Possible Reserves

Possible Reserves are the most speculative and least certain category of recoverable oil, gas, or mineral resources. Think of it as a treasure map where an “X” marks a potential spot, but there's only a slim chance treasure is actually buried there. In the world of energy and mining, these are resources that geological and engineering data suggest might be recoverable in the future, but the analysis is based on very limited information or optimistic interpretations. For a resource to be classified as “Possible,” industry standards, such as those from the Society of Petroleum Engineers (SPE), typically require at least a 10% probability of it being commercially extracted. This low level of confidence means they are far from a sure thing and often depend on significant technological breakthroughs or a substantial, sustained rise in commodity prices to become viable. For investors, Possible Reserves represent a potential long-shot payoff rather than a bankable asset you can use for a reliable company valuation.

To understand Possible Reserves, you need to see where they sit in the pecking order. Geologists and engineers classify resources based on their degree of certainty. This creates a hierarchy, often referred to by “P” numbers.

• Proved Reserves (1P): This is the gold standard. These are resources that geological data demonstrate with reasonable certainty (typically 90% or higher probability) can be recovered under existing economic and operating conditions. For a value investor, this is the closest thing to money in the bank.
• Probable Reserves: This is the next step down. These reserves are not as certain as Proved but have a “more likely than not” chance of being recovered (typically defined as a 50% or higher probability). When combined with Proved Reserves, they are known as 2P (Proved + Probable).
• Possible Reserves: This is the bottom of the ladder. As we've seen, they have a low chance of recovery (10% or higher, but less than 50%). When you add all three categories together, you get 3P reserves (Proved + Probable + Possible).

An easy way to remember this is with the 90-50-10 rule of thumb for certainty: 90% for Proved, 50% for Probable, and 10% for Possible.

For an investor following the philosophy of Value Investing, understanding the difference between these categories is crucial. It separates sober analysis from hopeful speculation.

The father of value investing, Benjamin Graham, taught investors to demand a Margin of Safety—paying a price so low compared to a company's intrinsic value that you are protected from bad luck or errors in judgment. Possible Reserves offer no such safety. They are the definition of speculative hope. A conservative value investor calculating the value of an energy company would, in most cases, assign a value of zero to Possible Reserves. The valuation should be anchored in the high-certainty 1P reserves, with perhaps some carefully discounted value assigned to 2P reserves. Relying on 3P reserves to justify an investment is like paying for a lottery ticket at the price of a winning ticket—it's a recipe for disaster.

That said, Possible Reserves aren't entirely useless to a savvy investor. They can be viewed as a free “kicker” or optionality. Imagine you find an oil company trading at a deep discount to the value of its 1P reserves alone. In this case, you are essentially getting the Probable and Possible reserves for free. If, down the line, new technology or higher oil prices allow the company to convert those Possible Reserves into Probable or even Proved, it's pure upside on an already solid investment. The key is not paying for them in the first place.

Finally, pay close attention to how a company talks about its reserves. If the Management team constantly hypes up its vast 3P reserves while its 1P reserves are stagnant or declining, it's a major red flag. This can be a sign that they are trying to distract investors from poor operational performance or a weak underlying asset base. Honest and conservative management teams focus on what they can deliver, which means they emphasize their Proved Reserves.

Possible Reserves are the “maybes” of the natural resources world. They represent potential but not promise. For the disciplined value investor, they should be treated with extreme skepticism and generally excluded from a conservative valuation of a company. While they can provide a pleasant surprise as a free bonus on an otherwise cheap stock, they should never be the reason you invest. Always anchor your analysis in the certainty of Proved Reserves—that's where the real, measurable value lies.