Society of Petroleum Engineers PetroTech Study Group, Gulf Coast Section You Asked for Change, and Y

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Society of Petroleum EngineersPetro-Tech Study
Group, Gulf Coast SectionYou Asked for Change,
and You Got ItThe New SEC Reserves Definitions

• Stuart L. Filler
• Senior Staff Reservoir Engineer
• Southwestern Energy Company
• November 10, 2009

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Disclaimer

• The information contained herein is for
  informational purposes only and is not to be
  considered definitive by the presenter(s),
  Southwestern Energy Company, or any organization.
  The sole purpose is to present information
  considered to be recognized as generally accepted
  reserves evaluation practices for the types of
  examples presented herein. This information may
  not be appropriate for all types of petroleum
  reserves and resources estimates.
• The presenter(s) and supporting organization(s)
  do not accept any liability for the consequences
  arising from the application, use, or misuse of
  any information contained herein, including any
  actual, nominal, consequential, or punitive
  damages, direct or indirect.

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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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Introduction

• After reserves train wrecks of 2004 SEC staff
  increased surveillance and implemented more
  stringent controls on reserves estimates in
  financial disclosures with the SEC.
• This increased scrutiny soon showed
  inconsistencies in the old SEC definitions that
  were promulgated in 1978.
• Reliance on flow tests to surface
• One-offset rule.
• Ignoring high-quality seismic data.
• Ignoring other new technology that has enhanced
  reservoir description and increased reserves
  reliability.

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Introduction

• After many industry conferences (including The
  Energy Forum series, Cambridge Energy Research
  Associates reserves workshops, and the SPE/AAPG
  Interdisciplinary Reserves Conference), SEC
  issued a Concept Release on possible revisions to
  the disclosure requirements relating to oil and
  gas reserves on December 12, 2007.
• Comments on the Concept Release led to Proposed
  Rules issued June 26, 2008.
• These proposals led to the issue of Final Rules
  on December 31, 2008.
• At the time of preparation of this talk, FASB had
  issued a draft Topic 932 Extractive Industries
  Oil and Gas, for comment.

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Introduction

• Topic 932 implements the new reserves definitions
  and disclosure requirements in the SEC Final
  Rules only proved reserves are addressed for
  accounting issues.
• Comments on the Topic 932 were due October 15,
  2009.
• These proposals led to the issue of Final Rules
  on December 31, 2008.
• SEC has issued new guidance on October 26, 2009,
  to conform to the new definitions.

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Introduction

• It is important to remember the practical
  definition of reserves
• Reserves are estimated quantities of hydrocarbons
  upstream of the well-head which are expected to
  be produced in the future.
• Hydrocarbons located downstream of the wellhead
  are considered to be production.
• Net reserves reflect entitlement to reserves
  upstream of the wellhead through lease ownership.
• Entitlements to reserves downstream of the
  wellhead cannot exist.
• IRS v. Amoco - Windfall Profits case.

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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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SEC Proved Reserves Definitions (1978)

• Regulation S-X, 210.4-10(a)
• 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. Prices include consideration of changes
  in existing prices provided only by contractual
  arrangements, but not on escalations based upon
  future conditions.

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SEC Guidance (for 1978 Rules)

• 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.
• We will see that a similar statement has been
  made in the new definitions, but the new
  definitions are explicit that the concept applies
  to estimated ultimate recovery (EUR).

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SEC Proved Reserves Definitions (1978)

• Reservoirs are considered proved if economic
  producibility is supported by either
• Actual Production or
• Conclusive Formation Test.
• The area of a reservoir considered proved
  includes
• That portion delineated by drilling and defined
  by gas-oil and/or oil-water contacts, if any and
• The immediately adjoining portions not yet
  drilled, but which can be reasonably judged as
  economically productive on the basis of available
  geological and engineering data.
• In the absence of information on fluid contacts
• The lowest known structural occurrence of
  hydrocarbons controls the lower proved limit of
  the reservoir.

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SEC Proved Reserves Definitions (1978)

• Reservoirs which can be produced economically
  through application of improved recovery
  techniques (such as fluid injection) are included
  in the proved classification when
• Successful testing by a pilot project or
• The operation of an installed program in the
  reservoir.
• Provides support for the engineering analysis on
  which the project or program was based.
• N.B. The support must be through production
  response.

