Shell shock highlights dilemma over reserves reporting system

Shell's recent announcement that 20% of its reserves were no longer 'proved' has raised questions over the workings of the current system of reserves reporting. Kenneth Chew, vice president, industry performance and strategy, IHS Energy, considers the issues surrounding reserves reporting and looks at relevant regulatory controls. Why do companies report reserves anyway? The purpose of reserves reporting is undoubtedly commendable and there are good fiscal and regulatory reasons for doing so. It also allows investors and the public at large to put a value on the assets of an E&P company and to make comparative analysis between companies. However, this only works if all companies report reserves to the same standards and this is where industry regulators enter the picture. Financial accounting rules (and thereby reserves reporting) vary from country to country. The most commonly used accounting standard, which is a requirement for all companies quoted on the New York Stock Exchange, is that of the US Financial Accounting Standards Board (FASB). Issued in November 1982, FAS 69 (Disclosures about Oil and Gas Producing Activities) provides the reporting and accounting rules and reporting formats for (1) proved oil and gas reserve quantities, (2) capitalized costs relating to oil and gas producing activities, (3) costs incurred for property acquisition, exploration and development activities, (4) results of operations for oil and gas producing activities, and (5) a standardized measure of discounted future net cash flows relating to proved oil and gas reserve quantities. The fifth item is one of the most contentious because it requires future cash inflows to be calculated by applying year-end oil and gas prices (no matter how atypical they may be) to yearend reserves and bases future costs on year-end costs and the assumed continuation of existing economic conditions. As Shell said in its statement: ‘The information so calculated does not provide a reliable measure of future cash flows from proved reserves…’ Although the FASB makes the rules, the resultant company reports are filed with the United States Securities and Exchange Commission (SEC). Furthermore it is the SEC that has defined what is actually meant by the various terms incorporated into FAS 69, such as ‘oil and gas producing activities’, ‘exploration costs’ and, perhaps most importantly, ‘proved reserves’. Regulation SX, Rule 4-10, where these definitions appear, was first published in 1978 and, although slight modifications have been made to it since that time, it remains essentially unchanged. This has created numerous problems for companies because technology has not stood still in the meantime. As an example, advances in seismic such 3D, 4C and direct hydrocarbon detection, the use of huge computing power to make reservoir simulations, and probabilistic calculation methods all allow far greater precision in establishing in-place and recoverable hydrocarbon volumes than was possible a quarter of a century ago.