The updated reserves reporting rules enacted by the Securities and Exchange Commission (SEC) for U.S. exploration and production (E&P) companies may prove a struggle for independents in choosing whether to be aggressive with their bookings versus a more conservative approach, particularly when booking proved undeveloped (PUD) locations, analysts said Thursday.
BMO Capital Markets' Dan McSpirit and Chris Sloan used the revamped SEC rules, which took effect this year (see NGI, Nov. 9, 2009a), to review Bill Barrett Corp.'s (BBG) year-end proved reserves report to demonstrate their point. E&Ps now may report probable and possible reserves along with proved reserves (see NGI, Jan. 5, 2009). Previously the SEC only allowed producers to disclose "proved" reserves in their filings.
BBG reported on Thursday that its proved reserves in 2009 were up 18% to 965 Bcfe, compared with 818 Bcfe in 2008 (see related story). BBG was able to book an "extra" 64 Bcfe under the SEC guidelines, the analysts said. (El Paso Corp. on Wednesday also reported that its proved reserves were up, increasing 8% in 2009 over 2008 (see related story). However, El Paso said the SEC impact "was minimal, beyond the change to a new standard using 12-month average pricing.")
"Revisions to the SEC reserve reporting guidelines were meant to 'modernize' and 'update' disclosure requirements in an effort to better reflect the industry's current day practices, from the unconventional nature of the rock being drilled to the somewhat unconventional nature of the technology being applied to unlock the molecules," wrote McSpirit and Sloan. "We see it with the inclusion of oilsands as an economically viable resource, for example. We also see it with the inclusion of probable and possible reserve estimates at the option of the subject company."
The changes "present the investor with the challenge of making an apples-to-apples comparison to what was booked in previous periods and, maybe more important, judging the degree to which a management team is aggressive," said the duo. They noted that it wasn't their aim to point out that BBG was not being conservative in estimating reserves, but rather using the company as an example of what to expect.
What the BMO team said it expects is more capital going to drilling PUDs and companies including locations a distance greater than one direct offset in their undeveloped reserve estimates.
"Will this result in a wild increase in PUD reserves?'' they asked. "Unlikely. Recognize the five-year rule is the governing factor, plus capital budgets and the industry's ability to spend outside cash flow, in general. We point investors in the direction of looking at PUD reserve increases over time and what amount that represents of reserves and reserve additions."
If BBG had used the older SEC rules, its 2008-2009 proved reserve growth would have been only 10% versus 18%, after excluding the 64 Bcfe location addition, said the BMO team. "Those are big numbers, and big differences. But those are the rules. Folks, just watch the percentages, ratios that may be as much a reflection of management bias as they are about the unconventional resource being exploited.
"While we believe Bill Barrett is playing fair (and shouldn't be expected to do anything less under the new rules)," said the analysts, "we contend that investors would do well to be long truer 'resource style' stories where reserve growth is potentially more pronounced and the 'trade' offers potentially greater upside."
Last November EOG Resources Inc. CEO Mark Papa, who offers his outlook on issues affecting the industry during every quarterly conference call, said "it is our belief that the new PUD booking rules provide a much larger amount of flexibility than previously was permitted" (see NGI, Nov. 9, 2009b). "Hence, you can expect to see big variations in PUD bookings across companies, making it difficult for analysts to make comparisons between companies regarding proved reserve replacement rates and finding costs.
"This is not code for EOG signaling a reserve or finding cost problem," Papa said then, "but I felt that at least one industry executive should alert shareholders that you will have one less comparative tool to measure industry results."
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