Pittsburgh Post Gazette: Big oil, SEC differ on calculation of petroleum reserves: “Big oil threw down the gauntlet in a battle with U.S. regulators over how to calculate a crucial measure of the industry's long-term health: how much oil and natural gas it has in the ground. A report released Wednesday by an industry consultant -- and bankrolled with help from most of the world's major oil companies…”: “…in the wake of the Shell reserves scandal, several companies have begun reporting their reserves according to the Dec. 31 guideline _ and have had to lower their reserve-addition numbers as a result” (ShellNews.net) 25 Feb 05

By Jeffrey Ball, The Wall Street Journal

Friday, February 25, 2005

DALLAS -- Big oil threw down the gauntlet in a battle with U.S. regulators over how to calculate a crucial measure of the industry's long-term health: how much oil and natural gas it has in the ground.

A report released Wednesday by an industry consultant -- and bankrolled with help from most of the world's major oil companies _ criticizes the method the Securities and Exchange Commission uses to assess oil and gas reserves as outdated and pessimistic, saying it misleads investors because it underestimates the success the industry is having finding new stores of fossil fuel. Indeed, the difference between the SEC's method of tallying reserves and the calculation favored by the industry can amount to the equivalent of hundreds of millions of barrels of oil at one company alone.

The report, by Cambridge Energy Research Associates, calls on the SEC to revamp its reserves-accounting methodology to reflect changes in the oil industry since the guideline was hatched more than 20 years ago.

Among those changes: improved technology, which allows the industry to retrieve more of the oil and gas it finds, and increasing globalization, which means that more of the world's fossil-fuel supply lies in countries where the oil and gas is owned by the state, whose policies on production don't mesh with the SEC's rules. CERA officials noted that the industry has shifted from one focused on on-shore fields in the U.S. to one increasingly reliant on deep-water production around the world.

At issue is how energy companies calculate their ability each year to find enough new oil and gas to at least replace what they have pumped out of the ground. While investors watch quarterly earnings as a short-term measure of an energy company's success, they monitor replacement ratios as a fundamental indicator of a company's growth prospects. Reserves tell investors, in effect, how much money an energy company has in its bank.

Daniel Yergin, CERA's chairman, said energy companies and Wall Street already focus on a broader measure than the SEC's in assessing reserves: not just "proved" reserves, which means oil and gas that can be produced given current technology and current market prices, but "probable" reserves, which takes into account longer-term estimates of technological development and price changes. 

"Companies are going ahead and, indeed, investing billions of dollars based on indirect methods for assessing reserves," said Mr. Yergin. "They're making huge bets, and it is very, very dependent upon technological innovation." An SEC reporting standard that doesn't give companies flexibility to account for expected technological improvement "penalizes present investors," he said.

The CERA study was funded by oil and gas companies, accounting firms, law firms and industry consultants.

But they aren't the only ones criticizing the SEC's method. "To continue focusing on proved reserves is what really doesn't make sense," said Eric Knight, managing director of Knight Vinke Asset Management, a money manager that campaigns for improved corporate governance.

Mr. Knight's firm has been working with the California Public Employees' Retirement System, the largest U.S. public pension fund, which also has called on oil companies to subject their reserve estimates to external auditors. SEC rules don't require outside auditing of reserve numbers.

John Heine, an SEC spokesman, said agency officials "will read the report with interest but have no immediate comment."

Officials of Exxon Mobil Corp., one of the companies that helped to fund the study, said they endorsed its overall conclusions. A spokesman at BP PLC, which also helped pay for the study, said company executives hadn't yet read the final report and wouldn't comment specifically about it.

Notably absent from the list of sponsors was Royal Dutch/Shell Group, whose disclosure last year that the company massively overstated its reserves triggered the recent spotlight on reserves accounting in the first place. Shell has revised downward its energy tally by about a third so far, and it still faces continued scrutiny from investigators on both sides of the Atlantic. "We follow with interest the debate on proved reserves," a Shell spokesman said, but Shell's focus remains "on ensuring that we meet SEC requirements."

In addition to criticizing the SEC's focus on proved reserves, the CERA study criticizes how the SEC asks companies to compute that number. The level of proved reserve additions that a company can report in a given year depends on the prevailing price of oil and gas. Traditionally, the higher the price, the more a company can profitably pump out of the ground. 

Since 1982, a Financial Accounting Standards Board guideline has recommended that energy companies compute their annual reserve-replacement ratios based on the price of oil and gas on Dec. 31. The goal is to give investors an apples-to-apples way to compare one company's performance with another's.

For years, oil companies largely ignored the Dec. 31 guidance. Exxon, for instance, has calculated its reserves based on the price the company uses internally to determine whether an oil or gas project will be suitably profitable over the long term. Exxon argues that measure is the most realistic for investors, because it reflects the way the company runs its business.

But in the wake of the Shell reserves scandal, several companies have begun reporting their reserves according to the Dec. 31 guideline _ and have had to lower their reserve-addition numbers as a result.

Exxon was among the most vocal holdouts against the Dec. 31 method. Yet last week Exxon said it will officially report its 2004 reserve numbers according to the SEC's preferred method. Because prices on Dec. 31 were lower than the 2004 average, the Dec. 31 pricing method reduced Exxon's reserve-replacement ratio to 83 percent. It would have been 112 percent according to Exxon's traditional method. Put another way: The difference between the two methods amounts to the equivalent of 500 million barrels of oil.

The big hit for Exxon came from a project in Canada in which the company is producing bitumen, a tar-like substance that is the heaviest and least valuable grade of crude oil. On Dec. 31, bitumen prices had plunged to an unusually low level. They have since rebounded, and with them, Exxon's reserves.

http://www.post-gazette.com/pg/05056/462689.stm