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Welcome to Fundamentals of International Oil & Gas Accounting. Dr. Linda Nichols, CPA Texas Tech University Course Developer. c Linda Nichols. Instructor for this Course. D. Larry Crumbley, Ph.D., CPA, CrFA, CFFA, FCPA Louisiana State University Editor, Oil, Gas & Energy Quarterly .

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Instructor for this course

Welcome to Fundamentals of InternationalOil & Gas Accounting

Dr. Linda Nichols, CPA

Texas Tech University

Course Developer


Instructor for this course

c Linda Nichols

Instructor for this Course

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

Louisiana State University

Editor, Oil, Gas & Energy Quarterly

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

c Linda Nichols

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


  • Module 1 petroleum operations and introduction to accounting

    c Linda Nichols

    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.


    Petroleum geology

    c Linda Nichols

    Petroleum Geology

    • Organic theory

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

    5


    Needed for reservoir formation

    c Linda Nichols

    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

    6


    Steps in petroleum production

    c Linda Nichols

    Steps in Petroleum Production

    1Broad G&G reconnaissance work

    2A lease or an option to lease may be obtained

    3Detailed G&G work is done to evaluate area of interest.

    4Data gathered in steps 1 and 3 are analyzed. If results positive, a lease is obtained (if not already obtained).

    5Further analysis of available data and possible more seismic studies done to select drill site.

    6The well is drilled.

    7Based on data obtained during the drilling process (cuttings, well logs, etc), decision made on commerciality.

    8aSufficient oil and gas

    Well completed & production started.

    8bInsufficient oil and gas

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

    7


    Necessary components of an oil or gas field

    c Linda Nichols

    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

    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 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

    c Linda Nichols

    Phases of Upstream Operations

    • Initial prospecting

    • Mineral right acquisition

    • Exploration

    • Appraisal

    • Development [proved]

    • Production

    • Abandonment & restoration

    10


    Types of agreements

    c Linda Nichols

    Types of Agreements

    Concessionary

    Leases

    Concession Agreements

    Contractual

    Production Sharing Contracts (PSCs)

    Risk Service Contracts

    11


    Concessionary agreements

    c Linda Nichols

    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


    Leases interests created from working interest

    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


    Instructor for this course

    c Linda Nichols

    Authority for Expenditure

    14


    Contractual system

    c Linda Nichols

    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


    Agreement 1 leases

    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

    16


    Agreement 2 concessions

    c Linda Nichols

    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

    17


    Agreement 3 production sharing contracts

    c Linda Nichols

    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

    18


    Pscs accounting issues

    c Linda Nichols

    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.

    19


    Types of psc bonuses

    c Linda Nichols

    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


    Pscs accounting issues1

    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.

    21


    Agreement 4 risk service

    c Linda Nichols

    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

    22


    Risk service accounting issues

    c Linda Nichols

    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.

    23


    Reserve estimation methods

    c Linda Nichols

    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.

    24


    Gaap for reserves definitions

    c Linda Nichols

    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).

    25


    Sec s definition of proved reserves

    c Linda Nichols

    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


    Proved reserves subdivided

    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


    Probable and possible reserves

    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


    Bias assumptions

    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


    Shell board kept in the dark

    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


    Types of reserves proved reserves

    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

    31


    Accounting standards gaap

    c Linda Nichols

    Accounting Standards: GAAP

    • US – FASB & SECSFAS 19 & SFAS 69

    • UK – ASB & OIAC

    • International – IASB

      IFRS 6 & IAS 1

    32


    Fasb iasb project

    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

    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

    c Linda Nichols

    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


    Four types of costs

    c Linda Nichols

    Four Types of Costs

    • Acquisition Costs

    • Exploration costs

    • Development costs

    • Production costs

    36


    Some acquisition costs

    c Linda Nichols

    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


    Some exploration costs

    c Linda Nichols

    Some Exploration Costs

    • 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.

    • 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.

    • Dry hole contributions and bottom hole contributions.

    • Costs of drilling and equipping exploratory wells.

    • 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


    Drilling and development costs

    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


    Oil derrick

    c Linda Nichols

    Oil Derrick


    Types of wells

    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

    41


    Successful efforts vs full costs

    c Linda Nichols

    Successful Efforts vs. Full Costs

    42


    Module 2 nondrilling exploration costs under successful efforts

    c Linda Nichols

    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.

    43


    G g exploration

    c Linda Nichols

    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


    Seismic surveys having to do with earthquakes or earth vibrations

    c Linda Nichols

    Seismic Surveys[Having to do with earthquakes or earth vibrations]

    • Two-dimensional Seismic – stringing geophones in a line along the surface or the earth or behind a ship.

    • Three-Dimensional Seismic – geophones in a closely spaced grid, gives a three-dimensional view.

    • Electromagnetic recording with 3D.

    • Four-dimensional surveys (time) – can monitor water flood fronts and oil migrations within reservoirs.

    45


    Seismic technology

    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


    International gaap

    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.

    47


    Geological geophysical costs

    c Linda Nichols

    Geological & Geophysical Costs

    • Peters Co. Pays €30,000 for G&G studies on Block A

      US GAAP:

      G&G Expense30,000

      Cash30,000

      UK& IASB specific structure:

      Intangible Assets30,000

      Cash30,000

    48


    Shooting rights

    c Linda Nichols

    Shooting Rights

    Peters Oil obtained shooting rights on 5,000 kilometers for €.50 per kilometer.

    US:

    G&G expense2,500

    Cash2,500

    UK & IASB specific structure:

    Intangible assets2,500

    Cash2,500

    49


    Records maintenance costs

    c Linda Nichols

    Records Maintenance Costs

    Peters has records maintenance costs of €600 on Block C.

    US:

    Records maintenance expense600

    Cash600

    UK & IASB specific structure:

    Intangible assets600

    Cash600

    50


    Uk iasb gaap

    c Linda Nichols

    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 assets33,100

      Intangible assets33,100

    51


    Test well contributions

    c Linda Nichols

    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.


