Revisions of international firms’ energy reserves and the reaction of the stock market

Abstract

Energy companies can adjust the estimation of their reserves. We investigate how these revisions impact on the value of these firms. We analyze 100 revisions in seventeen countries for the period 2000-2010. We use an event study and find that the revisions of energy reserves significantly impact on the market value of the firm. We also discover an asymmetry in this response as the market’s reaction to downward revisions is much larger than that to upward revisions. Furthermore, the response to revisions in Australia, Canada, UK and US is smaller than that in the other 13 countries and the response is smaller in the years with turmoil on the energy markets.

Introduction

How do revisions of estimated energy reserves impact on the market value of equity of the revising firm? To find out, we focus on technical revisions of proven reserves. That is, reserves that are claimed to have reasonable certainty (at least 90% confidence) of being recoverable under the existing technical, economic and political conditions. This usually is referred to as P90 or 1P [1]. Reserves are relevant for the valuation of energy companies as they are a source of future earnings [2]. Therefore, the revisions of reserves can affect the value of these firms too. So far, most attention regarding the energy reserves and revisions thereof is directed at an aggregate level, see e.g. the discussion about peak oil [3], [4], the analysis of oil transition [5] and the analysis of energy resources and use [6], [7], [8]. Alternatively, several studies concern the role of reserves in the operational management of firms and fields [9], [10], [11], [12], [13]. But, as far as we are aware of, the impact of reserve revisions on firm’s financial value has not been investigated. In this paper, we investigate the effect of P90 reserve revisions on the market value of the equity of international energy firms in the period 2000–2010.

Since the beginning of the 1980s, analysts and experts worry about the quality of the information about the reserves energy companies report [2], [14]. This worry results from the fact that estimating reserves is quite complicated and is subject to various choices that must be made [15]. Firms and governments may use different methodologies, definitions and classifications to arrive at reserve estimations. And there can be incentives for firms and governments to overstate the reserves [16]. Spear [17] examines the changes in the proven reserves reported by US oil and gas producers in annual reports of 1984–1988. He finds that revisions only have a modest influence on security returns.

In this paper, we want to investigate whether and how the stock market responds to unexpected revisions of P90 energy reserves. We analyze 100 revisions for energy firms located in 17 countries in the period 2000–2010. We employ the event study methodology to find out about the stock market response [18], [19], [20], [21]. We investigate upward and downward revisions and assess the symmetry in the market response to these revisions [22]. We think this asymmetry is interesting as several papers have found that there is a greater impact on economic activity of oil price increases than of oil price decreases [23], [24], [25], [26], [27], [28]. This literature suggests two possible explanations for the asymmetric impact of positive and negative oil price shocks. It first suggests that it is the magnitude of relative price changes that matters. Second, the literature stresses there is an option value associated with waiting to invest. The rationale for these two explanations is usually based on adjustment costs, financial stress, sentiment, monetary policy responses and investment under uncertainty [26], [27]. Furthermore, we check the robustness of our model to arrive at expected returns and go into the sensitivity of our findings by focusing on the response to reserve changes with various subsamples.

In the remainder of the paper, we first introduce the data and the methodology. Then we report and discuss the results. The last section holds the conclusion.