An analysis of 2010 year-end reserve reports from exploration and production companies indicate that the industry is starting to remove undeveloped reserves of natural gas from the proved category. This is due to the industry shift towards oil and liquids development and new government rules on reserve accounting adopted last year that impose a five year development limit on the industry.

IN PICTURES: 4 Biggest Investor Errors

New Rules
In late 2008, the Securities and Exchange Commission (SEC) adopted a new set of rules governing the reporting requirements for oil and gas companies. One of these changes impacted the treatment of undeveloped reserves in the proved category.

The SEC imposed a five-year limit on keeping undeveloped reserves in the proved category, unless "specific circumstances" prevented its development within that time frame. What this means is that, unless an exploration and production company can drill and complete a well or set of wells on its properties within five years, the proved undeveloped reserves have to be shifted to the probable category.

The specific circumstances loophole was included so that undeveloped reserves associated with projects that take more than five years to develop, such as oil sands, would not have to be removed from the proved category.

The Evidence
Newfield Exploration (NYSE:NFX) just released its 2010 reserve report and showed a 20% increase in proved reserves compared to a year earlier. The company might have reported even stronger growth in proved reserves for the year, but was obligated to move 315 Bcfe of proved undeveloped reserves into the probable category.

These reserves were mostly natural gas and located in the mid continent area of the United States. Newfield Exploration cited a "deferral of development activity" that would make it unlikely the company would develop these assets within the five year time limit.

Venoco (NYSE:VQ) also released its 2010 reserve report and disclosed that the company had reclassified 2.7 million barrels of oil equivalent (BOE) of proved undeveloped reserves into the probable category. This was due to a planned reduction in drilling in 2011 on its natural gas properties. In the Sacramento Basin, which Venoco has been developing for years, the company plans to drill 40 wells in 2011, down from 100 in 2010.

Chesapeake Energy (NYSE:CHK) announced a plan earlier in the year to divert capital away from natural gas development and towards oil and liquids instead. The company also announced a new financial strategy to reduce its debt by 25% over the next two years through the reduction of leasehold acquisition and asset sales. Chesapeake Energy released its preliminary 2010 reserve report, but didn't disclose the removal of any undeveloped natural gas reserves from the proved category as a result of its new strategy. The company may have additional information on its reserves when it releases its final report.

Other companies are staying with natural gas and didn't remove any proved undeveloped natural gas reserves at the end of 2010 due to the five year rule. CONSOL Energy (NYSE:CNX) is accelerating the development of its natural gas properties and didn't recategorize any proved undeveloped reserves at the end of the year.

The Bottom Line
The exploration and production industry shift towards oil and liquids development will mean less development of natural gas properties over the next few years. This has resulted in the removal of undeveloped reserves of natural gas from the proved category. (For related reading, also take a look at Understanding Oil Industry Terminology.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  2. Stock Analysis

    Fortinet: A Great Play on Cybersecurity

    Discover how a healthy product mix, large-business deal growth and the boom of the cybersecurity industry are all driving Fortinet profits.
  3. Stock Analysis

    2 Catalysts Driving Intrexon to All-Time Highs

    Examine some of the main reasons for Intrexon stock tripling in price between 2014 and 2015, and consider the company's future prospects.
  4. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  5. Savings

    Do Natural Gas Prices Always Follow Oil Trends?

    Prices for oil and natural gas are highly correlated. But investors should be aware of different factors affecting the prices of these commodities.
  6. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  7. Technical Indicators

    4 Ways to Find a Penny Stock Worth Millions

    Thinking of trading in risky penny stocks? Use this checklist to find bargains, not scams.
  8. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  9. Investing Basics

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  10. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!