June 15, 2016

Active rigs:

	6/15/2016	06/15/2015	06/15/2014	06/15/2013	06/15/2012
Active Rigs	28	77	187	185	214

RBN Energy: update on Hawaii going green. Hawaii's move from oil to LNG is a slow one. It seems Hawaii "Big Gas" and Hawaii "Big Electricity" can't come to agreement.

Primer on reserves. Don sent me this article. I saw the headline, but had not read the article. I assumed I understood most of this -- the blog and readers have really helped me out over the years. Even for folks who follow the oil industry fairly closely, this is a good article. I don't particularly care for Yahoo!Finance articles mostly because there is a) too much chaff to get to the wheat; and, b) I'm always leery of hidden agendas.

Note: in a long note like this, there will be typographical and factual errors. The notes were taken from a very superficial article. In addition, I may have misunderstood what the article said in places. I also include my own comments and world vision (myth) which may or may not be accurate. 

Having said that, here are the takeaways on this article that suggests that "billions in proven oil reserves have suddenly become unproven." 

By the way, for those who remember, this feels a lot like the "mark to market" debacle in 2008 which some can argue led to the near-collapse of the US stock market.

This "sudden loss" in "billions in proven oil reserves" is to some extent due to the calendar and Federal regulatory policy.

The government, through the SEC, rules that for unproduced oil underground to be considered "proven reserves" two criteria must be met:

• wells must be profitable at a price set by a SEC formula
• undeveloped wells must be drilled within five years after the wells have been added to a company's book.

For me, the biggest "aha" moment some months ago was that "proven reserves" had to do with the second rule: the FIVE-YEAR rule.

I was aware of the "cost" rule but was a bit fuzzy on the details.

The COST-PROFIT rule:

• oil price "set" by the SEC
• the time period for the price "set" by the SEC

With fracking, the industry lobbied the SEC to count more undeveloped acreage as proved reserves, arguing that shale prospects are predictable across wide expanses. 

That effort/change apparently occured only a few years ago (previously posted on the blog). It was a pretty good deal for the industry when oil hit $100 and when this deal between the SEC and the oil industry was being hammered out.

It's not such a good deal when the price of oil plummets. Again, sort of like the SEC's ruling "mark to market" back in 2008 that set off the near-collapse of the US stock market.

Apparently to deal with that risk, "The companies got a temporary reprieve for 2014 because the SEC number was about $95 a barrel even though crude had plummeted to less than $50 by the time results were reported in early 2015. "

As the linked article notes, that "advantage" disappeared. It disappeared in "early 2015."

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Valuing Oil Companies

More from the linked article on reserves: one could argue that the value of an oil company can be determined by a) margin of current (and expected) profitability; and, b) how much product one has left.

A huge profit margin means squat if one is projected to run out of product one year down the road.

So, "proven reserves" are a huge, huge deal when "valuing" an oil company.

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A Few Data Points On Reserves

More from the linked article on reserves, some data points:

• proven reserves surged 67% over five years after the 2009 SEC ruling
• much of these "proven reserves" existed only on paper (well, duh)
• by the end of 2014: undeveloped properties accounted for 39% of proved oil and gas reserves
• by the end of 2014: this was up from 33% at the end of 2009 (hmmm?); up about 8 billion bbls
• the article mentions three oil companies that got into bankruptcy problems and how they handed their proven reserves: Ultra Petroleu, Linn Energy, and Goodrich Petroleum.
• George Soros (buried deep in the article): invested in Penn Virginia Corp; this company booked paper wells in naturla gas prospects where it hadn't drilled in years (this takes me back to a series of blog posts on The New York Times "scam"; The New Yorks Times is vindicated to some extent

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What The SEC Is Told; What Investors Are Told

From the linked article:

Penn Virginia Corp., a company in which billionaire George Soros had a stake, booked paper wells in natural gas prospects where it hadn’t drilled in years, according to letters from the SEC.

“Your actual drilling has consistently failed to follow schedules,” the SEC wrote in an April 2015 letter. Penn Virginia responded that it had intended to get to the wells within five years but its plans changed when prices fell. 

That’s not what company executives told investors, according to conference call transcripts. H. Baird Whitehead, Penn Virginia’s chief executive officer, said in a November 2012 call that “under almost no scenario” would the company resume gas drilling. Yet, when Penn Virginia filed its report with the SEC three months later, the prospects accounted for more than 40 percent of its reserves.

During an April 2013 call, Whitehead said, “We don’t plan on drilling natural gas wells.” Still, the undeveloped natural gas wells comprised 19 percent of the company’s reserves at the end of that year. Patrick Scanlan, a spokesman for Penn Virginia, declined to comment.

How did all that work out?

Penn Virginia erased most of its undeveloped reserves this year. The company filed for bankruptcy May 12 with $1.2 billion in debt. Records show Soros sold his six million shares in the first quarter.

Later, June 16, 2016: 24/7 Wall Street also weighed in on this subject. What was their point?

Beginning in 2009, the U.S. Securities and Exchange Commission requires U.S. producers to use a formula that values a barrel at the average price a company receives on the first day of each of the 12 preceding months. At the end of 2014, that figure was right around $95 a barrel. At the end of 2015 the figure had fallen to less than $50.

Because the barrels could not be economically recovered at a price below $50 a barrel, they moved from the proved reserves category to either “probable” or “possible” reserves. It doesn’t matter which because the value of a company’s assets is based on its proved reserves only.

And ends with this:

The oil is still in the ground and will rejoin the ranks of proved reserves once the price rises enough to make extracting the barrels profitable. But that could take longer than many investors are willing to wait, given the difficulty crude has had holding about $50 a barrel this year.

Yes, the oil hasn't gone anywhere. It's simply a function of the SEC.