PROPERTY VALUATION

What Are Petroleum Reserves?

W. S. EGGLESTON­ UN/ON OIL CO. OF CALIFORNIA MEMBER A/ME LOS ANGELES, CALIF. Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021

Introduction 2. For tax purposes-(a) income tax, (b) inheritance tax and (c) county or state taxes. The valuation of oil and gas properties often starts a chain of events requiring that estimates of reserves and 3. For financing purposes-(a) bonds and debentures rates of production be established, costs determined, prop­ and (b) bank loans. erty, mineral and income taxes calculated, land titles 4. For purposes of purchase or sale of companies or searched, contracts examined and arrangements made for properties-(a) outright sale or purchase, (b) merger and financing. Each of the elements bearing on the final valua­ (c) consolidations. tion and action taken requires the assistance of one or all 5. For budget purposes-(a) development drilling, (b) of the professions of accounting, law, taxation, economics production income and (c) refinery runs. and engineering. 6. For purposes of unitization or joint operations­ The estimation of petroleum reserves is the particular division of ownership in a field or property. field of the reservoir, subsurface and valuation engineer. All of these specialties are included within the term 7. For purposes of gas sales in interstate commerce­ "petroleum engineering". The methods, the techniques and (a) for determination of production rates and (b) for price the pitfalls encountered in estimating petroleum reserves determination. have been analyzed in text books and professional papers without number. The procedures of estimating petroleum Purposes of Estimates reserves have been standardized to the point where, although the answers may differ, the methods do not. Any concept of estimating oil and gas reserves and the processes of making the estimates are influenced by the Technical terminology and definitions present a different particular purpose for which the estimates are being made. situation because no uniform standards have been accepted or agreed upon throughout the industry as a whole. Part 1. Estimates made to establish company depletion and of this difficulty is probably due to the fact that, while depreciation rates have become customary practice in the engineers prepare the estimates, other individuals trained industry. The rates affect company taxes and earnings, and in other professions interpret and apply them. Before a estimates for this purpose constitute one of the more series of definitions pertaining to petroleum reserves is important responsibilities of the department charged with considered, it would seem to be pertinent to state some this duty. Such estimates are generally made by most of the reasons why petroleum reserves are estimated. companies once a year, either at the end of the calendar year or at the end of the fiscal year. The estimates of oil Reasons for Estimates and gas reserves so made are used by the comptrollers department to establish depletion and depreciation rates for Estimates of petroleum reserves are prepared for a spe­ the corporation during the coming year, while the tax cific reason. The purpose of the estimate will in large department uses these same figures to establish cost deple­ measure dictate the method employed and the time spent tion or depreciation to compute "statutory" depletion for in making the estimate. The estimate is seldom an end the past year. Supplementary estimates must be made from in itself, but is merely the first step in a series of calcula­ time to time during the year on individual new producing tions for the purpose of gaining knowledge that will properties in new producing areas in order for depletion influence current or future decisions. and depreciation to be taken as soon as oil is shipped from Some of the more important reasons for such estimates the property. To facilitate accounting, the sooner the are as follows. comptrollers are advised of new producing properties and 1. For corporate purposes in setting depletion and depre­ given an estimate of reserves the better. ciation rates-(a) for corporate accounting and (b) for 2. Estimates made for tax purposes as applied to cor­ tax accounting. porations are almost entirely confined to income taxes and are either for the purpose of establishing cost depletion Original manuscript received in Society of Petroleum Engineers of­ and depreciation, or for determining if percentage depletion fice Feb. 2. 1962. Revised manuscript received May 16. 1962. Paper pre­ sented at SPE Petroleum Economics and Valuation Symposium held applies. The same reserve estimates made to establish cor­ March 15-16. 1962. in Dallas. *Retired from Union Oil Co. of California. effective June 1. 1962. porate depletion and depreciation rates can, and probably

