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SEC Reserves Booking Principles (with Comments on New Proposed Rules)

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Title: SEC Reserves Booking Principles (with Comments on New Proposed Rules)


1
SEC Reserves Booking Principles(with Comments on
New Proposed Rules)
Stuart L. Filler Commercial Evaluation
Supervisor Devon Energy Corporation October 16,
2008
2
Contributors
  • Stuart L. Filler, P.E.
  • Commercial Evaluation Supervisor, Devon Energy
  • Waldo Borel, P.E.
  • Petroleum Engineering Consultant
  • Bob Wagner, P.E.
  • Senior Vice President (Retired), Ryder Scott
    Petroleum Consultants

3
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

4
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

5
Current Trends
  • Increased Surveillance and Enforcement by SEC
    Since Enron, Shell, and El Paso
  • Comment Letters and Inquiries
  • Reserves train wrecks
  • 2004
  • Shell writes down 5 billion BOE
  • El Paso writes down 1.8 TcfE (0.3 billion BOE)
  • Other write-downs occur
  • 2005 - Stone Energy writes down 161 BcfE
  • 2006 Repsol YPF writes down 1.25 billion BOE
  • Results Officers of companies resign or are
    dismissed, several lawsuits, large fines by
    regulators on Shell

6
SEC Staff
  • Petroleum Engineering Vacancy Most of 1990s
  • Roger Schwall
  • Assistant Director of the Office of Natural
    Resources and Food, Division of Corporation
    Finance (since 1996)
  • Two Engineers Added in Early 1999
  • Ron Winfrey
  • Jim Murphy
  • Recent years have seen increased investigation of
    methodology and assumptions used in reserves
    estimates that are reported in financial filings

7
What are Oil and Gas Reserves?
  • 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

8
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

9
Reserves Reporting Obligations
  • Externally, reserves of companies that issue
    shares or share depositary receipts are reported
    in
  • Annual Report (for shareholders)
  • SEC 10-K or 20-F (Reserves and Standardized
    Measure of Discounted Future Net Cash Flows
    Relating to Proved Oil and Gas Reserve
    Quantities, or SMOG)
  • EIA 23 (reserves in fields operated by the
    company)
  • Indirectly, other items are related to reserves,
    such as quarterly ceiling tests, allowable
    hedging volumes, abandonment liabilities (FASB
    143), and DDA calculations

10
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

11
Major Advances(Through 2007 PRMS)
  • There are two recognized methodologies for
    estimating reserves
  • Deterministic
  • Probabilistic
  • SEC currently recognizes both methods but prefers
    deterministic reserves (probabilistic reserves
    are accepted only if professionally prepared
    and strictly apply SEC definitions and guidance)
  • N.B. Proposed rules recognize both methods and
    allows entity or company to choose method

12
Reserves Estimation Methodologies
  • 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

13
Proved Reserves Category
  • Deterministic requires reasonable certainty
  • Probabilistic (from Proposed Rules) is 90
    probability that ultimate volumes recovered will
    equal or exceed the estimate
  • Note that SEC, under current rules, declined to
    take a position on the confidence level for
    proved reserves in a probabilistic estimate

14
Deterministic Approach
  • Category Descriptive Term
  • Proved Reasonable certainty
  • Probable More likely than not
  • Possible Less likely than probable
  • Contingent Resources Discovered, not committed
  • Prospective Resources Undiscovered

15
Probabilistic Approach
  • Probability of Achieving or
  • Category Exceeding Estimated Recovery
  • Proved (1P) 90
  • ProvedProbable (2P) 50
  • ProvedProbablePossible (3P) 10
  • N.B. These are compatible with the Proposed
    Rules and are not yet accepted by the SEC, but
    these are the levels set in PRMS.

