Exxon, the Chase for Reserves, and the Oil Sands

Talking to corporate analysts over the several years that I've been back in the U.S. and covering oil, a recurring question I hear is how Exxon manages year after year without exception -- unlike its Big Oil rivals -- to replenish its cache of proven oil and natural gas reserves. That's what the company has reported in its news releases and annual reports for the last nine years -- an unbroken trajectory of replacing more than 100% of the oil and natural gas that it pumps out of the ground.

The answer is that it hasn't done so, not at least according to the rules of the Securities and Exchange Commission, which governs such matters. When you examine Exxon's annual filings for 1999-2008, the company has had a quite-normal -- for oil companies, that is -- four years of exceeding 100% replacement, and five years not. For instance, for 2008 the company issued a statement saying that it possessed 22.8 billion barrels of proven reserves; yet its 10-K filing with the SEC reported just 21.1 billion barrels in proven reserves (to get there, see page 7 of the 10-K, and tally up the developed and undeveloped reserves in the consolidated and equity categories).

So I gave Exxon a call. How do you get from 21.1 billion barrels to 22.8 billion barrels? I asked.

Add in the oil sands, was the reply.

That would be the approximately 1.8 billion barrels of oil equivalent that Exxon has booked so far in its Alberta, Canada, oil sand holdings (see pages 22 and 23 of the 10-K; add the Syncrude and Kearl reserves).

Strictly speaking, SEC rules don't permit comingling of oil that's pumped out of the ground, along with oil sands -- exceptionally tar-like material that in most cases isn't pumped, but instead is actually mined like a mineral, then mixed with chemicals in order to move it to a refinery for processing. But companies can comingle them in public announcements such as news releases and annual reports that are read by reporters, investors and Wall Street analysts, according to an SEC spokesman.

This isn't criticism of Exxon. Rather, it's simply evidence that Exxon, like all of Big Oil, is mortal. I wrote about this in a piece earlier this week for Business Week.

In fact, Exxon has been highly critical of how the SEC requires it to report reserves. It has said that it has its own, rigorous, internal methods of assessing its proven reserves, and that this process far more accurately reflects what it possesses.

Why does reserve replacement attract so much attention? Because investors and company analysts regard this metric as a primary measure of an oil company's health. If a company's reserve base is consistently stable or growing, then it's regarded as maintaining its assets as a base for growth. If the reserve base is consistently shrinking, a company can be thought to be cannibalizing itself.

For 2008, for instance, Shell says that it replaced just 95% of what it drilled. The year before, Chevron reported a replacement rate of just 10-15%. That attracted them much critical commentary.

And Exxon? It reported that it replaced 101% of its production in 2007, in addition to 103% in 2008. Yet its SEC report shows that its proven reserves actually dropped both years -- to 21.7 billion barrels from 22.1 billion barrels from 2006 to 2007; and, as mentioned above, on down to 21.1 billion barrels in 2008. The sands made the difference. Without the sands, Exxon's reserve replacement last year would have been about 27%.

The situation will change starting next year. The SEC is going to start allowing companies to combine the oil sands with other reserves. The decision came after oil companies argued strenuously that new technology makes unconventional oil equivalent to conventional reserves, so that now there is no reason not to permit companies to put them in the same basket.

Whatever the case, for the record below are the comparisons for the last nine years, including links for most of them to both the 10-Ks and the relevant news release or annual report.

Exxon's Reserve Replacement (in barrels of oil equivalent)

Oil sands

SEC-10K

In News Release

1999	577 mln		20.6 bln	21.3 b
2000	610 m		20.8 b	21.5 b
2001	821 m		20.79 b	21.5 b
2002	800 m		20.68 b	21.7 b
2003	781 m		21.1 b	22 b
2004	757 m		20.9 b	22 b
2005	738 m		21.6 b	22.4 b
2006	718 m		22.1 b	22.7 b
2007	694 m		21.7 b	22.7 b
2008	1.87 b		21.1 b	22.8 b

For Big Oil, a Day of Reckoning

Most of us are elated with gasoline prices, especially those driving to see relatives. We are down on the Chesapeake shore, and filled up the mini-van for $1.49 a gallon. But if you are an oil company, these aren't happy times.

