There are numerous uncertainties inherent in estimating quantities and values of proved reserves
and in projecting future rates of production and the amount and timing of development expenditures,
including many factors beyond our control. Future development and abandonment costs are
determined annually for each of our properties based upon its geographic location, type of production
structure, water depth, reservoir depth and characteristics, currently available procedures and
consultations with engineering consultants. Because these costs typically extend many years into the
future, estimating these future costs is difficult and requires management to make judgments that are
subject to future revisions based upon numerous factors, including changing technology and the
political and regulatory environment. Reserve engineering is a subjective process of estimating the
recovery from underground accumulations of oil and gas that cannot be measured in an exact manner
and the accuracy of any reserve estimate is a function of the quality of available data and of
engineering and geological interpretation and judgment. Because all reserve estimates are subjective,
the quantities of oil and gas that are ultimately recovered, production and operating costs, the amount
and timing of future development expenditures and future oil and gas sales prices may all differ from
those assumed in these estimates. Approximately 95% of our 2011 proved reserve information is
based on estimates prepared by outside engineering firms. Estimates prepared by others may be
higher or lower than these estimates.
The standardized measure represents estimates only and should not be construed as the current
market value of the estimated oil and gas reserves attributable to our properties. In accordance with
SEC requirements, the estimated discounted future net revenues from proved reserves are generally
based on average oil and gas prices in effect for the prior twelve months and costs as of the date of the
estimate. Actual future prices and costs may be materially higher or lower than the average prices and
costs as of the date of the estimate.
Impairments of Oil and Gas Properties.
Under the SEC’s full cost accounting rules, we review
the carrying value of our oil and gas properties each quarter. Under these rules, for each cost center,
capitalized costs of oil and gas properties (net of accumulated depreciation, depletion, amortization
and related deferred income taxes) may not exceed a “ceiling” equal to:
• the present value, discounted at 10%, of estimated future net cash flows from proved oil and
gas reserves, net of estimated future income taxes; plus
• the cost of unproved properties not being amortized; plus
• the lower of cost or estimated fair value of unproved properties included in the costs being
amortized (net of related tax effects).
The rules generally require that we price our future oil and gas production at the twelve-month
average of the first-day-of-the-month reference prices adjusted for location and quality differentials. Such
prices are utilized except where different prices are fixed and determinable from applicable contracts for
the remaining term of those contracts, including derivative contracts that qualify and are designated for
hedge accounting treatment. The derivative instruments we have in place are not classified as hedges for
accounting purposes. An impairment is required if our capitalized costs exceed this “ceiling”. The pricing
in ceiling test impairment calculations may cause results that are not indicated by market conditions
existing at the end of an accounting period. For example, in periods of increasing oil and gas prices, the
use of a twelve-month average price in the ceiling test calculation may result in an impairment.
Conversely, in times of declining prices, ceiling test calculations may not result in an impairment.
At December 31, 2011, the ceiling with respect to our domestic oil and gas properties exceeded
the net capitalized costs by 30% and we did not record an impairment.
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