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October 2003
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Petroleum Reserves & The Needs of Financial Reporting
Petroleum Reserves & The Needs of Financial Reporting
Michael Lynch-BellPartner in Charge
Energy, Chemicals & Utilities, Transaction Advisory Services
Ernst & Young LLP
+44 20 7951 3064
Michael Lynch-BellPartner in Charge
Energy, Chemicals & Utilities, Transaction Advisory Services
Ernst & Young LLP
+44 20 7951 3064
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BackgroundBackground
• There is no consistency in Financial Reporting
• There are several approaches
• US
• UK
• International Accounting Standards
• and many others
• The International Community would like one standard approach
• There is no consistency in Financial Reporting
• There are several approaches
• US
• UK
• International Accounting Standards
• and many others
• The International Community would like one standard approach
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Major Initiative In ProgressMajor Initiative In Progress
• To adopt International Financial Reporting Standards (IRFS) for all listed companies by 2005
• In European UnionSouth AfricaAustralia
• To adopt International Financial Reporting Standards (IRFS) for all listed companies by 2005
• In European UnionSouth AfricaAustralia
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Oil and Gas AccountingOil and Gas Accounting
• Accounting standards for Oil & Gas companies even more confused
• Specific standards in only a few countries:UK, US, Australia, Canada, Nigeria, Indonesia
• Often scoped out or exemptions under existing UK and International Accounting Standards
• And then, two inconsistent approaches:
- Full cost- Successful efforts
• Accounting standards for Oil & Gas companies even more confused
• Specific standards in only a few countries:UK, US, Australia, Canada, Nigeria, Indonesia
• Often scoped out or exemptions under existing UK and International Accounting Standards
• And then, two inconsistent approaches:
- Full cost- Successful efforts
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Oil and Gas AccountingOil and Gas Accounting
• Accounting is historic cost-based (in the main)
• Under any of the approaches, accounts do not reflect the value of the underlying reserves and resources
• Balance sheet value based on any or all of:
- Historic cost of exploration and development- Historic cost of licence acquisition- Fair value at the time of acquisition of exploration and producing interests- Revaluation of oil and gas interests- Reassessment for impairment
• Accounting is historic cost-based (in the main)
• Under any of the approaches, accounts do not reflect the value of the underlying reserves and resources
• Balance sheet value based on any or all of:
- Historic cost of exploration and development- Historic cost of licence acquisition- Fair value at the time of acquisition of exploration and producing interests- Revaluation of oil and gas interests- Reassessment for impairment
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Standard setters have attempted to bring consistency to oil and gas company accounts,
started by the SEC
Standard setters have attempted to bring consistency to oil and gas company accounts,
started by the SEC
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Schedule of Applicable SEC RulesSchedule of Applicable SEC Rules
• Introduced 1977
• Regulation S-X
Article 4
210. 4-10
• FASB Statements 19, 25, 69, 109, 144
• SEC Financial Reporting Release
• SEC – Division of Corporation Finance, current issues
• Introduced 1977
• Regulation S-X
Article 4
210. 4-10
• FASB Statements 19, 25, 69, 109, 144
• SEC Financial Reporting Release
• SEC – Division of Corporation Finance, current issues
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Basic RulesBasic Rules
Basically
• Use proved reserves
• Year-end prices for estimates
• Disclose reserve quantities and standardised measure of value
• Extremely conservative approach
Basically
• Use proved reserves
• Year-end prices for estimates
• Disclose reserve quantities and standardised measure of value
• Extremely conservative approach
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Clarification Guidance issued, which demonstrates how the SEC is thinkingClarification Guidance issued, which demonstrates how the SEC is thinking
• Reasonable Certainty
• Existing Economic and Operating Conditions
• What is not proved
• Continuity of production
• Probabalistic methods
• Web site disclosure
• Reasonable Certainty
• Existing Economic and Operating Conditions
• What is not proved
• Continuity of production
• Probabalistic methods
• Web site disclosure
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In order to attribute proved reserves to legal locations adjacent to such a well (i.e. offsets), there must be conclusive, unambiguous technical data which supports reasonable certainty of production of those volumes.
