No one is looking for those missing barrels -- because they likely never existed, according to the securities officials who have rewritten the rule book for the half-art, half-science of estimating reserves of oil and natural gas deep underground.
Called National Instrument 51-101, the new rules laid down by the Canadian Securities Administrators (led by the Alberta Securities Commission) have come into force just as a series of high-profile reductions in reserves elsewhere in the world -- most notably Royal Dutch/Shell Group's massive 4.47-billion-barrel writedown. They have thrown a spotlight on the reliability of those numbers, which measure the assets that are the future revenue of any oil and gas company.
Under NI 51-101, the entire Canadian oil patch has for the first time been required to report reserves and their value using the same mathematical standard of certainty, replacing the less precise requirement for a "high degree of certainty" for proven reserves; it is also the first time that oil executives have had to certify that those figures are accurate, and to use outside engineers to verify internal assessments.
In the only industry-wide analysis of the effect of those new rules, The Globe and Mail has found that the equivalent of 118 million barrels of oil and natural gas have vanished from the proven and probable reserves of 140 firms under the category of "technical revisions." The reductions in proved reserves, the most reliable estimate of oil and natural gas reservoirs, have erased $3.2-billion from the value of that future production.
The cuts have wiped out the equivalent of one in every 34 barrels of oil for the industry as a whole, but some companies have been hit much harder.
Reserves fell by at least 30 per cent at the five most affected companies, according to the Globe and Mail analysis of the regulatory filings of all reporting firms on the Toronto Stock Exchange, and the top quarter of such companies on the TSX Venture Exchange.
However, some companies that were already using the more specific standards of NI 51-101, such as ARC Energy Trust, saw their reserves adjusted upward because of different kinds of technical revisions.
NI 51-101 imposes a single -- and, parts of the oil patch protest, tighter -- standard for calculating reserves and their value, as well as the requirement that executives report and certify those numbers each year, much like other securities regulations in Canada and the United States oblige senior officers to certify the accuracy of financial statements.
There is still furious debate within the oil patch about what the reserves reductions mean, with some contending it is merely a paper reduction while others, including the ASC, insist that the new numbers are the most accurate reflection of the oil patch's future production.
At Baytex Energy Trust (which had the largest absolute reduction to its reserves with a drop of 39.1 million barrels) unit prices suffered in the runup to the release of its numbers under NI 51-101. "I think there was a lot of speculation and trading on that," says Daniel Belot, Baytex's chief financial officer and vice-president of finance.
There was little reaction after the company came out with a 30-per-cent reduction, but only because there had been speculation about a 50-per-cent drop, he adds.
One of Calgary's most prominent deal makers says the new measurement and disclosure standards will transform the way the oil patch does business.
"The ripple effect of this is equally as great -- but probably hasn't gotten the same profile yet -- as the ripple effect of Enron and the Sarbanes-Oxley rules that came in after that," says Gowlings partner John S. Burns, who specializes in mergers and acquisitions, and who helped to draft the rules that NI 51-101 replaced.
Mr. Burns says any company that has reduced its reserves value under NI 51-101 should expect to command a lower price in any M&A negotiations. He and other observers predict further ripples, including:
A likely end to downward revisions in coming years -- a reflection of the magnitude of this year's reductions.
A hit on a company's stock price for unexpected revisions, especially those that reduce the net present value of reserves.
Increased scrutiny from institutional investors and ratings agencies of reserves figures, particularly on firms whose numbers are now revised downward.
Canadian companies benefiting from being subject to stringent rules in an era where doubt is being cast on the reliability of reserves figures. "Anything that can boost confidence has to ultimately be to the benefit of those seeking capital," says Stephen Murison, vice-chairman at the ASC and one of the lawyers who helped to draw up NI 51-101.
On the other hand, the new rules could limit access to U.S. capital markets if the current boom in oil prices comes to a halt, and Canadian firms suffer unfavourable comparisons to companies operating under less restrictive rules. "The other way you can look at it is that you're probably being too conservative in Canada, so you're probably restricting your access to capital. I think there's potential for that," says Peters & Co. Ltd. analyst Brian Prokop, adding that he does not believe NI 51-101 is a hindrance with oil hovering around $40 (U.S.) a barrel.
He added that high prices have cushioned the blow from the downward revisions, since increases in price expectations allow energy companies to increase their estimates of the amount of oil and gas they can profitably extract -- offsetting the impact of the downward technical revisions. Exploration and infill drilling, for instance, can increase reserve estimates; also, other factors influence technical revisions, including more sophisticated analyses of existing information.
Because of those other factors, overall reserves rose at many companies even with large downward technical revisions.
The impact of NI 51-101 has also been muted because most of Canada's largest oil and natural gas companies have been exempted from what Mr. Prokop calls its "stringent, strict and restrictive" reserves measures. Eleven companies argued successfully that they need to be able to use the standards of the U.S. Securities and Exchange Commission to remain comparable to American peers.