JULY, 1962 SPE 255 719 should, be used for income tax purposes to avoid con­ but are intended primarily for the purpose of recording all fusion. These same estimates can be used to check the proved developed and proved undeveloped lands, and calculations of assessed value by the county or state supplying reliable estimates designed to establish reasonable tax assessor. values or estimates for the specific purpose in hand. 3. Estimates made for the purpose of floating bonds Reserve estimates should be made with care and should and debentures take on many of the aspects of those include all of the lands proved productive of petroleum, estimates made to establish depletion and depreciation with as realistic estimates as are possible at the time the rates. Estimates made for bank loan purposes generally estimate is made. emphasize rates of producing during the term of the loan Estimates of oil and gas reserves are just that­ rather than total reserves. estimates. They are not guarantees; they are not commit­ 4. Estimates of oil and gas reserves made for the pur­ ments; they are just what they purport to be-estimates. pose of buying or selling specific oil or gas properties are Exception may be taken to this statement on two counts, usually calculated as of a date in the future, often two to depending upon the interpretation of the words "guar­ six months in the future in order to have the estimate antee" and "commitment". current at the time of transfer. Such estimates generally 1. Bank Loans-where a company may guarantee pay­ are calculated in much more detail than estimates made ment even though the property may not be able to perform for the purpose of establishing depletion and depreciation up to specifications. Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 rates where the whole spread of a company's holdings 2. Gas Reserves Committed to a Pipeline-where a pro­ must be considered in a relatively short time interval. ducer has the right to cycle gas and in the event of a 5. Estimates made for budget purposes are usually con­ deficiency agrees to make up the deficiency from another fined to individual well estimates to determine the advis­ source. ability of the proposed development, and to relatively In neither of these cases, however, are the reserves short-term production rates (six months to two or three guaranteed to be available from the particular properties years) to determine production income and refinery avail­ under consideration; the supply or payment is guaranteed, ability. Predicting future rates of production even for a not the reserves. short period of time involves some of the techniques employed in making reserve estimates. Classification of Lands 6. Estimates of petroleum reserves for the purpose of determining the division of ownership interests in unit or Lands are divided into two categories for accounting joint operations of a field or property are generally calcu­ purposes: (1) proved oil and/ or gas lands, and (2) un­ lated by a committee of engineers or by an outside con­ proved lands. Many valuation engineers who are highly sultant. Such estimates are made in great detail and, when regarded because of the quality of their appraisals have final agreement is reached, are the basis for participation supported the contention that oil or gas reserves are proved of the various ownership interests. if there is a very high degree of assurance, or if there is 7. Estimates of gas reserves dedicated to interstate sale every reasonable assurance, that the lands will produce are the result of agreement between the pipeline purchaser commercially. Proved reserves, including developed and and the producer. The reserves involved are a critical undeveloped, are those reserves considered to be economi­ factor in determining both the rate of take and the price cally recoverable by present methods of production or by the producer will receive per 1,000 cu ft of gas sold. those practices that can reasonably be predicted for the future. Prior to about 1946, very few oil companies made formal estimates of gas reserves, and it was not until about Unproved or prospective lands are those lands where, 1952 that statements of gas reserves were prepared for while they may have great merit from an exploratory corporate purposes on the same basis as crude-oil reserves. standpoint, the element of proof is lacking. Since that time, the estimation of natural-gas reserves has " 'Proof' is quite relative and entirely a matter of defini­ become increasingly important to the industry and to the tion, and considerable leeway exists among engineers as to nation. In interstate commerce, the gas reserves committed those features and characteristics which establish land as to a contract are of primary importance since both the rate definitely proved. There is no rule.,n of take (production) and the price paid by the pipeline It is necessary to estimate both developed and unde­ purchaser is determined in large measure by the volume of veloped reserves since developed reserves are used to gas reserves in the field or area subject to the contract. determine depreciation rates, while both developed and All of the reasons for estimating petroleum reserves that undeveloped reserves are used to establish depletion rates. have been mentioned apply to the estimation of gas Also, developed reserves have a greater value than do reserves. In addition, there are a number of other reasons undeveloped reserves because, in considering undeveloped that pertain to gas reserves more specifically: (1) construc­ reserves, the cost of development must be taken into tion of interstate pipelines; (2) obtaining certificates of account. public convenience and necessity for construction of inter­ state pipelines; (3) determining the annual rate of pro­ Classification of Petroleum Reserves duction the pipeline purchaser will take and pay for; (4) determining a take or pay rate of production; and Crude-oil and gas reserves are generally classified under (5) determining the price the pipeline purchaser will pay two categories or divisions: (1) proved developed reserves for the gas per thousand cubic feet. (Large volumes of and (2) proved undeveloped reserves. Some appraisal en­ production and reserves command a better price than do gineers subdivide developed reserves into two classes: (1) small reserves and rates of production.) producing and (2) nonproducing. Estimates of developed producing reserves assume recovery from present wells in It should be understood that reserve estimates in no present mechanical condition and from present completion sense serve as an advertising medium for either the exploration or exploitation departments of a company, lRefel'ences given at end of papel'.

