Petroleum Reserves

1
Petroleum Reserves The Needs of Financial
Reporting

• Michael Lynch-Bell
• Partner in Charge
• Energy, Chemicals Utilities, Transaction
  Advisory Services
• Ernst Young LLP
• 44 20 7951 3064
• mlynchbell_at_uk.ey.com

2
Background

• There is no consistency in Financial Reporting
• There are several approaches
• US
• UK
• International Accounting Standards
• and many others
• The International Community would like one
  standard approach

3
Major Initiative In Progress

• To adopt International Financial Reporting
  Standards (IRFS) for all listed companies by 2005
• In European Union South Africa Australia

4
Oil and Gas Accounting

• Accounting standards for Oil Gas companies even
  more confused
• Specific standards in only a few countries UK,
  US, Australia, Canada, Nigeria, Indonesia
• Often scoped out or exemptions under existing UK
  and International Accounting Standards
• And then, two inconsistent approaches
• - Full cost - Successful efforts

5
Oil and Gas Accounting

• Accounting is historic cost-based (in the main)
• Under any of the approaches, accounts do not
  reflect the value of the underlying reserves and
  resources
• Balance sheet value based on any or all of -
  Historic cost of exploration and development -
  Historic cost of licence acquisition - Fair
  value at the time of acquisition of exploration
  and producing interests - Revaluation of oil
  and gas interests - Reassessment for impairment

6

• Standard setters have attempted to bring
  consistency to oil and gas company accounts,
  started by the SEC

7
Schedule of Applicable SEC Rules

• Introduced 1977
• Regulation S-X
• Article 4
• 210. 4-10
• FASB Statements 19, 25, 69, 109, 144
• SEC Financial Reporting Release
• SEC Division of Corporation Finance, current
  issues

8
Basic Rules

• Basically
• Use proved reserves
• Year-end prices for estimates
• Disclose reserve quantities and standardised
  measure of value
• Extremely conservative approach

9
Clarification Guidance issued, which demonstrates
how the SEC is thinking

• Reasonable Certainty
• Existing Economic and Operating Conditions
• What is not proved
• Continuity of production
• Probabalistic methods
• Web site disclosure

10
SEC Corporation Finance Division Current Issues
In order to attribute proved reserves to legal
locations adjacent to such a well (i.e. offsets),
there must be conclusive, unambiguous technical
data which supports reasonable certainty of
production of those volumes.
11
SEC Corporation Finance Division Current Issues
If an improved recovery technique which has not
been verified by routine commercial use in the
area is to be applied, the hydrocarbon volumes
estimated to be recoverable cannot be classified
as proved reserves unless the technique has been
demonstrated to be technically and economically
successful by a pilot project or installed
program in that specific rock volume.
12
SEC Corporation Finance Division Current Issues
This requires the use of physical pricing
determined by the market on the last day of the
(fiscal) year. A monthly average is not the
price on the last day of the year, even though
that may be the price received for production on
the last day of the year.
13
UK Approach

• Proved plus probable reserves
• Managements view on prices
• Reserve quantity disclosure

14
Measures of Performance

• Reserve replacement
• Reserve valuation
• Finding cost per unit
• Production cost per unit
• Reserve life
• Value replacement
• Reserve distribution
• Standardised measure of cash flow

15
Other Disclosures which depend on reserve
definitions

• Amortisation
• Impairment
• Decommissioning provisions
• Standardised measure of cash flow
• Other performance measures

16
IASB

• IASB have established a group to develop a
  standard
• Unlikely to be a standard until 2007

17
Current IASB Thinking

• Only a revised form of successful efforts will
  survive (no full cost)
• Want one definition for reserves and resources ie
  commercially recoverable reserves
• Would like it to be the same as (consistent with)
  mining definitions
• Value-based accounts unlikely
• Value-based disclosures very likely
• Agree that the use of year-end prices for
  estimates could be misleading (but this is not
  the SEC view)

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Where do we need to get to?

• Any reserve definition to be useful for financial
  reporting must reflect the following
• Commerciality of reserves
• Likely future prices to be received for the
  reserves produced
• Forward sales contract
• Hedging
• Management view
• Forum curve
• Timing of production
• Cost of production
• Use of technology, existing and likely future

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Most Sensitive Issues

• Views on future prices
• Views on availability of technology
• We need help in demonstrating that any approach
  is not aggressive
• Less Sensitive Issues
• Cost of production
• Timing of production
• Geology

20
Conclusion

• Output of what you are doing is very important to
  financial reporting
• BUT
• SEC concerned about using any definition other
  than proved
• IASB has not got extractive industries very high
  on the agenda, and reserve definitions even lower
  down the priority list, however by 2005 they will
  be looking for an answer

21

• You have the time to influence the international
  accounting debate

22
Thank you!
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