It is a bit of encouraging news to read Ian Urbina’s report that the SEC is issuing subpoenas to gas companies to investigate whether or not reserves might be inappropriately reported. Urbina’s previous articles highlighted some industry insiders’ opinions that assets may be overvalued, perhaps to the point of criminal misrepresentation. Lawmakers, in response to the information presented by Urbina and the New York Times, called for investigations from a number of quarters, including the SEC (see details here: http://news.maars.net/blog/2011/06/29/lawmakers-seek-inquiry-of-natural-gas-industry/).
In order to better understand the SEC’s capacity to investigate, though, we must understand the basis by which a gas company is allowed to book the value of its gas property holdings. This hinges on the difference between PD (proven, developed) and PUD (proven, undeveloped) reserves, and how each is calculated. In the shell game that is a shale play, the difference between PD and PUD reserves is an important concept. Terrel Shields, a blogger (and Registered Geologist, Certified General Appraiser–Wellsite services and mineral rights appraisal since 1973), has this to say about the SEC allowing PUD to be the basis of asset booking for SEC purposes (to report to shareholders):
In my opinion, the SEC made a serious mistake by allowing companies to “book” reserves based on PUD – Proven undeveloped – acreage. Proven undeveloped is an oxymoron as “development” (drilling) may “prove” that it isn’t there and the individual wells are performing far less uniform than many believe. The SEC requires these companies to drill those PUD locations within 5 years and so there is a lot of scrambling to drill for the numbers rather than where the best locations are.
James “Chip” Northrup, a 30-year veteran of the oil and gas planning and investment business, points out that the valuation process for SEC/investment purposes is based on PUD reserves, while the NYS regime for ad valorem taxation (the contribution that the value of the mineral reserves make to the property tax levy) is based only on proven, developed gas– in fact, only documented production, measured in hindsight, is taxed. However, undocumented reserves– which undeveloped reserves are by definition– are exclusively used when selling stocks or other investments. The measurement protocol for payouts (taxes and royalties) is the smallest possible number– gas actually produced and captured for sale. Any gasses lost to the atmosphere or flared off are not counted (although these both add greatly to global climate change and so have public cost). Any gas left in the ground, because it is uneconomic to recover it at this time, is similarly not counted.
On the investment side, the largest possible number is used– PUD, aka the undocumented estimate of gas in the shale. The industry is allowed to compute this assessment based on a proprietary methodology that is not shared with government regulators, as it is considered a “trade secret.”
So, back to what is within the purview of the SEC to investigate. If some in the industry were not content with the terribly skewed way of counting gas reserve assets, and went beyond that to otherwise exaggerate the value of the investment, there may be some indictments coming. But, the largest part of the distortion of the value of the Marcellus Shale resource may be defined to be entirely lawful. In which case, it may be difficult for the SEC to fully investigate and reveal the problem.
However, they may provide some valuable pieces of the picture, which, combined with Ian Urbina’s continuing investigations, and the work to add to our understanding done by other journalists and bloggers, may eventually add up to a clear public comprehension of the distortion. NYS Attorney General, Eric Schneiderman, also has issued some subpoenas. NYS Comptroller Tom DiNapoli has initiated shareholder actions to encourage gas companies to accurately report risks. And, NYS legislation has been introduced to make sure that gas leasing entities are leaving a sufficient paper trail (attaching enough information to deeds) to make their movements with regard to locking up land under lease traceable.
As governmental units, both state level and federal, look more closely at gas drilling, we will gain more understanding. However, we must always keep in mind the limits of the governmental agency doing the looking. If the DEC, using the SEQRA process, it will only be able to accomplish what is allowed in that process (which, by the way, DOES NOT include a cost-benefit analysis, which law has clearly shown to be not permitted as a component of the SEQRA process). The SEC can look at the investments that it has purview over (public companies, not partnerships or LLCs). The true cumulative assessment that any of us can make as an individual is expressly forbidden any one governmental agency.