| Independent Assessment Of Reserves In UK E&P Companies?

2nd Sep '09 by uncommon13

8 comments 2783 reads

Who carries out the independent assessment of reserves in UK E&P companies listed in London? Also, what is likelihood of incorrect information in these reports, that is, deliberately providing false information to manipulate the share price, etc?

This thread came about since I watched on TV about a documentary on Enron and the spectacular way it went about falsifying information for so long without getting caught. Also, when the reputable accountancy firm, at least at the time, Arthur Andersen kept quiet and played along.

As an example, and in no way connected to irregularities as far as I can see, I was looking at Dana Petroleum. I see that financial accounts are audited by Ernst & Young. However, what I'm interested in are the oil and gas reserves figures. In their annual report, they have the following statement:

Reserve quantities have been estimated by the Group’s petroleum engineers in accordance with the definition of proven and probable reserves applicable to mineral companies primarily involved in the extraction of oil and gas resources as set out in Appendix 1.1 to the UKLA Listing Rules.

Further down in the footnotes, they also have:

“2008 Proven and Probable reserves and contingent resources have been assessed by the Company’s internal reservoir engineers, utilising data available from operators and other sources. The Company’s properties have also been audited by a recognised Competent Person in accordance with the definition of proven and probable reserves applicable to mineral companies primarily involved in the extraction of oil and gas resources as set out in Appendix 1.1 to the UKLA Listing Rules.”

What’s the likelihood of over-estimating reserves since they are using the company’s internal engineers, for example, Shell plc a few years back? How vigilant can one be here or do we just have to trust management?

Why don’t UK listed companies undergo an independent review of reserves such as those listed in Canada, for example? Is it too expensive?

Thanks and hopefully may be someone will just point to some place where all this might have been discussed before.

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emptyend

3rd Sep '09

Hello uncommon,

I don't think that this IS a topic that has been discussed before - so fair enough to raise it!

Who carries out the independent assessment of reserves in UK E&P companies listed in London? Also, what is likelihood of incorrect information in these reports, that is, deliberately providing false information to manipulate the share price, etc?.....

What’s the likelihood of over-estimating reserves since they are using the company’s internal engineers, for example, Shell plc a few years back? How vigilant can one be here or do we just have to trust management?......

Why don’t UK listed companies undergo an independent review of reserves such as those listed in Canada, for example? Is it too expensive?

I'll defer to others on the details of the listing rules and the specific legal frameworks governing E&Ps and their accounts, but AIUI a company's assessment of their own reserves is required to be subject to periodic audit by a "Competant Person". AFAIAA this is not an annual requirement though - which makes sense in the context of most companies' reserves not changed much from year to year except by depletion. Neither do I think that (unlike in Australia and Canada) the "Competant Person" is required to make a public statement on their findings - though you'll note that many UK companies often feel it is in their interests (especially when trying to big up some fairly recent finds) to publish such reports.

There is clearly some risk of a systemic false belief (amongst a company's technical teams and even within the whole industry) affecting the estimation of reserves. In particular, whilst calculation of OOIP in a structure is relatively straightforward, the calculation of the likely recovery rates can be a matter of considerable uncertainty, especially in new fields and unusual geological situations. For example, whilst the "going rate" for recovery in most reservoirs might be considered to be around 30%, I heard a figure yesterday for the Forties field that claimed recovery rates there were already at 70%! ...And, OTOH, recovery rates in some shales (eg Tawke?) is reckoned to be in the 15-18% range. But one never knows these things for sure until a production history is built up.

One of the other issues (and IIRC this was the main issue in the Shell example you cite) is that reserves entitlements under most standard PSCs FALL as the oil price rises (and vice versa). The reason for this is that the contracts have been structured to give a rising share of the upside to the host governments or state partners [nb - this does NOT apply in all cases, such as in certain Asian JVs!! ;-)]. Obviously this is a matter of the oil price and is independent of the technical assessment of recovery rates etc.

Leaving aside those considerations, whether the assessment of reserves can be relied upon comes down to two things IMO:

How large and diversified are the company's assets?
How trustworthy is management?

If reserves are spread over many dozens of individual assets, then the chance of significant or systemic errors is reduced, because each asset is assessed independently (and often there can be cross-checks made by the market because assets are usually shared with other oil companies, so one can look at what they are claiming).

The biggest risk area by far is when a management that may not be wholly trustworthy is promoting a reserves assessment that is heavily dependent on only one or two particular fields. I'm sure I don't need to point you towards examples of this potential risk in the market today!! ;-)

I'm not entirely sure that they "kept quiet and played along". I have observed first hand that auditors frequently rely a great deal on company management and staff to explain to them how particular complex products work (having had to make such explanations myself)....and Enron was stuffed full of such complexities. With Enron, I simply compared the sluggardly pipeline company I looked at in the 1980s with the apparent global powerhouse being lauded in the 1990s - and I couldn't see a good explanation of how they had got from one to the other. Sadly auditors aren't asked to make any sort of contextual checks like that but have to stick to the figures presented.

