Shale Loses 9 Billion Barrels of Reserves After SEC Inquiries

(Bloomberg) -- Ultra Petroleum Corp. was a shale success story. A former penny stock that made the big leagues, it was worth almost $15 billion at its 2012 peak.

Then came the bust. Almost half of Ultra’s reserves were erased from its books this year. The company filed for bankruptcy on April 29 owing $3.9 billion.

Ultra’s rise and fall isn’t unique. Proven reserves -- gas and oil resources that are among the best measures of a company’s ability to reward its shareholders and repay its debts -- are disappearing across the shale patch. This year, 59 U.S. oil and gas companies deleted the equivalent of 9.2 billion barrels, more than 20 percent of their inventories, according to data compiled by Bloomberg. It’s by far the largest amount since 2009, when the Securities and Exchange Commission tweaked a rule to make it easier for producers to claim wells that wouldn’t be drilled for years.

Wider Effort

The SEC routinely questions companies about their reserves. Now, agency investigators are also on the hunt for inflated reserves estimates, according to a person familiar with the matter.

“Reserves make up a large share of the value of these companies, so it really matters,” said David Woodcock, a partner at Jones Day in Dallas who served as the SEC regional director in Fort Worth, Texas, from 2011 to 2015. “They’re looking even more closely at how companies are booking reserves, how they’re evaluating the quality of those reserves and what their intentions really are. They’re not accepting pat answers.”

For more on proved reserves, click here.

Drillers face pressure to keep reserves growing. For many, the size of their credit line is tied to the measure. Investors want to see that a company can replace the oil and gas that’s been pumped from the ground and sold.

Find More

There are two ways to increase reserves: buy more or find more. Fracking made it easier to do the latter, and the industry lobbied the SEC to count more undeveloped acreage as proved reserves, arguing that shale prospects are predictable across wide expanses.

The SEC agreed, with two key limits. First, the wells must be profitable to drill at a price set by an SEC formula. The companies got a temporary reprieve for 2014 because the SEC number was about $95 a barrel even though crude had plummeted to less than $50 by the time results were reported in early 2015. 

That advantage has disappeared. When companies reported their 2015 reserves this year, the SEC price was about $50. Wells that vanished this year may return if prices rise.

The SEC also requires that undeveloped wells be drilled within five years of being added to a company’s books. The five-year plan can’t just be wishful thinking. “The mere intent to develop, without more, does not constitute ‘adoption’ of a development plan,” the SEC explained in 2009.

Despite those limitations, reserves surged 67 percent in the five years after the 2009 rule change, according to 53 companies that have records going back that far. Almost half the gains came from wells that existed only on paper.

Fix Estimates

By the end of 2014, undeveloped properties accounted for 39 percent of proved oil and gas reserves, up from 33 percent at the end of 2009, an increase of nearly 8 billion barrels. 

In its first letter to Ultra, in July 2014, the SEC said it would take about 13 years for the company to drill its backlog. About two months later, Ultra raised $850 million in debt. The SEC letters weren’t yet public. Over the next 19 months, the regulator twice told the company to revise its estimates.


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R.J. Spoley  |  June 16, 2016
All the hubbub is about reserves and the dollars they represent either in finding costs, cash flow or collateral to back debt. It all hinges on reserves that are real and actually producible. The best way to evaluate reserves is to understand the reservoir containing them and the trapping mechanism. The reservoirs in every case are very fine grained, shale with very low porosities, very high water saturations, extremely low permeability and are extensive in area. Most contain far more gas than liquid oil and the oil is usually condensate of 50 degrees or better API. Recovery factors are rarely more than a few percent of the hydrocarbons in place. The trapping mechanisms are usually not described in geologic or engineering terms. I think I know what the trapping mechanism is and something about the reserves that can be captured. The trapping mechanism is relative permeability. Once this is fully understood in the engineering sense the reserve picture comes into focus. Relative permeability is the permeability of the wetting fluid relative to the non-wetting fluid. As the perm of one goes up, the other goes down. The breaking point is usually about 30%. Thus with 70% water saturation, there is little or no permeability to hydrocarbons and they are trapped by the water saturation. In fine grained shale rocks, water is tightly held by flat shale minerals with very small spaces between them making the water immovable. Production is obtained by fracking and enlarging the intra-granular spaces and de-watering the formation. This changes the relative permeability by lowering the water saturation and allowing permeability to the non-wetting fluids to increase and results in production. Reservoir energy is provided by the over-compressed gas created by the fracking process. Since liquids and solids are non-compressible, the only thing that can be compressed is the gas. As the gas is depleted, reservoir energy is also depleted and the relative permeability swings back to a higher water saturation. This explains the very steep decline curves of all these kinds of traps. High porosity reservoirs lost their hydrocarbons early in their life as permeability to the non-wetting fluids was high enough to allow for migration into standard traps. Reserves that can be captured are a function of what was initially in place (porosity and water saturation), reservoir energy and relative permeability. Porosities and permeability were low to start with while water saturations were very high. Technology changes those parameters for a short time but can not change the volume of non-wetting fluids initially in place. Those volumes steadily decrease during production thus raising water saturations resulting in lower to perm to O&G. As I understand it, most of the reservoirs in these plays have porosities of less than 7% and water saturations greater than 85% leaving very little room for hydrocarbons. The fact that these formations have high shale content with large surface areas relative to their volumes means that they cant really be effectively be de-watered. All this results in low recovery factors of probably less than 10% of the in place non-wetting fluids. The net result in all this, is that good wells with high reserves and long lives are a pipe dream. When compared to dollars to accomplish the inevitable results, especially with an overproduced commodity, this looks like a Ponzi Scheme to me.

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