Fundamentals of Oil and Gas Accounting: Upstream Oil and Gas Operations: An Introduction

1. Fundamentals of Oil and Gas
Accounting
Upstream Oil and Gas Operations: An Introduction
Dayana Mastura Baharudin (USM Penang) & Associate Prof. Dr. Maran Marimuthu (UTP
, Perak)

2. Upstream oil and gas activities / Exploration
& Production (E&P) activities
Exploration Acquisition Drilling Developing Production of oil and
gas

3. Downstream oil and gas activities
Refining Processing Marketing Distribution

4. Midstream
oil and gas
activities
Upstream activities
Downstream activities

5. Integrated oil and gas company
Upstream oil and
gas activities
Midstream oil and
gas activities
Downstream oil
and gas activities

6. Independent
oil and gas
company
Exploration activities
Production activities

7. Characteristics of E&P activities
HIGH LEVEL OF RISK A LONG-TIME SPAN
BEFORE ROI CAN BE
ACHIEVED
LACK OF
CORRELATION
BETWEEN
MAGNITUDE OF
EXPENDITURES AND
THE VALUE OF ANY
RESULTING
RESERVES
HIGH LEVEL OF
REGULATION
COMPLEX TAX
RULES
UNIQUE COST-
SHARING
AGREEMENTS

8. Why do you need to differentiate between
Upstream, Midstream & Downstream?
THERE IS A SPECIALIZED SET OF
ACCOUNTING RULES
THERE IS A SPECIFIC SET OF
FINANCIAL REPORTING STANDARDS
ONLY FOR UPSTREAM OIL AND GAS
OPERATIONS

9. Oil and Gas exploration: Geological
Identification of rocks and
minerals
Near the surface rocks and
minerals
Understanding the
environments in which
rocks and minerals are
formed
Aerial photography
Satellite imaging Imaging radar Topographical mapping Geological mapping
To identify for petroleum-
bearing subsurface
formations

10. Oil and Gas exploration: Geophysical
Subsurface studies
Locating and
detecting subsurface
structures
Determination of size,
shape, depth &
physical properties
Indication of oil and
gas reservoirs
Gravitational studies Magnetic evaluation
Electromagnetic
evaluation
Seismic studies

11. Steps in finding oil and gas onshore or
offshore
1. G&G work
2. Lease may be obtained based on
results obtained in 1
3. Detailed G&G evaluation, seismic
surveys, test wells drilled
6. Well is drilled
5. Further analysis of available data
and more seismic studies done to
select dril site
4. Data gathered in steps 1 and 3 are
analysed. Positive results then lease
obtained if not done yet
7. To determine if there is sufficient
oil and gas to justify completing the
well
8. If sufficient oil or gas - well is
completed and production to start
9. If insufficient oil and gas then
another drill site on the lease is
selected or the lease is abandoned &
the entire process repeated

12. Oil and Gas
Lease
 Lessor – mineral rights owner who
leases the property to another party
and retains a royalty interest
 Lessee – the party leasing the
property, receives a working interest
or operating interest.
 Lessee’s working interest –
includes investigating, exploring,
prospecting, drilling, and mining for
oil and gas and other minerals as
well as for conducting G&G surveys,
installing production equipment and
the production of oil and gas.

13. Provisions within the
oil and gas lease
contracts
 Lease bonus
 Royalty provision
 Primary term
 Delay rental payment
 Shut-in payments
 Right to assign interest
 Rights to free use of resources for lease
operations
 Option payment
 Offset clause
 Minimum royalty
 Pooling provisions

14. 4 basic costs of oil and gas exploration and
production activities
 Acquisition costs
 Exploration costs
 Development costs
 Production costs

15. Acquisition Costs
Costs incurred in
acquiring the rights to :
Explore Drill Produce oil and natural
gas

16. Exploration Costs:
Type 1 – Non-drilling
costs
 Geological and geophysical (G&G)
costs – topographical costs, G&G
studies, rights of access to properties
to conduct G&G studies, salaries of
geologists, geophysical crews
 Costs of carrying and retaining
undeveloped properties – delay
rentals, ad valorem taxes on oil and
gas properties, legal costs for title
defense
 Test-well contribution type 1 (Dry-hole
contribution) – Payment is made only
if the well is dry or not commercially
producible
 Test-well contribution type 2 (Bottom-
hole contribution) – Payment is made
when an agreed-upon depth is
reached, regardless of the outcome of
the well (dry or producible)

