When in April 2007 the Russian environmental watchdog agency Rosprirodnadzor announced an investigation into several publicly-listed oil companies, many observers believed that this might bring about the forced consolidation of the bottom 10 percent of Russia's oil industry. In the wake of the Sakhalin II affair, many were skeptical about the agency's claim that the companies had in fact overstated their reserves to boost stock market value.
But while Natural Resources Minister Yury Trutnev's announcement on Friday that no problems were found with all but one company alleviated the industry's worst fears, it may just be the beginning of a business nightmare for the company singled out: London-listed Imperial Energy Corporation.
With a market capitalization of around $540 million and 140 employees, the independent oil company is far from being a big fish. For several months until the end of 2006, its stock had been slowly losing value, bottoming out at 6.10 pounds in mid-January.
But on December 31, 2006, the international audit company DeGolyer & MacNaughton (D&M) delivered its assessment report, according to which Imperial's reserves had increased dramatically by about 150 percent to a total of 802.6 million barrels. From then on, the stock began to climb slowly, inching up to 8.92 pounds on March 5. When on March 6 the audit reports were made public, Imperial's trading value increased by 71.6 percent in a single trading day. By April 15 it had reached 15 pounds.
But stock prices tumbled down to 10.92 pounds in a matter of days after Rosprirodnadzor accused the company of violating environmental standards and overstating its reserves by as much as 10 times, threatening to revoke Imperial's license.
Imperial admitted that its Western Siberian oil pipeline had in fact been constructed in violation of Russian environmental standards, though it put the blame on a contractor. But the company insisted that its reserve assessment was accurate and had been audited by D&M.
But assessing natural reserves is inherently difficult. Not only is it impossible to measure them directly, but their size depends on a number of factors which are difficult to quantify. The most widely used systems are those of the Society of Petroleum Engineers (SPE) and the U.S. Securities and Exchange Commission (SEC).
Both systems classify reserves as proven, probable, and possible, but the SEC system is more conservative in its assessment of probable and possible reserves - those not currently exploited and not profitable under current technological and market conditions.
The SEC's more restrictive approach generally results in lower estimates for proven and probable reserves. Investment banks prefer the SEC approach as it provides less room for interpretation. The difference between the two can be as large as 25 percent.
But while the SPE and SEC classifications are an international standard, Russia's system is different altogether. According to a source in a major Russian oil company, the Russian system is "based on ‘technical' criteria," that do not take economic factors into consideration. As a result, Russian reserve estimates will "almost always be higher than SEC or SPE ‘proved' reserves."
The situation in this case may be different, however. In its Monday press release, Imperial Energy states that "SPE reserves ... are entirely different to Russian Registered Reserves" and that methodologies and matters taken into account "vary materially" between the two.
In what may be a concession to the Russian system, Imperial also stated that it "recognizes the importance of Russian Registered Reserves and intends ... to move to duality of reporting with appropriate explanations as to the differences in standards and the mechanics of ... estimations and registration."
A source close to Imperial explained to The Moscow News that SPE estimates for probable reserves are "usually higher" than Russian estimates: Russia apparently does not recognize technologies such as "fraccing" which allow for significantly increased production. And Russian standards take into consideration producing fields only. SPE guidelines consider the ‘probability of success,' based on indirect data gained from seismological tests, for example.
But while Imperial seems to believe that Rosprirodnadzor is using Russian standards as the basis of its accusations, it is possible that the agency may be using SEC standards instead.
In its 35-page assessment report for Imperial, DeGolyer and MacNaughton writes that "the proved, probable, and possible reserves estimated in this report have been prepared in accordance with reserves definition approved ... by the SPE". Not SEC. The summary data provided by the report is identical to the data published by Imperial in March 2006.
If Rosprirodnadzor bases its objections on the difference between the Russian and the SPE/SEC approach, it is not clear why the agency would single out Imperial, while finding no fault with the more than 10 international companies that were part of the same investigation. As of Thursday, Imperial said it had not been notified by the Ministry on which classification system the claims against the company were based.