16
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

17
SEC guidance states
  • 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.
  • If strictly followed, this leads to a deliberate
    low estimate, which is a probabilistic bias

18
SEC Reserves Definitions
  • Best use of all available engineering,
    geological, and geophysical data, good
    engineering judgment, and use of analogous
    reservoirs should be used to establish a
    compelling case to meet SEC definitions and
    guidelines for proved reserves
  • 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

19
Performance versus Volumetrics
  • Inappropriate forecast using current volumetrics
  • Appropriate forecast using decline analysis

20
SEC Proved Reserves Definitions
  • 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.

21
SEC Proved Reserves Definitions
i.
  • 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

22
SEC Proved Reserves Definitions
ii.
  • 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.

23
SEC Proved Reserves Definitions
iii.
  • 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.

24
Current SEC Reserves Categories
  • Proved
  • Developed
  • Undeveloped
  • The SEC does not split the Developed reserves
    classification into producing and nonproducing
    segments.

25
Current SEC Reserves Categories
  • Proved
  • Developed
  • Undeveloped

26
Proved Developed Reserves
  • 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

27
Current SEC Reserves Categories
  • Proved
  • Developed
  • Undeveloped

28
Proved Undeveloped Reserves
  • 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

29
Proved Undeveloped Reserves
  • Continuity can not be established solely by
    mapping, geological or geophysical
  • SEC guidance points out that there is no
    mitigating adjective in front of certainty

30
Proved Reserves Unconventional Resources
  • SEC treats unconventional resources (tight gas,
    shale gas, coal bed methane) as conventional
    reservoirs
  • One-offset rule, undrilled fault blocks same as
    any reservoir
  • Compelling case has reportedly been made to
    accept reserves from areas farther than one
    location away for an unconventional reservoir,
    but information is anecdotal and not published.

31
Proved Reserves
32
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

33
SEC Hot-button Topics Problem Areas
  • A. Proved Undeveloped Reserves
  • B. Determination of LKH
  • C. Year End Prices
  • D. Recovery Factors
  • E. International Approvals and License
    Expirations
  • F. Seismic Data
  • G. Areal Extent of Reservoirs
  • H. Revenue from Sale of Non-Hydrocarbons
  • I. Flow Test Requirements
  • J. Net Profits Interest
  • K. Markets
  • L. Plants
  • M. Gas Balancing
  • N. Economic Limit
  • O. Operating Expenses and Overhead Costs

34
Proved Undeveloped Reserves
  • Very strict definitions and guidelines
  • One location offsets
  • Definite plans (within 5 years unless very good,
    documented reason for longer)
  • Drainage areas established by analogous
    performance or regulatory spacing, whichever is
    smaller
  • Financial commitment and ability
  • Must have a market
  • Secondary recovery requirements for proved
    reserves must be met

35
Proved Undeveloped Reserves
  • Pitfalls
  • Stale proved undeveloped reserves assignments
    (on books year after year after)
  • Use of old statistics for analogies
  • Location below LKH in a reservoir
  • Known reservoir requires well (seismic alone not
    sufficient)

36
Proved Undeveloped Reserves
  • Horizontal wells present special problems for SEC
    reserves reporting
  • Until recently, no real guidance had been given
    for horizontal proved undeveloped locations
  • Parallel Petroleum case was announced in July
    2007 in a press release
  • Horizontal PUDs can be booked as shown in the
    following slide

37
Proved Undeveloped Reserves
  • Horizontal Wells and PUDs

38
Proved Undeveloped Reserves
  • Horizontal PUDs can also be booked using proved
    undeveloped vertical locations, where applicable
  • Where a horizontal lateral crosses a drilling
    unit that would otherwise qualify as proved
    undeveloped for a vertical well, that portion of
    the lateral can be classified as proved
  • Where the lateral intersects drilling units that
    do not qualify as proved undeveloped, that
    portion of the lateral is unproved
  • This makes reserves accounting difficult

