Global Technical, Financial Experts Discuss Reserves

Joel Parshall, JPT Features Editor

Some 130 persons from 20 countries participated in the first International Multidisciplinary Reserves Conference held 24–26 June in Washington, DC, a milestone in bringing together a wide range of generators and users of oil-and-gas-reserves data throughout the industry and the financial world. Attending were engineers, geoscientists, accountants, bankers, investors, policymakers, and regulators. The event was organized by SPE and the American Association of Petroleum Geologists (AAPG), and jointly sponsored by the World Petroleum Council (WPC) and the Society of Petroleum Evaluation Engineers (SPEE). Participating bodies included the Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), and United Nations Economic Commission for Europe (UNECE).

The conference followed the March release of the Petroleum Resources Management System (PRMS), developed over a 2-year period by SPE, AAPG, WPC, and SPEE, and coordinated by the SPE Oil and Gas Reserves Committee (OGRC). PRMS consolidates, builds on, and replaces guidance contained in the 1997 SPE/WPC Petroleum Reserves Definitions, the 2000 SPE/WPC/AAPG Petroleum Resources Classification and Definitions, and the 2001 SPE/WPC/SPEE Guidelines for the Evaluation of Petroleum Reserves and Resources. The major objective in developing PRMS was to enable the industry to meet the increasingly rigorous and encompassing requirements of major stakeholders spurred by technology advances, international industry expansion, and the increasing role of unconventional resources.

A “Groundbreaking” Event

In his welcoming remarks, conference Cochairperson, Mike Black, vice president, Reservoir Engineering, Greystone Oil & Gas, called the conference “groundbreaking” and “long overdue.” As a former director of SPE, Black represented the society as one of the two chairpersons of the event. He shared the podium with Pete Rose, founder of Rose & Associates and past president of AAPG. “We have, in fact, shared a vision for the common, urgent need to bring together all the stakeholders who have a vested interest in the accuracy and reliability of the oil and gas and resource data,” Black said.

Mentioning his more than 30 years in the oil industry, Black added, “It has always struck me how the simple phrase, ‘but these are proved reserves,’ can have so many different meanings to so many people.” He said that most of the audience probably agreed with him that the world faces “an impending energy crisis, in which the efficiency of global energy markets is of paramount importance. That efficiency can only be facilitated by a complete, accurate, and transparent assessment of actual energy supplies.”

Sigurd Heiberg, chairperson of the UNECE Group of Experts on the Harmonization of Fossil Energy and Mineral Resources Terminology, made a presentation on the importance that a common resource terminology holds for energy policies, government and business processes, and financial reporting. Heiberg, who is a project manager for Statoil, described the goal of “a common global terminology where the issues of communication will diminish drastically….

“There will be an increasing need,” Heiberg continued, “to view reserves as the economic products of projects rather than as properties of resource accumulations.” The classification definition ultimately adopted by industry stakeholders must reflect the full resource base, especially with the importance that today’s “contingent resources” will likely have in energy-development projects after 2030, Heiberg said. Recoverable-quantity estimates must be related directly to project costs, development time, and the willingness of host countries to accept investments, he said, and a full material balance must be provided to account for “what is produced and sold and produced and used.” The capture and storage of carbon, Heiberg noted as an example, could absorb a resource energy value of 5 to 20%.

New System Reviewed

John Ritter, chairperson of the SPE OGRC and a member of the AAPG Committee on Resource Evaluation, reviewed the revised PRMS reserves definitions. Ritter, senior director, Worldwide Reserves and Reservoir Engineering, Occidental Petroleum, explained, “This system is project-based; classification and categorization are separated; it is based on the evaluated forecast of future conditions; and it also applies to unconventional resources.” Ritter also said, PRMS

Affords users greater granularity, the ability to move to more-detailed levels of information or to alternative classification and identifying systems for internal analysis
Allows the use of either deterministic or probabilistic calculation methods
Formalizes and defines more fully the categories of proven, probable, and possible reserves (termed 1P, 2P, and 3P reserves, respectively)
Provides a new definition of contingent resources

Education programs on PRMS through its sponsoring bodies are planned around the world, and an implementation guide will be developed (probably a multiyear project). Discussions have been held with the UN and the Committee for Mineral Reserves International Reporting Standards on potential harmonization with their standards. “There is a lot of work in trying to recognize and bring together the similarity between these different standards,” Ritter said.

Jim Ross, a consultant on oil and gas reserves/resource evaluation, classification, and reporting issues, gave a talk titled “Putting Numbers on Fugitive Liquids—How Reserves and Resources Estimates Are Derived.”

