fm-gallun i-viii.qxd 5/30/01 1:13 PM Page i Fundamentals Oil & Gas of Accounting fm-gallun i-viii.qxd 5/30/01 1:13 PM Page ii fm-gallun i-viii.qxd 5/30/01 1:13 PM Page iii Fundamentals Oil & Gas of Accounting Rebecca A. Gallun Charlotte J. Wright Linda M. Nichols John W. Stevenson f o u r t h e d i t i o n Disclaimer The recommendations, advice, descriptions, and the methods in this book are presented solely for educational purposes. The authors and publisher assume no liability whatsoever for any loss or damage that results from the use of any of the material in this book. Use of the material in this book is solely at the risk of the user. Copyright © 2001 by PennWell Corporation 1421 South Sheridan Road Tulsa, Oklahoma 74101 800-752-9764 800.752.9764 +1.918.831.9421 [email protected] www.pennwellbooks.com www.pennwell.com Marketing Manager: Julie Simmons National Account Executive: Barbara McGee Director: Mary McGee Managing Editor: Marla Patterson Operations/Production Manager: Traci Huntsman Cover & book design by Morgan Paulus Library of Congress Cataloging-in-Publication Data Fundamentals of oil & gas accounting / Rebecca A. Gallun … [et al.].--4th ed. p.cm Rev. ed.: Fundamentals of oil & gas accounting / Rebecca A. Gallun, 3rd ed. 1993 Includes bibliographical references and index. ISBN 0-87814-793-4 ISBN 13 978-0-87814-793-9 1. Petroleum industry and trade--Accounting. 2. Gas industry--Accounting. I. Title: Fundamentals of oil and gas accounting II. Gallun, Rebecca A. III. Gallun, Rebecca A. Fundamentals of oil & gas accounting. HF5686.P3 G3 2000 657'.862--dc21 00-060655 All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or transcribed in any form or by any means, electronic or mechanical, including photocopying and recording, without the prior written permission of the publisher. 6 7 8 9 11 10 09 08 WG_copyright.indd 4 6/20/08 9:55:41 AM fm-gallun i-viii.qxd 5/30/01 1:13 PM Page v C ONTENTS CHAPTER 1 A Profile of Petroleum Operation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 CHAPTER 2 Introduction to Oil & Gas Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 CHAPTER 3 Nondrilling Exploration Costs Under SE. . . . . . . . . . . . . . . . . . . . . . . . . . 65 CHAPTER 4 Acquisition Costs of Unproved Property Under SE . . . . . . . . . . . . . . . . . . 81 CHAPTER 5 Drilling and Development Costs Under SE . . . . . . . . . . . . . . . . . . . . . . . 121 CHAPTER 6 Proved Property Cost Disposition Under SE . . . . . . . . . . . . . . . . . . . . . . 159 CHAPTER 7 Full Cost Accounting (FE) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 CHAPTER 8 Accounting for Production Activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . 261 CHAPTER 9 Accounting for Revenue from Oil and Gas Sales . . . . . . . . . . . . . . . . . . . 283 CHAPTER 10 Basic Oil & Gas Tax Accounting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 349 CHAPTER 11 Joint Interest Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395 CHAPTER 12 Conveyences. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465 CHAPTER 13 Oil & Gas Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 531 CHAPTER 14 Accounting for International Petroleum Operations . . . . . . . . . . . . . . . . . 583 v fm-gallun i-viii.qxd 5/30/01 1:13 PM Page vi CHAPTER 15 Analysis of Oil &Gas Companies’ Financial Statements. . . . . . . . . . . . . . 605 CHAPTER 16 Overview of Gas Pipeline Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . 633 APPENDIX A Authorization for Expenditure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 661 APPENDIX B Regulation SX 4-10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 665 APPENDIX C Excerpt from Regulation S-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 679 APPENDIX D Excerpt from Statement of Financial Accounting Standards No. 19. . . . . . 681 APPENDIX E Kerr-McGee Corporation 1999 Annual Report . . . . . . . . . . . . . . . . . . . . 697 ABBREVIATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 741 INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 745 vi 01-gallun 1-30.qxd 5/30/01 1:14 PM Page 1 c h a p t e r o n e A Profile of Petroleum Operations Today’s oil and gas companies may be involved in four different types of functions or segments: • Exploration and production (E&P) • Transportation • Refining and gas processing • Marketing and distribution An integrated oil companyis one involved in E&P activities as well as at least one of the other segments listed above. An independent oil companyis one involved primarily in only E&P activities. The oil and gas industry is uniquely characterized by • a high level of risk • a long time span before a return on investment is received • a lack of correlation between the magnitude of expenditures and the value of any resulting reserves • a high level of regulation 01-gallun 1-30.qxd 5/30/01 1:14 PM Page 2 Fundamentals of Oil & Gas Accounting • complex tax rules • specialized financial accounting rules These characteristics are most evident in the E&P functions of oil and gas companies. This book describes the accounting for transactions relating to the E&P activities of oil and gas companies. Exploration and production procedures and processes are essentially the same for any type of oil and gas company. The procedures and steps involved in locating and acquiring mineral interests, drilling and completing oil and gas wells, and producing and selling petroleum prod- ucts are briefly reviewed in this chapter. A basic knowledge of these procedures is necessary in order to understand