On average, reserves represent greater than 60% of a producer’s total assets on the balance sheet.
Reserve estimation is a complex, imprecise process requiring a synthesis of diverse data about the geologic environment, reservoir rock structure and other characteristics and engineering analysis. Due to the material balance and highly sensitive estimation process, reserves are generally a high-risk area for financial statement users and auditors. Below we’ll take a closer look at the reserve process and the information necessary to create as accurate of a reserve report as possible.
General Estimation Methods
There are four common approaches to estimating reserves:
- Analogy employs experience and judgment to estimate reserves based on observations of similar situations (i.e. nearby producing wells) and consideration of hypothetical performance. It’s used most when data is unreliable and/or insufficient to warrant the use of other estimating methods. Analogy alone is considered to have a low degree of accuracy relative to other methods, but any reserve estimation method employs some degree of analogy in application.
- Volumetrics calculates the hydrocarbons in place, and an estimate of those recoverable, by using a combination of measured physical data and estimates for certain unmeasurable data. Factors like rock and fluid properties are combined with estimates of the reservoir volume derived from seismic and/or drilling information to determine quantities that can be economically recovered. The volumetric method is most commonly used in newly developed and/or non-pressure depleting reservoirs. Overall, it has a low degree of accuracy, though good rock quality, well control and uncomplicated reservoirs can improve precision.
- Performance Curves. For many properties, oil and gas production rates and reservoir pressures decline in patterns or curves that can be extrapolated to estimate future production. Historical production is plotted on a logarithmic graph scale to identify trends; engineers end the curve extrapolation and future production when the production rate declines to the property’s economic limit. This limit occurs when production is too low to provide monthly cash inflow from production sales in excess of monthly cash outflow for operating costs.
Performance curves are considered to provide more precise estimates than volumetric or analogy approaches. Most commonly used after production is established, accuracy generally improves as historical data accumulates. The analysis of decline curves requires special attention when 1) wells are not producing at capacity; 2) the number of producing wells is changing; 3) operating practices change; or 4) completion zones are not consistent over time. - Material Balance Analysis involves complex calculations based on analysis of the relationship of production and pressure on well performance. It recognizes that reservoir pressure declines as more fluid is removed. Accuracy of this method is directly related to the quantity and quality of relevant data. Obtaining the data necessary to justify such a detailed study is relatively expensive.
Information Needed for Reserve Estimation
In addition to the geologic and engineering data referred to above, other information is needed for calculating the estimated reserves:
- Records of Production. Historical records of daily or monthly production that should be provided for both operated and non-operated properties. Engineers use such records to establish a production decline curve for determining the remaining recoverable reserves.
- Records of Ownership. For ownership interests, the entity’s net share of reserves is the only one reported. These interests come from the lease records department and must agree with the interests being used for revenue and joint interest billing. Ownership interest can change over time based on agreements among the owners.
- Records to Determine Current Pricing and Operating Costs. For proved reserves that are, by definition, based on current economic and operating conditions, engineers use current prices and operating costs to determine the economic limit. Lease operating costs are usually available from lease operating statements but require analysis to identify recurring costs, repairs and maintenance.
- Expected Future Capital Expenditures
- Records of Gas Imbalances
As you gather information to provide to the engineer, make sure you also share it with your auditor. This will prevent future reserve report revisions and save money and time if they identify any material exceptions in testing of the inputs.
If you need any assistance in gathering information for your reserve estimations, reach out to a member of the Schneider Downs Natural Resources Industry Group.
About Schneider Downs Energy & Resources Services
The Schneider Downs Energy & Resources industry group provides specialized financial advice and services to our clients in the oil and gas, mining and aggregates, forest products and alternative fuel and energy industries throughout the Columbus and Pittsburgh regions. Our extensive knowledge of industry issues enables us to provide proactive audit, tax and management consulting services.
To learn more, visit our Energy and Resources Industry Group page.