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SEC Proved Reserves Definitions (1978)

• Estimates of proved reserves do not include the
  following
• Oil that may become available from known
  reservoirs but is classified separately as
  indicated additional reserves
• Crude oil, natural gas, and natural gas liquids,
  the recovery of which is subject to reasonable
  doubt because of uncertainty as to geology,
  reservoir characteristics, or economic factors
• Crude oil, natural gas, and natural gas liquids,
  that may occur in undrilled prospects
• Crude oil, natural gas, and natural gas liquids,
  that may be recovered from oil shales, coal,
  gilsonite, and other such sources.

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Proved Developed Reserves (1978)

• Reserves that can be expected to be recovered
  through existing wells with existing equipment
  and operating methods.
• Additional oil and gas expected to be obtained
  through the application of fluid injection or
  other improved recovery techniques for
  supplementing the natural forces and mechanisms
  of primary recovery should be included as proved
  developed reserves only after testing by a pilot
  project or after the operation of an installed
  program has confirmed through production response
  that increased recovery will be achieved.

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Proved Undeveloped Reserves (1978)

• Reserves that are expected to be recovered from
  new wells on undrilled acreage, or from existing
  wells where a relatively major expenditure is
  required for recompletion.
• Reserves on undrilled acreage shall be limited to
  those drilling units offsetting productive units
  that are reasonably certain of production when
  drilled.
• Proved reserves for other undrilled units can be
  claimed only where it can be demonstrated with
  certainty that there is continuity of production
  from the existing productive formation.
• Under no circumstances should estimates for
  proved undeveloped reserves be attributable to
  any acreage for which an application of fluid
  injection or other improved recovery technique is
  contemplated, unless such techniques have been
  proved effective by actual tests in the area and
  in the same reservoir.

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SEC Proved Reserves Categories

• Proved
• Developed
• Undeveloped
• The SEC does not split the Developed reserves
  classification into producing and nonproducing
  segments.
• This does not change under the new definitions.

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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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Release 33-8995 Modernization of Oil and Gas
Reporting

• Issued December 31, 2008.
• Complete revision of Regulation S-X 4-10(a).
• Meant to provide investors with more meaningful
  and comprehensive understanding of oil and gas
  reserves.
• Result of work primarily by Dr. John Lee of Texas
  AM University, who was appointed the Academic
  Engineering Fellow with the SEC for a year.
• Effective date is January 1, 2010.
• Year-end 2009 10-K report must follow these new
  definitions.

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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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Current SEC Reserves Definitions

• Major changes include
• Definition of proved reserves, especially
  criteria used to assess and quantify resources
  that can be classified as proved reserves.
• Expand categories of reserves that may be
  disclosed.
• Change pricing used in estimating reserves.
• Allow use of reliable technology in estimating
  reserves.
• Require discussion of internal controls
  applicable to reserves estimation process.
• Expand activities that are classified as oil and
  gas producing activities.
• Increase geographic disclosures where reserves
  are material to a company. (Countries with 15 or
  more of entitys net reserves must be disclosed
  separately.)

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Current SEC Reserves Definitions

• The SEC now has a glossary and defines the term
  reserves as well as other terms.
• Definition of Reserves
• Reserves are estimated remaining quantities of
  oil and gas and related substances anticipated to
  be economically producible, as of a given date,
  by application of development projects to known
  accumulations. In addition, there must exist, or
  there must be a reasonable expectation that there
  will exist, the legal right to produce or a
  revenue interest in the production, installed
  means of delivering oil and gas or related
  substances to market, and all permits and
  financing required to implement the project.

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Current SEC Reserves Definitions

• Definition of Proved Reserves
• Proved oil and gas reserves are those quantities
  of oil and gas, which, by analysis of geoscience
  and engineering data, can be estimated with
  reasonable certainty to be economically
  producible from a given date forward, from
  known reservoirs, and under existing economic
  conditions, operating methods, and government
  regulations prior to the time at which
  contracts providing the right to operate expire,
  unless evidence indicates that renewal is
  reasonably certain, regardless of whether
  deterministic or probabilistic methods are used
  for the estimation. The project to extract the
  hydrocarbons must have commenced or the operator
  must be reasonably certain that it will commence
  the project within a reasonable time.