HTH

cheers

doverbeach

you'll note that many UK companies often feel it is in their interests (especially when trying to big up some fairly recent finds) to publish such reports

And of course any company wanting to raise money to develop discoveries, whether from banks or by issuing equity, is going to find the going very tough without an independent assessment of those discoveries.

In reply to emptyend (post #1)

...ps......I might add that the issue applies at least equally to claims of reserves made by OPEC members. For example, the reserves claimed by Saudi Arabia have remained roughly static at 264bn bbls for very many years now .....despite producing at a rate of 3bn+ bbls pa

Some would say that this involves some pretty cavalier assumptions about recovery rates continuing to be raised due to technological advances, given that they have announced very few meaningful new oilfield discoveries since they raised their reserves claims in 1988.

Others would say that, since over half their production comes from a single (huge, complex) field at Ghawar ...... and has done so now for over 60 years!....... then the Saudi claims are extremely vulnerable to the sort of "groupthink overclaiming heavily dependent on one or two assets" that I was warning against earlier.

Certainly it would be a REAL shock to the world economy if/when the Saudis admit to Ghawar coming off its production peak - especially as decline rates (given the amount of horizontal drilling and advanced recovery techniques applied in recent years) may be faster than average?

uncommon13

In reply to doverbeach (post #2)

And of course any company wanting to raise money to develop discoveries, whether from banks or by issuing equity, ...

Yes, but in Enron's case, at least nine global elite banks were alleged to have been possibly involved in creating, structuring and selling securities linked to Enron...aiming to profit from these:
http://news.bbc.co.uk/1/hi/business/1917627.stm

The "Natwest Three" were convicted of their fraud charges with Enron:
http://www.chron.com/disp/story.mpl/special/enron/5333449.html

As you can see, the lack of transparency and how this relates similarly to E&P reserve figures is what slightly worries me..

Best

In reply to uncommon13 (post #4)

Since you seem mainly concerned about the issues around Enron, in fact I cannot see how this relates to E&P reserves. By comparison with the intricacies of structured deals surrounding Enron, understanding E&P reserves is a total piece of cake!! In addition, unlike the Enron scenario, third parties are unlikely to make significant amounts of money by facilitating some sort of systematic misrepresentation.

The banks that supplied Enron with the structures/products/advice that they needed to sustain the chimera were simply using their brains and resources (perfectly legally in most cases, IMO) to make money.

Interesting coincidence on this topic today.....

I see that there are press reports suggesting that the Ormen Lange gas field in Norway (owned by Shell, Exxon and others) may be up to 25% smaller than they'd all thought - which is "inconvenient" since they've spent $11bn between them on developing it!!

Unusual coincidence...thanks ee :)

I have found some interesting articles related to the new changes in USA's SEC disclosure for oil and gas reserves...which apparently haven't changed for over 25 years till the last few days of 2008!

Link to the google cache link as the original link requires registration:
http://209.85.229.132/search?q=cache:aRDwNsasBo4J:https://www.complianceweek.com/article/5228/new-oil-gas-reserve-rules-bring-reporting-current+20-f+oil+reserves+estimate&cd=19&hl=en&ct=clnk&gl=uk&client=firefox-a

SEC's announcement:
http://www.sec.gov/news/press/2008/2008-304.htm

Companies must begin complying with the disclosure requirements for registration statements filed on or after Jan. 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on or after Dec. 31, 2009. However, the adopting release notes that the SEC will consider whether to delay the compliance date as it works on revisions to existing accounting literature with the Financial Accounting Standards Board.

Issuers will not be able to start reporting under the new rules early, due to concerns that early compliance might make disclosures incomparable.

Among other things, the new disclosure rules require companies to report oil and gas reserves using an average price based on the prior 12-month period, rather than year-end prices; permit the use of new technologies to determine proved reserves; and allow companies to disclose their probable and possible reserves to investors.

4th Sep '09

In reply to uncommon13 (post #7)

.....permit the use of new technologies to determine proved reserves; and allow companies to disclose their probable and possible reserves to investors.

These are the most important bits - and were widely discussed some while ago. The effect should be to bring US companies into line with those elsewhere in the world, in allowing them to make public their realistic up to date assessment of both proven and probable reserves on a similar basis to companies elsewhere. Until they come in, US companies are constrained to talking only in terms of "proven" reserves, calculated using conservative out-dated assumptions.

There are a couple of things that should flow from that:

a) US investors should be more readily alerted to companies with large probable reserves in relation to proven - and they may also be more prepared to look internationally, since the playing field is both more level and is clearer

b) US companies may be more willing to buy into projects that have low proportions of probable reserves in relation to the 2P figure. This may benefit companies (especially those operating outside the US) by expanding their range of partners.

We'll find out in due course....

Independent assessment of reserves in UK E&P companies?

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Uncommon13

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