Petroleum Resources Management System (PRMS)

The Petroleum Resources Management System (PRMS) is a globally recognized standard for classifying and reporting oil and gas resources. Developed and maintained by a coalition of industry bodies, including the Society of Petroleum Engineers (SPE), the PRMS provides a common language for oil and gas companies, regulators, and investors. Think of it as the GAAP or IFRS for what’s buried underground. Before this system, estimating and reporting oil and gas assets could be a bit of a wild west, making it incredibly difficult for investors to compare the assets of one company to another. The PRMS brings much-needed consistency and transparency by setting out specific rules and definitions for what can be called a “reserve” versus a more speculative “resource.” For an investor, understanding the basics of PRMS is non-negotiable if you want to value an energy company and avoid being misled by overly optimistic claims.

In the world of value investing, reliable data is king. You can't calculate the intrinsic value of a business if you can't trust the numbers it reports for its most important assets. For an oil and gas producer, those assets are its petroleum deposits. The PRMS is critical because it forces companies to categorize these assets based on their commercial viability and the certainty of their existence. This framework helps an investor distinguish between:

• Bankable Assets: Oil and gas that is highly likely to be extracted and sold profitably.
• Potential Upside: Deposits that might become profitable in the future if, for example, oil prices rise or new technology becomes available.
• Pure Speculation: Discoveries that have a very low chance of ever seeing the light of day.

By forcing this clarity, the PRMS allows you to peer through management's marketing spin and focus on the real, tangible value within a company.

The PRMS framework is best visualized as a grid. It classifies resources along two axes: the chance of commerciality (horizontal axis) and the range of uncertainty in the estimated volumes (vertical axis). The horizontal axis is the most important for a first look. It moves from highly speculative resources to commercially-ready reserves:

• Prospective Resources: These are undiscovered quantities in unexplored areas. It's pure potential based on geological surveys. This is the most speculative category.
• Contingent Resources: Oil and gas has been discovered here, but it's not yet commercially viable to produce. This could be due to a missing pipeline, a pending government permit, or because the current oil price is too low to justify the investment.
• Reserves: These are discovered, recoverable, and, crucially, commercially viable to produce under current conditions. This is the category that investors care most about.

Within the “Reserves” category, the PRMS drills down further to express the level of confidence in the estimated volume. This is where you'll see the famous “P” classifications.

This is the gold standard. Proved reserves have a high degree of certainty (at least a 90% probability) that the estimated quantities can be recovered profitably with existing technology and under current economic conditions. Most conservative valuation models and bank lending decisions are based almost exclusively on a company's 1P reserves. This is the oil you can virtually “take to the bank.”

These are reserves that are “as likely as not” to be recoverable, meaning they have about a 50% probability of being produced. They are less certain than Proved reserves. When you add a company's Probable reserves to its Proved reserves, you get its 2P figure. While less certain than 1P, 2P reserves are still a key metric watched by serious analysts.

This is the most speculative of the reserve categories, with only a low probability (typically around 10%) of being recovered. When added to 2P reserves, you get the 3P total. A company with a huge amount of Possible reserves might sound impressive, but a savvy investor knows to heavily discount this figure, as it's far from a sure thing.

When analyzing an oil and gas company, use the PRMS framework as your guide to cut through the noise.

• Focus on 1P (Proved) Reserves: Base your primary valuation on 1P reserves. They are the most reliable predictor of a company's future cash flow and its ability to service debt.
• Watch the Reserve Replacement Ratio (RRR): This ratio tells you if a company is finding more oil than it's producing. A company that consistently replaces over 100% of its production with new Proved reserves is a healthy and sustainable business. Be wary of companies that can only achieve a high RRR by adding riskier Probable or Possible reserves.
• Look for Contingent Resource Conversion: A company with a large pile of Contingent Resources isn't necessarily a bad thing. The key is to investigate why they are contingent. If the only barrier is a final investment decision on a straightforward project, these resources could soon be converted to high-value Proved reserves, representing a source of hidden value.
• Be Wary of “3P Hype”: Management teams love to talk about their giant “3P” reserve base. Don't fall for it. This is often more sizzle than steak. A value investor's job is to focus on the 1P steak and treat the 2P and 3P figures as potential—but uncertain—side dishes.