Introduction Reserve Definitions

8/6/2019 Introduction Reserve Definitions

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Petroleum ReservesDefinitions

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Definitions

Petroleum is the world's major source of energy and is a key factor in thecontinued development of the worlds economies. Therefore, it is essential for thecountries future planning to have a clear assessment of their petroleum reserves.Such assessment is of considerable importance to governments, internationalagencies, economists, bankers, and the international energy industry.

Petroleum

Crude oil is a mixture of hydrocarbons that exists in a liquid phase innatural underground reservoirs and remains liquid at atmospheric pressureafter passing through surface separating facilities. Production volumesreported as crude oil include:

liquids technically defined as crude oil;small amounts of hydrocarbons that exist in the gaseous phase innatural underground reservoirs, but which are liquid at atmosphericpressure after being recovered from oil well (casing head) gas in

lease separators;small amounts of non-hydrocarbons produced with the oil.

Natural gas is a mixture of hydrocarbon compounds and small quantities ofvarious non-hydrocarbons existing in the gaseous phase or in solution with oilin natural underground reservoirs at reservoir conditions.

Natural gas liquids (NGLs) are those reservoir gases liquefied at thesurface in lease separators, field facilities or gas processing plants. NGLsconsist of field condensates and natural gas plant products such as ethane,pentane, propane, butane and natural gasoline.

Petroleum refers to the naturally occurring liquids and gases which arepredominately comprised of hydrocarbon compounds. It may also containnon-hydrocarbon compounds; such as nitrogen, carbon dioxide, andhydrogen sulfide.

Petroleum Resources

Petroleum resources are defined as the oil and gas originally in place

estimated by the existing petroleum technological methods. The gas originallyin place is either non-associated or associated. The non-associated gas is


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defined as the natural gas in reservoirs that do not contain significantquantities of crude oil or do not contain crude oil at all. The associated gas isdefined as the natural gas that exists in oil reservoirs. It is either free ordissolved. The free gas, commonly known as the gas cap, overlies and is incontact with the crude oil in the reservoir. The dissolved gas is the quantity ofgas, expressed in standard cubic feet (SCF), which is dissolved in one stocktank barrel (STB) of oil. By Natural Gas Liquid (NGL), which is originally inplace, we mean the components that are volatile in free gas, all of which willbe converted to NGL phase by means of the current/planned gas processing.

Petroleum Reserves

Petroleum reserves refer to the quantities of petroleum available for production plus the quantities which are anticipated to become availablewithin a practical time frame through additional field development,technological advances, or exploration. This definition implies that, for oil andgas, in order to be called reserves,

Oil and gas must be physically and economically producible. Forexample, if there are billions of barrels of oil in place, but it isuneconomical to produce it with existing technology, then oilreserves sum up to zero.Since the resource has not been produced and is inaccessible,reserves can not be measured, they can only be estimated.Since reserves are remaining, there is a time line associated witheach reserve estimate.

That said, the word reserves is an abstractconcept; i.e. it can never be afixed volume but it can and does change from time to time and from observerto observer. For this reason, reserves cannot have value, but can only

represent value in an abstract sense. For example, if all conditions areidentical, a property with greater reserves can be construed to have a greatervalue. Said differently, a comparison to an office building is illustrative; anoffice building retains the same physical size and character whether the rentsfor the building go up or down. Reserves, on the other hand, may increase ordecline with changes in oil price.

Since we are interested only in those reserves which remain to beproduced from this time forward, this leads to the term remaining reservesfrom the effective date of study. When the study starts at the discovery date,we speak of original reserves. This term includes all oil and gas which is

expected to be recovered over the life of the field or well. The term ultimaterecoverymay also be applied to mean original reserves. Since also we are


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dealing with estimates, the terms should be known as estimated remainingreserves (ERR) and estimated ultimate recovery (EUR). Hydrocarbons whichwere produced up to the effective date of the study are known as cumulativerecovery (Cum). The relationship between ERR, EUR, and Cum is as follows:

EUR = ERR + Cum (1)

In some cases, Cum may not be known as of the effective date ofproduction. This is because the production data normally takes a month or

two to get through the system. In this case, it will be necessary to estimateproduction from the last measured data to the effective date. Therefore, wemay wind up with an estimated Cum as of the effective date.

