With the SEC's textbook reserves-booking definitions as guidelines, reporting reserves should be easy. Not so, according to panelists at the recent KPMG energy conference in Houston. The guidelines are dated, making the process of accurately booking reserves and evaluating E&P success anything but easy. Currently, the SEC mandates that proved reserves should be reasonably certain, which means there should be 90% probability of producing at least the booked amount, said Scott Rees, president and chief operating officer of reservoir-analysis firm Netherland, Sewell & Associates. E&P business decisions are made on the basis of the most likely case and have a 50-50 chance of going up or down, Rees said. "But the SEC definition implies that revisions should trend upward, not down." Analogy, performance analysis and volumetrics all help determine reserves, and all have the potential for flaw. "The SEC definitions are pretty clear. It's the subsequent interpretations by staff that leave room for inconsistency," Rees said. Yet, as the debate on liberal booking practices continues, the panelists agreed that confused investors can't be smart investors. "The outcome of all this should not muddle investors' already difficult task of understanding what's happening with a company's reserves," said Andrew Oram, vice president and senior credit officer at Moody's Investors Service. "Given the nature of the business, it's not hard to underestimate risks, timing, complexity and costs. And reserves contain definite compromises-modeling assumptions, human bias and judgments can all result in problems and errors that can compound over time." Despite these hurdles, E&P companies must continue to make reserves reporting as transparent as possible for the layman to gauge near-to-immediate market trends. To identify winning firms, Oram looks for capacity for leveraged cash-on-cash returns of 200% or greater; strong equity currency; a good product/capital base; supportable trends in three- to five-year drillbit finding and development and all-in acquisition costs; and a track record of solid production replacement with upward revisions. He also reviews management's track record, a company's risk mix and the outlook of price to cost production replacement. Red flags include high debt levels, underperformance under shareholder pressure, untimely/ excessive buybacks, imbalanced reserves and property portfolios and reduced market access, Oram said. "Realistically, there are two sets of reserves," said David Hobbs, head of E&P strategy service at Cambridge Energy Research Associates. "There are the ones companies deal with daily, and there's what's presented annually via disclosure. When this frenzy first began about reserves reporting, what was really interesting to us was how the rules themselves may have been wrong. "Unfortunately, the industry has been using Band-Aids instead of taking a modernized look at updating how the reporting system works." The SEC reserves guidelines are outdated. "I understand why nobody has the appetite for coming above the parapet to get their head shot off. But at first glance, it's obvious that this is an old system in need of modernization." SEC rules are needed, but they should be effective, at least. "The rules for reserves certainly do matter, and their discussion shouldn't be viewed as an arcane subject," Hobbs said. "Only one person has to believe the wrong number for a lot of capital to be unwisely redeployed into the industry."