SEC Final Rule

April 2018 | Posted in Energy, Whitley Penn
Energy, Whitley Penn

SEC Final Rule:  The SEC’s Final Word on Valuing Oil and Gas Reserves?

Looking back on the roller coaster ride that was oil and gas prices in 2015 and 2016, we need to take note of the effects of major price fluctuations of crude oil have on financial disclosures.  Additionally, we as accountants should review guidance and make sure that the disclosure requirements are substantial enough to promote comparability and not mislead investors in the valuation of oil and gas reserves.

The SEC’s “Final Rule” related to the valuation of oil and gas reserves is aimed at creating a uniform valuation metric to increase comparability of oil and gas financial statement disclosures.  “In calculating economic production, a company must use a 12-month average price, calculated as the unweighted arithmetic average of the first-day-of-the-month price for each month within the 12-month period prior to the end of the reporting period, unless prices are defined by contractual arrangements.”

As Jeff Edwards noted in his blog on oil pricing looking forward into 2018, oil used to be more predictable.  Since OPEC’s decision to not cut production in late 2014, prices have become much more volatile.  This 2014 drop in oil prices provides us with a great case study to see how the SEC’s Final Rule works in times of increased volatility.

The SEC requires reserves to be valued using the twelve month average beginning of month price of WTI, which in 2014 was $94.42.  This is due to oil hovering around $100 a barrel for most of the year.  However, 2014 was unique in that as of December 31, 2014, the price of oil was $53.27, almost half of what had been for most of the year!  As a result, most oil and gas reserve disclosures were grossly inflated in a manner that most accountants would agree is not reflective of the underlying market.  Using the (New York Mercantile Exchange) NYMEX strip futures pricing (a common benchmark to use for impairment calculations) at the end of 2014, oil reserves would be reported at $64.97 a barrel, still a 31% decrease from what was mandated by the SEC.

I would argue that by emphasizing comparable information regarding the valuation of oil and gas assets, the SEC has created a disclosure with the possibility to mislead investors.  Obviously pricing reserves based on a single day year end price would open up the reserve valuation to even more volatility, but I believe a five year futures price average would allow companies to reflect the economics of the anticipate production curve for most wells while smoothing out the volatility generally found by using a single date spot price.

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