Oil and Natural Gas “Reserves” — Definitions Matter

When determining energy policy, many politicians, pundits, and policymakers discuss the amount of America’s oil and natural gas “reserves” without fully appreciating how broad a range of possible meanings is covered by the term “reserves.” True, the various definitions all refer to oil and natural gas resources in the ground–but which to include–only what’s recoverable or all that’s in place? Discovered or projections of the yet undiscovered? With how much certainty?  With what technology and at what price? The ambiguities leave oil and natural gas “reserves” vulnerable as a political bull’s eye. Different definitions and comparisons can be used depending on how rosy or bleak one wants the outlook to appear. We’d like to clear up just a little of the confusion, do a rough sketch of some of the basics, and explore how recent advances in technology have changed the meaning of “reserves.”

Plethora of Definitions

There are different purposes behind the effort to define reserves. They range from near-term, high certainty, conservative estimates of what can be produced by an individual company that can be used as the basis for project planning and financing, all the way to blue-sky, long-horizon, inferred projections for a whole region or country of resources that may exist regardless of the current state of technology or economics.

Thus, many entities have their own definition of “reserves”–the U.S. Geological Survey, American Association of Petroleum Geologists, Society of Petroleum Engineers, the Society of Petroleum Evaluation Engineers, the World Petroleum Congress, not to mention the Securities and Exchange Commission, the Internal Revenue Service, and the United Nations Framework Classification.  Geologists and petroleum engineers have various highly developed systems of categories and terminology, and have spent considerable effort coming up with definitions that can be applied repeatedly and consistently. However, to keep our analysis brief (and since we are neither engineers nor accountants), we’ll limit ourselves to distinguishing between “proved reserves” and “technically recoverable reserves.”

Proved Reserves

An example of  proved reserves is the Securities and Exchange Commission (SEC) definition, effective in 2010, since public companies are required to provide reserves data in their 10-K reports.

“Proved oil and gas reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible–from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations.”

One key term is “reasonable certainty,” which is generally taken as 90% probability. It implies estimates are only for areas with solid data from existing wells and production history from which highly certain and reasonably precise estimates can be made. The term “economically producible…under existing economic conditions, operating methods, and government regulations” excludes any projection of future technology improvements, and implies that producing this resource must be economic with current market prices and other economic conditions.

In other words, proved reserves” is an extremely conservative definition. It has little downside risk and potentially a great deal of upside potential. With a bent towards precision and high certainty, it can exclude large amounts of oil and natural gas that are likely to exist but can be estimated less accurately and with less stringent requirements for certainty.  In fact, “reserves growth,” a common industry phrase, is almost a foregone conclusion even in the “proved reserves” category, as existing producing areas undergo infill drilling, reservoir assessment, re-completions, work-overs, re-fractures, and refinements in development strategies.

Technically Recoverable Reserves

By contrast, the term technically recoverable” is much more expansive. According to the U.S. Geological Survey, “Technically recoverable resources” are “resources in accumulations producible using current recovery technology but without reference to economic profitability.” This differs from “proved reserves” in many ways. It is less restrictive than the 90 percent probability point, often including a range of estimates with a corresponding range of probabilities; it includes estimates of yet-to-be-discovered oil and gas; and includes oil and gas that may not be producible with current prices and other economic conditions. Thus, it can be a much larger figure than “proved reserves.”

Technology Expands Estimates

A key point about “technically recoverable reserves” is that those estimates change as technology changes – sometimes changing in a major way, when, for example, horizontal drilling is combined with hydraulic fracturing.

This has been clearly illustrated as many shale gas and shale oil plays have become viable thanks to new technologies. For example, in 1995, the USGS estimated that the Bakken formation, discovered in the 1950s, held only 0.15 billion barrels of technically recoverable oil. In just under twenty years, in 2008, thanks to advances in tight oil technologies, it updated this to 3 to 4.3 billion barrels! The situation has changed rapidly enough that the USGS is working on yet another assessment (out of cycle) expected in late 2013. Meanwhile, other industry experts have put the figure for the Bakken much higher, closer to 20-24 billion barrels with total original “oil in place” (total volume present in a reservoir) nearing 1 trillion barrels.

Hardly a new hydrocarbon region with the first well drilled in 1921, the Permian Basin of Texas and New Mexico, has a production history of well over 30 billion barrels of oil since then. Yet technological advances have significantly altered assessments of its technically recoverable reserves. In 2007, USGS assessments for the region included for the first time “continuous resources,” a term which includes shale gas and shale oil plays. Without these added assessments, the Permian estimates of undiscovered technically recoverable resources would have been limited to the conventional plays, put at 5.2 tcf of natural gas and just under 1 billion barrels of liquids by the USGS. But the addition of “continuous resources” added another 35.4 tcf of gas and 1.3 billion barrels of liquids, putting the total estimate of undiscovered technically recoverable amounts at 41 tcf of gas and 2.3 billion barrels of liquids. Original crude oil in place is estimated at 95.4 billion barrels, with 33.7 billion barrels of that produced or in discovered, recoverable reserves.

Overall, the assessment of U.S. technically recoverable reserves of both oil and natural gas have grown markedly over the past decade, as the chart shows.

International Apples and Oranges

Before one compares U.S. “reserves” with other producing countries around the world, it’s important to know what is being compared. For example, some countries for political reasons may focus on more expansive definitions of “reserves” or even on “oil in place”— not all of which is commercially recoverable. Some countries may withhold detailed technical data, which makes independent assessment of reserves difficult. Knowing how and when to apply definitions to emerging technologies can also lead to differences. For example, Canada’s oil sands reserves estimates have been subject to different interpretations by various analysts, ranging from dozens of billions of barrels to well over a hundred billion barrels. Thus, comparing U.S. “proved reserves,” one of the most conservative definitions in use, with these broadly-defined figures distorts the comparison.

Caution: Future May Be Brighter Than Appears

From the beginning days of the industry, continued innovation has led to new, expanding assessments of “technically recoverable” oil and natural gas. Edwin Drake’s first well in 1859 astounded onlookers with production of all of 10 barrels per day as oil from surface seeps was quickly surpassed by the volumes of oil producible by simple drilling. From those early days onward, improvements in technology, geologic understanding, and operational experience have progressed as the industry moved to deeper prospects, differing geologies, and more challenging environments offshore. Independents have often been at the vanguard of technological innovations that have made these milestones possible–using ever evolving engineering, information processing, and innovative operational practices.

For shale oil and shale gas and other tight, low-permeability plays, the industry is only at the beginning of the technology story, with much room left to grow in recovery factors and depletion curves. Thus the final outcome is unknown–but may be brighter than experts could have ever projected in the past.  The turnaround in U.S. oil and gas production, with independents at the helm, is concrete evidence of the growing commercial resource base of American oil and natural gas–and great encouragement for America’s energy future.

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