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FERC Urges Adding Shale, Stranded Gas to Reserve Counts

June 16, 2008
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The Securities and Exchange Commission (SEC) said last week that it was close to a decision on revamping its rules for reporting oil and natural gas reserves. Besides the question of whether proven and unproven reserves should be reported, the SEC is considering recommendations from FERC that a true estimate of natural gas reserves ought to include shale gas and so-called "stranded" natural gas.

"Given that vast amounts of natural gas are expected to be recovered from these types of [shale and coalbed] formations, the level of proved reserves will be vastly understated when gas from such sources is excluded. Indeed, currently 15% of total U.S. gas production comes from these formations," Berne L. Mosley, director of the Federal Energy Regulatory Commission's (FERC) Division of Pipeline Certificates, told the SEC.

"In 2006 and 2007 FERC authorized four projects specifically intended to bring gas from shale formations in Texas, Oklahoma and Arkansas to market. In total, these projects comprise 529 miles of new pipeline, and will bring over 4 Bcf/d of natural gas produced from shale deposits to market," he noted, adding that four more projects are pending at the Commission to deliver an additional 5.9 Bcf/d of shale gas to market.

Mosley also took issue with the SEC's restrictions on the reporting of shut-in and stranded gas as proved reserves. "FERC...believes that the lack of existing pipeline infrastructure connecting the resource to the market should not be used to exclude 'shut-in' or stranded gas supplies when determining proved resources. The time necessary to authorize, construct and place a connecting pipeline into service could be a matter of a few months if performed under FERC's blanket certificate process, depending on the distance that shut-in supplies are from existing infrastructure. Even infrastructure projects involving hundreds of miles of new pipeline...may still be constructed and placed into operation in a relatively shot period of time."

He cited the western leg of the Rockies Express Pipeline (REX) as an example. The first segment of REX-West, which involved 503 miles of new pipeline through four states, was placed into service nine months after being authorized by FERC. It "allows formerly shut-in Rocky Mountain gas supplies to reach the market. However, according to current SEC policy, the gas reserves now transported by REX-West should be excluded from proved reserves. Clearly, lack of connecting infrastructure is not an appropriate exclusionary factor," Mosley said.

FERC's response, which was filed in February, followed a concept release issued by the SEC last December in which the agency solicited comments on whether changes in the requirements for reporting reserves were needed (see NGI, Dec. 17, 2007). The commission last week said it received approximately 80 comment letters, which generally supported updating the reporting requirements for reserves to reflect the changes that have taken place in the industry. The letters also provided a "great deal" of input about the specific types of updates that are needed, the SEC staff said.

The SEC's Division of Corporation Finance and Office of Chief Accountant last Thursday said they have prepared for SEC consideration recommendations to update and modernize the requirements for oil and natural gas companies to report reserves -- a move that has been widely supported by the industry. Issuance of a proposed rule by the SEC based on staff recommendations will require agency approval, and will be followed by a public comment period.

The recommendations seek to change the existing rules, which were adopted more than 25 years ago, that allow producers to disclose only "proved" reserves in their filings, but not speculative and uncertain oil and gas reserves because these may be too confusing to investors. To classify reserves as proved, a company has to be reasonably certain, based upon geological and engineering data, that it can economically recover them.

The SEC staff proposals reflect the "significant changes" in the oil and gas industry, including improved technology and alternate resources, since the adoption of the original reporting requirements between 1978 and 1982, according to the agency staff. Among other things, the recommended proposals would allow companies to provide investors with "additional information" about their oil and gas reserves, the SEC said. The SEC staff did not say what that additional information would include.

In comments in response to the concept release, the American Petroleum Institute (API), representing major producers, also urged the SEC to nix the restrictions on the reporting of reserves from oil shale, tar sands and other unconventional sources. "The investment community...views hydrocarbons produced from such resources as an integral part of the upstream oil and gas production business."

Likewise, Denise Bode, CEO of the American Clean Skies Foundation, proposed removing the restrictions for disclosing reserves from shale, tar sands and coalbed methane. "There is no good reason for this exclusion to continue. Indeed, the SEC recognizes that current technology makes these resources more available and predictable."

