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Tiny SEC Staff Monitors Data on Oil Reserves

The Wall Street Journal: Tiny SEC Staff Monitors Data on Oil Reserves

Amid Lawyers and Accountants,

Two Petroleum Engineers Plumb

The Depths of Corporate Claims

By MICHAEL SCHROEDER

Staff Reporter of THE WALL STREET JOURNAL

Posted 27 May 04 (originally published 12 March 04)

WASHINGTON — Hundreds of lawyers and accountants at the Securities and Exchange Commission scour company annual reports to make sure the numbers add up. But when it comes to double-checking the oil and natural-gas reserves claimed by oil companies in their filings, the job is left to just two staff petroleum engineers.

Because of their expertise, the two men are key participants in the SEC’s investigation into whether Royal Dutch/Shell Group may have intentionally inflated the reserves it reported in recent annual reports. The probe follows Royal Dutch Shell’s admission in January that it overstated its reserves by 20% — the equivalent of 3.9 billion barrels.

For years, producers and regulators have debated how best to determine what should be classified as “proven” oil and natural-gas reserves: deposits with “reasonable certainty” that can be expected to be produced. Oil companies gripe that regulators continue to use a standard set 25 years ago to determine reserves without taking into consideration three-dimensional seismic data and other new technologies.

Since they joined the SEC in 1999, petroleum engineers Ronald Winfrey and James Murphy have bluntly argued in public forums that the industry’s reliance on new technologies had caused many reserve write-downs over the past few years. “Prove it to us or take it out,” Mr. Murphy barked at a Society of Petroleum Evaluation Engineers Forum in October. “Investors do not believe the reserve numbers anyway,” he added.

Despite the combative nature of their jobs, the two engineers generally are respected by the industry. “They do a credible job but are constrained by the rules,” said Charles Gleeson, president of the engineers society and head of a small engineering firm in Midland, Texas.

Top executives and auditors, under the threat of harsh penalties dictated by the Sarbanes-Oxley Act, generally are taking additional steps to make sure financial reports are accurate. In the midst of the Shell investigation, for instance, the oil industry and accounting firms are asking if the SEC will act to force producers to hire outside reserve engineers to audit reserve data. SEC officials say they haven’t decided.

Oil-and-gas-reserves reports, which oil companies that trade on U.S. exchanges must file with the SEC, are a much-watched indicator for many investors and analysts of an oil company’s operational success and future value.

Before the Enron Corp. accounting scandal, the short-staffed SEC frequently missed its goal of scrutinizing large companies’ annual reports every three years. Harvey Pitt, SEC chairman when the Enron scandal erupted, ordered the agency’s corporation-finance division to review all 2001 annual reports of the 500 largest companies, which included the major oil companies.

It isn’t clear if the SEC asked questions that eventually led to Shell’s decision to restate reserves. But Lynn Turner, a former SEC chief accountant who left in 2001, said he believes the engineers began asking Shell questions about its reserves in early 2002 as part of the formal SEC review of the largest public companies.

That suggestion appears to be backed up by an internal Shell group memo, described by two people familiar with it, which was drafted Feb. 11, 2002. It warned that about one billion barrels of oil-equivalent reserves appeared not to be in compliance with SEC guidelines.

The SEC wouldn’t discuss its Shell investigation.

Messrs. Murphy and Winfrey are considered by the industry to be plainspoken, competent and hard working. “Even though we have irritations from them from time to time, there is a level of comfort from the work the SEC does,” said Ron Harrell, chief executive of Ryder Scott Co., oil consultants in Houston.

Both engineers have experience in the private sector. After serving in the Air Force and nearly completing a doctorate degree in physics at the University of Oklahoma, Mr. Winfrey, 58 years old, worked about 20 years for a small petroleum-engineering firm in Oklahoma City.

Mr. Murphy, 55, came to the SEC from the Energy Department’s former Elk Hills Naval Petroleum Reserve near Bakersfield, Calif., which was sold to the private sector in 1998. A University of Houston engineering graduate, he also worked for nine years for the former Arco, now part of BP PLC.

An engineer or two has been on the SEC staff since the 1970s, frequently recruited from other federal departments. In the 1990s, the engineers spent a lot of time evaluating engineering oil-reserve reports of small penny-stock oil companies, some of which became the targets of enforcement cases for using fraudulent reserve information to pump up stock prices.

They have an unusual status at the agency. Their authority is magnified because the agency’s lawyers and accountants “won’t second-guess them,” a former SEC official said. “They are big fish in a little pond.”

Write to Michael Schroeder at [email protected]

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