    Test well contributions1

    c Linda Nichols

    Test Well Contributions

    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

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

    US: Test-well contribution expense12,000

    Cash12,000

    UK&IASB: Intangible assets12,000

    Cash12,000

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

    No entry

    53


    Test well contributions2

    c Linda Nichols

    Test Well Contributions

    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

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

    US: Test-well contribution expense15,000

    Cash15,000

    UK&IASB: Intangible assets15,000

    Cash15,000

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

    No entry

    54


    Depreciation of support equipment

    c Linda Nichols

    Depreciation of Support Equipment

    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.

    US or UK & IASB with no specific structure:

    G&G expense – depreciation 8,000

    Accumulated depreciation 8,000

    G&G expense – operating costs10,000

    Cash10,000

    UK & IASB with specific structure:

    Intangible assets 8,000

    Accumulated depreciation 8,000

    Intangible assets10,000

    Cash10,000

    55


    Module 3 acquisition costs of unproved property se

    c Linda Nichols

    Module 3: Acquisition Costs ofUnproved Property/ SE

    Overall Objective:

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

    56


    Purchase

    c Linda Nichols

    Purchase

    Peters acquired rights on Block A and paid a signature bonus of €5,000.

    US:

    Unproved property5,000

    Cash5,000

    UK & IASB:

    Intangible assets5,000

    Cash5,000

    57


    Development and production bonuses

    c Linda Nichols

    Development and Production Bonuses

    • Development bonuses – normally capitalized as a deferred signing bonus.

    • Production bonuses – normally capitalized as a deferred signing bonus.

    58


    Bonus example

    c Linda Nichols

    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 assets1,000,000

      Cash1,000,000

      Commercial discovery:

      Tangible assets1,000,000

      Intangible assets1,000,000

      Production reaches 1 million bbls:

      Tangible assets1,200,000

      Cash1,200,000

    59


    Internal costs

    c Linda Nichols

    Internal Costs

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

    Block A – investigated and acquired 500 kilometers

    Block B – 1500 kilometers investigated; none acquired

    May capitalize based on kilometers acquired:

    Intangible assets – Block A1,000

    Overhead control1,000

    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 A250

    Overhead expense750

    Overhead control1,000

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

    60


    Options

    c Linda Nichols

    Options

    Peters paid €1,000 for an option to acquire 500 kilometers.

    Property purchase suspense1,000

    Cash1,000

    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 suspense1,000

    Cash5,000

    61


    Option with shooting rights

    c Linda Nichols

    Option with Shooting Rights

    Peters paid €1,000 for an option to purchase 300 acres and shooting rights. The value of the shooting rights alone is €400.

    US GAAP:

    G&G expense400

    Property purchase suspense600

    Cash1,000

    UK & IASB GAAP:

    Intangible assets400

    Property purchase suspense600

    Cash1,000

    62


    Impairments of unproved property

    c Linda Nichols

    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.

    63


    Us ias significant vs insignificant

    c Linda Nichols

    US & IAS: Significant vs. Insignificant

    • If acquisition costs are:

  • Significantassess individually

  • Not significantimpair on a group or aggregate basis

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

    64


    Us impairment of significant property

    c Linda Nichols

    US: Impairment of 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 expense5,000

    Allowance for impairment – Block A5,000

    65


    Us impairment of insignificant properties

    c Linda Nichols

    US: Impairment of Insignificant Properties

    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.

    .25 x €300,000 = €75,000

    75,000 – 40,000 = 35,000

    Impairment expense 35,000

    Allowance for impairment – group35,000

    66


    Uk and ias impairment

    c Linda Nichols

    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 Impairment5,000

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

    67


    Abandonment

    c Linda Nichols

    Abandonment

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

    68


    Abandonment1

    c Linda Nichols

    Abandonment

    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.

    Surrendered property expense45,000

    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 – group10,000

    Unproved property (Intang. assets) – group10,000

    69


    Reclassification of property

    c Linda Nichols

    Reclassification of Property

    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.

    US GAAP:

    Proved property45,000

    Allowance for impairment 5,000

    Unproved property50,000

    UK & IAS:

    Tangible assets45,000

    Allowance for impairment 5,000

    Intangible assets50,000

    70


    Reclassification of property1

    c Linda Nichols

    Reclassification Of Property

    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.

    US GAAP:

    Proved property10,000

    Unproved property – group10,000

    IAS:

    Tangible assets10,000

    Intangible assets10,000

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

    US GAAP:

    Proved property 5,000

    Unproved property – group 5,000

    IAS:

    Tangible assets 5,000

    Intangible assets 5,000

    71


    Cost centers

    c Linda Nichols

    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.

    72


    Module 4 drilling and development

    c Linda Nichols

    Module 4: Drilling and Development

    Overall Objective:

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

    73


    Drilling contracts

    c Linda Nichols

    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.

    74


    Some drilling terms

    c Linda Nichols

    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.

    75


    More drilling terms

    c Linda Nichols

    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


    Scallop gun

    c Linda Nichols

    Scallop Gun


    Exploratory drilling se

    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

    78


    Types of dual purpose platforms

    c Linda Nichols

    Types of Dual Purpose Platforms

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

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

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

    • 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


    Offshore platform

    c Linda Nichols

    Offshore Platform


    Offshore drilling

    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


    Development drilling se

    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.

    82


    Drilling development costs se

    c Linda Nichols

    Drilling & Development Costs/ SE

    Exploratory Well

    Drilling costs

    Development Well

    Drilling costs

    DrySuccessful

    Capitalized

    Expensed Capitalized

    83


    Christmas tree

    c Linda Nichols

    Christmas Tree


    Idc vs tangible costs

    c Linda Nichols

    IDC vs. Tangible Costs

    85


    Pumper

    c Linda Nichols

    Pumper


    Exploratory drilling costs

    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&WE200,000

    • Cash 230,000

    • Assume the well is dry:

    • Dry hole expense230,000

    • Wells in progress – IDC 30,000

    • Wells in progress – L&WE200,000

    • Assume, instead that the well is successful.

