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SEC Loosening of Rule Let Natural Gas Firms Recalculate Reserves, Potential Profits

Despite concerns that natural gas companies might exaggerate their reserve estimates, the SEC relaxed restrictions on how companies calculate their untapped reserves, according to the New York Times.

Natural gas has been widely promoted across the political spectrum as a key to solving U.S. energy problems. “The potential for natural gas is enormous,” President Obama said recently, referencing an estimate that the United States has enough gas to supply the country for more than a century.

That’s a contention that’s being challenged by a series of New York Times articles over the past few days that show some U.S. Energy Department officials and energy market analysts questioning whether the much-ballyhooed “natural gas boom” is overhyped, or even a “giant Ponzi scheme.” Emails from officials and industry analysts show them raising concerns about exaggerated estimates of gas reserves making the natural gas business appear more profitable than it really is. (Check out the emails.) According to the Times, the industry’s estimates for how well it will produce gas are based on “limited data and a certain amount of guesswork.”

The debate about overstated reserves isn’t entirely new in the industry, which may be why stocks of natural gas companies haven’t taken much of a hit this morning. For example, in 2009, a petroleum geologist with decades of experience wrote a column for a trade publication questioning natural gas production estimates. He later resigned as contributing editor of the column after getting fiercepushback from within the industry.

But setting aside what appears to be an ongoing debate, it’s clear that a rule change made by regulators in 2008 helped boost the perception that untapped gas reserves—and potential profits—were plentiful. The Times details how the Securities and Exchange Commission, bowing to industry pressure, relaxed the rules on how companies calculate reserve estimates:

Previously, companies were allowed to count gas only from areas close to their active wells as part of their “proved” reserves, the amount of gas that a company estimates to investors it will tap. This was meant to prevent companies from claiming reserves of gas based largely on guesswork.
After the rule change, companies were allowed to include gas located farther from producing wells in their reserves estimates, using modeling methods to predict how much gas could be produced from these yet-untapped areas. But the S.E.C. said that the companies, for reasons of trade secrecy, did not have to disclose precise details about the technology they used to estimate reserve sizes. Though the commission considered requiring third-party audits to verify the reserve estimates, the idea was dropped in the end.

The agency’s rule change sent some gas companies’ estimates of reserves—and the companies’ stocks—soaring, according to the Times. It also made the cost of drilling the wells seem small, relative to the enlarged estimates of the potential payoff. 

We’ve reported extensively on the potential safety tradeoffs of hydraulic fracturing—the method used to blast through layers of rock in order for the purpose of extracting gas. (Don’t understand it? Here’s a graphic and a music video.)

Chesapeake Energy, a major natural gas company, stood by its reserve estimates, stating that the “new modernized SEC rules reasonably reflect the advancements in our industry’s ability to predictably produce oil and natural gas resources from unconventional formations." 

In an email sent on Sunday to employees, the company’s CEO, Aubrey McClendon, said the analysts and geologists casting doubt on the industry have been “a relatively small group.” He noted that their claims run counter to the investments made by leading oil and gas giants such as Exxon, Shell, BP, Chevron, and others, and he urged employees to “get involved by joining Chesapeake Fed PAC, our political action committee."

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