Tuesday, November 12, 2013

Understanding Oil and and Gas Reserves

Recently a report has come out saying BC has much larger natural gas reserves which makes for a great headline but it is a much more complex issue.   For almost all natural resources there numerous ways to measure and report on the resource.   In the case of this report I feel like the way the data was presented is somewhat misleading.  I think the report tells us there is a ballpark but people are reading it is if it tells the score of the game.

When we speak of reserves of oil and gas it is important to understand the differences between some major categories.   Here in simplified terms are the four major oil and gas reserve categories:

Theoretical estimated reserves or potential reserves - what may actually be in the the ground.   This changes when knowledge and assumptions about geology changes.   As an example, in the last 10 years there have been new major oil reserves off of Brazil that have changed assumptions about where oil and gas could be found.   In general this number does not change much globally because so much of it is tied up in several very large known reserves.  The range for the estimate tends to be very wide with the low end being much less than the high end estimates.

Proven reserves - the actual discovered reserves.   These are the reserves that have been geologically proven to exist.  In the case of oil this number is much larger than the next type of reserves because of the existence of the tar sands in Canada and Venezuela.   Just because we know the oil is there, this does not mean we can get it.

In many cases discoveries that are not likely to be economic are not fully explored and we end up with measurements of probable or possible reserves which are not quite fully proven.  They are estimates but are often lumped in with overall proven reserves which confuses the terms.

Proven recoverable reserves - this is the oil and natural gas that we can recover with current technology.  It is also called the producible fraction.   In all oil and gas deposits there will be a significant portion that is not recoverable.  In the case of unconventional resources the vast majority can not currently be recovered.  Changes in technology such as fracking or new methods to extract oil from tar sands increases the recovery of oil and gas.   Recoverable reserve numbers have risen with the new technologies.

You can see something like this in action when companies go hack to old gold mines and process the tailings piles for the gold that was not recovered in the past.  In Hedley BC this was done in the 1990s.  In the past it was not physically possible to recover all of gold but the new methods meant it is financially worthwhile to process the dirt.   In another generation it will likely be worthwhile to go to Eskay Creek and process their tailings piles if the price of gold remains high enough.

There are people out there trying to predict how quickly new advances in technology will increase the reserves.

Cost of production or legal barriers, such as being in a park, are not considered restrictions for this type of reserve.

Proven economically recoverable reserves or marketable reserves - this is really the only one that matters most of the time.   This type of reserve is measured by how likely an oil or gas reserve is to be produced This is also the one that change the fastest because it depend on medium and long term price forecasts for oil and gas.

For a company like Shell, their value as a company is directly related to how much oil and gas they can produce now and for the next decade.   Much of their capital value is tied up in their proven economically recoverable reserves.    As a publicly traded company they are required by financial regulations to accurately reflect their proven economically recoverable reserves.  With a high price for oil or gas the reserves they own rise.   Each day as the price of oil and gas changes, their reserves change.  

Economically recoverable reserves also increase because of technology.   The current low price in North America for natural gas is because of a change in technology making a lot more natural gas economically recoverable.

1P, 2P and 3P
To confuse everything companies report three different type of reserves of which two of the measures go beyond what are proven economically recoverable.  The US SEC requires publicly traded companies to provide solid data for 1P reserves.

1P  - proven developed and undeveloped reserves that have a 90% certainty of being developed
2P - 1P along with probable reserves  - probable meaning a 50% certainty of being produced
3P - 2P plus possible reserves - possible meaning at least a 10% of being produced

The Ultimate Potential for Unconventional Petroleum from the Montney Formation of BC and Alberta
The report released covers both the over all potential reserves of oil and gas in the formation and then makes an estimate of the marketable resource levels.  What is important to understand here is that neither number is a proven reserve, they are estimates based on good geological information.    The report has a large range so only tells us what the ballpark looks like and not what the score in the game is or even if there is a game going on.

An important aspect to know about the report is how it defines Marketable resources.  From page 1 of the report:

“Marketable resources”, as used in this report, indicates the volume of in-place petroleum that is recoverable under foreseeable economic and technological conditions and in a condition ready to be used by the market. While it implies a sense of economic recovery, no economic assessment was performed (my emphasis)

I think it was misleading to use the term marketable if no economic assessment was done.  The equations on pages 11 to 15 and the table on pages 16 and 17 make it clear there was no attempt to determine the economic potential reserves.   Though in a round about way there is some economic data because the calculations use real world wells to get their data on what natural gas could be recovered.  

What people need to be clear on is that this report is a measure of potential and not a measure of anything proven.   It is also not a measure of how much natural gas could be economically produced and my read on the report is that the marketable resource numbers are higher than economically recoverable reserves.

What the report has to say is not a surprise to people in the oil and gas industry.   The actual development of natural gas will depend first and foremost on the price for the product.  As long as the price remains so low the amount that will be developed will be significantly less than the marketable resources from the report.


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