There is general consensus in the oil and gas industry that estimating reserves, both quantities and the associated values, is an imprecise science. Nevertheless, in the past two or three years, the reserve estimate has become a very important component of public reporting in the industry; and those that disclose or rely on reserve information (officers, directors, underwriters, lenders) have a responsibility to determine the estimates have been appropriately determined. This change in emphasis is not only due to the Securities and Exchange Commission rules regarding audited reserve information (now postponed) but is also caused by changing economics in the petroleum industry with crude prices and finding costs both rising rapidly. Thus, it is incumbent upon all oil and gas companies to place a higher priority on internal controls over, and internal audit coverage of, the reserve estimation process.

This document, INTERNAL AUDIT OF OIL AND GAS RESERVES should assist companies in their review of controls over the reserve estimation process and suggests an approach that internal auditors may wish to consider when auditing the functioning of such controls.

The approach described in this document involves a review of existing information rather than a full redetermination of reserves. By following the procedures outlined, the internal auditor can assess whether the work was based on proper assumptions, accurately documented and carefully performed by qualified persons under the direction of unbiased supervisors. The cost of this approach is much lower (usually no more than 10%) compared to a complete redetermination by an outside party.

The suggested audit plan requires first that an understanding be gained of the environment in which reserves are estimated. This includes the company's organization, qualifications of estimators, review procedures and other standardized approaches for reporting exceptions and monitoring of property operations. Second this understanding is confirmed through discussions with appropriate personnel, review of internal reports and, where necessary, field locations visits. Finally, based on this understanding and the confirmation thereof, the internal auditor selects a number of properties to be reviewed in detail. The sample should be representative (chiefly large but some small properties) and should comprise a majority of the Company's reserves but only a relatively small percentage of the properties. By following the detailed procedures outlined in the approach, the auditor should, if no exceptions in his test procedures are noted, be persuaded that the reserve information has been reasonably determined.

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