Emerging Issues Subcommittee Spring Meeting Wednesday, April 25, 2018 9AM Fort Smith, Arkansas AGENDA TIME AGENDA ITEM DISCUSSSION LEADERS 9:00 Welcome and Introductions Antitrust Statement 9:15 Emerging Issues in the Oil and Gas Industry (3 CPE hours) Kevin Launchbaugh & Craig Buck Description This session will consist of five topic presentations and guided case studies. Specific topics include non-consent operations and payout accounting; rig mobilization cost allocation; temporary abandonment; completion overhead for swabbing operations and operator-owned equipment. Learning Objectives: By the end of this session you will be able to: Discuss the payout accounting under the terms of the JOA as it relates to a non-consent owner for a workover operation. Discuss the appropriate allocation of rig mobilization costs among the wells which benefit from the mobilization services. Discuss chargeability of drilling and producing overhead to temporarily abandoned wells under the various COPAS Accounting Procedures. Discuss swabbing operations and the application of drilling overhead to swabbing operations. Discuss the chargeability of operator-owned equipment under various scenarios. Program Level: Intermediate Pre-requisite: Some familiarity with the COPAS Accounting Procedures. Advance Preparation: Read the relevant Case Study for each topic ahead of the sessions. Delivery Method: Group Live Field of Study: Specialized Knowledge CPE Credits: 3
Class Topic Presentations 9:15 Topic One: Non-Consent Operations and Payout Accounting Kevin Launchbaugh 9:45 Topic Two: Rig Mobilization Cost Allocation Craig Buck 10:15 Topic Three: Temporary Abandonment Kevin Launchbaugh 10:45 Break 11:00 Topic Four: Completion Overhead for Swabbing Operations Craig Buck 11:30 Topic Five: Operator-Owned Equipment Kevin Launchbaugh 11:55 Suggestions for New topics 12:00 Adjourn Council of Petroleum Accountants Societies (COPAS), Inc. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.
Case Study 1 Non-Consent Operations and Payout Accounting XYZ Oil and Gas operates the Jim Bob 1-H. In May of 2017, XYZ proposed to its WI partner, Super Energy, a workover to install a compressor, generator, and gas lift system on the Jim Bob 1-H. Super Energy elected to participate, and XYZ ordered a compressor and generator which were billed to Super Energy in June of 2017. Due to operational issues, no activity commenced until January 14 of 2018. The May 2017 election expired on November 21, 2017. On the second proposal, signed on December 5, 2017, Super Energy declined to participate in the operation and went non-consent under the JOA. The JOA includes the following language concerning non-consent operations: (b) Relinquishment of Interest for Non-Participation. The entire cost and risk of conducting such operations shall be borne by the Consenting Parties in the proportions they have elected to bear same under the terms of the preceding paragraph. Such relinquishment shall be effective until the proceeds of the sale of such share, calculated at the well, or market value thereof if such share is not sold (after deducting applicable ad valorem, production, severance, and excise taxes, royalty, overriding royalty and other interests not excepted by Article III.C. payable out of or measured by the production from such well accruing with respect to such interest until it reverts), shall equal the total of the following: (i) 100 % of each such Non-Consenting Party's share of the cost of any newly acquired surface equipment beyond the wellhead connections (including but not limited to stock tanks, separators, treaters, pumping equipment and piping), plus 100% of each such Non-Consenting Party's share of the cost of operation of the well commencing with first production and continuing until each such Non-Consenting Party's relinquished interest shall revert to it under other provisions of this Article, it being agreed that each Non-Consenting Party's share of such costs and equipment will be that interest which would have been chargeable to such Non-Consenting Party had it participated in the well from the beginning of the operations; and (ii) 300 % of (a) that portion of the costs and expenses of drilling, Reworking, Sidetracking, Deepening, Plugging Back, testing, Completing, and Recompleting, after deducting any cash contributions received under Article VIII.C., and of (b) that portion of the cost of newly acquired equipment in the well (to and including the wellhead connections), which would have been chargeable to such Non-Consenting Party if it had participated therein. Discussion Question: 1) Which costs should be applied to the payout? a) All costs starting December 5, 2017, the date of Super s non-consent election. b) All costs starting June of 2017, the date of first costs billed for the activity. c) All costs starting January 14, 2018, the date the work started Page 1 of 10
