Oil at US$95 a barrel discovered in SEC rules on reserves

[NEW YORK] There's one place in the world where oil is still $95 a barrel.

On paper.

The US Securities and Exchange Commission requires drillers to calculate the value of their oil reserves every year using average prices from the first trading days in each of the previous 12 months. Because oil didn't start its freefall to about US$45 till after the Opec meeting in late November, companies in their latest regulatory filings used US$95 a barrel to figure out how much oil they could profitably produce and what it's worth. Of the 12 days that went into the fourth-quarter average, crude was above US$90 a barrel on 10 of them.

So Continental Resources Inc, led by billionaire Harold Hamm, reported last month that the present value of its oil and gas operations increased 13 per cent last year to US$22.8 billion. For Devon Energy Corp, a pioneer of hydraulic fracturing, it jumped 31 per cent to US$27.9 billion.

This year tells a different story. The average price on the first trading days of January, February and March was US$51.28 a barrel. That means a lot of pain - and writedowns - are in store when drillers' first-quarter numbers are announced in April and May.

"It has postponed the reckoning," said Julie Hilt Hannink, head of energy research at New York-based CFRA, an accounting adviser.

Companies use the first-trading-day-of-every-month calculation to estimate future cash flow and to tally how much crude can be profitably pumped out of the ground. The SEC introduced the formula in 2009 as part of wider changes in how the regulator required drillers to report reserves. Prior to the shift, the value of the reserves was measured based on the oil price on the last day of the year, which also caused distortions.

There are no current plans to revisit or modify SEC reporting rules, Erin Stattel, an SEC spokeswoman, said in an e- mail. She declined to comment further.

Most shale drillers are reporting increases in what's known as proved reserves. The SEC requires oil producers to submit an annual tally, along with an estimate of the present value of the future cash flow from those properties.

The estimates are limited to what the firm is reasonably certain it can extract from existing wells and prospects scheduled to be drilled within five years.

The reports are based on factors such as geology, engineering, historical production - and price. To count as proved, the resources must be economic to develop given existing market conditions.

"What the SEC requires isn't thorough enough to get to the numbers investors really want," said Mike Kelly, an analyst with Global Hunter Securities in Houston.

"What is the true cost of producing a barrel of oil? And what is the real value of the assets?"

A similar pricing formula helps determine whether some companies need to write off their oil and gas properties.

West Texas Intermediate for April delivery fell 5 cents to US$50.47 a barrel in electronic trading on the New York Mercantile Exchange at 8:18 am London time. Brent dropped 57 cents to US$60.45.

Continental provides one example of how much the price move matters. The company's Feb 3 press release announcing the US$22.8 billion figure included a disclaimer saying the estimate didn't represent market value.

Three weeks later, Continental published more detail in its annual financial report to the SEC. Using current prices instead of the SEC-prescribed US$95 a barrel would erase US$13.8 billion, or 61 per cent, from the value of Continental's oil and natural gas properties. It would also mean that 10 per cent of the company's reserves, the equivalent of 135 million barrels, would be too expensive to pump with prices where they are, the company said in the filing.

"Continental just follows the rules like everyone else that are mandated by the SEC" and provided additional details to investors in its filing, John Kilgallon, the company's vice president of investor relations, said in an interview.

Continental shares have risen almost 14 per cent this year. Devon's stock is little changed. That compares with the Bloomberg Intelligence North America Independent Exploration & Production Index, which has risen more than 2 per cent since the beginning of 2015.

The drillers in the index will lose an estimated 89 cents per share in the first quarter of 2015, according to data compiled by Bloomberg Intelligence. The companies gained $1.13 in the first quarter of 2014 and 26 cents in the three months ended Dec 31, the data show.

Devon follows SEC regulations and provides updates "in the course of regular disclosures under SEC rules," Tim Hartley, a company spokesman, said in an e-mail.

The company's Feb 17 press release said that its proved oil reserves rose "to the highest level in company history." Three days later, in its SEC filing, the Oklahoma City-based driller said it expects to take writedowns "beginning with the first quarter of 2015."

The company didn't offer details except to say that it doesn't expect the amounts to have an impact on cash flow or liquidity. However, they will be material to its net earnings.

BLOOMBERG