Revisions to Regs on Proven Reserves

[oddlots]

Just starting to read this so a bit pre-mature to post but strikes me as significant and comes very highly recommended by an analyst I respect. Here's the intro:

My purpose is to alert you to revision of SEC Regulation S-K and Regulation S-X effective January 1, 2010. Concealed in a handful of benign new regs is a financial truck bomb that's going to blow away "proved reserves" as a meaningful metric of oil company assets.

Old definition: Proved Reserves are those quantities which can be estimated with reasonable certainty to be commercially recoverable from known reservoirs under defined economic conditions. Proved quantities arelimited by the lowest known hydrocarbon as seen in a well penetration unless otherwise indicated by definitive geoscience, engineering, or performance data. Seismic data alone is not sufficient to define fluid contacts. Undeveloped locations may be classified as Proved in undrilled areas of a reservoir that can be judged with reasonable certainty to be commercially productive.

New definition: Industry is no longer constrained by the criterion of certainty. An operator can book incremental proved reserves from planned enhanced recovery projects (gas injection, acid fracturing) based on a pilot project. Coal seam gas, bitumen, oil shale and other unconventional resources can be booked as Proved Reserves. Estimated reservoir properties in the aggregate is a departure from the old rules. The new SEC definition does not require that an analogous reservoir has to be in the immediate area or in pressure communication. Seismic analysis and reservoir models are sufficient to book Proved Reserves.

Hold on to your shorts, it gets worse.

Under the new SEC rules you don't have to drill a well and actually produce oil. An operator can establish levels of lowest known hydrocarbons and highest known oil through "reliable technology" other than well penetrations. It doesn't have to be 90% reliable or widely accepted by industry peers...

You can get the full paper here:

http://incakolanews.blogspot.com/200...ad-on-oil.html

If our banks don't actually have to be solvent to do business, why should our oil and gas companies actually have to have any reserves?

[Adeptus]

Re: Revisions to Regs on Proven Reserves

So just to be clear, this will translate into...

1. Every oil drilling corp or oil land owners re-adjusting their "proven" reserves way upwards
2. The price of oil goes down because there is now much supposed reserves available.
3. When the 'proven' reserves are found to be as proven as BRE-X, the market panics and we see a skyward shoot in the price of oil

Now who's clairvoyant enough to know the dates and place bets against the events?

Adeptus

[oddlots]

Re: Revisions to Regs on Proven Reserves

I agree that what's imparted here isn't necessarily actionable but I thought it was useful:

- a good, unedited window into the practitioner's world (the snark is kind of the point)
- offered a good case study of how contentless, statistical arguments (subprime anyone?) can be extended into other fields to feed the beast of stock promotion
- while not a surprise to anyone here, the SEC getting behind it in this case should inoculate the reader against hype to come
- the case study of Petrobras's success as a result of creative financing (off balance sheet accounting) I thought was a useful antidote to peak-oil inspired bias toward investment success (you don't know why you've been lucky)

I have no idea how to trade it but I don't think that's the only value on offer, at least for non-insiders.

[GRG55]

Re: Revisions to Regs on Proven Reserves

...If our banks don't actually have to be solvent to do business, why should our oil and gas companies actually have to have any reserves?

Exactly. If the banks don't have to "mark to market", why should the oil companies? :rolleyes: :p

I agree that what's imparted here isn't necessarily actionable but I thought it was useful:

- a good, unedited window into the practitioner's world (the snark is kind of the point)
- offered a good case study of how contentless, statistical arguments (subprime anyone?) can be extended into other fields to feed the beast of stock promotion
- while not a surprise to anyone here, the SEC getting behind it in this case should inoculate the reader against hype to come
- the case study of Petrobras's success as a result of creative financing (off balance sheet accounting) I thought was a useful antidote to peak-oil inspired bias toward investment success (you don't know why you've been lucky)

I have no idea how to trade it but I don't think that's the only value on offer, at least for non-insiders.

It's mostly going to benefit the "unconventional resource" plays such as [ta da] shale gas. Also shale oil and bitumen/oil sands. Some of what was "resource" can now be moved into reserves, apparently.

