Adding Fuel to the Oil and Gas Boom

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Had I written such a headline a decade ago -- heck, just five years ago -- I might have looked like a prescient genius. Writing it as I do now, years after oil and gas company stocks have exploded, oil itself sits north of $140 a barrel, and many feel that big oil has ruined their lives, I appear to be a tad behind the times. Or am I? A coming rule change by the SEC could provide yet more fuel for the blazing oil and gas boom.

Prove it to me
When oil and gas companies report their reserves, they are required by regulation to only consider "proved reserves." The SEC has typically considered that to mean reserves that are economically feasible to produce. Moreover, oil deposits that have typically been uneconomical to extract, including oil shales and tar sands, now seem far more feasible, thanks to advances in technology and the cost oil.

At lower price levels, the costly production of oil sands is too costly to try. But when the price of oil sits north of $100 a barrel, oil sands make more economic sense. Canada, where companies like Oilsands Quest (AMEX: BQI) own properties, has the world's largest deposits of oil sands, along with Venezuela. With much of the "cheap oil" already tapped, more expensive forms, like the oil-sands variety, are becoming attractive, leading oil-sands big dogs like Canadian Natural Resources (NYSE: CNQ) and Suncor Energy (NYSE: SU) to build and expand infrastructure to support the production and upgrading of the extra-heavy oil.

SEC regulations have specifically prohibited companies from including such reserves in their numbers. That could all change now, because the SEC has been prodded to catch up with the times. It is proposing to change the rules on what exactly constitutes "proved reserves," and that greater transparency on oil and gas companies' reserves could represent an extreme buying opportunity.

Discounting the unknown
Oil and gas companies are valued upon their proved reserves and their ability to produce them. The SEC requires that future net cash flows be discounted at an annual rate of 10% to determine their "present value." However, if (or when) the rule change goes into effect, the amount of proved reserves could skyrocket for some companies, which would make many companies' current enterprise values to proved reserves seem extremely undervalued by comparison.The SEC is recognizing that modern technology, such as the 3-D and 4-D seismic tools used by Dawson Geophysical (Nasdaq: DWSN) and OYO Geospace (Nasdaq: OYOG), allow companies to employ sound waves to estimate with reasonable certainty the undeveloped reserves present. As it stands now, the rule would only allow such reserves to be counted if they were immediately adjacent to currently productive wells or by drilling the reservoir and conducting flow-through tests.

Final Foolish thoughts
The rules in effect now were written some 25 years ago, and like most government regulations, they change at a glacial pace. Yet with the changes contemplated by the regulations, investors could find themselves in a better position than wildcatters blindly digging for black gold. They could be sitting on a gusher of profits just waiting to be tapped.