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October 2003

Petroleum Reserves & The

Needs of Financial Reporting
Michael Lynch-Bell
Partner in Charge
Energy, Chemicals & Utilities, Transaction Advisory Services
Ernst & Young LLP
+44 20 7951 3064


• 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

Major Initiative In Progress

• To adopt International Financial Reporting Standards

(IRFS) for all listed companies by 2005
• In European Union
South Africa

Oil and Gas Accounting

• Accounting standards for Oil & Gas companies even more

• 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

Oil 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

Standard setters have attempted to bring
consistency to oil and gas company accounts,
started by the SEC

Schedule 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

Basic Rules

• Use proved reserves
• Year-end prices for estimates
• Disclose reserve quantities and standardised measure of
• Extremely conservative approach

Clarification 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

SEC Corporation Finance Division
Current Issues

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 Issues

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 Issues

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.

UK Approach

• Proved plus probable reserves

• Management’s view on prices
• Reserve quantity disclosure

Measures 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

Other Disclosures which depend on
reserve definitions

• Amortisation
• Impairment
• Decommissioning provisions
• Standardised measure of cash flow
• Other performance measures


• IASB have established a group to develop a standard

• Unlikely to be a standard until 2007

Current IASB Thinking:

• Only a revised form of successful efforts will survive (no full

• Want one definition for reserves and resources ie
commercially recoverable reserves
• Would like it to be the same as (consistent with) mining
• 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)

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
- Forward sales contract
- Hedging
- Management view
- Forum curve
• Timing of production
• Cost of production
• Use of technology, existing and likely future
Most 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

• Output of what you are doing is very important to financial


• SEC concerned about using any definition other than

• 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

You have the time to influence the
international accounting debate

Thank you!

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