New SEC Concept Floated to Change Way E&P Companies Book Reserves
Posted by nate hagens on December 18, 2007 - 9:22pm
The SEC, with little fanfare, has posted a "Concept Release" on possible changes to oil and gas reserve disclosure. The pdf can be dowloaded here. Johnson Rice, one of my favorite energy research shops, had the following to say about this 'curious' SEC release:
Bottom line: The SEC has been reviewing its reserve booking rules for some time now and this Concept Release is a step in that process. The document does not contain formal rule changes or recommendations, but the direction the SEC is heading is clear. The current rules were last updated back in 1982 and fail to take into account the development of vast resource plays and the technological advances that have been made in the industry. While many industry players stand to benefit, the biggest impact will be for the onshore companies with large acreage positions in resource plays such as shale plays or coal bed methane. A change in the booking rules will potentially allow companies to book significantly more proved reserves than are allowed today. This will ripple through the E&P space in terms of higher NAV’s based on higher proved reserves. This will also impact acquisition economics as acquirers can point to a higher level of proved reserves being acquired to justify the price, not just 2P or 3P potential the acreage may contain.
Again, from Ken Carroll at Johnson Rice:
A couple of points to note in the SEC document below:
§ First, keep in mind that this is a conceptual document that is seeking public comment. As you read through it, there is little detail and no real recommendations for changes to the reserve booking rules, simply a lot of questions about why things are done the way they are today and if they should be changed given the technology advances we have seen and the nature of much of the drilling today.
§ Starting on page five, the document outlines the current definition of proved reserves and some of the strict interpretations that the SEC has used in allowing companies to book proved oil and gas reserves.
§ As part of this discussion, the concept paper lays out current rules allowing companies to book only immediately adjacent locations. It is clear that this interpretation, which may have been perfectly valid back in 1982, is no longer relevant in today’s world of resource plays, particularly shale and coal bed methane plays, and that the SEC strongly considering changing this. The idea is that what most companies consider Probable or 2P reserves in these resource plays have the same risk profile as that immediately adjacent PUD location.
§ Page nine begins a discussion of the technological advances, including 3-D and 4-D seismic, that have occurred since the last major change to reserve booking rules back in 1982. It also notes how the rules do not include “the extraction of hydrocarbons from shale, tar sands or coal.” This has implication for both gas resource plays and oil and tar sand developments.
§ Finally, the piece notes that the Society of Petroleum Engineers released a revised reserve classification framework in February 2007, which defines “a broad range of reserves categories, contingent resources and prospective resources”, and that this framework is used by companies and investors for private financing transactions…
§ The document then requests comments on a broad range of topics including whether the SEC replace the current reserve disclosure guidelines and what form that should take. Should companies be allowed to report reserves other than proved reserves? Should the definition of proved reserves be changed?
My take
If this floated rule 'passes', and I am hearing that it eventually will, I see 3 implications:
1)In a financial world where credit is increasingly dear, it will make it easier for energy companies to borrow money - what originally was 100 million in proved reserves is now 200 million. Banks will give loans to real assets. Good? timing.
2)US proved reserves will increase, which might politically look good, since we peaked in production in 1970 and all that.
3)There will be a surge in prices in companies that now can sign off on higher reserves (that started to happen today IMO). Of course, in the evolutionary arms race that is Wall St, the 'buyers' of these companies will gradually change the metrics by which they evaluate companies, and we'll eventually be right back where we started.
An accounting game, but with some short term financial winners. Sadly, the SEC, cannot magically create oil. Now the Federal Reserve however....
Thoughts welcomed.
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This is a potential minefield. I'll comment on two problem areas;
1) technology assumptions
For example what is reported as coalbed methane can mean both free flowing gas of high heating value and the product of insitu coal gasification via incomplete combustion. What emerges from ICG can contain not only methane but nitrogen from the air pumped down the well and carbon oxides mon and di. The reserve statement should therefore include an estimate of net energy per unit compared to existing reserves.
2) depletion protocols
While these plans may be formulated at a national level I assume individual producers will have to abide by them. The plan may be to extract a resource at say 10%, 9%, 8.1%... of proven starting reserves. If you convince yourself your company's reserves are double what they really are you bottom out much faster.
I must admit I've been stunned by the discovery rate not so much of FFs but of certain metals in some regions. Just with FFs we need to kid ourselves more.
I thought this administration (Cheney)was pro tarsands development.Too bad they missed Alberta Tarsands......just a 2 tillion bbl resource plus or minas. Curious oversight......
I'm not sure I would call what was posted today a "rule". The SEC calls it a "Concept Release", and it reads like a document intended to start discussion, rather than proposed rule.
The discussion in the concept release indicates that the SEC is considering liberalizing what can be counted as reserves. If SEC does make a change, there will be a period of discontinuity, at the time the reserve definition is changed.
Apart from the transition issue, I don't see a problem with the idea of changing the reserve definition. The current method is strange, and does not correspond well to what other countries are doing. If there are big changes in the valuations of oil companies, it is because investors don't understand what the current reserves are measuring.
If a method can be developed that is an accurate reflection of the real 2P reserves, it would seem like it would be a step forward.
Its not a 'rule' but it seems like they are requesting feedback of sorts. I doubt firms will complain. So I see no reason why it won't come to pass - something like this was probably overdue - I just find it curious that its happening when banks lending practices are puckering.