d) All costs attributable to the workover AFE, regardless of when the costs were incurred, plus all costs starting January 14, 2018, the date the work started. e) Only costs attributable to the AFE workover (no operating costs). 2) Which revenues should be applied to the payout? a) All revenues starting December 5, 2017, the date of Super s non-consent election. b) All revenues starting June of 2017, the date of first costs billed for the activity. c) All revenues starting January 14, 2018, the date the work started. Page 2 of 10
Case Study 2 Mobilization Cost Allocation Operator ABC enters in to a 14 well drilling program with Big Rig Drilling Company. The mobilization charge for the drilling rig is $500,000. The Operator allocates this charge to the 14 wells based upon drilling days for each well. The drilling days for the first 5 wells drilled are between 50 to 70 days while the drilling days for the remaining 9 wells are between 30 to 40 days. Based upon this allocation, the first 5 wells were allocated a significantly higher portion of the mobilization costs than the last 9 wells in the drilling program. 1) Assuming the working interest owners and JOAs are different for these wells, the depth drilled on all the wells averages 15,000 feet, and there were no significant problems incurred while drilling and completing these wells, is the use of drilling days to allocate the mobilization costs a fair allocation method? 2) Assume that drilling rig has a mechanical failure during the drilling of the 4 th well in a 14 well drilling program and is on the well for an extended period of time. Is it fair to use drilling days to allocate mobilization costs to the 14 wells in this case? Does the 4 th well derive more benefit from the drilling rig in this situation? Page 3 of 10
Case Study 3 Temporary Abandonment An Operator is temporarily abandoning 15 wells based upon the fact that the wells are no longer producing. The Operator enlists a workover rig to pull tubing, downhole pumps and other equipment out of the wells. The same workover rig is used to pump down chemicals to preserve the wellbores and keep them stable/non-corrosive and to place a plug in each well. The Operator plans to come back in one to two years and perform a full abandonment and reclamation operation for each of the 15 wells. 1) Can the Operator charge drilling overhead for this temporary abandonment operation based upon the following COPAS Accounting Procedures? a. 1974? b. 1984? c. 2005? 2) Can the Operator charge producing overhead for this temporary abandonment operation based upon the following COPAS Accounting Procedures? a. 1974? b. 1984? c. 2005? Page 4 of 10
Case Study 4 Completion Overhead for Swabbing Operations Scenario 1 Operator ABC starts stimulation operations on December 1, 2016 and completes stimulation operations December 3, 2016. On December 9, 2016, pressure in the well begins to subside and the Operator decides to send a swabbing rig out onto the location. The rig arrives on the location on December 13 and finishes swabbing operations on December 16. The rest of the month, the well is producing. The Operator charged the Joint Account for 16 days of drilling overhead during the month of December 2016. Description Date Completion begins 12/1/16 Completion ends 12/3/16 Swabbing begins 12/13/16 Swabbing ends 12/16/16 1) Is swabbing a producing operation or a different type necessary to complete the well? If not a producing operation, what type of operation? 2) Would you allow drilling overhead to be charged continuously through December 16? 3) If the swabbing operations lasted five or more days, would you allow drilling overhead to be charged from December 1 st through the date the rig left the location? Scenario 2 Operator XYZ completes a well in January 2016. In March 2016, the well stops producing and a swabbing rig is sent out to kick the well into production. The swabbing rig was on location March 1 through March 6 and March 20 through March 26, 2016. The rig was again sent to the location April 7 through April 13 and April 24 through April 30, 2016. The Operator opted to charge drilling overhead for the period March 1 through April 30, 2016. The same situation occurred in June and July where the Operator charged drilling overhead every day during each month. Description Date Completion begins 1/1/16 Completion ends 1/3/16 Swabbing begins 3/1/16 Swabbing ends 3/6/16 Swabbing begins 3/20/16 Page 5 of 10