    • Wells & related E&F – IDC 30,000

    • Wells & related E&F – L&WE200,000

    • Wells in progress – IDC 30,000

    • Wells in progress – L&WE200,000

    • Proved property (UK & IAS: Tangible assets) 30,000

    • Unproved property (UK& IAS: Intangible assets) 30,000

    87


    Time limit on wells in suspension

    c Linda Nichols

    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.

    88


    Workovers

    c Linda Nichols

    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).

    89


    Workovers1

    c Linda Nichols

    Workovers

    Peters paid €60,000 for a workover on well #1.

    • Workovers in progress60,000

    • Cash60,000

    • If useful life is increased:

    • Wells & related E&F – L&WE60,000

    • Workovers in progress60,000

    • If useful life not increased:

    • Operating expense60,000

    • Workovers in progress60,000

    90


    Enhanced recovery

    c Linda Nichols

    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 CO2 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


    Service wells development wells

    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&WE80,000

    • Cash80,000

    • When completed:

    • Wells & related E&F – L&WE80,000

    • Wells in progress – L&WE80,000

    92


    Capitalization of interest

    c Linda Nichols

    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).

    93


    Interest capitalization

    c Linda Nichols

    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 – IDC40,000

  • Interest Expense40,000

  • 94


    Module 5 proved property cost disposition under se

    c Linda Nichols

    Module 5: Proved Property Cost Disposition under SE

    Overall Objective:

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

    95


    Basic depreciation depletion amortization formula

    c Linda Nichols

    Basic Depreciation, Depletion & Amortization Formula

    Production for the Year

    X book value at year end

    Estimated reserves at

    the beginning of theyear

    96


    Equivalent dd a formula

    c Linda Nichols

    Equivalent DD&A Formula

    Book Value

    X Production for the year

    Estimated reserves at

    the beginning of the year

    97


    Differences in reserves

    c Linda Nichols

    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.

    98


    Se dd a example us

    c Linda Nichols

    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:

      6,000X €80,000 = € 530

      900,000 + 6,000

      DD&A for Wells & Equipment:

      6,000X € 200,000 = € 11,321

      100,000 + 6,000

    99


    Se dd a example uk

    c Linda Nichols

    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:

      6,000X €280,000 = € 1,854

      900,000 + 6,000

      Using proved and probable:

      6,000x €280,000 = € 1,393

      900,000 + 300,000 + 6,000

    100


    Se dd a example 2 calculate 2008 dd a for lease a

    c Linda Nichols

    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 equipment2,000,000

    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

    101


    Dd a answer us

    c Linda Nichols

    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


    Dd a answer uk

    c Linda Nichols

    DD&A Answer - UK

    Using Total Proved:

    100,000x 2,215,000* = 197,767

    1,020,000 + 100,000

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

    Using proved and probable:

    100,000x 2,215,000= 167,803

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

    103


    Joint production

    c Linda Nichols

    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.

    104


    Exclusion of costs

    c Linda Nichols

    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.

    105


    Exclusion of costs example us

    c Linda Nichols

    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

    106


    Exclusion of reserves

    c Linda Nichols

    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.

    107


    Exclusion of reserves example

    c Linda Nichols

    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.

    108


    Module 6 impairment and abandonment

    c Linda Nichols

    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.

    109


    Dismantlement costs

    c Linda Nichols

    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.

    110


    Dismantlement costs example

    c Linda Nichols

    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&F1,000,000

    Liability for restoration1,000,000

    At the end of one year, accrete discount:

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

    Accretion expense 60,000

    Liability for restoration 60,000

    111


    Impairment of producing properties

    c Linda Nichols

    Impairment of Producing Properties

    US GAAP – 3 stages

    • Trigger event.

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

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

      IAS & UK – 2 stages

    • Trigger event.

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

    112


    Impairment example

    c Linda Nichols

    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.

    113


    Partial abandonment

    c Linda Nichols

    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.

    114


    Retirement of well example

    c Linda Nichols

    Retirement of Well Example

    Accumulated DD&A100,000

    Wells & related E&F100,000

    115


    Module 7 full cost accounting

    c Linda Nichols

    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.

    116


    Basics of fc

    c Linda Nichols

    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.

    117


    Basic dd a

    c Linda Nichols

    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

    118


    Asset retirement obligations aro

    c Linda Nichols

    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.

    119


    Inclusion of future development costs

    c Linda Nichols

    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.

    120


    Exclusion of costs1

    c Linda Nichols

    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.

    121


    Impairment of unproved property

    c Linda Nichols

    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.

    122


    Impairment example us significant property

    c Linda Nichols

    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 A5,000

    123


    Uk and iasb impairment

    c Linda Nichols

    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 Impairment5,000

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

    124


    Abandonment2

    c Linda Nichols

    Abandonment

    • US & UK – abandoned costs remain capitalized and included in the amortization base.

    125


    Abandonment example

    c Linda Nichols

    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 costs45,000

    Allowance for impairment 5,000

    Unproved property (Intangible asset)50,000

    126


    Advanced dd a

    c Linda Nichols

    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/P500,000

      Wells in progress, U/P600,000

      Dry holes, U/P700,000

      Accumulated DD&A (500,000)

      Future development costs 300,000

      Proved reserves, 12/31/08600,000 bbls

      Production, 2008 100,000 bbls

      Probable reserves, 12/31/08 200,000 bbls

    127


    Include all costs

    c Linda Nichols

    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

    128


    Exclude all possible costs

    c Linda Nichols

    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

    129


    U s ceiling test

    c Linda Nichols

    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

    130


    Uk impairment

    c Linda Nichols

    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.

    131


    Module 8 production activities

    c Linda Nichols

    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.

    132


    International gaap1

    c Linda Nichols

    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.

    133


    Direct cost examples

    c Linda Nichols

    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.

    134


    Allocable indirect cost examples

    c Linda Nichols

    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.

    135


    Items to consider in completion decision

    c Linda Nichols

    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

    136


    Capital decisions

    c Linda Nichols

    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?

