A study on oil and gas reserve accounting

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The aim of the investigation project is find out what similarities and differences in oil and gas reserve accounting in Russia, Norway and The United Kingdom compare them with International Financial Standards.

In order to achieve this aim, it is necessary to make a literature review. Literature review is the first stage of the study because it allows the researcher to be aware of what was written on the issue, and eventually make deficiencies, gap research or lacking of proper coverage (Bryman A., Bell A., 2003). It is a survey and discussion of the literature in a given area of study. It is a critical look of what has been studied, argued, and established about the topic. The researcher reviewed surveys scholarly articles, books, newspapers and online recourses such as journal and magazines articles.

Problem of oil and gas reserves has attracted worldwide attention when the Anglo-Dutch Royal Dutch / Shell lowered its proven reserves of hydrocarbons by almost a quarter. Because of different interpretations of the rules of reservation of oil and gas reserves, established by the Commission on the Securities and Exchange (SEC) 30 years ago, companies in different ways to reserve their stocks on the same field.

The purpose of financial reporting is to provide information about the financial position, results of operations and changes in financial position. This information is required a wide range of users in making economic decisions.

Oil and gas industry is very specific industry because of number of factors which make necessary to develop and put into practice special accounting rules for this industry:

High capital intensity

A long production cycle (from exploration and acquisition of the field to production of sufficient quantities of oil in order to cover all expenses)

High volatility of oil prices and high dependence of company profit on it

High degree of government regulation in the industry

A specific type of assets - oil and gas reserves

There are some difficulties with the assessment of the main asset of oil companies - oil and gas reserves. It is difficult to calculate how much oil and gas will be withdraw from the field, because of constant updating geological data during the process of production, as well as updating new production technologies and changing economic conditions.

Different types of accounting standards for oil and gas

At the present time in the world accounting practices, there were two most powerful systems: International Financial Reporting Standards (IFRS) and U.S. accounting standards (U.S. GAAP). There are many differences and coincidences in IAS or U.S. GAAP, each of them have certain advantages and disadvantages, however conceptual frameworks are similar. It should be noted that the United States has already accumulated considerable experience in accounting for the oil companies, with fairly detailed standards for the industry, while IFRS only beginning to develop special rules.

Generally Accepted Accounting Principles (GAAP)

In the United States Principles and rules of accounting and reporting are governed by Generally Accepted Accounting Principles (GAAP). Accounting standards for oil and gas activities, as well as other standards developed by the professional community of accountants in Financial Accounting Standards Board (FASB). In general, the following provisions of Financial Accounting Standards (SFAS), which relate to petroleum activities (Wright, C.J, Gallun, R.A, 2008):

SFAS 19 Financial Accounting and Reporting by Oil and Gas Producing Companies

SFAS 25 Suspension of Certain Accounting Requirements for Oil and Gas Producing Companies-an amendment of FASB Statement No. 19

SFAS 69 Disclosures about Oil and Gas Producing Activities-an amendment of FASB Statements 19, 25, 33, and 39

In accordance with SFAS 19 oil and gas activity is defined as activities related to the acquisition of rights to minerals, prospecting and exploration activities, development of fields and production of oil, including condensate and natural gas.

Oil company which listed in the United States stock exchange have to reported oil and gas reserve in compliance with requirement of US Securities and Exchange Commission (SEC), given in the Manual SX Rule 4-10. This document establishes two method of accounting for oil companies: successful effort method, defined standard SFAS 19 and the full cost method. In article by David. F. Morehouse (1997) , there are a background discussion of the methods used to estimate proved oil and gas reserves the and ultimate recovery, which is followed by a discussion of the factors that affect the ultimate recovery estimates reservoirs and fields.

David H Malmquest(1990) suggest that the choice between these full cost and successful effort methods is relevant to all firms who do, or may in the near future do, some drilling, and who have reserves to value and contracts to monitor. According to him, firms choose systematically the accounting method that provides the most efficient monitoring of contracts between all economic agents.

