What Is Probable Reserves?
Probable reserves represent an estimated quantity of natural resources, typically hydrocarbons such as oil and natural gas, that analysis of geoscience and engineering data indicates are less likely to be recovered than proved reserves but more certain to be recovered than possible reserves. This classification is a critical component of natural resource valuation within the oil and gas industry. When applying probabilistic methods, there should be at least a 50% probability that the actual quantities recovered will equal or exceed the sum of estimated proved plus probable reserves (often referred to as 2P reserves). Probable reserves inherently involve a degree of uncertainty in their recovery.
History and Origin
The concept of classifying petroleum reserves into categories like "proved," "probable," and "possible" has evolved significantly over time to provide a standardized framework for the oil and gas industry and financial markets. Early efforts to standardize definitions began in the 1930s, primarily focusing on proved reserves. However, as geological understanding and exploration technologies advanced, the need for more nuanced classifications became evident.
The Society of Petroleum Engineers (SPE), in collaboration with other organizations like the American Association of Petroleum Geologists (AAPG) and the World Petroleum Council (WPC), developed the Petroleum Resources Management System (PRMS). The PRMS provides a comprehensive classification system that includes probable reserves. This system is widely recognized internationally for its consistent and reliable approach to estimating hydrocarbon resources. The U.S. Securities and Exchange Commission (SEC) modernized its oil and gas reporting requirements in 2008, moving from a previous prohibition on disclosing probable and possible reserves in public filings to permitting, but not requiring, such disclosure. These new SEC definitions are largely consistent with the PRMS definitions, providing a more transparent view for investors8, 9. The SEC's updated guidance, for example, defines probable reserves as those quantities which, when added to proved reserves, are as likely as not to be recovered7.
Key Takeaways
- Probable reserves are estimated quantities of oil and gas with a greater than 50% chance of being recovered when combined with proved reserves.
- They reflect a lower degree of certainty than proved reserves but a higher degree than possible reserves.
- Their estimation relies heavily on detailed geological surveys and engineering studies.
- Probable reserves are a key component in a company's total resource base for financial reporting and strategic planning.
- The classification helps in risk assessment and investment decisions within the energy sector.
Interpreting Probable Reserves
Interpreting probable reserves involves understanding the probabilistic nature of their estimation. While proved reserves are considered recoverable with "reasonable certainty" (typically a 90% probability or P90), probable reserves fall into a lower certainty category. The industry standard, recognized by both the SPE-PRMS and the SEC, defines probable reserves such that the sum of proved plus probable reserves (2P) has at least a 50% probability that the actual quantities recovered will be equal to or greater than this estimate5, 6.
This means that while the recovery of individual probable reserve volumes is less certain than proved reserves, the combined 2P estimate provides a "most likely" outcome. Interpreters of these figures, often analysts or potential investors, consider the underlying data from geological surveys and production histories. The assessment of probable reserves also considers factors such as reservoir performance, the success rate of nearby wells, and the economic viability of future drilling and development activities.
Hypothetical Example
Consider "Horizon Energy," a hypothetical oil and gas company that has performed an exploration drilling program in a new offshore field.
After initial drilling and testing, Horizon Energy's geologists and engineers determine the following:
- Proved Reserves (1P): 100 million barrels (MMbbl) – these are the quantities they are reasonably certain they can recover from the drilled wells given current economic conditions and technology.
- Probable Reserves (P50 increment): 75 MMbbl – this represents additional quantities estimated to be recoverable from extensions to the known reservoir, or from formations that appear productive based on limited data, but with a lower certainty than the proved portion. When added to proved reserves, there is at least a 50% probability that the total volume of 175 MMbbl (100 MMbbl proved + 75 MMbbl probable) will be recovered.
- Possible Reserves (P10 increment): 50 MMbbl – these are even less certain, often requiring further drilling or more advanced technology. When added to proved and probable, there is at least a 10% probability that the total volume of 225 MMbbl (100 + 75 + 50) will be recovered.
For Horizon Energy's financial reporting, they would publicly disclose their proved reserves. However, for internal planning, investment decisions, and discussions with lenders, they would frequently utilize the 2P (proved + probable) estimate of 175 MMbbl to represent a more realistic expected range of future production and potential cash flow.
Practical Applications
Probable reserves play a significant role in various aspects of the energy sector beyond just public disclosure.
- Investment Decisions: While proved reserves are the primary metric for valuing oil and gas companies, probable reserves inform longer-term capital expenditure planning and strategic investments. Investors and lenders often consider 2P (proved + probable) or 3P (proved + probable + possible) figures to gauge a company's total resource potential and future growth prospects.
