February 19, 2008
I have been involved as an engineer in the estimation of oil and gas reserves for over 20 years. For 12 of those years I worked for an oil and gas consulting firm where I estimated reserves for both public and private companies. In dealing with the public companies one of the biggest discrepancies I saw from staff to staff was understanding how to utilize constant prices and costs. From a change of policy, it would be great for the SEC to further define what base price to use and how to use the appropriate differentials compared to the base price. I would like to see the SEC go to a trailing 12 month average of NYMEX final day closing prices for natural gas and the trailing 12 month average of NYMEX daily closing prices for oil. Also, I would like to see the SEC go to a trailing 12 month average of pricing differentials between the oil and gas price actually received at the well head compared to those NYMEX closing prices. If they could make a policy statement that oil and gas hedging contracts are not to be used in determining the oil and gas prices received at the well head that would also help reduce oil and gas pricing errors.
An individual’s interpretation of operating costs is another area of discrepancy. Many people eliminate “one time costs” in their estimate of current operating costs. These “one time costs” occur every year but maybe just for a different well or in another field. Therefore, public companies are usually understating their current operating costs in their reserve estimations. I think it is important for the SEC to include how to calculate operating costs in their new policies. For instance, they could make it a policy that you must use the prior 12 month average operating costs, without excluding any one time costs. For new wells, you could use the number of month’s available or analog data for the current operating costs.
However, regardless of any policy changes the SEC makes, I believe there is a much larger issue and that is poor judgment or lack of engineering and geoscience skills used in the interpretation of estimating reserves. I see a lot of reserve reports over the course of the year and most, if not all, are overstated. I would strongly encourage you to discuss with some of the heads of the consulting firms to see if they also believe this is an issue. You can change all the guidelines you want but if the person(s) interpreting the data is unqualified or uses poor judgment then their interpretation of reserves is going to much more of an issue. If indeed more people believe this is a big issue then discussions with the Society of Petroleum Evaluation Engineers and the Society of Petroleum Engineers as to how to solve this problem would be much more important. The changing in some of the SEC guidelines is a good first step but not the last.
Thanks for allowing input into this important subject.
John N. Davis
Davis Family Energy Partners, LP