The issues involved in the full cost-successful efforts controversy were perhaps less important than the message the controversy itself conveyed: For the purposes of either predictive or comparative investment analysis, the earnings figures of oil and gas producing companies have rarely been worth the ink used to print them.
The thoughtful investor must ask: How can I measure (1) the value of a producing company’s assets and (2) its operating success? The value of oil and gas reserves in the ground is the key to both answers. If a company’s increase in estimated reserve value represents a reasonable return on its investment outlay for the period, after considering the degree of risk associated with the reserves, then the company is doing well.
The financial statements of oil and gas companies have not displayed evaluations of oil and gas reserves in the ground; their balance sheets either omitted these assets or represented them in terms of historical acquisition costs. The SEC’s August proposal, however, will require companies to provide estimates of these values in terms of what it calls “reserve recognition accounting.”
The author explores the kinds of assumptions and caveats that underlie such estimates. Current prices differ from well to well, and future prices of production over the life of a recently drilled well are anybody’s guess. In many cases, the judgment of geologists familiar with a drilling area is far more important than elaborate mathematical computations. And the investor who relies on reserve valuations should comb the footnotes for contingencies — especially those resulting from recent tax law changes and from significant developments since the balance sheet date.