- Internal Planning and Development: Energy companies use probable reserves for internal forecasting, budgeting for future drilling programs, and evaluating the economic viability of potential projects. These estimates help prioritize development activities and allocate resources efficiently.
- Lending and Financing: Banks and financial institutions often use proved plus probable reserves as a basis for determining the collateral value for loans to oil and gas companies, especially for financing new projects. The larger the probable reserves, the greater the perceived long-term asset base.
- Resource Management: Governments and regulatory bodies, such as the U.S. Energy Information Administration (EIA), track various categories of reserves to understand national energy endowments, assess long-term supply outlooks, and inform energy policy. Chan4ges in reserve estimates from year to year are influenced by new discoveries, reappraisals of existing fields, and advancements in technology.
3Limitations and Criticisms
While providing a more comprehensive view than proved reserves alone, probable reserves come with inherent limitations and criticisms.
- Subjectivity and Uncertainty: The estimation of probable reserves involves a significant degree of geological and engineering judgment. Unlike proved reserves, which require "reasonable certainty," probable reserves rely on assumptions about future conditions and interpretations of data that are less conclusive. This can lead to variations in estimates between different evaluators or over time as more data becomes available.
- Potential for Overestimation: There have been instances where companies have been accused of "reserves overbooking," especially in the probable or proved undeveloped (PUD) categories, to present a more optimistic financial picture. Such2 overstatements can distort resource valuation and mislead investors, potentially leading to significant write-downs and adverse financial consequences if the reserves prove unrecoverable or uneconomic.
- 1Economic Sensitivity: Probable reserves are highly sensitive to commodity prices and operating costs. A sustained drop in oil or gas prices, or an increase in capital expenditure or operating costs, can render previously probable reserves uneconomic, leading to their reclassification or removal from the reserve base. This highlights the ongoing risk assessment required in the industry.
- Technological Dependence: The categorization of probable reserves often assumes the successful application of certain technologies for recovery. If these technologies do not perform as expected, or if their costs escalate, the recoverability of probable reserves may be compromised.
Probable Reserves vs. Proved Reserves
The distinction between probable reserves and proved reserves lies primarily in the degree of certainty regarding their economic recoverability.
| Feature | Probable Reserves | Proved Reserves |
|---|---|---|
| Definition | Those additional quantities of oil and gas that, when added to proved reserves, are as likely as not to be recovered (at least a 50% probability that actual recovery will equal or exceed the 2P sum). | Those quantities of oil and gas which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward from known reservoirs under existing economic conditions, operating methods, and government regulations (typically 90% certainty). |
| Certainty Level | Lower certainty than proved reserves; considered "more likely than not" (P50 or 2P). | Highest degree of certainty; considered "reasonably certain" (P90 or 1P). |
| Evidence Basis | Based on geological and engineering data that are less conclusive than for proved reserves, such as extensions to known areas or unconfirmed producing zones. | Supported by strong geological and engineering evidence, including actual production data, successful drill stem tests, and direct observation from wells. |
| Usage | Used for long-term strategic planning, internal project evaluations, potential future production forecasts, and sometimes for collateral in project financing. May be disclosed optionally by U.S. public companies. | Primary basis for public financial reporting, reserve-based lending, and evaluating a company's current production capacity. Mandatory disclosure for U.S. public companies. |
The key area of confusion often arises because both are "reserves" and imply future recovery. However, the probability threshold is the defining difference, with proved reserves being the most conservative and assured estimate, while probable reserves introduce a layer of informed optimism based on available data.
FAQs
Q: Why are probable reserves important if they are less certain?
A: Probable reserves provide a more comprehensive view of a company's total potential hydrocarbon assets. While less certain than proved reserves, they are crucial for long-term investment decisions, strategic planning, and assessing a company's growth potential. They represent a realistic upside to the proved base.
Q: Who estimates probable reserves?
A: Probable reserves are estimated by qualified petroleum engineers, geologists, and geophysicists, often from independent third-party consulting firms or internal company teams. These professionals use specialized tools and methodologies, including geological surveys and engineering studies, to assess the likelihood of recovery.
Q: Do all companies disclose their probable reserves?
A: In the United States, under SEC regulations, public companies are permitted, but not required, to disclose probable and possible reserves in their filings. Many companies choose to do so to offer a fuller picture of their resource valuation to investors, but the primary focus for mandatory public disclosure remains on proved reserves.
Q: How do economic conditions impact probable reserves?
A: Economic factors such as commodity prices, operating costs, and capital expenditures significantly influence whether a reserve is considered probable. If prices drop too low or costs become too high, quantities previously classified as probable may no longer be deemed economically producible, leading to their reclassification or removal from the reserve base. This constant re-evaluation is part of effective financial reporting.