1. Petroleum Reserves & The Needs of Financial Reporting
October 2003
Petroleum Reserves & The Needs of Financial Reporting
Michael Lynch-Bell
Partner in Charge
Energy, Chemicals & Utilities, Transaction Advisory Services
Ernst & Young LLP

2. Background 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 approach

3. Major Initiative In Progress
To adopt International Financial Reporting Standards (IRFS) for all listed companies by 2005
In European Union South Africa Australia

4. Oil and Gas Accounting
Accounting standards for Oil & Gas companies even more confused
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

5. 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

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

7. Schedule of Applicable SEC Rules
Introduced 1977
Regulation S-X
Article 4
FASB Statements 19, 25, 69, 109, 144
SEC Financial Reporting Release
SEC – Division of Corporation Finance, current issues

8. Basic Rules Basically Use proved reserves
Year-end prices for estimates
Disclose reserve quantities and standardised measure of value
Extremely conservative approach

9. 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

10. 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.

11. 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.

12. 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.

13. UK Approach Proved plus probable reserves Management’s view on prices
Reserve quantity disclosure

14. 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

15. Other Disclosures which depend on reserve definitions
Amortisation
Impairment
Decommissioning provisions
Standardised measure of cash flow
Other performance measures

16. IASB IASB have established a group to develop a standard
Unlikely to be a standard until 2007

17. Current IASB Thinking:
Only a revised form of successful efforts will survive (no full cost)
Want one definition for reserves and resources ie commercially recoverable reserves
Would like it to be the same as (consistent with) mining definitions
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)

18. 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 produced:
Forward sales contract
Hedging
Management view
Forum curve
Timing of production
Cost of production
Use of technology, existing and likely future

19. Most Sensitive Issues Less 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

20. Conclusion
Output of what you are doing is very important to financial reporting
BUT
SEC concerned about using any definition other than proved
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 answer

21. You have the time to influence the international accounting debate

22. Thank you!
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