39
Determination ofLowest Known Hydrocarbon (LKH)
  • SEC accepts well log data only for initial
    volumetric estimates. This is a conservative
    position and can lead to significantly smaller
    volumes than are expected to be recovered in a
    purely technical evaluation
  • Performance data can increase bookings below LKH
    when initial bookings are overproduced

40
Year End Prices
  • SEC position is non-interpretative. All
    financial filings must use price on effective
    date, which is December 31 of the year
  • SEC position is based on FAS 69
  • Year-end price to be used for revenue projections
    and economic limits, which can lead to abnormally
    high (or low) economic well lives
  • Forecast prices based on historical data are not
    allowed

41
Recovery Factors
  • SEC has increased scrutiny of recovery factors.
  • SEC staff is pressing for hard evidence for
    recovery factors higher than low-side of range.
  • SEC may ask for supporting documentation of
    assumptions that result in higher recovery
    factors.
  • Examples for higher recovery
  • water drive for oil
  • absence of water drive for gas

42
International Approvals andLicense Expirations
  • Roger Schwall of SEC has stated (personal
    communication) that as matter of SEC policy, all
    foreign government approvals must be in hand
    before booking of proved reserves attributable to
    fields outside of the United States.
  • SEC policy requires a definitive history of
    approvals of license extensions in a foreign
    country before reserves can be booked past the
    expiration of the current license.

43
Seismic Data
  • Historically SEC has dismissed seismic alone as
    too uncertain as a basis for proved reserves
  • Seismic data is not allowed for
  • Extension of lowest known hydrocarbons
  • Proving up nearby untested analog structures
  • Proving up anomaly areas-extensions
  • Thickness estimation over the thickest reservoir
    section seen in a well

44
Areal Extent of Reservoirs
  • SEC comfort level
  • 40 acres for oil
  • 160 acres for gas
  • Can use larger areas with compelling case,
    including analogies (most important source of
    larger areal assignments) and seismic structure,
    where definitive

45
Revenue from Sale of Non-Hydrocarbons
  • SEC prohibits all non-hydrocarbon reserves
    (including sulfur, CO2, and helium)
  • Third-party processing revenue excluded
  • Cannot use non-hydrocarbon income to offset or
    reduce operating costs

46
Flow Test Requirements
  • In certain areas, flow tests are not seen as
    necessary or feasible (deep water GOM)
  • April 15, 2004 letter to producers
  • Must have seismic data, WFT pressures and
    samples, core data, and log data for booking
    proved undeveloped reserves in deep water GOM
    ONLY (case-by-case basis)
  • SEC Guidelines and Clarifications allow booking
    in other instances without actual flow tests
  • Analogous reservoirs in same field with
    appropriate data (logs and cores)

47
Net Profits Interest (NPI)
  • For properties subject to payment of net profits,
    SEC requires property owner to deduct NPI
    reserves from owned reserves when filing SEC
    10-K unless agreement states that interest is a
    financial arrangement only
  • Review of agreements before execution is
    essential to avoid loss of reserves in these
    types of transactions
  • Recent interpretations may require deduction of
    NPI reserves owed to other party regardless of
    language in agreement

48
Markets
  • Reserves which are economically producible under
    existing operating and economic conditions should
    be recorded as proved if in the foreseeable
    future a market will exist, as evidenced by
    negotiations with or announced plans by a
    transporter (letter of intent or memorandum of
    understanding at minimum)
  • If the market is intermittent, or if sales to the
    market are not continuous, only those portions of
    produced gas that can be reasonably certain of
    actual sales should be booked as proved reserves
    (important where lease or license has expiration)
  • Market must be established, especially for
    frontier areas

49
Plants
  • Plants can not own reserves. Reserves recovered
    in plants must be attributable to lease interests
  • If plant agreement is for percent of proceeds
    only (not percent of products), all plant
    products can be attributed back to lease and
    claimed as reserves.
  • If plant agreement is for percent of products,
    only amount credited to lease can be booked.

