New SEC Rules to Allow For Larger Crude Oil and Natural Gas Proven Reserve Estimates

A new proposed SEC plan will overhaul oil and gas reporting rules that have existed since the 1970. The new rules will boost the proven reserves reported by oil companies, and in the process boost their shares and potentially increase interest in takeovers (see Financial Week article). The plans will essentially allow companies to book reserves from “unconventional” oil and gas sources, including oil sands and coal-bed methane. Some deep-water projects that to date have not been allowed to be described as “proven” will also now be included. Furthermore, firms will be able to publish data on what are called “probable” and “possible” reserves, where recovery is not as certain. The new rules obviously don't change the amount of oil and gas that is available worldwide, but they will help investors better calculate future cash flows and thereby place a proper valuation on a company. Needless to say, the oil companies are in favor of the new rules.

The plan will affect both U.S. and international companies that report under SEC rules, which often includes most of the larger international firms. Those with the largest non-traditional sources of future production are most likely to benefit. Analysts expect that Royal Dutch Shell is likely to benefit the most among the oil majors given that they are investing capital to retrieve crude from bitumen-soaked soil in Canada, as well as extract natural gas in coal beds in Australia and China, both of which can now be included as reported proven reserves. ConocoPhillips (COP), Exxon (XOM), and BP (BP) have also invested in non-conventional sources of oil. The reporting of non-traditional proven reserves could also have an impact on acquisitions and takeovers. As mentioned by Neil McMahon, analyst from Bernstein:

“We believe that these rule changes could be the catalyst for a wave of acquisitions, with those companies with the largest unproved resource bases making juicy takeover targets for some of the larger cash-rich majors.”

McMahon feels that Marathon Oil (MRO), with investments in oil sands and shale, and British gas producer BG, with its stakes in the deep-water Brazilian fields and a new 25% stake in Chesapeake Energy (CHK) and the Fayetteville shale, are potential targets. In fact, given that the changes will make the SEC rules more in line with European rules, the impact on UK-listed firms, among others, is expected to be positive.

The rule changes are likely to apply to 2009, and not 2008 year-end reporting since the SEC is still in a consultation period and has not committed to a time line for implementation. Given that the market is forward looking, share prices may nonetheless begin to see the impact of the proposed changes which are expected to be approved and put into place quickly.