Proved Reserves - Louisiana State University

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Welcome to

Fundamentals of International

Oil & Gas Accounting

Dr. Linda Nichols, CPA

Texas Tech University

Course Developer

Instructor for this Course


D. Larry Crumbley, Ph.D., CPA, CrFA, CFFA, FCPA

Louisiana State University

Editor, Oil, Gas & Energy Quarterly

c Linda Nichols

2

Energy is the fundamental building block for modern industrialized economies, the very
lifeblood of developed economies. When it is available, we take it entirely for granted, like
water flowing tamely from the tap. When availability fails, our lives are disrupted and
restricted, the veneer of comfort and accommodation quickly erodes, and economic activity
grinds to a halt. C.E.H. Ross and L.E. Sloan

Class Purpose


Overall Learning Objective:


To provide basic understanding and hands
-
on practice of
the accounting concepts involved in Oil & Gas
Accounting on an international basis.



To understand the accounting behind the financial
statements and how your accounting entries roll into the
financial statements.



Competencies Involved:


Basic level general accounting




c Linda Nichols

3

Module 1 : Petroleum Operations and Introduction to
Accounting


Overall Objective:



Provide a high level overview of terms and
concepts relating to petroleum operations
that will be discussed in the various
accounting modules.

Introduce successful
-
efforts and full
-
cost accounting.



c Linda Nichols

4

Petroleum Geology


Organic theory


Oil is formed from organic matter of marine origin
deposited with rock particles millions of years ago.


c Linda Nichols

5

Needed for Reservoir Formation


Source rock (remains of land/sea life)


Conditions to cause petroleum formation (heat and
pressure)


Porosity or pore space (10% or more) and permeability
(connectability)


Trap: structural or stratigraphic




c Linda Nichols

6

Steps in Petroleum Production

1

Broad G&G reconnaissance work

2

A lease or an option to lease may be obtained

3

Detailed G&G work is done to evaluate area of interest.

4

Data gathered in steps 1 and 3 are analyzed. If results positive, a lease is
obtained (if not already obtained).

5

Further analysis of available data and possible more seismic studies done
to select drill site.

6

The well is drilled.

7

Based on data obtained during the drilling process (cuttings, well logs, etc),
decision made on commerciality.

8a

Sufficient oil and gas




Well completed & production started.

8b

Insufficient oil and gas


Another drill site on the lease is selected, or lease abandoned


c Linda Nichols

7

Necessary Components of an Oil or Gas Field



Source rock


Conditions to cause petroleum formation


Porosity (10% or more) and permeability


Trap: structural or stratigraphic




c Linda Nichols

Hydrocarbon System

Source rock:
organic
-
rich shale that generates oil and/or gas

Migration:
hydrocarbons escaping from the source rock and moving to a reservoir

Reservoir:

sandstone or limestone rock with (generally) high porosity and permeability that can hold
hydrocarbon fluids

Trap:
a structure or stratigraphic discontinuity in the reservoir rock that keeps buoyant hydrocarbons from
migrating all the way to the surface

Seal:

Impermeable rock above/around the reservoir that keeps hydrocarbons from leaking to surface

8

Upstream vs. Downstream Operations


Upstream: All necessary activities to find
hydrocarbon reserves and bring them to the surface.



Downstream: Refining and marketing.


“Finding new resevoirs is the name of the game.”


M. Economides and R. Oligney

c Linda Nichols

9

Phases of Upstream Operations


Initial prospecting


Mineral right acquisition


Exploration


Appraisal


Development [proved]


Production


Abandonment & restoration

c Linda Nichols

10

Types of Agreements

Concessionary


Leases


Concession Agreements


Contractual


Production Sharing Contracts (PSCs)


Risk Service Contracts



c Linda Nichols

11

Concessionary Agreements


In U.S., parts of Canada, and Trinidad, individuals may own mineral rights (e.g., lease
agreement).


Some countries allow non
-
governmental ownership of oil/ gas after produced
(concessionary contract).


Lessor (land owner) leases to the lessee (operator) the right to explore, develop, and
operate the oil/ gas.


Concessionary contract: For up
-
front bonuses, royalties, and taxes, a government
transfers ownership to the minerals to the petroleum company when the minerals are
produced or sold.


Back
-
in or Participation: Government retains the right to participate as a WI owner (e.g.,
joint venture partner) after the results of initial exploration and drilling are known.

12

c Linda Nichols

Leases: Interests Created from Working Interest

Joint Working Interest: Two or more parties each own an undivided fraction of the WI in a
single lease by 1) leasing, 2) sales or exchanges, or 3) sharing arrangements.


Overriding Royalty Interest (ORI): Similar to a royalty interest. Original lessee executes a
sublease and retains an overriding royalty interest (ORI).


Production Payment Interest (PPI): A non
-

operating interest created out of the WI which
is limited to a specific amount of money, time, or a certain quantity of oil or gas. Thus,
a PPI normally ends before the reservoir is depleted.


Net Profits Interest (NPI): Non
-

operating interest created out of the WI by either a carve
-
out or retention.


Utilization: Agreement between two or more parties owning operating interests to have
such interests operated on a joint basis and share the production by a stipulated
percentage or fractional basis.


Pooling: Bringing together small tracts sufficient for the granting of a well permit under
state spacing rules.

13

c Linda Nichols

14

c Linda Nichols

Authority
for
Expenditure

Contractual System


All citizens in the country owns the minerals.


Production sharing contract: The petroleum company is
allowed to recover certain costs and receive a share of the
profits.


Risk service contract: Contractor bears all costs and risks
related to exploration, development, and production. If
production, contractor is allowed to recover costs as
production is sold. Plus the contractor is paid a fee of its
services.

15

c Linda Nichols

Agreement 1: Leases

Grants to oil and gas company right and obligation to
operate on a property


Bonus


Royalty


Lessee responsible for all costs


In effect indefinitely with production



c Linda Nichols

16

Agreement 2: Concessions


Bonus


Royalty or in
-
kind payment


Contractor responsible for all costs without
reimbursement


In effect indefinitely with production


Ownership of minerals transferred to contractor



c Linda Nichols

17

Agreement 3: Production Sharing Contracts


Government gets royalty (may be in
-
kind)


Government retains ownership of minerals


Contractor responsible for all exploration costs


Government (through state oil company) has option to become WI
owner in development and production


Contractor may be required to build country infrastructure


Bonus


Costs are recoverable through
cost oil


Profit oil divided between government, state oil company and
contractor


Contractor has
entitlement interest



c Linda Nichols

18

PSCs: Accounting Issues


May have signature, development, or production bonuses


Maximum time for production phase results in state oil company taking over
100% working interest.


Cost recovery is capped, often 50% of gross production


Cost recovery order is specified:



Operations



Unrecovered exploration & appraisal



Development



Imputed interest on development






Excess cost oil may be treated as profit oil or allocated to the government.



c Linda Nichols

19

Types of PSC Bonuses


Signature bonus: A signing bonus; generally a lump
-
sum,
but may be in the form of equipment.