720 JOURNAL OF PETROLEUM TECHNOLO(;Y intervals. Costs of maintaining production from developed Petroleum Reserves Classified as to Ownership reserves are charged to expense. Petroleum reserves are customarily classified as gross Developed nonproducing reserves are the reserves esti­ reserves controlled reserves and net reserves for the pur­ mated to be present hehind the casing or at minor depths pose of' distinguishing ownership. It is important that the below the producing zones which are considered proved by degree of ownership be clearly stated. production either from other wells in the field, by success­ Gross reserves are the total recoverable oil or gas ful drill-stem tests, or by core analysis from the particular reserves estimated to be available for production and sale zones. This class of reserves is assumed to require only from the field or property, irrespective of ownership. These moderate additional costs to make the well or wells pro­ include company interest, royalty interest and co-owner ductive from these zones. It is a matter of definition as to interest, and also petroleum production in which the whether such reserves should be classified as developed company may not have an ownership interest. nonproducing or as undeveloped reserves. Gross reserves are primarily of interest to the petroleum Accounting practice may be the controlling factor. Many or reservoir engineer, or to the economist engaged in companies follow the practice of expensing all costs of predicting future supply on an industry-wide basis. maintenance of production in the present producing zone, Controlled reserves represent total oil or gas recoverable including redrilling, and the recoverable reserves available from properties (whether operated by the company or are considered as developed. Reserves located behind the

others) in which the company has an ownership interest Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 casing or below the presently producing zone are consid­ including co-owners, royalty, and others' interests to the ered to be undeveloped rather than developed nonproduc­ extent that it has been, and is expected to be, regular ing, since the cost of opening these intervals to production practice for the company to purchase such interests. An is a capital charge. ownership interest may be held directly, such as through The latter practice appears to be the more defensible affiliates. Another definition equally applicable is, "Con­ and may result in less confusion. Here the question as to trolled reserves represent the estimated future production whether reserves are developed or undeveloped depends from those properties in which the company, its sub­ upon whether capital or expense money is involved. sidiaries, and affiliates have an ownership interest to the extent that such production has been and is expected to be Proved undeveloped reserves are those considered available to the company".' proved for production by reasonable geological and en­ gineering interpretation of adequate structural control in Controlled reserves are of concern to an integrated com­ reservoirs producing or proved by other wells, but are not pany where the future feed stock supply to a refinery may recoverable from present wells within the reasonably pre­ be of great importance. Estimates made for refinery pur­ dictable future. This class of reserves requires the drilling poses emphasize controlled rather than net supply. of additional wells, the deepening of present wells, or the Company net interest in reserves represents the com­ plugging-back and perforating of zones behind the casing pany's net interest after deducting co-owner, royalty and of present wells. others' interests, together with cash bonuses payable out of oil (expressed in equivalent barrels) in reserves recover­ Reserves available by secondary recovery operations are able from properties held directly by the company, plus considered proved in those fields or reservoirs where such its equity in affiliated companies' net interest in their operations now are actually employed or will be employed respective recoverable reserves. in the immediate future. Company net reserves constitute a measurement of a Known occurrences of petroleum that are at present company's financial position-its ability to borrow money uneconomic to exploit are not reserves within the limited -and is a determining factor in the event of sale. meaning of the term, although they may be in the future. Financial houses are much more concerned with a com­ Oil shale deposits and occurrences of petroleum in inac­ pany's net reserves than with its gross or controlled cessible regions are not considered to be reserves at the reserves. present time. Neither should the "indicated", "possible", Estimates of petroleum reserves are subject to some "inferred", or so-called "geological reserves" be dignified rather interesting and possibly unique restrictions in the by the term "reserves". Paul Paine,' approximately 20 oil and gas industry. "Although oil and gas reserves in the years ago, suggested the term "recoverable oil" to replace ground are one of the more important assets of a company, the term "reserves"; he further made the following com­ they are significantly missing from most of the published ment. "A tract of land is either proved or it is not proved; reports of oil and gas producing companies".' These figures and if it is not proved then no circumstance warrants are, in large measure, considered to be confidential. Neither crediting it with reserves. It is simply nonproducing and are the estimates of oil and gas reserves customarily unproved acreage. The only satisfactory index for meas­ aUdited, although both cost depletion and depreciation uring and recording its value is market value where, as rates are determined by the estimates. of a specific time, the trading range of similar properties has been established by sales and purchases." There are few single accounting procedures that can so influence the consolidated-earnings statement as can the It is suggested that the use of such terms as "probable" amount that is written off under depletion, depreciation and "possible" be confined to the descriptive section of a and amortization. Cost depletion rates for representative report. To assign barrel or cubic feet numbers to these companies range from $.12 to $.15/ bbl, and depreciation unknown and hypothetical deposits can throw considerable rates are at least three times this amount, or in the range doubt upon the validity of an otherwise excellent appraisal. of $.40 to $.50/bbl of production. The combined rates will This is especially so if these hypothetical numbers are range from $.40 to $.65/bbl. A change in these rates of supported by pseudo-scientific formula. $.05/bbl, or approximately 10 per cent, can conceivably "Estimates of proved reserves are limited to that part increase or reduce net earnings materially. The books of of discovered oil which can be recovered by known meth­ the comptrollers department are audited annually, but the ods and at economic levels of costs and prices. ,,' statement of reserves is not. It is only during periods of

