Accounting for Extractive Activities An Oil and Gas Company Perspective

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Accounting for Extractive ActivitiesAn Oil and
Gas Company Perspective
IASC Foundation IFRS Conference
AMSTERDAM

• JUNE 2008

Bob Deere Vice President Accounting
Reporting Royal Dutch Shell plc
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THE LIFE CYCLE OF EXTRACTIVE ACTIVITIES
PROSPECTING
EXPLORATION
EVALUATION
CONSTRUCTION AND DEVELOPMENT
PRODUCTION
CLOSURE
Confirms geological presence of hydrocarbons
Exploration Data interpreted / Commercial aspects
assessed
Execution risk remains throughout Life of Field
Assess Abandonment Liability throughout Life of
Field

Prospects identified / Access secured
Among International Oil Companies.
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Accounting for the Life Cycle of Extractive
Activities
FINANCIAL STATEMENT IMPACTS
SIGNIFICANT ACTIVITY OVER LIFE OF FIELD

• Multiple financial statements published during
  life of field (LOF)
• Both assets and activities must be accounted for
• Assets are important for liquidity analysis
• Most focus will be on earnings as a guide to
  future cash flow generation
• Management manages to profitability (or
  maximizing return on investment)
• Annual financial statements only provide a
  partial view of LOF cash flow

• Timeframe of years, possibly decades
• Expenditures are made without certainty as to
  total return
• Investments made with intent to produce
• Even production phase has risk associated with it
• Portfolio effect results in multiple stages of
  life cycle all present at the same time
• Investors focused on return on capital invested
• Cash Flow is realized upon production (and sale).

SAKHALIN LNG PLANT
LNG COMMISSIONING CARGO ARRIVAL
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The Life Cycle of Extractive Activities

• Key issues
• Balance sheet approach vs. income statement
  approach
• What is the asset and when is it recognized
• Basis of measurement / Correlation to realization
• Disclosures
• Preparers view of User Perspective

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Balance Sheet / Income Statement Perspective
INCOME STATEMENT
BALANCE SHEET

• Focus on Activities
• Revenue generation
• Periodic cost incurred
• Amortization of capital costs
• Period of time orientation

• Focus on Assets
• Definition of Asset
• When is Asset created
• Valuation of Asset
• Point in time orientation

CABAZON

• Current use
• Utilized rarely except in liquidity analysis
• Potential issue of basis of valuation
• Many assets are created not just reserves
• Better aligned with Balance Sheet oriented
  Conceptual Framework

• Alignment
• Corresponds to how management views company
• Most external communication focused on earnings
• Correlates to cash flow from operations
• Difficult to align with Balance Sheet oriented
  Conceptual Framework

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Definition of an Asset
Which asset is the asset
Focus is on reserves

• Reserves represent future production
• However
• Reserves are estimable not auditable
• Quantities not determinable early in Life Cycle
• Historical or Prospective valuation
• Activities result in other outcomes that meet the
  conceptual definition of an asset

Conceptual Framework Definition
Assets prior to reserves booked
Assets after reserves booked

• Right to access prospect
• Information indicative of existence of
  hydrocarbons
• Exploration tangible equipment (wells)
• Option value is evidence of expected future
  benefits

• Right to extract production
• Control of operations
• Equipment (wells, pipelines)
• Land
• A producing property is more than reserves in the
  ground

• Current Framework
• A resource controlled by the entity as a result
  of past events and from which future economic
  benefits are expected

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Basis of Measurement
Valuation
Historical Cost

• Estimated
• Intended to be predictive of realization (may not
  be)
• Benefits in the form of increased value are
  recognized before earned
• Remeasurement required at each balance sheet date
• Amounts presented are ranges of estimates
  presented as single point values
• Resulting valuation may be discarded by users in
  light of their own assessment of value

• Verifiable
• Correlated to realization though not predictive
  of such
• Aligned with concept of investing then earning a
  return over time
• Does not give benefit before earned
• Does not require periodic remeasurement
• Amounts presented are actual values
• Historical costs provides trends for users to
  develop their predictions of future cash flows

SAKHALIN LNG PLANT
LNG COMMISSIONING CARGO ARRIVAL
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Financial Statement Disclosures - Current
Disclosures
DISCLOSURE ISSUES
BASIC FINANCIAL STATEMENTS

• Balance Sheet/Income Statement/Cash Flow
• Carrying value of assets
• Revenue earned
• Expenses incurred
• Amortization of asset value (or valuation change)
• Capital invested
• Primary Financial Statements would be different
  depending on historical costs or valuation basis

• Are these the right disclosures?
• Consistency of definitions
• Consistency among companies
• Interaction with basis of financial statements
• Uncertainty of predictive information

FOOTNOTE DISCLOSURES
RESERVE DISCLOSURES
OTHER DISCLOSURES

• Geographical segments
• Expenses for producing, exploration, other
  activities
• Capital spending for exploration vs. development
• Amortization inclusive of impairments

• Well counts
• Drilling activity
• Production
• Property Descriptions

• Volumes by geographical location
• Breakout between oil and gas
• Standardized valuation
• Nature of change activity between periods
  (including production)

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Preparers view of User Perspective

• Users will not accept management valuation
• Users desire information to make their own
  valuations
• Volatility and constant remeasuring will not be
  helpful
• Realization is important to shareholder
• Lack of clarity as to when numbers are estimates