by Bruce Fenton

The cold winter, strife in the Middle East and a contentious energy policy proposal all make fertile ground for investors looking to profit from investments in oil companies. However, as investors are finding out, a barrel of oil in the hand is not like a barrel in the ground!

Any investor looking to profit from an investment in an oil company wants to know the amount of oil available for sale. Unfortunately, that oil is in the ground, and its actual volume must be estimated and then extracted before it can be sold.

Measuring oil reserves is both a political and a practical problem. Different countries and oil companies use different methods. Politicians would like to see oil reserves grow and contribute to the wealth of the world. Regulators like the SEC are apt to take a more conservative approach. And there is the issue of the unit of measure—what constitutes a barrel of oil?

The Handbook of Chemistry and Physics lists eighteen different definitions of “barrel,” ranging from 30 to 50 U.S. gallons in volume. For example, a barrel of beer equals 43 U.S. gallons, while a barrel of oil is only 42 U.S. gallons, a measurement adopted by the Petroleum Producers Association in 1872.

In the political arena, the stated value of a nation’s oil reserves can enhance its perceived wealth, enabling it to borrow for other purposes at more advantageous rates against its oil reserves. Oil producers doing business within these nations are encouraged to use more liberal measurement techniques when measuring oil reserves. However, those who lend against reserves require a tighter definition of “reserves.”

Oil that has been discovered and remains in place is considered “reserves.” All discoveries are initially appraised for their size in terms of oil in place. Based upon complex calculations involving many variables, the probability for successful extraction is estimated. If there is a reasonable certainty that the oil can be recovered given current and projected future operating conditions, the reserves are considered to be “proven.”

The remaining reserves are assigned “probable” and “possible” designations. The former are reserves with better than a 50% chance of recovery and the latter have a less than 50% chance of being recovered.

Over time, reserves can be changed from probable or possible to proven or vice versa. For example, according to OPEC futures in 1944, a special mission estimated Persian Gulf reserves at 16 billion barrels proven and 5 billion probable. By 1975, those same fields had produced 42 billion barrels and had 74 billion remaining. In 1984, geologists estimated a 5% probability of another 199 billion barrels remaining. Within five years, they had already appeared.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.