Several companies also urged the SEC to nix the requirement for producers to use year-end prices to determine reserves value and to replace it with a 12-month average price.

"We understand and support the need for consistency in the price assumptions utilized in estimated reserves. However, we do not support the use of the price on the last day of the fiscal year as this is subject to too many anomalies and and seasonal factors that distort reality...For similar reasons, we do not support the use of a futures price as they also change constantly," said Canadian producer Nexen Inc.

"Instead, we support the use of 12-month historical average prices to eliminate short-term anomalies and seasonal noise...We recommend that the average price be determined two or three months prior to the year-end in order to accommodate timely year-end reporting. This would enable the reserves evaluations to be commenced earlier," the company noted.

"We believe that the requirement to use a year-end sales price in estimating reserves should be reconsidered" as well, said the accounting firm of Ernst & Young. "Although requiring the use of year-end prices enhances comparability between registrants, it can result in the use of prices that are inconsistent with longer term market expectations and the basis on which management is allocating resources and making investment decisions."

The current year-end pricing system "does not accurately reflect the reality of the natural gas market or natural gas reserve values," said the Clear Skies Foundation's Bode. "Because natural gas is a nonregulated commodity that fluctuates daily, the end-of-year price rarely, if ever, approximates natural gas prices for the next year."

On another key issue, the API urged the SEC to continue to require the reporting of proved reserves "only." To classify reserves as proved a company has to be reasonably certain, based upon geological and engineering data, that it can economically recover them.

"We believe that investors, other financial statement users and registrants would not be well served by the mandated inclusion of probable reserves or other reserve/resource categories below the proved threshold due to the increased uncertainty of resources in these categories and the breadth of methodologies and evaluation techniques that may be employed in their calculation," the API said.

"It is also felt that the reporting of reserve/resource categories below the proved threshold could expose companies to additional, unwarranted litigation due to the increased risk and uncertainty associated with these resources."

Apache Corp. agreed. "We are not in favor of reporting probable or possible reserves for financial purposes, as the further we move from drilled, producing reserves, the greater the risk of inaccurate estimates and investor confusion," the Houston-based independent oil and gas producer said.

Moreover, "many producers are concerned that any recognition of nonproved reserves would result in attempts by local taxing authorities to assess ad valorem taxes on nonproved reserves. This is a legitimate concern," Apache said.

"The principal reserve disclosures of a company should be those of proved reserves," noted Shell International B.V. "The disclosure of probable reserves (either separately or included in a 'Proved + Probable Reserves') would provide data that does not, by definition, have a high confidence level of reliability but is only 'more likely than not.' Such disclosure could be viewed as misinformation or misleading to investors. We believe that users of financial statements would not benefit from data that has a significant inherent volatility."

But Nexen believes companies should be allowed to formally disclose proved and probable reserves, as well as additional potential resources if it deems it appropriate. "Full disclosure enhances a reader's understanding of management's decision-making process and permits them to make an informed assessment of management's stewardship of its assets and a company's future potential. Proved reserves rarely show the full potential of a property and may call into question management's decision to develop a reservoir or continue to hold it," the company said.

"All reserves estimates are inherently uncertain...[And] we believe the uncertainty associated with the various categories is generally understood by informed readers and could be reinforced by the inclusion of cautionary language similar to that utilized for forward-looking information included in a company's disclosure," Nexen noted.

The Energy Information Administration said it believes producers should continue to be required to report their proved reserves, but also should have the option to additionally and separately report their probable reserves.

Standard & Poor's also advocated the reporting of unproved reserves. "We believe that permitting disclosure of unproved reserves in public filings will make them more consistent over time. With appropriate disclosure, analysts and others will understand the greater uncertainties of early-stage reserve development," the credit rating agency said.

Others, such as BHP Billiton Petroleum, the American Association of Petroleum Geologists and Ernst & Young LLP, agreed that the SEC should give producers the option to report their unproved oil and gas reserves.

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