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SEC Staff Provides Guidance Regarding New Oil and Gas Reporting Requirements

Securities Law Update

November 11, 2009

On October 26, 2009, the Staff of the U.S. Securities and Exchange Commission issued guidance regarding the recently amended oil and gas reporting requirements. These twenty questions and answers address several issues that have caused uncertainty for issuers and their reserve engineers, accountants and attorneys in preparing to implement the new rules. To access the Staff guidance, click here.

Separately, on October 30, 2009, the Staff published Staff Accounting Bulletin No. 113, to update Topic 12, Oil and Gas Producing Activities, of the codification of SABs to make it consistent with the new rules.

The new rules become effective for registration statements filed on or after January 1, 2010 and for annual reports on Forms 10-K and 20-F for fiscal years ending on or after December 31, 2009. To access the new rules, click here, and to review our prior alert summarizing the new rules, click here.

Reliable Technology

The Staff's guidance confirms that the utilization of "reliable technology" in booking reserves carries with it a verification and record-keeping obligation. 

Under the new rules, companies may use reliable technology to establish the requisite level of certainty for the assignment of reserves. Rather than adopting a static list of technologies that it would accept, the SEC defined "reliable technology" as technologies that have been "field tested and . . . demonstrated to provide reasonably certain results with consistency and repeatability in the formation being evaluated or in an analogous formation." In discussing the definition in the adopting release, the SEC stated that the new standard will permit the use of new technologies "once a company can establish and document the reliability of that technology."

In its guidance, the Staff further clarified that the burden of establishing and documenting the reliability and consistency of a proposed reliable technology is upon the issuer and that this information must be made available to the Staff upon request. Neither the final rules nor the Staff guidance contains a bright line test as to when a technology will be regarded as reliable (the proposing release included a 90% success rate threshold which was not ultimately adopted).

The Staff's guidance confirms our view that issuers should adopt internal procedures to capture data regarding the reliability of technologies, should record and document which technologies are used in booking reserves, and should be prepared to produce this data to the Staff in connection with the Staff comment letter process.

Development Plans for PUDs

The new rules provide that PUDs can be assigned to undrilled locations only if a development plan has been adopted pursuant to which such PUDs are scheduled to be drilled within five years, unless specific circumstances justify a longer time. In its guidance, the Staff provided two important clarifications of this provision.

First, the Staff stated that adoption of a development plan requires that a final investment decision has been made regarding the properties to be developed. The Staff stated that the intent to develop a property, by itself, would not constitute adoption of a development plan and would not justify the booking of PUDs.

In light of this guidance, an issuer should carefully document its development plan and the consideration and adoption thereof. Additionally, such plan should be realistic, should not contemplate schedules for development that exceed available or expected resources, and should be consistent with the issuer's disclosures regarding liquidity and other future plans.

Second, the Staff addressed what "specific circumstances" would justify booking PUDs that are not anticipated to be developed within the prescribed five-year period. The Staff acknowledged that certain projects—those located offshore, in urban areas, in environmentally sensitive areas and in remote locations—by their nature take longer to develop, but it refused to establish a per se list, stating that all of the facts and circumstances must be considered and that booking PUDs not anticipated to be developed within five years should be the exception and not the rule.

The Staff stated that a company should consider the following factors in determining whether to recognize reserves even though development may extend past five years:

  • its level of ongoing significant development activities in the area (minimum drilling to maintain leases would not constitute significant development activities);
  • its historical record of completing comparable long-term projects;
  • the amount of time the company has maintained the subject leases or booked reserves without significant development activities;
  • the extent to which the company has followed a previously adopted development plan (e.g., if a company has changed its development plan several times without taking significant steps to implement the plan, recognizing PUDs typically would not be appropriate); and
  • the extent to which delays in development are attributable to external factors as opposed to internal factors (e.g., shifting resources to develop new properties with higher priority).

In addition to documenting its development plan, a company should document and be prepared to defend the specific circumstances justifying the booking of any PUDs beyond the company's five-year development plan.

The Two-Parallel Offset Limitation

In comment letters to Parallel Petroleum Corporation during 2007, the Staff set forth its view that, in reservoirs to be developed by horizontal drilling, a company was limited to assigning PUDs to two parallel offsetting locations for each productive horizontal well. In the new rules, the SEC eliminated the basis for this Staff position when it changed the "certainty" requirement for locations beyond direct offset locations to "reasonable certainty" and allowed reliable technology to be used to establish such reasonable certainty. In its guidance, the Staff confirmed in part that its informal two-parallel offset rule no longer applied.

In its guidance, the Staff stated that an issuer can assign PUDs to horizontal locations offsetting the toe of an existing horizontal productive well if the offsetting locations are in the direction of other analogous producing horizontal wells, provided that the technical evidence supports the assignment with reasonable certainty. The Staff's response does not address the assignment of PUDs to horizontal locations offsetting a producing horizontal well in a direction that is not towards other analogous producing horizontal wells. The Staff's guidance does not preclude such an assignment, however, and such an assignment is not prohibited by the new rules if the requisite level of certainty can be established.

Additional Guidance

A summary of additional Staff guidance appears below:

  • If sufficient data to establish the requisite level of certainty is available, previous limiting principles such as "highest known oil" and "lowest known hydrocarbons" will not necessarily prohibit the assignment of reserves to volumes beyond such limits.
  • Issuers' procedures for calculating the cost components in the determination of economic producibility are not changed by the new rules.
  •  Unproved reserves (probable and possible) should be evaluated using the same price as used for proved reserves.
  • The option to use post-quarter-end prices to perform the capitalized-cost ceiling test under the full cost method of accounting has been eliminated.
  • For the purposes of identifying countries or fields containing 15% or more of an issuer's reserves (so as to require disclosure at such level), reserve quantities attributable to equity method investees should be combined with reserve quantities attributable to consolidated entities.
  • Reserves cannot be assigned to any un-penetrated, pressure-separated fault block until penetrated by a well.
  • An issuer is required to include in its filings a third-party report only where it discloses that it engaged the third party to prepare or audit any portion of its reserves estimates or to conduct a process review.

If you have any questions regarding these matters, please contact your Bracewell attorney or one of the following:

Michael S. Telle
Connie S. Stamets
Charles H. Still, Jr.
Gary W. Orloff
William S. Anderson
Brett A. Owens