Prospective Resource

A Prospective Resource is an estimate of undiscovered petroleum (oil or natural gas) in a location that has not yet been drilled. Think of it as a treasure map where 'X' marks a potential spot. Geologists use seismic data and geological studies to identify these potential traps, but until a well is drilled, their existence is pure speculation. These are the most speculative and high-risk category of hydrocarbon resources, representing what an E&P (Exploration & Production) company hopes to find, not what it has found. The volume is estimated based on a range of possibilities, and it carries a significant risk of failure—the trap might be empty, the rock might not be porous enough to hold oil, or the hydrocarbons may have escaped millions of years ago. Unlike proven Reserves, which are discovered, commercially viable, and ready for production, prospective resources are the stuff of geological dreams and investor prayers. They are the lottery tickets of the energy sector.

To truly grasp the speculative nature of prospective resources, it helps to visualize the “Resource Pyramid.” This is a classification system, formally known as the PRMS (Petroleum Resources Management System), that categorizes oil and gas assets based on their certainty. Imagine a pyramid: the widest, most uncertain base is at the bottom, and the narrowest, most certain peak is at the top.

• Prospective Resources (The Base): This is the foundation of the pyramid—vast, undiscovered, and purely conceptual. It's the “what if” category. A company might announce billions of barrels of prospective resources, but this is just a geological estimate of what could be there. The chance of discovery is low, and many prospects will turn out to be dry holes.
• Contingent Resource (The Middle): One step up. This is oil and gas that has actually been discovered by drilling a well. We know it's there! However, it's not yet commercially viable to extract. This could be due to low oil prices, a lack of pipeline infrastructure, political instability, or the need for new technology. It's a real asset, but it's sitting on the shelf, waiting for conditions to improve.
• Reserves (The Peak): This is the top of the pyramid—the holy grail. Reserves are discovered, commercially viable, and technically recoverable with existing technology. The company has a firm plan to develop and produce them. Reserves are further broken down by certainty:
  1. Probable and Possible Reserves (2P and 3P): These are less certain than Proved Reserves but are still considered valuable assets.
  2. Proved Reserves (1P): This is the gold standard. These are the volumes that can be produced with reasonable certainty (typically a 90% or higher probability). Banks lend against them, and they form the core value of any oil and gas company.

For a value investor, the word “prospective” should be a giant red flag. While exciting, these resources are grounded in hope, not in economic reality.

Following the wisdom of Benjamin Graham, investors should seek a Margin of Safety by paying for tangible, proven assets, not for speculative stories. Prospective resources are the opposite of this principle.

• Zero Value Assignment: In a conservative valuation, you should assign a value of zero to prospective resources. They are not assets; they are opportunities that may or may not materialize. Basing an investment on them is speculation, not investing. A company's share price should reflect its existing production and proved reserves, not its geologists' wish list.
• The “Wildcatter” Trap: Be especially wary of small exploration companies (often called “wildcatters”) whose entire market value is built on the hype surrounding a single large prospective resource. These stocks can soar on press releases and plummet to zero when the exploratory well comes up dry. This is a gambler's game, not a place for prudent capital.

While you shouldn't pay for them, that doesn't mean you should ignore them completely.

• For the Majors: In a giant, diversified company like ExxonMobil or Shell plc, a portfolio of prospective resources is just part of the ongoing business of replacing reserves. Their success or failure in any single prospect won't make or break the company. Here, you can view them as a potential, un-priced bonus—icing on an already very solid cake.
• As a Qualitative Factor: If two otherwise identical companies are trading at the same valuation based on their proved reserves, the one with a more promising and geologically sound portfolio of prospective resources might be the slightly better long-term bet. But this should only ever be a secondary consideration, never the primary reason to invest.

Prospective Resources are fascinating geological concepts that fuel the discovery of new energy supplies. For an investor, however, they represent a high degree of uncertainty. They are the sizzle, not the steak. A prudent value investor builds their portfolio on the solid foundation of proved reserves and predictable cash flows, treating any future exploration success as a welcome but entirely unexpected bonus. Don't buy the treasure map; buy the company that already has the gold in its vault.