Seems like a convenient way to put a wooden stake through the heart of Peak Oil, eh...

[jk]

Re: Revisions to Regs on Proven Reserves

Exactly. If the banks don't have to "mark to market", why should the oil companies? :rolleyes: :p



It's mostly going to benefit the "unconventional resource" plays such as [ta da] shale gas. Also shale oil and bitumen/oil sands. Some of what was "resource" can now be moved into reserves, apparently.

Seems like a convenient way to put a wooden stake through the heart of Peak Oil, eh...

if the banks mark-to-myth financial assets which turn out to be worthless, the fed can always print more money to top up bank reserves. if the oil companies' reserves turn out to be myth, we can always top up our gas tanks by... umm....

[GRG55]

Re: Revisions to Regs on Proven Reserves

if the banks mark-to-myth financial assets which turn out to be worthless, the fed can always print more money to top up bank reserves. if the oil companies' reserves turn out to be myth, we can always top up our gas tanks by... umm....

Point taken.

But this is in all respects another FIRE economy financial event [with the SEC involved, none of us are likely surprised by that :p].

Production supports debt servicing ability in a resource company, of course. This is one of the reasons that so many of the now debt-laden shale gas players are compelled to keep drilling...it's like running on a treadmill that you can't get off of. The high decline rates of the wells that were previously financed means more and more wells have to be drilled to maintain the cashflow...especially in a falling commodity price environment, as we've experienced in natural gas. Try to slow down, or stop, and you're dead.

The balance sheets of resource companies, on the other hand, are backed by the reserves it holds. So we have the interesting situation that by expanding/relaxing the definition of reserves it potentially opens the door for the companies with these big unconventional resources to expand their credit [and maybe goose their stock price too]. Not too difficult to see where this can lead.

Having said that, the old rules for reserves were not perfect...companies with legitimate long life reserves, such as say 50 years of oil sands production at zero decline, were handicapped by the old SEC rules which were geared around an annual economic test based on Dec 31 prices [which played havoc with reserves bookings from year to year, even though the company's operations may not have changed one iota].

Be careful out there...

[jk]

Re: Revisions to Regs on Proven Reserves

Point taken.

But this is in all respects another FIRE economy financial event [with the SEC involved, none of us are likely surprised by that :p].

Production supports debt servicing ability in a resource company, of course. This is one of the reasons that so many of the now debt-laden shale gas players are compelled to keep drilling...it's like running on a treadmill that you can't get off of. The high decline rates of the wells that were previously financed means more and more wells have to be drilled to maintain the cashflow...especially in a falling commodity price environment, as we've experienced in natural gas. Try to slow down, or stop, and you're dead.

The balance sheets of resource companies, on the other hand, are backed by the reserves it holds. So we have the interesting situation that by expanding/relaxing the definition of reserves it potentially opens the door for the companies with these big unconventional resources to expand their credit [and maybe goose their stock price too]. Not too difficult to see where this can lead.

Having said that, the old rules for reserves were not perfect...companies with legitimate long life reserves, such as say 50 years of oil sands production at zero decline, were handicapped by the old SEC rules which were geared around an annual economic test based on Dec 31 prices [which played havoc with reserves bookings from year to year, even though the companies operations may not have changed one iota].

Be careful out there...

i used to say that watching the economy was like watching a slow motion train wreck, unable to intervene and horrified by the devastation. now i'm starting to think it's like watching a slow motion robbery, or the sacking of a city, in which looters walk away with the spoils, dismembering the infrastructure which allows the city to function so that they can sell pieces of pipe as salvage.

[WildspitzE]

Re: Revisions to Regs on Proven Reserves

To your points above, the looting is rampant and most successful when information asymmetry exists. These new regs create much of such, allowing people in the know to get in cheap on over supply before people realize that the gas tank is getting nothing but fumes. This is another reason why a peak cheap oil investment thesis needs to be a thorough one, it will be a roller coaster.

economic parasitism 101: information asymmetry rules, be in the flow.