However, many academics argue that SEC reserve standards need to be updated to accurately reflect technological advances, corporate value, and a company's production growth potential (OGJ, 2006). According to Chairmen of US Securities and Exchange Commission Christopher Cox, these updates to the SEC rules will help ensure more meaningful and comprehensive disclosure of information that even thought it does not appear on a company's balance sheet, is of significance to investors in making informed investment decision"( SEC,2008). In addition, president of the American Association of Petroleum Geologist, Peter R. Rose said "no modern company runs its business on reserves as calculated by the SEC. We deceive ourselves into thinking we are going to get the exact answer, bur we never know the number of reserves until the well is shut in"( Peter R.Rose in Paula Dittrick, p 18). Cambridge Energy Research Associates (CERA) suggest that it was time to modernize the SEC's definition and recommended delegating responsibility for developing the new guidelines to the SPE. The report was funded by the most of the oil majors, including ExxonMobil, ConocoPhillips, BP and Royal Dutch Shell, industry organization such as the American Petroleum Institute and accounting firms such as PriceWaterhouseCoopers and KPMG (Oil and Gas Eurasia, 2007)

According to Victor Burk (2005), the SEC will now accept the application of certain new techniques in "proving" reserves.. .but only if these reserves fall within the deepwater areas of the US Gulf of Mexico. This position is scientifically indefensible and serves only to underline the weakness inherent in the SEC's continued adherence to a set of rules which have been outdated by technical progress over the last 25 years. Around the world other market regulators and accounting standard setters have also made reference to the oil and gas reserves definitions established by the SPE as the basis for disclosures required in prospectuses and annual filings.

The result of this debate was the issue of Final Rule Modernization of Oil and Gas Reporting Requirements by US Securities and Exchange Commission in 2008. The final rules:

Revises the definition of proved reserve. Including the pricing used to determine economic reducibility, and align full-cost accounting rules with the reserve definition

In estimating reserves for disclosure purposes, an oil and gas company will use a 12-month average of the closing prices for the commodity on the first day of each of the twelve months preceding the end of the company's fiscal year.

Expands the definition of oil and gas producing activities to include non-traditional and unconventional resources

Allows, but does not require, companies to disclose probable and possible reserve in SEC filings

Harmonize foreign private issuer oil and gas disclosure requirements with those domestic issuers

In the article by Rob Arnott ( 2004) describe the role of reserve report, the adequacy of company reserve disclosure, the interpretation of the existing Securities and Exchange Commission rules and consequently whether recent concerns are industry-generic or limited to certain companies.

International Accounting Standards Board

Separately, the International Accounting Standards Board (IASB) an in depended standards body reviewing accounting principles, is looking at all types of industries, including oil and gas industry.

In the other hand, until 2004, IFRS does not contain a specific standard for oil and gas activities. Currently, oil and gas companies, which prepare their financial statements, should follow IFRS standards, such as:

IFRS 6 "Search and evaluation of mineral resources",

IAS 8 "Accounting Policies, Changes in Accounting Estimates and Errors" regulate the effects of changes in estimates of reserves,

IAS 16 "Property, Plant and Equipment" in part regulates the accounting of costs for construction, the effect of certain provisions do not apply to oil and gas activities

IAS 18 "Revenue" applied with some adjustments,

IAS 23 "Borrowing Costs" regulates the capitalization of interest on loans in the oil and gas assets,

IAS 36 "Impairment of Assets" is used without any modifications to account for impairment of oil and gas assets,

IAS 37 "Provisions, Contingent Liabilities and Contingent Assets" is applied to the recognition of expenses and obligations to clean and restore area.

IFRS 6, "Search and evaluation of mineral resources" was released in November 2004, regulated by the region was very narrow: the standard is limited to outlining the requirements for the accounting of expenditures on search and evaluation of reserves, as well as their reflection in the statements. Board of IFRS explains the situation that way minimizes future amendments to the standard has withdrawn as a professional discussion about the full standard continues.

Issue standards relating to oil and gas activities, shows serious intentions of the Board to resolve the issue of IFRS accounting and reporting in a specific industry, making reporting more comparable. Robert P. Garnett (2006), IASB board member, maintains that IASB seeks reserves definitions that are accepted by all oil and gas producers and that have universal support for both geological use and financial reporting.

