OGARP DIGITAL LIBRARY “Accounting for International Petroleum Operations” Chapter 15 of Fundamentals of Oil & Gas Accoun ng, 5" Edi on By Charlo e J. Wright, Rebecca A Gallun Copyright © 2008 by PennWell Corp. All rights reserved. Published by PennWell Corp. ‘No part of this material may be copied, modiifed, adapted, translated, reproduced, transferred or distributed, in any form or by any means, and no deriva ve works may be made based on this materials without the prior permission of the GARP Digital Library and/or the publisher. You may nat alter, remove fr suppress in any manner any copyright, trademark or other no ces displayed in this material. 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In no event shall the GARP Digital Library or the publisher be liable to any other party or any other person or en ty for any special, consequen al, incidental Indirect, exemplary or puni ve damages, however caused, arsing out of or in connec on with the provisioning or use of this material regardless of the form of ac on, whether for breach of contract, breach of warranty, tort, negligence, o otherwise (including, without limita on, damages based on loss of profits, data, files, or business opportunity), and whether or not the party has been advised of the possibilty of such damages. This limita on shall apply notwithstanding ary failure of essen al purpose of ‘any limited remedy provided hereinReproduced fom Fundamentals f i and Gas Accounting by Chariot J. Wright Rabecca A. (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih Pennies Cor, 15 eee aa ACCOUNTING FOR INTERNATIONAL PETROLEUM OPERATIONS scooter aay tes an dates no enone in dome operat. Tor ‘tle company mat eons ht he ca opening ci coat te Hil wo behigher hin unerhing slr opeateay dex, In ome loss, heen bers asia waco ih ste ably ofthe fovenme abty fl the cere aguas ofthe sayof rsters a egupmen and alls oF Seis nk nas, alana als eyes wil encour ile Ens ant ests reining the onnetig of the wares, 25 ella a wie say of iret a kv and eutoes. The ll goverment ‘or tte ety. rat han an facial wb mit excion,o he ‘eas Consejuent an lla escompany rst ply eaeriat contact a thea ernment rhe rat tcl or an pro lan go ook These ‘elec complovand vary nly om cua ea. A of these iss imu of an gus comps enzasig in exlraton and prac avs tie the United Stes This chap pigs an rere of Iisiogal to reproduce this mater in any format without Ditituted by: frit wien approval ot Penesh Crp. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. PETROLEUM FISCAL SYSTEMS Since mineral righ are typically owned by the government of the foreign county ot host” country, the government and the oil and as Company must come to an agreement 4810 what eolztivepeyments ae 1 he rei hy the government in return fo allowing the company’ to operate in is county. Colney these payments ar refered 19 38 the ‘iseal sytem of the country. Exampos of such payinents include the folowing. + Upetront bonnes paid to the host country ‘+ Royatos pid tothe host country + vr an provincial income taxes + Various ote taxes collected by the host country inlading duties and special petoleum taxes + Production sharing, wherein ol orgs allocats! between the pate for the purpose of recosery of cspital or operating costs or both + Inastructure development fo the host country The exzt nature of payments thatthe government recess determined by the legal system in the county, Countries thet colt payment fr ol and gas produced primarily in the form of roylies and taxes arc refered 1 as having concessionary systems. The United States has a concessionary system, as does the Crited Kingdom, Norway. and a host of ‘other countret. In the United Slates und in lint situations in a fev ether counties it is possible for indivdaals to cwn mineral rights. Outside the United States, mineral rights 'ypically are owned exchsively by the hest government. Some countries allow foreign oil companies to owa mineral in place, while others do et. In countries rdyng primary on taxes and royalties, the contract between the government that owns the minerals and the oi and gas company wishing to explore, develop, and progce the mineral is referred to asa ‘concessionary contractor concessionary agreement Countries where the government dees not rely entirely on taxes and royalties are referred to as having contractual systems. In contractual sen, theo and gas company rust contract with the local government forthe right o sare in reve from wand ts produstion. The government typically retin tie to the minerals throughout exploration, evelopment, and production, The company either receives revenies fr) the sale OF i ‘Share of production or i allowed to rece cil anc zu in the form of repayment for east reooverya share of profs andlor servis rendered Aside sarsty of comiactare found ineonaculspsemncaing production sharing contracts (PSC) anc seve contrat, with PSC haing the most popu Concept «PSC, the foreign oil and yas company, fered toa the contractor, is allowed to reaver ‘sorta ost and roeves sha of the pois (Tho term contractor ca be wd orf to Single company If more than one foreign company owns a working interest he proper the ler suse eolletvely to refer tall ofthe foreign compas that sare in the working inres) The contractor typically revewes payment in-kind Gin he form of oi a gas). In {type service cont, the conntelor receives money representing Te for conducting exploration, development, and production sevice. In prctie, contracts ave numerous ‘lerent ers and conditions that ofen make i fest to elas them a hse eter Iisiogal to reproduce this mater in any format without Ditituted by: frit wien approval ot Penesh Crp. