Energy-Reserve Revisions

THE WALL STREET JOURNAL 

Falling Oil, Natural-Gas Prices Render Certain Proved Stockpiles as Uneconomic

By BEN CASSELMAN

Tumbling energy prices already have hurt oil companies’ revenue. Now they are threatening companies’ untapped oil and natural-gas reserves, a key measure of a company’s value.

Many companies will likely be forced to declare that big chunks of their oil and gas reserves are uneconomic. That could have wide-ranging implications for oil companies, which need to show increasing reserves to attract investors and, in some cases, to serve as collateral on loans.

Oil and gas producers must report annually the size of their proved reserves — that is, how much oil and gas they believe they can produce from the fields they control. Under securities rules, they can include only oil that can be produced economically — a calculation based on oil and gas prices at the end of their year, usually Dec. 31.

When oil prices soared to nearly $150 a barrel this summer, oil companies thought they would be able to report a significant jump in their reserves, as previously uneconomic fields suddenly appeared profitable. That is what happened for some companies last year, when oil prices rose to $96 at the end of 2007 from about $61 a barrel at the end of 2006.

Instead, prices plummeted. Oil settled Monday at $44.51 a barrel on the New York Mercantile Exchange, less than half the price at the end of last year. Natural gas, at about $5.64 a million British thermal units, is selling for nearly $2 a million BTUs less than a year ago.

“It’s going to impact some folks materially. For specific companies, I think it could be as much as a 20% or 30% cut” in reserves, said Don Roesle, chief executive of Ryder Scott Co., a consultancy that estimates reserves for companies.

The problem is compounded, Mr. Roesle said, by continued high costs for equipment and labor, which haven’t fallen in line with the collapse of prices.

Reserve estimates, which companies disclose in their annual reports, are the basis of many of the financial statistics watched most closely by Wall Street analysts, including the ratio of debt to proved reserves — a key measure of corporate leverage — and “finding and development cost,” a measure of exploration success.

“Inventories at the end of the year are very critical to companies’ valuations,” said Joseph Stanislaw, a senior energy adviser to Deloitte and a co-founder of Cambridge Energy Research Associates.

In 2004, Royal Dutch Shell PLC disclosed that it had overstated its reserves by 20%, leading to the ouster of its chairman, a Securities and Exchange Commission investigation and closer scrutiny of reserve calculations across the industry.

Reserve adjustments resulting from changing prices are a routine part of the business. Still, David Heikkinen, an analyst with energy-focused investment bank Tudor Pickering Holt & Co., said investors will take note of any companies that perform worse than their peers.

“Negative revisions give an indication of the quality of the reserves you’ve booked in the past,” Mr. Heikkinen said.

Smaller companies that rely on their reserves as collateral on their credit lines from banks could find their available credit shrinking along with the value of their booked reserves.

That could pose problems for companies that already are struggling to raise cash through other means. In response, companies are cutting spending so that they won’t face a cash crunch if their credit lines shrink.

“It will force producers to have even more conservative budgets,” said Jon Wolff, an analyst for Credit Suisse in New York.

Especially hard-hit could be companies such as Parallel Petroleum Corp., Delta Petroleum Corp. and Berry Petroleum Co. that already have drawn heavily on their revolving credit lines.

If banks reduce their credit lines in response to falling oil prices, those companies could be left with little financial flexibility or even could be forced to return some of the money they have borrowed. All three companies have sharply cut their capital budgets in recent weeks, in part in response to that threat.

“The [capital budget] cuts were really to pay down debt,” said Shawn Canaday, controller of Berry Petroleum, which has drawn down about $925 million of its $1.25 billion credit line. Mr. Canaday added that the company has “plenty of liquidity,” a sentiment echoed by a Delta Petroleum spokesman. Parallel Petroleum didn’t return a call requesting comment.

Mr. Canaday said the vast majority of Berry’s reserves are economic at $30 a barrel oil, and therefore aren’t threatened in the end-of-year reserve calculations.

Indeed, companies won’t be equally affected. Those with more-expensive production that needs high prices to be economic, including deep water offshore projects, will be hit harder.

Write to Ben Casselman at [email protected]

WSJ ARTICLE

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