Anadarko CEO Describes Best Practice for Estimating Reserves

"Oil and natural gas reserves are the most important asset of an exploration and production company and long overdue discussions on this topic are finally occurring," said Anadarko Petroleum Corporation (NYSE:APC) President and CEO Jim Hackett at today's Howard Weil Energy Conference in New Orleans.

"However, we need to look beyond the current fevered pitch that is focused primarily on third-party engineering by placing the majority of our attention and debate on the more important aspects of internal reserve estimation processes which are management integrity, external track records of reserve performance, and the public disclosures of the companies in which we all invest," Hackett said.

"There is no cookie-cutter, one size fits all model the industry can use when it comes to measuring a resource that you can't see or touch," Hackett said. "So, investors should consider a number of factors such as the technical tension in a company's internal review process, the diversity of its properties, its track record of production and reserve adds or revisions, and how clearly management retains the responsibility and accountability for reserves estimates."

Anadarko has 2.5 billion barrels of oil equivalent (BOE) in proved reserves. Its non-price-related revisions over the past decade have averaged a positive 0.2 percent of estimated reserves.

The company relies on an internal staff of more than 150 highly skilled engineers and geoscientists to review every well in every field, every year so its risk of performance surprises are greatly reduced. It also has a very diverse set of properties with its largest field representing only 7 percent of total proved reserves.

Significant reserve additions and changes are reviewed by a five-member formal corporate Reserve Review Team that includes Anadarko's chief engineer, chief geologist, manager of corporate reserves and economics, and a senior engineer. The fifth person on the team is a senior vice president from the petroleum consulting firm, Netherland, Sewell & Associates Inc. (NSA).

Anadarko hired NSA at the beginning of 2003 to review the processes and procedures by which the company estimates reserves. As part of that process, NSA reviewed about 70 percent of the company's 2003 reserve additions, as well as about half of Anadarko's existing reserve base. NSA's letter of confidence was filed with the company's fourth-quarter earnings on Jan. 30 and was included as part of its 2003 Annual Report on Form 10-K.

"We've heard a lot of discussion in the market recently regarding the benefits of an outside audit versus an outside review. Both help validate the processes and procedures used to arrive at estimates," Hackett explained. "Anadarko has used both concepts throughout its history, and neither system is perfect. The largest negative revisions we've had in the past have been on audited reserves, as have some of the more notable revisions announced by other companies in the recent past.

"At the end of the day, the U.S. Securities and Exchange Commission, and Anadarko's investors, are going to hold Anadarko accountable for our reserve estimates -- not an outside consulting firm. We have a comprehensive understanding of our properties and utilize a vigorous process with the right intellectual capital working on our reserve estimates. Because of these combined factors, we have considerable confidence in our numbers," Hackett added.

Anadarko has continued to expand disclosure and transparency around oil and gas reserves reporting to give investors a clear picture of the value of the estimated reserve base. The company's 2003 Form 10-K includes disclosure of the "vintage," or age, of its estimated proved undeveloped reserves, known as PUDs.

"We believe Anadarko's disclosures will provide a model for investors to use in asking for similar information from the other companies in which they invest," he said. "For our company, this annual vintaging process gives us the ability to monitor the conversion rate of PUDs into proved developed reserves, manage the investment plans for economically developing those reserves and ensure compliance with SEC guidelines. We pay particular attention to the older PUDs, specifically those three years old and older, to confirm we still have a current plan of development. More than 90 percent of our PUDs that were booked in 2003 are in North America, and we typically convert those to developed reserves within 18 to 24 months. Longer-term projects such as improved oil recovery, arctic Alaska satellite tie-ins, deepwater development and selected international programs may take longer than two years, but the vintaging and additional 10-K disclosures help point our investors to the future capital costs and timing of those projects, while ensuring that economic development plans are in place," Hackett added.

"Everyone knows that not all reserves are created equal. How long PUDs stay on the books, where they're located, their infrastructure requirements, and their production-cost and sales-pricing structures all have important implications for the current value of those booked reserves.

"Another quick test for investors is to look at a company's history of production growth relative to reserves growth, including PUDs. They will rarely match up exactly for any given time period, but they ought to be close to ensure that the booked reserves are not just staying on the books forever but are actually being produced. Anadarko has an excellent track record in this regard over an extended period of time."

The company has implemented several new controls to further strengthen its estimation process. This year, the Audit Committee of Anadarko's Board of Directors was given oversight of the company's proved reserve estimates. The Audit Committee chair has spent his career in the petroleum industry and since 1976 has served as chairman of a reservoir engineering company. In May, we will be asking the Audit Committee to hire the external reserve engineer just as they hire the independent external financial auditor each year. To enhance the objectivity of the internal reserve review process, the company is also removing the employees who serve on the internal corporate Reserve Review Team from any portion of the incentive bonus plan that is specifically related to reserves bookings.

"The reserve estimation and reserve quality issues are not going away, nor should they, since we're talking about the most significant portion of a company's valuation. Anadarko is committed to being at the forefront of best-practice adoption in reserve estimation, and we will continue to improve our practices as new ideas are tested," Hackett concluded.