January 9, 2008
Regarding your questions, although the current system certainly has deficiencies, the system is understood by most practicing reserve evaluation engineers I know. It is not perfect, but there is some degree of uniformity across reporting companies. I completely agree that the current system does not allow an investor to view the reserve potential through managements eyes. We are a private company and the vast majority of our capital expenditures are on reserves which are not considered proved within the existing SEC classification system, but are proved or probable within the SPE definition system. If a company plans to or actually invests significant dollars on a project it is indicative of the potential a company believe exists, otherwise they would not invest the capital. I would be in favor of a capital expenditure program table listing reserve potential for major projects utilizing an updated reserve classification program such as SPE. This table should clearly state that some or all of the reserve potential clearly does not conform to the traditional SEC proved definition.
Regarding question 10, the use of year end pricing has become outdated as hydrocarbon prices have become more and more volatile. This phenomenon can create swings in reserves quantities due to price alone, and does not reflect reserve replacement performance of companies. An example of this would be December 1998 and December 1999 when WTI spot prices were approximately $11.75/bo and $25.60/bo, respectively, an increase of 118%. I would suggest using a yearly average sales price instead. In this particular case, the averages for 1998 and 1999 were $14.36 and $19.27, respectively, an increase of 34%. Using a yearly average price would not eliminate the impact of price volatility, but it certainly would dampen large year to year swings in reserves due to price alone. It would also be helpful to investors to have the reserves stated using the 12 month average price of the prior year. That would allow investors to gauge for themselves the impact price volatility on a companys particular reserves.
Regarding question 15, I am not in favor or requiring the use of an independent third party. However, I am in favor of requiring that a company disclose whether reserves are prepared in-house or by a third party. If reserve estimates are third party prepared, then that third party should be disclosed and how long they have been preparing the company's reserves. Regardless of whether reserve estimates are in-house or third party, it should be required that estimates are prepared under the responsible charge of a professional petroleum engineer who has demonstrated competence within the area of reserve estimation. In the two states I am registered as a professional petroleum engineer, registrants are prevented by regulation from practicing petroleum engineering outside their area of competence. The Society of Petroleum Evaluation Engineers would be a good resource for further discussions along these lines.