Usually when prospects are risked O&G companies end up with three risk numbers: the P10 or P3, P50 or P2 and the P90 or P1 reserve estimates.

Each estimate assumes varying reservoir parameters. The P10 or P3 are the most optimistic and the P90 or P1 are the least optimistic with the P50 and P2 being around the middle or mean.

Thus as an example P90 or P1 estimate could be 280 bcf; the P50 or P2 could contain 1041 bcf and the P10 or P3 could be as high as 3,866 bcf, with a calculated overall Swanson mean of 1,666 bcf.

The estimate in fact moves from a P01 to a P99, where under this scenario the P1 could be 11,266 bcf and the P99 would be 96 bcf.

Oil and gas producers must report annually the size of their proved reserves, namely how much oil and gas they believe they can produce from the fields they control. Under security rules, they can include only oil or gas that can be produced economically, a calculation based on oil and gas prices at the end of their year, usually December 31st. Inventories at the end of the year are very critical to companies’ valuation. With the decline of oil prices, many companies will have to declare a big chunk of their oil and gas reserves as uneconomical.

When oil prices hit $147 many companies thought they would be able to report fields which had previously been uneconomic as part of their reserves portfolio.

Reserve estimates, which companies disclose in their annual reports, are the basis of many of the financial statistics watched closely by Wall Street analysts, including the ratio of debt to proved reserves – a key measure of corporate leverage – and finding and development costs – a key measure of exploration success.

Reserve adjustments resulting from changing prices are a routine part of the oil and gas business, but negative revisions give an indication of the quality of the reserves booked by a company in the past. Smaller companies that rely on their reserves as collateral on their credit lines from banks could find their available credit shrinking along with the value of their booked reserves. Even with falling prices, many companies may see their reserves rise. That is because record revenue earlier in the year (2008) when oil prices were high encourage greater drilling activity, enabling companies to prove the viability of their fields and therefore report them as proved reserves.

Many smaller companies also locked in high prices by hedging, which would also enable them to keep reserves on their books that might otherwise be uneconomic.

Falling price can also prove to have an upside for large producers, such as ExxonMobil and Chevron, which have much of their production in foreign countries. Contract with foreign governments that allow the companies a larger share of the oil as prices fall could help offset the loss of reserves that aren’t economic at lower prices. 2008 may be the last year that companies’ reserves will be subject to such wild swings in prices. The SEC is considering a rule change that would base reserve estimates on a 12-month average price, rather than the one-day price on December 31. If that had been applied for 2008, companies would have been calculating their reserves based on the year’s average price of just under $100 a barrel.