Canada's rule states that there must be a 90-per-cent probability that the quantity of oil and gas actually recovered by a company at least equals the amount recorded as proven reserves; there is a 50-per-cent probability requirement for probable reserves. The SEC simply requires "reasonable certainty" for proved reserves without laying down a specific number, similar to the rules Canada used before NI 51-101.
For the companies that are subject to NI 51-101, there is a deep divide about the significance of those disappearing reserves. The chief executive officer of Thunder Energy Inc., which reduced its reserves by a sixth, says the "ultraconservative" rules of NI 51-101 are behind what he views strictly as a reduction on paper.
"The reality is, whatever's there, is there. Nothing has changed," Douglas Dafoe says.
But ARC Energy Trust, whose reserves were revised upward 8 per cent under NI 51-101, views the amounts resulting from the new rules as "a fair estimate of what we expect to recover," says David Carey, vice-president of business development.
For its part, the Canadians Securities Administrators have told the oil patch that it cannot point to NI 51-101 as a reason for a significant reduction in reserves, stating that the new rules clarify how reserves should be measured, but are not a departure from the principle of coming up with the most accurate estimate of what lies underground.
"I wouldn't consider [NI 51-101]a full explanation, and maybe not an explanation at all," Mr. Murison says.
Indeed, the firm with the largest percentage reduction, Questerre Energy Corp., says its downward revision of all of its reserves had nothing to do with the new rules, but stemmed instead from the unhappy discovery that gas it had thought was trapped in the upper parts of its reservoirs, did not in fact exist.
Mr. Murison says investors, both in Canada and elsewhere, need to understand the differences in the standards.
But perhaps not for too long, if others adopt Canada's approach, he suggests. "We're even hopeful that people interested in the industry, or regulators, or standard setters, outside Canada may see merit in some of what we now have here."
Might that include the SEC, putting all North American energy firms on an equal footing? "I think there's always hope," Mr. Murison says.
The revision
Each icon represents approx. 119 million barrel equivalent. Total reserves, before technical revisions, were the equivalent of 4,049,064,843 barrels
Technical revision decreased the stock by 118,630,273 barrels equivalent.
The biggest losers
Top ten Canadian energy companies whose reserves have been revised downward under new rules *
Company..............................% change..................Company.....................Barrels of oil equivalent, million
Questerre Energy Corp................ 100.0.................Baytex Energy Trust.......................39.9
Canadian Superior Energy Inc...........40.0.................Penn West Petroleum Ltd.................20.4
TransAtlantic Petroleum Corp...........36.9.................Pengrowth Energy Trust...................15.1
Burmis Energy Inc........................32.7.................Nelson Resources Ltd.....................15.1
Bison Resources Ltd......................30.4.................Western Oil Sands..........................15.0
Baytex Energy Trust......................29.8.................Viking Energy Royalty Trust...............8.7
Kick Energy Corp.........................26.2..................Pan-Ocean Energy Corp...................8.2
Novitas Energy Ltd........................25.1..................Thunder Energy Inc........................5.9
Sentra Resources Corp....................24.1..................Pebercan Inc................................5.7
Tempest Energy Corp.....................22.3..................PrimeWest Energy Trust..................4.6
Numbers reflect only technical revisions, other factors including exploration, acquisitions and drilling extensions can also affect reserves.
Disappearing value
The top 10 companies with the biggest downward changes in the value of their proved reserves due to changing quantity estimates under the new rules, both by absolute amount and as a percentage reduction in overall proved reserves
Company...... Change in net present value *......$million.................Company............Change in net present value......% change
PetroKazakhstan Inc.................................$893.3............Questerre Energy Corp........................................100.0
Baytex Energy Trust...................................746.8.............CGX Energy Inc................................................93.3
Penn West Petroleum Ltd.............................385.0.............Bow Valley Energy Ltd........................................56.9
Enerplus Resources Fund..............................337.9.............Greentree Gas & Oil Ltd.......................................51.9
Acclaim Energy Trust..................................126.1.............Bison Resources Ltd.......................................... 51.8
Viking Energy Royalty Trust............................93.4..............Baytex Energy Trust...........................................48.5
Paramount Resources Ltd...............................88.9.............Kick Energy Corp...............................................34.2
Thunder Energy Inc......................................76.2.............Raven Energy Ltd..............................................33.9
Compton Petroleum Corp...............................69.4..............PetroKazakhstan Inc..........................................32.2
PrimeWest Energy Trust.................................5.9..............Dynamic Oil & Gas Inc........................................30.8
*Net present value is the current value of future revenues discounted by a factor of 10 per cent a year
SOURCE: COMPANY FILINGS
THE GLOBE AND MAIL