Production bonus: Subsequent payments are made to the
government when the production reaches an agreed upon
level.



Development bonus: Subsequent payments are made to
the government when development reaches an agreed
upon level

20

c Linda Nichols

PSCs: Accounting Issues


Overhead usually on sliding scale.


Ownership of equipment and facilities passes to government.


Significant production may go toward payment of taxes.


In past, state oil company was responsible for abandonment and
restoration.


In current agreements, all parties contribute to sinking fund for
abandonment and restoration. Funded amounts are computed on
a units
-
of
-
production basis.


May have domestic market obligation which may state a maximum
price.


Royalty and tax holidays may be granted.


Recoverable costs are identified in PSC.


c Linda Nichols

21

Agreement 4: Risk Service


Bonus


Royalty (may be in
-
kind)


Government retains ownership of minerals


All costs initially paid by contractor, but recoverable
from government


Government (through state oil company) has option
to be WI owner in operations



c Linda Nichols

22

Risk Service: Accounting Issues


After contract term, state oil company takes over.


Ownership of reserves by contractor is not
permitted.


Fee based on operating costs, capital costs, and a
profit factor.


Non
-
risk service agreements are possible, but are
rare.


c Linda Nichols

23

Reserve Estimation Methods


Deterministic


results in a single best estimate of
reserves. [SEC requires]


Probabilistic


results in a range of estimates with
their associated probabilities. Includes proven,
probable and possible reserves.


U.K. firms have choice.

c Linda Nichols

24

GAAP for Reserves Definitions


US GAAP


only proved reserves can be reported. They are
further classified as developed or undeveloped.



UK & GAAP


Permits companies to choose reporting using
either proved or probable reserves (using probabilistic
methodology) or proved developed and undeveloped
reserves (using deterministic methodology).

c Linda Nichols

25

SEC’s Definition of Proved Reserves

The estimated quantities of crude oil, natural gas and natural
gas liquids which geological and engineering data demonstrate
with reasonable certainty to be recoverable in future years from
known reservoirs under existing economic and operating
conditions, i.e., prices and costs as of the date the estimate is
made. Prices include consideration of changes in existing
prices provided only by contractual arrangements, but not on
escalations based upon future conditions. . . .


SEC Reg. 5
-
X, Rule 4
-
10(a)

26

c Linda Nichols

Proved Reserves Subdivided

Proved developed: those proved reserves that can
be expected to be produced through existing
equipment and operating methods.


Proved undeveloped: expected to be produced
through new wells to be drilled on proved property or
from existing wells for which significant expenditure is
required for recompletion.

27

c Linda Nichols

Probable and Possible Reserves

Probable reserves: Unproved reserves that are more likely than
not to be recoverable. Probable reserves may become proven
with additional drilling or with an enhanced recovery project.
These reserves also may become recoverable if the price of oil
or gas increases.


Possible reserves: Unproved reserves that are less likely to be
recoverable than probable reserves.


Commercial reserves: Based on proved reserves only. May, at
the company’s option, be either proven and probable or proved
developed and proved undeveloped.


*Statement of Recommended Practice (SORP) 2001,
Accounting for Oil and Gas Exploration,
Development, Production and Decommissioning Activities,
¶ 12
.

28

c Linda Nichols

Bias Assumptions


There are almost as many oil/gas reserve definitions as there are
countries.


During the first week of January 2004, Royal Dutch/Shell Group
slashed its estimates of oil reserves by 20% or about
3.9 billion
barrels of oil
.


Stock fell 9%.


Shell, Exxon/Mobil, and Chevron/Texaco make the estimates
themselves.


By the end of 2002, a total of 4.47 billion barrels cut; another 1.4
billion barrel cut in 2003.


Source: Susan Warren and P.A. Mckay, “Methods for Citing Oil Reserves Prove Unrefined,”
Wall Street Journal
,
January 14, 2004, p. C
-
4. Chip Cummins, “Shell Slashes Oil Reserves Again, News Overshadows Profit
Surge,” WSJ, February 4, 2005, p. A
-
3

29

c Linda Nichols

Shell Board Kept In the Dark


One memo drafted on February 11, 2002, warned that about
one billion barrels of oil
-
equivalent reserves appeared not to be
in compliance with SEC guidelines.


Board learned of information only in early January 2004.


Chairman Sir Philip was ousted in early March 2004.


Most of the misstated reserves were recorded from 1997 to
2000, when Sir Philip was in change of exploration and
production.


Oil/gas reserves were increased (not by discovery) by changing
its accounting.


Source: Stephen Labaton and Jeff Gerth, “At Shell, New Accounting and Rosier Oil Outlook,”
New York Times
,
March 12, 2004, pp. A
-
1 and C
-
4.

30

c Linda Nichols

Types of Reserves: Proved Reserves


Proved


Proved developed


Proved undeveloped

Before property fully developed:


Proved reserves = proved undeveloped + proved developed

After property fully developed:


Proved reserves = proved developed

c Linda Nichols

31

Accounting Standards: GAAP


US


FASB & SEC






SFAS 19 & SFAS 69



UK


ASB & OIAC



International


IASB



IFRS 6 & IAS 1

c Linda Nichols

32

FASB
-
IASB Project


Improve both U.S. GAAP and IFRS while concurrently
eliminating many individual differences.


Currently focused on “short
-
term convergence” projects.


Addresses differences outside the scope of a major project


Solution achievable in the short
-
term


The SEC is adopting rules to accept foreign private issuers
financial statements prepared in accordance with IFRS
without reconciliation to U.S. GAAP.

Vision 5 Years From Now


U.S. public companies will be following IFRS, not
U.S. GAAP


One standard setter (IASB) will promulgate IFRS


Still some to
-
be
-
determined role for national
standard setters (such as FASB)

Global Standards


A single set of high
-
quality, comprehensive
accounting standards involves the convergence of:


Auditing standards


Capital markets regulation


Audit oversight


Changes in the U.S. and legal environment

c Linda Nichols

Four Types of Costs


Acquisition Costs



Exploration costs



Development costs



Production costs

c Linda Nichols

36

Some Acquisition Costs



Signing bonus


upfront monies to governments*


Legal fees*


Filing/ Recording fees*


Title examination*


Options to purchase or lease*


Broker fee*


Option lapse (expense)


Shooting rights (U.S. GAAP expense; international capitalize)



* Capitalize U.S. GAAP and international.

37

c Linda Nichols

Some Exploration
Costs

A.
Costs of topographical, geological, and geophysical studies, rights
of access to properties to conduct these studies, and salaries and
other expenses of geologists, geophysical crews, and others
conducting these studies. Collectively, geological and geophysical
(G&G) costs.

B.
Costs of carrying and retaining undeveloped properties such as
delay rentals, ad valorem taxes on the properties, legal costs for title
defense, and maintenance of land and lease records.

