In principle, investors should be able to look to SEC filings for reliable information on publicly traded companies. As Bloomberg reports however, the commission’s rules on how drillers are required to value their reserves is effectively forcing companies to overstate the value of their O&G businesses by nearly two-thirds.
The U.S. Securities and Exchange Commission requires drillers to calculate the value of their oil reserves every year using average prices from the first trading days in each of the previous 12 months. Because oil didn’t start its freefall to about $45 till after the OPEC meeting in late November, companies in their latest regulatory filings used $95 a barrel to figure out how much oil they could profitably produce and what it’s worth. Of the 12 days that went into the fourth-quarter average, crude was above $90 a barrel on 10 of them.
Continental Resources (who reminded Bloomberg that it’s “just following the rules like everyone else”), reported the following data on proved reserves early last month:
PDP reserves increased 21% from year-end 2013 to 490 MMBoe at December 31, 2014. The Company had 2,994 gross (1,565 net) proved undeveloped (PUD) locations at year-end 2014. The Bakken accounted for 82% of PUD locations at year-end. Continental's year-end 2014 proved reserves had a net present value discounted at 10% (PV-10) of $22.8 billion, a 13% increase over PV-10 of $20.2 billion for year-end 2013 proved reserves.
As it turns out, the PV of the company’s proved reserves using current depressed oil prices is nearly $9 billion less, as outlined in the company’s 10-K:
Commodity prices have decreased significantly in recent months. Holding all other factors constant, if commodity prices used in our year-end reserve estimates were decreased by $40.00 per Bbl for crude oil and $1.00 per Mcf for natural gas, thereby approximating the pricing environment existing in February 2015, our PV-10 at December 31, 2014 could decrease by approximately $13.8 billion, or 61%.
For its annual report, Continental used a price of $94.99/Bbl to estimate its proved reserves and noted that for every $10 decrease in the price of crude, PV-10 drops by a whopping $3.2 billion.
Of course this backward looking accounting only compounds the problem investors face when attempting to value shale companies. As we’ve noted previously, the industry runs what is effectively a two-tiered bookkeeping system whereby companies can, with impunity, inflate the value of their reserves in order to lure investors while reporting a far lower figure to the SEC.
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The key takeaways here are: 1) when Q1 results start to roll in for E&P companies, we should expect to see massive writedowns across the board as industry balance sheets will no longer benefit from calculating PV-10 based on prices the market hasn’t seen in months, and 2) investors face a virtually insurmountable task when it comes to evaluating E&P companies as management is allowed to make up its own figures in investor presentations while the SEC mandates the use of months’ old prices for the purposes of calculating future cash flow. Fortunately, the SEC is on top of it.
There are no current plans to revisit or modify SEC reporting rules, Erin Stattel, an SEC spokeswoman, said in an e-mail. She declined to comment further.