    137


    The concept of sunk costs

    c Linda Nichols

    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.

    138


    Example

    c Linda Nichols

    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?

    139


    Solution

    c Linda Nichols

    Solution

    20,000 bbl30,000 bbl40,000 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

    272,000 408,000544,000

    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.

    140


    Module 9 accounting for revenue

    c Linda Nichols

    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.

    141


    Marketing arrangements

    c Linda Nichols

    Marketing Arrangements

    Crude Oil Contracts

    • Evergreen sales contracts

    • Spot Sales Contracts

    • Exchange contracts

    142


    Basic crude oil sales arrangements

    c Linda Nichols

    Basic Crude Oil Sales Arrangements

    • 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.*

    • 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.*

    • 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.


    Marketing arrangements1

    c Linda Nichols

    Marketing Arrangements

    • Natural Gas Contracts

      Swing contracts

      Baseload Contracts (spot sales)

      Firm contracts (term contracts)

    • Transportation Agreements

      Firm

      Interruptible

    144


    Marketing arrangements2

    c Linda Nichols

    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.


    Transportation agreements

    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.


    Recording of revenue

    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.

    147


    Revenue allocation example

    c Linda Nichols

    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 1/8th.

      Analysis:

      WI (7/8) 87,500

      RI (1/8) 12,500

      Total 100,000

    148


    Solution1

    c Linda Nichols

    Solution

    US:

    Accts Receivable100,000

    Royalty payable 12,500

    Oil sales 87,500

    UK Royalty paid in kind:

    Accts receivable87,500

    Oil sales 87,500

    UK royalty paid in cash:

    Accts Receivable100,000

    Oil sales100,000

    Royalty expense 12,500

    Royalty payable 12,500

    149


    Oil used off property

    c Linda Nichols

    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 A1,000

    Royalty expense 125

    Royalty Payable 125

    150


    Gas used off property for injection

    c Linda Nichols

    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 B1,000

    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 B1,000

    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

    151


    Allocation to wells leases

    c Linda Nichols

    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.

    152


    Allocation example

    c Linda Nichols

    Allocation Example

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

      Well24-hr TestDays Produced

      #1 40 28

      #2 50 30

      #3 35 24

    153


    Solution2

    c Linda Nichols

    Solution

    Allocation:

    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.

    Cash1,000

    Deferred revenue1,000

    In May, the purchaser took €2,000 in gas. US

    Cash1,000

    Deferred revenue1,000

    Royalty payable 250

    Gas Sales1,750

    UK royalty paid in cash:

    Cash1,000

    Deferred revenue1,000

    Gas sales2,000

    Royalty expense250

    Royalty payable 250

    Take-or-Pay Provisions

    155


    Revenue recognized when produced us

    c Linda Nichols

    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 sales875

    • May:

      Accounts receivable1,000

      Royalty payable125

      Crude inventory875

    156


    Revenue recognized when produced uk royalty paid in cash

    c Linda Nichols

    Revenue Recognized when Produced – UK Royalty Paid in Cash

    • April:

      Crude inventory1,000

      Sales1,000

      Royalty expense 125

      Royalty payable 125

      May:

      Accounts receivable1,000

      Crude inventory1,000

    157


    Revenue from gas us

    c Linda Nichols

    Revenue from Gas - US

    • Sale of gas of €1,000

      Royalty = 12.5%

      Pipeline charges €100 to transport to purchaser

    • Delivery to pipeline:

      Inventory1,000

      Royalty payable 125

      Deferred revenue 875

    • Final delivery to purchaser:

      Accounts receivable1,000

      Deferred revenue 875

      Transportation expense 100

      Accounts payable – pipeline 100

      Inventory 1,000

      Gas sales 875

    158


    Revenue from gas uk royalty paid in cash

    c Linda Nichols

    Revenue from Gas – UK Royalty Paid in Cash

    • Delivery to pipeline:

      Inventory1,000

      Deferred revenue1,000

      Delivery to purchaser:

      Accounts receivable1,000

      Deferred revenue1,000

      Transportation expense 100

      Accounts payable – pipeline 100

      Inventory1,000

      Gas sales1,000

      Royalty expense 125

      Royalty payable 125

    159


    Unitizations

    c Linda Nichols

    Unitizations

    • Both working and nonworking interests are redetermined based upon whatever sharing factors are agreed to. Typical sharing factors include square kilometers contributed, reservoir volumes attributed to each party, or recoverable bbls of oil-in-place contributed.

    160


    Example1

    c Linda Nichols

    Example

    • Peters discovered a new field in an area covered by an agreement with the government of Haran. The field is large and is covered also by another agreement Haran has with a different company. The government requires unitization.

    • Block A

      WI: 100% Peters

      RI: 10% to Haran

      Square kilometers: 50

      Est. net recoverable bbls: 1,000,000

      Block B

      WI: 60% Jasper, 40% Lacey

      RI: 11% to Haran

      Square kilometers: 15

      Est. net recoverable bbls: 1,500,000

    161


    Participation factors

    c Linda Nichols

    Participation Factors

    • Based on est. net recoverable bbls:

      Working Interest:

      Peters 100%(1,000,000/2,500,000) = 40%

      Jasper 60%(1,500,000/2,500,000) = 36%

      Lacey 40%(1,500,000/2,500,000) = 24%

      Royalty Interest:

      Haran 10%(1,000,000/2,500,000) = 4%

      Haran 11%(1,500,000/2,500,000) = 6.6%

      Total 10.6%

    162


    Participation factors1

    c Linda Nichols

    Participation Factors

    • Based on square kilometers contributed:

      Working interest:

      Peters 100%(50/65) = 76.92%

      Jasper 60%(15/65) = 13.85%

      Lacey 40%(15/65) = 9.23%

      Royalty:

      Haran 10%(50/65) = 7.69%

      Haran 11%(15/65) = 2.54%

      Total 10.23%

    163


    Weighted average unitization

    c Linda Nichols

    Weighted Average Unitization

    • Weighted averages of more than one participation factor may be used to determine the final participation factors.

