PUD Reserves Converted in Practice: Impact of the SEC’s Final Rule

Abstract

Abstract This paper offers new methods to navigate the United States Securities and Exchange Commission (SEC) modernized reserves regulations to help oil and gas companies understand and minimize the negative financial implications of overbooking Proved Undeveloped (PUD) reserves. We show how revising SEC disclosures to represent PUD volumes in two parts, (1) development for the next three years and (2) development beyond three years, aligns with both SEC disclosures and lending requirements, thus reducing uncertainty. Since 2009, roughly half of all exploration and production (E&P) SEC filers have not complied with its Five-Year Rule, revealing a trend of overbooked reserves that have influenced hundreds of corporate bankruptcies impacting billions of dollars. These bankruptcies could have been avoided with an exemption to the Five-Year Rule, which SEC regulations allow under specific circumstances, yet rarely grant. Many operators fund the development of PUD reserves through reserve-based loans (RBLs), which require repayment in three to five years with semi-annual redeterminations. This disclosure revision does not require a change in SEC regulations; it simply requires more SEC flexibility in granting exemptions to the Five-Year Rule, ultimately providing comparability of reserves volumes, reasonable certainty to capital availability, and clearer financial analysis for investors. We compiled PUD reserves data from 2009 to 2022 using a database of over 3,500 annual filings spanning 226 companies, comparing operators' ability to convert PUD reserves to proved developed producing (PDP). Our PUD conversion analysis involved first calculating a company's Annual PUD Conversion Rate, which the SEC and financial analysts expect to equal 20% per annum. Percentages below 20% have a higher risk of receiving an SEC comment letter requesting additional information on a filer's PUD development plans. Over the 14 years of data reviewed, 65% of companies did not achieve a PUD conversion rate of 20%, and 50% did not achieve a rate of 15%. These results are not problematic when viewed in the context of newly established or growing companies. Additionally, if PUD reserves grow, the annual conversion rate should not necessarily equal 20%. This metric offers limited insight into a filer's ability to convert PUD reserves over a five-year period but still elicits scrutiny from the SEC. Working from the Annual PUD Conversion Rate, we then calculate the Five-Year PUD Conversion Rate. This approach produced the most noteworthy findings. This method calculates whether a company converted all its PUD reserves to PDP within five years based on SEC guidelines. After culling data resulting from bankruptcy, acquisitions, or poor data quality, we found that roughly half of E&P operators did not convert their PUD reserves to PDP over five years. This research shows that the overbooking of PUD reserves continues to be an industry issue that could be remedied through modified disclosures and leniency in PUD development timing. These revisions provide a solution for booking reserves volumes within the existing SEC regulations.