Ross emphasized that no matter how thoroughly reserves and resources estimates are made, they are to some degree uncertain. “You cannot communicate information about uncertainty with a simple number. It is not possible,” Ross said. Reserves estimates for specific projects generally depend on the project’s design because the recovery depends on that design, he noted. “Reserves are the summation of a production forecast up to some limit, economic, technical, or contractual,” Ross said. “They are not hydrocarbons in place times recovery efficiency. I hope they are not, anyway. For reserves, we need forecasts because we need production forecasts; we need cost forecasts to go with them, otherwise we can’t do the economics.”

Estimation tools can include analogs; volumetric calculation methods; and production-performance, material-balance, and decline-curve analyses. “We use different techniques at different stages in the life of a project,” Ross said. “But quite often we can use more than one technique at any one time. And where we can, we should…. We get more confidence in what we’ve done.”

Discussing the PRMS reserves categories, Ross said, “The low estimate is proved (P), the best estimate is 2P, proved plus probable; and the high estimate is 3P, proved plus probable plus possible. Why do we call the middle one the best estimate? [Because] the right answer is more likely to be close to that number than it is to the other numbers.” The US Securities and Exchange Commission (SEC) has restricted public companies to publishing proved reserves in their annual reports. (Ross said in a later question-and-answer period that he believed the US is the only country to impose this restriction.) Under Canadian rules, he noted, most companies report proved and probable reserves; if companies choose, they can report possible reserves, as well as contingent resources and prospective resources.

“The first thing you need to know when you look at a reserve number, and this is a problem I find here in the US,” Ross said, “is that you're so focused, rightly so, on the proved-reserve number…you sometimes forget that there is a difference between proved reserves and just reserves.” People who say reserves often mean proved reserves, Ross said, and “you have to be careful because that’s just the low estimate.”

Reserves Estimation a Science

Ron Harrell, chairperson of the Joint Commission on Reserves Evaluators Training (JCORET) established by AAPG, SPE, WPC, and SPEE, spoke on qualifications and standards for reserves evaluators and auditors. Harrell, who is chairman emeritus of Ryder Scott, said it bothers him a bit when people ask if reserves estimation is an art or a science. “I know some well-meaning people who say, well, it’s kind of an art, not a science,” he said. “Folks, it’s a science.” The people who apply this science are professional evaluators, Harrell said, “and I underline that professional. We're not just the bean counters; we are evaluators. We are trained to do what we do. We may never have all the data that we would like to have, but it is our job to estimate quantities, volumes, and values as best we can as professionals.”

Harrell emphasized that evaluators must be responsible for obtaining the training they need to stay current in their profession. Although they may be able to get that training from or through their employers, the caliber of training available can vary considerably, he noted, and many evaluators throughout the world have not had access to the training they need. To remedy this, the four professional organizations sponsoring JCORET have initiated low-cost training programs offered worldwide and plan to meet ongoing needs through further program development and availability. To be sanctioned by JCORET, all training modules must first be approved by the committee’s sponsoring organizations, Harrell said.

Bob Garnett, board member, IASB, discussed the status of the IASB project on accounting for oil and gas reserves. IASB and FASB, Garnett noted, have been conducting joint research for some years to bring closer together the IASB’s International Financial Reporting Standards (IFRS), widely used around the world, and the US Generally Accepted Accounting Principles (GAAP). The goal is to base both sets of standards on the same principles so that the two “are in some measure interchangeable for companies seeking listings in other than their own jurisdiction,” he said.

Garnett viewed as significant that the SEC recently announced its intent to issue rules requiring companies registered with the commission from a foreign domicile to use IFRS as their sole primary financial reporting regime. Garnett mentioned the progress of Canada and Russia in spreading IFRS within their financial-services sectors and among listed companies more widely, and cited China as having committed to aligning its accounting principles with those of IASB. A tentative accounting standard for the extractive industries, covering reserves, is targeted for 2012, he said.

A major long-term question Garnett discussed was whether reserves and resources should “be recognized and measured on the balance sheet.” In most respects, they are not. However, they are effectively recognized when one company acquires another, he emphasized, as values are attributed to reserves at the point of acquisition—although not modified subsequently. Were reserves and resources to be listed on balance sheets generally, a number of questions would need to be answered, Garnett observed. “Should we value them at fair value? Should we value them at their historical cost? Should we find some other basis to do that?...We don’t know what the answer is at the moment.” More broadly, IASB and FASB need to determine whether the reserves information needed by investors is something “capable of being audited,” Garnett said. “Is it something that can be contained within the financial statements themselves, or is it something that should be positioned outside the financial statements, in the MD&A [management discussion and analysis] for example?”

Unconventional Resources

David Elliot, chief petroleum adviser, Alberta Securities and Exchange Commission, gave a perspective on dealing with unconventional reserves and resources. “The system we have had in place for the last 40 years for our disclosure is built on an oil-and-gas classification system very similar to PRMS,” he noted.

