What Are Petroleum Reserves?
Authors: Eggleston W.S. 
Published: December 2007

Introduction

The valuation of oil and gas properties often starts a chain of events requiring that estimates of reserves and rates of production be established, costs determined, property, mineral and income taxes calculated, land titles searched, contracts examined and arrangements made for financing. Each of the elements bearing on the final valuation and action taken requires the assistance of one or all of the professions of accounting, law, taxation, economics and engineering. The estimation of petroleum reserves is the particular field of the reservoir, subsurface and valuation engineer. All of these specialties are included within the term "petroleum engineering". The methods, the techniques and the pitfalls encountered in estimating petroleum reserves have been analyzed in text books and professional papers without number. The procedures of estimating petroleum reserves have been standardized to the point where, although the answers may differ, the methods do not. Technical terminology and definitions present a different situation because no uniform standards have been accepted or agreed upon throughout the industry as a whole. Part of this difficulty is probably due to the fact that, while engineers prepare the estimates, other individuals trained in other professions interpret and apply them. Before a series of definitions pertaining to petroleum reserves is considered, it would seem to be pertinent to state some of the reasons why petroleum reserves are estimated.

Reasons for Estimates

Estimates of petroleum reserves are prepared for a specific reason. The purpose of the estimate will in large measure dictate the method employed and the time spent in making the estimate. The estimate is seldom an end in itself, but is merely the first step in a series of calculations for the purpose of gaining knowledge that will influence current or future decisions. Some of the more important reasons for such estimates are as follows.For corporate purposes in setting depletion and depreciation ratesfor corporate accounting andfor tax accounting.For tax purposesincome tax,inheritance tax andcounty or state taxes.For financing purposesbonds and debentures andbank loans.For purposes of purchase or sale of companies or propertiesoutright sale or purchase,merger andconsolidations.For budget purposesdevelopment drilling,production income andrefinery runs.For purposes of unitization or joint operationsdivision of ownership in a field or property.For purposes of gas sales in interstate commercefor determination of production rates andfor price determination.

Purposes of Estimates

Any concept of estimating oil and gas reserves and the processes of making the estimates are influenced by the particular purpose for which the estimates are being made.Estimates made to establish company depletion and depreciation rates have become customary practice in the industry. The rates affect company taxes and earnings, and estimates for this purpose constitute one of the more important responsibilities of the department charged with this duty. Such estimates are generally made by most companies once a year, either at the end of the calendar year or at the end of the fiscal year. The estimates of oil and gas reserves so made are used by the comptrollers department to establish depletion and depreciation rates for the corporation during the coming year, while the tax department uses these same figures to establish cost depletion or depreciation to compute "statutory" depletion for the past year. Supplementary estimates must be made from time to time during the year on individual new producing properties in new producing areas in order for depletion and depreciation to be taken as soon as oil is shipped from the property. To facilitate accounting, the sooner the comptrollers are advised of new producing properties and given an estimate of reserves the better.Estimates made for tax purposes as applied to corporations are almost entirely confined to income taxes and are either for the purpose of establishing cost depletion and depreciation, or for determining if percentage depletion applies.

JPT

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