OSUOil&GasEnergyConference

8/13/2019 OSUOil&GasEnergyConference

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Oklahoma State UniversityOil & Gas Accounting Conference

Nov. 16, 2007

Reserves Estimation in

Accounting and Reporting

presented byDon Roesle, Chairman and CEORyder Scott Company, L.P.

www.ryderscott.com


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Discussion Outline

SEC Compliant Report

Validating a Reserve Report SEC Comment Letters

SEC Hot Button Issues


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The information presented herein

represents informed opinions about U.S. SEC

reserves reporting regulations but does not purport

to be identical to advice to be obtained from the SEC.

This presentation is offered for information purposes only.

Ryder Scott assumes no liability

for the use (or misuse)of the presented materials.


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What does the United States Securitiesand Exchange Commission (SEC)

expect in a 10-K Reserves filing?


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SEC 1978 Proved oil and gas reserves are the estimated quantities of crude oil,

natural gas, and natural gas liquids which geological and engineeringdata demonstrate with reasonable certaintyto be recoverable in futureyears from known reservoirs under existing economic and operatingconditions, i.e., prices and cost as of the date the estimate is made.

SPE/WPC 1997

Proved reserves are those quantities of petroleum which, by analysis ofgeological and engineering data, can be estimated with reasonablecertaintyto be commercially recoverable, from a given date forward,from known reservoirs and under economic condition, operatingmethods, and government regulations.

RESERVES DEFINITIONS


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SEC Guidelines

Reasonable Certainty

The concept of reasonable certaintyimplies that, as more technical databecomes available, a positive, or upward,revision is much more likely than a

negative, or downward, revision.


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SEC Guidelines

Reasonable Certainty Requirements Generated by supporting geological and engineering

data.

Validation of assumptions are necessary.

Criteria for analogies should be equal to or better thanreferenced reservoirs used as analogies.

Reasonable certainty is more than just the technicalconsiderations that oil and gas is recoverable. It also

includes resolution of how other barriers such asfinancial, environmental, marketing, legal and politicalwill be overcome.


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What is a SEC compliant report?

An estimate of the reserves and future revenuesusing existing economic and operatingconditions (12/31 prices and costs).

Recoverable from known reservoirsto a levelof reasonable certainty.

Revenues limited to that from sale of producedhydrocarbons and not associated income fromsulphur, CO2, processing fees, platform rentals,etc.

Limited reliance upon 3-D seismic and other new

technology.


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How does SEC assure thatcompanies are in compliance?

SEC Review Process

In recent years, the engineering staff issuescomment lettersinitially asking generic typequestions about many issues, including PUDs,pricing, reliance upon third-party firms,reserves-linked performance bonuses, recoveryfactors and other matters.


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How does SEC assure thatcompanies are in compliance?

SEC Review Process

Upon producer response, SEC then narrowsremaining relevant questions to specificproperties and may ask for maps and othersupporting documentation.

May result in iteration of several letters back andforth until SEC is satisfied or asks producer tomake modifications (Debooking or Restatement)


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SEC terms related to reserves compliance

De-booking typically results from SEC requestto remove certain reserves from the next annualreserves filing. Rather common but is nottypically publicized if the issuer voluntarilycomplies in the next annual 10-K filing.

Restatement is a much more serious result,particularly under SOX, as it requires the issuerto retroactively correct past reservesdisclosures and recalculate earnings.

U.S. Department of Justice (DOJ) will probablybe involved in any investigation thatsubsequently leads to a reserves restatement.


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What May Cause a Reserves Audit by SEC

Reasons for a Reserves Audits by SEC: History of downward reductions By press releases Response to Comment Letter Annual reports that dont conform to press releases Partner Activity, press releases, or revisions A history of SEC infractions Negative publicity The CalendarEvery 3 years

Unusual Stock Volume or Movement Whistle blowers or for several other reasons.


