Reserves classification

Reserve Report Red Flags Boards and Lenders Watch For

A reserve report is an argument for a number, not the number itself. When a bank sizes a borrowing base or a buyer prices a producing package, that report is the hinge the deal turns on — and a well-run report and an optimistic one look almost identical on the cover page. The difference is three or four inputs buried inside. You do not need to re-run the economics to find them; you need to know which assumptions carry the value and ask the report to defend them.

TL;DR: None of the seven flags below means a report is wrong. Each means a specific number is leaning on an assumption that deserves a question before you lend or bid against it. In most reports the headline value is broadly credible, but a disproportionate share of it rests on one or two load-bearing assumptions — find those and press on them.

The seven red flags, and a five-minute check for each

A hyperbolic decline with a high b-factor and no terminal switch

The Arps b-factor controls how fat the tail of the forecast is. A b above roughly 1.3–1.4, run to the economic limit with no terminal (minimum) decline segment, produces a long, slowly-declining tail that quietly adds barrels — and reserves — decades out. Real wells transition to boundary-dominated flow and steepen; a pure high-b hyperbolic never does. This single choice is the most common way an EUR gets inflated without anything on the page looking unusual.

Five-minute check

Find the b-factor and ask whether a terminal decline (a Dmin exponential, often 5–10%/yr) was applied. A high b with no terminal switch is the flag. Ask what EUR falls out at b = 1.1 for the same wells.

An EUR booked on less than 18–24 months of production

Early production is dominated by transient flow, before the reservoir's boundaries make themselves felt. Fit a decline to the first several months and the parameters are almost unconstrained — small changes in the early trend swing the EUR by large amounts. A confident single-number EUR on a well with under a year and a half of history is a confidence the data does not support.

Five-minute check

Line up months of actual production against the booked EUR per well. Flag any well carrying real value on a short history, and treat its number as a wide band, not a point.

A forecast that sits above the offset wells around it

Every well is drilled into a neighborhood. If the forecast for a well runs above the established type curve for nearby completions in the same interval, the report is implicitly claiming this well is better than its offsets — which may be true, but needs a reason (better rock, longer lateral, more proppant), not just a curve fit. Absent that reason, the optimism is unearned.

Five-minute check

Compare each well's initial rate and EUR to an offset analog or public type curve for the same bench. Ask what specifically justifies any well forecast above the pack.

Value concentrated in undeveloped (PUD) locations

Proved developed producing (PDP) barrels are in the ground and flowing. Proved undeveloped (PUD) barrels require capital, execution, and time — and, under SEC rules, must be reasonably certain to be developed within a defined window or come off the books (SEC Final Rule 33-8995). A PV-10 that looks robust can rest heavily on PUDs whose value depends on a drilling program that may not be funded on schedule. Watch for “rolling PUDs” that shift outward each year. The category mix matters as much as the total (SPE PRMS 2018).

Five-minute check

Ask for the PV-10 split by reserve category, and compare the undeveloped schedule to prior-year conversions and the capital budget. A high share of value in PUD/PDNP is a different, riskier asset than the same PV-10 in PDP — and should be priced that way.

A price deck richer than the SEC average or the strip

Revenue scales directly with the assumed price. SEC proved reserves use a prescribed first-of-month twelve-month average, while bank, acquisition, and internal cases use different decks for different purposes (SEC Final Rule 33-8995). A deck set above that average or above the forward strip lifts every well's value at once — and the realized-price differential to the benchmark (for basin location, quality, and gathering) is where optimism often hides. A flat deck at a headline benchmark with no differential is a quiet overstatement.

Five-minute check

Ask what deck was used, whether it matches the stated purpose, and what differential was applied. Compare the assumed realized price to the operator's actual revenue-per-barrel from recent statements.

Thin operating costs — no water, no abandonment

The economic limit — the rate at which a well stops paying its own way — is set by operating cost as much as by decline. Understate lease operating expense, ignore a rising water cut and its handling cost, or leave out plugging and abandonment liability, and you extend the economic life and inflate the reserves at the same time. Maturing wells in particular live or die on water and lifting cost, not on the headline decline.

Five-minute check

Sanity-check LOE per BOE against the operator's own MD&A and field norms, look for a water-cut trend and an explicit water-handling cost, and confirm abandonment/ARO is in the cash flow — not assumed away.

A single point estimate with no sensitivity

A reserves number reported to the dollar, at one discount rate, with no range around it, is telling you the answer while hiding how fragile it is. The useful question is never just “what is the PV-10” — it is “which one or two inputs, if I move them to a defensible-but-conservative setting, move the answer the most.” A report that cannot show you that has not been stress-tested; it has been asserted.

Five-minute check

Ask for PV-10 alongside its sensitivity to b-factor, price, and operating cost. If the value collapses when one input moves a reasonable amount, that input — not the total — is the real subject of diligence.

The pattern underneath all seven: diligence is not re-doing the whole report — it is finding the one or two assumptions the value actually rests on and pressing on them. When they hold, you bid or lend with confidence. When they do not, you have found the single most valuable thing in the data room.

What “good” looks like

A defensible report is not an optimistic one with the numbers shaded down. It is one that shows its work: decline fits with terminal segments and stated b-factors, EURs flagged where history is short, forecasts reconciled to offsets, value broken out by reserve category, a named price deck with realized differentials, operating costs that include water and abandonment, and a sensitivity that tells you where the answer is fragile. When you can see each of those, the total means something. When you cannot, the total is a claim awaiting a check.

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Reserve Report Red Flags Boards and Lenders Watch For

The seven red flags, and a five-minute check for each

A hyperbolic decline with a high b-factor and no terminal switch

An EUR booked on less than 18–24 months of production

A forecast that sits above the offset wells around it

Value concentrated in undeveloped (PUD) locations

A price deck richer than the SEC average or the strip

Thin operating costs — no water, no abandonment

A single point estimate with no sensitivity

What “good” looks like

Related reading

References