Today we’re going to explore the components of a Reserve Report, the foundation of property evaluations. In short, a reserve report gives estimates of the how much producible oil & gas is still in the ground (which is “reserves”), the future producing rates from such reserves, the future net revenue from such reserves, and the present value of such future net revenue.
What standards exist?
There are a few societies that standardize the contents and procedure of the report with Society of Petroleum Evaluation Engineers (SPEE) being the most specific. However, even their own documentation outline that “the wide variation in types of evaluation reports prohibits the development of strict report standards.” Comforting, right?
In 2007, several international societies SPE, WPC, AAPG, & SPEE) joined together to create the Petroleum Resources Management System (PRMS) in an attempt to standardize classifications, engineering evaluation methods, and reporting guidelines. Most countries with a financial regulatory body use the PRMS as a foundation for their own reporting requirements, such as the SEC guidelines in the US. SEC guidelines are generally more strict than PRMS and allow less speculation on future pricing and development scenarios.
So who uses which guidelines in the US?
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Publicly traded company —> SEC Guidelines (required to publicly disclose “proved” reserves volumes)
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Private company hoping to be acquired or competing for investor funding—> SEC Guidelines but with a second version using PRMS Guidelines to show a certain speculative scenario SEC does not allow.
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Small company or individual —> PRMS Guidelines, due to simplicity and better applicability
Contextual Components
The SPEE outlines that every reserve report should have the following information for context of the evaluation:
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The client for whom the report was prepared;
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The purpose of the report;
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The date the report was completed;
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The effective date of the report;
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A discussion of reserve and resource definitions, assumptions, methods, procedures, and sources of data;
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Disclaimers to warn the reader of limitations;
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A statement of independence of the preparer; and
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The signature of the preparer or firm responsible for the report
A change in any of the above components can cause the results of the evaluation to be significantly different. For example, if the effective date of the report (the “As Of” date) is 3/1/2020, the results of the valuation would be nearly impossible to use on 4/1/202o due to how significantly COVID-19 affected market pricing. If two parties split ownership of minerals 50-50, each party may have a different report value due to special contract pricing or production costs included/excluded.
Do not blindly use the results of a report without looking at these components.
Layout of the Report
What you’re really after (and the whole point of a reserve report) is the evaluation of properties of interest. What are they worth???
Again from SPEE, the standard layout to present value is:
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SUMMARY: A cover letter and discussion section
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METHODS: A copy of the reserve and resource definitions used in preparing the report and any requirements of governing regulatory bodies, if applicable; and
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DETAILED RESULTS: Tabular data showing summary results and detailed projections.
Honestly, the methods and detailed results section can be pretty dry. Lots of definitions and tables of numbers that are better suited for an excel file. The discussion is where your assumptions and summary of results should be, and 95% of people only ever need data from this section, although sometimes the cash flows can have useful nuggets of information not included in the summary.
Key Elements of Summary & Discussion
The summary section acts as the translator between engineering speak and layperson speak. The summary should state the purpose of the report (what question was asked) and a clear answer from the qualified reserve estimator.
The discussion section outlines key inputs to the answer and should be reviewed for accuracy (“Is my decimal interest correct? What did this expert assume?”):
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The effective date of report (the “as of” date)
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Which reserve guidelines were used (PRMS, SEC, other, etc)
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How value of the property was determined, and if it represents a fair-market value (discounted cash flow, going market rates, asset cost, etc)
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Some reports are more like a home appraisal (“you property SHOULD be worth this”) but you wouldn’t buy/sell your home with just that report in hand. It’s used more for backing financial transactions.
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Other reports are more like a Realtor’s Competitive Market Analysis, where it’s closer to actual fair-value and what you would expect to get on the market as of the report date.
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Be very clear on expectations up front!!!
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What data was provided by the client and what was assumed by the estimator
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Primary economic assumptions listed out in detail
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Ownership information
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Pricing projections and sources
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Lease operating costs
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Development costs and timing
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Taxes deducted from revenues
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Plugging and abandonment assumptions
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Discount factor
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Any relevant contracts or lease information
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Any probabilistic aggregations uses (if any). Don’t worry if you don’t know what this is.
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Final notes
A reserve report is only valuable if it’s prepared for the right purpose, by a qualified estimator, and presented in an understandable format. If you don’t understand the results of a report, this is not your fault. Your estimator needs to meet you where you are; it’s their job.
At Pecan Tree Oil & Gas, our promise to always make these complex reports as digestible as possible so you can make the best decisions. Never complete a transaction (buying, selling, investing) you don’t fully understand, even if the “experts” say you should, even if that expert is me. Your money, your property, your investment, your future is important enough to take the time to do it right, and we would be honored to help you take those informed steps however needed.