JULY, ]962 721 rettn"ncing that the reserves of a company are subject to production practice and (6) changes in crude-oil prices. critical review by outside auditors. It is evident that a certain amount of latitude exists in practically all estimates of oil or gas reserves. No experi­ enced valuation engineer deludes himself into thinking that Reliability of Estimates his particular estimate is closer than 5 or 10 per cent of Paul Paine,' a pioneer and forerunner of our present-day the final answer that only time will disclose. valuation engineer, observed many years ago that, "the best that should be expected from a carefully prepared References estimate of oil reserves is that it prove to be within plus 1. Paine, Paul: Oil Property Valuation, John Wiley & Sons, Inc., or minus 25 per cent of the correct figure which only N. Y. (1942). time will disclose". In the light of a recent survey made 2. Breeding, C. W. and Burton, A. G.: Taxation of Oil and Gas to determine the reliability and range in values of original Income, Prentice·Hall, Inc., N. Y. (1954). estimates as compared to revised and current estimates, 3. DeGolyer and MacNaughton: "Report on Reserves", Private this was a very astute observation. There is no way to communication (1949). determine the basis for Paine's statement, but it conforms very closely to the results obtained from this particular 4. Smith, C.A. and Brock, H. R., Jr.: Accounting for Oil and Gas Producers, Prentice-Hall, Inc., Englewood Cliffs, N. J. (1959). survey. 5. Committee on Oil and Gas Availability: "Petroleum Productive More than 60 separate estimates were examined. These Capacity", National Pet. Council (1952). Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 were made for the purpose of purchasing oil and gas prop­ 6. Lichtblau, John H. and Spriggs, Dillard P.: The Oil Depletion erties where an actual purchase was made and where Issue, Pet. Ind. Res. Found., Inc. (1959). records were kept not only of the original estimates, but 7. Sheldon, Dean H.: "Valuation of Oil Properties", Jour. Pet. also of cumulative production since the date of purchase; Tech. (July, 1953) V, No.7, 17. much more reliable data were available for the current 8. Arps, J. J.: "Estimation of Primary Oil Reserves", Trans., estimates. The original estimates encompassed a period of AIME (1956) 207, 182. almost 20 years, and the crude-oil reserves of the prop­ erties involved ranged from less than 10,000 bbl to over I 00 25 million bbl. Over 35 reservoir, subsurface and valuation engineers, many of them consulting engineers of national eo reputation, contributed to the original and to the final estimates, some of which were made as much as 20 years 80 after the original. Approximately 200 million bbl of oil were involved in the final determinations. The results of 70 this survey are shown on Fig. 1. ir \ eo Approximately 79 per cent of the reserves involved in ,\ the estimates fell within the range of being underestimated 50 by 20 per cent and overestimated by 16 per cent of the

