The Securities and Exchange Commission (SEC) may require independent auditors to examine energy companies’ proved oil and natural gas reserves in the wake of the major reserve write-downs by Royal Dutch/Shell Group and El Paso Corp. this year, according to an SEC memorandum that was sent to Rep. John Dingell (D-MI) last month.
The SEC currently does not require independent auditors to review reserves. Certified public accountants, as part of their audit of financial statements, are required to perform certain “limited procedures” related to the disclosures of oil and gas reserves, but the agency conceded they do not have the expertise needed to provide opinions on the accuracy of oil and gas reserves.
“In view of the recent revisions of many companies in this industry, the internal controls over preparation of reserve estimates may have been inadequate,” acknowledged Alan Beller, director of the SEC’s Division of Corporation Finance, and Donald Nicolaisen, chief accountant, in the June 24 memo. Dingell, responding to the memo Tuesday, called this remark an “understatement.”
The SEC officials noted that the Public Company Accounting Oversight Board (PCAOB) has recently approved an auditing standard requiring auditors to evaluate and report on controls for estimating oil and gas reserves, and that the SEC plans to meet with the oversight board to “evaluate, with them, whether auditors should be required to perform additional work.”
Dingell doesn’t believe the SEC is going far enough. “I believe that significant reforms are called for on all of these issues and would urge prompt action on the basis of what is learned in the ongoing civil and criminal investigations,” he said in his July 20 reply to the SEC, as well as the Financial Accounting Standards Board and Federal Energy Regulatory Commission.
He also called for the SEC to consider a proposal by Texas oilman Oscar S. Wyatt Jr., which calls for companies to review their reserves annually and to make full disclosure of the facts. The disclosures would be confirmed by responsible, independent engineers. And the SEC’s reserve group should then review the reserves on a biannual basis.
Pressure on the SEC to review its regulations follows news this year that top-level executives at Royal Dutch/Shell Group lied about the company’s proved oil and gas reserves for nearly two years. The company was forced to cut its reserves estimates several times, sending shock waves to investors. In addition, El Paso cut its proved oil and gas reserves by about 41% earlier this year. Royal Dutch/Shell is being investigated by the Department of Justice, and both companies reportedly are the targets of SEC probes.
Both Beller and Nicolaisen declined, however, to confirm for Dingell that the SEC was formally investigating the widespread overbooking and subsequent write-downs and restatements of oil and gas reserves by Royal Dutch/Shell. In addition, they refused to say whether the SEC was reviewing the reserve practices and disclosures of the entire industry.
However, they did note, “in the last three years, the Division [of Corporation Finance] has reviewed filings of over 150 companies with industry codes indicative of companies with oil and gas reserves.”
Beller and Nicolaisen said that they believed the SEC’s guidance on “proved” oil and gas reserves was clear. “Proved oil and gas reserves are defined as ‘the estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions,'” they noted.
“Reasonable certainty implies that proved reserves have a higher likelihood of recovery than not…We explain that reasonable certainty is determined by supporting geological and engineering data that indicates its assumptions such as decline rates, recovery factors, reservoir limits, recovery mechanisms and volumetric estimates, gas-oil ratios or liquid yields are valid,” the two said.
“While the SEC staff has, from time to time, considered whether the definition should be revised, we have not identified ways to significantly improve them. We believe these definitions are sufficiently understood to enable reasonably consistent disclosures of oil and gas companies.”
But Dingell disagreed. “Recent events and the increasing frequency of reserve write-downs would seem to belie this conclusion.”
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