Petroleum resources and reserves are related via recovery factor (RF):

EUR = N*RF (2)

Combining equations (1) and (2) yields:

ERR = N*RF Cum (3)

Notice that only Cum is measurable, all of the others are estimates.

Proven Reserves

Proven Reserves are defined as the estimated quantity of all hydrocarbonsstatistically defined as crude oil or natural gas, which geological andengineering data demonstrate with reasonable certainty to be recoverable infuture years from known reservoirs under existing economic and operatingconditions. Reservoirs are considered proven if economic producibility is

supported by either actual production or conclusive formation testing. Thearea of an oil reservoir considered proven includes those portions delineatedby drilling and defined by gas-oil or oil-water contacts, if any, and theimmediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological andengineering data. In the absence of information on fluid contacts, the lowestknown structural occurrence of hydrocarbons controls the lower proven limitof the reservoir.

Crude oil: estimates include oil that can be produced economically through

application of improved recovery techniques following successful completionof pilot testing. Estimates do not include:


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oil that may become available from known reservoirs but is reportedseparately as "indicated additional reserves";oil, the recovery of which is subject to reasonable doubt because ofuncertainty as to geology, reservoir characteristics or economicfactors;oil that may occur in untested prospects; andoil that may be recovered from oil shales, coal, gilsonite and othersuch sources.

Natural gas: estimates are prepared for total recoverable natural gas, non-associated gas and associated-dissolved gas. Estimates do not includegaseous equivalence of natural gas liquids expected to be recovered fromreservoir natural gas as it is produced, natural gas being held in undergroundstorage or non-hydrocarbon gases.

Recovery Factor

Some professionals in the oil business believe that the recovery factor is asole function of technology. Others do believe it is a function of geology andquality of the reservoir. As a matter of fact, it depends on all factors; i.e. itdepends on:

Geology and quality of the reservoir,Quality and type of recovery,Quality of the production scheme, andPresent technology.

For example, it is known that for poor reservoirs (fractured tight reservoir),the RF is about 3%, and for very high porous and permeable reservoir (as areef) it is about 80%. Similarly, the recovery method adopted, whether

primary or secondary, and the quality of production scheme will assuredlyhave a strong influence on the RF, not to mention the effect of technologyadopted in depleting the reservoir.

Reserve Growth

Reserve growth is defined as the increase in the successive estimates ofreserves. It has been observed in almost all fields or provinces, but mostnotably in mature petroleum provinces, like many in the U.S., where it hascontributed substantial additional reserves over the last two decades. It is the

most important problem in assessing the future production. Statisticallyreserves growth occurs because the reserves are badly estimated.


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At the present time, it is claimed that there is reserve growth in theevolution of reserves, but in fact the extent of reserve growth can bemeasured only when the fields have been depleted and abandoned. On stillproducing fields, cases of reserve growth are publicized whereas little is saidabout reserve decrease. The huge increase during the second half of the1980s by the OPEC countries was political (quotas) and the decrease in 1999of 20 Gb by Mexico was done after the financial crisis was solved (previouslylarge reserves were needed to guarantee the loan from the US and IMF andbefore Nafta agreement signed). Reserve growth is claimed to come from

higher recovery factor and from increase in oil price.Although reserve growth on individual pool or field levels may be either

positive or negative, the growth within a country or petroleum province isgenerally positive, and provides a means for estimating future potentialreserves. An evaluation of reserve growth, however, is complex, beingaffected not only by geological, reservoir, and engineering factors, but also bylocal laws and policies that control exploration, reserve reporting, and fielddevelopment activities.

Sources of Reserve Figures and Their Problems

The sources from which world oil reserves and production figures are reportedcan be grouped into two main sources:

Oil industry periodicals, andIndependent agencies.

