New rules on reserve reporting for the exploration and production industry are due to take effect with the 2009 reporting year, and the changes are certain to increase total proved reserves, confuse investors and increase volatility in the stocks. (For a primer on the oil industry, refer to our Oil and Gas Industry Primer.)

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Levels of Reserves
Reserve reporting has always been a contentious issue in the exploration and production industry. There are currently three levels of reserves - proved, probable and possible. The first major change is the price used to determine the level of proved reserves. Currently, exploration and production are required to use the price of oil and gas on the last day of the reporting period. The new rules will change that to a 12-month average price.

The new rules will also allow companies to estimate probable and possible reserves for the first time in official filings. Also, non-traditional oil and gas resources will be allowed in the proved categories, including oil sands and oil shale.

The new rules will also allow the use of new technologies that have "demonstrated reliabilities" to establish the level of reserves. The current rules specify the technologies that must be used to establish reserves.

EXCO Resources
(NYSE:XCO) covered the issue in its recent analyst day, and tried to quantify the effects the new rules will have on its reserve levels. The company believes it will have a positive impact and allow it to book "significant" proved reserves. EXCO Resources currently has 1.5 trillion cubic feet of gas equivalent (Tcfe) of proved reserves and 1.8 Tcfe of probable and possible reserves.

Phasing Up

Exploration and production companies with significant operations in the oil sands of Canada may see significant upward moves in proved reserves. Devon Energy (NYSE:DVN) has the Jackfish project under development in Canada. The company produced 4,000 barrels per day here in 2008, and is ramping up Phase I of the project to reach 35,000 barrels per day. Phase II is also underdevelopment here as well. Devon Energy has no proved reserves booked here under the current rules, and will be able to add with the 2009 reporting year.

Some companies are already presenting reserves using the new standards on a pro forma basis, as if the rules were in effect for 2008. XTO Energy (NYSE:XTO) reported proved oil and gas reserves of 13.86 Tcfe for 2008 using the current standards. The new rules resulted in slightly higher proved reserves of 14.66 Tcfe.

The reserve charges will also impact impairment charges that oil and gas companies take to write down the value of reserves when prices fall. GMX Resources (Nasdaq:GMXR) took an impairment charge of $183.7 million in the first quarter of 2009. The company used prices of $3.63 per Mmbtu for natural gas and $49.64 per barrel for oil, and as the company noted in its press release, the charge probably would have been smaller if average prices were used instead of end of quarter.

The Bottom Line
The oil and gas industry has been advocating for changes to reserve reporting for many years, and the new rules are finally set to take effect. These changes will increase the total amount of proved reserves for the industry.

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Tickers in this Article: XTO, XCO, DVN, GMXR

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