SEC Corporation Finance Division Current IssuesSEC Corporation Finance Division Current Issues
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If an improved recovery technique which has not been verified by routine commercial use in the area is to be applied, the hydrocarbon volumes estimated to be recoverable cannot be classified as proved reserves unless the technique has been demonstrated to be technically and economically successful by a pilot project or installed program in that specific rock volume.
SEC Corporation Finance Division Current IssuesSEC Corporation Finance Division Current Issues
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This requires the use of physical pricing determined by the market on the last day of the (fiscal) year.
A monthly average is not the price on the last day of the year, even though that may be the price received for production on the last day of the year.
SEC Corporation Finance Division Current IssuesSEC Corporation Finance Division Current Issues
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UK ApproachUK Approach
• Proved plus probable reserves
• Management’s view on prices
• Reserve quantity disclosure
• Proved plus probable reserves
• Management’s view on prices
• Reserve quantity disclosure
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Measures of PerformanceMeasures of Performance
• Reserve replacement
• Reserve valuation
• Finding cost per unit
• Production cost per unit
• Reserve life
• Value replacement
• Reserve distribution
• Standardised measure of cash flow
• Reserve replacement
• Reserve valuation
• Finding cost per unit
• Production cost per unit
• Reserve life
• Value replacement
• Reserve distribution
• Standardised measure of cash flow
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Other Disclosures which depend on reserve definitionsOther Disclosures which depend on reserve definitions
• Amortisation
• Impairment
• Decommissioning provisions
• Standardised measure of cash flow
• Other performance measures
• Amortisation
• Impairment
• Decommissioning provisions
• Standardised measure of cash flow
• Other performance measures
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IASBIASB
• IASB have established a group to develop a standard
• Unlikely to be a standard until 2007
• IASB have established a group to develop a standard
• Unlikely to be a standard until 2007
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Current IASB Thinking:Current IASB Thinking:
• Only a revised form of successful efforts will survive (no full cost)
• Want one definition for reserves and resources ie commercially recoverable reserves
• Would like it to be the same as (consistent with) mining definitions
• Value-based accounts unlikely
• Value-based disclosures very likely
• Agree that the use of year-end prices for estimates could be misleading (but this is not the SEC view)
• Only a revised form of successful efforts will survive (no full cost)
• Want one definition for reserves and resources ie commercially recoverable reserves
• Would like it to be the same as (consistent with) mining definitions
• Value-based accounts unlikely
• Value-based disclosures very likely
• Agree that the use of year-end prices for estimates could be misleading (but this is not the SEC view)
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Where do we need to get to?Where do we need to get to?• Any reserve definition to be useful for financial reporting must reflect
the following
Commerciality of reserves
• Likely future prices to be received for the reserves produced:
- Forward sales contract
- Hedging
- Management view
- Forum curve
• Timing of production
• Cost of production
• Use of technology, existing and likely future
• Any reserve definition to be useful for financial reporting must reflect the following
Commerciality of reserves
• Likely future prices to be received for the reserves produced:
- Forward sales contract
- Hedging
- Management view
- Forum curve
• Timing of production
• Cost of production
• Use of technology, existing and likely future
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Most Sensitive IssuesMost Sensitive Issues
• Views on future prices
• Views on availability of technology
We need help in demonstrating that any approach is not aggressive
Less Sensitive Issues• Cost of production
• Timing of production
• Geology
• Views on future prices
• Views on availability of technology
We need help in demonstrating that any approach is not aggressive
Less Sensitive Issues• Cost of production
• Timing of production
• Geology
20 #
ConclusionConclusion
• Output of what you are doing is very important to financial reporting
BUT
• SEC concerned about using any definition other than proved
• IASB has not got extractive industries very high on the agenda, and reserve definitions even lower down the priority list, however by 2005 they will be looking for an answer
• Output of what you are doing is very important to financial reporting
BUT
• SEC concerned about using any definition other than proved
• IASB has not got extractive industries very high on the agenda, and reserve definitions even lower down the priority list, however by 2005 they will be looking for an answer
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You have the time to influence the international accounting debate
You have the time to influence the international accounting debate
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Thank you!
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