Swabbing ends 3/26/16 Swabbing begins 4/7/16 Swabbing ends 4/13/16 Swabbing begins 4/13/16 Swabbing ends 4/24/16 1) Would you accept the drilling overhead charges for March 1 through April 30, 2017? Scenario 3 Operator TBD completes a well and two months later decides to place an artificial lift on location to produce the well. Prior to installing the artificial lift, the Operator sends out a swabbing rig to make the reservoir pressure more stable so there is a lower possibility of a blowout or spewing oil when the hole is uncovered. The swabbing rig is on location for three days from August 12 through August 14, 2016 and is released. The pumping unit is then installed during the period August 17 through August 22, 2016. The Operator charges drilling overhead to the Joint Account for 11 days during August 2016. Description Date Swabbing begins 8/12/16 Swabbing ends 8/14/16 Pumping unit install begins 8/17/16 Pumping unit install ends 8/22/16 1) Is the swabbing necessary to place the artificial lift on the well? If so, why? 2) Would you accept the drilling overhead for all eleven days? 3) Would you accept a portion of the overhead charges? Pertinent COPAS Excerpts MFI-51 2005 Accounting Procedure Paragraph III, Section 2: Charges for onshore drilling wells shall begin on the spud date and terminate on the date drilling and/or completion equipment used on the well is released, whichever occurs later Charges for any well undergoing any type of workover, recompletion, and/or abandonment for a period of five (5) or more consecutive days shall be made at the Drilling Well Rate Page 6 of 10
MFI-48 Drilling Overhead The COPAS 1984, 1986, 1995, 2005 and 1998 Project Team Accounting Procedures require workovers and recompletions last at least five consecutive work days to qualify for drilling overhead. The 1995, 2005 and 1998 Project Team Accounting Procedures also include abandonment operations as an activity qualifying for drilling overhead, provided the five consecutive work days criterion was met. COPAS Model Form Interpretations 17 and 19 (formerly Bulletins #22 and #25), state that Technology has produced tools that are able to perform such operations without requiring the use of large drilling rigs or other high cost units, and therefore, it has become more complicated to determine when these operations should qualify for drilling well overhead rates. Rather than require an accountant to know what type of equipment is capable of drilling, or use some other technical method, if the operation requires five or more consecutive work days using a rig or other unit, the operations qualify for the drilling well rate. Therefore, regardless of the type of rig or unit used in the operation, drilling overhead can be charged, assuming all other requirements are met. Refer to examples 2 and 3 in Section V. Page 7 of 10
Case Study 5 Operator-Owned Equipment Scenario 1 Operator BED opts to purchase a drill string and charges it to the Joint Account as Operator-Owned Equipment. The Operator gathers three quotes to determine an average daily rate, and charges the Joint Account for this rate less 20% for each day the drilling string is on location. The drilling string follows the rig; thus, the string is chargeable every day of the year. The three quotes are as follows: $2,000 per day, $1,800 per day, and $1,000 per day. Therefore, the Operator s calculated rate is $1,280 per day. A Non-Operator takes exception and states it is not equitable to charge the Joint Account at a rate higher than was available from a third party. 1) Does the Non-Operator have any contractual basis for their argument? 2) Should there be additional contractual language to define what constitutes market rates, and what constitutes greater than normal cost? Pertinent COPAS Excerpts: 2005 COPAS Accounting Procedure, Section II.6. EQUIPMENT AND FACILITIES FURNISHED BY OPERATOR In the absence of a separately negotiated agreement, equipment and facilities furnished by the Operator will be charged as follows: A. Operator shall charge the Joint Account for use of Operator-owned equipment and facilities, including but not limited to production facilities, Shore Base Facilities, Offshore Facilities, and Field Offices, at rates commensurate with the costs of ownership and operation. The cost of Field Offices shall be chargeable to the extent the Field Offices provide direct service to personnel who are chargeable pursuant to Section II.2.A (Labor). Such rates may include labor, maintenance, repairs, other operating expense, insurance, taxes, depreciation using straight line depreciation method, and interest on gross investment less accumulated depreciation not to exceed percent ( %) per annum; provided, however, depreciation shall not be charged when the equipment and facilities investment have been fully depreciated. The rate may include an element of the estimated cost for abandonment, reclamation, and dismantlement. Such rates shall not exceed the average commercial rates currently prevailing in the immediate area of the Joint Property. Page 8 of 10
