CHAPTER 25 CAPITAL MARKETS AND THE OIL & GAS GLOBAL INDUSTRY: SEC RESERVE REPORTING AND INTERNATIONAL PETROLEUM ARRANGEMENTS
| Jurisdiction | Derecho Internacional |
(Apr 2015)
CAPITAL MARKETS AND THE OIL & GAS GLOBAL INDUSTRY: SEC RESERVE REPORTING AND INTERNATIONAL PETROLEUM ARRANGEMENTS
Partner
Dechert LLP
Moscow and London
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SHANE R. DEBEER is a partner with Dechert LLP, in Moscow and London. Praised by clients as an "excellent Russian speaker with notable expertise in Russian law" (Chambers Global, 2012), Mr. DeBeer has over 20 years of experience acting on energy and natural resources matters in Russia, the CIS, and the Middle East, has extensive experience advising on transactions and operational issues in the upstream (exploration and production) sector, as well as on project finance, commercial real estate development, cross-border M&A, and general commercial matters. Mr. DeBeer has been repeatedly listed as a leading lawyer for energy and natural resources by both the leading independent guides to the legal profession, Chambers and Partners, and The Legal 500 EMEA. The Legal 500 EMEA, 2011 noted in the referee citations that he is "exceptional," "his thinking is very proactive and imaginative," and "he is readily available when engaged on a project, and his responses in such situations are very dynamic," while its current edition (2015) lists him in the elite "Leading Individuals" category for Energy and Natural Resources in Russia. Chambers Global, 2014 notes that he "continues to impress clients." He is also listed in The Legal Media Group's Guide to the World's Leading Energy and Natural Resources Lawyers.
Rule 410-A, Regulation S-X under the Securities and Exchange Act 1934,1 which sets out how and what an issuer of securities must report on reserves of oil and gas that it wishes to show on its balance sheet, was promulgated in 1940, six years after the passage of that key depression-era law regulating the US securities market. Before the passage of the 1934 Act, one of the commonest securities frauds in the US was "salting the mine", or misstating mineral or hydrocarbon reserves in connection with a public offering of shares. The 1920s, although remembered as a time of prosperity, also saw its share of scandal on Wall Street and elsewhere, including a case of undervalued government oil leases being granted to a crony of the Secretary of the Interior in Wyoming and California known as the "Teapot Dome" scandal that nearly brought down the presidency of Warren Harding.2 In 1940, just before the US entered the world war, the great preponderance (but certainly not all) of the hydrocarbon reserves on the books of publicly traded oil and gas companies in the US derived from acreage in the US. However foreign hydrocarbon reserves were not totally removed from Congress' consideration: just two years earlier, significant reserves had been wiped off the books of certain US oil and gas companies when Mexican President Lazaro Cardenas nationalized significant oil and gas assets of US and other foreign oil companies.
Today, of course, many US-listed companies from majors to minnows show hydrocarbon reserves from countries other than the US on their balance sheets, and more than a few exclusively so. In fact, the US Securities and Exchange Commission's (SEC's) reserve reporting requirements are now a necessary concern not only of US-based companies, but also for foreign companies listed on any US exchange, including companies with debt (such as bonds or options) rather than equity securities, for any company negotiating with a potential US investor (who will want to book the reserves) and for many other companies seeking investment, whether short or long term, as global investors often view the SEC's reporting rules as a benchmark for calculating reserves.
The most economically significant category of petroleum reserves is proved reserves, although probable reserves can be a substantial source of value. Here is the heart of the Regulations:
Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can he 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. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time. 3
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The petroleum industry has been "global" almost from its inception (if one thinks of the Baku oilfields, for example), and today is one of the most globalized industries in existence, both from the perspective of the global distribution of hydrocarbon resources and from the prevalence of cross-border transactions and projects, not just by international oil companies (lOCs), but increasingly by state-owned national oil companies (NOCs) as well. In that global context, not only the technology, but also the "existing economic conditions" and the "government regulations" can vary enormously, and seriously affect the ability of an energy company to book reserves. Besides considering some important technical changes in the SEC Rules, this article will consider these factors as well.
Significant as the SEC Rules are, they have at times lagged behind both standard industry methodology and widely accepted practices elsewhere in the world. While it could have been argued that the SEC's job is to protect investors rather than to reflect the petroleum industry's wishes (in the case of the first criticism), and that foreign practices did not necessarily have the same degree of protection for investors, by the 2000s, it was clear that the SEC rules needed revising, the last revisions having been in the 1980s. Some of the issues were clearly disadvantageous to investors as well; for example the SEC Rules of that era did not permit the booking of categories other than proved reserves, but energy companies found ways around that, which created a double standard of information for some investors as opposed to others in respect of an important source of value.
New Developments
The biggest "new" changes to the SEC Rules were developed in 2008 and came in to force in 2010, on the cusp of big changes in the industry, such as new technologies that made shale and other unconventional sources of oil and gas economical. The most important of these changes were: i) in pricing rules, ii) in the recognition of new technologies in reserve estimation, iii) in the specific recognition of unconventional sources, and iv) in relation to the time horizon for the category of Proved Undeveloped reserves (PUD's).
1. A relatively simple accounting change has made a big difference (especially in the volatile oil and gas market of recent years) in calculating reserves, namely that the oil price used in calculating reserves is now based on a 12 month average cost, rather than the (somewhat arbitrary) year-end price used before. This is the price used to determine the "economic producibility" of reserves, meaning the price that determines whether or not the producer can lift the hydrocarbons profitably using existing technology and getting this price for it. The important exception is where the price a producer receives is set by contract. Naturally, this issue is very important in evaluating a variety of international petroleum arrangements, including production sharing agreements (PSAs), certain types of licensing and concession arrangements and services/risk-sharing contracts, where the price per barrel (or cubic meter) may be set by contract, or subject to a mandatory buyer clause at a discount, or calculated in-kind using a formula with weak linkage to the market price.
2. A welcome change was the acceptance of new technologies both in reserve estimation and in production. This is reflected in a change in the definition of "proved reserves", which are now
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no longer dependent on "fluid contact" (the absolute necessity for a test well), but may now be demonstrated by new "reliable technologies", provided that those technologies can establish to a "reasonable certainty" that the proved reserves exist. Formerly, it was required to establish the existence of proved reserves to a "certainty", which in practice was a much more rigid standard that resulted in regular under-reporting of reserves.
3. It is impossible to ignore the rise of...
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