The Securities and Exchange Commission

[thepennyking]

Energy industry gets away with murky accounting practices

By Rachel Beck / AP Business Writer


NEW YORK -- Energy companies announcing big reductions in their oil and gas reserves have left many investors wondering what happened -- did the oil suddenly disappear or was it never there in the first place?

Don’t expect an easy answer to that.

The recent cuts by big names like Royal Dutch/Shell Group and others have provided a glimpse into the energy industry’s murky accounting practices, which are the result of imprecise government regulation that gives great discretion to oil company executives and allows results to be based largely on guesswork.

So-called proved oil and gas reserves are the estimated quantities that a company expects to commercially extract; unproved reserves are less certain to be extracted. Although some experts say that tallying reserves is more of an art than a science, they are considered an important asset for energy companies and are closely watched by investors as a key measure of future profit potential.

Shell announced in January it was reclassifying 20 percent, or 3.9 billion barrels, of its proved reserves to the unproved categories. And on Thursday, it said it reduce its estimated proved reserves by an additional 250 million barrels.

Other companies have done the same in recent months, including El Paso Corp. of Houston, which knocked down its proved reserves by 41 percent.

Companies often acknowledge the difficulties involved in determining reserves. Oil and gas can be buried deep below the earth’s surface, so there isn’t any easy way to gauge precisely what is down there and how much will actually be retrieved.

Also, changes in prices can require revisions in reserves. It might not be profitable to drill for hard-to-get oil when prices are at $15 a barrel, but that thinking changes when prices reach $30.

“There is some big science and some strong math behind what we do,” said Gary Swindell, a Dallas-based petroleum engineering consultant. “But at the end of the day, there is rarely enough information to feed our equations fully, and there is almost always some piece of conflicting information.”

That uncertainty can be exaggerated because of loose regulations, which give companies lots of leeway in determining their reserve levels and allow for divergent practices in the energy industry.

Using rules dating back to the late 1970s, the Securities and Exchange Commission requires companies to disclose their proved oil and gas estimates at the end of each year. They also need to say whether those proved reserves are developed, meaning they can be extracted by using equipment already in place, or undeveloped, which means more work and equipment is needed.

Proved figures are based on what companies believe they can recover with “reasonable certainty” from their energy reservoirs. The trouble is that companies can have different standards for what reasonable is.

Companies also can choose between two methods to account for their reserves. One, called the successful efforts method, is considered more conservative because companies more quickly have to write off their failures. Under the full-cost method, companies have a longer disclosure period.

Consider the case of Shell to see some of these inconsistencies at work.

Chevron Texaco and Exxon Mobil are Shell’s partners in Australia’s giant Gorgon gas project. While Shell had booked the reserves from that project as proved, the others did not. As it turns out, those proved reserves ended up accounting for a good portion of what Shell reclassified recently.

Shell’s revision doesn’t mean the oil doesn’t exist. But by moving its reserves from proved to unproved, the energy giant has acknowledged that it took an unrealistic view of how quickly the fields could be developed.

Now the SEC is now conducting a formal investigation into Shell’s accounting for its reserves.

Maybe the recent wave of reserve revisions will prompt calls for some standardization in the industry, or possibly even lead to tighter regulations in booking reserves.

An immediate change could come in requiring companies to hire independent engineers to review reserve estimates. They could work much like the auditors who test the accuracy and methodology of corporate financial statements.

That could at least begin to bring greater clarity to the industry’s accounting.

Rachel Beck is the national business columnist for The Associated Press. Write to her at [e-mail]