final or current figures. Final figures pertain to properties w 40 that have ceased to produce. Some 10 per cent of the I­ « NOT A INGLE reserves were overestimated in excess of 40 per cent, and ::E ESTIMATE BUT 30 less than 10 per cent were underestimated in excess of 50 l­ A SERIES V) L"{ per cent of the current estimates. Current estimates in­ W r-r- 20 cluded cumulative production since the date of purchase. W tl > UNDER a: 10 About 46 per cent of the reserves were overestimated to w ESTIMATED V) ~PERCENT some degree, and 51 per cent underestimated. Only 3 per w I + a: 0 ~ o cent of the estimates have required almost no change, ovkR .- although approximately 36 per cent of the reserves esti­ ~ 1 ESTIMATED a: - 10 PERCENT - r--r--- mated are within the range of ± 10 per cent. Apparently, o Ir-r- a: there is a slight tendency to underestimate reserves, but a: -20 IT not a very strong one. As a rule, the better fields or those W that are only partially developed are the ones that are ~ -30 79 PERCENT underestimated. W U a: -40 For properties that are fairly well developed and the W facts are known, engineers' estimates of recoverable oil a. will not vary greatly from the more correct figures deter­ -50 mined some years later when even more facts are known. - eo These observations apply to representative sampling of a substantial number of estimates; they may not always apply -70 to a single estimate. A single estimate may be too

optimistic or too pessimistic as gauged by the passage of -80 time and the opportunity afforded for reappraisal. A single estimate may miss the mark by a wide margin in either -eo CHART ~_ r-r- direction. w.S:E. 8-6/} -100 Some of the reasons that reserve estimates are changed o 10 20 30 40 50 eo 70 eo SlO 100 with time are as follows: (1) more information and better PERCENT OF TOTAL RESERVES records, (2) more performance history, (3) changes in the Fig. I-Estimation of oil reserves, 1938 through 1957. productive area, (4) extensions at depth, (5) changes in Original estimate compared with determination as of 1960.

722 JOURNAL OF PETROLEUM TECHNOLOGY DISCUSSION

W. W. WILSON CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST CO. MEMBER AIME CHICAGO, ILL.

Eggleston has done a commendable job of summarizing revise these reports to conform with bank policies regard­ the numerous purposes for estimates of hydrocarbon ing acceptable collateral. To perform this function, the reserves and has presented a useful breakdown of various bank engineer must be fully informed as to the definitions categories of reserves. However, one of the most valuable employed by the consultant and the exact meaning of the uses for reserve reports and evaluations was omitted­ terms used in the report. namely, internal audit and management control. Reserves During the last several years, the writer has made an represent the stock-in-trade of any producer, and the final informal review of the procedures used by producing com­ proof of effective operation and management is provided panies, consultants and bank engineers, and has reviewed Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 by analysis of proven reserves and capital expenditures. the available literature on evaluation procedures in an Eggleston refers to allowances for depletion in the order attempt to define the scope of this problem. The results of $.12 to $.15/bbl as being representative for many are both enlightening and confusing. There seems to be companies. As a banker, the writer cannot refrain from little uniformity in definitions of various types of hydro­ observing that any operator whose average depletion for carbon reserves, methods of classifying such reserves in tax purposes is in this order of magnitude certainly is not accordance with their degree of certainty or producibility, availing himself of the benefits of the tax laws and of and the nomenclature used in evaluation reports. It is modern tax-accounting procedures. Statistics have been emphasized that these factors are in no way associated reviewed for many companies which experience an effective with the normal use of engineering judgment in estimating depletion rate in the order of 24 to over 26 per cent of reserves or predicting future performance. gross revenues, or around $.75/bbl. This rate can be There appear to be very few published definitions spe­ achieved by effective planning of major lease development cifically defining crude oil, natural gas, condensate and and by the judicious use of carved-out oil payments to maximize depletion benefits when the statutory rate for natural-gas liquids. Such definitions as were found do not individual leases is limited to 50 per cent of net income. agree in all cases, and the degree of difference is sufficiently large that confusion is unavoidable. Some companies follow No doubt every reservoir engineer who has spent any the practice of classifying as proven reserves only hydro­ appreciable amount of time on reserve estimation has carbons recoverable from either existing wells or comple­ realized the necessity for having a reasonably firm system tions, and give no credit to undeveloped reserves in any of classifying reserves. Unfortunately, however, there has category. Certain other companies employ what amounts been no official action by any of the recognized technical to an accounting system for reserves records, and transfer societies to formulate or adopt a system to which all reserves from one classification to another as specific loca­ engineers can agree. tions are drilled or as wells are recompleted. There are, Most, if not all, reservoir studies are made for the of course, many other systems somewhere between these purpose of equating a given course of action with ultimate extremes. There appears to be no uniform manner of profit and, therefore, come under the general classification accounting for the various categories of undeveloped sec­ of evaluations. Reports of this type may be made for a ondary recovery or pressure maintenance reserves. variety of specific purposes, but ultimately they are used by management at some level for the solution of problems In most instances, consulting engineers follow the dic­ or the formulation of policy. The managements of most tates of their clients with regard to classification of proven companies have established specific policies to guide their or speCUlative reserves, but in the absence of specific engineering staffs, in order to assure uniformity of defini­ instructions each seems to follow his own set pattern. There tions and nomenclature. So long as these reports are is little uniformity with respect to definitions or classifica­ restricted to internal use this approach is workable and tion of reserves between individual consultants. The prob­ presents few difficulties. Serious problems will occur, how­ lems which this situation creates are compounded whenever ever, whenever comparisons are to be made of reserve it is necessary to composite the results of two different summaries or evaluations prepared by the technical staffs consultants, each of which has evaluated a part of a total of two or more companies, each having its own ground package of producing properties. Every bank engineer and rules. This is one of the main reasons why many com­ consultant is aware of many instances when engineers have panies are unwilling to publish reserves data in reports to been criticized severely because of their failure to agree stockholders, regulatory agencies or security analysts. within reasonable limits in evaluating specific properties. Most consulting engineers, when first starting their inde­ No doubt much of this ill will has been created unneces­ pendent practices, tend to follow the procedures used by sarily and is a direct result of confusion with respect to their former employers. Because of the wide diversity of definitions and reserve classification. procedures followed by consultants with different back­ It is my opinion that this is a serious problem which grounds of experience and training, serious problems are should be solved as promptly as possible. Several years created for lending institutions, security analysts and other ago the Society of Petroleum Engineers, after a careful persons who use the reports they prepare. Most commer­ study by a group of experts in the field, officially adopted cial banks that engage in oil and gas financing employ their a standard set of symbols to be used in literature pertaining own engineers to review evaluation reports submitted with to reservoir engineering and to well logging. This has met loan applications. One of their principal functions is to with universal acceptance and is conceded to be an appro-