C.
Dry hole contributions and bottom hole contributions.

D.
Costs of drilling and equipping exploratory wells.

E.
Costs of drilling exploratory
-
type stratigraphic test wells.


A., B., C. are non
-
drilling costs. U.S. GAAP, expense.


D., E., drilling costs. Possibly capitalized, U.S. GAAP.



38

c Linda Nichols

Drilling and Development Costs


Development wells


Lease flow lines


Separators


Treaters


Heaters


Storage tanks


Improved recovery system


Nearby gas processing facilities

39

c Linda Nichols

Oil Derrick

c Linda Nichols

Types of Wells


Exploratory Wells [unproved area]


Stratigraphic test wells (get info)*


Extension wells (test and extend known
boundaries) exploratory


Development Wells


Service Wells [gas injection, water injection,
saltwater disposal] development costs


*Exploratory and development types


c Linda Nichols

41

Successful Efforts vs. Full Costs


Cost

SE

FC

Acquisition

C

C

G&G

E (C)

C

Explor.dry hole

E

C

Expl.Well

good

C

C

Dev. Dry hole

C

C

Dev.Well

Good

C

C

Lifting costs

E

E

Cost Center

Field

Country

c Linda Nichols

42

Module 2: Nondrilling Exploration Costs under Successful Efforts




Overall Objective:


To gain a basic understanding of the accounting treatment of
geological and geophysical (G&G) costs.



c Linda Nichols

43

G & G Exploration


Surface Techniques


1. Oil Seeps


2. Aerial Photos


3. Satellite Surveys (Landsat 4)


4. Topographical Mapping


5. Geochemical surveying



Subsurface Techniques


1. Subsurface mapping utilizing seismic surveys.


2. Structural surface maps.


3. Subsurface geophysical measurements


4. Gravity meter measurements


5. Magnetic surveys.

44

c Linda Nichols

Seismic Surveys

[Having to do with earthquakes or earth vibrations]

1.
Two
-
dimensional Seismic


stringing geophones
in a line along the surface or the earth or behind a
ship.

2.
Three
-
Dimensional Seismic


geophones in a
closely spaced grid, gives a three
-
dimensional
view.

3.
Electromagnetic recording with 3D.

4.
Four
-
dimensional surveys (time)


can monitor
water flood fronts and oil migrations within
reservoirs.

45

c Linda Nichols

Seismic Technology


Seismic technology continued to advance, and the
next big breakthrough occurred in the early 1960s
with the advent of digital technology. This enabled
processing of enormous amounts of data and
provided dramatically improved knowledge of
subsurface geology. Now, time
-
lapse or four
-
dimensional seismic, created by multiple surveys
repeated over time, monitors reservoir performance
and helps improve recovery efficiency.


C.E.H Ross & L.E. Sloan

c Linda Nichols

International GAAP



US GAAP


Expense Geological & Geophysical



UK GAAP


If the costs cannot be identified with a particular
geological structure by year
-
end,
then expense
. If the costs
can be identified with a particular structure, then the costs
should remain
capitalized

at year
-
end.



IASB


May capitalize if associated with particular resources
(consistent with UK). Must assess for impairment.

c Linda Nichols

47

Geological & Geophysical Costs


Peters Co. Pays

30,000 for G&G studies on Block A


US GAAP:



G&G Expense


30,000



Cash





30,000


UK& IASB specific structure:



Intangible Assets


30,000




Cash





30,000


c Linda Nichols

48

Peters Oil obtained shooting rights on 5,000 kilometers for

.50 per kilometer.




Shooting Rights

US:


G&G expense



2,500


Cash






2,500



UK & IASB specific structure:


Intangible assets



2,500



Cash






2,500

c Linda Nichols

49

Peters has records maintenance costs of

600 on Block C.






Records Maintenance Costs

US:


Records maintenance expense


600


Cash






600


UK & IASB specific structure:


Intangible assets




600


Cash






600

c Linda Nichols

50

UK & IASB GAAP



If the structure becomes proved for which these
intangibles have been recorded, transfer the costs
to the field as tangible assets:



Tangible assets


33,100


Intangible assets


33,100

c Linda Nichols

51

Test Well Contributions


Bottom
-
hole contribution: Contribution paid to a driller by
adjoining property owners

for information from drilling in a
particular property regardless of the success or failure of
the drilling.



Dry
-
hole contribution: This concept is the same as
“bottom
-
hole contribution” except that payment is made
only if the drilling results in a dry
-
hole.

c Linda Nichols

In order to obtain formation information, Peters enters into the following
test
-
well contribution agreements on property close to Block C:

Well 1


bottom
-
hole contribution to 2,000 meters;

12,000

Well 2


bottom
-
hole contribution to 2,000 meters;

10,000

Well 3


Dry
-
hole contribution;

15,000

Well 4


Dry
-
hole contribution;

13,000






Test Well Contributions


Well 1 was drilled to 2,000 meters and was dry.

US:

Test
-
well contribution expense


12,000




Cash






12,000


UK&IASB: Intangible assets



12,000




Cash






12,000

Well 2 was drilled to 1,500 meters and abandoned.

No entry


c Linda Nichols

53

In order to obtain formation information, Peters enters into the following
test
-
well contribution agreements on property close to Block C:

Well 1


bottom
-
hole contribution to 2,000 meters;

12,000

Well 2


bottom
-
hole contribution to 2,000 meters;

10,000

Well 3


Dry
-
hole contribution;

15,000

Well 4


Dry
-
hole contribution;

13,000






Test Well Contributions


Well 3 was drilled to 2,500 meters and was dry.

US:

Test
-
well contribution expense


15,000




Cash






15,000


UK&IASB:

Intangible assets



15,000





Cash





15,000


Well 4 was drilled to 4,000 meters and produced.

No entry


c Linda Nichols

54

Peters has seismic equipment that was used only on Block A in 2008.
Depreciation on the equipment for 2008 is

8,000 and operating costs of the
equipment for the year was

10,000.

Depreciation of Support Equipment


US or UK & IASB with no specific structure:



G&G expense


depreciation




8,000



Accumulated depreciation





8,000


G&G expense


operating costs


10,000



Cash






10,000


UK & IASB with specific structure:



Intangible assets





8,000



Accumulated depreciation





8,000





Intangible assets




10,000


Cash






10,000

c Linda Nichols

55

Module 3: Acquisition Costs of

Unproved Property/ SE



Overall Objective:


Appreciate the various type of acquisition costs and
determine when unproved properties are impaired.


c Linda Nichols

56

Peters acquired rights on Block A and paid a signature
bonus of

5,000.

Purchase

US:


Unproved property



5,000


Cash






5,000


UK & IASB:


Intangible assets



5,000


Cash






5,000

c Linda Nichols

57

Development and Production Bonuses


Development bonuses


normally capitalized as a
deferred signing bonus.



