As previously mentioned, there are costs included in the corporate
budget that do not always appear in the reserve report. These costs
include general and administrative expenses (G&A), land costs, interest
It is crucial to review a company’s historical financials to determine
G&A and other non-operating costs or non-producing service lines
that need to be included in the budget. A review of the reserve report’s
discussion is often conducted to determine the inclusion of non-re-curring or maintenance costs that the company may incur. It is also
necessary to identify if upcoming plugging and abandonment costs
are included and the assumptions of netting salvage value to that
Step 4: Compile supporting facts
A preliminary budget is developed after assumptions are confirmed
and all costs and sources of revenue not listed in the reserve report
are identified. The company’s historical lease operating statements
(production month basis), financials and other available information
are used to independently verify the accuracy of the budget.
According to SPEE guidelines, engineers must identify the sources
of information and degree of independent verification. The financial
analyst can assume the engineers utilized their expertise to accurately
forecast the production curves, but the analyst must still apply professional skepticism when analyzing the pricing and costs
Important questions to consider when comparing the budget to
historical and other projected data include:
• How do future projections relate to past performance?
• Has the company historically produced reserves that meet their
reserve report estimates?
• Has the company historically achieved the pricing in the report
compared to the index used?
• What is the probability of success for future drilling prospects?
• To what degree does management expect future performance to
differ from historical performance?
The reserve report is an important tool when documenting a
company’s reserves for acquisition, an SEC report, asset sale, and
many other valuation purposes. An analyst can use the reserve report
in a number of ways if he or she knows how to use the discussion
section in connection with the cash flows. The reserve engineers offer
their expertise to calculate the future production streams of the
company’s reserves. Knowledge of how to read the report, isolate and
change certain costs or revenues, incorporate other business expenses,
and independently test the results enables a financial analyst to use
a standard report as the basis for creating a corporate budget.
ABOUT THE AUTHOR
Allison Firestone is a Director in the Restructuring
practice of Opportune. She specializes in building Excel
models to forecast future cash flows, financials, and
other analytics. Firestone focuses on financial restructuring and has experience in business plan development,
liquidity management, and litigation support. She holds
a degree from Texas A&M University.
T1: PRIMARY ECONOMIC ASSUMPTIONS INCLUDED IN THE DISCUSSION SECTION
Source of data
• Source of ownership interest data and information
• Source of price projections for products sold
• How do price projections relate to an index?
• How does the reserve engineer escalate prices?
• Are any contracts or hedges included?
Monetization of production
• Does revenue include sources other than the sale of hydrocarbons?
• Are lease fuel volumes reduced from reserves?
• Are gathering or transportation fees netted against sales price?
Additional guidance for SEC reporting purposes
■ Pricing based on first of the month averages from the preceding 12 months adjusted for transportation, quality, etc.
■ Prices not to be escalated; special consideration for certain hedges or contracts
• Where is ad valorem tax included? Is it included in LOE, identified separately or listed outside the report?
• Have income taxes been considered?
• Analyze any unusual tax situations, such as foreign taxes due
Lease operating costs
• Identify the source of data to estimate costs
• Review the reasoning for omitting costs, including recurring costs
• Does LOE include repair and maintenance costs?
• Identify the method used for projecting future fixed and variable LOE
• Study the treatment of corporate overhead and any reimbursement per COPAS (Council of Petroleum • Accounting
• Identify the source of data included for capex, the source of funds and any independent testing efforts
Additional guidance for SEC reporting purposes
■ Only wells scheduled to be drilled within five years are included in the Proved Undeveloped reserve category
Plugging and abandonment • Identify assumptions such as projected cost, source of funds and timing • Describe the independent verification of any costs
Other economic assumptions
• Identify and analyze the discount factor
• If unusual, discuss lease terms
• If applicable, identify the aggression level of probabilistic methods in the report
• Address other relevant company, such as production payments
Source: Recommended Evaluation Practice #1 – Elements of a Reserve and Resource Report. Part of SPEE suggested practices when developing reserve reports.