Some exploration and production (E&P) companies have been forced to remove undeveloped natural gas reserves from the proved category at the end of 2011. This reclassification was caused by reduced drilling in dry gas areas, which has pushed the development of these reserves past the five-year time limit required by government reporting regulations. (To know more about oil and gas, read Oil And Gas Industry Primer.)

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Proved Undeveloped Reserves
In 2008, the Securities and Exchange Commission (SEC) issued revised regulations involving the disclosures that oil and gas companies are required to make when reporting reserves and other data.

One major change instituted by the SEC involved the handling of undeveloped reserves in the proved category. Oil and gas companies are now required to have a development plan to drill these proved undeveloped reserves (PUD's) within five years, or reclassify them to the probable category.

PUD's can stay more than five years only if "special circumstances" exist, according to the SEC. These circumstances include reserves in remote or urban areas, environmentally sensitive locations or associated with projects that involve the construction of offshore infrastructure.

The collapse in natural gas prices has led to reductions in dry gas drilling, which has caused many operators to revise the development of these PUD's past five years.

Cabot Oil & Gas Corporation (NYSE:COG) reported total proved reserve of 3 trillion cubic feet equivalent (Tcfe) at the end of 2011, up 12% over the end of 2010. This proved reserve total incorporated the removal of 190 billions of cubic feet equivalent (Bcfe) of legacy proved reserves that the company felt could not be developed within five years.

Cabot Oil & Gas Corporation offset some of these PUD's by increasing the estimated ultimate recovery (EUR) on undeveloped Marcellus Shale locations. The company now expects the EUR on these locations to be 7.5 Bcf per well.

CONSOL Energy (NYSE:CNX) also cut PUD's, removing 380 billion cubic feet at the end of 2011. The company has redirected capital away from its conventional and coal bed methane properties and towards the Marcellus Shale and Utica Shale, and no longer expects to develop these reserves within the next five years.

Plains Exploration & Production Company (NYSE:PXP) has shifted much of its capital spending towards crude oil and liquids development, expanding its activity in the Eagle Ford Shale over the last few years. The reduction in dry gas drilling has led the company to reclassify 44 million barrels of oil equivalent (BOE) of Haynesville Shale reserves from the proved to probable category.

Despite this reclassification, it still has an active program in the Haynesville Shale and in 2012 plans to spend 20% of its $1.6 billion capital budget on this play.

Range Resources (NYSE:RRC) also bumped up against the five year development rule and removed 112 Bcfe of PUD's at the end of 2011. The company attributed this to the reallocation of capital towards the Marcellus Shale and other plays that produce natural gas liquids in the production stream.

Noble Energy (NYSE:NBL) lost 45 million BOE of PUD's in 2011, as the company reduced the vertical development of properties in the Denver Julesburg Basin. The company is accelerating horizontal development in this basin, and plans to drill 170 horizontal wells into the Niobrara in 2012.

The Bottom Line
While an investor may frown on a company that loses proved reserves, the removal of these PUD's is not a major cause of alarm. Improved fundamentals and the strengthening of natural gas prices will lead to an increase in dry gas drilling, and the reclassification of these reserves back into the proved category at some later date. (For additional reading, check out A Guide To Investing In Oil Markets.)

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At the time of writing, Eric Fox did not own shares in any of the companies mentioned in this article.

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