There are four oil industry periodicals that report values for world oil reservesand the annual production, those are:

Oil & Gas Journal (OGJ),

British Petroleum Amoco (BP),World Oil, andOPEC Annual Statistical Bulletin (ASB).

The most common independent agencies are the United States GeologicalSurvey (USGS) and Petroconsultants. Those agencies provide independentestimates after they have recognized the inconsistent nature of the reserve figuresreported in the trade journals and periodicals.

The data reported by the OGJ comes from a questionnaire distributed to thedifferent countries and are reported as received. However, when a country fails to

reply to the questionnaire, the number seems to be carried forward to the following


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year without adjustment (11). However, if the country makes an official declarationreporting new reserves, the numbers seems to be adjusted.

BP simply reproduces the numbers reported by the OGJ, with the following slightadjustments (11):

Numbers are shown to represent end-of-year (December 31) rather thanbeginning of the following year (January 1).Estimates of the NGL reserves are added to the USA and Canada oil reservefigures. There is no proof, however, that estimates of all other countriesinclude their NGL figures as well.

Higher numbers are reported for Azerbaijan and Kazakhstan in recent yearswithout specifying the source or reasons for the differences.

World Oil poses similar questionnaire to the countries, yet some reportednumbers are significantly different than those of OGJ and BP, especially for OPECcountries(11).

The numbers reported in the ASB are based on direct communications to theSecretariat, as well as various other sources, such as the Middle East EconomicSurvey, Petroleum Intelligence Weekly, Arab Oil and Gas, and, of course afterverification and comparisons(17), the OGJ, BP, and World Oil. The ASB shows tables

for member countries at the end of the year for both proven crude oil reserves andproven natural gas reserves. It also shows the worlds proven crude oil reservesand the worlds proven natural gas reserves.

BP numbers are the most widely quoted and used by experts and non-expertsalike. The analysts who use these numbers assume that they must have thesupport of the renowned oil company. In addition to the confusion when a notenext to the number says proved reserves conveying some sort of technicality tothe term.

OPEC also quotes from BP and their numbers are taken to represent accuratefigures, since OPEC is a professional international organization, and the numbers

are produced in an impressive volume with other energy data.

Why the Need for Reserves Definitions

In order to avoid a situation where reserves lose all meaning as a comparativemeasure, it is necessary that the industry adopt a consistent nomenclature or adefinition for reserves in order to provide some broadly accepted constraints on theconditions that would result in the estimation of reserves. Without a definition as aguideline or reference, a volume labeled as reserves could be anything but would

have no meaning to anyone.


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Until two decades ago, reserves estimation and classification was not a big issue,because oil and gas reserves were not sold or traded. They were kept as acompanys crown jewels. The reservoirs were much more conventional and lessrisky. Natural gas was not a valuable commodity and, in fact, there was anoversupply. Oil reserves were also greater than demand, resulting in a pro-rationing system. This system kept everyone honest, since everyone wasscrutinizing everyone elses reserves estimates. Companies also survived on cashflow and debt financing.

In todays environment, however, everything is for sale, from reserves to

processing plants to companies. There is a great need for raising capital on thepublic market. There is a good demand for both oil and natural gas. Withconventional sources becoming depleted, our industry is directing itself towardshigher risk ventures, such as shallow gas, heavy oil, and the more complexreservoirs. It comes as no surprise, then, that tighter controls need to be put inplace if the industry wants to attract public financing.

To express the variance in reserves estimates, the industry has developedreserves classification systems, referred to as Reserves Definitions. Proved,probable and possible reserves imply low, intermediate, and high degrees ofuncertainty, respectively. There are, however, as many reserves definitions in place

today as there are stakeholders in the industry, each one fulfilling a specificpurpose. Furthermore, the wording of the definitions is sufficiently vague, allowingevaluators a great deal of latitude when classifying reserves. This freedom, coupledwith companies pressure to look good in the financial market, has resulted in abending of the rules. Because of this seeming lack of control, many associationstoday are attempting to standardize reserves definitions and set up enforcementorganizations.

