Rob et al... First of all, my apologies as my comparison was over simplified re: Market Cap vs. Net Asset Value... Now, lets look at it in more detail then. The main asset, say 90% of the assets, lay underground. That is to say.. RESERVES. So what are these reserves? Well, that is now a contentious issue in the industry. In fact, the Canadian Securities Commission is in the process of adopting 150 new rules to help deal with this issue including the formation of totally independent reserve review committees for publicly traded companies to prevent "arm twisting" by publicly traded companies with respect to reserve reports. This is recent development, but a result of previous concerns raised by industry and others (see articles below). Now, RESERVES... it is not enough to simply find reserves, and add them to the NAV equation. One must look at CAN THESE RESERVES BE RECOVERED ECONOMICALLY? Many gold producers, including RYO, had lots of reserves... yet RYO went bankrupt under their debt load. Why? Another O&G producer which comes to mind is Dome Petroleum who found lots of gas reserves in the Beaufort Sea but went under from large debt load. Now, you can issue more shares, do more underwritings, pay off the debt and off you go to the races again. But this will only work for so long. In the end, positive cash flow must be able to sustain company growth. Now, with everyones definition and evaluation of 'Reserves' potentially being so different and subject to interpretation, and yet it means so much in determining the NAV of a Company, how much value are you willing to place on those "reserves"? Perhaps you are also relying a bit too much on luck. Not intending to get hostile, simply an exchange of ideas, opinions and information. SD Study urges tightening of oil, gas reserve reports Petroleum society paves way for greater disclosure BRENT JANG Alberta Bureau Tuesday, July 6, 1999 Calgary -- Corporate reporting of oil and gas reserves should be tightened, says a draft engineering study that paves the way for Canadian securities regulators to order greater disclosure from producers. The 10-page summary report, prepared by the Petroleum Society of the Canadian Institute of Mining, Metallurgy & Petroleum, provides guidelines for engineering firms to assess a producer's reserves. One key recommendation says that, in total, there must be "a 90-per-cent probability that at least the estimated proved reserves will be recovered," compared with the current 80-per-cent probability for an individual reserve evaluation. That 80-per-cent guideline has been in place since 1993 in the society's handbook, but neither the petroleum industry nor Canada's securities commissions have specified any minimum requirements. Harry Jung, a member of an Alberta Securities Commission (ASC) subcommittee of petroleum engineers studying the issue of reserves, said the definitions and guidelines will strengthen the industry by providing important standards. "There's a strong chance this report will be adopted by the securities commissions," he said in an interview yesterday. Guidelines for reserves are being reviewed amid controversy over Blue Range Resource Corp., a natural gas producer that received bankruptcy protection in March and is on the verge of being taken over by Canadian Natural Resources Ltd. of Calgary. Blue Range's current parent, Big Bear Exploration Ltd., alleges that 22 million barrels, or 37 per cent, of Blue Range's proved and probable reserves have gone missing. Former Blue Range executives deny the allegations that reserves were inflated, countering that Calgary-based Big Bear mishandled a thriving exploration and development program. Mr. Jung said the draft study has been sent to oil and gas producers for fine-tuning this summer, clearing the way for securities regulators to give a preliminary go-ahead for the new rules as early as this fall. Reserve evaluators will be required to reach the 90-per-cent threshold in aggregate, meaning that "nine times out of 10, your corporate total reserve estimates should stay the same or go up. That's a test you can put your finger on." Mr. Jung is also executive vice-president of Calgary-based Gilbert Laustsen Jung Associates Ltd. and chairman of the petroleum society's standing committee on reserve definitions. The draft report already has been endorsed by his engineering firm and three others from Calgary on the ASC subcommittee -- McDaniel & Associates Consultants Ltd., Sproule Associates Ltd. and Ashton Jenkins & Associates Ltd. The final report, which probably will run 40 pages and include technical information and examples of various calculations, could be formally introduced in the form of securities policies next year. Those policies could result in expanded and improved information from reserves disclosed in companies' information forms, prospectuses and annual reports. "Everything comes back to reserves," Mr. Jung said. "Reserves are the foundation for oil and gas companies, and it's what ultimately will generate their cash flow." Under another proposed threshold, there must be "a 50-per-cent probability that at least the sum of the estimated proved plus probable reserves will be recovered" in aggregate, compared with the current 40-per-cent probability for a "single reserves entity." The complex analysis of reserves must be based on geological, drilling, geophysical and engineering data, as well as "reasonable" economic assumptions and "known technology," the study says. Procedures for estimating reserves also have been outlined, helping to demystify the complicated system of calculating what energy riches are hidden beneath the ground, Mr. Jung said. For instance, engineers using the so-called volumetric method must calculate an oil and gas reservoir's rock volume. "Oil and gas in the ground is found in the pore spaces between rocks. It's not just a cavern. You have to know how much pore space there is, how much other fluids are in the reservoir, like the water saturation," Mr. Jung said. Another calculation called "material balance" involves computer modelling of reservoirs to analyze pressure levels as fluids are taken out. Once enough information is available, the production decline analysis looks at depletion and other variables in oil and gas deposits. DEFINITIONS A draft report by the Petroleum Society of the