Why Billions in Proven Shale Oil Reserves Suddenly Became Unprovenby
U.S. companies erased more than 20 percent of inventories
Regulator examined estimates as wells lingered on books
Ultra Petroleum Corp. was a shale success story. A former penny stock that made the big leagues, it was worth almost $15 billion at its 2012 peak.
Then came the bust. Almost half of Ultra’s reserves were erased from its books this year. The company filed for bankruptcy on April 29 owing $3.9 billion.
Ultra’s rise and fall isn’t unique. Proven reserves -- gas and oil resources that are among the best measures of a company’s ability to reward its shareholders and repay its debts -- are disappearing across the shale patch. This year, 59 U.S. oil and gas companies deleted the equivalent of 9.2 billion barrels, more than 20 percent of their inventories, according to data compiled by Bloomberg. It’s by far the largest amount since 2009, when the Securities and Exchange Commission tweaked a rule to make it easier for producers to claim wells that wouldn’t be drilled for years.
The SEC routinely questions companies about their reserves. Now, agency investigators are also on the hunt for inflated reserves estimates, according to a person familiar with the matter.
“Reserves make up a large share of the value of these companies, so it really matters,” said David Woodcock, a partner at Jones Day in Dallas who served as the SEC regional director in Fort Worth, Texas, from 2011 to 2015. “They’re looking even more closely at how companies are booking reserves, how they’re evaluating the quality of those reserves and what their intentions really are. They’re not accepting pat answers.”
Drillers face pressure to keep reserves growing. For many, the size of their credit line is tied to the measure. Investors want to see that a company can replace the oil and gas that’s been pumped from the ground and sold.
There are two ways to increase reserves: buy more or find more. Fracking made it easier to do the latter, and the industry lobbied the SEC to count more undeveloped acreage as proved reserves, arguing that shale prospects are predictable across wide expanses.
The SEC agreed, with two key limits. First, the wells must be profitable to drill at a price set by an SEC formula. The companies got a temporary reprieve for 2014 because the SEC number was about $95 a barrel even though crude had plummeted to less than $50 by the time results were reported in early 2015.
That advantage has disappeared. When companies reported their 2015 reserves this year, the SEC price was about $50. Wells that vanished this year may return if prices rise.
The SEC also requires that undeveloped wells be drilled within five years of being added to a company’s books. The five-year plan can’t just be wishful thinking. “The mere intent to develop, without more, does not constitute ‘adoption’ of a development plan,” the SEC explained in 2009.
Despite those limitations, reserves surged 67 percent in the five years after the 2009 rule change, according to 53 companies that have records going back that far. Almost half the gains came from wells that existed only on paper.
By the end of 2014, undeveloped properties accounted for 39 percent of proved oil and gas reserves, up from 33 percent at the end of 2009, an increase of nearly 8 billion barrels.
In its first letter to Ultra, in July 2014, the SEC said it would take about 13 years for the company to drill its backlog. About two months later, Ultra raised $850 million in debt. The SEC letters weren’t yet public. Over the next 19 months, the regulator twice told the company to revise its estimates.
Ultra responded that its drilling plans changed due to falling prices and the shrinking availability of financing. The company sometimes delayed or canceled certain wells in favor of more profitable locations, the company wrote.
Ultra ultimately agreed to a small revision to its 2011 reserves booking. It was disclosed in a footnote to its 2015 annual report, after the SEC completed its review in February. In the same report, Ultra deleted all of its undeveloped reserves because of uncertainty about financing.
The letters were made public in mid-March. By then, Ultra’s shares had plummeted to 58 cents, and the bonds issued less than two years before were selling for about 8 cents on the dollar. Prices have since rebounded.
Sandi Kraemer, Ultra’s director of investor relations, declined to comment. So did Judith Burns, an SEC spokeswoman.
Other companies have also drawn SEC scrutiny. The agency said in correspondence with Goodrich Petroleum Corp. that the company drilled only 4 percent of its undeveloped reserves each year, a slower pace than necessary to comply with the five-year rule. Linn Energy LLC kept undeveloped reserves on its books at the end of 2014 even after cutting its drilling budget by 61 percent. Both companies have gone bankrupt in recent months owing a combined $8.1 billion. Neither would comment for this story.
For many drillers, “development plans weren’t realistic,” said Julie Hilt Hannink, head of energy research at CFRA, an accounting advisory firm in New York.
Penn Virginia Corp., a company in which billionaire George Soros had a stake, booked paper wells in natural gas prospects where it hadn’t drilled in years, according to letters from the SEC.
“Your actual drilling has consistently failed to follow schedules,” the SEC wrote in an April 2015 letter. Penn Virginia responded that it had intended to get to the wells within five years but its plans changed when prices fell.
That’s not what company executives told investors, according to conference call transcripts. H. Baird Whitehead, Penn Virginia’s chief executive officer, said in a November 2012 call that “under almost no scenario” would the company resume gas drilling. Yet, when Penn Virginia filed its report with the SEC three months later, the prospects accounted for more than 40 percent of its reserves.
During an April 2013 call, Whitehead said, “We don’t plan on drilling natural gas wells.” Still, the undeveloped natural gas wells comprised 19 percent of the company’s reserves at the end of that year. Patrick Scanlan, a spokesman for Penn Virginia, declined to comment.
The company intended to follow the SEC’s five-year rule, according to a person familiar with Whitehead’s thinking.
Penn Virginia erased most of its undeveloped reserves this year. The company filed for bankruptcy May 12 with $1.2 billion in debt. Records show Soros sold his six million shares in the first quarter.