In this episode of the Oil 101 podcast series, we will discuss what determines reportable reserves in an oil and gas company’s balance sheet.

In this 3-minute podcast, we will discuss:

Listen to Oil 101 – What Are Reserves? below:

Welcome to Oil 101.

So, what are oil and gas reserves?

The vast amounts of crude oil and natural gas trapped underground are referred to as reserves.  

As we have discussed in other lessons, locating and developing the reserves is the key function of the upstream segment of the oil and gas business.  Reserves are the lifeblood of an exploration company, and every year they must find enough reserves to replace their annual production or the oil company is being liquidated.

However there are rules as to which discoveries can be added to an oil and gas companies reserves.

Proven reserves are the estimated quantities which geological and engineering data demonstrate can be recovered in future years from known reservoirs, assuming existing economic, technical and operating conditions.  Proven reserves have a more than 90 percent probability of recovery, while what are called probable reserves have greater than 50 percent probability of recovery.

Again,  reserves can only be booked as proven if they can be developed at the current crude price. So when crude prices fall, exploration companies are forced to write down their reserves.

Reserves definitions are based on sophisticated engineering estimate calculations set by two industry bodies:

Engineering estimates are the summation of production forecasts and are based on quantitative tools that use well data and production histories to estimate remaining oil or gas.

Accounting definitions, on the other hand, are set by the US Securities and Exchange Commission (SEC).  From 1982 to 2009 the SEC restricted public companies to publishing only proved reserves at the year-end price in their annual reports.

In new 2009 guidelines, the SEC rules were better aligned with the SPE-AAPG rules to get consistency between the accounting and engineering definitions.

The SEC now requires oil companies to disclose the year-end economic producibility of proved reserves.

In making this calculation, companies must use the unweighted average of oil and gas prices on the first day of each month for 12 months preceding the end of the company’s fiscal year. This is a change from the prior SEC requirement of calculating the year-end economic producibility of a reserve based on oil and gas prices on the last day of the year

Note that under Canadian rules, most companies report proven and probable reserves.

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