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SEC 5-Year Drilling Window – Fact, Fiction and Gray Areas

By April 17, 2022May 17th, 2022Oil & Gas Consulting

, Cawley, Gillespie & Associates

Warning

This article and series is specifically targeted for anyone involved or interested in oil and gas reserves reporting guidelines, methods, issues, calculations and pitfalls. Proceed at your own risk! Furthermore, this topic on the five-year drilling window was previously discussed in two articles I published in November and December of 2017, with portions re-published herein.

Introduction

Drilling locations come with an expiration date once booked in a reserve report. For public filers and/or aspiring private companies heading towards IPO, this means that all drilling locations expire in 5 years from date of first booking, unless production starts. Prudent operators will put a “clock” or tracking system on every drill once booked, and manage the drilling schedule and reserve reporting process with this in mind. For SEC-compliant reserve reports, third party consulting firms are required to follow SEC reporting guidelines, which should include a strong focus on proved undeveloped (PUD) drill timing, capital availability and intent to drill. Let’s run through using a “fact or fiction?” approach.

Fact or fiction? “The SEC 5-year window applies to all drilling locations, not just PUD.”

Mixed! The new(ish) SEC guidelines published in 2009 were initially interpreted to apply a 5-year drilling window to ALL drills. However, later clarifications and presentations from SEC engineers showed that their main focus was on PROVEN locations, since that was what most companies disclosed. But, the SEC encourages filers to honor the 5-year rule for ALL undeveloped drilling locations (PUD, PROB & POSS), and certainly if you are disclosing 3P reserves.

Fact or fiction? “You can restart an expired PUD if it is not booked (sits out) for one year.”

Fiction! This is in violation of the spirit of the 5-year rule, and is considered PUD “recycling” to keep aging drills on the books. If you were unable to get around to drilling a PUD in 5 years for any reason, this is evidence (as per the SEC) that there is lack of intent to drill and/or the predicted drilling pace was too aggressive. But, there are special circumstances where you CAN restart an expired PUD assuming you meet some very specific criteria (reach out to CG&A to learn more!).

Fact or fiction? “A 2-year-old PUD moved to PROB for 3 years due to market downturn can return to PUD status in year 6.”

Fact! The SEC will allow a PUD “restart” in this scenario, even though the PUD was originally booked 5 years ago. In fact, the SEC suggests to not only restart the clock, but also to reset the clock for another 5 years! However, this comes with important requirements that the SEC is auditing closely…

  • Intent to drill – is it scheduled to be drilled sooner than later, and has capital been allocated?
  • Available funds – does the company have proper capital available to fund not only this drill but all drills? Always check the “Use of Proceeds” in company disclosures, and compare and contrast this with available capital (borrowing base) and development plans (capital spend).
  • Execution – is the company currently drilling in this region and are they executing on their plan and converting undeveloped reserves to developed reserves on schedule?

Fact or fiction? “A PUD location expires after 5 years, but a decision was made to change its well name and move the staked location by 100 feet, so it can be restarted for another 5 years as a ‘new’ PUD.”

Fiction! This is in violation of the spirit of the 5-year rule, and is not allowed. The SEC has been very clear in that what really matters is the reserves volume, and not the specific location. Moving an expired 5 BCF PUD 100 feet to a new location, and disguising it with a new well name, is a violation. Even if a new field study causes you to revise reserves and/or well density for numerous drills in a development region, the original reserves volume and timing rule the day.

Helpful Reminders

  • If you are a private company intending to go public (IPO), reset all PUD clocks prior to filing.
  • If you have restructured, merged, or are under new operatorship, you have the option to reset all PUD clocks since your ownership and/or capital structure has changed.
  • The SEC appears to be more focused than ever on addressing development plans (capital spend, rig ramp up) and available capital, especially during the market downturn and as companies emerge from challenging times.
  • The SEC also noted that rescheduling the timing of a PUD year after year is a red flag and may indicate lack of intent. Shuffling a drill around is frowned upon, and the SEC will quantify these “at risk” reserves to compare against total reserves. If they see a high percentage of “at risk” reserves, prepare to be challenged.
  • The SEC treats a horizontal DUC (drilled but uncompleted well) as a PUD, mainly since a majority (over 50%) of the capital remains for completion and hookup. Also, the 5-year window for production to start applies to DUCs as well as PUDs. A DUC that is projected to start in report year 6 is considered a PROB at best, and should not be booked as proven except under very special conditions. However, there are circumstances where you can book DUCs as PDNP, and we have guided many clients through the decision process.
  • For an expired PUD to ever return to PUD status in the reserve report, the operator must have returned to the region with rigs (intent), drilled wells (execution), and have available capital for more drills (funds). Expired PUDs can only be re-booked if it directly offsets recent/modern producers, and this cautionary re-booking process prohibits an operator from returning an entire expired drilling program to the books at one time.

Closing

CG&A would be glad to try to answer your questions and/or help you navigate the tricky process of PUD management. Remember, we are just the messenger here, and trying to pass along valuable information to help you report and disclose properly. Feel free to reach out here through LinkedIn, or contact a CG&A professional at the links below. Thanks for reading!

Contact CG&A about Reserves: reserves@cgaus.com

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Published by
Todd Brooker
President – CG&A; Professional Engineer; SEC Reserves; Expert Witness; Technical Writer; Biz Dev; Father; Community Volunteer
Let’s dive in on a hot SEC Reserves topic… here is the next discussion in the hashtagCGAReservesReporting series… “SEC 5-Year Drilling Window – Fact, Fiction & Gray Areas”. Hope you enjoy. hashtagcawleygillespie hashtagcgatips hashtagpetroleumengineering hashtagreservoirengineering hashtagreserves hashtagoilandgas