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Art or science? Canadian oil and gas producers come face-to-face with tougher reserve disclosure standards and the consequences of reserve write-downs Gary Park Petroleum News Calgary correspondent
Junior oil and gas producers, including energy trusts, are entering new territory in Canada as they come to grips with tougher reserve disclosure standards designed to protect investors and help rebuild confidence in capital markets.
Several years after a string of reserves-related scandals in the 1990s led to unexpected reserve write-downs and bruised investors, a fresh set of rules was imposed Jan. 1 by the Canadian Securities Administrators, an umbrella organization representing 13 provincial and territorial securities commissions.
At the heart of National Instrument 51-101, public oil and gas companies trading on exchanges in Canada must hire independent reserves evaluators or auditors to put a number on their reserves and related future net revenue estimates.
The new code, viewed by some as more rigorous than 10K disclosure standards set by the U.S. Securities and Exchange Commission, requires evaluators to determine that there is at least a 90 percent chance that reserves listed as proven can be recovered. The level for probable reserves is 50 percent and 10 percent for possible reserves.
Currently the SEC only requires companies to give their own best estimates of reserves, just as Canadian companies previously needed only a reasonable certainty of realized reserves to put the numbers in the proven category.
Canada’s eight largest producers and any others who produce more than 100,000 barrels of oil equivalent per day are exempt from the standards.
John Dielwart, president and chief executive officer of ARC Resources and a member of the Alberta Securities Commission subcommittee that drafted the new rules, told an income trust symposium in January that most trusts already use independent evaluators.
But now management and directors bear greater responsibility for the reserves they disclose, which he suggested will see them “more focused on making sure that the reserves are representative,” he said.
Despite being in the exempt category, the first wave of reserve write-downs by Petro-Canada, Shell Canada, Nexen and Husky Energy saw all three take a buffeting on the stock exchange.
For the third time in three years, Shell downgraded its estimate of original sales gas reserves for Nova Scotia’s Sable gas project, this time by 300 billion cubic feet, after previously writing off 367 billion cubic feet.
Joining the parade, Petro-Canada lopped 5 percent off its proven reserves or 70 million barrels of oil equivalent, Nexen downgraded its worldwide numbers by 8 percent or 67 million boe, of which 60 million boe came from its maturing Canadian properties, and Husky chopped its estimate by 13 percent, including 131.6 billion cubic feet of gas in Canada and 142.9 billion cubic feet in Indonesia. Most of Nexen revisions heavy oil reserves The Canadian revisions are expected to result in a non-cash, after-tax impairment charge of about C$175 million, Nexen said.
“Over 80 percent of this charge relates to conventional heavy oil reserves. Our future depletion rate in Canada is expected to decrease by approximately 5 percent as a result of this charge,” Nexen Chief Executive Officer Charlie Fischer said.
“Our Canadian conventional assets have significant remaining economic value and we will continue to manage them to maximize that value.”
Despite these assurances, Nexen shares dropped by 7 percent in intraday trading following the announcement and closed down 4.4 percent. Petro-Canada took a 12 percent hit the previous week.
Fischer said the fact that his company has complied with SEC reserves rules for years made it easier to meet the new Canadian standards.
However, he said there is a “real sense in dealing with (independent evaluators) that their methodology has become more conservative.”
Fischer said the geological mapping and drilling tests that are employed to assess reserves are by no means certain. “On certain properties, we’re going to get surprises,” he said.
As Nexen moves from maturing conventional North American basins to unconventional projects, such as the oil sands, trying to anticipate reserves over a 25 to 30 years operating life was “not a precise science,” Fischer said. Securities Commission: reserves calculation a science That put him at odds with remarks by Glenn Robinson, senior petroleum evaluation engineer at the Alberta Securities Commission, who told the trust symposium that “reserves evaluation is a science, not an art.”
Regardless of the uncertainties, there are “good engineering techniques for evaluating reserves,” he said.
Daryl Gilbert, president and chief executive officer of Gilbert Laustsen Jung Associates, which conducts reserves determinations, said that meeting the new rules is an “inexact science ... we can’t precisely calculate reserves.”
Tom Pavic, an analyst with Calgary-based Sayer Securities, told the Globe and Mail newspaper that as the industry complies with reporting requirements in Canada and closer scrutiny in the United States, it faces widespread ramifications from lowered reserve calculations.
But he said it is important to “avoid the train wrecks that have happened in the past,” which include a number of smaller companies placed in creditor protection or receivership recently because their proven reserves did not support their debt level.
He suggested the greatest pain could be for junior producers. If they are forced to cut their reserve numbers, their stock market prices will drop, opening the door to predators hunting for cheap assets.
Pavic said the guidelines could fuel merger and acquisition activity, with some companies forced to sell assets because of lowered borrowing capacity.
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