, i.e., prices and cost as of the date the estimate is made. SPE/WPC 1997 Proved reserves are those quantities of petroleum which, by analysis of geological and engineering data, can be estimated with reasonable certainty to be commercially recoverable, from a given date forward, from known reservoirs and under economic condition, operating methods, and government regulations.
The concept of reasonable certainty implies that, as more technical data becomes available, a positive, or upward, revision is much more likely than a negative, or downward, revision.
Generated by supporting geological and engineering data. Validation of assumptions are necessary. Criteria for analogies should be equal to or better than referenced reservoirs used as analogies. Reasonable certainty is more than just the technical considerations that oil and gas is recoverable. It also includes resolution of how other barriers such as financial, environmental, marketing, legal and political will be overcome.
An estimate of the reserves and future revenues using existing economic and operating conditions (12/31 prices and costs). Recoverable from known reservoirs to a level of reasonable certainty. Revenues limited to that from sale of produced hydrocarbons and not associated income from sulphur, CO2, processing fees, platform rentals, etc. Limited reliance upon 3-D seismic and other new technology.
In recent years, the engineering staff issues comment letters initially asking generic type questions about many issues, including PUDs, pricing, reliance upon third-party firms, reserves-linked performance bonuses, recovery factors and other matters.
Upon producer response, SEC then narrows remaining relevant questions to specific properties and may ask for maps and other supporting documentation. May result in iteration of several letters back and forth until SEC is satisfied or asks producer to make modifications (Debooking or Restatement)
De-booking typically results from SEC request to remove certain reserves from the next annual reserves filing. Rather common but is not typically publicized if the issuer voluntarily complies in the next annual 10-K filing. Restatement is a much more serious result, particularly under SOX, as it requires the issuer to retroactively correct past reserves disclosures and recalculate earnings. U.S. Department of Justice (DOJ) will probably be involved in any investigation that subsequently leads to a reserves restatement.
History of downward reductions By press releases Response to Comment Letter Annual reports that dont conform to press releases Partner Activity, press releases, or revisions A history of SEC infractions Negative publicity The Calendar Every 3 years Unusual Stock Volume or Movement Whistle blowers or for several other reasons.
Process review is an analysis of the process and procedures established to ensure that reserves have been estimated using industry accepted practices and in compliance with relevant standards. May involve qualifications and independence of internal reserves evaluators and auditors. Does not address reserves
quantities
Reserves review is more typically a cursory investigation of client-selected properties for various client purposes.
Reserves audit
A reserves audit is an examination of the work of others for the purpose of expressing an opinion that a reserves report is reasonable in the aggregate and generally conforms to accepted engineering and geological principals and relevant reserves definitions. May include all or a portion of the properties of an entity. Acceptable tolerances usually within 5 to 10 percent. May include reserves, production forecasts and/or economics.
A reserves report is a grass roots evaluation in which an evaluator has examined and evaluated all available source data for the purpose of producing an independent estimate of reserves and reserves information in full compliance with the relevant reserves definitions. Includes projections of production, revenues, costs ( Capex, Opex, Taxes, Abandonment ) and future net income discounted at 10%. A reserves report may be internally or externally prepared.
Personnel should be trained in industry best practices regarding (1) acceptable geological interpretations and reservoir description (2) basic understanding of reservoir mechanics and fluid flow (3) comprehension of pertinent reserves definitions and (4) ethics. Evaluators should establish real time access to data from employer-operated properties and ASAP data from partner-operated assets.
Partners should be wary of accepting operatorsupplied reserves estimates. Attention must be given to documentation of all interpretative data steps, including narrative descriptions of critical decisions. All data and information related to a reserves report, including geological maps, must be archived in a form that can be accessed and reviewed by authorized parties at any time.
Some abuses of the proved classification (in no particular order) Spacing violations for PUDs PUDs which are too optimistic based on supporting data Seismic amplitudes for down dip limits Use of non-hydrocarbon revenue streams Misuse of reservoir simulation results Field level decline curve analysis Declining operating costs with declining well count Allocation of development costs to probable category to justify proved reserves economics Justification of proved reserves by analogy with non-analogous properties Misuse of statistical analysis Reserves being declared proved when no sales market exists Scheduling of reserves which extend beyond the term of foreign concessions
Series of questions that should be asked to help assess the degree of reserve risk associated with a companys reserves and their reserve report.
1.
Who did the underlying reserve evaluation? internal engineering or independent engineering firm
2.
Is the independent engineering firm or company engineering staff knowledgeable of SEC reserve definitions and the appropriate reporting requirement ?
3.
How long has the independent engineering firm been doing the companys reserves ?
Is the engineering firm familiar with special issues that might be involved with the companys properties ?
4.
Where are the reserves located ?