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Current SEC Reserves Definitions

• SEC defines reasonable certainty as a high degree
  of confidence that the quantities will be
  recovered.
• This means that, as new data becomes available,
  the EUR is much more likely to increase or remain
  constant than to decrease.
• The ultimate test of reasonable certainty is
  reservoir performance.
• If performance does not support calculation
  method, the results must be analyzed and revised
  to meet the reserves indicated by that
  performance. The following slide shows reserves
  that are not reasonably certain.

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Performance versus Volumetrics
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Current SEC Reserves Definitions

• The two calculation methods mentioned are defined
  as
• Deterministic Method
• A single best estimate of reserves is made based
  on known best estimates of geological,
  engineering and economic data.
• Probabilistic Method
• Estimated distributions of geological,
  engineering, and economic data are used to
  generate a range of reserves estimates and their
  associated probabilities.

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Current SEC Reserves Definitions

• Proved undeveloped reserves must now meet the
  criterion of reasonable certainty for all
  distances from producing wells, not absolute
  certainty for those more than one offset location
  from a producing well.
• Continuity can be established through reliable
  technology.
• Reliable technology is a grouping of one or more
  technologies (including computational methods)
  that has been field tested and has been
  demonstrated to provide reasonably certain
  results with consistency and repeatability in the
  formation being evaluated or in an analogous
  formation.

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Current SEC Reserves Definitions

• Reporting of Unproved Reserves
• The SEC now permits reporting of probable and
  possible reserves in addition to proved reserves.
• These categories are optional.
• Both categories are related to areas of
  reservoirs or other factors in reserves estimates
  that do not meet the reasonable certainty
  criteria for proved reserves.
• Either deterministic or probabilistic methods may
  be used to calculate these quantities.

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Current SEC Reserves Definitions

• Reserves Categories
• Category Descriptive Term
• Proved Reasonable certainty
• Probable As likely to be recovered as not
• Possible Less likely than probable
• Contingent Resources Not allowed in
  disclosures
• Prospective Resources Not allowed in
  disclosures

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Current SEC Reserves Definitions

• Probabilistic Estimates
• Probability of Achieving or
  Exceeding Estimated
• Category Recovery
• Proved (1P) 90
• Proved Probable (2P) 50
• Proved Probable Possible (3P) 10

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Current SEC Reserves Definitions

• A major (and welcome) change is the application
  of oil and gas prices to the reserves estimate.
• Existing economic conditions are defined in the
  glossary under the term Proved oil and gas
  reserves
• Prices shall be the average prices during the
  12-month period prior to the ending date of the
  period covered by the report, determined as an
  unweighted arithmetic average of the
  first-day-of-the-month prices for each month
  within such period (unless defined by contract).
• Costs continue to be an average of the previous
  years costs unless known events that have
  occurred or are reasonably certain to occur are
  documented.

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Current SEC Reserves Definitions

• The company filing must now disclose and describe
  the internal controls it uses in its reserves
  estimation effort.
• This includes disclosing the qualifications of
  the technical person primarily responsible for
  overseeing the preparation of the reserves
  estimates.
• If a reserves audit is performed by a third
  party, the qualifications of the technical person
  primarily overseeing that audit must also be
  disclosed.

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Current SEC Reserves Definitions

• SEC now treats unconventional resources (tight
  gas, shale gas, coal bed methane, oil sands) as
  oil and gas producing activities.
• Primary criterion is that activity results in oil
  and/or gas or products that will be upgraded into
  synthetic oil and/or gas.
• This expands the disclosure requirements to
  include oil, gas, synthetic oil, synthetic gas,
  and other products.

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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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Current SEC Reserves Definitions

• The Financial Accounting Standards Board (FASB)
  has issued Topic 932 that implements the SEC
  definitions. It was in the comment phase at time
  of preparation of this talk.
• The following slides are taken from the actual
  document (entered into Excel as shown in the
  document).
• These tables show the disclosure requirements for
  financial disclosures in the firms 10-K report
  (an optional sensitivity run table is not shown).

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Current SEC Reserves Definitions
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Current SEC Reserves Definitions
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Current SEC Reserves Definitions
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Current SEC Reserves Definitions
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Current SEC Reserves Definitions
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Current SEC Reserves Definitions
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Current SEC Reserves Definitions
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Agenda

• Introduction
• Highlights of the 1978 SEC Reserves Definitions
• Release 33-8995 Modernization of Oil and Gas
  Reporting
• Current SEC Reserves Definitions
• Example Tables for Disclosures
• QA

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QA

• Thanks for your invitation and your kind
  attention.
• Questions and Comments?