Reserve Audit Process

using SPE Petroleum Resources

Management System (PRMS)

Prepared for GCA Clients, July 2007

Project No. D105

Topics for Discussion

Brief comments on the revised Standards document and auditing

Review of key features of the new SPE PRMS definitions

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Standards Pertaining to the Estimating

and Auditing of Oil and Gas Reserve
Information

Although the standards have no legal or other force, they represent a

generally-accepted set of guidelines for the conduct of Reserves Estimation
and Auditing
The original version was published in 1977 and last updated in 2001
The current 2007 edition:
Includes modifications required to incorporate the latest PRMS

Although it remains concerned with Reserves only at present

Clarifies the terms auditors and auditing, as well as process review

Acknowledges the integration of geoscience with engineering in the preparation
of reliable reserves information

Companies may require their internal or external Reserves Estimators and

Auditors to comply with these standards

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Part I:

Reserve Audit
Fundamentals

Prepared for GCAs clients, July 2007

Project No. D105

Reserves Audit - 1

A Reserves Audit is the process of reviewing certain of the pertinent facts

interpreted and assumptions made that have resulted in an estimate of
reserves and/or Reserves Information prepared by others and the rendering
of an opinion about:
the appropriateness of the methodologies employed
the adequacy and quality of the data relied upon
the depth and thoroughness of the reserves estimation process
the classification of reserves appropriate to the relevant definitions used
the reasonableness of the estimated reserves quantities and/or the Reserves
Information
The term reasonableness cannot be defined with precision but should
reflect a quantity and/or value difference of not more than plus or minus 10%,
or the subject Reserves Information does not meet minimum recommended
audit standards
This tolerance can be applied to any level of reserves or Reserves Information
aggregation, depending upon the nature of the assignment, but is most often
limited to Proved Reserves Information
A separate predetermined and disclosed tolerance may be appropriate for
other reserves classifications
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Reserves Audit - 2

Often a reserves audit includes a detailed review of certain critical

assumptions and independent assessments with acceptance of other
information less critical to the reserves estimation
A reserves audit should be of sufficient rigor to determine the appropriate
reserves classification for all reserves in the property set evaluated and to
clearly state the reserves classification system being utilized
In some cases, the auditing procedure may require independent estimates of
Reserves Information for some or all properties

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Process Review

A Process Review is the result of an investigation by a person who is

qualified by experience and training equivalent to that of a Reserves Auditor
to address the adequacy and effectiveness of an entitys internal processes
and controls relative to reserves estimation
These internal processes and controls most often include some form of an
independent internal or external reserves audit system
The Process Review should not include an opinion relative to the
reasonableness of the reserves quantities or Reserves Information and
should be limited to the process and control system reviewed
The term process review includes reports that have also been termed
procedural audits or procedural reviews in the industry
Although such reviews may provide value to the entity, an external or internal
Process Review is not of sufficient rigor to establish appropriate
classifications and quantities of reserves and should not be represented to
the public as being equivalent to an audit of reserves

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Audit Methodology

The following list is intended to establish broad requirements for the conduct of a
reserves or resources audit
A more comprehensive data list is available separately

The fundamental methodology for an audit is that the company prepares the estimates
and that audit checks them
Therefore every number presented by the company must be traceable and supported by
documented analysis

All work to be carried out consistent with the specific definitions and guidelines
Whether they are regulatory (e.g. SEC) or industry (e.g. SPE PRMS)

Use the appropriate evaluation methodologies

And compare with more than one approach

Be consistent across assets

Maintain a thorough audit trail

And always exercise informed professional judgment

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Audit / Documentation Check List 1

1)

Development plan* in place and approved internal, partner(s), government

2)

Funding commitment

3)

Market and/or production constraints

4)

Methodology used - deterministic, probabilistic or scenario

5)

Assessment method - volumetric or performance based / primary &

secondary

6)

Proved area/volume tests applied

Vertical (LKH) illustrate with logs, pressure plots and cross sections

Lateral illustrate with maps

7)

Reservoir drive - document assumptions and role of analogs

8)

Producibility - evidence from well tests or other data

* Documentation should relate to specific project and decision to invest

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Audit / Documentation Check List 2

9)

License expiry

Typically, no reserve recognition outside current license term, unless specific

legal rights to extend (or precedence) exist

10)

11)

Improved Recovery increment issues

Describe method to be used

Successful pilot, actual implementation, commercial use in the area

Royalty treatment

Volumes taken in kind not included in Reserves

Royalty paid in cash:

Excluded; or

If included as Reserves, royalty treated as cost in economic limit test

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Audit / Documentation Check List 3

12)

Net Interest - economic interest or working interest?