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Reserves Terminology

Reviews - Audits - Determinations


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Two typical types of reviews

Process review is an analysis of the process andprocedures established to ensure that reserveshave been estimated using industry acceptedpractices and in compliance with relevant

standards. May involve qualifications andindependence of internal reserves evaluatorsand auditors. Does not address reservesquantities

Reserves review is more typically a cursoryinvestigation of client-selected properties forvarious client purposes.


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Reserves audit

A reserves audit is an examination of the work

of others for the purpose of expressing anopinion that a reserves report is reasonable inthe aggregate and generally conforms toaccepted engineering and geological principals

and relevant reserves definitions. May include all or a portion of the properties of

an entity.

Acceptable tolerances usually within 5 to 10percent.

May include reserves, production forecastsand/or economics.


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Reserves determination (reserves report)

A reserves report is a grass roots evaluationin which an evaluator has examined andevaluated all available source data for thepurpose of producing an independent estimate

of reserves and reserves information in fullcompliance with the relevant reservesdefinitions.

Includes projections of production, revenues,

costs ( Capex, Opex, Taxes, Abandonment ) andfuture net income discounted at 10%.

A reserves report may be internally or externallyprepared.


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Creation of auditable data and workproduct files

Personnel should be trained in industry bestpractices regarding (1) acceptable geologicalinterpretations and reservoir description (2)

basic understanding of reservoir mechanics andfluid flow (3) comprehension of pertinentreserves definitions and (4) ethics.

Evaluators should establish real time access to

data from employer-operated properties andASAP data from partner-operated assets.


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Creation of auditable data and workproduct files

Partners should be wary of accepting operator-supplied reserves estimates.

Attention must be given to documentation of all

interpretative data steps, including narrativedescriptions of critical decisions.

All data and information related to a reservesreport, including geological maps, must be

archived in a form that can be accessed andreviewed by authorized parties at any time.

G l R D t i ti


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General Reserves DeterminationProblems Identified by the SEC

Some abuses of the proved classification (in no particular order)

Spacing violations for PUDs

PUDs which are too optimistic based on supporting data

Seismic amplitudes for down dip limits

Use of non-hydrocarbon revenue streams

Misuse of reservoir simulation resultsField level decline curve analysis

Declining operating costs with declining well count

Allocation of development costs to probable category to

justify proved reserves economics

Justification of proved reserves by analogy with non-analogousproperties

Misuse of statistical analysis

Reserves being declared proved when no sales market exists

Scheduling of reserves which extend beyond the term of

foreign concessions


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Validating a Reserve Report

Series of questions that should be asked

to help assess the degreeof reserve risk associated

with a companys reserves

and their reserve report.


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Who did the underlying reserve evaluation?

internal engineering

or

independent engineering firm

1.


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Is the independent engineering firm orcompany engineering staff knowledgeable of

SEC reserve definitions

and the appropriate reporting requirement ?

2.


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How long has the independent engineering

firm been doing the companys reserves ?

Is the engineering firm familiar with special issues that

might be involved with the companys properties ?

3.


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4.

Where are the reserves located ?

How knowledgeable is the company of the areas where the reserves are

located ?

Are they in an area where assessment of reserves carries greater risk

(I.e. Gulf Coast vs. Mid-Continent) ?

Are the reserves concentrated in specific areas, or are they widely

scattered (I.e. do they have core areas of competency) ?

Are the reserves in areas that require higher operating and development

costs (I.e. profit margin is smaller and expenditure demands are higheron the company) ?

Are the reserves in areas that are environmentally very sensitive ?

Are the reserves all domestic,

or do they include international properties ?


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5.

Is the independent engineering firm familiar

with the areas where the reserves are located ?


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6.

Does the independent engineering firm look at

all of the company reserves or just apercentage ?

Does the engineering firm do a detailed study

or an audit ?


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7.

Are the companys reserves concentrated in a

small number of properties, or is the portfolioof properties more diverse ?

What type of interest position does the company hold

in its different properties ?


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8.

Are the reserves mature,

or relatively new with minimal production ?

