DALLAS (CBS.MW) — Estimating how much oil a company owns thousands of feet underground is, at best, a slippery business.
It depends on the expertise of petroleum geologists and the reliability of internal accounting and reporting, as well as compliance with Securities and Exchange Commission rules that leave companies plenty of leeway.
By the SEC’s own definition, companies need only report proved reserves with “reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions … as of the date the estimate is made.”
To do this, oil and gas companies turn to geologists and engineers to determine a level of reserves no one can even see.
“A proven reserves estimate, by definition from the SEC, is reasonable certainty, but it’s one that’s more likely to go up than down,” said Mike Cavanaugh, manager of corporate reservoir engineering at Apache (APA: news, chart, profile). “It’s still an estimate, and you never know until that final barrel is produced.”
Reservoir engineers at Apache, which had 1.66 billion barrels of oil equivalent at year-end 2003, rely on data collected from wells to determine the depth of the oil-bearing rock, the rock’s capacity to hold oil or gas, and whether and at what depths hydrocarbons are present.
Then they use geological interpretation to determine the extent of the reservoir to calculate the volume of hydrocarbons. Adding the geological history of the data to their calculations, the company estimates how many barrels of oil they will be able to squeeze from the formation.
The company then measures hydrocarbon flow rates and pressures to fine-tune the estimates over time, Cavanaugh added. Apache also has an independent third party, Ryder-Scott, audit its reserve estimates, though that’s not required by the SEC, according to Tony Lentini, an Apache spokesman.
Apache avoids potential conflicts by not awarding bonuses to its reservoir engineering group.
“Unless you crawl down the hole, this is the best science we have,” Lentini added.
Dr. Bala Dharan, professor of accounting at Rice University at Houston, said that companies rely on these procedures when paying for properties. Last week, Apache said it would shell out more than $500 million for Anadarko Petroleum’s (APC: news, chart, profile) Gulf of Mexico shelf properties. See full story.
The issue of proven reserves has become a hot topic since Royal Dutch/Shell Group (RD: news, chart, profile) (SC: news, chart, profile) and El Paso (EP: news, chart, profile) each slashed their estimates early in the year.
On Tuesday, Shell said it would pay a $120 million penalty to settle the overstatement with the SEC. See full story.
Dharan added in an interview that it’s critical to implement standardized auditing procedures. The SEC currently asks that companies report unaudited estimates.
“Until that is done, it’s hard to ask external auditors to put signatures on things that are not yet fully standardized,” he said.
Appearing before the House Committee on Financial Services on July 21, Dharan testified: “Over 70 percent of the total market value [for energy companies] is determined by the amount of proved reserves the company has.”
The reported total value of oil and gas reserves as reported by the 150 publicly owned U.S. producers is more than $3 trillion, according to Dharan.
“Both the industry and the SEC need to take concrete steps that will result in the end users perceiving the reserves data as reliable and useful for valuation purposes,” he said.
Lisa Sanders is a Dallas-based reporter for CBS.MarketWatch.com.
