Applications of PRMS Guidelines and SEC Rules: Ethical Issues and Biases

Peter R. Rose, Rose & Associates LLP

Ethical conundrums and conflicts are endemic in human affairs wherever perceived self-interest may appear to diverge from obligations of trust.  Well-grounded, realistic publications provide a framework for professional exercise of sound, ethical choices.

Rules-based Reserves classifications restrict technical choices, but often fail to allow legitimate departures from rules based on outdated knowledge.  Thus ethical mischief is more likely to require falsification of facts.  Principles-based classifications allow more discretionary technical choices, so that reserves may be expressed more realistically, using present knowledge.  There appears to be more potential for subtle ethical misbehavior using a Principles-based classification, such as the Petroleum Resources Management System.

Material misstatements of reserves in internal company estimates damage the company because the consequential portfolio is under-optimized as to performance and asset value, to the detriment of the stockholder.  But the damage caused by a substantial and widely publicized reserves write-down involving SEC-disclosures can be even worse.  The fall-out from a widely publicized reserves scandal involving an American corporation could result in the imposition of crippling new regulation on the E & P industry. If there is one prominent scandal, all public companies will suffer.  More than ever, E & P professionals must not only observe strictest ethical principles, but to insist on similar high standards among their colleagues, including their executive managements.  .

All reserves disclosures are estimates, and uncertainty constantly attends the process of deriving the parameters that govern reserves volumes. Wherever estimates are made under conditions of uncertainty, bias is operating.  The consequences of bias are to make a project or a portfolio appear to be more valuable, or less valuable, than it is, resulting in suboptimal performance of the asset.

There are three types of bias.  Cognitive bias relates to the way we perceive situations or circumstances.  Motivational bias occurs when the estimator perceives that some personal advantage may accrue from a higher or lower estimate.  Organizational bias is a pernicious, usually unconscious effect that derives from shared optimism among project members. 

Although advanced technologies may help to limit bias, the main remedies lie in 1] purposeful testing of parameter ranges; 2] independent multiple estimates; 3] “Nature’s Envelopes”; 4] “Reality Checks”; 5] proper statistical procedures; and 6] rigorous post-audits of projects.

AAPG Search and Discovery Article #90098©2009 AAPG Education Department, Houston, Texas 9-11 September 2009