IULY, 1962 723 priate action by this organization. A similar undertaking by writer, therefore, recommends that the SPE Board of SPE with respect to definitions and classification of hydro­ Directors appoint a committee to make a thorough study carbon reserves is in order. The weight of public opinion of this problem and submit recommendations to the Board which could be exerted by the Society inevitably would of Directors for the adoption of appropriate definitions result in the universal adoption of these standards. The and a reserves classification system.

DISCUSSION

J. J. ARPS THE BRITISH·AMERICAN OIL PRODUCING CO. MEMBER AIME DALLAS, TEX.

I agree with Eggleston that for most of the purposes successful pilot operation or by a successful full-scale Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 listed in his paper only "proved" reserves should be con­ secondary recovery operation in the same reservoir. In sidered, while the use of terms such as "probable" or areas where many secondary operations in a certain for­ "possible" should generally be avoided and certainly should mation are in progress so that the technological aspects be confined to the descriptive section of an appraisal are well known, secondary reserves may sometimes be report. However, in evaluating the results of an exploration considered proved for untested, similar reservoirs with program, or when considering the geologic potential of a otherwise satisfactory characteristics. given basin or area, there is occasionally a need for termi­ Primary reserves behind the casing or within the geolog­ nology which is somewhat less severe than the "proved" ical limits of a productive reservoir which do not qualify definition. The terms "probable" and "possible" may fill under the "proved" classification are classified as "prob­ that requirement, provided it is clearly understood what able". their limitations are. Secondary reserves from a reservoir, which appear· to Eggleston's paper makes a very fine contribution towards have desirable characteristics but which have not been a better understanding of what reserves are, what they are subjected to actual secondary operations and are not used for and what their limitations are. I propose that we located in an area of extensive secondary activity in similar even go a step further and make an attempt to settle on an reservoirs, are also classified as probable. over-all classification of reserves which will clearly spell The "possible" classification is reserved for cases where out what is meant by each of the terms used. Such a the possibility of finding oil or gas has not been con­ classification could be based upon the source of reservoir demned, but where the available evidence will not support energy (primary vs secondary), the degree of proof a higher classification. (proved, probable and possible), the development status (developed and undeveloped) and the producing status (producing and nonproducing). Development Status I submit herewith Fig. D-l, a table showing a proposal In the case of proved primary reserves, the difference for such standardization of our reserves terminology, and between the developed and undeveloped categories is that I welcome suggestions for improvement. The following the developed reserves will be produced through existing considerations effected the proposed breakdown in different wells, while the undeveloped reserves will require the groups. drilling of additional wells. In the case of proved secondary reserves, the difference Source of Reservoir Energy between the developed and undeveloped categories is that the undeveloped category requires the drilling of addi­ To deserve the name "reserves", the commercial aspects tional wells and, in many cases, the installation of auxiliary must be considered; i.e., the oil must be produced above secondary recovery facilities. an economic limit rate as controlled by prevailing prices and costs. The breakdown between primary and secondary Producing Status reserves is based upon whether the oil is expelled from the reservoir by the natural reservoir energy only, or Proved, developed primary reserves are further broken whether such energy has been supplemented by fluid down according to their producing status. The producing injection or otherwise. category comprises the reserves obtainable from comple­ tion intervals now open to production, while the nonpro­ Degree of Proof ducing category requires a relatively minor expenditure for additional perforating to open up behind the casing Primary reserves obviously may be considered "proved" reserves, or a minor deepening job in a zone open to when there is actual production at commercial rates. There production at the bottom of the hole. may be cases, however, where wells are not on actual pro­ Proved, developed secondary reserves may also be duction, but where indirect evidence such as that listed further divided according to their producing status into in the table may be considered sufficient proof. When the same two groups. The producing category comprises relying on such evidence one should be careful that no reserves to be produced from a going secondary operation; serious drainage has taken place since the log, core or in the nonproducing category the production of such test data were obtained. reserves requires a relatively minor additional expenditure Secondary reserves may be considered proved by a for the expansion of existing secondary recovery facilities.