Generally, the salient features of conventional hydrocarbons, Elliot explained, are “hydrodynamic emplacement and trapping controlled by local stratigraphy.” This local stratigraphic control means that reservoirs typically have defined limits, with characteristics such as a hydrocarbon/water contact and cap rock. “Basically, oil and gas bubble up until something stops them,” he said. “This leads to discrete fields…. But what about when we turn to unconventional resources? Trapping is not hydrodynamic. It is controlled by regional stratigraphy, not local. This leads to what are sometimes called continuously dispersed accumulations. They cover huge areas very often and have poorly defined limits so there are typically no discrete fields, except that sometimes the word field is used to mean an administrative unit.”

For conventional resources, Elliot said, “The key factor is typically exploration discovery.” A well is drilled, logged, and maybe cored; while a decision may be needed on whether to stimulate the well, he said, “typically, productivity is fairly easy to establish.” For unconventional resources such as bitumen and coalbed methane, Elliot noted, the priorities are reversed. “Typically, you know where it is….The real key is productivity. Can you produce it?” he said. To answer that question may require years of detailed geologic studies and great expense, including numerous wells drilled with long periods of testing and possibly pilot projects. “The current PRMS definition for a known accumulation doesn’t make an allowance for analogs,” Elliot said. “We have a definition in Canada that does; that may be an area that needs some attention.”

Elliot also questioned how to define the limits for determining reserves in unconventional accumulations. “With a conventional accumulation, you’re dealing with discrete pools,” he said. “But in an unconventional accumulation, how far can you step out from a well? Well the modern rule of thumb is one spacing unit. I would certainly ask questions if people went out more than one spacing unit. But maybe you could go out two for some probable reserves, maybe another one for possible reserves. How does that apply to unconventional hydrocarbons? I think that depends on how far you can extrapolate productivity, not presence. That’s a tricky one. I don’t have answers for that.”

P.H. (Pete) Stark, vice president, Industry Relations, IHS, gave a presentation titled “Perspectives on International Oil and Gas Reserves Reporting Practices.” He outlined the methods by which his company develops and tracks technically recoverable resources, using the term resources to distinguish them from the term reserves as used by SEC. Starting with the best historical annual liquids- and gas-production data that could be obtained for each country, a field-by-field database has been built. Using a “bottom up” approach, Stark said, estimates of proved and probable resources have been made on a field and countrywide basis. Yearly production totals have been subtracted from these estimates on an ongoing basis, while yearly resources coming from new-discovery development have been added continually to keep the database current. Analysis of timing as well as volumes on discovery-development activity enables assessment of their impact on future supplies.

In a number of cases, significant differences have emerged between these field-by-field numbers built into this database for each country and the countries’ official reserves statements. In this connection, Stark noted that for 68% of the 98 countries reporting proved reserves, the figures did not change between 2004 and 2005. For 17 of those countries, he added, the figures have not changed in 15 years. “This is a part of the lack of transparency, the lack of consistency, that brings a lot of uncertainty, and in essence distrust, about what these numbers mean,” Stark said.

Reporting From Different Jurisdictions

Mike Adams, reserves officer, Talisman Energy, Calgary, presented a talk on reserves reporting from different jurisdictions, a responsibility his company shoulders as an international independent with operations in Canada, the US, Europe, North Africa, East Asia, and Australia. Listed in Toronto and New York, the company must comply with Canadian and US securities regulations. As the SEC definition of proved reserves must be used in its US filing, Adams noted, Talisman uses this definition when reporting proved reserves in other jurisdictions, and proved reserves growth per share is a key metric that the company uses internally and externally. Talisman also reports its probable reserves where rules allow and uses the PRMS definition.

“It’s clear that to be credible to the markets…they need to see that we have a well-defined process that has a lot of proper governance in place,” Adams said. Furthermore, determining reserves should not be a year-end exercise but part of the business process, he emphasized. “We work with a full spectrum of resources,” Adams added, “so even though we only disclose proved and probable, we have possible reserves estimated for all our international assets; we have a list of contingent resources, and we have a list of exploration prospects—prospective resources. That’s needed to do our long-range planning.” Very recently, Talisman started to disclose some contingent-resource estimates, and Adams believes this will be a growing trend among companies, particularly in North America.

Michael Lynch-Bell, leader of Ernst and Young’s Global Oil and Gas Transaction Advisory Practice, London, discussed the value that consistent reserves and resources measures bring to merger-and-acquisition transactions. He is an ad hoc expert for the UN Framework Classification Committee and sits on the advisory panel of IASB’s extractive activities research project. “I am an accountant,” Lynch-Bell said. “I’m one of these simple souls who is desperate to understand the science you purvey. But no matter how many events like this I attend, I still believe in a single number. And lots of users still believe in the single number, so when you see a report that a 500-million-barrel oil field has been discovered. You believe it. So I think there is a lot of work to be done in terms of ensuring that people do understand and continue to understand the range of uncertainties that exist.”