However, it is a step towards more detailed and cumbersome IFRS standards, which originally were supposed to describe only the principal points of accounting and reporting.

Overview of accounting standards in the United Kingdom, Russia and Norway

UK perspective

According to final report of Oil and gas reserve Committee (2005), in the United Kingdom oil and gas companies have to follow Statements of recommended practices(SORP) for Oil and Gas industry, which required by Accounting Standard Board (ASB). "The primary objective is to provide consistent volume and associated value assessments such that investors may compare financial performance. The estimation guidelines are imbedded in their financial accounting regulations. Typically no overall reserve and resource classification context is supplied and the application guidelines take on the format of "rules".

Under SORP, reserves may be disclosed, at company's choice, as either "Proven developed and undeveloped oil and gas reserves" (option 1) or "Proven and Probable oil and gas reserves" (2P- option 2). Its 2P definitions clearly require that there should be a 50% statistical probability that the actual quantity of recoverable reserves will be more than the amount estimated as proven and probable and a 50% statistical probability that it will be less. Further "the equivalent statistical probabilities for the proven component of proven and probable reserves are 90% (probability actual =/>than estimated) and 10% (=/< than) respectively" (Mitchell, J, 2004).

Russian perspective

In the case of Norway and Russia, government agencies attempt to capture the full resource base in order to project future production potential for the country and are not primarily concerned to show recoverable volumes and values accruing to individual companies.

It should be noted that in Russia are used as the Russian Accounting Standards, as well as International Financial Reporting Standards (IFRS) or U.S. accounting standards (U.S. GAAP). The choice of what standards use depends on the oil companies. In Russia, among major oil companies increasingly used financial accounting standards under U.S. GAAP standards, because it is recognized on stock exchanges in the U.S., constituting more than half of the stock market.

According to Oil and Gas Reserve Committee (2005), in Russia undiscovered reserves split into 3 categories that can be roughly described as prospects (D1), leads (D2), and plays (D3). The Russian reserves classes A, B, and C1 grossly correlate to SPE Proved Developed Producing (PDP), Proved Developed Non-Producing (PNP) and Proved Undeveloped (PUD) respectively. Category C2 encompasses SPE probable and possible (unproven) and can only be dissected by detailed examination of the information available. Although probabilistic methods are rarely applied in Russia, this could be used as a basis for defining a 2P (best) versus 3P (high) estimating. In Russia the term reserves used for all types of discovered volumes whereas the SPE uses the term reserves only for the remaining, commercially recoverable portions of discovered volumes.

Norway perspective

There is the same situation in Norway. Norwegian companies allowed using their domestic standards, Norwegian Accounting Standards (NAS). Norway's reporting method is more lenient than that of more stringent countries like the United States, requiring a cash flow statement only for large companies. Moreover Norwegian companies are allowed to use international accounting standards - IFRS - in the consolidated accounts (in the EU/Norwegian regulation version).

The Norwegian Petroleum Directorate classification (NPD-2001) is based on the SPE/WPC/AAPG 2000 classification but expanded to utilize categories that differentiate projects based on their commerciality, that is, their maturity towards full producing status..

The concept of proved reserves according to deterministic criteria is not recognized from the SEC or SPE definitions. P90 reserves are however both a reasonable and simple, well defined substitute, remembering that future, uncommitted projects are not allowed to contribute to the 2P nor 3P reserves as this would distort the P90 of the distribution.

While the terms Proved, Probable and Possible are not utilized, the definitions of low/1P, base/2P, and high/3P estimated quantities allow derivation of these entities if required, notwithstanding that the base is the mean and not P50(OGRS, 2005).


From literature review we can underline that I n recent years, intensified the process of reform of accounting standards, as well as the existing accounting practices did not fully meet the needs of external users to disclose information about the company. As a result, companies that use the standards of the country in which there are, also must prepare their statements using accounting standards of individual foreign countries or international accounting standards.

It should be noted that the U.S. has already gained considerable experience in accounting for the oil companies. There are sufficiently detailed standards for the industry, while IFRS is only beginning to develop special rules.

The need for special accounting rules in business investment, and special reporting requirements due to high-risk nature of the activities of oil companies, as well as the specific type of oil company assets - oil and gas reserve