Production bonuses


normally capitalized as a
deferred signing bonus.

c Linda Nichols

58

Bonus Example


Peters (an IASB Co.) has a PSC with the government of Haran.
Peters pays a signing bonus of

1,000,000. Peters also agrees to
pay a production bonus of

1,200,000 when production reaches 1
million bbls.



Signing bonus:



Intangible assets


1,000,000




Cash





1,000,000



Commercial discovery:



Tangible assets



1,000,000




Intangible assets



1,000,000



Production reaches 1 million bbls:



Tangible assets



1,200,000




Cash





1,200,000

c Linda Nichols

59

Peters had

1,000 in overhead costs to be allocated to
two properties that were investigated during June.




Internal Costs


Block A


investigated and acquired 500 kilometers

Block B


1500 kilometers investigated; none acquired


May capitalize based on kilometers acquired:

Intangible assets


Block A



1,000


Overhead control





1,000


May allocate based on kilometers investigated:

Block A


500/2000 x 1,000 = 250

Block B


1500/2000 x 1,000 = 750


Intangible assets


Block A



250

Overhead expense




750


Overhead control





1,000


Note: Under US GAAP, Unproved Property would be debited instead of intangible assets.

c Linda Nichols

60

Peters paid

1,000 for an option to acquire 500 kilometers.

Options


Property purchase suspense



1,000


Cash







1,000


Peters decided to lease 250 of the kilometers and paid an additional bonus
of

5,000.


Surrendered lease expense





500

Intangible assets (US: Unproved Property)



5,500


Property purchase suspense




1,000


Cash







5,000


c Linda Nichols

61

Peters paid

1,000 for an option to purchase 300 acres and
shooting rights. The value of the shooting rights alone is

400.

Option with Shooting Rights


US GAAP:


G&G expense





400

Property purchase suspense



600


Cash







1,000


UK & IASB GAAP:


Intangible assets





400

Property purchase suspense



600


Cash







1,000

c Linda Nichols

62

Impairments of Unproved Property


US & GAAP: Significant properties are assessed individually.
Insignificant properties are assessed on a group basis.



UK & GAAP: All properties are assessed individually.
Capitalized G&G is included in the assessment.



IASB: Assess as individual cash
-
generating units or groups
of units not to be larger than a segment.

c Linda Nichols

63

US & IAS: Significant vs. Insignificant

If acquisition costs are:



Significant




assess individually




N
ot significant



impair on a group or






aggregate basis







c Linda Nichols

*

Cost of property, company size, number of unproved leases held, company’s overall
portfolio of unproven property held.

64

Peters paid a

50,000 bonus to obtain Block A, which is
individually significant. Management has determined that
Block A should be impaired 10%.

US: Impairment of Significant Property

Impairment expense

5,000


Allowance for impairment


Block A


5,000

c Linda Nichols

65

At year
-
end, Peters has group properties totaling

300,000. An allowance for impairment for these
properties has a balance of

40,000. Management
believes the group should be 25% impaired.





US: Impairment of Insignificant Properties

.
25 x

300,000 =

75,000

75,000


40,000 = 35,000



Impairment expense





35,000


Allowance for impairment


group



35,000


c Linda Nichols

66

UK and IAS Impairment


Peters paid a

50,000 bonus to obtain Block A, which is
individually significant. Management has determined that Block
A should be impaired 10%.



Amortization expense


5,000



Allowance for amortization and Impairment


5,000


The entry would also look like the above under IAS for grouped
properties.

c Linda Nichols

67

Abandonment



Treatment is similar between the U.S., U.K. and
IAS.

c Linda Nichols

68

Abandonment of Individually Significant Property

Peters has

50,000 in the unproved property (intangible assets) account for Block
A and has an allowance for impairment for that property with a balance of

5,000.
Peters abandons the Block.

Abandonment


Surrendered property expense



45,000

Allowance for impairment






5,000


Unproved property (Intangible assets)



50,000

Abandonment of Individually Insignificant Properties (The UK does not have
grouped properties.)

Peters has a balance of

300,000 in an unproved properties
-
group account, and a
related allowance for impairment with a balance of

75,000. Management decides
to abandon one of the properties in the group. The acquisition cost of that
property was

10,000.

Allowance for impairment


group



10,000


Unproved property (Intang. assets)


group


10,000


c Linda Nichols

69

Peters has an individually significant property with a balance of

50,000 in the
unproved property account and an allowance for impairment with a balance of

5,000. The property becomes proved.





Reclassification of Property


US GAAP:


Proved property




45,000

Allowance for impairment




5,000


Unproved property





50,000


UK & IAS:


Tangible assets




45,000

Allowance for impairment




5,000


Intangible assets





50,000


c Linda Nichols

70

Assume, instead, that an insignificant unproved property is proved. The
acquisition cost of the property was

10,000. The unproved property
-
group
account has a balance of

300,000 and the related allowance for impairment for
the group has a balance of

75,000.




Reclassification Of Property


US GAAP:

Proved property





5,000


Unproved property


group





5,000

IAS:

Tangible assets





5,000


Intangible assets






5,000




Assume, instead, that only half of the above property was proved:

US GAAP:

Proved property




10,000


Unproved property


group




10,000

IAS:

Tangible assets




10,000


Intangible assets





10,000


c Linda Nichols

71

Cost Centers


US GAAP: May be a property or reasonable
aggregation of properties with a common
geological structure. The field is by far the most
used.


UK & GAAP: On a field basis.

c Linda Nichols

72

Module 4: Drilling and Development




Overall Objective:


Study the two types of exploration drilling costs and both
drilling and nondrilling development costs.


c Linda Nichols

73

Drilling Contracts


Meter rate contracts: drilling contractor is paid a specific
amount per meter of hole drilled.


Day
-
rate contracts: drilling contractor is paid a specified
amount of each day worked on the well, regardless of the
number of meters drilled (virtually all offshore work).


Turnkey contracts: contractor performs specified services for
a set price and the operator merely has to turn the key when
the project is completed.


Overriding Royalty interest to Driller.


c Linda Nichols

74

Some Drilling Terms



Rigging
-
up:

drilling rig and equipment are set up.


Spudding
-
in:

after rigging up, the well is ready to be spudded
-
in.


Spud date:

date the rotary drilling bit touches ground.


Tripping
-
in or tripping
-
out:

pipes lowered into hole; drill pipes may
have to be removed when drill bit becomes worn or damaged or casing
is set.


Blow
-
out prevention equipment:

helps prevent an uncontrolled
explosion of oil/gas from a well.


Fishing:

attempting to recover lost equipment in the hole.


Sidetracking:

plugging the lower portion of a hole and drilling around
an obstruction (e.g., lost equipment)


Logging:

once total depth is reached, a logging device is lowered to
the bottom. It is pulled up and measures and records properties of the
formations and the fluids. Helps determine whether to complete or plug
the well.


c Linda Nichols

75

More Drilling Terms



Perforating:

use a perforating gun to make holes in casing and cement
so oil and gas can flow into the well bore.



