Understanding SEC Oil and

Gas Reserve Reporting

Atiba K. Henry ahenry@srr.com

Since August 2014, the price of crude oil, West Texas Intermediate

of 2014. Whatever the reason for the decline, at the close of 2014

(WTI) and Brent, has fallen precipitously. The reason for the

many exploration and production (E&P) companies and analysts

decline has been debated by energy analysts from around the

alike were assessing the market value of reserves held. When

world; ranging from global politics to supply and demand issues.

assessing the value of reserves, a distinction must be made

While the price of natural gas (Henry Hub) experienced some

between the SEC reported value in the notes to the publicly

volatility in the first quarter of 2014, it remained relatively stable

traded companies Form 10-Ks and the Fair Market Value of such

for most of the year before declining during the last few months

reserves.

2014 Daily Gas Prices

115.00

8.50

105.00

7.50

95.00

6.50

Dollars per MMBtu

Dollars per Barrel

2014 Daily Oil Prices

85.00

75.00

Main Team Members

Roles

65.00

5.50

4.50

Roles
3.50

55.00

2.50

45.00

1.50

Source: Bloomberg

Main Team Members

Source: Bloomberg

2015

The methodology and underlying reasoning used to value reserves

3 The future cash flows are reduced by estimated

production costs, costs to develop and produce the
proved reserves, and abandonment costs, all based
on year-end economic conditions.

may differ depending on the purpose of the valuation. For instance,

the determination of Fair Value used in a purchase price accounting
allocation is based on the concept of what market participants
would expect to receive in order to sell the business or assets.

4 Future income tax expenses are based on year-end

statutory tax rates giving effect to the remaining
tax basis in the oil and natural gas properties, other
deductions, credits, and allowances related to the
companys proved oil and natural gas reserves.

Assumptions for capital structure, tax rates, and synergies (such

as cost savings) are based on circumstances for a typical market
participant. Conversely, a valuation performed in support of a
merger or sale depending on its purpose, could assume a unique
buyer with a specific capital structure, tax rate, and synergies.

5 Future net cash flows are discounted to present

value by applying a discount rate of 10% (as
described earlier).

Where valuations are performed for tax purposes under the U.S.
Internal Revenue Code, the term Fair Market Value is used.

The SEC Reported Value n n n

The Securities and Exchange Commission (SEC) reported value is
known as PV-10. Under PV-10, the value of reserves is defined
as the present value of the estimated future oil and gas revenues,

The SEC Final RuleModernization of

Oil and Gas Reporting n n n

reduced by direct expenses and discounted at an annual rate of

For publicly traded U.S. E&P companies, oil and gas reserves

10%. Both the pricing of future oil and natural gas, and the discount

reported in the notes to their annual reports filed with the SEC are

rate is standardized under this method. PV-10 is the indicated

determined by the SEC Final Rule.

value of a companys oil and gas reserves for disclosure in filings

with the SEC. The purpose of such disclosure is to assist users

On December 31, 2008, the SEC issued a final rule revising

of oil and gas companies financial statements in determining the

disclosure requirements relating to oil and gas reserves. The

overall financial position of the company as well as to assess the

SEC Final Rule reflects the SECs consideration of comments

risks that may affect the issuers future financial position. While the

received from various stakeholders in the oil and gas industry.

SECs overall goal in requiring registrants to use this standardized

The amendments were intended to modernize and update oil and

metric was to make amounts reported by companies comparable,

gas disclosure requirements to align them with current industry

it can be misinterpreted as a measure of the Fair Market Value of

practices and to adapt to changes in technology.1 According to

E&P companies proved oil and gas reserves. Valuation experts

the SEC, these revisions were intended to provide investors with a

do not believe that PV-10 necessarily represents the Fair Market

more meaningful and comprehensive understanding of oil and gas

Value of a companys oil and gas reserves.

reserves and to facilitate comparisons between companies.

