What Are Probable Reserves?
Probable reserves are crude oil reserves calculated to be at least 50 percent likely to be recovered through drilling. Recovery probabilities help estimate the present and future value of assets owned or operated by firms in the oil and gas sector.
- Probable reserves are oil deposits with at least a 50% chance that what is available can be extracted for use.
- Probable reserves do not necessarily imply proven reserves since a firm may decide not to recover the deposits because of the expensive economics involved in extraction.
- Companies that report probable reserves use 2P valuation that includes possible and probable reserves.
Understanding Probable Reserves
Probable reserves make up a portion of the oil present in an area surveyed by an oil and gas exploration firm. Firms use the results of a seismic survey of a piece of land to determine the amount of oil available beneath that land. The companies then categorize the amount of oil based upon an estimate of the relative ease or difficulty of getting the oil or gas out of the ground.
Any combination of regulatory, economic, and technological challenges could reduce the likelihood that a firm can profitably extract the reserve. When firms decide that those factors combine to give them between a 50% and an 89% chance of successfully removing the oil or gas, they categorize the reserves as probable.
For example, reserves may appear to be a good fit with an established commercial recovery method that a firm does not currently have in use on the site, or had not initially planned to use. In that case, the firm would classify the reserves as probable, since their recovery would depend on the planning and execution of a new project, which may or may not be economically viable. In this case, even though the reserves would almost certainly be available to the company, the economics involved in extracting them might reasonably lead the firm to decide not to bother with the extraction.
Probable, Proven, and Possible Reserves
The Society of Petroleum Engineers recognizes three main categories of oil reserves based upon how likely an exploration and drilling company believes they are to be extracted.
- Possible reserves lie at the low end of the scale, with odds of commercial extraction under 50-percent, but higher than 10-percent.
- Proven reserves sit at the top of the scale, at a 90-percent or above likelihood of commercial extraction.
- Probable reserves are those with the likelihood of recovery for between possible and proved reserves, or over 50-percent but under 90-percent.
These categories help experts determine the fair market value (FMV) of a company’s reserves. FMV is the price that an item would sell for on the open market. The process involves the application of a discount rate to expected cash flow from reserves based on the category into which they fall.
Fair market valuations can help a company for planning and accounting purposes, but rules about what metrics oil companies must disclose to their investors vary by country. Most major oil and gas firms report proven reserves to help investors and analysts model future returns. Not all public companies necessarily communicate probable reserves, however.
Measuring Probable Reserves
Among companies that do report probable reserves, the most common formulation uses a 2P valuation, which includes both proved and probable reserves. This 2P value is typically understood to be a best-case scenario for recovered liquids from the firm’s portfolio. The EV/2P ratio is used to value oil and gas companies. It consists of the enterprise value (EV) divided by the proven and probable (2P) reserves. The enterprise value reflects the company's total value.
Some companies also use a 3P oil reserves equation, which uses the sum of proved, probable, and possible reserves. Because of the low likelihood that some portion of a 3P estimate will get recovered, investors can generally consider it a high-end estimate of likely recoveries.