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. (Chaper 15 «Accounting For Tnsraainal Psleun Operations 679 PSCS or service contacts Typical erms found in PSCs and service contracts are discussed in det later in the chapter, Almost every contact has is own unique terms and characterises Oflen it i not ‘only dificult to classy the contracs as being PSCs oF service contrat. but also as being ‘oveestonaryof contac in native. Each country negates the terms it believes me. bene] to the etizens ofthe country. Consequently. contracts aa agreements generated by any gwen country my be contractual in ature but have some aspects that resemble a concessionary contract and vice versa eis important to remember that any discussion of those coutracts wt the most asta case, Contracts can be very illest singe they ane the product of intense negotiation and can inclade whatever clauses and conditions the negotiators ace, CONCESSIONARY SYSTEMS [As mentioned above, other than ina imited number of counties an ESP company rst coatract with the lost goverment Fr the sight 1 explore, develop and produce. Ina concessionary system thecontractorsanductsexporaton dling, and posily development And prsction activist its soe risk and cost nother words the company payall a the ‘ost asocaied wi exploration and dling, without any prospec foe reimbursement if 0 ‘or gas is nat dscoere IF olor pas is dscenered and produce le 1 the ol or gas ina ‘concessionary stem wil at some pot pass tothe coatactoe Thecoatractor wil. iatatm, pay 4 roll tothe government as production occurs. contrat under a concessionary syste! contains basic lems that ae simi to a US. ease sgrsement Another form of revenue tothe goverament is axes. General all countries have some foem of income aks If the goverment docies to increase tho petroleunalated payments reccved bythe state, it ray enact other types of taxes and levies assesed on petroleum cxplocation and production activites The include for example, production o¢ severance taxes petroleum revenue taxes, vale added taxes and resource en taxes Ina coneesioary stem, the primary source of payments to the stat isin the form of royalties sed tes ‘Consequently, the countries having concessionary seme sometimes eer 0 8 aX 1 countries The following xarape lures simple concession sgeerent EXAMPLE Concession Agreement Tyee Company enters into concession agreement with the Canaan government, Tle pugs the government in US. dollar $5,000.00 signing bonus and wares to pay the ‘government eoyaies of 10% of grass production and a S%severance tax. Tyler bea all oF tho cout associated with exploration, development, ad prettion, Iisiogal to reproduce this mater in any format without Ditituted by: frit wien approval ot Penesh Crp. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. ‘Tye spends 85,000.00 on exploration and ding costs and in 2012 has gross reve of '57,00,000 and predution costs of $100,000. The income tax laws allow deduction ofall ‘roction costs, with exploration and dling costs dactble over 4 e-year period. The tart is 10% Gross eve for 2012 woul be shal by che prt fellows: ‘Tyler Company _ Government Gros rewaw. $7000.00 Royalty 70.090) Smo Production ax 3%, 05000) 350000 Net reveme $5950,000 Operating expenses (ono) 1S of exploration and driting costs 1.000000) “Twble income $8950,000 como tas 40% 1.530.090) Netto TlesiGonetnme s23m.0n CONCESSIONARY AGREEMENTS WITH GOVERNMENT PARTICIPATION One variation ofa concessionary agreement involves the host gavernment participating in ‘the oil ad gas operation aa working intzest ok ne. This type of arangerent is generally refered 10 as government participation. The government typically sts up a state-owned cil eompany te partipas inthe operations as a orking interest ott. This arrangement may also he refered to a5 a joint venture arrangement. As with othe joint operations a joint operating agrcemcot i ypically executed betwac the putes. this particular ype ‘of arrangement, th contractor may ates to pay 100% of the explorationype expenditures sand “carry” the state-owned company through the explocaton phase. th her words the contractor pays al of the costs rated to exploration, exploratory ding, and any othe tvs spit in the comteat commercial reserves are found, the government reins the «ight to participate oF ‘bak in to the development and prodvetion operations 2s a working intrest weer at an ingerestof upto SI, Thismeansthe goverment ca elt to become joint venture partner ‘vith the contacting conpuny after the result of intial exploration and dling are knowa, IE ‘the state-ovned oil eompany elect patsatit then becomes lable fr its proportionate share of al fame ding, development, and production costs The agrecment may allow the {ontractoe to recover al oF a portion ofits upfront exploration-eated expenditures. 