FASB Accounting Standards Codification (ASC) 932 requires

Among other changes, the SEC Final Rule requires companies to

disclosure of a standardized measure of discounted future cash

estimate proved reserves using oil and natural gas prices based

flows relating to proved oil and gas reserves quantities for public

on the 12-month historical average of the beginning-of-month

companies. This is sometimes referred to as the standardized

prices. Prior to the 2008 ruling the SEC rules required that a single-

measure of oil and gas, or SMOG. The standardized measure

day, fiscal year-end spot price be used to determine economic

of discounted future net cash flows from production of proved

producibility and future cash flows of oil and gas reserves. The

reserves are developed as follows:

SEC Final Rule changed this requirement to a 12-month average

price, calculated as the unweighted arithmetic average of the

1 Estimates are made of quantities of proved reserves

and future periods during which they are expected to
be produced. These estimates are normally done by
petroleum engineers based on the SEC Final Rule (as
described below).

2 The estimated future cash flows are compiled by applying

prices, based the SEC Final Rule, to the year-end
quantities of reserves of oil and natural gas.

first-day-of-the-month price for each month within the 12-month

period prior to the end of the reporting period, unless prices are
defined by contractual arrangements, excluding escalations based
upon future conditions.2
The SEC Final Rule defines the term proved oil and gas reserves
as those quantities of oil and gas, which, by analysis of geoscience
and engineering data, can be estimated with reasonable certainty to
be economically producible, from a given date forward, from known
reservoirs, and under existing economic conditions, operating
methods, and government regulations, prior to the time at which

1
2

SEC Modernization of Oil and Gas Reporting Release Nos. 33-8995; 34-59192; FR-78; File No. S7-15-08
Ibid

2015

contracts providing the right to operate expire, unless

NYMEX (5 Year) Forward Curves at 12/31/14

evidence indicates that renewal is reasonably certain

Oil

Nat Gas

methods are used for the estimation.3

80.0

8.0

For simplicity, lets focus only on oil reserves in this

70.0

7.0

60.0

6.0

Dollars Per Bbl

analysis. Before 2014, oil prices had remained relatively

strong since 2011 with the beginning-of-the-month
WTI spot prices averaging $96.04, $95.05, and $96.78
per barrel in 2011, 2012, and 2013, respectively. Under

50.0

5.0
Main Team Members

40.0

the SEC Final Rule, and assuming no adjustment for

4.0

Dollars per MMBTU

regardless of whether deterministic or probabilistic

Roles

2014, of $53.27 per barrel, and it is clear to see that the

Oil

Nat Gas

Nov 2019

Aug 2019

Feb 2019

May 2019

Nov 2018

Aug 2018

Feb 2018

May 2018

Nov 2017

Aug 2017

Feb 2017

May 2017

Nov 2016

Compare this to the closing price at December 31,

Aug 2016

12-month beginning-of-the-month average for 2014.

Feb 2016

2.0
May 2016

20.0

2014 was based on a price of $94.42 per barrel, the

Nov 2015

price differentials, the value of reserves at year-end

Aug 2015

3.0

Feb 2015

30.0

May 2015

quality, energy content, transportation fees, or regional

Source: Bloomberg

SEC Final Rule does not always reflect market prices

at a particular point in time.

If the average five-year futures price at the end of 2014

was used, oil reserves would be reported based on

Beginning-of-the-Month Oil Prices

a price of $64.97 per barrel. Comparing this price to

the SEC requirements shows a difference in oil pricing
of approximately 31%, assuming no adjustment

120.00

80.00

for quality, energy content, transportation fees, or

$94.42 Average

100.00

104.92
95.44

96.43

99.74

99.42

102.47

regional price differentials. Reserve values would

105.34
97.88

92.88

actually decline by more due to the cost structure of

90.73

the portfolio of reserves.

Dollars Per Bbl

78.78

60.00
40.00

69.00

Main Team Members

The implication of this is that depending on the

Roles

characteristics of a portfolio of reserves, an oil well

may be economically producible at $94.42 per barrel

20.00

but not at $64.97. This is because as an oil well

produces, it gets closer and closer to its economic

0.00

limit (where the operating cost of the well equals the

revenue). At a price of $64.97 per barrel a producing
Source: Bloomberg

oil well would reach its economic limit much faster

than it would at $94.42 per barrel. Additionally, for

Forward Prices vs. SEC Final Rule n n n

A more realistic way of estimating reserves, which is more
commonly used in the industry and by valuation experts, is an
analysis based on oil and gas future prices. Oil and gas futures
prices, or managements forecast of future prices, better represent
the value of the reserves and would be better aligned with the
Fair Market Value of the reserves, as historical prices have little to
do with a companys future investments and values.4 Additionally,
the use of futures price estimates should be accompanied by

undeveloped locations, at a price of $64.97 per barrel

an oil well may not be economically viable whereas at $94.42 per
barrel it might be. As a result, reserves that would be reported or
booked (captured by reserve engineering) at a price of $94.42 per
barrel would not be booked at $64.97 per barrel, because they
would not be economically producible. This would indicate that
the reserves reported in SEC filings may not represent the true
economic value or quantities of a given portfolio of reserves.