724 JOURNAL OF PETROLEUM TECHNOLOGY Source of Reiervoir Energy Degree of Proof Development Status Producing Status

PRIMARY i PRODUCING Reserves recoverable com- I Developed reserves to be mercially at current prices produced by existing wells and costs, by convantional 1 from completion interval(s) methods and e.quipment, DEVELOPED open to production. as a result of natural PROVED Proved reserves recoverable energy inherent in the Primary reserves which are through existing w~lls. NONPRODUCING reservoir. considered proved to a high Developed reserves to be degree of certainty by produced from eXisting actual production from the wells but which are now reservoir at cormnercial behind the casing or at rates, or in certain cases minor depths below the by successful well testes) bottom of the hole. The in conjunction with favor­ cost of opening up such able and reliable core reserves should be rela­ analysis data or quantita­ tively minor. tive log interpretation. This indirect evidence is UNDEVELOPED valid only if no substan­ Proved reserves under un­ tial drainage has occurred developed spacing units since these welles) were which are so close and so drilled or tested. related to developed spac­ ing units that they may be Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 assumed with confidence to become commercially pro­ ductive when drilled.

PROBABLE Primary reserves behind the casing of existing wells or within the known geo­ logical limits of a pro­ ductive reservoir, which are inferred from limited evidence of commercially producible oil or gas, but where the evidence is in­ sufficient to qualify under I the "proved!! definition. i

POSSIBLE Primary reserves whose exis tence may be inferred from geological considera­ tions but where available data will not support a higher classification.

SECONDARY PRODUCING Reserves recoverable com­ Developed reserves to be mercially at current prices produced by existing wells and costs, in addition to DEVELOPED from that portion of a re­ the primary reserves, as PROVED Proved reserves, recover­ servoir subjected to full a result of supplementing Secondary reserves which able through existing scale secondary operations. by artificial means the are considered proved to a wells from a reservoir natural energy inherent in high degree of certainty where successful secondary NONPRODUCING the reservoir; sorr.etimes by a successful pilot operations are in progress. Developed reserves to be in conjunct ion with a . operation or by satisfac­ produced by existing wells change in the physical tory performance of full upon enlargement of exist­ characteristics of the scale secondary operation ing secondary operations, reservoir fluids. in the same reservoir, or provided the cost of such in certain cases in a expansion is relatively similar nearby reservoir minor. producing from the same formation. UNDEVELOPED Proved reserves which may I be assumed with confidence I to be produced upon the installation of a second­ ary recovery project and/or by the drilling of addi- J. tional wells.

PROBABLE Secondary reserves which are inferred from past production performance or core, log, or reser­ voir data) but where the reservoir itself has not been subjected to second­ ary operations.