50
Gas Balancing
  • Gas balancing must be accounted for in reserves
    reported.
  • In practice, if balance amounts are not material
    and are spread through many properties, this
    requirement is relaxed (however, check overall
    sum to make sure the amount is immaterial).
  • In offshore fields in particular, this factor can
    be very material and should be included.
  • If a party is overproduced and reserves are
    insufficient to make up to the underproduced
    party, any reserves attributable to the
    overproduced party can not be booked.

51
Economic Limit
  • Cannot book reserves that go beyond the economic
    limit or book proved undeveloped reserves when
    the total SEC 10-K value is negative
    (undiscounted)
  • All previous sunk costs are not considered in the
    SEC SMOG. Abandonment costs that cause a field
    or well to have a negative value do not preclude
    the booking of reserves if the present cash flow
    is positive.

52
Operating Expenses and Overhead Costs
  • Operating costs must be at computed at current
    levels. The SEC allows use of an appropriate
    averaging period for operating costs.
  • Operating costs at abandonment conditions should
    not include general corporate overhead, income
    taxes, non-cash charges (DDA), non-recurring
    well repair capital expenditures, or other
    capital expenditures.
  • Overhead directly attributable to the operation
    of a field should be included in the operating
    expense calculations.

53
Documentation
  • Proved reserves should not be added to the books
    (i.e., change reserves category to proved in a
    database) or revised in a database without proper
    documentation.
  • Proper documentation does not mean a full
    reservoir study for every addition or revision,
    although one can be done where necessary. Proper
    documentation includes (but is not necessarily
    limited to)
  • Decline curve with date of change noted in
    comments
  • Volumetric calculation sheet with date of
    calculation
  • Reservoir engineering work with date of work
    performed
  • Material balance
  • Reservoir simulation
  • Type curve with date work was done
  • Note that the date of the work must always be
    included.

54
Reserves Evaluations vs. Audits
  • Evaluated proved reserves are those reserves
    estimated by an independent petroleum engineering
    firm that are reported externally.
  • Audited proved reserves are those reserves
    estimated by the reporting company that are
    compared to reserves estimated by an independent
    petroleum engineering firm to achieve a tolerance
    in the differences. Company reserves are
    reported externally.
  • When reserves are evaluated, only the
    independently estimated quantities from the
    external engineering firm may be reported. No
    company proved reserves can be added to the
    evaluated reserves total.

55
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

56
SEC Proposed Rules 33-8935
  • Released on June 26, 2008
  • Comments were due by September 8, 2008
  • 61 comments were received (of which 2 were
    duplicates)
  • Included comments from producers, consultants,
    analysts, individuals, accountants, lobbyists,
    government agencies, and 3 U.S. Senators
  • Wide variations in opinions, depending on topic

57
SEC Proposed Rules 33-8935
  • Document is located at http//www.sec.gov/rules/
    proposed/2008/33.8935.pdf
  • Proposal is based largely on SPE/AAPG/WPC/SPEE
    Petroleum Resources Management System (PRMS) and
    Canadian National Instrument (NI) 51-101.
  • NI 51-101 contains by reference the Canadian Oil
    and Gas Evaluation Handbook (COGEH)
  • One important difference in the Proposed Rules
    and the documents cited is the use of historical
    pricing in the SEC proposal NI 51-101 and PRMS
    use forecast prices as the base case

58
SEC Proposed Rules 33-8935
  • The following slides show some guidance from the
    documents cited for unproved reserves
  • The new proposed rules do not allow reporting of
    contingent resources and potential resources

59
Unproved Reserves
  • Categories
  • Probable
  • Possible

60
Probable Reserves
  • PRMS reads Probable reserves are those
    unproved reserves which analysis of geological
    and engineering data suggests are more likely
    than not to be recoverable. In this context,
    when probabilistic methods are used, there should
    be at least a 50 probability that the quantities
    actually recovered will equal or exceed the sum
    of estimated proved plus probable reserves.
  • The SEC Proposed Rules state Probable reserves
    are those additional reserves that are less
    certain to be recovered than proved reserves but
    which, together with proved reserves, are as
    likely as not to be recovered. When
    deterministic methods are used, it is as likely
    as not that actual remaining quantities recovered
    will exceed the sum of estimated proved plus
    probable reserves. When probabilistic methods are
    used, there should be at least a 50 probability
    that the actual quantities recovered will equal
    or exceed the proved plus probable reserves
    estimates.