13)

Flare & Fuel

14)

Economic limit test

Annual production forecast

Defined costs and prices

15)

"as of assessment date for SEC

License expiry/quota issues incorporated

Abandonment cost accruals incorporated

Developed/Undeveloped split

Developed includes behind pipe or other volumes requiring capital investment,

at a minority fraction (say 10% - 20%) of a new well cost

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Part II:

Reserve and Resources

definitions PRMS 2007

Prepared for GCAs clients, July 2007

Project No. D105

Resources Classification

Reserves
Discovered, recoverable, commercial,
remaining
Proved, Probable, Possible
1P, 2P, 3P (now formalized)
Contingent Resources
Discovered, potentially recoverable,
not yet commercial, remaining
1C, 2C, 3C (new terms)

Classification

Equivalent to Low, Best and High

Estimates

Prospective Resources
Undiscovered, potentially
recoverable, potentially commercial,
remaining
Low, Best and High Estimates
Unrecoverable
Discovered or undiscovered, not
recoverable

Categorization
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Discovery Status

A discovery is one petroleum accumulation, or several petroleum

accumulations collectively, for which one or several exploratory wells have
established through testing, sampling, and/or logging the existence of a
significant quantity of potentially moveable hydrocarbons
The PRMS intentionally does not require a flow test in order to establish a
discovery
In some instances it may nevertheless be considered that logging alone would
not be considered sufficient to identify a discovery since some indication of fluid
type and producibility will normally be required to comply with the following
requirement:
In this context, significant implies that there is evidence of a sufficient
quantity of petroleum to justify estimating the in-place volume demonstrated
by the well(s) and for evaluating the potential for economic recovery

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Determination of Commerciality

Discovered recoverable volumes (Contingent Resources) may be considered

commercially producible, and thus Reserves, if the entity claiming
commerciality has demonstrated firm intention to proceed with development
and such intention is based upon all of the following criteria:
Evidence to support a reasonable timetable for development
A reasonable assessment of the future economics of such development
projects meeting defined investment and operating criteria
A reasonable expectation that there will be a market for all or at least the
expected sales quantities of production required to justify development
Evidence that the necessary production and transportation facilities are
available or can be made available
Evidence that legal, contractual, environmental and other social and economic
concerns will allow for the actual implementation of the recovery project being
evaluated
With some minor differences, these criteria were typically applied to Proved
reserves under prior guidelines
Distinction between economic and commercial
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Economics and ELT

While each organization may define specific investment criteria, a project is

generally considered to be economic if its best estimate case has a
positive net present value under the organizations standard discount rate, or
if at least has a positive undiscounted cash flow
Economic limit is defined as the production rate beyond which the net
operating cash flows from a project, which may be an individual well, lease,
or entire field, are negative, a point in time that defines the projects
economic life
Operating costs should ... exclude depreciation, abandonment and
reclamation costs, and income tax, as well as any overhead above that
required to operate the subject property itself
Operating costs may be reduced, and thus project life extended, by various
cost-reduction and revenue-enhancement approaches, such as sharing of
production facilities, pooling maintenance contracts, or marketing of
associated non-hydrocarbons

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Project-Based Classification

The Reservoir assessment determines the petroleum initially in place, and fluid and
rock properties that affect petroleum recovery
The Project is applied to a specific reservoir volume to generate production and cash
flow schedule
One project may develop many reservoirs or many projects may develop one reservoir
The Property incorporates contractual rights and obligations, and fiscal terms, defining
the entitlement share of investments, production and revenue
One property may encompass many reservoirs or one reservoir may span many
properties

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Project Maturity - Reserves

On Production
The development project is currently
producing and selling petroleum to
market
Approved for Development
All necessary approvals have been
obtained, capital funds have been
committed, and implementation of the
development project is under way
Justified for Development
Implementation of the development
project is justified on the basis of
reasonable forecast commercial
conditions at the time of reporting,
and there are reasonable
expectations that all necessary
approvals/contracts will be obtained

