Reporting Oil Reserves: More Information or More Noise? (XOM, CVX, COP)

The SEC has proposed new rules that would permit oil and gas companies to report possible and probable reserves as well as proved reserves when completing their annual 10-K. According to the agency, more information should help investors assign a value to oil and gas company stocks. Ah, if it were that simple. The proposed rules do not require a company to report total reserves, they just permit it. Nor do the rules specify precisely how the estimate of total reserves would be derived. Instead, companies may choose the "deterministic" method (an educated guess prepared by experts) or the "probablistic" method (an educated guess using computer simulation).

Defining reserves has always been a bit squishy. Under the currentdefinition of "proved" reserves, a company must be "reasonably certain"that the oil or gas can be produced economically using existingtechnology. As technology improves and prices change, the amount ofproved reserves can also change. Probablistically speaking, a provedreserve has a 90% chance of being produced. Probable reserves are "aslikely as not" to be produced (50% chance) and possible reserves have a"low probability to exceed the sum of proved, probable, and possiblereserves" (10% or less).

A second major change eliminates the method of extraction as acriterion. Currently, oil sands and oil shale operations are excludedbecause they are considered mining operations.

Another major change is proposed for determining the price to use tocalculate the value of a company’s reserves. Currently, the SECrequires companies to use the spot price on the last day of the fiscalyear reporting period. The proposed rules would require companies touse an average annual price computed based on the spot price at the endof each month.

If the proposed rules are adopted, there is no requirement thatcompanies report probable and possible reserves, but it is almostinevitable that they will. Exxon Mobil (NYSE:XOM), in its 2007Financial & Operating Review, estimates its total reserves of oiland natural gas to be 72 billion barrels of oil equivalent (BOE). Ofthat total, 32% (about 23 billion BOE) is proved. Chevron (NYSE:CVX)estimates that its proved reserves total about 10.1 billion BOE.ConocoPhillips (NYSE:COP) estimated its total proved reserves at about11.2 billion BOE at the end of 2006. Neither Chevron nor Conocoprovides an estimate of total reserves.

So, do we now know more about Exxon than we do about Chevron or Conoco?Maybe so. Because technology improves over time, and prices usuallyrise over time, we know something about Exxon’s pipeline toward futureproduction that we don’t know about the others. What we don’t know isthe monetary value of that pipeline. The proposed SEC rules should helpinvestors evaluate the long-term strength of a company. But as far asgiving more precision to valuations, it will still be "Caveat Emptor."

Paul Ausick
September 8, 2008