Overestimating Natural Gas Reserves Results in Bad Investments & Stranded Assets

Natural gas is viewed by many as a cost effective way to produce power that will be an important stepping stone as we move away from fossil fuels. Coupled with reports from government and industry claiming significant recoverable reserves, natural gas seems like a viable option for the future. So what’s the catch? As it turns out, gas companies are financially motivated to issue the most optimistic reports of their reserves, and overestimation of proved reserves grants a false (and dangerous) sense of security in the fossil fuel sector. This sense of security threatens to undermine the purportedly bright future of natural gas, and accurate reserve reporting education and strict implementation is the only way to avoid economic downfalls, as well as preserve our slow-but-steady transition away from fossil fuels.

When companies log proved reserves, they are claiming that they are at least 90 percent certain that they can produce that amount of energy at today’s prices. The Securities and Exchange Commission (SEC), which regulates this process, allows companies to count quantities of gas and oil as part of their proved reserves as long as they plan to drill them out within the next five years; these undrilled resources are referred to as proved undeveloped reserves (PUDs). The company is allowed to count the entire expected lifetime amount of gas for a specific drill site as part of their reserves – long before they break ground, much less understand how fast/slow flowing or dense the shale reservoir may be.

Investors and pipeline companies see proved reserves as the key ingredient for investments, so oil and gas companies are overtly incentivized to produce the rosiest reports possible. Since about half of industry’s proved reserves are undeveloped, this overstatement of ‘proved’ reserves becomes important economically for investors and pipeline companies. Companies such as Shell, El Paso, Stone Energy, and Repsol YPF, among others, have already found themselves in the spotlight, and courtroom, for overstatements of oil and gas reserves. See page 73 here for continued reading on these case studies.

Issues that arise from overestimating proved reserves are complicated, but generally result in stranded assets which can be expensive for rate payers and other companies.  When a gas company touts a large shale gas reservoir, a pipeline company then builds a huge well and pipeline infrastructures to collect and transport this resource and utilities scale up dependence on gas fired power plants (see here). If the gas company overstated the size of the reserve, or it was more complicated and costly to maintain than was initially reported, this will ultimately result in expensive stranded assets.

SEC regulations regarding accurate reserves reports are already in place and significant corporate and/or employee penalties have been issued. Only through rigorous education and ethical enforcement of these regulations can we hope to avoid the economic downfalls caused by overreliance on a limited fossil fuel resource such as stranded assets, financial penalties, and/or lawsuits.

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