1 this Isthecas.therenre Wo methods of cover Ones diet payment by the gaverment to the Iisiogal to reproduce this mater in any format without Ditituted by: frit wien approval ot Penesh Crp. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. (Chaper 13+ Accounting For Tnternational Petroleum Operations 681 ‘ontrator: The oer, mre feguenth used methods alos the contractor wo ecover some ball of its costs by thecontrator keeping he state oil company’s share of produetinn unt the coniacir hs eenupad the alowed costs AMRerward, the sate-cwred company shares in ont and prodcton jut ike any other working interes owner. Under ths arrangement, the government sil receives «royally on gross production, along with income taxes and other fiscal obligations required by the hws and regulations f the count CONTRACTUAL SYSTEMS In some countries the Ig system 2s it pertains to mineral onmership i based on the Principle that natural resources ae owned by alleitzens of the country, andthe government Shoal actin sash a mance as to maxinize the vale of the soon: flowing back to the poople. Asa result the government ons and retains ttle to all minerals ‘The contractor paragraph 10 and 1 sal e separately isos for (athe enterprce's dome country (f slnfcant reser are located bere} and (1) each foreign _eoerophic area which significant rears ae Iooted. Foreign geographic ‘rca are individual countries or group of cura appropri for meaninghl dseloare nthe circumstances In practive companiediclose their net share of proved reserves by major geographic area, but few provide information further segregating the reserves related 10 PSCé or risk service contracts This practice may result in part, fom the fact thatthe disclosure of the “Standardized Measure of Discounted Futtre Net Cash Flaw rom the Production of Prowed ian Gas Reserves" sped by SFAS No. 69) docs not requir eporting reserves based ‘oncomtact sre Iisiogal to reproduce this mater in any format without Ditituted by: vir wien approval ol Penriel Cap. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih Pennies Cor, (Charer 1S «Accounting For Ts INTERNATIONAL ACCOUNTING STANDARDS International Financia! Reporting Standards (IFRS) are issued by the Intrmational Accounting Standans Board (JASB) All European Union countries follow international Accounting Standard. as do many other countries around the work. However, curently theres no IFRS tha comprebensvely address accounting sues in the upstieam oi and ‘a indusry The LAS s evalnatng alternatives and has expressed the intention of Sing Sch a sandan at some time in the fire. Meanwhile, companies wing International AAscounting Standards may apo vse SEAS Na 19 in accounting For thir exploration snd ‘alton activities. It dows aot appear thet the fall ost method willbe acceptable to the 1ASb. Therefor, many fll cot companies reporting in countries that follow International Accounting Slandards hive chosen o sith to successful eft opardlss of the country in which the pagent company is Jeated, most foxign overnncats require compass operating within their country to fle faancal statements prepared in acordanee with ocastattory accounting rules. Fr example, a French company fopstatiag in Venerusie mig be reguied to account for its Vanezueiin operations Using Ibe Vencrucln statutory accounting rcs and or purposs of parent company reporting, twals account forthe Venezuelan operations using lneznaional Accounting Standards Hiscorially the SEC required frcin companies whose scaitiesare raed inthe US.t0 rmconele thar oreign-GAAP fatal statements with US. GAAP Comnmedeing Nowembor 2007, he SEC dropped this requirement for frcgn registrants wing LASB stanancs For amore through discussion of International Accounting Standard, se Jneraatonal ‘Petcolen Accouaung by Wright and Gall, sal Petroleum Operations 695 PROBLEMS 1. Desi the fllowing domestic market obi singfencng cexstoil profit capital uplint production bons sling sea royalty tax holiday royaly holiday government participation Iisiogal to reproduce this mater in any format without Ditituted by: frit wien approval ot Penesh Crp. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. 