Even with the growing Securities and Exchange Commission (SEC) investigation into reserve revisions, which to date has put the spotlight on El Paso Corp. and Royal Dutch/Shell Group, investors appear to place minimal value on undeveloped reserves “proven or otherwise,” which lends support to a “going concern” equity return valuation approach, according to an energy report.

John Gerdes and Chris Clark of Southwest Securities analyzed the proven reserve write-downs by Shell and found that there has been “muted market response” because the predominantly undeveloped reserve writedowns were merely moved from the proven category into the “probable” category.

“While sustained high reserve replacement and low finding and development costs trends display significant correlation to superior exploration and production (E&P) share price performance, strong reserve replacement typically is a precursor to future strong production growth,” they said. “In our view, the market is deducing an expectation of future production/cash flow from reserve replacement results rather than giving significant credence to the reserve replacement result itself.”

The magnitude of recent proven reserve write-downs, they said, and the “diminutive equity market reaction suggests proven undeveloped reserves have minimal bearing on E&P equity valuation.” Instead, “firm-specific factors” are more likely to cause an “acute” market reaction to write-downs like Shell’s 20% reduction.

The “market doesn’t seem to penalize E&P companies with a lesser percentage of proven undeveloped reserves,” the analysts noted. As an example, they pointed to Cimarex Energy, which trades at a “relatively expensive 5.4X 2004 cash flow and essentially doesn’t book proven undeveloped reserves, reinforcing the argument that the market is indifferent to proven undeveloped reserves…”

©Copyright 2004 Intelligence Press Inc. Allrights reserved. The preceding news report may not be republishedor redistributed, in whole or in part, in any form, without priorwritten consent of Intelligence Press, Inc.