Under the condition of anonymity, the same source close to Imperial suggested that questions would be better directed at DeGolyer and MacNaughton, rather than Imperial, since the company had relied entirely on the quality of the assessment report. On Tuesday, Imperial announced that it had appointed DeGolyer and MacNaughton to perform the 2007 annual reserves report. When The Moscow News contacted DeGolyer and MacNaughton in Dallas, the company refused to comment.
Rosprirodnadzor deputy head Oleg Mitvol questions the validity of Imperial's claims on reserve increases in a number of license blocks acquired by Imperial in early 2006. In some cases, the company reported reserves 7 to 8 times higher than the data gathered during Soviet-era exploration work. According to Mitvol, that data had been audited by the international oil and gas consulting company Miller and Lents between 1982 and 1987. According to Imperial's 2006 annual report, the company "began 2006 with independently reported reserves of 228 million barrels of probable reserves," which by December 2006 had increased to 802.6 million barrels. "I don't understand this difference," Mitvol says, "they did almost nothing there since they bought the blocks. They simply changed the interpretation of the data."
But Mitvol apparently suspects that there might be more behind these discrepancies than a simple difference of interpretation. In a letter dated July 6, DeGolyer and MacNaughton told the agency that it had used data provided to them by a geological survey company. "But that company belongs to Imperial subsidiary Nord Imperial," Mitvol told The Moscow News, "I'm not sure the [stock exchange] regulators in London know that. This kind of work is normally done by an independent company."
But Imperial denies this. "The company in question has nothing to do with Imperial. It belongs to Integra [one of Russia's largest oilfield services companies]." In its press release, Imperial also said that "it is impossible ... to artificially contrive a full subsurface data set to such an extent that it has a material input on calculated reserves."
But Mitvol is skeptical. "Look, the company today is worth 10 times more than it was only two years ago. All because of this new data interpretation. How is that possible?" he asks. The Moscow News's source says there is nothing unusual about this in the least. "Imperial has been very successful exploring over the last year, and the stock price is simply a reflection of that. A lot of energy companies on the London exchange have had such increases," the source said.
While Mitvol refused to say that he suspects Imperial of securities fraud - "that's for the courts to decide" - he does voice concern that a number of institutional investors have bought close to half of Imperial's shares. "Why do pension funds invest in a company that produces almost no oil? They only have exploration licenses that expire at the end of the year."
Mitvol said the agency will submit its findings to British regulators next week. He also indicated that he may contact relevant bodies in the United States.
But Imperial disputes that by asserting that "we have combined exploration and production licenses for blocks 69, 77, 80, and Maiskaya - all of which are valid until 2029 or 2031." The company is also in the process of converting its exploration licenses for the remaining fields. The company plans to increase its production from 2,500 barrels per day in January to 35,000 barrels per day by the end of 2009. Russia's oil production was 9.769 million barrels a day
in 2006.
Most damaging is Mitvol's suggestion that Peter Levine, Imperial's founder and one of its principle shareholders had sold a significant amount of stock earlier this year. "Simply not true," the Imperial source said, "Peter has never sold any shares - he has always been buying." According to an official press release of May 4, the company announced that Levine was to buy 325,000 shares of Imperial.
Imperial is in a very early stage of its business in Russia, with profitability a long way off: while the company has invested some $600 million over the last three years in the Tomsk region, it sold oil worth $3.129 million in 2006. An additional $200 million for expenditure and working capital requirements is planned for 2007. The assessment report values the present discounted worth of Imperial's current reserves in Western Siberia at $2.846 billion.
Rosprirodnadzor's announcement on Friday resulted in an additional 7.9 percent share value drop by Wednesday, continuing an almost three-month negative trend that began after the investigations were opened in April.
By Dietwald Claus