their accounting implications which are discussed in the following chapters. A more detailed discussion of these procedures may be found in publications such as Introduction to Oil and Gas Production,1 A Primer of Oil-Well Drilling,2 or The Petroleum Industry: A Nontechnical Guide.3See the reference section at the end of the book for a list of other readings relating both to the oil and gas industry and to accounting for oil and gas operations. B H U.S. O G I RIEF ISTORY OF THE IL AND AS NDUSTRY The modern history of the U.S. oil and gas industry began in the latter half of the 19th century with the first commercial oil drilling venture in Pennsylvania. The product demand at that time was for kerosene, which was used as lamp fuel. The petroleum industry expand- ed greatly in the 20th century as new uses for oil were developed. The invention of the auto- mobile was responsible for much of the industry’s growth. Early in the 20th century, World War I strained the industry’s ability to supply fuel, prompting the decade of the 1920s to be one of great U.S. oil discovery. In that decade, many U.S. companies also began exploring for foreign oil in the Middle East, South America, Africa, and the Far East. The onset of World War II in 1937 once again tested the industry’s ability to supply oil. During World War II, drilling began in U.S. waters on offshore struc- tures that resembled the offshore drilling platforms of today. During and following World War II, U.S. companies also increased foreign exploration, especially in the Persian Gulf area. Following World War II, natural gas was established as a major fuel for industry and home heating. It was also during the post-war period that natural gas transmission pipelines were constructed, linking remote producing areas to large population centers. The U.S. increased its reliance on foreign oil during the 1950s and 1960s. In 1960, the Organization of Petroleum Exporting Countries (OPEC) was formed. Although OPEC was ineffective during its first decade of existence, its oil embargo of 1973-74 coupled with an increase in the price of crude oil created an energy crisis in the U.S. resulting in shortages of petroleum products. The nation for the first time became acutely aware of the myriad of prob- lems and issues resulting from its dependence on foreign oil. The energy crisis prompted the passage of the Energy Policy and Conservation Act of 1975, the purpose of which was to encourage energy conservation, reduce reliance on foreign 2 01-gallun 1-30.qxd 5/30/01 1:14 PM Page 3 Chapter 1 A Profile of Petroleum Operations oil, and encourage the development of alternative energy sources. Unfortunately, with the eas- ing of the energy crisis, the nation’s attention turned away from energy matters. By 1977, U.S. dependence on foreign sources of petroleum reached an all-time high of 47%. A second round of price increases occurred from 1979 through 1981. The U.S. dependence on foreign sources of petroleum fell to 27% by 1985. The world oil supply was again disrupted in 1990, with Iraq’s invasion of Kuwait. Although the crisis was short-lived, it once more brought to the forefront the nation’s depend- ence on foreign oil, and the need for alternative fuel sources. With the easing of the crisis, U.S. net imports of foreign oil again began to increase. By 1996, the U.S. was importing 46% of its petroleum needs. O P RIGIN OF ETROLEUM The most widely accepted hypothesis of the origin of oil and gas is the organic theory. This theory holds that petroleum (hydrocarbons) is formed from organic material including marine plants and animals that lived millions of years ago in low-lying areas—normally in the oceans of the world. These plant and animal remains were deposited throughout the years, along with layer after layer of eroded particles of igneous rock. The weight and pressure of the overlying layers caused the eroded rock particles to form sedimentary rock. The weight and pressure of overlying layers—and other not fully understood factors, such as chemical and bacterial processes—changed, and still change, the organic material into oil and gas. After formation, oil and gas move upward through the layers of sedimentary rock due to pressure and the natural tendency of oil and gas to rise through water (salt water is normally con- tained in the pore space of sedimentary rock). The petroleum migrates upward through porous and permeable rock formations until it becomes trapped by an impervious layer of rock. The impervious rock that prevents further movement of the oil and gas is called a trap(Fig. 1–1). Some of the common types of traps are as follows: • Fault trap—a trap formed when the movement of the earth’s crust causes different rock strata to offset or shear off. In a fault trap, a nonporous rock formation that has shifted stops the movement of oil or gas within an offsetting formation that allows petroleum to migrate. • Anticline—a trap formed by the folding of the earth’s crust into a dome. This upward folding is caused by pressures developed from the earth’s molten core. An impervious or non- porous layer of rock overlying the anticline traps the oil or gas in the anticline structure. Most of the earth’s oil and gas reserves are found in anticlines. • Salt dome—a trap created by a bed of nonporous salt pushing upward through over- lying formations. Faults, in which oil and gas are trapped, are created along the sides of the upthrusted salt dome. In order for an oil or gas reservoir to have been formed, four conditions must have been present: 3