24th June 2016
In previous articles this week, GCA has discussed the impact of commodity prices on the project CAPEX cycle and also on the mechanisms involved in Reserves and Resource estimation and reporting. This final article looks at the empirical impact of commodity prices on actual oil company reporting.
Reserve Booking Adjustments Under Low Commodity Pricing
An interesting question is, “How have the Reserves of oil companies responded to the drop in oil price in practice?”
GCA has analyzed changes to historical and recent SEC reported 1P reserves and we focused on the 5 super-majors: Exxon, Shell, BP, Total and Chevron. When we refer to reserve revisions in this context, we are referring solely to organic changes in existing SEC reported 1P Reserves primarily due to reservoir performance, new field studies, oil price fluctuations, and CAPEX changes. This does not include changes to reserves due to new discoveries, acquisition or divestiture of an asset, or yearly hydrocarbon production.
Firstly, if we look at 2013 as shown in Figure 1, where the Brent price used in SEC reporting was virtually constant around $110/bbl. The reserve revisions realized by the super-majors from beginning to end of year averaged a 3% increase. Therefore, 80 Billion BOE at the beginning of the year was revised upwards by about 2.4 Billion BOE due to organic effects. Since there were minimal changes in the cost and oil price environment during 2013, it seems a robust statement that normally we should see a slightly positive movement in reserve revisions during a “normal” year, mostly as some Probable reserves become Proved (1P) reserves.
Figure 1: Reserve Revisions (Selected Majors – 1P SEC) 2013 & 2014
In 2014, also shown in Figure 1, the SEC year-end reporting Brent oil price dropped by about $10/bbl to just under $100/bbl, and again we see a 2 Billion BOE upward SEC 1P Reserve revision on a circa 80 Billion BOE reserve base over the year reinforcing the “normal” expectation.
In 2015, the SEC year-end reporting Brent price dropped dramatically to $54/bbl. It could be expected that significant downward reserve revisions would have occurred as the lower oil price accelerated economic expiration of assets. However, during 2015 the super-majors still realized an overall average upward reserves revision of half a percent over the year as shown in Figure 2.
Figure 2: Reserve Revisions (Select Majors – 1P SEC) 2015
This observation is the opposite to the significant downward revision that some would have expected over 2015, begging the question: Do changes in hydrocarbon prices actually have a material impact on reserves in practice?
Economic Drivers for Reserve Bookings
To assess the economic drivers of reserves bookings, GCA analyzed the same super-majors solely on their European operations, because Europe is a relatively mature oil and gas area with limited unconventionals and very few production sharing contracts (PSCs). Interestingly, despite extensive public concern on the economic viability of North Sea assets in a low oil price environment, there has only been an average 1.5% downward 1P reserve revision for each of the last two years. The lack of dramatic downward revisions, suggests that the change in the economic life of assets due to halving the oil price does not outweigh the normal upward revisions due to improved reservoir performance. We also benchmarked the super-major analysis against a number of international independents, such as Apache, Conoco, and Centrica; they similarly combine for only a circa 2% downward revision in European 1P reserves, hence the insensitivity of reserve booking to reducing oil price was a common effect in a European conventional hydrocarbon plus tax/royalty environment.
The super-major assets in the United States were then considered to better assess the impact of unconventionals in the oil and gas landscape. In the US we see less than a 1% change to the super-majors’ 1P reserves due to revisions in 2014, but significant write-downs with over 13% (or nearly 2 Billion BOE) of 1P reserves removed in 2015. Independents reported a similar circa 15% downward reserve revision. The 2015 oil price reduction did not appear to materially change the economic life of existing production, but rather the reported downward reserve revisions were largely as a result of thousands of yet-to-be-drilled unconventional wells that had been commercial and booked as 1P reserves in prior years becoming uncommercial under the 2015 SEC price. So clearly oil price in this context does have an impact where unconventionals are significant and therefore unconventionals in the portfolio are important to reserve booking revisions in low oil price environments.
We then examined the assets of the super-majors in Asia, to review the impact of production sharing contracts on reserves. A reduction in the crude price under a PSC means a larger portion of the production needs to be allocated to the recovery of costs and therefore a larger overall net reserve entitlement should be realized for the Contractor. This is indeed the case as the super-majors realized a positive revision of 1P reserves of 1.4 Billion BOE in 2015 due to the oil price fall. Most companies mention specifically in their 10K or 20F documents that the change is attributable to PSC entitlement effects, confirming that oil price does influence reserve revisions in ways that are dependent on contractual regime.
We then examined other territories to assess the corresponding impact of low prices. Canada interestingly realized a sizeable upward revision in reserves due to the oil-linked royalty in Alberta. Revisions in Oceania and South America were little changed or mentioned in company financial documents, potentially due to PSCs and concessions in the regions offsetting one another. African countries largely rely on PSCs but only saw a couple of percentage points upward revision; this may be due in part to write-downs due to security reasons in northern Africa and because Algeria and legacy Nigeria assets are under tax/royalty regimes.
A summary of the findings is shown in Figure 3.
Figure 3: Global 1P Reserve Revisions in 2015 – GCA Analysis of Selected Super-Majors
In conclusion, it is clear that reserves reporting is dependent on oil price, development type and the fiscal framework to varying degrees. Since reserves are often used as indicators of expected revenue as well as important factors in management planning and debt-raising, it is necessary to have a firm understanding of what drivers could cause changes in such a significant metric.
As we have seen above, exposure to the unconventional space leads to a more severe revision than other more resilient contract or development types. If we were to calculate the SEC price on the first 5 months of this year, there would be a further $15/bbl decrease, indicating further reserve revisions, positive and negative, in the coming year. The landscape is continually changing but it is clear from our interactions that the recent downturn has made the industry more aware of how reserves as well as cash flow respond to the wide range of future price scenarios that are being contemplated during this uncertain time.
Impairments Under Low Commodity Pricing
An impairment is a write-down in the book value or “carrying amount” of an asset if it exceeds the future value expected to be recovered by the asset. Carrying value is basically capitalized costs related to an asset including: acquisition, exploration, development, and restoration costs and is reduced each year by the depreciation or depletion of the asset, often tied to current year production and remaining reserves.
The impairment test is usually at an asset or “Cash Generating Unit” level and involves a number of assumptions, that are not extensively defined, in order to determine the expected cash flow. If an impairment is determined to be necessary, a non-cash adjustment is made to the financial statement. Due to the uncertainty in what revenue streams are being included at the asset level, what costs continue to be carried by the company for each asset and what assumptions are used for projecting future cash flows, there is not always a clear correlation between impairments and cash flow or reserves revisions.
An example of the lack of clarity related to impairments can be seen in Shell’s US$2.6 Billion impairment for the Alaska drilling campaign, though Shell carried no reserves or expectations of near term cash flow. As another example, Exxon did not carry any impairment for US unconventional assets, despite a write-down of 6.7 Tcf of US gas reserves.
Reserves revisions and impairments are significant but different indicators of changes in a company’s health. Reserves bookings under the SEC rules are defined prescriptively, though the 1P (Proved) Reserves generally give only a partial view of a company's portfolio of hydrocarbon assets. Impairments are less tightly defined and therefore more exposed to subjectivity and future price projections. It should be noted that companies not listed in the US are not bound by SEC rules, and may report reserves under the SPE PRMS or Canadian systems that allow the use of a forecast of future oil prices.
A full and detailed understanding of the assumptions on costs, production and economic parameters behind an estimate of reserves is required in order to fully appreciate the value of an asset. Assessing the value of a portfolio or company requires a view, not only on the reserves, but also on the risks and uncertainties as well as the potential upsides.
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