Classification of Reserves

The estimation of reserves of natural gas, gas condensate and crude oil can be broken down into two components: (i) geological reserves, or the quantities of natural gas, gas condensate and crude oil contained in the subsoil and (ii) extractable reserves, or the portion of geological reserves whose extraction from the subsoil as of the date the reserves are calculated is economically efficient given market conditions and rational use of modern extraction equipment and technologies and taking into account compliance with the requirements of subsoil and environmental protection.

The Russian reserves system differs significantly from SEC standards and PRMS standards, in particular with respect to the manner in which and the extent to which commercial factors are taken into account in calculating reserves. Reserves that are calculated using different methods cannot be accurately reconciled. 

Russian reserves system

The classification of oil and combustible gas reserves and resources establishes Russia-wide uniform principles for calculating and keeping public record of oil, gas and gas condensate reserves and resources. Oil and gas reserves are classified into the following categories depending on their stage of commercial development and geological maturity: A (under development, drilled), B1 (under development, undrilled and explored), B2 (under development, undrilled and estimated), C1 (explored) and C2 (estimated).

Reserves that were drilled with development wells and developed under an approved design document shall fall within Category A (under development, drilled).

Reserves in deposits that were not drilled with development wells and the development of which is planned under a design document (a development plan or an amendment thereto, a development scheme or an amendment thereto) matured with seismic exploration or other methods as well as drilled with prospecting, appraisal, exploration, transit or deepened production wells that showed commercial flows of oil or gas shall be Category B1 (under development, undrilled, explored).

Reserves in deposits that were not drilled with production wells, development of which is under design in accordance with an approved design document (a development plan or an amendment thereto, a development scheme or an amendment thereto), matured with seismic exploration or other methods, availability of which is supported by geological and geophysical study data and testing data from individual wells obtained while drilling shall be Category B2 (under development, undrilled and estimated).

Reserves in deposits that were not put into commercial development and that may be the subject matter of production testing or individual well production testing shall be Category C1 (explored). The deposits shall be matured with seismic exploration or other methods and drilled with prospecting, appraisal, exploration wells giving commercial flows of oil or gas.

Reserves in deposits that were not put into commercial development and that are developed based on a production testing plan or individual well production testing plan, matured with seismic exploration or other methods, and availability of which is supported by geological and geophysical study data as well as testing data from individual wells obtained while drilling shall be Category C2 (estimated).

Based on their geological maturity, oil, gas and condensate resources shall be classified into one of the following categories: D0 (prepared), Dl (localized), D1 (prospective), D2 (forecast). The resource categories are based on the level of understanding of their geological structure and oil and gas potential of the area.

Oil, gas and condensate resources of potentially producing formations in the traps prepared for drilling, located in areas with proved commercial oil and gas potential or in undrilled producing formations of discovered fields. Resources for which the form, dimensions and conditions of occurrence of prospective deposits are defined based on the results of geological and geophysical surveys while thicknesses, formation properties, composition and properties of hydrocarbons are assumed to be similar to discovered fields shall be Category D0 (prepared).

Prepared resources of Category D0 indicate the potential of discovering oil and gas deposits in a trap prepared for prospecting drilling and are used to design prospecting activities.

Oil, gas and condensate resources of potentially productive formations in the traps identified during geological and geophysical exploration within the areas with proved commercial oil and gas potential shall be Category Dl (localized).

Localized oil and gas resources of Category Dl are used to plan exploration with the view to preparing traps for prospecting drilling and maturitng Category D0 resources.

Oil, gas and condensate resources of lithologic and stratigraphic complexes and horizons with commercial oil and gas potential proven within large-scale regional structures. Where quantitative assessment of prospective resources is based on regional geological, geophysical and geochemical studies and analogues to explored fields discovered within the area under review, the resources shall be Category D1 (prospective).

Prospective Category D1 resources indicate the potential of discovering oil and gas fields within the area under review and are used to design regional oil and gas exploration activities, select areas and prioritize them for prospecting.

Oil, gas and condensate resources of lithologic and stratigraphic complexes appraised within large-scale regional structures, which commercial oil and gas potential is yet to be proved. Where oil and gas potential of these complexes is determined based on the available data from geological, geophysical and geochemical studies and by analogy with other regions that are better understood and contain explored oil and gas fields, or by analogy with overlying oil and gas pays, resources shall be Category D2 (forecast).

Forecast Category D2 resources indicate the potential of discovering oil and gas fields in a region, whose commercial oil and gas potential remains yet to be proven, and underpin the design of regional oil and gas exploration activities.

Under the Russian reserves system, natural gas reserves in newly discovered natural gas or oil and gas deposits are estimated by the volumetric method. The volumetric method determines the volume of reserves by examining the reservoir properties based on (i) the area of the deposit; (ii) the effective depth of hydrocarbon saturation; and (iii) the porosity and the level of hydrocarbon saturation based on reservoir pressure and temperature.