Fair Market Value n n n

estimates of future costs, which can be subjective and not always

One way to estimate the Fair Market Value of oil and gas reserves,

comparable for determining future economic conditions. The chart

is to utilize certain risk-adjusted rates of return, commonly applied

below shows the 5-year forward curve for oil and natural gas as of

by buyers in the acquisition and divesture marketplace, to convert

December 31, 2014.

reserve reports into Fair Market Value amounts. This method can

3
4

Ibid
Ibid

2015

be seen as a form of the Income Approach but valuation experts

Other reserve categories include probable and possible reserves.

often use multiple methods to value oil and gas reserves.

2P reserves are the sum of proved and probable while 3P reserves

A reserve report is prepared by petroleum engineers and

estimates the remaining quantities of oil and gas (reserves)

More specifically, in order to calculate the Fair Market Value of

expected to be recovered from existing properties. Reserve

reserves, valuation experts generally applies different discount

reports provide information regarding the expected future pre-

rates to each stream of Cash Flow (PDPs, PDNPs, PUDs, Probable

tax net cash flows that would be produced from the various

and Possible) based on the relative riskiness of each category.

categories of reserves. Valuation experts generally utilize

It should be noted that very few publicly traded companies

reserve reports based on New York Mercantile Exchange

report probable or possible reserves (although companies in

(NYMEX) futures prices in effect as of the valuation date through

unconventional plays frequently discuss drilling location counts

some date in the future. These prices are usually adjusted

over and above PUD locations).To estimate the Fair Market Value

for regional and quality differentials, based on actual prices

of reserves, valuation experts consider these reserves categories

received as compared to NYMEX benchmarks.

under appropriate circumstances and facts but apply higher risk

In estimating reserves, petroleum engineers classify reserves as

proved, probable, or possible. The Society of Petroleum Engineers
establishes standards for each category. The category of proved
reserves, occasionally called 1P reserves, is generally broken
down, at a minimum, into three subcategories:

are the sum of proved, probable, and possible.

n Proved developed producing (PDP) reserves are

those for which the well is completed, and the reserves
are currently being produced. These are the most
valuable reserves and thus would receive the lowest
risk adjustment.

n Proved developed non-producing (PDNP) reserves

are those for which the well-bore exists and the reserves
are identified but are not currently producing for
some reason.

n Proved undeveloped (PUD) are the lowest category of

proved reserves and the least valuable because a new
well-bore is required to be drilled and completed, with
accompanying risk, to recover the value. Exploiting these
reserves requires the most capital investment and entails
the greatest risk. Therefore this category would receive
the highest risk adjustment of the proved reserves.

2015

adjusted rates of return than those used for proved properties.

Conclusion n n n
The decline in oil prices in late 2014 has rattled the oil and gas
industry as a whole and will probably suppress exploration in the
near term. Therefore, with this radical decline in prices in latter
part of 2014, as of December 31, 2014 the reserve values and
quantities reported on E&P companies SEC Form 10-Ks or other
reports may not represent the Fair Market Value.
Atiba K. Henry is an Associate in the Valuation & Financial
Opinions Group at SRR. Mr. Henry is a member the SRR energy
team in Houston. Mr. Henry can be reached at +1.713.221.5135
or ahenry@srr.com.
This article is intended for general information purposes only and is not intended to provide,
and should not be used in lieu of, professional advice. The publisher assumes no liability
for readers use of the information herein and readers are encouraged to seek professional
assistance with regard to specific matters. Any conclusions or opinions are based on the
specific facts and circumstances of a particular matter and therefore may not apply in all
instances. All opinions expressed in these articles are those of the authors and do not
necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC.