The U.S. Securities and Exchange Commission recently issued its final rule to modernize and update its oil and gas reserves disclosure requirements. The Final Rule introduces significant changes to the information that companies are required to or may disclose and the manner in which such information is presented.

The final rule (Final Rule) is intended to provide investors with a more accurate and comprehensive picture of the oil and gas reserves that a company holds by aligning the disclosure requirements with current practices and changes in technology. Compliance with the revised disclosure requirements will take effect for registration statements filed on or after January 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on December 31, 2009 and thereafter, subject to possible extension by the United States Securities and Exchange Commission (SEC). To maximize comparability of disclosure, the SEC will not allow early adoption of the revised disclosure requirements.

Key Provisions

In summary, key provisions of the Final Rule include:

  • allowing previously excluded resources, such as oil sands, to be classified as oil and gas reserves;
  • requiring that oil and gas reserves be reported on the basis of final products, distinguishing between traditional and synthetic oil and gas;
  • permitting the use of new technologies to calculate oil and gas reserves;
  • expanding the categories of resources that may be disclosed in SEC filings beyond proved reserves to include probable and possible reserves;
  • requiring companies to report oil and gas reserves using an average of the first-day-of-the-month price of each month during the 12-month period prior to the end of the reporting period;
  • codifying, with updating revisions, Securities Act and Exchange Act Industry Guide 2: Disclosure of Oil and Gas Operations as part of Regulation S-K;
  • requiring companies to report the independence and qualifications of the preparer or auditor of their reserves estimates;
  • requiring the filing of reports by companies that rely on a third party to prepare reserves estimates or conduct a reserves audit; and
  • harmonizing the oil and gas disclosures required of foreign private issuers with those required of U.S. domestic issuers.

Oil and gas producing activities

In the Final Rule, the SEC amends the definition of "oil and gas producing activities" to include sources of oil and gas that involve extraction by means other than "traditional" oil and gas wells. Examples include bitumen extracted from oil sands and oil and gas extracted from coal and shales. Consistent with the shift in focus away from sources of oil and gas to final products in the definition of "oil and gas producing activities," the amendments provide that reporting of oil and gas reserves must be based on final products. The amendments provide, however, that final products that are traditional oil and gas will be reported separately from those that are synthetic oil and gas. The SEC reasoned that investors may benefit from this breakdown between traditional and synthetic final products because of the additional costs that can be associated with unconventional oil and gas producing activities.

New technologies

The Final Rule also provides that new technologies may be used to establish oil and gas reserves, rather than the former reliance upon actual production or flow tests. These new technologies must be "reliable," as defined in the Final Rule, and must be disclosed in the producer's initial filing with the SEC in which reserves estimates are disclosed and in any subsequent filings disclosing material additions to reserves estimates.

Voluntary disclosure of probable and possible reserves

Many companies currently provide probable and possible reserves estimates on their websites and in press releases, and the Final Rule now allows companies to report this information in their SEC filings. Probable and possible reserves estimates, however, are less certain than proved reserves estimates, which may increase the litigation risk. For this reason, the SEC has made the disclosure of these unproved reserves estimates voluntary.

Oil and gas reporting price

The Final Rule requires that companies report oil and gas reserves using an average of the first-day-of-the-month price of each month during the 12-month period prior to the end of the reporting period. As compared to using a single-day price, this approach will facilitate greater comparability among companies and mitigate the variability that a single-day price may have on reserves estimates. The SEC simultaneously revised its full-cost accounting rules for oil and gas reserves to use the same 12-month average used for oil and gas reserves reporting. This revision will reduce duplication in the reserves estimates process for companies and decrease the potential for investor confusion that could result from the preparation of multiple reserves estimates based on different price calculations.

Codification of Industry Guide 2

In addition, the Final Rule provides for the codification, with updating revisions, in new Subpart 1200 of Regulation S-K of Securities Act and Exchange Act Industry Guide 2: Disclosure of Oil and Gas Operations. Subpart 1200 also includes new disclosure provisions, such as disclosure of reserves from non-traditional sources (e.g., bitumen, coal and shale), optional disclosure of oil and gas reserves' sensitivity to price, and disclosure of the development of proved undeveloped reserves (PUDs). The new rules specifically require an explanation of the reasons why any material amounts of PUDs in individual fields or countries have remained undeveloped for five years or more after being disclosed as PUDs. (See the Final Rule link below for the full text of Subpart 1200.)

Third party report

If a company represents that a third party prepared the reserves estimate or conducted a reserves audit of the reserves estimate, the company must file a report of the third party as an exhibit to the relevant SEC filing. The report must summarize the scope of work performed by, and the conclusions of, the third party. The report must include certain information, based on the audit report guidelines of the Society of Petroleum Evaluation Engineers, such as:

(i) the purpose of the report and for whom it was prepared;
(ii) the proportion of the company's total reserves covered by the report; and
(iii) the assumptions, data, methods and procedures used to conduct the reserves audit.

MD&A topics of discussion

In the Final Rule, the SEC provides guidance about the topics a company may find appropriate to discuss in its Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Such topics include changes in reserves estimates, technologies used to establish reserves estimates, and the company's ability to convert proved undeveloped reserves to proved developed reserves. While MD&A is typically presented as a self-contained section in a registration statement or other filing, the SEC noted that because a substantial amount of the new disclosure requirements in Subpart 1200 will appear in tabular format, it would be acceptable to place discussions that are directly relevant to the disclosure provided pursuant to Subpart 1200 with the relevant table (with appropriate cross references), rather than including it in the MD&A section.

Form 20-F conforming changes

The Final Rule also provides for conforming changes to Form 20-F -- the form on which foreign private issuers file their annual reports and Exchange Act registration statements. In particular, the SEC eliminated from Form 20-F the Appendix A to Item 4.D – Oil and Gas and inserted in its place reference to new Subpart 1200 of Regulation S-K. This change expands the oil and gas disclosures required of foreign private issuers, making them consistent with those required of U.S. domestic issuers. However, a foreign private issuer may still exclude required disclosures about reserves and agreements if its home country prohibits the disclosures. Also, the SEC clarified that the new disclosures will not apply to Canadian foreign private issuers reporting under the Multi-Jurisdictional Disclosure System using Form 40-F that comply with NI 51-101.

Effective date of compliance

Compliance with the revised disclosure requirements will take effect for registration statements filed on or after January 1, 2010, and for annual reports on Forms 10-K and 20-F for fiscal years ending on December 31, 2009 and thereafter, subject to possible extension as the SEC discusses and coordinates its revisions with the Financial Accounting Standards Board and the International Accounting Standards Board. To maximize comparability of disclosure, the SEC will not allow early adoption of the revised disclosure requirements.

A copy of the Final Rule can be found on the SEC's website at: http://www.sec.gov/rules/final/2008/33-8995.pdf.

Kevin Cramer is a partner in the Business Law Department of the firm's New York office where he practices U.S. securities and M&A law.
Stan Magidson is a partner in the Calgary office of Osler, Hoskin & Harcourt LLP, heading up Osler's business law practice in Western Canada.
Mark Shubitz is an associate in the Business Law Department in the firm's New York office.

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