One of the general concerns over the inclusion of intangibles in any accounting or statistical system is that they are hard to measure – unlike tangible assets which can be physically counted. Well, tangible assets often have a very intangible quality to them. Take for example, oil and gas reserves. Most of us would think that an oil companies proven reserves are pretty tangible. But, according to Daniel Yergin, Pulitzer-Prize winning author of Oil:
It is a crucial misunderstanding to think of oil and gas reserves as being similar to inventory or a company’s cash balances. They are not a fixed quantity capable of physical inspection or exact enumeration. Reserve auditors cannot enter the underground warehouse, that is the pore space in a reservoir, and check off the barrels. They cannot correlate and add up reserves to a second decimal place, as they can with revenues and net income.
Yergin was speaking in reference to a new study by his firm, Cambridge Energy Research Associates, on the problems with the way we count petroleum reserves. The study, In Search of Reasonable Certainty: Oil and Gas Reserves Disclosures, argues that the accounting methods for reserves are hopelessly outmoded. According the press release:
The study describes reserves as an approximation — estimates derived from a complex combination of direct evidence, expert interpretation, a variety of scientific methodologies and experience-based assumptions about the future, often stated in terms of probabilities. For the purposes of internal investment decision-making, companies may use probabilistic methods – alongside single-point deterministic estimates — to categorize reserves as either proven (90% chance of ultimate recovery), proven plus probable (50% probability), or possible (10% chance of recovery).
However, the study notes, the 1978 System focuses on proved reserves as defined by a standard of “reasonable certainty” pegged to “direct contact” with an existing well. The report described this measure as suitable for reserves forecasts of individual producing wells, but unsuited to an increasing proportion of the modern oil and gas industry, particularly to larger offshore projects.
Sounds to me like the standard problem of an accounting system that can’t deal with intangibles – in this case the intangibles of expert interpretation.
Now, on the other hand, where are the checks and balances that insure that these “expert interpretations” have anything to do with reality? We continue to get reports of companies modifying their stated reserves. As one critic, retired French engineer Jean Laherrere puts it:
What is needed for reserve definitions is good practice and good rules, to which every country in the world agrees. The problem is that oil and gas companies are not asking for precise rules as they prefer poorly defined rules, which allow them more freedom for reporting, and they want to keep confidential their field estimates. The push must come from the governments or from the banks.
When creating a reporting system that includes intangibles, it is important to balance the need for understanding these new measures with the check to ensure that they are real and not subject to manipulation. As is the case in many areas of understanding intangibles, transparency and disclosure rather than a bottom line number, may be the best solution.