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CERA Recommends Overhaul of Reserves Accounting Rules

With oil and natural gas companies poised to invest up to $6 trillion in exploration and production (E&P) through 2030, the 28-year-old reserves accounting rules overseen by the Securities and Exchange Commission (SEC) should be updated to reflect new technology advances, a year-long study by Cambridge Energy Research Associates (CERA) has concluded.

No definitive way exists to predict how much oil or gas lies in any given oil and gas field; a lot of industry professionals consider possible, probable and proven reserves estimates to be as much an art as a science. To protect investors and prevent inflated reporting by enthusiastic E&Ps, the SEC has long favored a conservative approach, and only proven reserves are reported. However, oil and gas companies want to add in some of their probable reserves, using longer-term price assumptions and more advanced technology.

"The accuracy and reliability of reserves data lie at the heart of stakeholder confidence in the industry's capability and its access to the funds needed to meet these huge needs," said David Hobbs, CERA's managing director of oil and gas research. He co-authored the study with CERA Chairman Daniel Yergin.

The project involved the participation of 30 oil and gas, accounting and reservoir consulting firms, industry associations and professional and technical societies, as well as input from other stakeholders including institutional investors. CERA then developed a broad consensus to "make the reserves reporting process relevant, accurate and reflective of real industry operations."

CERA identified several shortcomings in the SEC's accounting system. It found the interpretation and application of SEC's current system is inconsistent with the way investment decisions are made, which is the key information for investors. Also, despite SEC's "contrary intent," it "actually fails to achieve comparability between registrants' disclosures. The report illustrated how two joint and equal owners of the same asset would have been required to report radically different 2004 reserves estimates by virtue of a three-month difference in year-end financials. Finally, mined oil sands production, a growing component of North American output, is excluded from oil and gas disclosures.

According to CERA, advances in technology over the past three decades have enabled "earlier and more accurate recognition of reserves volumes." Changes in the structure of oil and gas commodity markets also are more volatile than when the SEC reserves accounting system was implemented in 1978. CERA also pointed to changes in the ability of new technology for many oil and gas projects. Innovation, it said, has allowed producers to develop more information per well than previously possible.

Overall, CERA is recommending the SEC transfer responsibility for reserves rulemaking to the Society of Petroleum Engineers (SPE), which has established updated guidelines for its members.

"Our review shows that modern SPE rules recognize all these important technical objectives while also providing conservative, reliable reserves assessments that have proven over long periods to be closer to the actual outcome after full reservoir development," said Hobbs. "This would enhance the SEC's ability to perform its regulatory role in the 21st century with 21st century methods. It would be in accord with the precedent the [SEC] has established in supervising other industries."

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