Fracturing:

in sandstone, coarse sand or synthetic beads (called
proppant) is mixed with a fluid, pumped into the formation under high
pressure, causing the formation to split or fracture.



Acidizing:

in calcium carbonate material, acid is pumped into the
formation to dissolve portions of the formation to create channels.



Swabbing:

if pressure is low, must swab the well to remove the fluid
(mud). Small expandable packer is lowered into the well, and by swiftly
pulling the packer back up, any fluid is removed.



Directional well:

drilled straight to a predetermined depth and then
curved or angled to a desired location.



Horizontal well:

initially drilled straight, but gradually curved into a
horizontal direction.

76

c Linda Nichols

Scallop Gun

c Linda Nichols

Exploratory Drilling
-

SE


U.S. and U.K.


Exploratory wells are capitalized if successful
and are expensed if dry.


Unsuccessful appraisal wells are charged to expense under
U.S. GAAP. In the U.K., these wells may remain capitalized
as long as further appraisal is planned. The IASB will likely
require these wells to be expensed.




In the 1970s, engineers developed down
-
hole motors that could rotate the drill bit at the
bottom of the well, allowing drillers to steer the bit and gradually guide the hole off vertical,
eventually turning 90 degrees.


C.E.H. Ross & L.E. Sloan

c Linda Nichols

78

Types of Dual Purpose Platforms

1.
Conventional jacket and deck
--
steel deck with jacket
extending down to sea bottom, anchored in place by steel
piles.

2.
Concrete gravity platform
--
massive pre
-
cast structures that
sit on the ocean floor, held in place by its own weight.

3.
Guyed tower
--
uniform
-
tubular steel structure that supports a
deck and anchored laterally to the ocean floor by steel
cables.

4.
Tension
-
leg floating structure held in place by vertical,
tubular steel members anchored to the ocean floor by piles.

Source: IRS Litigation Guideline Memorandum, Rev. TL
-
91, October 14, 1993.

79

c Linda Nichols

Offshore Platform

c Linda Nichols

Offshore Drilling

Mobile rigs drill exploratory and evaluation wells.

Massive platforms drill the development wells (e.g., Hoover
-
Diana Platform)

Production facilities are constructed on the platform to handle
the output.

Type of Mobile Exploratory Drilling Rigs:


Submersible Rigs
-

few today; shallow water.


Jack
-
up Rigs
--
350 to 400 feet
--
legs jacked up while moving.


Semi
-
submersible Rigs
--

e.g.,Marine 700


Drilling Barges and Drilling Ships

81

c Linda Nichols

Development Drilling
-

SE


All development wells are capitalized.



In the U.S., a development well is a well drilled in a proved
area to a known productive depth. In the U.K., development
wells include all wells drilled after the decision to develop the
field has been made. Therefore, some development wells in
the U.K. might be exploratory in the U.S.



Delineation wells are exploratory in the U.S. but are
development in the U.K.

c Linda Nichols

82

Drilling & Development Costs/ SE

Exploratory Well

Drilling costs

Dry

Successful

Expensed Capitalized

Development Well

Drilling costs

Capitalized

c Linda Nichols

83

Christmas Tree

c Linda Nichols

IDC vs. Tangible Costs

c Linda Nichols

85

Pumper

c Linda Nichols

Exploratory Drilling Costs

Peters is drilling an exploratory well on Block A. IDC are

30,000 and
L&WE costs are

200,000. The unproved property (intangible assets)
account for Block A has a balance of

30,000.


Wells in progress


IDC



30,000

Wells in progress


L&WE



200,000


Cash






230,000

Assume the well is dry:

Dry hole expense




230,000


Wells in progress


IDC





30,000


Wells in progress


L&WE




200,000

Assume, instead that the well is successful.

Wells & related E&F


IDC




30,000

Wells & related E&F


L&WE



200,000


Wells in progress


IDC



30,000


Wells in progress


L&WE




200,000

Proved property (UK & IAS: Tangible assets)


30,000


Unproved property (UK& IAS: Intangible assets)



30,000



c Linda Nichols

87

Time Limit on Wells in Suspension


US


One year limit unless a major capital expenditure is
required and more successful wells are needed to justify the
expenditure, the well would be completed if the expenditure
were made, and drilling of additional wells is planned.



UK


Three year limit in offshore or frontier environments,
two years elsewhere. Circumstances may dictate costs being
carried beyond these limits.

c Linda Nichols

88

Workovers


Restore or stimulate production from a particular
well.


Handled similarly in U.S., U.K., and IAS.


If the life or productivity of the well is materially
increased, then
capitalize
.


If the workover just maintains production, then
expense

(e.g., lease operating expense).

c Linda Nichols

89

Workovers

Peters paid

60,000 for a workover on well #1.


Workovers in progress



60,000


Cash







60,000


If useful life is increased:

Wells & related E&F


L&WE


60,000


Workovers in progress




60,000


If useful life not increased:

Operating expense




60,000


Workovers in progress




60,000


c Linda Nichols

90

Enhanced Recovery


Enhanced recovery technology has provided
impressive increases in the ultimate recovery of the
total oil in place in a reservoir. For example,
injecting CO
2

into old oil fields has in some cases
doubled recoverability up to 60% of oil in place,
further extending the field’s life.


C.E.H. Ross & L.E. Sloan

c Linda Nichols

Service Wells


Development Wells

Peters drills a gas injection well on Block A at a cost of

80,000.


Wells in progress


L&WE



80,000


Cash







80,000


When completed:

Wells & related E&F


L&WE


80,000


Wells in progress


L&WE




80,000

c Linda Nichols

92

Capitalization of Interest


U.S.


Interest is capitalized during the construction phase based
on average accumulated expenditures.



U.K.


Permits capitalization at the company’s option. Most do
not

capitalize except for very large projects.



IASB


Expensing is common. Capitalization is permitted. If there
is a specific borrowing for the project, that amount can be
capitalized. If borrowing is done centrally, the amount to be
capitalized is the amount expended on the asset multiplied by the
average borrowing rate. (IAS 23).



c Linda Nichols

93

Interest Capitalization

Peters has unproved property costs on Block A of

40,000 on January 1.
During the year, Peters incurred exploratory drilling costs of

400,000. A

500,000, 8% note was outstanding during the entire year specifically for
this Block. Total interest cost for the company is

800,000.



US : Avg. Expenditures:

40,000 + 440,000

=

240,000


2

Interest to capitalize:

240,000 x .08 = 19,200

Wells in progress


IDC




19,200


Interest expense






19,200


IAS: 500,000 x .08 = 40,000

Wells in progress


IDC



40,000


Interest Expense





40,000



c Linda Nichols

94

Module 5: Proved Property Cost Disposition under SE

Overall Objective:


To gain a basic understanding of cost disposition
using SE accounting.

c Linda Nichols

95

Basic Depreciation, Depletion & Amortization Formula

Production for the Year







X book value at year end

Estimated reserves at

the beginning of the

year


c Linda Nichols

96

Equivalent DD&A Formula

Book Value







X Production for the year

Estimated reserves at

the beginning of the year


c Linda Nichols

97

Differences in Reserves


US GAAP


proved reserves are used for
leasehold; proved developed reserves are used for
wells and equipment.