    164


    Example2

    c Linda Nichols

    Example

    • Based on the previous example, assume that the number of square kilometers is assigned a weight of 70% and the number of net recoverable bbls is assigned a rate of 30%.

    165


    Solution3

    c Linda Nichols

    Solution

    • Working interest:

      Peters 70%(76.92) + 30%(40.0) = 65.84%

      Jasper 70%(13.85) + 30%(36.0) = 20.50%

      Lacey 70%(9.23) + 30%(24.0) = 13.66%

      Royalty interest:

      Haran 70%(7.69) + 30%(4.0) = 6.58%

      Haran 70%(2.54) + 30%(6.6) = 3.76%

      Total 10.34%

    166


    Equalization

    c Linda Nichols

    Equalization

    The parties must agree on an acceptable approach for equalizing the value of the equipment and facilities being contributed to the unit.

    1. Identify the allowable pre-unit contributions.

    2. Determine the value of the contributions of each pre-unit WI

    owner.

    3. Calculate the obligation of each WI owner for pre-unit costs.

    4. Determine the settlement.

    167


    Example3

    c Linda Nichols

    Example

    • Assume that three parties each contribute property to a unit and each receive 1/3 of the WI. Assume the following costs and values:

      Company Participation Value Share of Over

      Factor Contributed Value(Under)

      A .333 2,000,000 5,000,000 (3,000,000)

      B .333 4,000,000 5,000,000 (1,000,000)

      C .333 9,000,000 5,000,000 4,000,000

      The companies may choose cash equalization. When paying or receiving cash, the offsetting side of the journal entry should be to wells and equipment. The companies may choose to equalize, instead, by disproportionate future spending.

    168


    Overlift underlift or balancing

    c Linda Nichols

    Overlift / Underlift or Balancing

    • US – the Sales or entitlement method may be used.

    • UK – the entitlement method is required.

    169


    Example4

    c Linda Nichols

    Example

    • Assume that Golden Oil has a 49% WI in Block A in Haran. State Oil has a 51% interest. The government gets a 10% royalty paid in-kind (unaffected by imbalances).

    170


    Production

    c Linda Nichols

    Production

    Jan. Feb.

    Production, bbl 400,000 440,000

    Royalty, 10% (40,000)(44,000)

    Net to WI, bbls 360,000 396,000

    Sales Price $50 $50

    171


    Balance report

    c Linda Nichols

    Balance Report

    Jan. Feb.

    Entitlement:

    Golden (49%)176,400194,040

    State Oil (51%)183,600201,960

    Total360,000396,000

    Deliveries Taken:

    Golden300,000 96,000

    State 60,000 300,000

    Overlift/(Underlift)

    Golden123,600 (98,040)

    State(123,600) 98,040

    172


    Entries

    c Linda Nichols

    Entries

    • Sales Method – Revenue is recorded for the volume actually delivered to each party. All volumes taken are considered each party’s share of reserves in the ground.

    • Entitlement Method – Revenue is recorded by each party based on what they were entitled to take. If they took more than their entitlement, a liability is recorded; if they took less than their entitlement, a receivable is recorded.

    173


    Entries sales method

    c Linda Nichols

    Entries – Sales Method

    January:

    Golden:

    Accounts rec. (300,000 x 50)15,000,000

    Oil revenue15,000,000

    State:

    Accounts rec. (60,000 x 50) 3,000,000

    Oil revenue 3,000,000

    February:

    Golden:

    Accounts rec. (96,000 x 50)4,800,000

    Oil revenue 4,800,000

    State:

    Accounts rec. (300,000 x 50)15,000,000

    Oil revenue15,000,000

    174


    Entries entitlement

    c Linda Nichols

    Entries - Entitlement

    January

    Golden:

    Accounts rec. (300,000 x 50)15,000,000

    Imbalance rec./pay. (123,600 x 50)6,180,000

    Oil revenue (176,400 x 50)8,820,000

    State:

    Imbalance rec./pay. (123,600 x 50)6,180,000

    Accounts rec. (60,000 x 50)3,000,000

    Oil revenue (183,600 x 50)9,180,000

    February

    Golden:

    Accounts rec. (96,000 x 50)4,800,000

    Imbalance rec./pay. (98,040 x 50)4,902,000

    Oil revenue (194,040 x 50)9,702,000

    Golden now has a credit balance of $1,278,000 in the Imbalance rec./pay. This represents the net overdelivery for both months of 25,560 bbls. (25,560 x 50 = 1,278,000)

    175


    Entries entitlement1

    c Linda Nichols

    Entries - Entitlement

    February

    State Oil:

    Accounts rec. (300,000 x 50)15,000,000

    Imbalance rec./pay. (98,040 x 50) 4,902,000

    Oil revenue (201,960 x 50)10,098,000

    State Oil now has a debit balance of $1,278,000 in the Imbalance rec./pay. This represents the net underdelivery for both months of 25,560 bbls. (25,560 x 50 = 1,278,000)

    176


    Module 10 joint operations

    c Linda Nichols

    Module 10: Joint Operations

    Overall Objective:

    In this module, we will gain an understanding of joint interest operations, billings, allocations, and issues of non-consent.

    177


    Contracts

    c Linda Nichols

    Contracts

    • Carefully examine joint operating agreements and the related accounting procedures.

    • International joint operations are often governed by an operating committee. The committee has representatives of the government and each contracting party. The committee is responsible for all major decisions. The party designated as the operator must manage the property on a day-to-day basis.

    178


    Cash calls

    c Linda Nichols

    Cash Calls

    • The operator often estimates the cash requirements for the next month and may provide two or three month projections. A cash call might be made for prepayment of the next month’s estimated cash needs.

