Accurately Disclosing Oil Reserves

Thom Lambert —  8 February 2006

Yesterday’s W$J reported on an effort by oil companies to change the way reserves are reported in securities filings. SEC rules, it seems, mandate that reserves be measured in a manner that understates the actual amount of available oil. For example, the rules (available here) require that only proven reserves (those for which there is a “reasonable certainty” of actual recovery) be reported. On first glance, this doesn’t sound unreasonable, but the manner in which “reasonable certainty” is determined essentially translates the criterion into one of “virtual certainty.”

First, the reserves must be recoverable using fairly old-fashioned technology. New technologies, of course, can recover harder-to-reach oil. While oil companies know such oil is there, and are quite confident that they will be able to get it, the SEC doesn’t permit them to report the oil.

Second, it must be economically feasible to recover the oil at the end-of-year price for the previous year. There are a couple of problems here. First, the one-day, end-of-year price is notoriously variable and may bear little resemblance to the average prevailing price. For example, WTI Oil Price data reveal that the year-end price of oil in 1999 was 33.5% higher than the annual average price; in 2001, it was 23.7% lower. An average price of some sort would present a more accurate picture of economic conditions. In addition, ignoring oil that’s clearly available, but not profitably recoverable at this point in time, paints an unduly bleak picture of our energy situation. If and when prices rise a bit in response to increased demand and/or reduced supply, lots more already-discovered oil will become economically recoverable. Anyone wishing to evaluate the true state of oil reserves would want to know about this discovered, but not yet economically recoverable, oil. SEC rules pretend it doesn’t exist.

The SEC insists that its somewhat arbitrary rules are necessary to prevent fraud and to provide investors with “apples-to-apples” comparisons of energy companies’ reserves. Perhaps the rules do that, but at what cost? If the goal of mandatory disclosure is to provide investors with an accurate picture of a company’s financial condition, then shouldn’t the information disclosed be that by which the company judges its own financial health and upon which it bases operating decisions? In fact, the major oil companies, which base all sorts of business decisions on reserve data, internally measure their reserves using alternative standards jointly developed by the Society of Petroleum Engineers and the World Petroleum Council. Those same standards are used by the Energy Information Administration (EIA) of the U.S. Department of Energy and the Minerals Management Service (MMS) of the U.S. Department of Interior. Reflecting technological developments and permitting recognition of highly probable reserves, these alternative standards present a much clearer picture of how much oil is really available.

Isn’t this the information investors should have? As the W$J reported last week, venture capital is flowing freely toward developers of alternative fuels. That makes sense if that’s the highest and best use of that capital, given the current energy situation. But it doesn’t if it’s not. Of course, venture capitalists are unlikely to base their investment decisions on SEC disclosures regarding oil reserves; the capital markets will eventually see through (and ignore) metrics that are unreliable. It does seem, though, that the SEC could assist in the effort to channel capital in the right direction by ensuring that the disclosures it mandates reflect economic reality.

Thom Lambert


I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

5 responses to Accurately Disclosing Oil Reserves


    So the regulators impose a disclosure requirement practically calculated to lead to . . . more regulation. That does seem surprising.

    As Thom notes, one problem with mandatory disclosure of information set x is that it seems to preference information set x over information set y. There are many market mechanisms to overcome this distortion, but there are few political mechanisms to do so, and even the market mechanisms are imperfect:

    For example, even if non-mandatory information would be more valuable to disclose, disclosure always carries with it a lawsuit risk. At the margin, unless the value of disclosure is greater than the cost, the information won’t be disclosed. For information subject to mandatory disclosure, this calculation is biased in favor of disclosure. Not so for the non-mandatory information. To the extent the mandatory and non-mandatory information sets are substitutes (even imperfect ones), the combination of mandatory disclosure regime and lawsuit risk surely induces some substitution from more-useful to less-useful information.


    I agree with Bill and Michael that oil companies can, and do, disseminate more accurate reserve information (i.e., the data they themselves rely on) despite the SEC rule. As Michael notes, they’d likely do so absent any regulatory intervention.

    I do think, though, that there’s a real danger in the government mandating disclosure of an affirmatively misleading figure. There’s a lot of misinformation in the press regarding our purported energy “crisis.” Pressured by worried constituents, governments are scrambling to invest public money in alternative fuels. Unlike venture capitalists, who are motivated by profits and will see through faulty metrics, government “investors” are motivated by constituent pressures. Those pressures are largely influenced by media reports. Journalists are busy folks and will tend to believe (quite rationally, I suppose) that the information in a mandated securities filing is accurate. Thus, we end up with all sorts of news stories about how major oil companies are producing at record levels, while their reported reserves are oh-so-small. Politics takes over from there.

    Michael Guttentag 8 February 2006 at 9:39 am

    A big vote of support for your argument: “If the goal of mandatory disclosure is to provide investors with an accurate picture of a company’s financial condition, then shouldn’t the information disclosed be that by which the company judges its own financial health and upon which it bases operating decisions?� This is what I have argued for elsewhere, and I think the existence of a commonly accepted standard for oil reserves makes the argument all the more plausible here.

    If I may go further, you may ask why information in this form might not happen without regulatory intervention?


    I assume oil companies publicly disclose reserves calculated using the alternative standards. Off hand, I can’t think of an SEC regulation that would prevent them from doing so. It seems similar to the disclosure of pro forma earnings, which companies do all the time. Therefore, I suspect that capital is not being erroneously channeled.

    I agree with your broader point that if the SEC metric is worthless, it should perhaps be changed.

Trackbacks and Pingbacks:

  1. TRUTH ON THE MARKET » More on the SEC’s Antiquated Disclosures Rules for Oil Reserves - April 27, 2006

    […] Back in February, I criticized the SEC’s rules regarding how energy companies must disclose their oil reserves in securities filings. My main point was that the conservative manner in which the SEC measures reserves is quite different from the approach the oil companies themselves take when deciding how to invest billions of their own dollars. If the SEC is going to require disclosure of some reserve estimate, shouldn’t it be the estimate upon which managers are willing to bet the corporation’s money? […]