By John Klenner, Senior Manager - Assurance Services & Hector Reinoso, Supervisor - Assurance Services
In October 2009, the Securities and Exchange Commission ("SEC") staff issued new Compliance and Disclosure Interpretations ("C&DI") Oil and Gas Rules and Staff Accounting Bulletin ("SAB") 113, both of which revise previous guidance in SAB Topic 12, "Oil and Gas Producing Activities." The combination of the C&DI and SAB 113 are referred to as the SEC’s Modernization of Oil and Gas Reporting. This guidance was the first such revision to reporting of oil gas producing activities in 26 years. Registrants with oil and gas producing activities are required to comply with this new guidance in annual reports for fiscal years ending on or after December 31, 2009 and in registration statements filed on or after January 1, 2010. Early adoption is prohibited.
The most significant areas of the modernized guidance include revisions to:
Determining reserve quantities
Required disclosure in financial statements of registrants
Guidance with respect to Management’s Discussion and Analysis
Inclusion of third-party reserve reports and related consents to include such reports
The most significant changes in the modernized guidance relate to the determination of reserve quantities. Registrants are required to report proved oil and gas reserves as quantities of oil and gas recoverable from owned or leased property under existing economic conditions, meaning that reserves may only include quantities that may be produced economically. Previously, registrants were required to use the year end spot price under the theory of existing economic conditions. Now, registrants are required to utilize a twelve month average price utilizing the spot price on the first day of each month. The use of the average spot price rather than the year end spot price better reflects seasonal and other variations in price for reserves to be produced in the future. However if a registrant has contracts in place which determine a contractual price rather than a market price then the contractual price must be used in the calculation of reserves.
Registrants are also permitted to include previously prohibited sources of oil and gas beyond traditional oil and gas wells, principally due to advancements in extraction and processing technologies. Permitted “non-traditional” sources include bitumen extracted from oil sands and oil and gas extracted from coal and shale. However, there are restrictions on the inclusion of non-traditional sources. Any non-traditional sources must be economically producible and the registrant must intend to produce oil and gas from the non-traditional source. Registrants are required to disclose separately the components of their reserves that are from traditional versus non-traditional sources.
The amount of reserves that a registrant reports is also impacted by the revised definition of proved oil and gas reserves. A registrant is now permitted to include reserves determined by new reliable technologies that do not require well penetrations which mean that proved oil and gas reserves may include reserves which are proven through other means and not necessarily adjacent to proved locations. Previously, proved oil and gas reserves utilized the concept of the "lowest known hydrocarbons" and restricted the inclusion of reserves to spaces adjacent to currently proved reserves. However, for the registrant to include such reserves and proved oil and gas reserves, the reserves must be established with "reasonable certainty" and must be economically producible. The modernized guidance includes specific discussion of reasonable certainty and reliable technology. Registrants must now include a concise summary of the technology or technologies utilized to prove oil and gas reserves that have not been proven by well penetration.
The modernized guidance also limits the extent to which proved undeveloped reserves may be included in the aggregate reserves. Specifically, the registrant must have adopted a development plan in order to include undrilled locations in reserves. Generally, for locations to be included in the reserve report the development plan must include a plan to drill the identified locations within five years. The SEC has indicated that there are exceptions to this general rule since some projects by their very nature can take longer periods of time to develop. Examples include off shore projects, remote locations, or environmentally sensitive locations. Additionally, the registrant should evaluate its prior historical experience, how long a location has remained undeveloped, the ability of the registrant to execute the plan of development based on historical experience, among other factors, to determine if the inclusion of reserves as proved undeveloped reserves is appropriate. The C&DIs clarify that a registrant must not only have the intent to develop undrilled locations but must have adopted and committed to the investment for the plan of development to demonstrate intent. Furthermore, the registrant must have the ability to execute the plan of development. In the event that a registrant owns or leases acreage that it does not intend to begin development of for a period of at least five years then such reserves should not be included in proved oil and gas reserves.
The modernized guidance provides significant revision to and clarification of disclosure requirements by registrants with oil and gas production activities. The most significant changes include the disclosure of oil and gas producing activities by geographic areas. The registrant is required to determine what segregation of geographic regions provides the most meaningful information to the reader. Such geographic areas may be segregated by country, groups of countries within a continent or by continent. However, if a country accounts for 15 percent of more of total proved oil and gas reserves then the registrant is required to disclose that individual country. Additionally, registrants are required to disclose information about average sales price, production costs and quantities in each country or field that contains in excess of 15% of total reserves. A registrant is also required to disclose certain additional information about proved undeveloped reserves including total quantity of proved undeveloped reserves at year end, material changes to proved undeveloped reserves occurring during the year including conversion to developed reserves, investments and progress made during the year to convert undeveloped reserves to proved developed reserves and if applicable why certain proved undeveloped reserves remaining undeveloped for a period greater than five years have not been converted to proved developed reserves. Thought not required to, a registrant may include disclosure of unproved reserves as discussed in the modernized guidance.
The modernized guidance also includes specific information to be included in Management’s Discussion and Analysis which is not limited to, but must contain at least the following as is applicable:
Changes in reserves as well as the source of the change including price changes, technical revisions or other material changes
Technologies used to establish material additions and the level of certainty for such additions including increases in reserve estimates
Price and cost data
Performance of producing wells
Performance of mining activities to produce hydrocarbons
The ability to successfully convert proved undeveloped reserves to proved developed reserves
Minimum remaining terms of leases and concessions
Material changes to any line item in required tabular presentation
Potential effects of different rights to resources and geopolitical risks
Another important aspect of the modernized guidance surrounds the use of third-party preparers of reserve reports. If a third-party preparer is engaged and referred to in the filings of the registrant then the report must be included in the filing and the third-party prepare must provide the registrant with consent to include such report(s) in the registrants filings. The report is required to be submitted as an exhibit and is not required to be the full report. However, certain element of the report must be included as defined in the modernized guidance.
The SEC staff promulgated SAB 113 and the related C&DIs in response to significant technological and scientific advancements in the oil and gas field over the last 26 years. While the modernized guidance provides a registrant with greater latitude with respect to the definition of proved oil and gas reserves, the guidance also raises the bar with respect to the thresholds for recognition of proved reserves and the granularity of disclosure in an effort to provide users of financial statements more accurate, timely and useable information on which to base their decisions.