UK & GAAP


for all costs, permits either proved
developed and proved undeveloped or proven and
probable reserves.


c Linda Nichols

98

SE DD&A Example
-

US


Exploration Inc. drilled the first successful well on Block A early in 2008. Data for the
block as of 12/31/08 follows:


Signing bonus






80,000

Wells & related E&F





200,000

Production during 2008, bbl




6,000

Proved reserves, bbl 12/31/08




900,000

Proved developed reserves, bbl 12/31/08




100,000

Probable reserves, bbl 12/31/08



300,000

DD&A for Leasehold:


6,000



X

80,000 =


530


900,000 + 6,000


DD&A for Wells & Equipment:


6,000



X


200,000 =


11,321


100,000 + 6,000

c Linda Nichols

99

SE DD&A Example
-

UK


Exploration Inc. drilled the first successful well on Block A early in 2008. Data for the
block as of 12/31/08 follows:


Signing bonus






80,000

Wells & related E&F





200,000

Production during 2008, bbl




6,000

Proved reserves, bbl 12/31/08





900,000

Proved developed reserves, 12/31/08



100,000

Probable reserves, bbl 12/31/08




300,000

Using total proved:


6,000



X

280,000 =


1,854


900,000 + 6,000

Using proved and probable:



6,000


x

280,000 =


1,393


900,000 + 300,000 + 6,000



c Linda Nichols

100

SE DD&A Example 2
-

Calculate 2008 DD&A for lease A

The balance sheet for Roberts Oil Company as of 12/31/07 is as follows for Block A:


Property costs


proved properties




110,000

Less: Accumulated DD&A





20,000


Net property costs






90,000


Wells & related equipment



2,000,000

Less: accumulated DD&A




300,000


Net wells & equipment




1,700,000


Roberts’ activities during 2008 related to Lease A were:


Exploratory dry hole drilled







300,000

Development dry hole drilled






275,000

Tanks & separators installed






150,000

Production








100,000 bbl

Proved reserves 12/31/08



1,020,000 bbl

Proved developed reserves 12/31/08


900,000 bbl


Probable reserves 12/31/08





200,000 bbl

c Linda Nichols

101

DD&A Answer
-

US

DD&A for Leasehold:


100,000



X


90,000 =




8,036

1,020,000 + 100,000


DD&A for Wells & Equipment:


100,000



X


2,125,000* =


212,500

900,000 + 100,000



* Equipment costs:



Beginning equipment (net)



1,700,000


Development dry hole




275,000


Tanks & separators






150,000




Total





2,125,000

102

c Linda Nichols

DD&A Answer
-

UK

Using Total Proved:


100,000


x 2,215,000*

= 197,767

1,020,000 + 100,000


* Equipment of 2,125,000 + property of 90,000


Using proved and probable:



100,000


x 2,215,000

= 167,803

1,020,000 + 200,000 + 100,000

c Linda Nichols

103

Joint Production



When both oil and gas are produced together, a conversion to
equivalent energy units is required in both the U.S. and U.K.
Commonly, a rate of 1 bbl = 6 mcfs is used.

c Linda Nichols

104

Exclusion of Costs


US


If significant development costs are incurred before all
proved reserves are developed,
exclude

the portion of the
development costs attributable to the undeveloped proved
reserves.



UK


All costs are
included

since either all proved reserves
or proved and probable reserves are used for depletion.

c Linda Nichols

105

Exclusion of Costs Example
-

US


Production platform constructed at a cost of $4,000,000



15 wells drilled; total of 60 wells planned



Exclude: 45/60 X $4,000,000 = $3,000,000



Include $1,000,000



c Linda Nichols

106

Exclusion of Reserves



US


If proved developed reserves can be produced only
after an improved recovery system is constructed,
exclude

the proved developed reserves associated with the costs that
have not yet been incurred.



UK
-

If proved developed reserves can be produced only
after an improved recovery system is constructed,
include

an estimate of the future development costs in the depletion
calculation.

c Linda Nichols

107

Exclusion of Reserves Example

Gas injection project will cost

3,000,000. Proved developed
reserves are 1,200,000 bbls but 500,000 of those barrels cannot
be produced until after the project.




US
-

Exclude

500,000 bbls PDR associated with project in
computing depletion.




UK


Include

all proved (or proved and probable) reserves in
depletion but include the

3,000,000 cost of the project in the
calculation.



c Linda Nichols

108

Module 6: Impairment and Abandonment

Overall Objective:



Upon completion of this module, you will have a
basic understanding of accounting for asset
retirement obligations and impairments under
successful efforts.

c Linda Nichols

109

Dismantlement Costs


Handled the same in the U.S. and internationally
(IAS 37).



The present value of the future obligation is
recorded as an asset and liability on the date the
environment is disturbed. Annual accretion of
discount on the liability is charged as a type of
interest.


c Linda Nichols

110

Dismantlement Costs Example

When the environment is disturbed, the present value of the future obligation at the
company’s cost of capital at 6% is 1,000,0000.


Wells & related E&F




1,000,000


Liability for restoration





1,000,000


At the end of one year, accrete discount:

1,000,000 x .06 = 60,000


Accretion expense





60,000


Liability for restoration






60,000


c Linda Nichols

111

Impairment of Producing Properties

US GAAP


3 stages


1.
Trigger event.

2.
Compare BV (include ARO) to undiscounted cash flows (exclude ARO).

3.
If BV > undiscounted cash flows, write down to fair value (usually discounted cash
flows excluding ARO).


IAS & UK


2 stages


1.
Trigger event.

2.
Compare BV (without ARO) to FV (usually discounted cash flows excluding ARO)
minus the ARO liability.

c Linda Nichols

112

Impairment Example

Book value of field without ARO:




3,000,000

Carrying amount of ARO liability:



521,000



Undiscounted future net cash flows:


2,800,000

Discounted future net cash flows before ARO:


2,100,000



US: write
-
down: 3,521,000


2,100,000 = 1,421,000


IAS & UK: (3,000,000)


(2,100,000


521,000) = 1,421,000




Loss on producing properties



1,421,000



Accumulated capitalized cost reduction



1,421,000


Can credit accumulated DD&A instead of Accumulated capitalized cost reduction.


c Linda Nichols

113

Partial Abandonment


Treatment is consistent between the U.S., U.K. and
IASB. If only a portion of a cost center is abandoned
(a well), the item is treated as fully amortized and is
charged to accumulated DD&A.

c Linda Nichols

114

Retirement of Well Example

Accumulated DD&A



100,000


Wells & related E&F




100,000



c Linda Nichols

115

Module 7: Full
-
Cost Accounting


Overall Objective:



Upon completion of this module, you will have a
basic understanding of the full
-
cost method of
accounting.



c Linda Nichols

116

Basics of FC


All costs, except production costs, are capitalized. This
includes G&G costs and all dry holes.