    179


    Accumulation of costs in regular accounts

    c Linda Nichols

    Accumulation of Costs in Regular Accounts

    • Operator’s WI – 60%; Non-operator WI- 40%

    • Cost of operating the property for April: €2,000

      Operating expense 2,000

      Cash2,000

      At month end:

      Accounts receivable-nonoperator 800

      Operating expense 800

    180


    Distribution of costs as incurred

    c Linda Nichols

    Distribution of Costs as Incurred

    • Operator’s WI – 60%; Nonoperator’s WI – 40%

    • Cost of operating the property for April: €2,000

      Operating expense1,200

      Accts rec.-nonoperator 800

      Cash 2,000

    181


    New material transfer

    c Linda Nichols

    New Material Transfer

    • Invoice price including transportation is €10,000

    • Operator’s WI – 60%; Nonoperator’s WI – 40%

      Accounts receivable-nonoperator4,000

      W/P-WE6,000

      Cash 10,000

    182


    Transfers to from warehouse

    c Linda Nichols

    Transfers to/from Warehouse

    • A – new; current price + freight

    • B – used but sound; 75% of new price + freight

    • C – used and needs reconditioning; 50% of new price plus cost of reconditioning with total not to exceed condition b (+ freight)

    • D – used and not good for original purpose; price commensurate with use + freight

    • E – junk; prevailing junk prices + freight

    183


    Material transferred from warehouse

    c Linda Nichols

    Material Transferred from Warehouse

    • Operator’s WI – 60%; Nonoperator’s WI – 40%

    • Condition B equipment transferred from the warehouse.

    • New cost: €500,000; Book value: €360,000

    • €375,000 allowed (€500,000 x .75)

      Accounts receivable-nonoperator150,000

      W/P-WE216,000

      Warehouse inventory360,000

      Gain on transfer 6,000

    184


    Transfers between properties

    c Linda Nichols

    Transfers between Properties

    • B – if originally A when moved to current property, then 75% of new cost + freight. If originally B when moved to current property, then 65% of new cost + freight.

    • C,D,&E – same as before when moving from warehouse.

    185


    Material transferred between properties

    c Linda Nichols

    Material Transferred Between Properties

    • Condition B equipment is transferred from field S to field T. The equipment was condition A when first put on field S.

    • Original cost of equipment: €470,000; New cost: €500,000

    • Interest is S field: 70%; Interest in T field: 60%

    • €375,000 allowed (€500,000 x .75)

      Accounts receivable-T nonoperator150,000

      W/P-L&WE T field225,000

      Accum DD&A – S field 66,500

      Accounts receivable-S nonoperator112,500

      L&WE S field329,000

    186


    Overhead

    c Linda Nichols

    Overhead

    • In international JOAs, overhead rates are often on a sliding scale. Various percentages are applied to amounts of identified direct charges. The rate scale may be different for exploration, development, and production. Overhead covers indirect costs including such things as district offices, home office clerical, administrative, engineering, accounting, legal, and other similar costs.

    187


    Overhead example

    c Linda Nichols

    Overhead Example

    Based on Direct Costs of Exploration Activities

    Up to $6,000,0006%

    $6,000,001 to $12,000,0005%

    $12,000,001 TO $25,000,0004%

    Over $25,000,0003%

    188


    Non consent

    c Linda Nichols

    Non-Consent

    • One or more parties may decide not to participate in the drilling of one or more wells on the property. The remaining parties have the option of picking up that party’s share of costs to drill the well. They will then receive the nonconsent party’s share of production from that well until paid back with a penalty.

    189


    Non consent example

    c Linda Nichols

    Non-Consent Example

    • Golden Oil has a 30% WI and is the operator on Block A in Haran. Total has a 19% WI and State Oil has a 51% WI.

    • Golden sends out an AFE proposing to drill an additional development well at a cost of $1,200,000. Total elects not to participate in the well.

    • Golden and State agree to drill the well and each carry a proportionate share of Total’s cost.

    • The JOA calls for a 300% nonconsent penalty. Total will not receive revenue (production) from this particular well until Golden and State receive their extra costs back with the penalty.

    190


    Division of costs

    c Linda Nichols

    Division of Costs

    Original Int.Proportionate Int.

    Golden 30% 30/81 = 37.03704%

    State 51% 51/81 = 62.96296%

    Costs paid:

    Golden w/nonconsent 1,200,000 x 37.03704% = 444,444

    Golden normally 1,200,000 x 30% = 360,000

    Excess paid 444,444 – 360,000 = 84,444

    State w/nonconsent 1,200,000 x 62.96296% = 755,556

    State normally 1,200,000 x 51% = 612,000

    Excess paid 755,556 – 612,000 = 143,556

    191


    Amount recoverable by golden

    c Linda Nichols

    Amount Recoverable by Golden

    Proportionate share of Total’s normal cost$84,444

    Penalty x 300%

    Amount Recoverable 253,332

    Assume that the well is drilled and completed, and begins production 8 months later in August 2007. Assume that net revenue (after royalty and operating costs) for the well is $600,000 in August.

    Golden w/excess revenue600,000 x 37.03704% = 222,222

    Golden normally600,000 x 30% = 180,000

    Excess received222,222 – 180,000 = 42,222

    Amount recoverable going into September:

    253,332 – 42,222 = 211,110

    192


    Module 11 conveyances

    c Linda Nichols

    Module 11: Conveyances

    • Overall Objective:

      To gain a basic understanding of the nature of mineral ownership and how to account for conveyances.


    Common mineral agreement provisions

    c Linda Nichols

    Common Mineral Agreement Provisions

    • Signing bonus: Upfront monies to mineral owners or governments.

    • Royalty provision: Non-operating interest bearing no portion of the costs; retained when the owner of land grants to another (e.g., lease) the right to ascertain if oil/ gas exists and if so, to develop the property. Paid to landowner (e.g., 1/8th).

    • Working interest (WI): Created by the lease and is responsible for the exploration, development, and operations.

    • Primary term: Sets the time limit for the length of the lease.

    • Delay rental payment: Lease normally requires a lessee to commence drilling operations by a certain date; Afterward delayed rental payment extents the lease.

    • Shut-in payments: Property placed in production, but later shut-in for some reason. Lease requires additional payments (i.e., natural gas pipeline not available).


