Proven Reserves (1P)

Proven Reserves (also known as 1P reserves) are the crown jewels of any oil, gas, or mining company. They represent the quantity of resources that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Think of them as the most bankable and dependable portion of a company's underground assets. The term “reasonable certainty” isn't just a vague reassurance; in the industry, it typically implies a high degree of confidence, often defined as at least a 90% probability that the quantities recovered will equal or exceed the estimate. Because of this high standard of proof, Proven Reserves are the most conservative and closely watched category of reserves. They are crucial for a company's financial reporting, securing loans, and, most importantly for us, for conducting a sound valuation.

For companies in extractive industries, the real factory is the ground itself. Their primary asset isn't machinery on a factory floor but the valuable resources buried beneath the surface. Proven Reserves are the most tangible and reliable measure of this core asset. For a value investor, understanding 1P reserves is fundamental to assessing the company's true worth. It's the bedrock of any Asset-Based Valuation. A company with a large and growing base of Proven Reserves is like a manufacturer with a full and expanding warehouse—it signals a healthy, sustainable business that is successfully replacing the resources it produces. Conversely, a company with dwindling 1P reserves is essentially liquidating itself, selling off its inventory without replenishing it. This is a major red flag. By tracking the changes in a company's Proven Reserves over time, you can gain a powerful insight into its operational competence and long-term viability.

To really grasp the importance of Proven Reserves, it helps to understand where they fit in the broader classification system. Analysts often talk about the “Three P's.”

As we've covered, these are the high-confidence reserves. With a 90%+ probability of being recovered, they are the most reliable figures. Think of an apple orchard: 1P reserves are the apples you can clearly see, reach, and are sure you can pick.

Probable Reserves are the next step down in certainty. These are quantities estimated to have a 50% or greater chance of being recovered. They are not as certain as Proven reserves but are still considered reasonably likely. In our orchard, these are the apples higher up the tree; you're pretty sure you can get them with a ladder, but it's not a guarantee. The term 2P refers to the sum of Proven and Probable reserves.

Possible Reserves are the most speculative category. These have a low chance of being recovered, typically estimated at around 10%. They might be based on less complete geological data or require a significant, unproven technological breakthrough to extract. These are the apples at the very top of the tree that you might get if a strong, favorable wind blows them down. The term 3P refers to the sum of Proven, Probable, and Possible reserves. A savvy investor always focuses on the 1P number first, as it represents the most realistic picture of the company's assets.

When analyzing a company's reserves, don't just take the headline number at face value. Dig a little deeper with these key questions.

A single year's 1P figure is a snapshot, but the trend is the story. Is the company consistently replacing the reserves it produces?

• Check the Reserve Replacement Ratio (RRR): This metric tells you how much new reserve a company has added relative to what it has produced in a period. An RRR consistently above 100% is a sign of a healthy, growing company. An RRR below 100% means the company is slowly depleting its core assets.

The definition of Proven Reserves is tied to “existing economic conditions.” This is a crucial, dynamic element.

• Commodity Prices: If oil prices fall from $100 to $40 a barrel, some high-cost reserves may no longer be profitable to extract. As a result, they can be “de-booked” and removed from the 1P category, causing the company's Book Value to shrink overnight. Always consider the quality and cost of extraction for the reserves.
• Look for the PV-10 Value: Many companies report this metric. It represents the present value of the future income from its Proven Reserves, calculated using a standard 10% Discount Rate. It provides a useful, albeit simplified, benchmark for the value of a company's 1P assets.

Not all barrels in the ground are created equal.

• Geopolitical Risk: A million barrels of oil in West Texas are far more valuable and secure than a million barrels in a politically unstable region. Political turmoil can disrupt operations or even lead to expropriation. Always factor in the geopolitical risk associated with the location of a company's reserves.