Sunday, October 2, 2011

Comment on PetroBakken Reserves

I commented on another blog regarding PetroBakken (PBN) and received the following question.  Since the response explains some of the technicalities of reserve reports, I have posted it here for educational purposes. 

Thanks very much for reading and making a comment: it is very useful to consider a problem from all angles, to be sure. Therefore, could you please tell me how you arrived at the number of $49.40/boe as three year cost. Do you know for sure that it doesn’t include interest and G&A–and can you prove that point?
On your own blog (“PetroBakken – 2010 Annual Review“), you wrote:
In conclusion, it is vital that potential investors calculate returns on a per share basis and avoid the headlines in most press releases. I could have spent more time getting into how the PDP reserves (the BOE’s actually on production) cost $64.47/boe to find, develop or acquire, but why bother? The company nets around $42/boe for each barrel produced (Revenue less cash costs). Usually you want to find the barrel of oil for less than you can sell it for.
It appears to me that the production cost per barrel, between Q4 2010 and today (presumably Q2 2011) has dropped (by your calculation) 64.47-49.40 =$15.07 boe. That is a very dramatic difference. Could it possibly be explained by the metrics in the chart above, which makes it clear that initial production will be much more costly and as more wells come online, the legacy production will continue at a lower rate for many years. Thus we would expect that number (cost per barrel) to come down regularly in the months to come.

My Response

This is the last free analysis, and my last discussion on this subject.   I don't want to beat a dead dog.

How did I arrive at my number, it is calculated using the net change in proven reserves over the last three years divided by the capital spent. 

Do I know for sure that it doesn't include interest and G&A?  This is a silly question... Yes I know for sure and No it doesn't include those items.  You want proof?  Go to PBN's website, and download the Q2 financials.  Go to page 2.  Revenue less royalties less production expenses is your operating netback (transportation should also be deducted).  This is the cash left over after you produce a barrel of oil and sell it.  With that money you have to pay normal business expenses and hopefully find another barrel.  You need a recycle ratio of around 1.3 to just breakeven. 

Next problem.  The $64.47/boe is for a proven developed producing (PDP) barrel.  These are the reserves at are actually on production (producing oil or gas) as of the date of the reserve report.  The $49.40/boe is for a Proven (1P) Barrel.  Proven reserves (1P) are ones that are very highly likely to be recovered.  However 1P reserves includes PDP reserves (already mentioned) + proven developed non-producing + proven undeveloped reserves (PUDs).  Proven developed non-producing are wells that are drilled but need to be tied in to production.  PUDs are wells that are not drilled but planned on being drilling usually within a year.  PUDs are typically wells that are drilled in-between two known wells in a field (infill drilling) and therefore have a very high likely hood of containing the estimated reserves. 

Further, 2P reserves included 1P reserves plus fringe wells that haven't been drilled and may or may not be economic. 

The PDP cost of $64.47/boe is very high but can't be taken in isolation.  The three year average proven reserves is a good number but not as conservative as PDP for the reasons mentioned above.  You have to understand the proven reserves contain a number of assumptions.  These assumptions include what the reserves of the PUDs will be and what the actual capital cost will be to bring the well into production.  When the PDP is consistently higher than 1P reserves cost over a 3 year period you can know one of two things is happening.  One is either the reserves are not what they forecasted or the capital cost have been much higher than estimated.  For PBN I would guess it's a combination of both. 

If you don't understand these things I would strongly recommend consulting a professional for investment advice. 

Best Regards,


  1. For the record, I am a blogger and a theologian and never claim to be an investment advisor. I am an investor of my own personal wealth, esp. in oil stocks, and I do indeed consult the advice of experts, including such people as Roger Serin at TD Securities. As for needing a professional investment advisor, I am DIY and doing well for myself, losses on PBN notwithstanding. Nevertheless, while I disagree with you strongly for various reasons, I do appreciate the vocabulary lesson.