2. Distinguish beeen the flowing: concessionary system contractual sytem 4. Distinguish been the following oni srice contract, risk service contac 4 Describe the simian and ierences between PSCs and rik vervice comiracts 5. Discuss the various methods that governments uilize to generate revenues and other ‘elite rom mineral resoures 6. Explain how estimation of a company’s net proved reserves cles when operating under a concessionary contact versus PSC. 1. Jones Oil Company operates under a PSC asresment in the South China Sea. Jones hus {9)r of the working interest, and Sinhsi Oil Compeny (hich i owmed by the Chinese government) has 31% ofthe working intrest. The agicoment calls for animal gross prodition to besplitin the following order 8. VAequal 107% 0F annual gos production 1. Royalty of 13% anual goss production «Cost oli limited 1 62% of annual goss production, with oss to be reovered in the allowing oder 1) Operating expenses 2) Exploration expenditures (Jones il Company, 10%) 3). Development costs Jones Oil Company, $9, and Sinha il Company, 51%) 44. Annual gross production omni lr cost rocverybovores profit oil and issplc 1} The government reccies 15% of profit 2) ‘Theremaiing 85% is shared by hones and Sina based oa thee working interests Dering 2012 Recoverable operating costs equ $4.00, 000. Unrocovered exploration costs equal $10,000,000. Unrecovered development costs equal $10,000,60. “Thesannal goss production for the yea i 200,000 barrel of oi REQUIRED: Assuming the price fo be usd to comer costs into bates S100 alloca the ‘roti Uo Ue panties Iisiogal to reproduce this mater in any format without Ditituted by: vir wien approval ol Penriel Cap. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. (Charer 15 «Accounting For Tnsraainal Psleumn Operations 697 ', Assuming the privet be used to convert cot into bares is SMB allocate the production othe pati 8. Assume that Prox Company a US. compan, is involved in petroleum operations in ‘Thailand. Proex Company hash Wl, whe th Local OH Company hs a WL. Annual gros prection so be split the following order a. Royalty is 15% of annual gros production andi tobe paid in-kind ‘VAT sequal to 5% of annual gross pedvetion and is tobe paid in-kind © Cos ols tite to 50% of goss production, with costs to be recovered in the Follosing ort 1). Operating expenses pid 4% by Protx Company anal 60% by Local (Of Company. 2) Exploration costs (pid entirely by Protex Company) 3) Development costs after completion of exploration, Local Oi Company opted to patcpate at 60. Therelore, development and operating cesis were pal -Av/ahy Protex Company and Phy Local Oil Corian. 4. Any exces remaining afer cost weary bacon prio: 1) OF the profit ei, 2% goes o the goverment 2) ‘Th remainder is spit between Protex and Local Oil Company based on thet working interests For 2014, assume the following 4+ Recotsabl operating costs total 2.600. + Exponation costs unrecotere to date otal 8260.00.00, + Development costs unzecoered to date total $1, 300,00,000, + Anyeosts not recovered the eurrent year may be card forward o be recover in futae years + Theannal gros produetion forthe yer 10,00,000 bares of ol + The agrod upon price i 6S REQUIRED: Allocate the production between the parties. 9, Ibis Company enters into concession agreement with te British government. Ibis pas he government a 10.00.00 (LS) signing bonus and aprees to pay the government royals of $s of gross production and 9 severance tx. [bis bears all ‘ofthe cose aaocated with exploration, development, and production, Daring 201% his spends $7,00000 on exploration and driling ess. Gros evenne 00.00, and proiaton costs were $2,000. Th income 2 labs lan ‘eduction of al production cost with exploration and iling costs deductible over ‘seven-year pero The ax rates 40%. REQUIRED: Shor how the gros even for 2013 woul be shared bythe parties Iisiogal to reproduce this mater in any format without Ditituted by: vir wien approval ol Penriel Cap. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih emit Corp. 10, Fortune Company enters into a risk service agreement withthe Chikan government. Fortune pays the government, in US. dollars @$3.0,00 signing bonus and abo gies to pa all of the costs asoviate with exploration devslopmen, snd production. [Ths consrat defines costs inured in the exploration snd develops plas of cach projet are as being capital costs (CAPEX, and lleosts incur in the production phase as being operating costs (OPEX) Each year in which production cecus, the povernment apres to pay Fortune fee compat of the fling: {AIL OPEX incurred in he cuten! year 10th oF all unrecovered CAPEX, « Si-AUDHon production from Oto 4.640 Dbiay $0.0F84 on proton from ‘4001 to 10,000 Beda, and $0.90 on produetion above 10,00 bela. ‘he maxienun total ee that wil be paid any year it SI 2071 ties te total murder of barra produced. Any unrecovered OPEX oF CAPE (unrecovered de tothe ‘maximum fs) can he card forward to future years. Assume tha in 2012, production commences onthe Lam Fel, Atha tne, Fortune hha spent 10,000,600 on CAPEX, and duting 2012, spends $3,000,000 in OPEX, Pradocton equals 500.000 bares or 5 000,000363 = 13,089 bb REQUIRED: Compute the fo that Fortune Company would reve For 2012. Iisiogal to reproduce this mater in any format without Ditituted by: vir wien approval ol Penriel Cap. OGARPReprosuced rom Fundametals of © and Gas Accounting by Chariot J. Wht, Rabecea A (Gatun. Copyright © 2008 by PeriWell Crp. Al ights esahved. Used by arangorent wih Pennies Cor, (Charer 1S «Accounting For Ts REFERENCES 1. Wright, Chalote J, and Rebgesa A. Callun, 200. fernrionalPeteolewn Accowniag [sted Tus, OK: Penne sal Petroleum Operations 699 2. hid Iisiogal to reproduce this mater in any format without Ditituted by: frit wien approval ot Penesh Crp. OGARP