US
-

cost center is a country.



UK
-

cost center may consists of regional groups of
countries.



IASB


may eliminate FC in the future.



Both in the U.S. and internationally, all costs must be written
off over proved reserves.


c Linda Nichols

117

Basic DD&A


Peters has

2,500,000 of costs to be amortized in the
Germany (book value) at December 31, 2008. Production for
2008 was 25,000 bbls and proved reserves at December 31,
2008 was 400,000 bbls. Probable reserves are 100,000
bbls.



US and UK using proved:




25,000



x 2,500,000 = 147,059


400,000 + 25,000




c Linda Nichols

118

Asset Retirement Obligations (ARO)


Handle as with SE. When the environment is
disturbed, estimate the future cost and record the
present value of those costs as an asset and
liability.



The asset is included in the DD&A calculation.

c Linda Nichols

119

Inclusion of Future Development Costs


Because all proved reserves are used to compute
DD&A, the future costs to develop the undeveloped
reserves must be estimated and added to the
capitalized costs to be amortized.

c Linda Nichols

120

Exclusion of Costs


US


Costs related to unproved properties may be excluded
until commercial reserves are found or the property is
impaired or abandoned. Costs related to major development
projects that require significant future expenditures to
determine proved reserve quantities may also be excluded.



UK


Costs related to unproved properties may be excluded
until the evaluation of the property is complete.

c Linda Nichols

121

Impairment of Unproved Property



US


As with SE, properties are considered significant or are
grouped. When impaired, an asset account, impairments, is
debited and the allowance is credited. If excluding U/P from
DD&A, the U/P net of allowance is excludable, but the
impairment asset account must be included.



UK


Similar treatment except that all properties are
considered significant.

c Linda Nichols

122

Impairment Example


US Significant Property


Peters paid a

50,000 bonus to obtain Block A, which is individually
significant. Management has determined that Block A should be
impaired 10%.


Impairment





5,000


Allowance for impairment


Block A



5,000

c Linda Nichols

123

UK and IASB Impairment


Peters paid a

50,000 bonus to obtain Block A, which is individually
significant. Management has determined that Block A should be impaired
10%.


Impairment (Intangible)




5,000


Allowance for amortization and Impairment



5,000


The entry also would look like the above under IASB for grouped properties.



c Linda Nichols

124

Abandonment



US & UK


abandoned costs remain capitalized
and included in the amortization base.

c Linda Nichols

125

Abandonment Example

Abandonment of Individually Significant Property

Peters has

50,000 in the unproved property (intangible assets)
account for lease A and has an allowance for impairment for that
property with a balance of

5,000. Peters decides to abandon the
lease.


Abandoned costs



45,000

Allowance for impairment





5,000


Unproved property (Intangible asset)


50,000



c Linda Nichols

126

Advanced DD&A


Peters had the following costs in Germany at December 31, 2008:



Proved property







30,000


Unproved property




50,000


Nondrilling exploration, P/P




60,000


Nondrilling exploration, U/P




70,000


Development well, P/P



500,000


Wells in progress, U/P



600,000


Dry holes, U/P




700,000


Accumulated DD&A



(500,000)


Future development costs




300,000


Proved reserves, 12/31/08



600,000 bbls


Production, 2008





100,000 bbls


Probable reserves, 12/31/08




200,000 bbls


c Linda Nichols

127

Include All Costs


Using proved reserves:




1,510,000 + 300,000 = 1,810,000




100,000


x 1,810,000 = 258,571


600,000 + 100,000


c Linda Nichols

128

Exclude All Possible Costs


Using proved reserves



Exclude:


U/P






50,000


Nondrilling exploration, U/P




70,000


Wells in progress, U/P




600,000








720,000



1,810,000
-

720,000 = 1,090,000




100,000


x 1,090,000 = 155,714

600,000 + 100,000


c Linda Nichols

129

U.S. Ceiling Test


Compares the book value of the cost center to a ceiling composed of:


PV of future net revenues (using current prices and costs and

10% rate for
proved reserves only)


+ Costs of properties being excluded


+ The LCM of unproved properties included


-

Tax difference on above

c Linda Nichols

130

UK Impairment


Follow FRS 11 as interpreted in 2001 SORP.


Perform test only if triggered.


Compute cash flow projections using expected prices and
costs.


Use commercial reserves


may include probable (or use
only proved)


Flexibility in discount rate.


Risks may be reflected by adjusting either future cash flows
or the discount rate.

c Linda Nichols

131

Module 8: Production Activities

Objective:


Upon completion of this module, you will understand
how to account for direct and allocable costs of
production. You will also understand the basics of
well economics.


c Linda Nichols

132

International GAAP


Treated similarly worldwide. Production costs are
expensed.



Costs may be direct or indirect.



Indirect costs must be allocated to the fields
covered on a reasonable basis.

c Linda Nichols

133

Direct Cost Examples


Repairs that can be traced to individual wells.


Repair of a pumping unit.


Wages for employees who work on only one property.


Wages for employees who designate hours worked on certain
properties.


Fuel for properties, invoices indicate particular properties.


Depreciation of a truck used on one property.


Workover for the purpose of restoring production.

c Linda Nichols

134

Allocable (Indirect) Cost Examples


Wages for employees who work on several
properties, detailed records not kept.


District office expenses.


Depreciation of a truck used on multiple properties
without detailed records of use.


Depreciation of district office facilities.

c Linda Nichols

135

Items to Consider in Completion Decision


Quantity of reserves


Timing of production


Future selling price


Future production costs, including production taxes


Completion costs


Cost of capital


c Linda Nichols

136

Capital Decisions


If we have drilled a well at a cost of

300,000 and it
will cost an additional

150,000 to complete,
should it be completed if the present value of future
net revenues is expected to be

250,000?

c Linda Nichols

137

The Concept of Sunk Costs


Costs already expended (that cannot be sold and
recouped) are sunk costs.


Always look to the future.


Compare future cost to the PV of future net cash
flows.


