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The Wall Street Journal: Reserves Lose Their Power

Wall Street Journal Reserves Chart

Wall Street Turns
To Other Measures
For Energy Firms
By ANGEL GONZALEZ
April 17, 2007; Page A10

As a crystal ball into the energy industry’s prospects, proved crude-oil and natural-gas reserves aren’t as clear as they used to be, at least not for the biggest oil companies.

Reserves are an estimate of the quantity of oil and gas a company controls and will produce. Reserves and a company’s abilities to replace supplies of oil and gas pumped out of the ground have long been a gauge of future production and profitability and closely scrutinized by investors.

Last week, Royal Dutch Shell PLC said it will pay investors outside the U.S. $352.6 million plus administrative costs in a settlement related to a 2004 reserves-accounting scandal. It said it expects to settle with U.S. investors for about $80 million.

But for many of the larger energy companies, reserves can be an increasingly difficult measure to follow. Big bets on a handful of long-range projects, demands by governments for a growing share of resources and other factors have led major oil companies to report volatile or murky reserves results.

Wall Street’s assessments of Exxon Mobil Corp., BP PLC and other oil giants increasingly are focused on other qualities, such as the market’s perception of executive competence, or a company’s proficiency in managing megaprojects that take years to develop.

Reserves are “still a valid measure, but they are harder to get a handle on than what they have been in the past,” said Bruce Lanni, an analyst at A.G. Edwards who covers the largest oil companies. “It’s a very important number, but you have to look beyond that.”
 
In a conference call in January, ConocoPhillips Chief Executive Jim Mulva said the company expects reserve replacement to be “somewhat uneven” on a yearly basis, as major development projects take time to develop and resources become harder to access.

The company downgraded its 2006 reserves by 260 million barrels of oil equivalent because of technical difficulties in a Caspian oil field and North Sea fields. Conoco’s 2006 reserve replacement was 300%, but that included the $35 billion acquisition of Burlington Resources. Discounting the Burlington deal, Conoco’s 2006 reserve replacement would have been just 10% to 15%.

Some analysts are willing to overlook a bad reserve-replacement year if a company has enough promising prospects in the pipeline through a successful exploration program.

For example, Chevron Corp.’s recent drilling successes in the Gulf of Mexico and elsewhere — along with record profit lifted by high commodity prices — helped to offset the negatives associated with the company’s difficulty in replacing reserves in recent years. Chevron replaced 101% of its reserves in 2006 after replacing just 18% in 2004. Like Conoco, Chevron’s reserve replacement has been bolstered by a large acquisition, its $18 billion purchase of Unocal Corp. in 2005.

As the biggest companies have undertaken bigger projects like the Sakhalin oil-and-gas ventures in eastern Russia, Canadian oil-sands mining operations or cross-continent liquefied-natural-gas ventures, project management has become essential. Such big projects sometimes involve unconventional sources of oil that can’t be accounted for as reserves under some standards.

Rising economic nationalism is also a factor that can distort a company’s reserves. Further downgrades by Conoco, Exxon, Chevron, Total SA and Statoil ASA are expected, reflecting their reduced ownership in Venezuela’s Orinoco belt heavy-oil projects, in which state-owned Petróleos de Venezuela SA will gain a majority stake on May 1.

In January 2006, Spanish-Argentine giant Repsol-YPF SA cut 25% of its proved reserves because of changes in Bolivia’s hydrocarbons law. Most companies maintain that these changes don’t affect their operations’ profitability.

In late March, Bolivian officials reminded foreign operators to keep local reserves off their books. “Can companies register reserves at stock exchanges? I clearly tell them, ‘No,’ because the owner is the Bolivian state,” energy minister Carlos Villegas told the Senate, according to local news reports.

Analysts doubt that this sort of economic nationalism will spread beyond Latin America, at least as far as reserves are concerned. Countries including Libya and the former Soviet republics are more focused on recouping a greater share of profits than on whether Western companies book reserves, A.G. Edward’s Mr. Lanni said.

Reserves “shouldn’t matter,” Occidental Petroleum Corp. Chief Financial Officer Steve Chazen says. “If you move to a service contract, nothing really happens. You get the same cash flow that presumably you’d have gotten otherwise. It’s just cosmetic.”

Write to Angel Gonzalez at [email protected]

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