Probable Reserves

Probable Reserves are quantities of oil and gas, minerals, or other natural resources that are estimated to be recoverable from known deposits, but with a lower degree of certainty than proved reserves. Think of them as a well-educated guess rather than a sure thing. According to industry standards like the Petroleum Resources Management System (PRMS), the “probable” label means there is at least a 50% probability that the actual quantities recovered will meet or exceed the sum of the proved plus probable estimates. These reserves are identified based on geological and engineering data, but that data might be less complete or subject to wider interpretation than what's available for proved reserves. For example, they might be located in a less-drilled part of a known reservoir or require a new, unproven extraction technology. For investors, probable reserves represent potential upside, but they carry more risk than their “proved” counterparts.

To really get a handle on probable reserves, it helps to see where they fit in the pecking order. Geologists and engineers classify a company's resource assets into three main categories based on confidence. It's a bit like planning a treasure hunt:

• Proved Reserves (1P): This is the treasure you've basically found. You have a detailed map, you've drilled test holes, and you're reasonably certain (typically a 90% or higher probability) you can pull it out of the ground with current technology and at current prices. This is the most conservative and reliable measure of a company's assets.
• Probable Reserves: This is the part of the treasure map marked with a big, promising 'X', but you haven't fully excavated it yet. You have good reason to believe it's there, but it's not a done deal. When added to proved reserves, this forms the Proved + Probable (2P) category, which has a 50% chance of being met or exceeded.
• Possible Reserves: This is a clue on the back of the map that suggests more treasure might be buried over the next hill. It's speculative and based on limited geological data. The chance of recovery is low (at least 10%), making it the riskiest category.

As a value investor, you’re always looking for misunderstood or undervalued assets, and a company's reserve profile is a fantastic place to hunt. It's not just about the numbers; it's about the story they tell.

Companies in the extractive industries, such as oil, gas, and mining, must disclose their reserves, and smart investors pay close attention. A company with a large pile of probable reserves might be sitting on a future growth engine. The market, however, often focuses heavily on the more certain 1P reserves. This can create opportunities. The key metric to watch is 2P (Proved + Probable), as it gives a fuller picture of a company's medium-term potential. A rising 2P figure can signal a healthy future, even if 1P reserves are temporarily flat.

The real art is judging the quality of those probable reserves. This is where you have to investigate the management team.

• Track Record: Does the company have a history of successfully converting its probable reserves into proved reserves? A company that consistently delivers on its estimates is demonstrating operational skill and conservative accounting. This builds trust.
• Red Flags: Conversely, a management team that constantly touts huge probable reserves that never seem to get upgraded is a major red flag. It could suggest they are either incompetent or trying to artificially inflate the company's perceived value.

Analysts and investors don't treat all reserves equally. When building a financial model, they apply a higher discount rate to the cash flows expected from probable reserves compared to proved reserves. This reflects the higher risk. Your job as a value investor is to decide if the market's discount is fair. If you believe, based on your research into the company's technology and management team, that their probable reserves are more likely to be recovered than the market thinks, you may have found a company trading below its intrinsic value. It’s a classic application of the margin of safety principle—betting on an outcome that you believe is more probable than the market price implies.