Why the Need for Harmonization

Accepting the fact that there are as many reserves definitions in place today asthere are stakeholders in the industry, there must be a means of harmonizing thosedefinitions. This is necessary for the following reasons:

Enhance communicationMake terms comparable and compatibleProvide a methodology for evaluating resources on a common basisImproved support for financial reporting


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Historical Development of Reserves Definitions

The American Petroleum Institute (API) was the first agency that set definition ofreserves in the mid - 1930's. From 1936 to 1964, the American Petroleum Institute(API) set the standards for definitions of Proved Reserves. This effort was joined bythe American Gas Association (AGA) in 1946 with the joint API-AGA annualpublication of Proved Reserves of Crude Oil, Natural Gas Liquids and Natural Gas.In 1964, the Society of Petroleum Engineers (SPE) issued reserve definitions, which

agreed closely with revised API definitions.The events of the 1970s and the resulting changes in the oil industry led to theissuance of definitions by the Security and Exchange Commissions (SEC) in 1979,by SPE in 1981 and by the World Petroleum Congress (WPC) in 1983. SPE revisedits definitions in 1987 and, in cooperation with WPC, again in 1997. Until 1983 allreserves definitions, at least those issued by recognized authorities such as API andSPE, were for Proved Reserves only. The WPC definitions of 1983 includedcategories ranging from Proved to speculative reserves. The 1987 SPE definitionswere the first to formally define Proved, Probable and Possible. This does not meanthat the terms were not in use or that Probable and Possible reserves had not beencalculated and reported. Producing companies, consulting firms, banks andgovernment agencies developed their own criteria for UnProved reserves and usedthem.

Despite the efforts of SPE/WPC and SEC to standardize reserves, multiplereserve definitions remain in use. Many companies and agencies retain their owndefinitions which, while close to the SPE standard, have certain idiosyncrasiesresulting from law and regulatory requirements, corporate policy decisions and/oringrained habit. This is particularly true regarding the boundary between Provedand Unproved and, to a lesser extent, the sub-categories within Proved. In thisreport, the following reserves definitions are examined:

1. ARPS 1962 reserves classification2. The SPE/API 1965 reserves definitions3. The McKelvey Box resource classification system4. The SEC definition of 19795. The 1981 SPE definitions6. The 1988 SPE definition7. The SPE/WPC definitions8. The SPE/WPC/AAPG definitions9. The UNFC classification system10. The SPEE expansions of the SPE 1987 and 1997 definitions

11. The California State Board of Equalization (SBOE) definition contained inrule 468 of the California R&T Code.
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12. Canadian reserves definitions13. Chinese classification system14. The CCOP classification system

The SPE and SPE/WPC definitions are intended to provide industry and observersof the industry, consultants and the financial (lending) community with a standardto which all evaluators should conform. The 1981 and 1987 SPE definitionssucceeded in providing that standard for domestic use, and the 1997 SPE/WPCcollaboration attempted to provide an international standard. In any case, SPE is

considered to be the industry standard.The SEC definitions are the response of government to the perceived need for a

benchmark by which producing companies could be compared to each other. Theprimary beneficiary of this effort is the equity financial community and consultingfirms. The Rule 468 definition is the recognition by SBOE of the need for aregulatory standard that should be followed by assessors in appraising oilproperties. The SPEE expansion of the SPE definitions is included because of theextensive explanation of the SPE definitions rendered by SPEE and the historicalcontext for these definitions provided by SPEE.

The Escalated/Un-escalated Issue

The definitions of reserves include the phrase under existing economicconditions [where] and for Proved reserves says, current economic conditions[where] current economic conditions include prices and costs prevailing at thetime of the estimate. SPE provides no further elaboration of the intent of the terms existing, or current, or economic conditions as used in the definitions andgives no guidance as to the selection of initial prices and/or estimation of operatingcosts(14).

The SPE language has often led to debates among evaluators regarding thetreatment of future prices and costs. Why are two different terms used? Arereserves to be established only by using the price and cost in effect on the date ofevaluation or can reserves be established by projecting prices and costs whichchange over time from the initial values? The former is generally referred to as theun-escalated case while the latter is referred as the escalated case. Further, theretends to be an assumption that escalated always means increasing rather thansimply a change from the initial value.

