New Oil, Gas Reserve Rules Bring Reporting Current

The energy industry finally has new rules for how to report oil and gas reserves, a much-needed overhaul that should bring companies into line with current practices and changes in technology, and provide better information to investors too.

The Securities and Exchange Commission approved the final rules and published a 160-page adopting release just before New Year’s. The amendments cap a year-long effort to modernize the disclosure rules, which were last reviewed by the SEC more than 25 years ago.

Givertz

“The new rules are a welcome improvement and bring the SEC reporting requirements into the 21st Century and more in line with industry standards,” says Adam Givertz, a partner in the law firm Shearman & Sterling. At the same time, he says, compliance will require more work from companies, since the rules mandate new, detailed disclosures such as a breakdown of reserves estimates by geographic area and final product.

Rocky Horvath, a partner in the energy practice of audit firm BDO Seidman, says the final rules address many of the concerns raised by commenters on the proposing release. “The SEC … appeared to be very receptive to respondents’ comments and concerns on the initial proposal,” he says.

Companies must begin complying with the disclosure requirements for registration statements filed on or after Jan. 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on or after Dec. 31, 2009. However, the adopting release notes that the SEC will consider whether to delay the compliance date as it works on revisions to existing accounting literature with the Financial Accounting Standards Board.

Issuers will not be able to start reporting under the new rules early, due to concerns that early compliance might make disclosures incomparable.

Among other things, the new disclosure rules require companies to report oil and gas reserves using an average price based on the prior 12-month period, rather than year-end prices; permit the use of new technologies to determine proved reserves; and allow companies to disclose their probable and possible reserves to investors.

“Issuers need to get familiar with new disclosure requirements and review them carefully, so that they have the ability to meet the new reporting standards on a timely basis.”

— Adam Givertz,

Partner,

Shearman & Sterling

The final rules drew praise from the Society of Petroleum Engineers. In a statement, SPE President Leo Roodhart said the updated rules “recognize the importance of new technologies in making accurate and reliable estimates of oil and natural gas reserves as the industry develops resources in harsher environments.”

Delores Hinkle, chair of the SPE’s oil and gas reserves committee, says the updates give companies the flexibility to provide additional reserve information to investors and “should result in better reserve estimates due to the inclusion of the advanced technologies and evaluation practices now in use.”

One of the most significant changes for companies is the new definition of proved reserves: It requires the use of a 12-month historical average price to estimate proved reserves, rather than the single day fiscal year-end price used under the current rules. That change alone could profoundly reduce short-term volatility, Givertz says, especially in a world where oil can swing from $145 to $40 per barrel in a matter of months.

Horvath says the revised definition also aligns the SEC’s definition more closely with the reserve figures companies use to make business decisions; that should result in higher quantities of reserve volumes being reported.

More Changes

The SEC did make one notable departure from its original proposal: It abandoned a provision that would have required companies to use a 12-month average price to estimate reserves for disclosure purposes, but a single-day, year-end price for accounting purposes. Instead, the final rule uses a single price based on a 12-month average. That means companies that use full-cost accounting will use the 12-month average for both accounting and reserve reporting purposes.

INFORMATION COLLECTIONS

The following excerpt from the SEC’s “Modernization of Oil and Gas Reporting” offers a summary of information collections:

The new rules and amendments increase existing disclosure burdens for annual

reports on Forms 10-K and 20-F and registration statements on Forms 10, 20-F, S-1,

S-4, F-1, and F-4 by creating the following new disclosure requirements, many of which

were requested by industry participants:

Disclosure of reserves from non-traditional sources (i.e., bitumen, shale,

coalbed methane) as oil and gas reserves;

Optional disclosure of probable and possible reserves;

Optional disclosure of oil and gas reserves’ sensitivity to price;

Disclosure of the company’s progress in converting proved undeveloped

reserves into proved developed reserves, including those that are held for

five years or more and an explanation of why they should continue to be

considered proved;

Disclosure of technologies used to establish reserves in a company’s initial

filing with the Commission and in filings which include material additions

to reserves estimates;

The company’s internal controls over reserves estimates and the

qualifications of the technical person primarily responsible for overseeing

the preparation or audit of the reserves estimates;

If a company represents that disclosure is based on the authority of a third

party that prepared the reserves estimates or conducted a reserves audit or

process review, filing a report prepared by the third party; and

Disclosure based on a new definition of the term “by geographic area.”

In addition, the amendments harmonize the disclosure requirements that apply to

foreign private issuers with the disclosure requirements that apply to domestic issuers

with respect to oil and gas activities. In particular, foreign private issuers must disclose

the information required by Items 1205 through 1208 of Regulation S-K regarding

drilling activities, present activities, delivery commitments, wells, and acreage, which

previously were not specified in Appendix A to Form 20-F. These disclosure items

codify the substantive disclosures called for by Items 4 through 8 of Industry Guide 2,

although much of this disclosure may have been disclosed by some companies under the

more general discussions of business and property on that form.

Source

SEC: Modernization of Oil and Gas Reporting (Dec. 31, 2008).

Horvath

That revision came in response to public comments asking for the change. “The accounting change is good news for companies that use full-cost accounting because, in general, they’ll only have to prepare one reserve report, which will make recordkeeping easier for those companies,” Horvath says.

For U.S. companies, Givertz says the biggest change is the option under the new rule to disclose probable and possible reserves. Under the previous rules, those issuers could only report proven reserves.

“That change brings the SEC rules in line with international standards and is helpful in terms of disclosure,” he says.

While that change is likely to be welcome by most companies, Horvath says that there’s “some concern” that the option to show probable and possible reserves could increase companies’ litigation risk, since (obviously) they are less certain than proven reserves.

The new rules also give companies the ability to report reserve estimates of bitumen and other non-conventional resources. Givertz says many issuers are likely to welcome that change.

Still, the new rules won’t do much for junior exploration companies that only have “resources” rather than “reserves,” Givertz says, since resources are the most uncertain of potential oil and gas reservoirs. U.S. industry practice (and many foreign securities disclosure regimes) does allow companies to report resources, but the new SEC rules continue to prohibit the disclosure of resources except in limited circumstances.

Observers say companies would be wise to prepare for the new rules sooner rather than later. Horvath suggests companies meet with their external and internal reserve engineers and their SEC counsel to help them prepare for the new disclosure requirements.

“Issuers need to get familiar with new disclosure requirements and review them carefully, so that they have the ability to meet the new reporting standards on a timely basis,” Givertz says.