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Project Maturity Contingent Resources

Development Pending
A discovered accumulation where
project activities are ongoing to justify
commercial development in the
foreseeable future
Development Unclarified or on Hold
A discovered accumulation where
project activities are on hold and/or
where justification as a commercial
development may be subject to
significant delay
Development Not Viable
A discovered accumulation for which
there are no current plans to develop
or to acquire additional data at the
time due to limited production
potential

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Project Maturity Prospective Resources

Prospect
A project associated with a potential
accumulation that is sufficiently well
defined to represent a viable drilling
target
Lead
A project associated with a potential
accumulation that is currently poorly
defined and requires more data
acquisition and/or evaluation in order
to be classified as a prospect
Play
A project associated with a
prospective trend of potential
prospects, but which requires more
data acquisition and/or evaluation in
order to define specific leads or
prospects

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Project Maturity Linked to Decision Gates

(can be quantified if desired)

Chance of commerciality

Chance of discovery

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Volume Categorization

The PRMS recognizes three distinct

approaches to volume categorization
Deterministic incremental (risk-based)

Deterministic scenario (cumulative)

1P, 2P, 3P
1C, 2C, 3C
Low, Best, High Estimates

Probabilistic

Proved, Probable, Possible

There are no incremental categories for
CR or PR, so by inference this is expected
to be applied to Reserves only

P90, P50, P10

The PRMS notes these approaches in the

order given above
Although the probabilistic method may be
applied to any volume, it is also indicated
that this is most often applied to volumetric
calculations in the early phases of an
exploitation and development project
And although not mentioned, it is also
typically applicable for Prospective
Resources
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Proved Reserves Comparison

SPE/WPC 1997

SPE PRMS 2007

Proved reserves are those

quantities of petroleum which, by
analysis of geological and
engineering data, can be
estimated with reasonable
certainty to be commercially
recoverable, from a given date
forward, from known reservoirs
and under current economic
conditions, operating methods,
and government regulations

Proved Reserves are those

quantities of petroleum, which by
analysis of geoscience and
engineering data, can be
estimated with reasonable
certainty to be commercially
recoverable, from a given date
forward, from known reservoirs
and under defined economic
conditions, operating methods,
and government regulations

If deterministic methods are

used, the term reasonable
certainty is intended to express a
high degree of confidence that
the quantities will be recovered
If probabilistic methods are
used, there should be at least a
90% probability that the
quantities actually recovered will
equal or exceed the estimate

If deterministic methods are

used, the term reasonable
certainty is intended to express a
high degree of confidence that
the quantities will be recovered
If probabilistic methods are
used, there should be at least a
90% probability that the
quantities actually recovered will
equal or exceed the estimate

Comments
Very similar definitions, with the
key difference being the use of
defined economic conditions
Still requires reasonable
certainty

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Probable Reserves Comparison

SPE/WPC 1997

SPE PRMS 2007

Probable reserves are those

unproved reserves which
analysis of geological and
engineering data suggests are
more likely than not to be
recoverable

Probable Reserves are those

additional Reserves which
analysis of geoscience and
engineering data indicate are
less likely to be recovered than
Proved Reserves but more
certain to be recovered than
Possible Reserves.
It is equally likely that actual
remaining quantities recovered
will be greater than or less than
the sum of the estimated Proved
plus Probable Reserves (2P)

In this context, when

probabilistic methods are used,
there should be at least a 50%
probability that the quantities
actually recovered will equal or
exceed the sum of estimated
proved plus probable reserves

In this context, when

probabilistic methods are used,
there should be at least a 50%
probability that the actual
quantities recovered will equal or
exceed the 2P estimate

Comments
Removed mathematical
inconsistency in the definitions
of Probable and 2P

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Possible Reserves Comparison

SPE/WPC 1997

SPE PRMS 2007

Possible reserves are those

unproved reserves which
analysis of geological and
engineering data suggests are
less likely to be recoverable than
probable reserves

Possible Reserves are those

additional reserves which
analysis of geoscience and
engineering data indicate are
less likely to be recoverable than
Probable Reserves

In this context, when

probabilistic methods are used,
there should be at least a 10%
probability that the quantities
actually recovered will equal or
exceed the sum of estimated
proved plus probable plus
possible reserves

