Financing bioenergy, and making better investment decisions – via renewable proved reserves

November 21, 2013 |

hamilton-1Reserve accounting — a powerful balance sheet and analytic tool for traditional energy companies.

When will it be available for renewables, and how?

In November 2011, the Digest ran a story on a remarkable proposition — advanced by Richard Hamilton, CEO of Ceres — that biofuels companies – on the “level playing field” theory advanced by opponents of government mandates and subsidies, should  have a mechanism to book their reserves of crude renewable fuel production, in a parallel to the reserve accounting system associated with oil & gas projects.


Hamilton’s presentation can be viewed here.

About proved reserves and balance sheets

Most investors understand proved reserves. Under specific (and generally conservative) SEC rules, proved reserves (that is, which have a 90% or higher probability of being feasibly extracted) can be added to the balance sheet.

These reserves currently total 44 billion barrels for the top six oil exploration companies (ExxonMobil, BP, Shell, Total, ConocoPhillips and Chevron), and when we speak about the massive oil company balance sheets, this is very much in the mind of the investors when they value each company, especially in terms of their predicted future ability to produce revenues.

Strides towards making an idea into a reality

In Houston this week, as the biofuels world considered the short-term implications of cuts in the Renewable Fuel Standard targets, a small group gathered at a workshop at Total Energy USA to consider the long-term implications of developing a classification system for renewable energy reserves — a system for valuing renewable energy reserve that parallels the way we value oil reserve, which helps make them inherently more fungible, more comparable, more investable.

The group gathered to hear a report on progress by DuPont’s Jan Koninckx and BP’s David MacDonald, on an initiative to amend the United Nations’ standards for classifying energy reserves to include renewables. The UN has championed the effort as a part of its Sustainable Energy For All movement, which in turn is championed by Secretary-General Ban Ki-Moon.

The working group has been small to date – in order to move quickly, and has included Shell, Total, BP and DuPont.

A comparable system of classifying projects — for, despite the obvious differences, renewables and oil & gas share important characteristics — would assist energy companies to fairly value renewables projects alongside traditional oil exploration.

In doing so, it is more than a vehicle by which renewable project developers can more efficiently tap the capital markets, though this is a benefit. It extends the value of every integrated energy company engaged in bioenergy, geothermal, solar, wind or hydro.

If you might wonder how and why companies like Shell, BP and Total are championing the effort — it is because they are looking farther down the road than erecting ethylene crackers as a play on cheap natural gas.

The rationale?

Well, as former BP chief Lord John Brown put it, “a company is not in business to make money, but to be sustainable. There is making money today, but more important are the companies that have the resources, understanding and technology to make money for 20 years, 50 years.”

And it is not an idle issue of long-term interest only. Back in 2004, Shell restated its reserves with a 30% overall reduction, and it led to a 15% drop in price — something like the wiping out of billion of dollars in equity.

“The business of renewables to this point has been all about capacity and delivery – not reserves,” says David MacDonald, Vice President for Segment Reserves at BP where he is responsible for the estimation, approval, reporting and governance of BP’s reserves and resources. “How can you choose an uncertainty threshold for going forward with a project, if you can’t compare projects, compare investments, and have consistency in comparison. Particularly if you are a diversified investor or lender, or a diversified energy company with opportunities in oil& gas as well as renewables?”

You can view MacDonald’s presentation, here.

How does reserve accounting work?

The heart of reserve accounting is a three dimensional model of risks and uncertainties. In traditional reserve accounting, the risks are:

Geological – reserves are as much as 3 miles below the surface; you don’t ever exactly and perfectly see the reserve — so there always remains a degree of geological uncertainty. This uncertainty is rated on a 1 to 4 scale.

Technology — there is the question of whether technology exists to extract the deposit, how current technology will perform in that task today, and how technology will change over time. Technological feasibility is measured on a scale of 1 to 4.

Economic — the risks and uncertainties around price and the social right to harvest the deposit. Mores can change, prices can change, rules can change, costs of capital and exploration can change. Economic feasibility is measured on a scale of 1 to 3.

Accordingly, every project gets a rating. 111, for example, is the highest – representing the project that best has limited or addressed the risks and has the lowest levels of uncertainty.


