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Reserve Estimates Under Scrutiny

Certification a Solution?

When Shell checked its oil at the beginning of the year, the dipstick read 3.9 billion barrels low.

Shell reduced its reported proved reserves by that amount in January, and later wrote down another 220 million boe from year-end 2003 reserves.

Then, in February, El Paso Corp. reduced its proved natural gas reserves by 41 percent.

The size of those revisions stunned many investors and caught the attention of regulatory agencies.

Questions soon followed, distilled to a single concern:

Is the oil and gas industry having trouble estimating its known reserves?

You'll hear at least three answers, "Probably not," "Apparently yes" and "Maybe."

The last two answers are problematic, because the entire industry suffers when stockholders, lenders and other investors begin to doubt the reliability of its reported numbers.

Naresh Kumar is president of Growth Oil and Gas in Dallas, and an international consultant experienced in reserves estimation who currently chairs AAPG's Committee on Resource Evaluation.

In a post-Enron world, investor questions about company reports should come as no surprise, according to Kumar.

"I can understand why there is so much skepticism right now, because nobody thought the balance sheets audited by very respected accounting firms would be called into question, and that has happened," he said.

"Our industry has to be especially careful and especially vigilant about what's being reported," he added.

That noted, Kumar doesn't believe a few reserve revisions will have any deep impact on the industry.

"At this stage," he said, "I don't see that we have any real crisis."

Training Days?

Following the Shell and El Paso revisions, a call to certify E&P professionals in reserves estimation came from Ron Harrell, chairman and CEO of Ryder Scott Co. LP, a Houston-based reservoir evaluation consulting firm.

In March, Harrell publicly urged the industry to establish a formal process of training courses, examinations and certification for qualified petroleum geologists and engineers.

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When Shell checked its oil at the beginning of the year, the dipstick read 3.9 billion barrels low.

Shell reduced its reported proved reserves by that amount in January, and later wrote down another 220 million boe from year-end 2003 reserves.

Then, in February, El Paso Corp. reduced its proved natural gas reserves by 41 percent.

The size of those revisions stunned many investors and caught the attention of regulatory agencies.

Questions soon followed, distilled to a single concern:

Is the oil and gas industry having trouble estimating its known reserves?

You'll hear at least three answers, "Probably not," "Apparently yes" and "Maybe."

The last two answers are problematic, because the entire industry suffers when stockholders, lenders and other investors begin to doubt the reliability of its reported numbers.

Naresh Kumar is president of Growth Oil and Gas in Dallas, and an international consultant experienced in reserves estimation who currently chairs AAPG's Committee on Resource Evaluation.

In a post-Enron world, investor questions about company reports should come as no surprise, according to Kumar.

"I can understand why there is so much skepticism right now, because nobody thought the balance sheets audited by very respected accounting firms would be called into question, and that has happened," he said.

"Our industry has to be especially careful and especially vigilant about what's being reported," he added.

That noted, Kumar doesn't believe a few reserve revisions will have any deep impact on the industry.

"At this stage," he said, "I don't see that we have any real crisis."

Training Days?

Following the Shell and El Paso revisions, a call to certify E&P professionals in reserves estimation came from Ron Harrell, chairman and CEO of Ryder Scott Co. LP, a Houston-based reservoir evaluation consulting firm.

In March, Harrell publicly urged the industry to establish a formal process of training courses, examinations and certification for qualified petroleum geologists and engineers.

Harrell said he became even more convinced about the need for certification when he observed the interactions at meetings between members of the Society of Petroleum Evaluation Engineers (SPEE) and petroleum engineers on the staff of the U.S. Securities and Exchange Commission (SEC).

Industry engineers showed some confusion about SEC rules and guidelines, and often lacked a full grasp of the reporting regulations, according to Harrell.

"I think there very definitely are gaps," he said. "That is one point of evidence that there is a lot of confusion about the SEC requirements."

AAPG President Steve Sonnenberg, along with several members of the DPA executive committee were to meet with Harrell and others to further explore the possibilities of AAPG being a cooperating certifying entity. DPA already has a proposal readied to allow reserve estimators to be qualified in Canada by virtue of DPA membership.

Harrell noted that his concern about industry standards for reservoir evaluators is long-standing.

Last year, he presented a paper about the need for better industry stewardship of reserves estimation, especially in light of requirements in the Sarbanes-Oxley Act, a U.S. corporate responsibility law.

