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Reserve reports for oil and (natural) gas production companies (producers) form the fundamental basis for valuation analyses. Reserve engineering by a producer is a complex and often subjective process through which the company itself and many constituents, including shareholders and lenders, make critical investment decisions. A reserve report is a series of cash flows and net present values that result from the forecast of gross and net hydrocarbon production, commodity price assumptions, transportation costs, product quality adjustments, geographic-based price differentials, taxes, and operating, capital and end-oflife costs. Reserve reports are utilized by production companies to determine the value of oil and gas assets in a variety of contexts, including purchase and sale activities and SEC reporting (in the case of public companies).
The purpose of this article is to provide an overview of the technical aspects of reserve reports, how they are generated, what they are used for and how they can factor into debtor and creditor behavior. It is not meant to be comprehensive and omits certain information that can be critical to any analysis of oil and gas reserves.
Proved and Unproved Classifications
Reserves are those quantities of petroleum that are anticipated to be recovered from accumulations at specific times. All reserve estimates involve some degree of uncertainty, which depends on the amount of reliable geologic and engineering data available at the time of the estimate and the interpretation of these data. The relative degree of uncertainty is conveyed by classifying reserves as either proved or unproved. Unproved reserves are less certain to be recovered than proved reserves and may be further subclassified as probable and possible reserves to denote progressively increasing uncertainty in their recoverability. Identifying reserves as either proved, probable or possible' has been the most frequent classification method and gives a general indication of the probability of recovery. Producers revise reserve estimates as additional data becomes available, as economic conditions change, as required by government regulations or as otherwise required in loan or equity documents.2
Developed and Undeveloped Classifications
Developed Reserves: Developed reserves are expected to be recovered from existing wells. Enhanced-recovery reserves are considered developed only after the necessary equipment has been installed, or when the costs to do so are relatively minor. Developed reserves may be further...