Proved Reserves (1P)

Proved Reserves (also known as 1P) are the crown jewels of an `oil and gas industry` company. They represent the quantity of `crude oil` and `natural gas` that geological and engineering data demonstrate with reasonable certainty to be commercially recoverable in future years from known reservoirs. Crucially, this calculation must be based on existing economic conditions, current operating methods, and government regulations. The key phrase here is “reasonable certainty,” which the U.S. `Securities and Exchange Commission (SEC)` and other regulatory bodies like the `Society of Petroleum Engineers (SPE)` define as a high degree of confidence that the quantities will be recovered. This is typically interpreted as having at least a 90% probability. This makes 1P the most conservative and reliable estimate of a company's underground assets. It’s not a wild guess about what might be found; it’s a carefully calculated inventory of what the company is highly confident it can produce and sell using today’s technology and at current `commodity prices`. For a value investor, 1P `reserves` form the bedrock of any analysis of an energy company.

To understand the importance of 1P, it helps to know its more speculative siblings: `Probable Reserves (2P)` and `Possible Reserves (3P)`. Think of it as counting your chickens before they hatch.

• 1P (Proved): These are the eggs already in your basket. You have a 90% or higher confidence you can get them to market. This is the most bankable figure.
• 2P (Proved + Probable): This includes the Proved reserves plus Probable reserves. Probable reserves have a lower level of certainty, typically around a 50% confidence level of being recovered. This is like counting the eggs you expect your healthy hens to lay soon. It's a reasonable expectation, but less certain.
• 3P (Proved + Probable + Possible): This is the most optimistic number, adding Possible reserves to the 2P figure. Possible reserves have a low chance of being recovered, often just 10%. This is akin to counting eggs from hens you haven't even bought yet. Management might talk about 3P to paint a rosy picture, but conservative investors should be highly skeptical.

A prudent investor always starts with 1P. The other categories represent potential upside, not a reliable foundation for valuation.

For followers of a `value investing` philosophy, focusing on Proved Reserves isn't just a technical detail; it's a fundamental principle of prudent analysis.

Proved Reserves are the primary input for valuing an oil and gas exploration and production (E&P) company. Analysts use 1P figures to build `discounted cash flow (DCF)` models that project the future revenue from producing and selling these reserves. A key metric you'll often see is `PV-10`, which is the present value of the future income from a company's proved reserves, discounted at an annual rate of 10%. Essentially, it’s an attempt to answer the question: “What is the company's proved oil and gas in the ground worth in today's money?” Without a reliable 1P number, any valuation is built on sand.

The legendary investor `Benjamin Graham` taught that the secret to sound investing is the `margin of safety`—paying a price so far below your estimate of intrinsic value that you are protected from bad luck or errors in judgment. By basing your valuation on 1P reserves, you are automatically building in a margin of safety. You are valuing the company based only on what is highly certain. If the company successfully develops some of its 2P or 3P reserves, or if energy prices rise, that's a welcome bonus—an upside surprise you didn't pay for.

Even within the “proved” category, there are different levels of certainty and required investment. Smart investors know the difference.

1. Proved Developed Producing (PDP): This is the gold standard. These reserves are flowing from wells that are already drilled and actively producing. They require minimal additional capital to keep generating cash flow.
2. Proved Developed Non-Producing (PDNP): These reserves are from wells that have been drilled and are ready for production but are currently shut-in for some reason (e.g., waiting for a pipeline connection, minor repairs). They are still considered very low-risk.
3. Proved Undeveloped (PUD): These are the trickiest. PUDs are reserves in a known field that require significant future investment to be brought online—for example, a new well needs to be drilled. While they meet the 90% certainty threshold from a geological standpoint, they carry execution risk and require significant future `capital expenditures`. A company with a high percentage of PUDs in its 1P mix is riskier than one whose reserves are mostly PDP.