New Reserve Rules Expand PUDs

By Eric Fox | February 22, 2010 AAA

New reserve rules, which went into effect for the exploration and production industry, have revealed interesting differences in how rules are applied to book developed and undeveloped proved reserves across various basins in the United States.

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Rule Change Eases Restrictions On PUDs
One major rule change allowed companies to book multiple proved undeveloped locations for each proved well location "where reliable technology exists that establishes reasonable certainty of economic producibility at greater distances". These proved undeveloped locations, or PUDs, were previously restricted to only one offset for every proved well.
Another rule change restricted the booking of proved undeveloped locations to those that the companies could be expected to develop within five years, based on capital plans and their funding.

Conservative Reserves Calculation
Ultra Petroleum
(NYSE: UPL) was fairly conservative in its reserves calculation for 2009. The company is starting to develop its Marcellus Shale acreage, but it decided not to book any proved undeveloped locations in that area. This gives a company-wide proved undeveloped to proved developed location ratio of 0.65 to 1. Ultra Petroleum also uses a three-year limit on development when booking proved undeveloped locations, making it more conservative on this measure as well.

Petrohawk Energy (NYSE: HK) had 22 producing wells in the Eagle Ford Shale as of mid-January 2010, and the company booked 136 proved undeveloped locations in that area for a ratio of 5 for every producing well.

Five-Year Development Rule
While this seems like a higher ratio than other operators, Petrohawk Energy plans to drill 60 wells at its Hawkville Field in the Eagle Ford Shale in 2010. Under the five-year development rule, and barring a disaster in commodity prices, the company should have no problem drilling the 136 proved undeveloped locations within five years. (Diverse commodity asset classes provide both downside protection and upside potential. Learn how in Commodities: The Portfolio Hedge.)

Quicksilver Resources (NYSE: KWK) recorded proved reserves of 2.1 trillion cubic feet of natural gas equivalents at the end of 2009 on its Barnett Shale properties.

Quicksilver booked 919 proved developed locations and 281 proved undeveloped locations in the Barnett Shale. The company said that reserves in its proved undeveloped locations total 768 billions of cubic feet equivalent and will be drilled by 2014, within the five-year time frame.

Southwestern Energy (NYSE: SWN) reports its earnings on February 26, and it will be interesting to see how many proved undeveloped locations the company books in its core Fayetteville Shale properties.

New Rules May Add Volatility To Proved Reserve Totals
The two new rules on proved undeveloped locations may add extra volatility to proved reserve totals for companies that are aggressive in booking these types of reserves. If another credit crisis hits and funding dries up through combined lower commodity prices and restrictive credit, these companies will be forced to remove many proved undeveloped locations from their reserve base. (Find out how this tough economic period can be a learning experience for all; check out The Bright Side Of The Credit Crisis.)

Bottom Line
An updated set of rules for booking reserves in the exploration and production industry was sorely needed, but the rules have had an interesting effect on 2009 year-end reserves, particularly in the area of PUDs. (Drill down into financial statements to tap into the right companies and let returns flow. See Unearth Profits In Oil Exploration And Production.)Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

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