oil reserves 101

When a company reports it’s reserves, unless otherwise noted, it is talking about something called proved reserves.  This is the quantity of oil that has been identified in the ground, which they have the legal ownership off, that are deemed to have at least a 90% chance of being extracted with current prices and technology.  In order to report something as proved reserves their data must be audited by an independent reservoir engineering firm, just as the financial reports of a company must be audited by an accounting firm.  Typically most proved reserves will already have the producing infrastructure in place, but sometimes the infrastructure is not fully in place.  Because of this, proved reserves may be divided into proved-developed (PD) and proved-undeveloped (PUD).   In the event of a sudden decline in prices PUD reserves are much more at risk of being written off by the company.  This happened several years ago for PUD gas reserves in the Haynesville shale when the price of gas plummeted.  Proved-developed reserves are rarely written off because the money has already been spent to get the wells to production, and the operating cost of maintaining production is usually very low.  Proved undeveloped reserves can only be counted as reserves if the company has a reasonable expectation that they will be developed within 5 years (sometimes called the 5 year rule).  Because of the amount of work involved in doing  a survey of reserves, in companies make an annual “reserve report”, which states reserves typically as of calendar year end.

Other types of reserves:

Historically, the SEC only allowed oil companies to report proved reserves to investors.  This may have been to prevent companies from confusing investors and exaggerating their prospects to them.  But at the end of 2008 a rule change was proposed and later adopted, allowing companies to report “probable” and “possible” reserves.

Probable Reserves- These have been shown to have at least a 50% chance of being produced with current technology and at current prices.

Possible Reserves- These have at least a 10% chance of being produced with current technology and at current prices.

Sometimes reserves are also discussed in terms of 1P, 2P, 3P reserves.  1P is proved only.  2P is proved + Possible.  3P is proved + possible + probable.

Another change that the SEC has made recently was that certain catagories of oil were prohibited as being reported as reserves, including oil sands and shale oils.  This change was also proposed in 2008.

One area of confusion among people not familiar with the industry, is that sometimes they hear the term reserves, and think that this is a best guess for how much more oil can be produced.  This is not the case at all.  Reserves are oil that has been proven to be extractable.  Even if a quantity of oil is known to exist, it cannot be considered a reserve unless a company owns the right to extract it, and has demonstrated the technical and financial feasibility of extraction. 

OPEC stated reserves: Countries like Saudi Arabia have long reported the same exact proved reserve figure (260 billion barrels in that case).  This has led some to accuse them of just cooking their books.  They produce 3.5 billion a year and yet the number never goes down!  While they may indeed be adjusting the number for political reasons, they could possibly be adding reserves through engineering work to compensate for the produced barrels.  It is difficult to say, but if we look at OPEC proved  reserve charts, the chart for many countries look very suspicious.  Starting in 1986 OPEC began trying to use a formula system to set production quotas for each member country.  Reserves were a factor, and if a country had large reserves, it would help get it a higher quota.  For this reason many countries increased their stated reserves massively, as shown in the chart below.  Their reserves are not independently audited, like they are for a private-sector company.  It is not possible that these revisions were all the result of some overnight engineering.  Either the reserves were deliberately understated prior to 1986 or they were deliberately overstated after that point.  Also note the huge increase for Canada- this is when they started counting the oil sands as reserves.

Article is from http://www.theoildrum.com/node/7363