Does it really matter if Exxon Mobil changes its reported oil reserves?
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The latest quarterly earnings reports season looms on the horizon, providing full employment for business reporters, accountants, attorneys, various species of number crunchers, prognosticators, kibitzers and pizza delivery firms catering to all of them as they burn the midnight oil.

And that is before the reports are submitted to the Securities and Exchange Commission (SEC) and other government bodies with responsibilities to examine them.

After submission, it is the turn of the government green-eyeshade types to work long hours asking the usual array of questions about accuracy, completeness and all the rest.

The reports, by necessity, must report the past and speculate about the future. That engenders for the oil industry a real accounting complexity: how to estimate the amount of reserves in the ground that can be produced profitably — that is, what price to assume when estimating the volume of reserves that are economically recoverable or "proven."

Consider Exxon Mobil, always a favorite target of the politically ambitious, the upwardly mobile and those seeking to signal their own virtue. Exxon Mobil historically has been reluctant to allow the eternal ups and downs of oil prices to create substantial variability, or instability, in its public estimates of its proven reserves.

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SEC rules require that estimates of proven reserves be based upon average prices for the previous year, which was about $43 per barrel for West Texas Intermediate (WTI) for 2016. That WTI now is at about $54 per barrel provides some vindication for Exxon Mobil's position; after all, even though the price today is the best estimate of the price tomorrow, while the expected price tomorrow determines the price today, estimates of proven reserves cannot be changed with every price shift.

 

That would be an administrative nightmare, and obviously would reduce the usefulness of such estimates from the viewpoint of the investing community.

At the same time, reality at some point must be acknowledged: Exxon Mobil last month announced that 2016 proven reserves were 20 billion barrels, a net reduction of 3.3 billion barrels from 2015. That reduction is due to some combination of a price decline of over $5 per barrel from 2015, and new engineering information and the like from ongoing operations.

But the importance of the price effect is obvious: In the announcement, Exxon Mobil made it clear that virtually all of the reduction in net proved reserves is due to the effects of lower prices on the profitability of heavy-oil production in Alberta, Canada.

And so many of the usual suspects now are accusing Exxon Mobil of "fraud" for not having allowed earlier price shifts to affect its estimates of proven reserves. Accusations of fraud, of course, must be premised upon a showing or assumption that some individual or group has been defrauded, that is, fooled into taking or avoiding actions that otherwise would have been chosen.

Is there evidence of that?

Not that anyone seems to have reported, and that deafening silence is easy to explain: These sorts of accounting shifts are largely irrelevant, in that accounting numbers are a veil for underlying market values. Marginal investors should be able to see through the veil.

Suppose that the government mandated that proven reserves be listed at zero; would the market believe that? One could hypothesize, reasonably, that Exxon Mobil has better information than is the case for outsiders about the volume of its reserves that can be produced profitably at the current market price. Even that is not entirely obvious, in that outsiders have powerful incentives to discover such information, even if only rough, about the costs of producing given fields.

But unless the accounting shift contains some sort of surprise — say, a sizeable downward change in proven reserves below that expected by the market — the accounting numbers, again, are a veil, a tool for lawyers but not very meaningful in terms of the market value of Exxon Mobil assets. That today's announcement of proven reserves is substantially lower than that of a year ago does not mean that the change was unexpected.

Do the critics of Exxon Mobil seriously want to argue that outsiders do not understand that lower prices reduce proven reserves?

Do they believe that investors are fools?

There is the further matter that Exxon Mobil, like other private entities with large capital investments, is a long-lived entity with powerful incentives to protect its credibility. The critics of Exxon Mobil and of others in this context have not explained how the firms derive benefits for themselves and their shareholders over the longer term by publishing false estimates of proven reserves, even if one assumes for discussion purposes that some investors are fooled for a time.

Even in the extreme case in which Exxon Mobil has been lying blatantly about the magnitude of its proven reserves, that condition, perhaps surprisingly, would be irrelevant, since it would not be long before market participants understood that reality. Because those observers' beliefs about the actual size of proven reserves inevitably would vary, there would be a statistical distribution of beliefs about the proven reserves.

Since in this world the market participants know that Exxon Mobil is or might be lying, the effect is to shift the entire distribution of beliefs to the left, so that the market in effect hedges against the likelihood or certainty of being misled. When people shop for used — sorry, preowned — cars, do they systematically believe the salesperson's assertions?

Actually, they might if the used-car dealer is a long-lived institution with large capital investments, and thus incentives to be truthful. And these customers would be right to do so.

The re-estimates of proven reserves required by the SEC are unlikely to matter much if at all, as the accounting value of the reserves is a veil for the true market value. The mere fact that Exxon Mobil has reduced its estimate makes for loud headlines, but does not mean that the market is being provided with new information.

Superficiality may reign supreme in the Beltway, but that does not mean that the rest of us should care. 

Benjamin Zycher is the John G. Searle scholar at the American Enterprise Institute.


The views of contributors are their own and not the views of The Hill.