Canadian Institute of Mining, Metallurgy & Petroleum provides the following definitions and guidelines for calculating oil and gas reserves in aggregate: Proved reserves: Remaining reserves that can be estimated with a high degree of certainty to be recoverable. (There is a 90-per-cent probability that at least the estimated proved reserves will be recovered.) Probable reserves: Reserves that are less certain to be recovered than proved reserves but that are more likely than not to be recovered. (There is a 50-per-cent probability that at least the sum of the estimated proved plus probable reserves will be recovered.) Possible reserves: Reserves that are less certain to be recovered than probable reserves. (There is a 10-per-cent probability that at least the sum of the estimated proved plus probable plus possible reserves will be recovered.) Friday, June 04, 1999 Digging up the dirt in the oilpatch Two former investment dealers have set up shop in Calgary providing an independent research facility for institutional investors wanting due diligence studies on prospective purchases Claudia Cattaneo Financial Post Todd Korol, National Post / Allan Ross, left, and Michael Smith in the new headquarters of Ross Smith Energy Group in Calgary. CALGARY - Over the years, investment industry veterans Allan Ross and Michael Smith have come to recognize the warning signs of a potential oil stock disaster -- selective disclosure, aggressive booking of reserves that is inconsistent with independent expert views, or a key officer's questionable background. They also know what it takes to make a star: A good start is a glowing dispatch from an oil industry scout watching the drilling of a natural gas exploration well. The pair recently formed a Calgary-based independent research firm, Ross Smith Energy Group, that digs for oilpatch intelligence for a growing roster of institutional investors in Canada and the United States with billions in exposure to the Canadian energy sector. Stung by well-publicized stock market disasters like Bre-X Minerals Ltd., Blue Range Resources Corp., Amber Energy Inc. and Remington Energy Ltd., money managers are increasingly willing to pay for independent "due diligence," the partners said. That's because they no longer trust traditional sources, like producers or investment analysts that cover them, to tell the full story. "There is a level of dissatisfaction with the existing information flow," said Mr. Smith. "The avoidance of a problem is sometimes more important than finding a stock that doubles or triples," adds Mr. Ross. "We are hoping that by raising the level of integrity and raising the bar in terms of disclosure and information, it provides a higher level of confidence, and that ultimately will bring American capital and foreign capital back into the industry." The firm's research model involves gathering information using 60 to 70 independent experts like accountants, engineers, geologists, investigators and even oil scouts -- spies who monitor the drilling of wells to obtain information ahead of its public release. They comb through publicly available records, do background checks on key officers and directors, test management's ability to take its company to the next level and even produce questions a money manager may ask a firm's management before making a stock purchase. Particular care is given to independent evaluation of reserves because 90% of an energy company's assets are underground. Targets are picked by clients -- currently 10 large money managers in Canada and four in the United States -- who are fed the data on a confidential basis. Bill Wheeler, president of the Vancouver-based money management firm Leith Wheeler Investment Counsel Ltd., is among those who've grown uneasy about the public reporting of Canadian energy companies, particularly as it relates to reserve estimates. The company is the single largest shareholder of Blue Range, whose stock collapsed when the natural gas producer was placed under court protection from creditors after its new owners said "sloppy" accounting had inflated reserves and underestimated liabilities. "This is what analysts should be doing, but I think many of them are working in places where there is another relationship with a company, and can't really do it," Mr. Wheeler said. Before launching the firm last fall, both Mr. Ross and Mr. Smith worked at the Calgary-based energy investment dealer Peters & Co. Ltd., where they regularly dealt with institutional investors as institutional salesmen. They say their due diligence technique is similar to the way investment dealers approached research in the past. But with the introduction of discount brokers, full service investment dealers are moving away from in-depth independent research and placing a greater emphasis on corporate finance because of its larger revenue potential. This rarely results in "sell" recommendations. Recent U.S. research, for example, showed only 1.4% of analyst recommendations on 6,000 U.S. companies are "sells." "A lot of the work they do involves looking at publicly available information, but they compile it and dig deep and access it, and that adds value to us," said Keith Graham, vice-president and portfolio manager of Trimark Investment Management, a Ross Smith client with $1-billion in exposure to the Canadian oil and gas industry. "One of the first keys in making money is trying not to lose any," Mr. Graham added. "Research like this helps you avert a disaster and helps you find value." While reluctant to disclose names of companies under its microscope, the firm's principals said the Canadian company that most intrigues U.S. clients is Canadian 88 Energy Corp., the successful natural gas producer run by oil industry maverick Greg Noval. Because no input is required from the company being evaluated, Ross Smith is regarded with suspicion by the industry. Its principals admit they've already ruffled a few feathers, including those of an oil company president who demanded to see their report before its release. "We knew we needed a thick skin, so we are trying to make our product as professional and as high quality as we can -- a product we have a great deal of pride in," Mr. Ross said. "We might not have people phoning up and inviting us to their golf tournament, but we do want to get their respect."