    Finally, you be would so kind to answer, I would really like to know, in what aspect of the oil industry that you, as a professional engineer, are actually engaged; your blog and your analysis are at such a level of sophistication, I assume you must be involved in exploration, drilling, reservoir analysis, or production. Which is your field of speciality and what is it that you actually do in your day job. Is your CV available? Obviously publishing such information would buttress your street cred. But saying that you are involved in the oil and gas industry doesn't make you an expert, for you could be involved in building roads to the oil fields, wiring the electricity to field ops or something else (a maintenance guy in the company buildings??). I.e., you could be a engineer in the field working as a civil or electrical engineer with no real experience in petroleum engineering.

  2. Hi Petros,

    You look to Roger Serin for advice? Let me tell you a little story about Roger. Roger was looking to buy some natural gas wells from a company (that I owned) to pad his retirement account. When the company told him to take a hike, he promptly started downgrading the stock. He is no longer allowed to cover the company in question. You want to talk about conflict of interests. I’ll let you be the righteous judge of character in that case.

    As for my background, that is confidential. However if you send $500 to my paypal account we’ll see what happens.

    I am an engineer, love to read and have a lifelong passion for learning. What more do you need to know? I don’t judge people based on the number of letters after their name and I would recommend the same. Francis Chou used to be a Maytag repairman (or something like that) and I highly respect him.

    All of the information I shared about reserves and reserve reports is not all that complicated. If you read the reserve report from any oil company you’ve invested in you would learn all about those categories. The trouble is most people either find them too technical or too boring. Jim Rogers once said if all you did was read annual reports you would be miles ahead of other investors... it's so true.


  3. Kevin:

    You seem all too willing to accuse others of crimes. (1) You said, "Insiders are giving their friends an opportunity to sell before the news hits the steets. Since the insiders don't own any shares, they don't need to sell." Well this is just wrong (insiders do own shares) and you offer absolutely no evidence --just pure speculation. Plus, telling your friends before the public about impending decision is securities fraud; in case you wondering, that's called "insider trading" and it is against the law; (2) You have now also publicly accused Roger Serin of dishonesty, of downgrading a security because of a personal vendetta--while I'm not sure this is crime, it is certainly unprofessional, dishonest, and unethical and would be severe blight on his reputation. So if you are unable to prove accusation in a court of law, its probably better to take it back before you have a defamation law suit. This is what gives me the general impression that you are an amateur; because a professional would be much more careful in the way they go about accusing others of dishonesty and fraud. A professional would never open himself up to a lawsuit over things he can't prove.

    But another thing that gives me the impression that you are not yourself totally transparent is that you have twice suggested that I should pay you; you say this was your last "free" analysis, suggesting that you are sufficiently professional that you could charge for you services. Next you say that you would require $500 to tell me what area of the oil and gas business that you are actually involved in. So from henceforth, Kevin, I will consider you a non-specialist, since I have no choice but to think that you are actually hiding from everyone what your real area of expertise is. But you want my money. This does not inspire confidence. First tell me what your experience is. Then I will determine whether I can pay you for your services. That's the way it works in the real world. But you claim not to be a professional (on your About Me page). Well, there is a disconnect between your claim to be a non-professional, on the one hand, and your desire to be paid and your ueber-confidence on the other.

    By the way, I've made this comment for educational purposes.

  4. Petros,

    I don’t have time for your useless and baseless claims, but thanks for coming back for round three. While I don’t have to defend myself, this link should suffice.

    Since you have accused me of being dishonest and a fraud, I would tread very lightly. If you want to comment on my blog again, I expect a full apology and a more respectful dialog.


  5. I agree with the article that Serin shouldn't have been covering Peyto and that full disclosure is insufficient. That still doesn't prove that he downgraded the stock because of a personal vendetta, but nevertheless I apologize for accusing you of wrong on this count. You have sufficiently proved that something not quite right was going on.

    Still, what is your evidence that insiders at Petrobakken have given their friends a chance to sell before the news of dividend cut was made public?

    I did not say you were a fraud or dishonest. I said that you gave me the impression that you were an amateur and that you are not being transparent--which is not quite the same thing. And I did not start the lack of respect thing. Remember, you corrected my (British) spelling on my blog, and you said my question was "silly". I don't care if you approve this comment, because that would help end the discussion.

  6. Hi Peter,

    While I don't know if that was a full apology, I will accept and offer the same in return. I wasn't aware that you are British.