Comments
Essentially identical definitions

The total quantities ultimately

recovered from the project have
a low probability to exceed the
sum of Proved plus Probable
plus Possible (3P), which is
equivalent to the high estimate
scenario
When probabilistic methods are
used, there should be at least a
10% probability that the actual
quantities recovered will equal or
exceed the 3P estimate

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Contingent Resources Comparison

SPE/WPC/AAPG 2000

SPE PRMS 2007

Contingent Resources are those

quantities of petroleum which
are estimated, on a given date, to
be potentially recoverable from
known accumulations, but which
are not currently considered to
be commercially recoverable

Contingent Resources are those

quantities of petroleum
estimated, as of a given date, to
be potentially recoverable from
known accumulations, but the
applied project(s) are not yet
considered mature enough for
commercial development due to
one or more contingencies

Comments
Essentially identical definitions

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Prospective Resources Comparison

SPE/WPC/AAPG 2000

SPE PRMS 2007

Prospective Resources are those

quantities of petroleum which
are estimated, on a given date, to
be potentially recoverable from
undiscovered accumulations

Prospective Resources are those

quantities of petroleum
estimated, as of a given date, to
be potentially recoverable from
undiscovered accumulations by
application of future
development projects

Comments
Essentially identical definitions

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Some Important Observations

Brief observations on the following topics will be made

Economics
Project Financing
Aggregation
Best Estimate
Transition from CR to Reserves
Lease Fuel
Risk Service Agreements
Contract Extension
Developed and Undeveloped

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Economics

The economic evaluation underlying the investment decision is based on

the entitys reasonable forecast of future conditions, including costs and
prices, which will exist during the life of the project (forecast case)
Such forecasts are based on projected changes to current conditions
SPE defines current conditions as the average of those existing during the
previous 12 months
Alternative economic scenarios are considered in the decision process and,
in some cases, to supplement reporting requirements
Evaluators may examine a case in which current conditions are held constant
(no inflation or deflation) throughout the project life (constant case)
Companies (and consultants) need to define a consistent set of forecast
case parameters such as oil and gas prices (and differentials), cost inflation,
perhaps exchange rates, and discount rates to be used for reserve evaluation
purposes
Companies reporting to the SEC will of course continue to use constant prices
and cost cases as of the reporting date
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Project Financing

While SPE guidelines do not require that project financing be confirmed

prior to classifying projects as Reserves, this may be another external
requirement
In many cases, loans are conditional upon the same criteria as above; that is,
the project must be economic based on Proved Reserves only
In general, if there is not a reasonable expectation that loans or other forms
of financing (e.g., farm-outs) can be arranged such that the development will
be initiated within a reasonable timeframe, then the project should be
classified as Contingent Resources
If financing is reasonably expected but not yet confirmed, the project may be
classified as Reserves, but no Proved Reserves may be reported as above

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Aggregation

Petroleum quantities classified as Reserves, Contingent Resources, or

Prospective Resources should not be aggregated with each other without
due consideration of the significant differences in the criteria associated with
their classification [emphasis added]
In particular, there may be a significant risk that accumulations containing
Contingent Resources and/or Prospective Resources will not achieve
commercial production
GCA does not believe that it is appropriate to report the aggregation of
different resource classes (such as Prospective or Contingent Resources
with Reserves) under any circumstances
Such classes should always be reported separately, with no totaling between
classes
Also, unless undertaken as part of an integrated portfolio analysis
incorporating chance of success, Prospective Resources for individual
prospects should not be aggregated

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Best Estimate

The best estimate ... is generally considered to represent the sum of Proved
and Probable estimates (2P) when using the deterministic scenario or the
probabilistic assessment methods
It should be noted that under the deterministic incremental (risk-based)
approach, discrete estimates are made for each category, and they should not
be aggregated without due consideration of their associated risk.
GCA concurs that generally the best estimate is represented by the most
likely case (termed 2P or P50 by definition), if such as been evaluated
However, there are other circumstances to consider:
Using the deterministic incremental approach, it is not necessarily the case
that the sum of Proved plus Probable will necessarily represent the best
estimate
It is therefore recommended that reports include the individual reserves
categories and not their aggregation
The best estimate of a well-established decline curve may actually be
representative of Proved reserves, rather than 2P
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Transition from CR to Reserves

