Look Back at Reserves Doesn't Yield Agreement

A report released last week casts last year's gas reserve replacement as disappointing and suggests the industry might have trouble meeting future demand. But other industry watchers are far less alarmed.

Proved domestic gas reserves were essentially unchanged in 1997 despite a 24% increase in extensions and discoveries to 10.1 Tcf, the highest level of drillbit gas reserve additions in the five-year study period, according to U.S. Upstream Performance Trends, a study by Arthur Andersen and John S. Herold Inc. The study noted, however, that negative reserve revisions of 1 Tcf, including a 623 Bcf downward revision by EEX Corp. and smaller downward revisions by Amoco, Mobil and Pioneer Natural Resources, are included in the figures.

"Although annual reserve additions have improved measurably from the low additions that accompanied depressed wellhead gas prices in 1992, Andersen and Herold remain concerned that domestic gas reserve additions may not be adequate for the industry to meet continuing increases in U.S. demand for natural gas," said Victor A. Burk, managing director of Andersen's energy industry services group. "The lack of an apparent supply response in domestic natural gas is puzzling, especially in light of continuing natural gas price strength at the wellhead and the active level of gas well drilling over the past several years."

Bill Fisher, a University of Texas geology professor, said he is "probably a little less concerned than" Andersen and Herold. "It's very hard to look at expenditures in one year and reported reserves in the same year." Fisher noted companies have been spending a lot of money in the deep-water Gulf and have not yet added reserves there to their company totals. Fisher also said the negative revisions found by Andersen and Herold are contrary to the trend of Energy Information Administration (EIA) statistics, which show revisions have been positive for the last several years. (EIA's report on last year's reserves won't be out for several months.)

The Andersen-Herold study looked at the top 49 publicly traded domestic exploration and production companies with domestic proved oil and gas reserves exceeding 100 MMBoe at the end of 1997. Burk said Andersen and Herold "really were surprised" proved gas reserves for the 49 companies didn't change. "When it comes to natural gas, the industry is in effect running up the down escalator," said Arthur L. Smith, John S. Herold CEO.

That's particularly true when one considers expectations for increased gas demand in the coming years, driven mainly by gas-fired power generation. "In some way this may explain the surprising strength we've seen in natural gas prices this year," Smith said. A recent H. Zinder &amp Associates study commissioned by the Gas Research Institute esimates that retirement of coal capacity in order to meet new air quality standards could result in between 1 quad/year and 1.5 q/yr of fuel for additional gas-fired power plants.

Pencils v. Drillbits

John Cochener, principal analyst for GRI resource evaluation, said the Andersen/Herold study shows that producers had their best year ever last year if one ignores "activities from the pencil." Basically, "it shows that 1997 for this group of 49 [companies] was the best year ever when you consider just the activities originating from the drillbit. People completely replaced what they had produced, whereas in prior years they produced more than they discovered and added," he told NGI. "That's the same thing we are saying - that industry has become more productive - and it jives with what the EIA has been reporting." He noted the agency has reported increases in proven reserves for 1994 through 1996, and is expected to announce another gain this year.

Given that success rates for producers have increased during the 1990s and that reserve recovery is up per well, Cochener doesn't see much to worry about in the industry. "We feel this is a trend. As long as that trend continues, we do not see a problem," he noted. "Right now it looks like the trend will continue in the short term."

Cochener isn't too high on the Andersen-Herold study because it includes reserve additions that are the result of accounting sleight-of-hand. "I came from an operating company, and I know that you can play tricks with accounting numbers. Essentially by mixing accounting numbers in there without doing it for everybody in the industry, you can come up with a distorted picture."

He noted the 49 companies examined by Andersen and Herold don't represent the whole industry. Reserves move back and forth between companies in the group of 49 and smaller players. "There's a danger in extrapolating from a small sample to the entire industry, and the distinction needs to be made between operations from the drillbit and activities of the pencil." It's the "revisions that are from the pencil that distort what the final answer is," Cochener said. If all companies were included, "a lot of this would zero itself out."

Looking at Andersen and Herold's data for years 1993 through 1997 shows last year to be the first year additions through extensions, discoveries and improved recovery equaled the level of production. "This is the first time in five years that producers have completely replaced reserves," Cochener said. In previous years, the additions fell short. "It says to me here again the drillbit is paying off. They don't have to rely on the pencil to make up the difference." And the bigger players haven't necessarily been the industry's best performers, he noted. "Their little brothers have been running circles around them." But, Cochener added, "the big guys are finally getting their act together, and they're not going to be a drag on the industry."

Burk and Smith said they would have expected weak oil prices to put more downward pressure on gas prices. Burk noted fundamentals, besides the simple supply-demand picture, don't support currently strong gas prices.

While much has been made of coming Canadian gas supplies, the consultants said domestic producers aren't trimming their E&ampP plans in light of this. "I think there's a myth that a lot of the Canadian gas reserves are very long-lived reserves," Burk said. This is not the case, he said, as Canadian reserves being developed now have higher depletion rates than those developed during the 1970s and 1980s, and there is concern on the part of some over whether Canadian producers will be able to fill all the capacity coming on line to the United States.

As for what's needed to stimulate domestic gas producer activity, Burk cited Arthur Andersen's 1997 U.S. Oil &amp Gas Industry Outlook survey. Responding to a question of what the average gas price needs to be to "significantly increase the domestic reserve base," 30% of respondents said $2.50/Mcf; 32% said $2.50 to $3.50/Mcf; and 11% said $3.50/Mcf or more. Joe Fisher, Houston

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