    Common mineral agreement provisions1

    c Linda Nichols

    Common Mineral Agreement Provisions

    • Right to assign interest: Rights of both parties (e.g., lessee, lessor) may be assigned in whole or part without permission of the other (e.g., overriding royalties).

    • Overriding royalty: Original lessee executes a sublease and retains an overriding royalty.

    • Option payment: Payment to obtain a preleasing agreement giving the lessee a specified time to obtain a lease.

    • Right to free use of resources for lease operations: Operator has the right for the free use of the oil and gas produced on the lease to carry out operations on the lease.

    • Offset clause: An adjacent operator must drill an offset well within specified time to avoid the draining of a reservoir.

    • Minimum royalties: Payment of minimum amount to the lessor (commonly recoverable from future royalty payments) regardless of production.


    Common mineral agreement provisions2

    c Linda Nichols

    Common Mineral Agreement Provisions

    • Advanced royalties: Royalty to lessor to be paid before minerals actually extracted.

    • Pooling provisions: If a working interest (WI) owner forms a pool (or unit) with other leases, the royalty interests and other non-WI owners may be forced to combine their interests with other non-WI owners.

    • Production holds lease: The rights to minerals in place that is limited to time, amount, or number of units to be produced (e.g., retained, carved-out, and advances).

    • Production sharing agreement: In a contractual system (govt. owns all minerals), petroleum company is allowed to recover certain costs and receive a share of the profits (e.g., payment-in-kind).

    • Top lease: A new lease is executed before expiration or termination of an existing lease.


    Accounting for conveyances

    c Linda Nichols

    Accounting for Conveyances

    • The main question is when should a gain or loss be recognized?

    • The answer depends on if the property is proved or unproved and if the entire interest or only a partial interest is being sold.

    197


    Unproved properties

    c Linda Nichols

    Unproved Properties

    • If selling the entire interest, the difference between proceeds and book value is a gain or loss.

    • If selling a partial interest, all proceeds are considered a recovery of cost all the way to bringing the basis to zero.

    • Practice is same in U.S. and internationally.

    198


    Accounting

    c Linda Nichols

    Accounting

    • Sale of entire individually significant unproved property.

      EX:

      U/P – Intangible assets €60,000

      Impairment allowance €20,000

      Sold for €45,000

      Cash45,000

      Impairment allowance20,000

      U/P – Intangible assets60,000

      Gain 5,000

    199


    Accounting1

    c Linda Nichols

    Accounting

    • Sale of entire unproved property in U.S. assessed on group basis

      EX:

      Original cost €100,000; sold for €90,000

      Cash90,000

      Impairment allowance10,000

      Unproved property100,000

      If sold for €110,000:

      Cash 110,000

      Unproved property 100,000

      Gain 10,000

    200


    Accounting2

    c Linda Nichols

    Accounting

    • Sale of individually assessed unproved property – partial interest

      EX:

      Cost €200,000; impairment allowance €50,000 (BV €150,000); sold 25% for €75,000

      Cash 75,000

      U/P – intangible asset75,000

      If selling price were €170,000 (over BV):

      Cash170,000

      Impairment allowance 50,000

      Unproved property – intangible asset200,000

      Gain 20,000

    201


    Accounting3

    c Linda Nichols

    Accounting

    • Sale of unproved property in U.S. assessed on a group basis – partial interest

      EX: Cost €200,000; sold 30% of the WI for €100,000

      Cash100,000

      U/P100,000

      If selling price were €220,000:

      Cash220,000

      U/P200,000

      Gain 20,000

    202


    Proved properties

    c Linda Nichols

    Proved Properties

    • If entire interest is sold, the difference between proceeds received and book value is a gain or loss.

    • If a partial interest is sold, the book value is allocated to the portions retained and sold based on relative fair values.

    • Practice is same in U.S. and internationally.

    203


    Accounting4

    c Linda Nichols

    Accounting

    • Sale of entire proved property

      EX:

      Currently have on the books for this proved property:

      P/P – tangible assets€ 50,000

      Wells & rel. E&F 220,000

      Accum. DD&A 30,000

      Sold for €200,000

      Cash 200,000

      Accum. DD&A 30,000

      Loss on sale 40,000

      P/P – tangible assets 50,000

      Wells & rel. E&F 220,000

    204


    Accounting5

    c Linda Nichols

    Accounting

    • Sale of partial interest in proved property

      EX:

      The 100% WI owner carved out some WI (30%) and sold it for €300,000. 70% of the WI was retained, 30% was sold.

      Current BV: property €100,000; Wells & rel. E&F €600,000; total BV €700,000

      Allocation:

      FV sold/Total FV x BV = BV sold

      300,000/1,000,000 x 700,000 = 210,000 sold

      (received 300,000 so gain is 90,000)

      Cash300,000

      P/P - Tangible assets (.30) 30,000

      Wells & rel. E&F (.30)180,000

      Gain on sale 90,000

    205


    Accounting6

    c Linda Nichols

    Accounting

    • Sale of WI in proved property with retention of non-WI

      EX:

      BV property €100,000; Wells & rel. E&F €600,000; total BV €700,000

      The WI is sold for €750,000 but an ORI is retained.

      750,000/1,000,000 x 700,000 = 525,000 sold

      Gain is 225,000 (750,000 - 525,000)

      Cash750,000

      Investment in ORI175,000

      P/P – tangible assets100,000

      Wells & rel. E&F600,000

      Gain225,000

    206


    Module 12 international

    c Linda Nichols

    Module 12: International

    Overall Objective:

    In this module we will examine issues of international operations, and foreign currency transactions.

    207


    Types of agreements1

    c Linda Nichols

    Types of Agreements

    • Leases

    • Concessions

    • Risk service

    • Production sharing contracts

    208


    Foreign currency transactions

    c Linda Nichols

    Foreign Currency Transactions

    • In the U.S. and in most of the world, a two-transaction approach is required wherein the underlying asset is carried at historical cost with monetary gains or losses taken directly to income in the period in which they occur.

