In light of the extent and pace of changes in the oil and gas industry and public concern that its oil and gas reserves requirements are not fully aligned with current industry practice, the U.S. Securities and Exchange Commission (SEC) has published a concept release (the Release) requesting public comment on possible revisions to its oil and gas reserves disclosure requirements and related issues. The SEC adopted the current disclosure requirements between 1978 and 1982. During the intervening decades, there have been significant changes in the oil and gas industry, including changes to technology and the ways in which companies and investors classify oil and gas reserves. Canadian oil and gas issuers who have been complying with the SEC’s oil and gas reserves disclosure policies will be particularly interested in the Release.

Current Framework

The current oil and gas reserves disclosure requirements of the SEC were adopted nearly 30 years ago and are set out in Item 102 of Regulation S-K, Item 4 and Appendix A of Form 20-F, and Rule 4-10 of Regulation S-X. Companies are prohibited from disclosing in their SEC filings reserves estimates other than “proved reserves.” Such reserves are defined in Rule 4-10 of Regulation S-X as estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions.

With respect to the definition of “proved reserves,” the SEC staff (the Staff) has interpreted “reasonable certainty” to mean that when more information regarding a reservoir becomes available, it will more likely than not support the company’s original quantity estimate. Also, Rule 4-10 of Regulation S-X specifies tests that a company must perform to estimate with “reasonable certainty” its proved reserves. Under Rule 4-10, there must be either actual production or a satisfactory conclusive formation test, which the Staff has interpreted to mean drilling and well-flow testing. The Staff has interpreted “under existing economic and operating conditions” to mean that (a) there currently exists a mechanism to ship the resources to market and (b) the company can sell the resources for more than it costs to extract and ship them to market, applying the fiscal year-end price of the resources. Also, the definition of proved reserves specifically excludes certain resources, such as crude oil, natural gas and natural gas liquids recovered from oil shales, coal, tar sands and other sources.

Rule 4-10 of Regulation S-X allows companies to classify “proved undeveloped reserves” as part of their proved reserves in certain circumstances, but this classification requires that any proved undeveloped reserves on undrilled acreage either (a) be immediately adjacent to a productive site and be reasonably certain of production or (b) exhibit continuity of production with the productive site that can be demonstrated with certainty. The Staff has viewed the certainty requirement, which it considers to be a higher threshold than reasonable certainty, to preclude the use of certain new technologies to demonstrate certainty of continuity of production.

Industry Evolution Over the Last 30 Years

Since 1978, technological advances have changed the ways companies identify oil and gas reserves. These advances include 3-D and 4-D seismic interpretation and computer reservoir simulation models. One result is that companies use new techniques to identify reserves but, in the absence of production, return to drilling and well-flow testing to satisfy the SEC’s conclusive formation test requirement. Also, using new technology, companies are able to identify resources that are more difficult to access than in the past, such as tar sands and oil shales, which now can be extracted through relatively new techniques.

When the SEC promulgated the current framework, it relied upon definitions of proved reserves that were based on definitions used by the Society of Petroleum Engineers (SPE) and the oil and gas industry. Since 1978, the SPE has revised its classification framework, which today defines a range of reserves classes as well as contingent resources and prospective resources. In the Release, the SEC noted that the SPE’s classification framework currently may be used by companies and investors in private financing transactions and business combinations where compliance with Regulations S-K and S-X is not required.

Request for Comment

Among other things, the SEC has requested comment on:

  • whether it should replace its current rules-based oil and gas disclosure requirements with a principles-based rule and, if so, what disclosure principles should be considered;
  • whether companies should be allowed to disclose reserves other than proved reserves and, if so, what other reserves should be considered;
  • whether the SEC should adopt all or part of the Society of Petroleum Engineers – Petroleum Resources Management System, or whether other classification frameworks should be considered;
  • whether the current definitions of proved reserves, proved developed reserves and proved undeveloped reserves should be revised and, if so, how;
  • whether the tests that companies undertake to estimate reserves should be specified and, if so, what tests should be required;
  • whether the concept of “reasonable certainty” should be reconsidered;
  • whether the concept of “certainty” with regard to proved undeveloped reserves should be reconsidered;
  • whether the concept of “economic producibility” should be reconsidered;
  • whether the concept of “existing operating conditions” should be reconsidered;
  • whether requiring companies to use a sale price in estimating reserves should be reconsidered and, if a sale price should be used, what price framework should be considered;
  • whether eliminating any current exclusions from “proved reserves” should be considered;
  • whether eliminating any of the current exclusions from oil and gas activities should be considered;
  • whether eliminating the current restrictions on including oil and gas reserves from sources that require further processing, such as tar sands, should be considered;
  • what aspects of technology should be considered in evaluating a disclosure framework; and
  • whether requiring companies to engage an independent third-party to evaluate their reserves estimates in their filings with the SEC should be considered.

Canadian Context

The issues upon which the SEC is seeking comment have been largely addressed in Canada by National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities (NI 51-101). It applies to Canadian reporting issuers who are engaged in oil and gas activities to the extent that the issuer did not obtain an exemption from the application of NI 51-101. Canadian oil and gas issuers who obtained an exemption from the application of NI 51-101 and who have been complying with the SEC’s oil and gas reserves disclosure policies will be particularly interested in the Release.

Canadian oil and gas issuers who file their annual information reports with the SEC utilizing Form 40-F and have not been exempted from the application of NI 51-101 will not be affected by any modifications to the SEC rules. They will continue to comply with NI 51-101’s disclosure obligations. In addition, sales of securities by such companies into the United States made in reliance on the multi-jurisdictional disclosure system will continue to contain disclosure of oil and gas reserves mandated by NI 51-101. Canadian oil and gas issuers who have elected to file their annual reports with the SEC on Form 20-F or Form 10-K will continue to have their disclosure of oil and gas reserves in their annual reports and/or prospectuses governed by SEC policies. Thus, this latter category of Canadian oil and gas issuers will also be interested in responding to the SEC’s request for comments.

In the event the SEC advances this initiative beyond the concept release stage, it will be interesting to see the extent to which the SEC follows NI 51-101. At the very least, the potential inclusion of oilsands disclosure could be a positive development for issuers involved in Alberta’s oilsands.

A copy of the Release can be found on the SEC’s website at: www.sec.gov/rules/concept/2007/33-8870.pdf. Comments are due on or before February 19, 2008.