Musings: How to Question Reserve Reports Without Any Knowledge

Musings: How to Question Reserve Reports Without Any Knowledge

In what now seems like the distant past, The New York Times wrote a series of articles suggesting that industry practitioners were raising questions about the economic performance of the gas shale wells and thus whether the extent of the resource was over stated.  Those articles were written in late June and generated a firestorm of reaction within the natural gas industry, but also among Washington politicians. What followed was disclosure that a handful of E&P companies, active in the gas shale business, had received subpoenas from the Securities and Exchange Commission (SEC) for their records of well performance and the economics of behind their reserve calculations. The data was sought to compare with the companies' disclosure regulatory filings and investor presentations of the operational risks, production performance and economics of these gas shale wells. At the time the subpoenas were disclosed, we wrote about it in the Musings (last July), fully anticipating that there would be further disclosures. Since mid-summer, there has been no activity arising from the subpoenas. 

What followed was disclosure that a handful of E&P companies, active in the gas shale business, had received subpoenas from the SEC for their records of well performance and the economics of behind their reserve calculations

Our interest was piqued recently when we received a newsletter from an energy investment group we belong to that contained an employment ad for a petroleum engineer position with the SEC in Washington. We sent an email to the SEC requesting additional information about the opportunity, not that we were going to apply. Rather, we were intrigued by the idea that the SEC has launched an investigation into gas shale reserves, well productivity and well economics and then is seeking to hire a petroleum engineer. We wondered whether this position was to bolster a staff of petroleum engineers or was it a new position.

We received the usual email response – We have received your email request and someone from the SEC will respond in the next 24-48 hours. It wasn't until about four days later that we received a phone call from someone with the SEC. Unfortunately, we were unable to answer the phone so the caller left a voice message. The caller suggested that he had no idea whether the SEC employed any petroleum engineers and had no way of finding out. He suggested that we should contact the Fort Worth SEC office as that would seem to be the most likely office to employ such an individual. We did speak with the SEC official and ascertained that he had no idea what a petroleum engineer was, let alone whether the SEC employed any, and again received the suggestion to call the Fort Worth office.

She told us that the Fort Worth office employed one petroleum engineer who had been hired earlier this year

We called the Fort Worth office and spoke with a lady there and asked whether the SEC had any petroleum engineers on its staff.  She told us that the Fort Worth office employed one petroleum engineer who had been hired earlier this year. The SEC has 4,000 employees. That means if they hire another one in response to the Washington, D. C. office advertisement, the SEC will have a 100% increase in its technical talent for dealing with petroleum industry issues. Whether the new petroleum engineer position is a result of the proposed SEC study of gas shale disclosures we don't know, but we find it strange that they would inquire about technical information without having someone on the staff that could help frame the questions and review and interpret the data provided in response. 

What we haven't done is check on whether New York State, which issued subpoenas to three E&P companies and a data request to a fourth, as reported by the law firm of Andrews Kurth in an early September alert to clients, has any petroleum engineers on its staff.  The alert stated, "According to the published reports, the subpoenas seek information as to whether the companies have accurately disclosed the estimated commercial life of shale gas wells, the prospects for their natural gas wells and reserve estimates. The companies that received the subpoenas were reportedly selected because New York State pensions have more than $45 million invested in those companies and if the energy company disclosures are inaccurate New York State could lose some of its investment; they were not selected solely based on their operations in New York." If we had to guess, we believe New York doesn't employ petroleum engineers. They may hire some as consultants. Of course, the SEC can hire petroleum engineering consultants, also, but most likely not the prominent industry firms who would have conflicts of interest because they help E&P companies with their public documents filed with the SEC and state regulators.

Mr. Markopolos wrote a book in which he documented his investigation and dealings with the SEC that failed to understand the scheme despite the documentation or lacked the interest in pursuing an investigation

All of this brings us back to Harry Markopolos. For those who don't know of Mr. Markopolos, he was the financial fraud investigator who uncovered the Ponzi Scheme operated by Bernie Madoff. Mr. Markopolos began his investigation of the Madoff fund in 1999 and made multiple submissions of complaints to the SEC in Boston and New York providing documentation and information pointing to red flags demonstrating the existence of the scheme. Mr. Markopolos wrote a book, No One Would Listen: A True Financial Thriller, in which he documented his investigation and dealings with the SEC that failed to understand the scheme despite the documentation or lacked the interest in pursuing an investigation. Increasingly, the SEC has demonstrated that its staff is behind the financial industry in understanding new, sophisticated investment schemes and derivative securities. Lacking petroleum specialists, the SEC is probably behind on the disclosure of gas shales, too. We can only hope that their move to hire one or more petroleum engineers will enable the agency to better understand the technical aspects of E&P reserve calculations and well economics contained in the regulatory filings required of public companies and in their investor presentations. With a petroleum engineer or two, possibly the SEC will avoid another Bernie Madoff embarrassment.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.

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