How knowledgeable is the company of the areas where the reserves are located ? Are they in an area where assessment of reserves carries greater risk (I.e. Gulf Coast vs. Mid-Continent) ?
Are the reserves concentrated in specific areas, or are they widely scattered (I.e. do they have core areas of competency) ?
Are the reserves in areas that require higher operating and development costs (I.e. profit margin is smaller and expenditure demands are higher on the company) ? Are the reserves in areas that are environmentally very sensitive ? Are the reserves all domestic, or do they include international properties ?
5.
Is the independent engineering firm familiar with the areas where the reserves are located ?
6.
Does the independent engineering firm look at all of the company reserves or just a percentage ?
Does the engineering firm do a detailed study or an audit ?
7.
Are the companys reserves concentrated in a small number of properties, or is the portfolio of properties more diverse ?
What type of interest position does the company hold in its different properties ?
8.
Are the reserves strictly primary, or do they include secondary and EOR projects ?
9.
Are most of the properties operated or non-operated ?
If a high percentage of the companys reserves are non-operated, what is known about the operators ? Are the various operators substantial from a technical and business standpoint ? Do the operators have an established track record of operations in the areas where the reserves are located ?
10.
What is the breakdown on proved reserve status categories (I.e. producing, shut-in, behind pipe and undeveloped) ?
Are the reserves fairly well split between categories, or is there a high percentage in the non-producing and particularly in the undeveloped ?
11.
What kind of reserve life index is there for the proved producing reserves ?
Is this realistic for the type of proved producing reserves stated in the SEC filing ? Is this realistic taking into account the current production of the company ?
12.
What kind of reserve life index is there for the total proved reserves ?
What level of producing rates will have to be added by non-producing and undeveloped reserves to make a reasonable life index ? Does this seem attainable for the types of reserves involved ?
13.
Are the reported reserves based on the appropriate economic parameters as specified by the Securities and Exchange Commission ?
Did the reserve appraiser use current economic conditions ?
15.
Historical Checks
Do future cost projections appear reasonable considering recent historical company expenditures ?
Have the appropriate operating costs been applied against the reserve projections ? Does the company have sufficient cashflow to carry their burden of operating costs and service other necessary company expenditures ?
Have sufficient development costs been included to develop the stated non-producing and undeveloped reserves ?
Does the company have an established track record and the financial stability to spend the amounts of capital dollars necessary to fund the development ?
16.
Company Performance
How does the company look over the years in regards to revisions of previous estimates ?
Have the revisions consistently been significant in size in relation to the companys base reserves ? Are the revisions consistently negative ?
Are the negative revisions consistently associated with the non-producing and undeveloped reserve categories ?
17.
Company Performance
Extensions, discoveries, other additions are an indicator of how well the company is moving proved undeveloped and probable reserves into the developed reserve base of the company. Is the company historically demonstrating an ability to do so ?
How well is the company finding new reserves through the drill bit ? Does the company have an active exploration and development drilling program ? Does the company have a good acreage position around its developing properties ? What kind of exploratory acreage position does the company hold ?
18.
Company Performance
Does the company typically grow through acquisitions or the drill bit ? Is there a good mix of both ?
Does purchase of reserves in place contribute significantly to the companys reserve base ? If the company traditionally grows through acquisitions, is the company paying an appropriate amount for reserves ? Could too much success with competitive bids mean they are over-paying for the reserves ?
19.
Company Performance
Does the company sell reserves in place to divest themselves of non-strategic reserves ?
Is the company burdened with a large number of low margin wells in non-core areas ?
20.
How recent is the reserve evaluation that is the source of the companys reserves in the public filing ?
Based on the answers to some of the previous questions, are the reserves of a nature that significant changes in reserve quantities can occur over a limited period of time ? Is the reserve evaluation a recent study or a prior study that has been mechanically adjusted to a specific as-of date for public reporting purposes ?
A series of questions posed by accountants, lawyers, and engineers designed to test the compliance of the company with SEC regulations regarding technical and commercial issues. The first producer answers are typically followed by a shorter list of questions, which typically are more specific and ask for more detail. SEC may request maps, logs, test data, copies of contracts, market studies, etc. Iteration of letters may lead to request to restate previous filings, "de-booking" of reserves in subsequent reports or, simply, no more letters. Most favorable response from SEC is We have no more questions at this time.
Please inform us of any circumstance where you have reported proved reserves located structurally below the lowestknown hydrocarbons as established through well logs and if these additional reserves have not been confirmed through performance history.
Please inform us of any circumstances where your reported reserves and future income were estimated using prices other than those in effect on the last day of the year.
Have you reported any undeveloped reserves attributable to well locations more than one offset location (legal location) away from a commercial well?
Who has the authority to engage third party engineers and who do they report to?