61
Probable Reserves
Reservoir 1
Reservoir 2
62
Unproved Reserves
  • Categories
  • Probable
  • Possible

63
Possible Reserves
  • PRMS states Possible reserves are those
    unproved reserves which analysis of geological
    and engineering data suggests are less likely to
    be recoverable than probable reserves. In this
    context, when probabilistic methods are used,
    there should be at least a 10 probability that
    the quantities actually recovered will equal or
    exceed the sum of estimated proved plus probable
    plus possible reserves.
  • The SEC Proposed Rules state Possible reserves
    are those additional reserves that are less
    certain to be recovered than probable reserves.
    When deterministic methods are used, the total
    quantities ultimately recovered from a project
    have a low probability of exceeding proved plus
    probable plus possible reserves. When
    probabilistic methods are used, there should be
    at least a 10 probability that the total
    quantities ultimately recovered will equal or
    exceed the proved plus probable plus possible
    reserves estimates.

64
Possible Reserves
65
SEC Current vs. Proposed Definitions
  • Reserves definitions can make a difference. The
    following example, adapted from a Society of
    Petroleum Evaluation Engineers (SPEE) SEC
    Reserves Forum, shows a dramatic difference in
    the results of reserves evaluations.
  • A common source of mistakes in SEC reserves
    bookings is the use of PRMS reserves definitions
    rather than the current definitions used and
    interpreted by the SEC.
  • As shown above, the SEC Proposed Rules are very
    similar to PRMS and should result in similar
    reserves estimates.

66
Determination of Lowest Known Hydrocarbons
  • Current and Proposed definitions read similarly
  • Current In the absence of information on fluid
    contacts, the lowest known structural occurrence
    of hydrocarbons control the lower proved limit of
    the reservoir.
  • Proposed In the absence of data on fluid
    contacts, proved quantities in a reservoir are
    limited by the lowest known hydrocarbons (LKH) as
    seen in a well penetration unless geoscience,
    engineering, or performance data and reliable
    technology establishes a lower contact with
    reasonable certainty.

67
Determination of Lowest Known HydrocarbonsStructu
ral Cross Section Lowest Known Oil
68
Determination of Lowest Known HydrocarbonsFormati
on Pressure Interpretation
Significant Differences In SEC Current
andProposed Reserves Definitions
8100
WFT
Well A WFT Pressures
8200
Top of sand
8300
WFT
Well B WFT Pressures
Depth TVDSS
Base of sand
8400
Calculated OWC
8500
Top of sand
8600
8700
Base of sand
8800
4880
4920
4960
5000
5040
5120
5160
5200
5080
Pressure PSIA
Wireline test data established
69
Determination of Lowest Known HydrocarbonsMap
View
SIGNIFICANT DIFFERENCES IN SEC CURRENT
AND PROPOSED RESERVES DEFINITIONS
Well A
VolumeAllowedby ProposedSEC
Current SEC Proved
Well B
8300
8400
8500
LKO (Log)
OWC (WFT)
Proposed SEC proved reserve volumes are
double the SEC current proved reserves in this
example
70
Agenda
  • Introduction
  • Reserves Reporting Obligations
  • Types of Reserves Estimates
  • Current SEC Reserves Definitions
  • SEC Hot-Button Topics and Problem Areas
  • SEC Proposed Rules 33-8935
  • Q A

71
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