For natural gas reserves in deposits that are already under development, the Russian reserves system envisages reserve estimation by both volumetric and material balance methods. The material balance method takes into account temporal changes in the effective reservoir pressure as a result of hydrocarbons recovery and the resulting influx of water.

In accordance with the Law on Subsoil, mineral reserves in Russia are subject to mandatory state examination, and subsoil users cannot be granted a production license for a field that was not examined. The state examination of reserves is conducted by subsidiary entities of the Federal Agency on Subsoil Use, including the State Reserve Commission, the Central Reserve Commission and its regional branches. If the commercial feasibility of certain reserves is approved by any such entity, the reserves are entered in the State Balance of Mineral Products. Once a subsoil user is granted an exploration, development or production license, it is required to file annual statistical reports reflecting changes in reserves. In addition, subsoil users’ reserve reports are submitted annually for examination and approval by the Central Reserve Commission or its regional branches or, if there has been a substantial change in reserves, by the State Reserve Commission.

Apart from annual reports, our licenses may require that we do reserve estimations in certain years or upon completion of certain field development stages. Such estimates are submitted for consideration and approval by the State Reserve Commission.

Estimation of reserves, as examined by the state expert organizations and reflected in subsoil users’ annual statistical reports, are accumulated in the State Balance of Mineral Products.

SEC standards

SEC standards differ in certain material respects from PRMS standards. The principal differences include the following:

Certainty of Existence. Under PRMS standards, reserves in undeveloped drilling sites that are located more than one well location from a commercial producing well may be classified as proved reserves if there is “reasonable certainty” that they exist. Under SEC standards, it must be “demonstrated with certainty” that reserves exist before they may be classified as proved reserves.

Duration of License. Under PRMS standards, proved reserves are projected to the economic production life of the evaluated fields. Under SEC standards, oil and gas deposits may not be classified as proved reserves if they will be recovered after the expiration of a current license period unless the license holder has the right to renew the license and there is a demonstrated history of license renewal. The Subsoil Resources Law of the Russian Federation provides that a license holder may request an extension of an existing license where extractable reserves remain upon the expiration of the primary term of the license, provided that the license holder is in material compliance with the license. The SEC has not provided definitive guidance on whether in these circumstances such extractable reserves could be considered proved under SEC standards.

Accordingly, information relating to an estimated proved natural gas, gas condensate and crude oil reserves under SEC standards is not necessarily indicative of information that would be reported under SEC standards in an offering document registered with the SEC. In addition, SEC standards do not permit the presentation of reserves other than proved reserves. SEC Regulation S-X Rule 4-10 paragraph (a) defines proved reserves as follows:

Proved oil and gas reserves. Proved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalations based upon future conditions.

(i) Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes:

(A) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any; and

(B) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir.

(ii) Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the “proved” classification when successful testing by a pilot project, or the operation of an installed program in the reservoir, provides support for the engineering analysis on which the project or program was based.

(iii) Estimates of proved reserves do not include the following:

(A) oil that may become available from known reservoirs but is classified separately as “indicated additional reserves;”

(B) crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors;

(C) crude oil, natural gas, and natural gas liquids, that may occur in undrilled prospects; and

(D) crude oil, natural gas, and natural gas liquids, that may be recovered from oil sales, coal, gilsonite and other such sources.

Proved developed oil and gas reserves. Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as “proved developed reserves” only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved.

Proved undeveloped reserves. Proved undeveloped oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir.

PRMS standards

While the Russian reserves system focuses on the actual physical presence of hydrocarbons in geological formations, and reserves are estimated based on the probability of such physical presence, PRMS standards take into account not only the probability that hydrocarbons are physically present in a given geological formation but also the economic viability of recovering the reserves (including such factors as exploration and drilling costs, ongoing production costs, transportation costs, taxes, prevailing prices for the products, and other factors that influence the economic viability of a given deposit).

Under PRMS standards, reserves are classified as “proved,” “probable” and “possible,” based on both geological and commercial factors.

Proved reserves include reserves that are confirmed with a high degree of certainty through an analysis of the development history and/or volume method analysis of the relevant geological and engineering data. Proved reserves are those that, based on the available evidence and taking into account technical and economic factors, have a better than 90% chance of being produced.

Probable reserves are those reserves in which hydrocarbons have been located within the geological structure with a lesser degree of certainty because fewer wells have been drilled and/or certain operational tests have not been conducted. Probable reserves are those reserves that, on the available evidence and taking into account technical and economic factors, have a better than 50% chance of being produced.

Possible reserves are those unproven reserves that, on the available evidence and taking into account technical and economic factors, have a 10% chance of being produced.

An evaluation of proved, probable and possible natural gas reserves naturally involves multiple uncertainties. The accuracy of any reserves evaluation depends on the quality of available information and engineering and geological interpretation. Based on the results of drilling, testing and production after the audit date, reserves may be significantly restated upwards or downwards. Changes in the price of natural gas, gas condensate or crude oil may also affect our proved and probable reserves estimates, as well as estimates of its future net revenues and net present worth, because the reserves are evaluated, and the future net revenues and net present worth are estimated, based on prices and costs as of the audit date.