OIL AND GAS RESERVES ESTIMATING WE HAVE MET THE ENEMY, AND HE IS US Peter R. Rose Senior Associate, Rose & Associates, LLP., and President AAPG Austin, Texas

1.Write your name on the form 2.Follow instructions 3.Try hard to answer objectively 4.Write your answers down 5.No joint ventures -- work independently 6.P90 is a small number; P10 is a large number RULES OF THE GAME

DETERMINISTIC ESTIMATE A single number (best guess) among a wide range of possible real outcomes. Low confidence in being precisely correct. Amount of uncertainty affects willingness to invest in your estimate.

FOR $20, HOW MUCH ARE YOU PREPARED TO BET THAT YOUR BEAN-ESTIMATE IS EXACTLY CORRECT? $10? $5? $2? $1? 50¢? 20¢? 10¢? 5¢? Chance of estimating the exact number of beans? !REMOTE! UNCERTAINTY & CONFIDENCE

EXPRESSING CONFIDENCE I Traditional Engineering Convention -- ±10%? Ranges of Numbers Corresponding to Confidence: Confidence (=,>) > 10 beans > 100 beans > 1,000 beans > 200 beans > 2,000 beans > 20,000 beans very, very high high moderate fairly high low very, very low Confidence (=,>)

EXPRESSING CONFIDENCE II LET US SPECIFY: “High Confidence” = 90% sure =, > P90 value “Low Confidence” = 10% sure =, > P10 value “50/50 Confidence” = 50% sure =, > P50 = Median

Superiority Of Probabilistic Method “... still just estimates cloaked in probabilities?” Advantages: 1.Measure our estimating accuracy by comparing probabilistic forecasts against actual outcomes 2.Use statistical principles to make better estimates (lognormal expectation, calculate mean of distribution, defined low-side & high-side criteria

P1Geologically possible; but extremely unlikely P10Reasonable Maximum P50Half below, Half above, the Median P90Reasonable Minimum P99As small as it could be... Yet detectable PRACTICAL ATTRIBUTES OF KEY PARAMETERS Boundary Conditions 80% confidence level

Superiority Of Probabilistic Method “... still just estimates cloaked in probabilities?” Advantages: 1.Measure our estimating accuracy by comparing probabilistic forecasts against actual outcomes 2.Use statistical principles to make better estimates (lognormal expectation, calculate mean of distribution, defined low-side & high-side criteria 3.Reality-checks -- natural limits, unrealistic extremes, analog distributions 4.Faster, more efficient

Compare your original “best estimate” (circled number, item 2, colored form) with your neighbor Does anyone in the audience have a circled number that is EXACTLY

Another bean slide... New confidence-level: NOTE: REASONABLE CERTAINTY ≠ “BEST GUESS

I am “Reasonably Certain” that there are ________ beans or more. NOTE: THIS IS A PROBABILITY STATEMENT, ALTHOUGH NO PROBABILITY (= CONFIDENCE LEVEL) IS SPECIFIED WHAT IS YOUR REASONABLE CERTAINTY? 50%? 67%? 75%? 80%? 90%? 95%? 99%? HOW CAN YOU MEASURE YOUR ESTIMATING ABILITY USING AN UNDEFINED CRITERION? 446

COMPLICATIONS 1.A larger estimate may be in your personal interest 2.Your boss may prefer larger to smaller estimates 3.Possible consequences if actual result is less than your estimate a)Negative Press b)Employer Disciplines c)State Penalizes

U.S. SEC REFUSES TO SPECIFY THE CONFIDENCE-LEVEL OF “REASONABLE CERTAINTY” 99%? 80%? 95%? 67%? 90%? 75%? 98%? 50%?

... BUT SEC will not specify confidence level assigned to “PROVED”

“Proved” Reserves...are the estimated quantities which geological and engineering data demonstrate with reasonable certainty to be recoverable....sec.gov / divisions / corpfin / forms / regsx. htm This is the foundational statement of what we think is an outdated (1978) system. Let’s take a look at the evolution of the wording reasonable certainty www

1936 Every reasonable probability 1964 Reasonable certainty 1976 Capen SPE Revised def. for proved 1987 Proved probable & possible 1978 Proved w reasonable certainty API Yergin and Hobbs, 2005 ogj SPE US SEC 1982 Year-end pricing 1997 Probabilistic methods guidelines published “Proved” Reserves reasonable certainty

DETERMINISM GETS INCREASINGLY COMPLEX Proved, Probable, Possible Developed & Undeveloped Weighting schemes to account for uncertainty ? Applicability to Undrilled Prospects and Plays?

PROBABILISTIC ESTIMATING COMES TO PETROLEUM EXPLORATION (≈ 1985  ) Exploration is a “repeated-trials game” of many uncertain ventures Statistical treatment is appropriate Statistics = “Language of Uncertainty” Aids to Improved Estimating --  Lognormality  Reality Checks  Project post-audits  improved estimating skills Leads to Portfolio Management

PROBABILISTIC ESTIMATING: STANDARD EXPLORATION PRACTICE Tipping Point mid-1990s SPE/WPC acknowledged in 1997, recognizing both Deterministic and Probabilistic approaches SPE/WPC recommendation: Proved = 90% Confidence

Reserves Estimating: A Divided Industry Exploration:Fully Probabilistic Production:Mostly Deterministic (Proved, Probable, Possible, Developed, Undeveloped, etc.)

TWO VIEWS OF E&P WORK: Deterministic View:Probabilistic View: TIME & $$ ← UNCERTAINTY → TIME & $$ ← UNCERTAINTY → “THE ANSWER” (Determinism) P90P50P10 STOP! Use this time & $$ to find other prospects

Determinism Promotes Unaccountability Attempts to represent highly uncertain parameters with a single, “precise” number, and without expressing how much uncertainty surrounds it. Proved, Probable, Possible: terms not defined quantitatively, so impossible to measure and calibrate estimating abilities objectively

So the Deterministic Method is unaccountable to: Professionals Clients and Employers Investors General Public

PROBABILISTIC METHODS PROMOTE ACCOUNTABILITY All possible outcomes are assigned likelihood of occurrence Compare estimates with outcomes: Detects and measures bias Encourages learning and improved estimating Compatible with Portfolio Management Adaptable to considerations of Chance of Success Can be universally applied to all E&P projects (Plays, Prospects, Developments, Workovers, EOR’s, etc.)

? Resistance to change? ? Propped up by SEC? ? Accountants can’t deal with uncertainty? ? Encourages false confidence? ? Desire to remain unaccountable?

DETERMINISM ENCOURAGES UNREALISTIC THINKING ABOUT HIGHLY UNCERTAIN RESOURCE VALUES Executives, Board Members, Bankers, Analysts, Stockholders Enables Decision-makers to maintain unwarranted confidence Discourages realistic assessments of uncertainty and risk

One Simple Remedy to Start Fixing the Problem A unified statement from the E&P professional community that “Proved” = 90% confidence. Imposed Definition on SEC Support of Professional Societies? Support of Influential Companies? Industry professionals created this problem -- Why don’t we, as responsible Professionals, change it? (Walt Kelly, POGO)

OIL AND GAS RESERVES ESTIMATING WE HAVE MET THE ENEMY, AND HE IS US Peter R. Rose Senior Associate, Rose & Associates, LLP., and President AAPG Austin, Texas