Lynch-Bell said it is essential to have “full, transparent disclosure of the assumptions used” in determining reserves and resources. “There are benefits from consistent and comparable data, as long as that consistent information meets the needs of users,” he said, noting that reserves and resources, along with key financial estimates, are fundamental to anyone evaluating a company. “Certainly a consistent framework would be a major step forward,” Lynch-Bell said.

Lynn Hughes, US District Judge, Southern District of Texas, gave a presentation titled “Legal and Ethical Consequences of Reporting Uncertain Assets: A Spectrum of Behaviors and Remedies.” His wide-ranging talk covered Enron and a number of other prominent, recent corporate scandals that involved misleading regulators, markets, and the public about major asset values. “Technical competence does not replace ethical integrity,” Hughes said. A successful society must be based on rule of law, including respect for regulations and strong personal and corporate responsibility for honest reporting and disclosure, he emphasized. “Lying requires a reason,” Hughes said. “Telling the truth does not.” As much as it is a company responsibility to maintain a climate of honest, ethical practices throughout its business, individuals still have to be willing to resist any pressure from above to misrepresent the valuations stated to investors, regulators, and others, Hughes said. Many cases of major wrongdoing, he noted, have stemmed from “honest men doing something out of character.”

The conference included eight breakout sessions on reserves-evaluation topics dealing with evaluator training; market valuations; probabilistic methods; unconventional resources; resolving different definitions; PRMS and regulatory disclosures; legal, ethical, and reputational issues; and accounting measures vs. running-the-company measures. Brief summaries, along with recommendations from each breakout, were presented in a plenary session on the final afternoon.

Specified Confidence Levels Needed

A far-reaching recommendation came from Rose, conference cochairperson and leader of the breakout session on probabilistic methods. Citing subjective terms such as “reasonably certain” [used in the definition of proved reserves—i.e., an estimate of future production that the estimator is reasonably certain will be reached or exceeded], Rose said, “E&P must adopt specified confidence levels [probabilities] for key metrics versus subjective terminology. Otherwise, estimators can-not improve their estimation skills.”

Other conference speakers included Pierce Riemer, director general, WPC; Abdul-Jaleel Al-Khalifa, 2007 SPE president; Scott Tinker, 2007–08 president-elect, AAPG; Tim Smith, 2007 president, SPEE; Clark Talkington, economic affairs officer, Sustainable Energy Division, UN; and Glenn Brady, project leader, extractive activities research project, IASB.

SEC Chairman Christopher Cox attended an evening reception at the conference on 25 June. During brief informal remarks to the conference participants and a question-and-answer period, Cox said he welcomed the interest and views of the industry on subjects such as those under discussion at the conference and praised the participants for their efforts to improve and unify definitions and standards related to reserves, as well as promote harmonization of accounting principles and overall business and financial transparency globally. The chairman was asked about a job advertisement that SEC has recently placed to attract applicants for a new “academic petroleum-engineering fellowship” at the commission, for which applicants need to have significant reservoir-engineering experience, “expertise in petroleum-reserves estimation,” and familiarity with “modern reservoir-assessment methods.” Cox said that with the increasing prominence of energy issues, the commission was interested in building its expertise on important oil and gas subjects.

Cox also encouraged the industry to use a new interactive financial-reporting tool written in a computer language called XBRL, which the SEC is making available as an optional means of electronically filing financial reports.

Earlier, John White, director, SEC Corporate Finance Division, addressed conference participants in a luncheon presentation and focused heavily on the advantages of XBRL filing, citing the ease and the savings in time and expense achievable by using the system. Because it is interactive, it enables users of the SEC website to compare key metrics of multiple companies (filing with the system) on the same screen. Also, because use of this system is completely voluntary, companies are free to publish information above and beyond their SEC filings and provide it even if they handle their required filings through other means.

At the end of the conference the following day, Bob Eccles, managing director of Perception Partners and a leader of one of the breakout sessions, strongly recommended that conference participants urge their companies’ financial organizations to participate in the voluntary XBRL program. Not only would it be a good way to disclose a wider range of reserves and resources information in an SEC environment, but it would probably put the companies in a good position to have joined this effort voluntarily, should the XBRL filing method eventually be made mandatory.

White, in his luncheon talk, referred to the aforementioned SEC decision to have foreign-domiciled issuers use the IFRS reporting regime without needing to reconcile it with GAAP. A coming development, he said, could be US companies having the option of using IFRS instead of GAAP.