Is the reserve analysis primarily based on performance

methods or volumetrics ?

Are the reserves strictly primary, or do they includesecondary and EOR projects ?


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9.

Are most of the properties operated

or non-operated ?

If a high percentage of the companys reserves are

non-operated, what is known about the operators ?

Are the various operators substantial from a technical

and business standpoint ?

Do the operators have an established track record

of operations in the areas where the

reserves are located ?


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10.

What is the breakdown on proved reserve

status categories

(I.e. producing, shut-in, behind pipe and

undeveloped) ?

Are the reserves fairly well split between categories, or

is there a high percentage in the non-producing and

particularly in the undeveloped ?


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11.

What kind of reserve life index is there for the

proved producing reserves ?

Is this realistic for the type of proved producing

reserves stated in the SEC filing ?

Is this realistic taking into account the currentproduction of the company ?


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12.

What kind of reserve life index is there for the

total proved reserves ?

What level of producing rates will have to be added by

non-producing and undeveloped reserves to make a

reasonable life index ?

Does this seem attainable for the types of

reserves involved ?


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13.

Are the reported reserves based on the

appropriate economic parameters

as specified by the

Securities and Exchange Commission ?

Did the reserve appraiser use current

economic conditions ?


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14.

Historical Checks

Do future revenue projections appearreasonable considering recent historical

company revenues ?


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15.Historical Checks

Do future cost projections appear reasonable

considering recent historical company

expenditures ?

Have the appropriate operating costs been applied against

the reserve projections ?

Does the company have sufficient cashflow to carry their burden of

operating costs and service other necessary company expenditures ?

Have sufficient development costs been included to develop the stated

non-producing and undeveloped reserves ?

Does the company have an established track record

and the financial stability to spend the amounts of capital dollars

necessary to fund the development ?


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16.Company Performance

How does the company look over the years in

regards to revisions of previous estimates ?

Have the revisions consistently been significantin size in relation to the companys base reserves ?

Are the revisions consistently negative ?

Are the negative revisions consistently associated

with the non-producing and undeveloped

reserve categories ?

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Extensions, discoveries, other additions

are an indicator of how well the company ismoving proved undeveloped and probable

reserves into the developed reserve base

of the company.

Is the company historically demonstrating anability to do so ?

How well is the company finding new reserves through the drill bit ?

Does the company have an active exploration and development drillingprogram ?

Does the company have a good acreage position around its developingproperties ?

What kind of exploratory acreage position does the company hold ?

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Does the company typically grow throughacquisitions or the drill bit ?

Is there a good mix of both ?

Does purchase of reserves in place contributesignificantly to the companys reserve base ?

If the company traditionally grows through

acquisitions, is the company paying an appropriateamount for reserves ?

Could too much success with competitive bids mean

they are over-paying for the reserves ?


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19.

Company Performance

Does the company sell reserves in place

to divest themselves

of non-strategic reserves ?

Is the company burdened with a large number of low

margin wells in non-core areas ?


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20.

How recent is the reserve evaluationthat is the source of the companys reserves

in the public filing ?

Based on the answers to some of the previous

questions, are the reserves of a nature

that significant changes in reserve quantities can

occur over a limited period of time ?

Is the reserve evaluation a recent study or a prior

study that has been mechanically adjusted to a

specific as-of date for public reporting purposes ?


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SEC Comment & Audit Letters

Typical SEC Staff question:

Please inform us of anycircumstancewhere you have reported proved reserveslocated structurally below the lowest-knownhydrocarbons as establishedthrough well logsand if these additionalreserves have not been confirmed throughperformance history.


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Another question may be:

Please inform us of any circumstances whereyour reported reserves and future incomewere estimated using prices other than thosein effect on the last day of the year.


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Another common question asks:

Have you reported anyundeveloped reservesattributable to well locations more than oneoffset location(legal location) away froma commercial well?


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A recent letter also posed thefollowing:

Are performance bonuseslinked to reservesincreases?


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In the same letter:

Who has the authority to engage third partyengineers and who do they report to?


