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SEC rules hurt with dropping oil prices
John Porretto Associated Press Energy Writer
The sharp drop in crude prices is forcing oil companies to exclude some untapped oil and natural gas reserves from their books because they’re no longer economically viable, potentially affecting company borrowing power.
Under Securities and Exchange Commission rules, oil companies are required to report the size of their proven oil and gas reserves each year and determine whether they could be produced economically, based on year-end prices. With crude at $40 a barrel, some deepwater offshore and other costlier production is no longer feasible.
The rules will change next year, allowing companies to use 12-month average prices instead of year-end values. Until then, some companies will have to omit reserves deemed too costly to produce. That’s a big blow for any oil company because new reservoirs are getting harder to locate, and reserves represent a key measure of a company’s value and long-term financial prospects.
In recent years, current SEC rules didn’t cause significant problems because average prices and year-end prices were more comparable, said Mark Sadeghian, an analyst at Fitch Ratings. That wasn’t the case in 2008, a year that saw prices peak near $150 per barrel in July, then plummet to around $45 amid a burgeoning recession.
“Everyone is going to test reserves at a really low number, so I’d expect to see negative price-based revisions, and it may well be widespread,” Sadeghian said.
Conoco reserves down Earlier in January, ConocoPhillips, the third-largest U.S. oil company, said it expected to reduce its proven reserves by an unspecified amount because of the year-end price rule — the last thing any major producer wants to do as new sources of oil and gas grow scarcer.
ConocoPhillips noted it likely would replace only about 25 percent to 30 percent of its 2008 production with new reserves. Excluding price-based revisions, Fitch said, the company’s reserves replacement is expected to come in around 80 percent to 85 percent. Analysts typically say a company’s reserves replacement should average more than 100 percent over a three- to five-year period to indicate growth.
When crude climbed close to $150 a barrel last summer, it appeared oil companies would be able to grow their reserves, as higher-priced fields suddenly made economic sense. All that changed as prices collapsed in the latter half of the year.
Natural gas spiked and fell, though not as badly, ending the year down about 25 percent.
“These price declines indicate that marginal reserves (especially oil-weighted ones) that were on the books in 2007 are at risk of being removed from the proved category,” Raymond James & Associates equity research analysts said in a report the week ending Jan. 23.
Other producers, including giants Exxon Mobil Corp. and Chevron Corp., are expected to report 2008 reserves replacement levels in the coming weeks.
Smaller companies hurt Fitch said companies mostly likely to get pinched by having to exclude reserves are smaller, independent producers whose ability to borrow money is based in part on oil and gas holdings. “Not only can this have implications for growth/drilling activity levels, but to the extent that reserve debookings are substantial, liquidity concerns can arise as borrowing capacity is reduced,” the Fitch report said.
In response, many companies large and small are slashing capital spending as they prepare to ride out this period of low prices. One consequence, analysts say, is that lower production could eventually intersect with renewed demand once economies begins to rebound and cause yet another spike in energy prices.
Looking ahead, the new rules, which take effect at the end of 2009, largely bode well for the industry and could, in fact, help to boost reserve bookings.
The SEC’s reporting rules for oil and natural gas reserves were adopted more than 25 years ago, and the revisions are intended to reflect technological changes in how oil companies identify proven reserves.
Among other things, the recently adopted revisions broaden the technologies used to determine proven reserves provided the technologies have been shown to lead to reliable assessments. They also allow companies to disclose probable and possible reserves to investors. For now, SEC rules limit disclosure only to proved reserves.
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