?In response to a recent SEC announcement that it will review and evaluate current disclosure requirements for oil and gas reserves held by E&P companies, Standard & Poor’s suggests a set of protocols needed to understand key information in reserve disclosures.
The first concerns thoroughly explaining all material reserve changes in text accompanying reconciliation tables, in what could be called a reserve management discussion and analysis. The second is requiring sensitivity analyses for the effects of possible price changes. The third is reporting reserve tables as of each year-end and updating material changes in quarterly financial statements.
The fourth is disclosing estimated future production for the next three to five years. The fifth is aging (by date of booking) and discussion of proved undeveloped reserves. The final is providing expanded geographic disclosures for important countries or regions.
S&P considers reserves as the key factor in determining E&P performance. While S&P’s rating levels don’t carry reserve size requirements, the amount a company reports as reserves and the ratings it receives generally correlate strongly. Reserves are also useful for calculating financial risk.
S&P also thinks that the SEC should reevaluate its rules and that changes can improve disclosed reserve information. Currently, E&P companies must adhere to the definitions set by the SEC in 1978. Recently, however, the Society of Petroleum Engineers, the World Petroleum Council, the American Association of Petroleum Geologists and the Society of Petroleum Evaluation Engineers approved a common petroleum resource management system that could possibly replace the archaic SEC definitions.
This includes consistent reserve information that allows reserves be as comparable as possible. Standardization would minimize the differences affecting variability. All E&P companies should use a common benchmark, such as final investment decision, under this system.
Oil and gas reserves should also be reviewed by management and directors to ensure reliability, as there are currently no requirements for audit committees and the board to approve reserve reports. S&P suggests reserve estimates be conservative, meaning estimates related to reservoir performance should generally be upward revisions and downward performance-related revisions should be unusual.
S&P also thinks the SEC standards should be more complete, as current reserve information excludes assets such as unconventional oil reserves, including extraction of crude oil from shale, tar sands or coal. Currently, the SEC considers this activity to be mining related.
Also, reserve reconciliation tables, while useful, should be expanded to show increases or decreases in reserves due solely to price movements, separate from changes in estimates. Standardized pricing may also offset any potential unusual situations, such as when the sale price of heavy Canadian crude oil reached lows in late December 2004, causing reductions of crude oil reserves at year-end despite recovery of sale prices in early 2005.
Further issues to be considered include sensitivity analysis, which would allow analysts to understand the effects of a plausible percentage increase or decrease in year-end sale prices on reserves, and on the standardized measure of discounted future net cash flows relating to proved reserves.
The timing of disclosure, future production, and proved undeveloped reserves are other issues that require attention, S&P adds.