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Interesting QuestionsOne recent SECcomment letter asked for the following:

Identify all independent engineering firmsused over last 5 years.

What properties were reviewed?

How much the firms were paid for work onprojects other than year-end type work?

If the firms were discharged, reason(s) why?


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Another common question asks:

Have you reported proved reserves inuntestedfault blocks, structures, or seismicamplitudes?

(Untested here refers to the drilling of a wellconfirming presence of oil and/or gas)



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November 9th, 2004, the SEC sent a 9 page, 23

question inquiry to an independent US oilcompany

Among other items, the SEC asked for:

A one line summary for each proved reserve entry onthe books as of 12/31/2002 and 12/31/2003

Narratives, engineering and geological exhibits for thethree largest reserve extensions or discoveries during2003

SEC C t & A dit L tt


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Hindsight analysis of 5 largest PUD locations booked asof 12/31/2002 drilled during 2003

Include the engineering and geological exhibitsused to justify the reserve booking at each year endand a brief narrative reconciling the differencesbetween the two estimates.

Address corporate methodology for eliminatingfuture discrepancies between the estimates


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Narratives, engineering and geological exhibits for the3 largest reserve revisionsboth positive and negativenot caused by economics

Supplementally, tell us all the estimated hydrocarbonvolumes, if any, you have claimed as proved reserves;

A) In undrilled fault blocks

B) Below the LKHpenetrated or assessedstructural occurrence of hydrocarbons



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For the PUD locations as of 12/31/2002 drilled during2003, provide a comparison table of projected capitalexpenditures and actual expenditures for each well.Explain any variances over 1%. (This is not a typo)

Prepare a list of the PUD wells as of 12/31/2002projected to be drilled during 2003 but were notdrilled. Provide an explanation as to why the wellswere not drilled, if they are still carried as PUDlocations as of 12/31/2003 and why they still qualify as

PUD locations.

S C C & di


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Discuss the internal controls you have in placeto assure consistency and conservatism in yourproved reserve estimations.

Discuss how the effectiveness of these controlsis reflected in your history of proved reserverevisions over the past 3 years

Identify the personnel in your company whohave final authority over your proved reserves

SEC Red Flags and Hot Button Topics


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SEC Red Flags and Hot Button Topics

Technical IssuesValidation of proved undeveloped locations (PUDS)Proper use of analogiesDetermination of down dip limits/LKHApplication of seismic interpretationsRecovery factorsApplication of reservoir simulation

Flow testing/Data comprising a conclusive formation testUndrilled fault blocks

Commercial IssuesSEC year-end pricingCostsCapex and OpexNon-hydrocarbon revenues

Financial commitment to develop/project stagnationProject sanctioningCommercialitylack of marketBooking under PSCS

SEC HOT BUTTON TOPICS


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A) SEC year-end pricing

SPE/WPCallow some latitude, average period OK

SECno interpretation. Must use price on effective

date SEC position reflects its dated origins (1978)

A time with less volatility in O&G markets

Now O&G sold on spot markets

Year-end price to be used for rev. projections and economic

limits Can lead to abnormally high (or low) economic well lives

SEC HOT-BUTTON TOPICS

CONSEQUENCES OF SEC SINGLE DAY


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YEAR-END PRICE

A) SEC Year-End Pricing

CONSEQUENCES OF SEC SINGLE DAY


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A) SEC Year-End Pricing

YEAR-END PRICE



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B) Recovery factors

SEC increasing scrutiny

Staff pressing for hard evidence for recovery factors higher

than low-side of range

May ask for supporting documentation of assumptions

Examples:

water drive for oil

absence of water drive for gas




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C) PUDs

One offset rule (regulatory spacing)

Websitecertainty beyond one location

Rule also applies to CBM

Large percentage of PUDs

Stale PUDs

PUDs remain undrilled

Analogy for PUDs no longer valid




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D) Reliance upon seismic interpretations