[Jay]

Re: Revisions to Regs on Proven Reserves

i used to say that watching the economy was like watching a slow motion train wreck, unable to intervene and horrified by the devastation. now i'm starting to think it's like watching a slow motion robbery, or the sacking of a city, in which looters walk away with the spoils, dismembering the infrastructure which allows the city to function so that they can sell pieces of pipe as salvage.

What a great post jk.

[Jay]

Re: Revisions to Regs on Proven Reserves

To your points above, the looting is rampant and most successful when information asymmetry exists. These new regs create much of such, allowing people in the know to get in cheap on over supply before people realize that the gas tank is getting nothing but fumes. This is another reason why a peak cheap oil investment thesis needs to be a thorough one, it will be a roller coaster.

economic parasitism 101: information asymmetry rules, be in the flow.

Hudson likes to say that your money will be taken one way or the other by those who run the show. That always stuck with me.

[Rajiv]

Re: Revisions to Regs on Proven Reserves

Excellent paper here - The Tragedy of the 21 Darts (pdf)

This is a long article on the subject of oil & gas reserves and due diligence.

My purpose is to alert you to revision of SEC Regulation S-K and Regulation S-X effective January 1, 2010. Concealed in a handful of benign new regs is a financial truck bomb that's going to blow away "proved reserves" as a meaningful metric of oil company assets.

Old definition: Proved Reserves are those quantities which can be estimated with reasonable certainty to be commercially recoverable from known reservoirs under defined economic conditions. Proved quantities are limited by the lowest known hydrocarbon as seen in a well penetration unless otherwise indicated by definitive geoscience, engineering, or performance data. Seismic data alone is not sufficient to define fluid contacts. Undeveloped locations may be classified as Proved in undrilled areas of a reservoir that can be judged with reasonable certainty to be commercially productive.

New definition: Industry is no longer constrained by the criterion of certainty. An operator can book incremental proved reserves from planned enhanced recovery projects (gas injection, acid fracturing) based on a pilot project. Coal seam gas, bitumen, oil shale and other unconventional resources can be booked as Proved Reserves. Estimated reservoir properties in the aggregate is a departure from the old rules. The new SEC definition does not require that an analogous reservoir has to be in the immediate area or in pressure communication. Seismic analysis and reservoir models are sufficient to book Proved Reserves.

Hold on to your shorts, it gets worse.

Under the new SEC rules you don't have to drill a well and actually produce oil. An operator can establish levels of lowest known hydrocarbons and highest known oil through "reliable technology" other than well penetrations. It doesn't have to be 90% reliable or widely accepted by industry peers. It can be AVO bright spots, or a fuzzy patch of seismic that could conceivably be a mud volcano, or the ridiculous Russian hokum of "passive" hydrocarbon indicators. You don't even have to explain exactly what your technology does, if it's proprietary and trade secret.

We [the SEC] proposed to define the term ‘‘reliable technology,’’ expressed in probabilistic terms, as technology that has been proven empirically to lead to correct conclusions in 90% or more of its applications. Several commenters expressed concern that this proposed 90% threshold would be difficult to verify and support on an ongoing basis. We agree that a bright line test would be difficult to apply to a particular technology or mix of technologies to determine their reliability. Therefore, we are not adopting the 90% threshold as part of the definition... The proposal also would have required reliable technology to be ‘‘widely accepted.’’ However, some commenters were concerned that this requirement would exclude proprietary technologies that companies develop internally that have proven to be reliable. We concur with these commenters and have removed the ‘‘widely accepted’’ requirement from the final rule.” [Federal Register Vol. 74, No. 9, p 2166]

Who were the commenters in favor of playing dueces wild? Basically everybody. Oil companies, professional groups like SPE and AAPG, consultants, academics, Wall Street speculators and Bush Administration lawyers.

Why? -- because the Shell reserves fraud made them duck and cover.
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[oddlots]

Re: Revisions to Regs on Proven Reserves

Well Rajiv, I'll take that as a compliment: you've just referenced the same paper that started the thread.

[Rajiv]

Re: Revisions to Regs on Proven Reserves

Yes indeed! But I did think that a more direct link was needed -- as the responses indicated that the original paper had not been read! I am also surprised that this has not been commented on more widely -- at least I haven't come across it, other than your original citation, and now on the Oil Drum.