Production Activities

1
Production Activities

• Types of costs
• Lifting the oil and gas to the surface
• Gathering the oil and gas
• Treating the oil and gas
• Processing the oil and gas
• Storing the oil and gas
• Generally called
• Production expense, lease operating expense
  (LOE), or lifting costs

2
Production Costs Defined Per SFAS 19

• Production costs are those incurred to operate
  and maintain an enterprises wells and related
  equipment and facilities, including depreciation
  and applicable operating costs of support
  equipment. Examples are
• Cost of labor to operate wells and equipment
• Repairs and maintenance
• Materials, supplies, and fuel consumed in
  operating wells and equipment
• Property taxes and insurance
• Severance taxes

3
SE and FC Production Costs

• Costs are the same for SE and FC
• Costs are expensed when incurred
• Includes workover costs to maintain or increase
  production from an existing completion interval

4
Gas in Pipeline

• Gas must remain in pipeline to move gas to market
• Referred to as fill gas or line fill
• WI owners may own the gas in the pipeline

5
Unsold Oil

• Oil may be held in tank batteries on the lease
  and not picked up at yearend

6
Inventory Issues

• Accounting for oil and gas that is unsold at year
  end?
• 30 recognize crude oil in lease tanks as
  inventory
• 20.7 recognize crude oil in downstream storage
  facilities as inventory
• 26.7 recognize natural gas held in storage as
  inventory
• Valuation issues

7
Inventory Valuation

• Costs Direct costs, DDA, overhead
• All include direct costs
• 57.1 include DDA
• 42.9 include corporate overhead
• Most companies use either LCM or net realizable
  value
• ARB 43 may carry inventory at above cost if
• Inability to determine appropriate approximate
  costs
• Immediate marketability at quoted price
• Units completely interchangeable
• SEC Interpretation (March 2001) - Only in
  exceptional cases may inventory be stated at an
  amount above cost

8
Costs Centers for Production Costs

• Cost Centers
• FC the Country
• SE Lease, reservoir, or field
• Accounting Records must be kept to a more
  specific area (lease or well) due to
• Management needs
• Regulatory needs (including IRS)
• Contractual needs (penalty clauses for
  nonparticipation)

9
Costs Assigned to a Lease

• Direct costs
• Direct labor, materials, supplies, fuel
• Contract costs
• Repairs maintenance
• Property tax, severance tax, insurance
• Indirect costs
• Field offices and salaries
• Depreciation of support equipment
• Saltwater disposal system several leases
  involved

10
Allocating Indirect Costs Find a Reasonable
Allocation Base

• Number of direct labor hours
• Amount of direct labor costs
• Number of miles driven (transportation equipment)
• Gallons of water used for waterflooding

11
Allocation of Indirect Costs Problem 8-3

• Allocate 48,000 of office expense if allocation
  based on of wells
• Lease A 6 wells 5,000 bbls
• Lease B 2 wells 1,000 bbls
• Lease C 4 wells 2,000 bbls
• Total 12 8,000
• Lease A 6/12 X 48,000 24,000
• Lease B 2/12 X 48,000 8,000
• Lease C 4/12 X 48,000 16,000

12
Allocation of Indirect Costs Problem 8-3
(Contd)

• Allocate 48,000 of office expense if allocation
  based on of bbls of oil
• Lease A 6 wells 5,000 bbls
• Lease B 2 wells 1,000 bbls
• Lease C 4 wells 2,000 bbls
• Total 12 8,000
• Lease A 5/8 X 48,000 30,000
• Lease B 1/8 X 48,000 6,000
• Lease C 2/8 X 48,000 12,000

13
Allocation of Indirect Costs Problem 8-3
(Contd)

• Entry for problem 8-3(a) DR CR
• Lease operating expense Lease A 24,000
• Lease operating expense Lease B 8,000
• Lease operating expense Lease C 16,000
• District office expense 48,000

14
Individual Production Costs - Issues

• Labor costs If detailed time kept, charge to
  leases according to time spent. If not, some
  other reasonable method
• Employee benefits often 30 to 40. Charge
  along with labor costs
• Repairs maintenance Invoices should indicate
  the lease and well. If contract pumper, allocate
  to wells serviced.

15
Individual Production Costs Issues (Contd)

• Workover costs depend on the purpose. If to
  restore production from same zone, production
  costs. If to another zone, exploratory or
  development.
• Shut in payments if not recoverable from future
  production, expense as production cost. If
  recoverable, set up receivable.

16
Individual Production Costs Issues (Contd)

• Severance tax in Oklahoma
• Oil Varies as follows
• gt17.00/bbl 7
• Between 14.00 17.00 4
• lt14.00/bbl 1
• Gas Varies as follows
• gt2.10/mcf 7
• Between 1.75 2.10 4
• lt1.75/mcf 1

17
Overhead Costs

• Overhead costs not directly related to oil and
  gas producing activities are generally not
  allocated to producing properties

18
Secondary Tertiary Recovery

• Expenditures for wells and equipment are
  generally recovered through DDA (development)
• The costs of the injectants may be included with
  equipment and recovered through DDA or they may
  be charged as production expenses
• Routine maintenance and operating costs of
  secondary or tertiary recovery projects are
  production costs.

19
Problem 8-4

• Part (a) if only underlies Lease A then
• LOE Lease A 20,400
• Cash 20,400
• Part (b) if reservoir underlies three leases
  then allocate to leases using volume of water

20
Problem 8-4 Contd

• Total volume of water is 1,275 gallons allocated
  as follows
• Lease Vol H2O Pct Dollars
• A 200 15.69 3,200
• B 450 35.29 7,200
• C 625 49.02 10,000
• 1,275 100.00 20,400

21
Other Costs - Gathering systems

• Pipeline transfers oil and gas from individual
  well to central point
• Oil and gas are separated and basic sediment
  water (BSW) is removed
• Oil gathering system includes separators, heater
  treaters, and gathering tanks
• Cost of system is subject to DDA and operations
  are production costs

22
Saltwater Disposal Systems

• Removes salt water, treats it, and injects it
  back into the ground.
• If system covers several leases, allocate the
  costs
• Allocation may be on a per well basis or on
  gallons of saltwater

23
Tubular Goods

• Initial costs of tubing and casing are
  capitalized.
• Replacement and repair are operating costs
• Problem 8-17

24
Decision to Complete a Well

• Compare incremental costs (not total costs) with
  revenues
• Sunk costs are now immaterial to the decision
• Estimate the following
• Quantity of oil and/or gas recoverable
• Timing of future production
• Future selling price
• Completion costs
• Cost of capital

25
Completion Decision Problem 8-8

• Estimated costs to complete 500,000
• Estimated selling price 60
• Severance tax 6
• Lifting costs per bbl 20
• WI 87.5
• RI 12.5

26
Completion Decision Problem 8-8 (Contd)

• Compute profit per barrel
• (60 X .875) - 20 3.15 29.35
• Additional revenue at various production levels
• 10,000 bbls X 29.35 293,500
• 20,000 bbls X 29.35 587,000
• 30,000 bbls X 29.35 880,500

27
Problem 8-8 (B) Cash Flows Discounted _at_ 5

• Assume 20,000 bbls equally over 10 yrs