17. Exploration costs: Type
2 – Drilling Costs
 Costs of drilling and equipping exploratory
wells
 Costs of drilling exploratory-type
stratigraphic test wells (drilled offshore to
determine the existence and quantity of
proved reserves)

18. Development
Costs
Costs incurred in preparing proved reserves for production: Costs to obtain
access to proved reserves
Costs to provide facilities for oil and gas :
Extracting
Treating
Gathering
Storing

19. Production Costs
Costs of lifting the oil
and gas to the surface
Costs of gathering oil
and gas
Costs of treating oil
and gas
Costs of storing oil
and gas

20. Historical
Cost
Accounting
Methods
The previous mentioned FOUR basic types of costs incurred by oil
and gas companies in E&P activities must be accounted for by
using one of the two generally accepted historical cost methods:
Successful efforts methods (SE) or the Full Cost Method (FC)
Successful-efforts accounting allows a company to capitalize on
only those expenses associated with successfully locating new oil
and natural gas reserves.
Full-cost accounting allows companies to capitalize on all operating
expenses related to locating new oil and gas reserves, regardless of
the outcome.

21. Differences
between the
SE & FC
methods
Timing of the expenses
Loss charged against revenue
Size of the cost centre over which
costs are accumulated and amortized

22. Cost centres
under the
SE & FC
methods
The cost centre size has implications in
computing the DD&A (Depreciation,
Depletion and Amortization) costs
Cost centre for SE: Lease, Property,
Fields or Reservoir
Cost centre for FC: Country

23. Successful
Efforts (SE)
vs Full Cost
(FC)
Item Successful Efforts Full Cost
Acquisition costs Capital Capital
G&G costs Expense Capital
Exploratory dry hole Expense Capital
Exploratory well, Capital Capital
Development dry hole Capital Capital
Development well,
successful
Capital Capital
Production costs Expense Expense
Amortization cost centre Lease, Property, Field or
Reservoir
Country

24. Example: A simple illustration of
Income Statements and Balance
Sheets under the SE & FC methods
 Tyler Oil Company began operations on March 3, 2019 with the
acquisition of a lease in Texas. During the first year, the following
costs were incurred. DD&A (depreciation, depletion and
amortization) were recognized and the following revenue was
earned:
 G&G costs $ 60,000
 Acquisition costs $ 100,000
 Exploratory dry hole $ 1,400,000
 Exploratory wells, successful $ 800,00
 Development costs $500,000
 Production costs $50,000
 DD&A expense (SE) $40,000
 DD&A expense (FC) $90,000
 Revenue $250,000
 Required: Prepare the Income Statements and Balance Sheets
under the SE & FC methods for Tyler Oil Company.

25. Tyler Oil
Company:
Income
Statements
SE SE FC FC
Revenue 250,000 250,000
Expenses:
G&G 60,000 0
Exploratory
dry hole
1,400,000 0
Production
costs
50,000 50,000
DD&A 40,000 90,000
Total
expenses
1,550,000 140,000
Net Income (1,300,000) 110,000

26. Tyler Oil
Company:
Balance
Sheets
SE FC
G&G costs 0 60,000
Acquisition costs 100,000 100,000
Exploratory dry 0 1,400,000
Exploratory wells,
successful
800,000 800,000
Development costs 500,000 500,000
Total Assets 1,400,000 2,860,000
Less: Accumulated
DD&A
(40,000) (90,000)
Net Assets 1,360,000 2,770,000

27. Fortune Global 500 –
Top 10 Companies in
the World in 2019 :
70% are Oil and Gas
Multinational
Companies (MNCs)

28. Chevron: Income Statements in 2017,2018 & 2019

29. Chevron: Balance Sheets in 2018 & 2019

30. Chevron: Cash Flow Statements in 2017,2018 & 2019

31. Chevron is
ranked 28th in
year 2019
FORBES Global
Fortune 500 ranking
of top 500
companies globally

32. The pride of Malaysians ~ the
sole MNC ranked within the
Forbes Global Fortune 500
 Petroliam Nasional Berhad
(PETRONAS)
 Ranked #158 in 2019