Renewable vs fossil reserves

Well, you can see that the technology and economic uncertainties are broadly similar, though the drivers may be different. In the case of geological risk, it is replaced by terrestrial risk – the weather, the rain, climate change itself. But the classification system doesn’t need to change — projects could still be rated and pursued on this basis. A 111 project might have different attributes, but similar levels of risk.


The key phrase here is project. You see, there are no “proved reserves” based on the potential of oil fields. You might have heard of the “potential” of the Bakken formation, but proved reserves are, rather, attached to a given project. To that project’s technology, to its technology — even though that technology may evolve over time, just as the economics might evolve.

In the end, it is about a given project’s capacity, over time (in the case of renewables, over the life, say, of contracts for biomass) to convert potential to energy. It is about extractable volumes, not “potential”.

Appraising the potential

MacDonald says that the process for analyzing renewables is not all that different from nor should be, the process for appraising fossil potential.

“At BP, we have a basic seven-stage capital valuation and decision process. Projects may differ, but they hare a similar path of development.”

They are:

Access  – pure exploration aimed at understanding the potential of a given field.

Appraise – decide the potential value of a given reserve.

Select – choose how to develop. In this stage, the development is pending; it is “potentially commercial?”

Refine – this is the stage of detailed engineering -understanding the technology potential for the given deposit to become commercial.

Define – make the financial justification for development.

Execute – approved for development, being built.

Operate – the production stage.

The difference between understood reserves and proved reserves

“Most companies” says MacDonald, “have 10-15 years of proved reserves but they have 30-40 years of assets which are not yet proved. Only those reserves in the “Operate” or “Execute” stage, and maybe in some circumstances the “Define” stage — are ever booked as proved reserves.

“But there’s no way to really understand the opportunities for a company to add value,” said MacDonald, “unless there is a classification effort that analyzes the potential added value of the entire potential reserve, and measures the risk.

“If you are doing Sustainable Development for all, your definition must include the entire resource base, recognize the total potential, and not indulge in over conservatism that may lead to lost opportunity.”

Reserves, influencers and end users

There’s a value chain in analyzing reserves, according to MacDonald.

First, he says, there are the external influencers. These governments and other stakeholders might define what you can count, what you can report, what you must report. What doesn’t count. When you must report.


Then there are the internal preparers and the internal users of the reserve data. Then there’s governance and assurance process that minimizes the risks of mis-stating or goofing the numbers. Then there are the external users — for example, investors looking at projects to finance.

“From there,” said MacDonald, “individual internal or external stakeholders can decide what threshold they want to set for project decisions. It will be different, usually, from the “proved reserves” that are publicly reported. A give company may well take on more risk — and certainly will in the early, exploration stage, where capital must be spent but you are far from proving a reserve.”

But it’s a common process to understand a project, and that’s what reserve accounting is about. Four steps:

1. Do you have the access, do you have the right to be there?
2. Do you have the approvals, the social license, the permits?
3. Do you have market and connectivity. Is there a market and do you have connectivity to that?
4. Do you have the raw economic value – based on your internal threshold?

Next steps

What’s the next step?” asked DuPont’s advanced biofuels chief Jan Konickx, “To inform people, create awareness of the effort, gather views on how to proceed and identify stakeholders.”

As Konickx explained, an industry-led group developed the first concepts. Eventually the UN came on board when UNEC for Europe called on Expert Group on Resource Classification to “develop ideas” for renewable reserve accounting.


The work has proceeded quickly, as UN-oriented work goes. As many know, it can seems like it takes a year to get a cup of coffee via a UN process

But they’ve moved quickly. A draft for public distribution is expected by March or April.

Meanwhile, anyone can join the expert group – get involved, add views, or represent concerns. There’s an annual 3 day meeting in geneva and a one-day workshop ahead of that to give a “get up to speed workshop” for newcomers.

Right now it is top heavy with the heavyweight integrated energy companies. Total, Shell and BP amongst the mix. They would like to have a pure solar, a pure wind developer. And bioenergy. Where possible, project developers and their advisers.

You can see Jan Konickx’s presentation here.

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