    209


    Foreign currency transactions export example

    c Linda Nichols

    Foreign Currency Transactions: Export Example

    • On June 1, Assume that Peters, a U.S. company, sells crude to a German customer at a price of 1 million Eurodollars (EUD) when the spot exchange rate is $1.26 per EUD. Peters allows the German customer 30 days to pay. At the end of 30 days, the EUD has depreciated to $1.25.

      June 1

      Accounts receivable EUD 1,260,000

      Sales1,260,000

      To record sale at spot rate

      July 1

      Foreign exchange loss 10,000

      Accounts receivable EUD 10,000

      Adjust to new spot rate

      Cash1,250,000

      Accounts receivable EUD1,250,000

      Record payment and conversion

      If the balance sheet date comes before the payment date, the receivable should be revalued at that time.

    210


    Foreign currency transactions import example

    c Linda Nichols

    Foreign Currency Transactions: Import Example

    Peters makes a purchase of equipment on December 1 from a German company for 1 million EUD when the spot rate is $1.26. Peters has 60 days to pay. The spot rate is $1.255 on 12/31 and $1.25 when paid on February 1.

    December 1(Record purchase at spot rate)

    Equipment1,260,000

    Accounts Payable1,260,000

    December 31(Adjust value of payable)

    Accounts payable 5,000

    Foreign exchange gain 5,000

    February 1(Adjust value of payable)

    Accounts payable 5,000

    Foreign exchange gain 5,000

    (Record payment)

    Accounts payable1,250,000

    Cash1,250,000

    211


    Production allocation example

    c Linda Nichols

    Production Allocation Example

    • Assume that Zapco is involved in petroleum operations in China, Zapco has 49% WI while Local has 51% WI. Annual gross production is to be divided as follows:

    • VAT 5% of gross production

    • Royalty 12.5% of gross production

    • Cost oil 62% of gross production. Order: Operating expense, exploration costs (paid by Zapco), development costs.

    • Remaining is profit oil: 10% to government, remainder split between Zapco and Local based on WI.

    • Assume: Recoverable operating costs are €10,000,000

      Unrecovered explorations costs are €50,000,000

      Unreceovered development costs are €100,000,000

      Annual gross production is 7,000,000 bbls

      Price is €20 per bbl

    212


    Instructor for this course

    c Linda Nichols

    213


    Module 13 disclosures

    c Linda Nichols

    Module 13: Disclosures

    Overall Objective:

    In this module we will gain a basic understanding of the disclosures required by SFAS No. 69 in the US as well as international disclosures.

    214


    The six required us disclosures

    c Linda Nichols

    The Six Required US Disclosures

    Historical disclosures

    • Proved reserves information

    • Capitalized costs related to oil and gas producing activities

    • Incurred acquisition, exploration & development costs

    • Results of operations for E&P forward-looking disclosures

    • Standardized measure of discounted future cash flows

    • Change in the standardized measure of discounted future cash flows

    Forward-looking disclosures

    215


    International standards

    c Linda Nichols

    International Standards

    • The UK does require reserve value disclosures (#1,2,3,4).

    • UK does not require 5 and 6.

    • The IASB is in favor of 1,2,3,4, but undecided about 5 and 6.

    216


    Module 14 financial statement analysis

    c Linda Nichols

    Module 14: Financial Statement Analysis

    Overall Objective:

    In this module, we will gain a basic understanding of statement analysis utilizing ratios, concentrating on industry-specific ratios.

    217


    Liquidity

    c Linda Nichols

    Liquidity

    • Current ratio

      Current assets

      Current liabilities

    • Quick Ratio

      Cash + Securities + Receivables

      Current liabilities

    218


    Financial strength

    c Linda Nichols

    Financial Strength

    • Debt to S/E: Total debt

      S/E

      Return on S/E:Net income

      S/E

      Return on assets:Net income

      Total assets

    219


    Specialized industry ratios

    c Linda Nichols

    Specialized Industry Ratios

    • Reserves Replacement:

      Extensions and discoveries + improved recovery

      Production

      Average reserves per well:

      Proved reserves at beginning of year

      Net wells

      Average daily production per well:

      Annual production/365

      Net wells

    220


    Specialized industry ratios1

    c Linda Nichols

    Specialized Industry Ratios

    • Finding Cost Ratio:

      G&G costs + all exploratory drilling costs

      Reserve extensions and discoveries (excluding revisions)

      Lifting Costs per BOE:

      Total annual lifting costs

      Annual production in BOE

      DD&A per BOE:

      Total annual DD&A

      Annual production in BOE

    221


    Specialized industry ratios2

    c Linda Nichols

    Specialized Industry Ratios

    • Reserve Life Ratio:

      Total proved reserves at beginning of year

      Production

    222


    Example5

    c Linda Nichols

    Example

    • ABC provides the following information at December 31, 2006:

      Proved reserves of oil (in thousands of barrels)

      Beginning of year180

      Revisions of previous estimates 10

      Improved recovery 20

      Extensions & discoveries 60

      Production(25)

      End of year245

      Number of net wells producing 6

      G&G costs € 40,000

      Exploratory drilling costs 700,000

      Lifting costs 125,000

    223


    Example ratios

    c Linda Nichols

    Example Ratios

    • Reserves Replacement:

      60 + 20 = 3.2

      25

      Reserve Life:

      180 = 7.2

      25

      Average Reserves per Well:

      180,000 = 30,000 bbls

      6

    224


    Example ratios1

    c Linda Nichols

    Example Ratios

    • Average Daily Production per Well:

      25,000/365 = 11.42 bbls per day

      6

      Finding Cost Ratio:

      €40,000 + €700,000 = €12.33/bbl

      60,000

      Lifting Cost per BOE:

      €125,000 = €5/bbl

      25,000

    225


    Abbreviations

    c Linda Nichols

    Abbreviations

    226


    Instructor for this course

    c Linda Nichols

    Abbreviations

    227


    Thank you

    c Linda Nichols

    Thank You !!

    [email protected]

    [email protected]

    228


    Instructor for this course

    c Linda Nichols

    229


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