The debate is usually framed as follows:


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One side of the debate says that existing economic conditions are the totality ofthe conditions that may affect the value of a property and/or influence the futureoperation of a project. The evaluator may start with the price(s) and cost(s)occurring on the date of evaluation, but if the prevailing economic conditions aresuch that the price and/or costs can reasonably be expected to change in someparticular manner, then the evaluator should incorporate those anticipated changesinto the estimation of future cash flow.

The other side of the debate takes the position that using current economicconditions, which include prices and costs prevailing at the time of the estimate,

allows no change in those prices or costs over the life of the evaluation. This latterconstruction ignores the inclusive interpretation of the term include and makesthe term an absolute.

This issue has far more to do with cash flow and the valuation of income thanwith reserves. Reserves are influenced in only two ways. First, changing prices andcosts over the life of the projection may result in a different economic limit ofproduction for the property/project than would be obtained using a flat price/costprojection; reserves are added at the end of the life when the economic limit isreduced and the life is extended. On the other hand, when economic limit isincreased and producing life is shortened, reserves are reduced. Second, capital

investment in workovers or remedial work or new drilling that would not beeconomically justified at current prices might be justified if prices were escalated(increased). In this latter case, new reserves might be added through increasedproduction.

In Monograph I (1988 edition), SPEE takes the position that existing economicconditions and current economic condition mean the same thing, which is thatthe prices and costs in effect at the time of the evaluation are carried forward withno changes. SPEE goes farther and states (page 45):

If the reserves are increased by escalating product prices and costs, then

the change in the reserves should be shown separately in the engineersreport as Unproved Reserves.

SPEE advises that the evaluator can avoid this by using the same economic limit(the unescalated one) for both cases thereby assuring that no reserves are addedat the end of life. This, of course, ignores the fact that many operators will continueto produce beyond this artificial limit.

The position taken in Monograph I (both 1988 and 1998) is the only serious flawin an otherwise excellent document. The position is untenable as a practical matterand has some very serious logical loopholes. In practice, it is often ignored. It is

quite common for evaluators to cite the SPE definition in their reports and thenescalate (de-escalate) prices and/or costs and include all the reserves as Proved.


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Within SPEE, the subject is often warmly debated, and the issue of escalation ornon-escalation is far from a unanimous agreement.

Three major areas of failure of the SPEE proposition are as follows:

1. In periods of changing prices and costs an evaluation done of Property A inOctober might have one reserve estimate, while an evaluation done inNovember could have a second (higher or lower) reserve estimate. Bothwould be considered correct, but which one is really correct? If the same

evaluator had estimated the reserves in October by projecting the Octoberprice to change to the November price, the change in reserves would beUnproved while the same volume in the November evaluation is consideredProved. In all other respects, a change in reserves category is a function ofrisk derived from the likelihood of recovery (See SPE Definitions for examplesthat illustrate Proved, Probably and Possible). In the SPEE Interpretation,however, a major change in reserves categorization occurs due solely to thetreatment of prices and costs.

2. The SPEE proposition assumes that escalated prices are increasing prices anddoes not consider the impact of pricing cycles and/or decreasing prices or

costs. Further, it fails to consider the effect of differing escalations of pricesas compared to costs. If decreasing prices are projected with flat orincreasing costs, the economic limit would be increased and the reserves maybe decreased. The amount of reserves lost, as it were, cannot be classifiedas Unproved since they do not exist as reserves. In that case, they are simplydeducted from Proved reserves. Reserves that were measurable, bydefinition, when prices were increasing, become no longer measurable whenprices go down.

3. Finally, SPEE is not consistent on this issue. While being specific about pricesfor oil, Monograph I also says: Determining current gas price would be more

difficultcommon sense and good judgment are called for This is true ofthe entire evaluation process and applies equally to production projectionsand price projections.

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Introduction Reserve Definitions