Chiefly, if you are a petro-state or an oilman, you've probably got whiplash. Last summer, customers were paying you up to a whopping $147 a barrel for your oil, and though few except perhaps Arjun Murti over at Goldman Sachs thought those prices would stick around, it was equally so that almost no one expected to be paid as little as $32 a barrel just a few months later (and $36 today). Russia, Venezuela, Iran and most of the rest of the oil producing states simply cannot balance their budgets.

But, focusing for now on oil companies big and small, matters are about to get worse. As others are pointing out, that will become clear in just a few days -- on Dec. 31 to be precise. One might call it the day of reckoning. The Wall Street Journal's Ben Casselman was ahead of the pack in writing about this.

But what these reports aren't pointing out is that, if projections are anywhere near correct, this isn't a one-year matter. The companies may be in for trouble for at least the next couple of years. (After alarming the skittish market in the summer by forecasting $200-a-barrel oil, Goldman Sachs is now predicting average $45-a-barrel oil next year. The World Bank expects an average of $75 a barrel oil over the next two years.)

Here's why: It's the price of oil on Dec. 31 that all oil companies -- at least those that sell shares to the public -- must use as a measuring stick of just just how much in the way of proven oil and gas reserves they own. The most important factor in this calibration is how much it costs a company to drill a barrel of oil in, say, Canada, or the Gulf of Mexico. If they cannot drill that barrel economically at $40 a barrel (presuming that's about the price five days from now), it must be stricken from the books. Along with that number, the companies report their so-called "reserve replacement" -- to what degree managed to replenish the oil and natural gas they drilled during the year.

Those numbers must be reported to the Securities and Exchange Commission on a company's 10-K statement. That's where the trouble begins: When the companies go public with their reports in February and March, Wall Street will use the numbers to help calculate how much their share price is worth; and banks and venture capitalists will do the same to determine whether to lend to oil drillers in this tight financial environment, and if so at what interest rate.

Even for 2007 -- when oil ended the year at about $95 a barrel -- the struggle for some of the companies to replace reserves was already apparent. By the SEC rules, Exxon replaced just 76% of its reserves (though by its own internal methods it said it replaced 101%). Chevron replaced just 10%-15% of the oil and gas it drilled. BP said it replaced more than 100%.

But at $35 or $40 a barrel, those percentages are going to be far lower. Stay tuned for some news-spinning from Big Oil's public relations arms in the coming weeks and months. The companies' share prices have already been pummeled this year by Wall Street.

Some say that a focus on reserve reports is something for "unsavvy investors" and commentators -- "the resources are still there for a price," said this fellow calling others unsavvy.

That view is correct to a point -- Dec. 31 is an arbitrary date to judge one's reserves. But it's a narrowly drawn view, concentrating only on the presence of fossil fuels in the ground. It ignores that that oil and gas is becoming far harder and more expensive to drill; it's situated in smaller and smaller reservoirs, requiring the drilling of more and more wells to produce the same volume of oil; and it's largely controlled by petro-states that, even if low oil prices drive petro-states to be friendlier toward international oil companies, are still likely to demand far tougher terms than they did, say, in the 1990s.

In short, company reserves are becoming smaller, and the focus on reserves reporting is demonstrably relevant.

Some good news for the companies is that the SEC is going to change the reporting rule starting in 2010 -- companies will be able to use an average of the annual price rather than the year-end price.

But that's a slender reed of hope if trends and oil forecasts for an average $40-$60 a-barrel oil next year are accurate.

According to inflationdata.com, the average oil price in 2007 was $66.40; so far this year, it's about $98. So that if the current trajectory holds, the price on which the companies will report their 2009 reserves will be relatively low, too.