B. In lieu of charges in Section II.6.A above, the Operator may elect to use average commercial rates prevailing in the immediate area of the Joint Property, less twenty percent (20%). If equipment and facilities are charged under this Section II.6.B, the Operator shall adequately document and support commercial rates and shall periodically review and update the rate and the supporting documentation. For automotive equipment, the Operator may elect to use rates published by the Petroleum Motor Transport Association (PMTA) or such other organization recognized by COPAS as the official source of rates. COPAS MFI-51 Interpretation of the 2005 COPAS Accounting Procedure, II.6 Where the service is expected to involve a greater than normal cost, the Operator shall obtain a separate letter or other type of agreement authorizing the charge. Scenario 2 Operator QRS drills and completes wells in the Bakken shale in North Dakota. The Operator purchases a frac string for $200,000 and charges the total amount to the Joint Account. The frac string is used to protect the wellbore against pressure during completion activities. The frac string is removed from the well when no longer required, typically a few days following the completion. The Operator credits the Joint Account at condition B value which is 75% of the total amount of the frac string. It is the Operator s policy to transfer the used frac string from one property to another until it is no longer useful E Condition. See the illustration below. Well A: Charge to Joint Account - 100%, Credit Received - 75%, Net charge - 25% Well B: Charge to the Joint Account - 75%, Credit Received - 65%, Net Charge - 10% Well C: Charge to the Joint Account - 75%, Credit Received - 0%, Net Charge - 75% Well C received no credit because the frac string was valued as junk. 1) Is it equitable to follow the Materials section and charge wells for frac strings using the standard condition value mechanism? 2) Does the Non-Operator have a valid exception related to these costs? 3) Could an Operator allocate the costs of the frac string evenly among the three wells? If so, would the Operator need to get permission for the non-operators as suggested in AG-24 Accounting Procedure Exceptions? Page 9 of 10
Scenario 3 Operator TUV also purchases a new frac string for the recently drilled wells but accounts for it differently by renting the frac string to Joint Accounts from the period it is set in the well till when it is removed. The Operator purchases the frac string for $200,000. It is the Operator s policy to set the frac string immediately after drilling with the primary drilling rig. Completion operations begin 90 days later due to completion crew availability and based on other wells in the Operator s completion program. The Operator charges a rate of $0.21/foot/day for the frac string set and the total length is 10,000 feet. Completion operations are completed in 30 days and the frac string is removed from the wellbore. Through the rental, the Operator is able to recoup a total of $252,000 for each well served by the frac string. The Operator reuses the frac string on two additional wells, recouping a total of $756,000. 1) Do you accept the method of renting the frac string? Why or why not? 2) Would you change your mind if the Operator sets the frac string a week before frac operations begin and removes it immediately after completion assuming that completion operations last a month? Pertinent COPAS Excerpts MFI-51 2005 Accounting Procedure Section II, Part 6: Theoretically, the Operator s charges to the Joint Account should not result in a profit or loss for the use of its equipment and facilities; however, the charging of the agreed upon or commercial rates may result in a gain or loss to the Operator Section IV, Part D: (1) Condition A New and unused Material in sound and serviceable condition shall be charged at one hundred percent (100%) of the price as determined in Sections IV.2.A (Pricing), IV.2.B (Freight), and IV.2.C (Taxes) (2) Condition B Used Material in sound and serviceable condition and suitable for reuse without reconditioning shall be priced by multiplying the price determined in Sections IV.2.A (Pricing), IV.2.B (Freight), and IV.2.C (Taxes) by seventy-five percent (75%) (3) Condition C Material that is not in sound and serviceable condition and not suitable for its original function until reconditioning shall be priced by multiplying the price determined in Sections IV.2.A (Pricing), IV.2.B (Freight), and IV.2.C (Taxes) by fifty percent (50%) Condition E Junk shall be priced at prevailing scrap value prices. Page 10 of 10