A report released last week casts last year’s gas reservereplacement as disappointing and suggests the industry might havetrouble meeting future demand. But other industry watchers are farless alarmed.

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

“Although annual reserve additions have improved measurably fromthe low additions that accompanied depressed wellhead gas prices in1992, Andersen and Herold remain concerned that domestic gasreserve additions may not be adequate for the industry to meetcontinuing increases in U.S. demand for natural gas,” said VictorA. Burk, managing director of Andersen’s energy industry servicesgroup. “The lack of an apparent supply response in domestic naturalgas is puzzling, especially in light of continuing natural gasprice strength at the wellhead and the active level of gas welldrilling 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’svery hard to look at expenditures in one year and reported reservesin the same year.” Fisher noted companies have been spending a lotof money in the deep-water Gulf and have not yet added reservesthere to their company totals. Fisher also said the negativerevisions found by Andersen and Herold are contrary to the trend ofEnergy Information Administration (EIA) statistics, which showrevisions have been positive for the last several years. (EIA’sreport on last year’s reserves won’t be out for several months.)

The Andersen-Herold study looked at the top 49 publicly tradeddomestic exploration and production companies with domestic provedoil and gas reserves exceeding 100 MMBoe at the end of 1997. Burksaid Andersen and Herold “really were surprised” proved gasreserves for the 49 companies didn’t change. “When it comes tonatural gas, the industry is in effect running up the downescalator,” said Arthur L. Smith, John S. Herold CEO.

That’s particularly true when one considers expectations forincreased gas demand in the coming years, driven mainly bygas-fired power generation. “In some way this may explain thesurprising strength we’ve seen in natural gas prices this year,”Smith said. A recent H. Zinder &amp Associates study commissionedby the Gas Research Institute esimates that retirement of coalcapacity in order to meet new air quality standards could result inbetween 1 quad/year and 1.5 q/yr of fuel for additional gas-firedpower plants.

Pencils v. Drillbits

John Cochener, principal analyst for GRI resource evaluation,said the Andersen/Herold study shows that producers had their bestyear ever last year if one ignores “activities from the pencil.”Basically, “it shows that 1997 for this group of 49 [companies] wasthe best year ever when you consider just the activitiesoriginating from the drillbit. People completely replaced what theyhad produced, whereas in prior years they produced more than theydiscovered and added,” he told NGI. “That’s the same thing we aresaying – that industry has become more productive – and it jiveswith what the EIA has been reporting.” He noted the agency hasreported increases in proven reserves for 1994 through 1996, and isexpected to announce another gain this year.

Given that success rates for producers have increased during the1990s and that reserve recovery is up per well, Cochener doesn’tsee 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,” henoted. “Right now it looks like the trend will continue in theshort term.”

Cochener isn’t too high on the Andersen-Herold study because itincludes reserve additions that are the result of accountingsleight-of-hand. “I came from an operating company, and I know thatyou can play tricks with accounting numbers. Essentially by mixingaccounting numbers in there without doing it for everybody in theindustry, you can come up with a distorted picture.”

He noted the 49 companies examined by Andersen and Herold don’trepresent the whole industry. Reserves move back and forth betweencompanies in the group of 49 and smaller players. “There’s a dangerin extrapolating from a small sample to the entire industry, andthe distinction needs to be made between operations from thedrillbit and activities of the pencil.” It’s the “revisions thatare from the pencil that distort what the final answer is,”Cochener said. If all companies were included, “a lot of this wouldzero itself out.”

Looking at Andersen and Herold’s data for years 1993 through1997 shows last year to be the first year additions throughextensions, discoveries and improved recovery equaled the level ofproduction. “This is the first time in five years that producershave completely replaced reserves,” Cochener said. In previousyears, the additions fell short. “It says to me here again thedrillbit is paying off. They don’t have to rely on the pencil tomake up the difference.” And the bigger players haven’t necessarilybeen the industry’s best performers, he noted. “Their littlebrothers have been running circles around them.” But, Cocheneradded, “the big guys are finally getting their act together, andthey’re not going to be a drag on the industry.”

Burk and Smith said they would have expected weak oil prices toput more downward pressure on gas prices. Burk noted fundamentals,besides the simple supply-demand picture, don’t support currentlystrong gas prices.

While much has been made of coming Canadian gas supplies, theconsultants said domestic producers aren’t trimming their E&ampPplans in light of this. “I think there’s a myth that a lot of theCanadian gas reserves are very long-lived reserves,” Burk said.This is not the case, he said, as Canadian reserves being developednow have higher depletion rates than those developed during the1970s and 1980s, and there is concern on the part of some overwhether Canadian producers will be able to fill all the capacitycoming on line to the United States.

As for what’s needed to stimulate domestic gas produceractivity, Burk cited Arthur Andersen’s 1997 U.S. Oil &amp GasIndustry Outlook survey. Responding to a question of what theaverage gas price needs to be to “significantly increase thedomestic 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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