Being the skeptic I am I suspect that under the old rules a lot of oil companies may have been facing big reserve write downs. By liberalizing the rules this right down of high quality but over estimated reserves is hidden in a large expansion of lower quality reserves. Generally these types of changes are initiated by the people affected by the changes in the first place not because of sudden enlightenment of the government. Whats probably important is that pressure to change the rules has not been significant till now.
I was expecting that we would see large write downs in the very near future but this move would hide this. So I find it very interesting.
So why was this not done in 1990 2000 etc etc if it was that bad ?
Nate - thanks for posting this. The existing SEC rules are archaic and unworkable. But I'm not confident that they will be able to update these to make better sense.
Its worth while using the Shell scandal as an example. They got caught out on 2 gas fields for different reasons. On Ormen Lange you could actually image the gas water contact using 3D seismic. Not good enough for the SEC I'm afraid, even though the seismic model had been verified by a number of wells. On Gorgon, they had the gas but not yet finalised a market for that gas. These are two examples where vast, good quality reserves had been discovered but were unbookable.
Companies should clearly be allowed to book unconventional gas and tar sand reserves - but in a completely different category owing to the greater investment required and longer time frame of development.
The fact the SEC are revisiting this now betrays awareness of trouble ahead. Booking vast volumes of tar sand may lull the politicians, the public and markets into a false sense of security.
Not so sure about the point you make about raising loans. Most of the majors are buying back stock - so raising capital is clearly not a problem for them, and I've never heard any stories about smaller companies having problems raising finance through either banks or the market. In the UK there has been some localised abuse by companies claiming reserves in prospects that didn't actually exist.
Since the proposed revised rules are good for oil companies, there is scope for a quid pro quo. I'd suggest:
1) No unrealisable reserves growth numbers. Fix it so that the booked number is good for real technology and make clear the expect growth is very low. Playing games with numbers with no physical basis should be a hanging offence - we need good public figures.
2) Book the expected production rates, not just reserves. Different fields have different characteristics and its no good saying "your reserves are X billion so you can borrow Y billion against it" if the production rate is so slow that you could never pay back the credit in reasonable time. In other words shift from a reserves only figure to a production rate figure that is much more useful in future difficult fields. That would help to mitigate the silly numbers on oil shales.
One last post. One last post. One last post.
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Gary,
That was my knee-jerk reaction as well. On reflection, I think this approach is open to criticism...
Fix it so that the booked number is good for real technology and make clear the expect growth is very low
Nice idea in principle, but does anyone know what percentage of world oil and gas reserves are subject to SEC regulation? My SWAG would be in the 15% range. Aramco et al aren't answerable to regulators, and will continue to do what they want.
its no good saying "your reserves are X billion ... if the production rate is so slow that you could never pay back the credit in reasonable time.
I think that applies de facto now. The public and the op-ed scribblers might be fooled by the SEC's machinations; loan officers at commercial banks serving the energy sector are generally a bit more shrewd.
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Got them Bulletproof Car Waiting Outside Blues. Gotta head for the airport and back to my cold dark country of origin. Feliz Navidad y Prospero Año a todos. Looking forward to a white-knuckle ride in 2008.
See y'all at $150,
The Plucky Underdog
Entropy's Janitor
Hmm, evidence of the current, ongoing, credit debacle suggests they have less smarts than man on the street - seduced by big numbers and unwilling to do the work to look behind them.
As for the rest of the world not reporting to the same standards, need to take it one step at a time. First get your own house in order, then lean on the 'state secrets' crowd to be more open (probably via the UN). Hell, with the information that countries have you could probably get a good real world estimate without their cooperation - and then publishing it would shame them.
Hmm, evidence of the current, ongoing, credit debacle suggests they have less smarts than man on the street...
You might want to watch the link on money that Cherenkov posted yesterday. It's a bit long, but both entertaining and quite informative.
My take has changed on the sub-prime debacle since watching that link. If you buy into the notion that debt must continue relentlessly to drive capital markets then it's easier to see why the banks and funds went into sub-prime fairy-land. They had no other place to make loans. The U.S. has exported it's industrial base and a great deal of it's middle class jobs. Investing in China has significant repatriation issues.
So we are where we are. And the water is cold and deep.
Long overdue and does not, in my view, represent any sort of asset inflation. As long as some discipline is applied in kind to unconventional resources--principally the tar sands--it's actually a very good thing because it will help the market to price the various public and private names more rationally. Yes, investors can price in reserves long before the SEC gets around to allowing the companies to do so. However, I would remind that institutional investors often bar themselves from investing as much capital as they would like, based on just such seeming vagaries. In funds with conservative, value mandates, it will become much easier to increase positions in various oil sands companies.
Of course, for the small investor like myself, we have the advantage of being able to price in such things long before some of this type of capital arrives. In general, I would say this is a seriously good development for the Juniors. This is going to make their capital raising easier, for a host of reasons. Not least of which is that larger companies like Shell, Oxy, BP, or whomever will know they can buy a junior, and then, book the reserves.
Being able to book reserves is no small matter.
This is huge stuff.
Gregor
yup
well put
this will help juniors, as well as smaller players needing financing.
Ahhh now I understand.
Interesting.