Sam Fletcher
A new framework for assessing oil and natural gas reserves should be implemented for better estimation, increased accuracy, and improved production and income potential, said analysts in two briefing papers recently issued through the Royal Institute of International Affairs, also known as Chatham House, London.
The institute said the United Nations Framework Classification for Energy and Mineral Resources (UNFC) "offers a clear identification of the different effects of economics, project feasibility, and geology," based on professional guidelines developed by the Society of Petroleum Engineers and the World Petroleum Congress for estimating oil and gas reserves. Experts under the UN Economic Commission for Europe recently proposed a detailed method for applying that framework to petroleum, and the UN Economic and Social Council recommended in July that the method be applied in all regions.
Better understanding needed
"If the UNFC proposals were to be generally adopted, the governments and publics of countries with state [oil and gas] monopolies, as well as the international financial and trading community, would be better able to understand their own as well as the global reserves situation," said John V. Mitchell, an associate fellow with the Sustainable Development Program and author of one of the briefing papers.
He noted that national regulatory authorities in countries such as the UK, Norway, and Canada, "where petroleum resources are not exclusively in state hands," constrain private-sector procedures for estimating reserves "and publish national reserves and resource estimates whose basis is clearly explained."
Also, the US Securities and Exchange Commission (SEC) strictly defines information used to report proven reserves by companies whose securities are traded on US exchanges. However, Mitchell said, "Some 80% of the world's 'proven' oil resources are in countries where information about reserves, mainly from state monopoly companies, need not necessarily comply with such procedures. National government estimates of these countries' reserves are publicly stated (in the case of [Organization of Petroleum Exporting Countries] to the OPEC secretariat) and are collected by the commercial press."
Mitchell concluded, "The continued existence of this mixture of approaches and the absence of a clear and consistent internationally applied metric or standard create confusion and lead to misunderstanding, leaving open the potential for those wishing to take advantage of the confusion of estimates to advance their own agendas or influence policy."
Until the UNFC system is widely adopted, "especially in major oil and gas resource countries," Mitchell said, "great care needs to be exercised in interpreting numbers which purport to describe reserves of oil and gas."
Reserves definitions
Unlike estimates of oil or gas in place, which are estimates of physical measurements, oil or gas reserve estimates are "really predictions of production in the foreseeable future, combined with the record of past production, if any," said Mitchell. That requires input on economics, feasibility, and geology, he said.
"UNFC proposes that each known accumulation of oil be ranked or coded on each of these three factors, with the most favorable ranking scoring 1, so that an estimate ranking E1.F1.G1. has the highest probability (the UNFC proposes 90%) of being realized. This corresponds roughly to the traditional definition of 'proven' reserves used by SPE-WPC and others," he said. The variation in geological ranking also corresponds roughly to the traditional distinction among proven, probable, and possible reserves, he said.
Under the UNFC system, all other categories of hydrocarbons would not be part of reserves but rather would be defined as contingent or prospective resources. "Contingent resources would be discovered oil, which failed to score 1 on either the economics or feasibility code. The subcategory would lift the estimate into the class of reserves; for example, an accumulation of geology that is well-defined, scoring G1, might require a dramatic improvement in price or new technology to lift it from F3 or E3 into F1 or F2," he said.
Mitchell cited the billions of barrels of bitumen trapped in carbonate rocks under Athabasca tar sands for which "there is no known method" of recovery. An additional category is proposed for prospective resources, i.e. exploration prospects, "for which no project feasibility or economics can be defined," such as "clathrate hydrates of methane in deep ocean-bottom sediments," he said.
Like other traditional systems, the UNFC system "is designed to make very clear the degree of uncertainty about the geology underlying the estimates of reserves," said Mitchell. "But these estimates of 'recoverable' reserves involve more than scientific uncertainties. A key problem in structuring information about reserves is that relatively objective estimates of reservoir characteristics must be combined with subjective forecasts of project feasibility and commerciality.
"Some of these uncertain factors—for example, technology and cost—may be at least partly under the control of the companies, depending on their ability to maintain investor confidence for their risky development. Others, such as tax, may be under the control of governments; others, such as the climate of policy for environmental and social impacts of development, are in the wider realm of public opinion," he said.
Communicating
The second briefing paper maintains that reserves reports should reflect an oil company's underlying value better than its balance sheet.
"The balance sheet records the historical costs associated with drilling for, development of, or acquisition of oil and not the value of the oil and gas interests. The reserves disclosure, while not perfect, helps investors to fill this information gap," said Rob Arnott, a senior research fellow on oil, gas, and corporate strategy at the Oxford Institute for Energy Studies.
To help improve communication between oil companies and the financial sector, he suggests "a simple adjustment" to existing SEC disclosure that would require companies "to show in greater detail, at a field level, the level or reserves booked."
Arnott noted: "Companies will rightly respond that this reserves information is confidential or cannot be disclosed under terms of license, operating, or partner agreements. However, this is debatable when the information being disclosed is not the real 'proven plus probable' (P50) reserves estimate (it is the 'proven' or P90 reserves estimate) and the financial or fiscal terms are not being disclosed."
Given that many Western governments and nongovernmental organizations are pressing for greater disclosure of the oil industry's financial and tax payments to developing countries, Arnott said, "It might be useful for companies to disclose movements in reserves on a country-by-country basis. This would have the additional benefit of allowing investors to discriminate in more detail between the relative risks of investments in different countries. Such reserves reporting should also discriminate between oil and gas reserves."
International financial reporting standards must address whether disclosure of reserves should be supplemented with greater financial and value disclosure, he said. "In terms of the volumetric disclosure, the reconciliation of annual reserves movements already presented under US disclosure would form a strong framework from which to start."
Arenott said reserves information presented in support of financial filings should reflect consistency, transparency, and utility.
"Consistency is important so that everyone is reporting on the same basis under a clearly understood framework with maximum objectivity," he said. "Companies should provide as much transparency as possible with regard to geographical breakdown and the booking of material costs."
He said, "Consideration should be given to how investors use this reserves information and how its disclosure in financial reports should be tailored accordingly. There is a real case for companies to provide additional information beyond the 'proven' reserves definition…. This is already provided in some countries (e.g. Australia and Canada), and perhaps it is time for the SEC requirements to take this into account."