"People are going to say that the timing of this (call for certification) is just because of Shell and the others. That's not true," he said.

In the worldwide petroleum industry, the number of reservoir evaluators "has exploded over the past few years" because of privatization and the formation of new companies, he observed.

At the same time, Harrell said, evaluation has become more and more complex with the availability of new software packages and other tools.

"It's a little bit mind-boggling, all the tools that are available to us," he said. "It's important that everyone use these responsibly."

In addition to a certification process, Harrell urged the industry to develop a set of reserves-estimation best practices that could be shared among companies.

It could be difficult for one professional in a single petroleum company to see the need for industry-wide action on reserves estimation, especially if that company has strong faith in its own reserves numbers, he noted.

"They might say, 'Where's the problem?' But we work with 51 companies that report reserves," Harrell said.

"I do have a unique perspective, because we see the inside of a lot of companies," he added.

Going By the Book

In general, reserves estimates can vary for three major reasons.

Or maybe five reasons.

Although it might be four.

Or even six.

Everything depends on how you count.

That's why regulatory agencies like the SEC work to develop standardized reporting rules for industry.

H. Roger Schwall is assistant director for the Office of Natural Resources in the SEC's Corporation Finance Division.

Schwall said his office is less concerned with dictating specific practices than making sure SEC regulations are followed across the industry.

"Our main focus is, 'Are companies complying with the rules?'" he said.

To that end, Schwall encouraged reserves estimators to contact his office if they have any doubt about meeting SEC requirements. While his staff won't consider hypotheticals, it can offer assistance on specific problems and questions, he explained.

"If companies have some question about their situation, the best thing they can do is contact our engineers at the SEC," he said.

He said his office in Washington, D.C., can be reached at 202-942-1870.

Schwall added that information also is available on the SEC's Web site at www.sec.gov, including matters addressed in the "Current Issues" sections of the Corporation Finance Division page.

The SEC is investigating Shell's reserves revision, and so are regulatory agencies in Britain and the Netherlands.

In the coming year, the petroleum industry can expect a closer focus on reserves estimation. Look for scrutiny of any company with sizeable reserves, including national oil companies.

Largely because of comments by investment banker Matthew Simmons, the industry recently began another round in a continuing debate about the reliability of Saudi Arabia's reserves estimates.

Also, regulators may require companies to face stiffer requirements for reserves reporting.

Earlier this year, Canadian producer Nexen Inc. reduced its reported reserves by 67 million boe — 8 percent of its worldwide total — to meet stricter standards.

Part of El Paso's large reserves reduction came from evaluation of its coalbed methane production.

Methods and Ethics

AAPG's Committee on Resource Evaluation is considering resource assessment methodologies that involve nonconventional resources, including coalbed methane and tight gas sands, according to Earl Ritchie.

Ritchie, the committee's co-chair, is vice president and general manager, Houston division, for EOG Resources Inc.

"The assessment of those is in some ways more difficult than the assessment of more conventional resources," he said. "We're looking at methane hydrates as well."

In general, Ritchie noted, the committee deals only with assessment methods and approaches, and does not consider proved reserves issues.

"To some extent, the proved reserves reporting is more of a reservoir engineering function," he said.

Kumar said reserves revision won't affect AAPG's view of the overall available oil and gas resource.

"It does not because the Committee on Resource Evaluation's charter is to look at the methodology by which resource estimates are made.

"One thing we have stayed out of ourselves is criticizing the numbers the various agencies have come out with," Kumar noted.

"We generally do not get involved with specific numbers-proved, probable, possible reserves. The total numbers we see may not change much, if the reserves are shifted around among categories," he added.

If reserves reporting comes under more scrutiny, one effect might be increased caution by estimators, according to Kumar.

"I have a feeling that what will happen over time is that people will get even more conservative, and the reported reserves are already fairly conservative.

"That is partly why we have what we call 'field growth,' the additional reserves that will come out of known fields over time," he said. "This is a very, very significant amount added to the resource every year."

Harrell proposed that ethics training should be part of any certification process for reserves evaluators, in addition to tests related to technical competency and knowledge of applicable regulations.

He sees a need to "draw some fairly bright lines" in setting ethical standards.

"In different parts of the world, ethics mean a lot of different things," Harrell said. "A certification program could bring some of those differences to light and see that they are addressed."

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