A project may be unprofitable, but a loss might be
minimized by completing it.

c Linda Nichols

138

Example


Peters Oil estimates the following costs to drill and complete
a well on Block A:


Drilling costs




300,000



Completion costs




100,000


Selling price per bbl


22



Lifting costs per bbl



4



Royalty interest


20%


Is the well profitable at 20,000 or 30,000 or 40,000 bbls?


c Linda Nichols

139

Solution



20,000 bbl

30,000 bbl

40,000 bbl

Total revenue (22 x bbl)


440,000


660,000


880,000

Less: RI's share (20%)



88,000


132,000


176,000

WI's share


352,000 528,000 704,000

Less: Lifting costs (4 x bbl)



80,000


120,000


160,000




272,000


408,000



544,000

PV of above


188,210


276,310


360,580


The well is not profitable under any of the cases, but should be completed in each case.

c Linda Nichols

140

Module 9: Accounting for Revenue

Objective:


In this module, we will gain an understanding of how
revenue is allocated, recorded, and will look at issues
involving unitizations and balancing.


c Linda Nichols

141

Marketing Arrangements

Crude Oil Contracts



Evergreen sales contracts


Spot Sales Contracts


Exchange contracts



c Linda Nichols

142

Basic Crude Oil Sales Arrangements

1.
Evergreen sales contract:
month
-
to
-
month sales contract
, called an
evergreen sales contract,
generally refers to a contract negotiated for an
initial period

of a month and
renewed
each month
until either party cancels the agreement.
In the current era of oil price volatility, most evergreen
contracts reflect a negotiated price per barrel based on a fluctuating market price, an indexed
price, or a fixed price plus adjustments or escalations.
*


2.
A
spot sales contract
consists of the
short
-
term
sale of a
stated volume

of production for a stated
short
-
term period (such as a few days or a month or two) for the sale of crude oil based on a
negotiated price between the buyer and seller. For example, the parties may agree to buy/ sell
100 barrels per day of South Texas Light crude oil from the Ralph #1, located in Hidalgo County,
Texas, for each day of a specified month at $112 per barrel. Once the time period has ended or
the specified sale has occurred, the contract ends.
*


3.
The third type of sales arrangement is the
exchange
(sometimes referred to as a buy/ sell
arrangement), in which producers will exchange crude oil production for another stream of oil
production (e.g., two companies exchange Texas crude oil for California crude).


*

Evergreen and spot sale contracts allow producers to
change oil purchases

on short
notice, but most producers rarely do so.

c Linda Nichols

Marketing Arrangements


Natural Gas Contracts


Swing contracts


Baseload Contracts (spot sales)


Firm contracts (term contracts)



Transportation Agreements


Firm


Interruptible

c Linda Nichols

144

Marketing Arrangements

Natural Gas Contracts



Swing contract: Contract guaranteeing one of two parties periodic delivery of
a certain amount of natural gas (the nominated amount) on certain dates in
the future, within a certain delivery period, at a stipulated constant price (the
strike price). Often short term.



Baseload contract (spot sales): Similar to swing contract, but both parties
agree that they will attempt to deliver or receive the specified volume on a
best
-
effort basis, and they agree not to end the agreement due to market
price movements. Little legal recourse.



Firm contract (term contract): Both parties are legally obligated to either
receive or deliver the amount of gas specified in the agreeement.

c Linda Nichols

Transportation Agreements


Firm service:

Offered to customers under schedules or
contracts which anticipate no interruptions.




Interruptible:

Low priority service under schedules or
contracts which anticipate and permit interruption on short
-
notice, generally at peak
-
load seasons.




Off
-
peak service:

Only for a specified part of a year
during the off
-
peak season.

c Linda Nichols

Recording of Revenue


US


Revenues are reported net of royalty. Reserves that will
ultimately go toward royalties are
excluded

from reported proved
reserves.



UK


If producer is obliged to dispose of production and pay royalty
in cash, then the royalties are considered like a production cost or
tax. Revenue is recorded for the full sales amount and the royalty
is recorded as an expense. If the royalty owner is paid in
-
kind, then
revenue is recorded net of royalty and the reserves that will go
toward royalties are excluded from reported reserves.

c Linda Nichols

147

Revenue Allocation Example


Exploration Inc owns the WI in Block A. During January, 5,000 bbl of
oil were produced and sold. Assume the price for oil is

20/bbl. The
royalty interest is 1/8
th
.



Analysis:





WI (7/8)


87,500



RI (1/8)



12,500


Total


100,000



c Linda Nichols

148

Solution

US:

Accts Receivable



100,000



Royalty payable





12,500



Oil sales




87,500


UK Royalty paid in kind:

Accts receivable



87,500



Oil sales






87,500


UK royalty paid in cash:

Accts Receivable



100,000


Oil sales





100,000


Royalty expense




12,500


Royalty payable





12,500




c Linda Nichols

149

Oil Used Off Property


1,000 of oil from Block A was used on Block B.




Royalty = 12.5%


US:


Operating expense


Block B



1,000


Royalty payable





125


Sales A






875


UK Royalty paid in kind:

Operating expense


Block B



875


Sales A





875


UK paid in cash:

Operating expense


Block B



1,000


Sales A




1,000


Royalty expense



125


Royalty Payable





125

c Linda Nichols

150

Gas Used Off Property for Injection


1,000 of gas from Block A was used for injection on Block B.


Royalty = 12.5%


US:



Operating expense


Block B



1,000




Royalty payable






125




Gas Sales Block A






875




UK royalty paid in kind:



Operating expense Block B




875




Gas sales Block A






875




UK royalty paid in cash:



Operating expense


Block B



1,000




Gas Sales A





1,000




Royalty expense







125




Royalty payable






125










If some gas is recovered and resold for


600:



Accounts receivable








600




Operating expense


Block B




600



c Linda Nichols

151

Allocation to Wells/Leases


Production may be measured at a central point in a
field and need to be allocated back to the individual
wells. Likewise, measurement may be taken at a
central point for multiple fields. In this case, a two
-
stage allocation is needed, first back to the field
and then back to the individual wells.

c Linda Nichols

152

Allocation Example


Determine the bbls of production allocated to each well, given that 3,300
bbls were measured and produced.


Well


24
-
hr Test

Days Produced


#1



40



28


#2



50



30


#3



35



24

c Linda Nichols

153

Solution

Allocation:

c Linda Nichols

Well

24
-
hr

Test

Days

Produced

Theoretical

Production

Ratio

3300/3460

Actual

Production

1

40

28

1,120

X 0.954

= 1,068

2

50

30

1,500

X 0.954

= 1,431

3

35

24

840

X 0.954

= 801

3,460

3,300

154

Take
-
or
-
Pay Provisions

c Linda Nichols

Purchaser agreed to

1,000 in gas per month; took 0 in April.

Royalty = 12.5%.


Producer records as deferred revenue.

Cash





1,000


Deferred revenue




1,000


In May, the purchaser took

2,000 in gas. US

Cash





1,000

Deferred revenue




1,000


Royalty payable





250


Gas Sales




1,750


UK royalty paid in cash:

Cash





1,000

Deferred revenue




1,000


Gas sales




2,000


Royalty expense




250


Royalty payable





250

155

Revenue Recognized when Produced
-

US


1,000 worth of oil is produced in April and sold in May.


Royalty = 12.5%


April:

Crude inventory




875



Oil sales





875



May:

Accounts receivable


1,000



Royalty payable




125



Crude inventory




875







c Linda Nichols

156

Revenue Recognized when Produced


UK Royalty Paid in Cash


April:


Crude inventory