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Looking for best practices Anadarko’s Hackett touts reserve record, presents guidelines for industry reporting Ray Tyson Petroleum News Houston Correspondent
Anadarko Petroleum, which along with a lot of other exploration and production independents is feeling the heat from the U.S. Securities and Exchange Commission, took its campaign for better oil and gas reserve reporting to the prestigious Howard Weil Energy Conference in New Orleans, La.
“Anadarko has continued to expand disclosure and transparency around oil and gas reserves reporting to give investors a clear picture of the value of the (company’s) estimated reserve base,” James Hackett, Anadarko’s new president and chief executive officer, said in a March 29 keynote address to industry analysts who were no doubt concerned about the flurry of reserve write downs by companies in recent months.
“We believe Anadarko’s disclosures will provide a model for investors to use in asking for similar information from the other companies in which they invest.”
Hackett is no stranger to government scrutiny when it comes to reserves and the SEC. As the head of Ocean Energy, which was taken last year by Devon Energy in a $5.3 billion stock deal, Hackett and Ocean’s board of directors “decided” to change the company’s method of calculating reserves following a SEC review and before Ocean and Devon merged “to be consistent with the SEC’s interpretation of its applicable regulations and guidelines.” SEC only recognizes reserves that can be economically produced The SEC recognizes only proved reserves or those reserves that can be economically produced. Had Ocean applied SEC’s formula during 2002, in the year before shareholders approved the merger, Ocean’s total proved reserves would have been about 3 percent lower, or 578 million barrels of oil equivalent versus the 593 million barrels actually reported by Ocean. On a pro forma basis, the combined proved reserves of Ocean and Devon would have been roughly 0.7 percent lower, or 2.187 billion barrels compared to 2.203 billion barrels.
Ocean also noted in an 8-K filing with the SEC that the combined company’s depreciation, depletion and amortization expense would have been $12 million higher, or $1.823 billion rather than $1.811 billion, and combined earnings would have been $8 million lower, or $58 million instead of $66 million. Anadarko had been seen as aggressive booker of reserves Before Hackett’s arrival at Anadarko last December, the big Houston-based independent was perceived as an aggressive booker of reserves, a reputation Hackett attempted to diffuse in Anadarko’s January conference call on 2003 fourth-quarter earnings results.
Anadarko, which reported both lower profits and production compared to the quarter a year earlier, spent a considerable amount of time in the call with analysts justifying its year-end 2003 reserve bookings, which despite lower production rose 8 percent to 2.5 billion barrels of oil equivalent. Hackett said he was “confident” with the estimate and even received a “letter of confidence” from independent consulting firm Netherland, Sewell and Associates testifying to its “confidence in both our process and the reasonableness of our numbers.”
Hackett joined Anadarko following a tumultuous year in which the company struggled with production and costs. Anadarko was forced to cut its workforce by 15 percent in an effort to save $100 million in annual overhead and also began to focus on debt reduction. Estimates now in hands of board In his address to the Howard Weil Energy Conference, Hackett said Anadarko had implemented several new controls to further strengthen its estimation process, including handing oversight of the company’s proved reserve estimates over to the Audit Committee of Anadarko’s board.
In May, he added, Anadarko plans to ask the Audit Committee to hire the external reserve engineer just as it hires the independent external financial auditor each year. To “enhance the objectivity” of the internal reserve review process, the company is also removing the employees who serve on the internal corporate Reserve Review Team from any portion of the incentive bonus plan that is specifically related to reserves bookings, Hackett said.
“The reserve estimation and reserve quality issues are not going away, nor should they, since we’re talking about the most significant portion of a company’s valuation,” he concluded. “Anadarko is committed to being at the forefront of best-practice adoption in reserve estimation, and we will continue to improve our practices as new ideas are tested.”
However, companies need to emphasize their own internal review process rather than follow “the current fevered pitch” of depending on third-party engineers to validate reserve estimates, Hackett said, adding that while Anadarko has used both external auditors and reviewers, “neither system is perfect.”
“At the end of the day, the U.S. Securities and Exchange Commission, and Anadarko’s investors, are going to hold Anadarko accountable for our reserve estimates — not an outside consulting firm,” Hackett said.
He said Anadarko relies on an internal staff of more than 150 engineers and geoscientists to review every company well in every field, every year so its risk of performance surprises are reduced. The company also has a diverse set of properties with its largest field representing only 7 percent of total proved reserves, he noted.
In Anadarko’s case, a five-member team that includes the chief engineer, chief geologist, manager of corporate reserves and economics and a senior engineer reviews significant reserve additions and changes. The fifth person on the team is a senior vice president from outsider Netherland, Sewell.
Anadarko hired Netherland, Sewell at the beginning of 2003 to review the processes and procedures by which the company estimates reserves. As part of that process, the firm reviewed about 70 percent of the company’s 2003 reserve additions, as well as about half of Anadarko’s existing reserve base. No cookie-cutter model, Hackett says “There is no cookie-cutter, one size fits all model the industry can use when it comes to measuring a resource that you can’t see or touch,” Hackett said. “So, investors should consider a number of factors such as the technical tension in a company’s internal review process, the diversity of its properties, its track record of production and reserve adds or revisions, and how clearly management retains the responsibility and accountability for reserves estimates.”
He said Anadarko continues to expand disclosure and “transparency around oil and gas reserves reporting” to give investors a clearer picture of the value of the estimated reserve base. For example, the company’s 2003 Form 10-K includes disclosure of the “vintage,” or age, of its estimated proved undeveloped reserves, known as PUDs.
Hackett said the annual vintaging process gives Anadarko the ability to monitor the conversion rate of PUDs into SEC-recognized proved developed reserves, manage the investment plans for economically developing those reserves and ensure compliance with SEC guidelines.
“We pay particular attention to the older PUDs, specifically those three years old and older, to confirm we still have a current plan of development,” he said, adding that more than 90 percent of Anadarko PUDs booked in 2003 were in North America. He said it typically takes the company 18 to 24 months to convert PUDs to developed reserves.
“Everyone knows that not all reserves are created equal,” Hackett said. “How long PUDs stay on the books, where they’re located, their infrastructure requirements, and their production-cost and sales-pricing structures all have important implications for the current value of those booked reserves.”
He added: “Another quick test for investors is to look at a company’s history of production growth relative to reserves growth, including PUDs. They will rarely match up exactly for any given time period, but they ought to be close to ensure that the booked reserves are not just staying on the books forever but are actually being produced.”
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