    Just to give you a little background... Back in 2005 someone was saying that Peyto was about to take a reserve writedown. Peyto even hired a second independent reserve evaluator to disprove this rumour. GLJ and Paddock both evaluated the reserves to be with a few percentage points. Now as for why Peyto management blew the whistle, I will leave that up to you to decide.

    If you do want to see some candor, I would suggest reading what Don Gray and Darren Gee (from Peyto) have said in the past about this kind of stuff in the oil patch. Darren's latest monthly CEO letter is another example. Let's just say that they aren't real popular because of it.

    I never said PBN insiders were spreading insider information. All I'm saying is that I wasn't born yesterday. When PBN drops 20% in one day on no news something is up. I heard something today which may be part of the reason. Don't get your hopes up... it's not insider information (but it is information).

    As for my "silly" comment, I apologize if I offended you. It's amazing how when one person says something the other person hears something totally different (just ask my wife, or blame the McGurk effect). I just found it silly that a shareholder in PBN didn't know what an operating netback was despite it being on the second page of their Q2 results. And here I thought I was being gentle.

    Now this may sound harsh, but I'll say it anyway. I don't have time to debate things when the other party doesn't want to do the appropriate analysis or lacks a basic understanding of key concepts. That is why I recommended professional help in selecting oil and gas investments.

    Best Regards,

  7. Kevin:

    I am more bemused than offended by your tone, which you didn't know could be taken as condescending. So no need to apologize, but I am glad that you accept my apology. As for me, I try to have a thick skin as a blogger and sometimes to respond in kind.

    As an investor, there are certain things I'm looking for; if an oil company, e.g., has a vast amount of oil in the ground that is not yet calculated into the market price, that is interesting to me. So I'm not too worried about current proven reserves vis-a-vis the cost to produce them. There was a great comment on my blog that is reflective of my own point of view:

  8. Hi Peter,

    Your like the energizer bunny, you just won't quit.

    I have a thick skin however when you attack my credibility with no basis, I take offence.

    Your comment regarding is oil in the ground is evidence you don't understand what's important about analyzing O&G companies. Your not concerned about the reserves and the capital it costs to find them? That is fine. I am concerned because that is how a company makes money.

    I read the comment on your blog. He didn't comment here or at least it didn't come through. If the confirmation page doesn't come up the comment wasn't submitted (a blogger glitch). I have had this happen several times to me.

    Now as for his comments. He's correct in what he says regarding land and reserve calculations. That is why I said above, you cannot take the PDP F&D cost in any one year in "isolation". I then said a three year average for proven is better but not as conservative.

    I commented on the land problem in my PBN 2010 annual review and raised three questions.

    1) How prospective is the land (feel free to speculate)? Some blogger feel it's like shooting fish in a barrel.

    2) Why are they buying all this land when they supposedly have thousands of drilling locations in the Bakken?

    3) Why are they drilling wells to retain land? Is land an asset or liability? Is land retention drilling the best use of shareholder cash?

    I would like to add two more questions just for fun (not from my 2010 annual review)...

    4) This year (2011) when PBN buys a bunch more land are we suppose to exclude that capital cost also from our F&D calculations again?

    5) Why do you believe management when the try to mislead by showing gross production increases yet it is actually declining on a per share basis? The same could be asked for reserves?

    Listen, I already told you no more free analysis. Ask your buddy Don to answer the above "great" questions. If course you won't, because you flagrantly disregard any fact or evidence that is contradictory to your thinking.

    I will do the same analysis next year and we'll see if PBN actually created any shareholder value (on a per share basis).

    Lastly, do you think O&G executives allow the engineers to spend a dollar in capex without a strong understanding of what the F&D costs will be? Or, do you think it's just a game of lets drill some holes, and not worry about the costs?

    I'm being dead serious. You said, "So I'm not too worried about current proven reserves vis-a-vis the cost to produce them."

    That's the equivalent of saying, "I'm not too worried about how many widgits we produce vis-a-vis the cost to produce them."

    Don't make me use the silly word again. I am done with you. Quit wasting my time and your money. I will not be responding further.

    Best Regards,