Without new technical information, there should be no change in the

distribution of technically recoverable volumes and their categorization
boundaries when conditions are satisfied sufficiently to reclassify a project
from Contingent Resources to Reserves

This implies that 1C becomes 1P, 2C becomes 2P, and 3C becomes 3P

While in principle this is reasonable, there are two implications, especially for
the Low Estimate:
If this were to apply in all cases, the 1C estimate would have to be made
including all constraints (other than commercial ones) that apply for Proved
reserves, such as complying with LKH
Alternatively, if the 1C estimate did not comply with the Proved volume
constraints, it would need to be revised before moving to Proved

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Lease Fuel

For consistency, lease fuel should be treated as shrinkage and is not

included in sales quantities or resource estimates
However, some regulatory guidelines may allow lease fuel to be included in
Reserves estimates where it replaces alternative sources of fuel and/or power
that would be purchased in their absence
Where claimed as Reserves, such fuel quantities should be reported
separately from sales, and their value must be included as an operating
expense
Flared gas and oil and other losses are always treated as shrinkage and are
not included in either product sales or Reserves
The recommendation is therefore to exclude fuel from Reserves
However, it is not clear why the value should be included as an operating
expense, as long as the value is not included in sales
There is no cost associated with this volume

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Risked-Service Agreements

Risked-Service Contracts (RSCs) are similar to PSCs, but in this case, the
producers are paid in cash rather than in production
As with PSCs, the Reserves claimed are based on the parties net economic
interest
The requirement is therefore to assess net volumes based on net economic
interest (entitlement), rather than working interest, which some companies
have used

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Contract Extension

Reserves should not be claimed for those volumes that will be produced beyond the
ending date of the current agreement unless there is reasonable expectation that an
extension, a renewal, or a new contract will be granted
Such reasonable expectation may be based on the historical treatment of similar
agreements by the license-issuing jurisdiction
Otherwise, forecast production beyond the contract term should be classified as
Contingent Resources with an associated reduced chance of commercialization
Moreover, it may not be reasonable to assume that the fiscal terms in a negotiated
extension will be similar to existing terms
Similar logic should be applied where gas sales agreements are required to ensure
adequate markets
Reserves should not be claimed for those quantities that will be produced beyond those
specified in the current agreement or reasonably forecast to be included in future
agreements
In either of the above cases, where the risk of cessation of rights to produce or inability
to secure gas contracts is not considered significant, evaluators may choose to
incorporate the uncertainty by categorizing quantities to be recovered beyond the
current contract as Probable or Possible Reserves
It is important to keep in mind that the requirement for reporting of Proved reserves is
still one of reasonable certainty, so if that condition is not met, then no Proved
Reserves can be reported after the termination of the contract term
If the reasonable expectation criterion can be met, then Probable and/or Possible
Reserves can be assigned
Consideration applies to terms as well as will it happen?
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Developed and Undeveloped Reserves

Reserves ... may be allocated to the following subdivisions based on the

funding and operational status of wells and associated facilities within the
reservoir development plan
Developed Reserves are expected quantities to be recovered from existing
wells and facilities
Undeveloped Reserves are quantities expected to be recovered through future
investments

Thus these subdivisions are applied to all Reserves categories, not just
Proved

Regarding the distinction between PDNP and PUD, the PRMS says:
Undeveloped Reserves [are] ... where a relatively large expenditure (e.g. when
compared to the cost of drilling a new well) is required to (a) recomplete an
existing well or (b) install production or transportation facilities for primary or
improved recovery projects
This is useful, but there is no quantitative guidance given

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Unconventional Resources

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Conclusions

The PRMS is a major contribution to international oil and gas resources

management and one that many companies will adopt
There is clear recognition of the different ways that reserves and resources
can be estimated and these are all embraced within the system
Certain changes in procedures will probably be required to ensure that the
differences with the prior definitions are recognized and incorporated into
resource reporting
Nothing will change with respect to reporting Proved reserves to the SEC
Contingent Resources should become better understood and more
acceptable as a valid resource category and not just not reserves
The revised Standards document should remain a valuable guidebook in
the practical and ethical application of reserves estimation and auditing
procedures

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Reserve Audit Process

using SPE Petroleum Resources
Management System (PRMS)

Prepared for GCA Clients, July 2007

Project No. D105