Historically SEC has dismissed as too uncertain for proved

reserves

Extension of lowest known hydrocarbons

Proving up nearby untested analog structures




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E) Booking reserves under PSCs

Necessary Elements

Right to develop and extract

Reasonable certainty of production

Intent and commitment to develop

Capital at risk

Legal right to produce at the date of the estimate SEC Positionafter foreign government declaration of commerciality or

government approval of development plan

Exceptions if Compelling Case made to SEC




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F) Determination of LKHSEC - well logs only

SEC position can lead to significant differences relative to SPE/WPC

reserves

Reversal of 2000 SPEE forum positioncompelling case


SIGNIFICANT DIFFERENCES IN SEC AND


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Determination of lowest-known hydrocarbons

SPE and SEC definitions read similarly

SECin the absence of information on fluid contacts, the lowest

known structur al occur rence of hydrocarbons contr ol the lower

proved limit of the reservoir.

SPElowest known occur rence of hydrocarbons controls the

proved limit unless otherwise indicated by defini tive geological,

engineering or performance data.

SPE / WPC RESERVES DEFINITIONS



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Determination of Lowest-Known Hydrocarbons

Well A Well B

O = 31.1%K = 1100 md LKO Log

SPE Proved VolumeIncrement

OWC (RFT)

Reservoir cross section through wells A and B

O = 32.4%K = 1600 md




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Formation Pressures

Wireline test data established

Pressure PSIA

Base of sand

Top of sand

Base of sand

Top of sand

MDT

Dep

thTVDSS

8100

8200

8300

8400

8500

8600

8700

8800

4880 4920 4960 5000 5040 5080 5120 5160 5200

Well BMDT Pressures

Calculated OWC

Well AMDT Pressures





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G) Simulation-derived reserves estimates

Model in-place volumes limited by SEC

LKH limitations

Flow test requirements

SEC recognizes models often represent expected case

SEC requires good history match




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H) Revenue from Sale of Non-Hydrocarbons

SEC Prohibits All Non-Hydrocarbon Reserves (including Sulphur ,

CO2, and Helium)

Third Party Processing Revenue excluded

Cannot use non-hydrocarbon income to offset or reduce operatingcosts

S C O U ON O CS



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I) Flow Test Requirements

SECReserves are considered proved i f economic producibil i ty is

supported by either actual production or conclusive formation test.

SEC Survey on Booking Practices in GOM

SEC Special Project

Inquiry concerning booking proved reserves without conventional

flow test

Addressed in 2002 SPEE Forum with SEC



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I)Flow Test Requirements

Significant Unresolved IssueSEC Definition ofconclusive formation test

In certain areas- GOM -not seen as necessary or feasible

Producers reasons for no flow test in deepwater GOM

Redundancy to calculated test rates

Costs often exceed $10MM

Delays of up to two years

Environmental concerns and permitting requirements



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I)Flow Test Requirements

Potential Impact of SEC DecisionIf Position Enforced

Producers will be required to under report reservesImpact will be greater on smaller independentsSECs mandate of full disclosure may not be met

Deepwater GOM ruling

Collaboration of logs, cores, seismic and MDTs



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J) Net Profits Interest (NPI)

For properties subject to payment of net profits, SEC requires

property owner to deduct NPI reserves from owned reserves

SPE/WPC definitionssilent, but tradition considers NPIs to be

financial transaction without reserves ownership

Whats on the Horizon


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Whats on the Horizon SPE is revising its petroleum reserves definitions and will

issue new ones in 2006-2007. The United Nations has integrated the SPE/World

Petroleum Congress reserves definitions into itsframework with an aim to fully align both.

SPE is working with the International AccountingStandards Board and other organizations, including theUN, to ensure the adequacy of reserves standards.

The IASB and FASB have agreed to work towards theconvergence of existing U.S. and international financial

accounting practices and the joint development of futurestandards.

According to Roger Schwall, assistant director for theDivision of Corporate Finance - the SEC has no currentplans to change their definitions or guidelines.


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Thank You for Listening

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