POSSIBLE Secondary reserves from reservoirs which appear to be suited for secondary operations but where avail­ able data will not support a higher classification.

Fig. D-l-CIassification of petroleum reserves.

JULY, 1962 725 Author's Reply to W. W. Wilson and J. J. Arps

One of the factors instrumental in causing this paper sible" reserves in an annual report; they should not be to be presented was that Arps and Wilson, authorities in taken into account in calculating either cost depletion or their respective fields, offered to provide discussions to depreciation rates, or in making contracts with pipeline accompany the talk. Their positions in the oil industry and purchasers of gas, or in bank loans. One of the drawbacks in the investment-banking field give weight to their observa­ to the use of the terms "probable" and "possible" is the tions, and their comments deserve serious consideration customary practice of presenting reserve estimates in the on the part of petroleum engineers engaged in valuation form of a tabulation and adding the numbers to a total, work. The question of "What Are Petroleum Reserves?" which if the "possibles" are added in is a little like adding is not altogether clear; because of this fact, the observa­ up horses and rabbits. tions and opinions of more than one author are in order Wilson points out that one of the important uses of and were solicited. reserve estimates and valuations is for internal audit and Arps' Fig. D-l, "Classification of Petroleum Reserves", management control. His observation is well taken. It is was developed after a great deal of thought had been obvious that I skipped too lightly over this subject in brought to bear on the problem, and it has a number of Item 5, "for budget purposes" (see "Purposes of Esti­ features that can be readily adopted without change. Per­ mates"). Budgets are prepared to provide a means of Downloaded from http://onepetro.org/JPT/article-pdf/14/07/719/2214029/spe-255-pa.pdf by guest on 01 October 2021 sonally, I would like to see him delete the terms "probable" internal audit and management control. Another oversight and "possible", and consider these two items in another on my part was failing to properly emphasize the fact that place well separated from the "proved" classification. I do "cost" depletion rates for representative companies are in not think that it adds anything to our terminology or our the range of $.12 to $.15/bbl. Percentage or statutory technology to incorporate the imaginative numbers inherent depletion is a horse of another color. in the "probable" and "possible" concepts in the same tab­ Cost depletion should not be confused with statutory ulation with the more definitive terms customarily used. or percentage depletion. "Statutory" depletion as opposed The temptation is too great, on the part of many valuation to "cost" depletion is based on percentage of either gross engineers, to resist adding such hypothetical numbers into or net income, while the amount of cost depletion depends a total with the proved reserves, thus making a travesty of upon the cost of productive lands. a valuation report. Such a report ceases to be a valuation I agree with Wilson that the Society of Petroleum Engi­ appraisal and becomes an exercise in determining the gulli­ neers can perform a valuable service by forming a com­ bility of the recipient. mittee to study, define and classify petroleum reserves and In recent years, the question "what are petroleum re­ the products of production, such as crude oil, condensate, serves?" has become a controversial issue. Part of this natural gas, dry gas and liquid plant products-LPG. *** controversy undoubtedly is due to the difficulty experienced by most companies in maintaining their reserve position. It is becoming more and more difficult each year to make W. S. EGGLESTON, who recently re­ up for last year's production by current discoveries. tired from his position as manager of I have read somewhere that "probable" and "possible" reserves and valuations for Union Oil reserves are important because they provide the incentive Co. of California in Los Angeles, now for spending additional capital in exploration. I wonder if works as a consulting petroleum en­ it is the "probable" and possible" reserves (with barrel gineer from his home in San Marino, numbers assigned) that provides this impetus or is it due Calif. He joined Union's Colorado sub­ to the prospective merits of the acreage that strongly sidiary in 1926 after graduating from indicates productive possibilities which may be proved or The U. of California with a BS degree disproved by drilling? in geology. With Union he held a num- In considering reserves, the proved class is reasonably ber of responsible positions, and was definite, positive and factual while the other class is prob­ named manager of reserves and valuations in 1957. Eggle­ lematical and subject to question, although useful in dis­ ston also has served as district oil and gas commissioner cussions that have to do with the future potentialities of for the state of California from 1944-56 and as an advisor an area or a country. I seriously question the advisability to the director of Naval Petroleum Reserves for explora­ of a corporation's publishing either "probable" or "pos- tion work in Arc-tic Alaska.

7Z6 JOURNAl~ OF PETROLEUM TECHNOLOGY