Interesting Questions One recent SEC comment letter asked for the following:
Identify all independent engineering firms used over last 5 years. What properties were reviewed? How much the firms were paid for work on projects other than year-end type work? If the firms were discharged, reason(s) why?
Have you reported proved reserves in untested fault blocks, structures, or seismic amplitudes?
(Untested here refers to the drilling of a well confirming presence of oil and/or gas)
November 9th, 2004, the SEC sent a 9 page, 23 question inquiry to an independent US oil company Among other items, the SEC asked for:
A one line summary for each proved reserve entry on the books as of 12/31/2002 and 12/31/2003 Narratives, engineering and geological exhibits for the three largest reserve extensions or discoveries during 2003
Include the engineering and geological exhibits used to justify the reserve booking at each year end and a brief narrative reconciling the differences between the two estimates. Address corporate methodology for eliminating future discrepancies between the estimates
Narratives, engineering and geological exhibits for the 3 largest reserve revisions both positive and negative not caused by economics Supplementally, tell us all the estimated hydrocarbon volumes, if any, you have claimed as proved reserves;
A) In undrilled fault blocks B) Below the LKH penetrated or assessed structural occurrence of hydrocarbons
Discuss the internal controls you have in place to assure consistency and conservatism in your proved reserve estimations. Discuss how the effectiveness of these controls is reflected in your history of proved reserve revisions over the past 3 years Identify the personnel in your company who have final authority over your proved reserves
Technical Issues
Commercial Issues
Validation of proved undeveloped locations (PUDS) Proper use of analogies Determination of down dip limits/LKH Application of seismic interpretations Recovery factors Application of reservoir simulation Flow testing/Data comprising a conclusive formation test Undrilled fault blocks
SEC year-end pricing Costs Capex and Opex Non-hydrocarbon revenues Financial commitment to develop/project stagnation Project sanctioning Commerciality lack of market Booking under PSCS
SPE/WPC allow some latitude, average period OK SEC no interpretation. Must use price on effective date
A time with less volatility in O&G markets Now O&G sold on spot markets
B) Recovery factors
SEC increasing scrutiny Staff pressing for hard evidence for recovery factors higher than low-side of range May ask for supporting documentation of assumptions Examples:
One offset rule (regulatory spacing) Website certainty beyond one location Rule also applies to CBM Large percentage of PUDs Stale PUDs PUDs remain undrilled Analogy for PUDs no longer valid
Historically SEC has dismissed as too uncertain for proved reserves Extension of lowest known hydrocarbons Proving up nearby untested analog structures
Necessary Elements Right to develop and extract Reasonable certainty of production Intent and commitment to develop Capital at risk Legal right to produce at the date of the estimate
SEC Position after foreign government declaration of commerciality or government approval of development plan Exceptions if Compelling Case made to SEC
SEC position can lead to significant differences relative to SPE/WPC reserves Reversal of 2000 SPEE forum position compelling case
SEC in the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons control the lower proved limit of the reservoir. SPE lowest known occurrence of hydrocarbons controls the proved limit unless otherwise indicated by definitive geological, engineering or performance data.
Well A
Well B
O = 31.1% K = 1100 md
SPE Proved Volume Increment OWC (RFT)
LKO Log
O = 32.4% K = 1600 md
Top of sand
8300
Depth TVDSS
8400
8500
8600
8700
Base of sand
8800 4880 4920 4960 5000 5040 5080 5120 5160 5200 Pressure PSIA
SEC recognizes models often represent expected case SEC requires good history match
SEC Prohibits All Non-Hydrocarbon Reserves (including Sulphur , CO2 , and Helium) Third Party Processing Revenue excluded Cannot use non-hydrocarbon income to offset or reduce operating costs
SEC Reserves are considered proved if economic producibility is supported by either actual production or conclusive formation test.
SEC Special Project Inquiry concerning booking proved reserves without conventional flow test Addressed in 2002 SPEE Forum with SEC
In certain areas- GOM -not seen as necessary or feasible Producers reasons for no flow test in deepwater GOM
Redundancy to calculated test rates Costs often exceed $10MM Delays of up to two years Environmental concerns and permitting requirements
For properties subject to payment of net profits, SEC requires property owner to deduct NPI reserves from owned reserves SPE/WPC definitions silent, but tradition considers NPIs to be financial transaction without reserves ownership
SPE is revising its petroleum reserves definitions and will issue new ones in 2006-2007. The United Nations has integrated the SPE/World Petroleum Congress reserves definitions into its framework with an aim to fully align both. SPE is working with the International Accounting Standards Board and other organizations, including the UN, to ensure the adequacy of reserves standards. The IASB and FASB have agreed to work towards the convergence of existing U.S. and international financial accounting practices and the joint development of future standards. According to Roger Schwall, assistant director for the Division of Corporate Finance - the SEC has no current plans to change their definitions or guidelines.