Winter 2018 Emerging Issues Sub-Committee Meeting

Houston, Texas, January 25, 2018

Case Study 1

Material Transfer Pricing

1.  COPAS MFI-51 (2005 Accounting Procedure) allows an operator to price material transfers using any of the following methods as long as they are consistent:

(1) Using published prices in effect on date of movement as adjusted by the appropriate COPAS Historical Price Multiplier (HPM) or prices provided by the COPAS Computerized Equipment Pricing System (CEPS).

(a) For oil country tubulars and line pipe, the published price shall be based upon eastern mill carload base prices (Houston, Texas, for special end) adjusted as of date of movement, plus transportation cost as defined in Section IV.2.B (Freight).

(b) For other Material, the published price shall be the published list price in effect at date of movement, as listed by a Supply Store nearest the Joint Property where like Material is normally available, or point of manufacture plus transportation costs as defined in Section IV.2.B (Freight).

(2) Based on a price quotation from a vendor that reflects a current realistic acquisition cost.

(3) Based on the amount paid by the Operator for like Material in the vicinity of the Joint Property within the previous twelve (12) months from the date of physical transfer.

(4) As agreed to by the Participating Parties for Material being transferred to the Joint Property, and by the Parties owning the Material for Material being transferred from the Joint Property.

Scenario: An Operator drills a set of wells in Oklahoma. During an audit, the auditors discover that the Operator is inconsistent in its tubular pricing methods. The auditors request that the Operator use a consistent pricing method per MFI-51. In response, the Operator performs an adjustment to the Joint Account using MFI-51, Option 2 (Vendor Quotes) to re-price all tubulars. The Operator provides vendor quotes for tubulars to be delivered in Houston, TX as supporting documentation for the price adjustment. Using these quotes, the prices are typically higher than the original material transfer prices and the prices per CEPS. No actual invoices for tubular purchases were provided by the Operator.

Discussion Question:

1)  If an Operator chooses to use Option 2 (Vendor Quotes), what is to stop the Operator from ordering multiple vendor quotes, purchasing tubulars at the cheapest quoted price and then billing them to the joint account at the highest quoted price?

2)  Should an Operator be required to provide multiple vendor quotes as pricing support?

3)  Can an Operator be required to provide the original purchase invoice for the tubulars in addition to the vendor quotes?

4)  Option 3 (Material Purchases) requires pricing to be based on invoices within the vicinity of the Joint Property and within the previous 12 months. Why do these requirements not apply to Option 2?

5)  MFI-38 – Materials Manual, states “the Operator should purchase material for inventory rather than making a Direct Purchase for the sole purpose of re-pricing the material.” What obligation does the Operator have to prove they are transferring actual operator owned equipment/tubulars and not directly purchasing for each well? And what would be sufficient evidence?

Case Study 2

Producing Overhead Application

Discussion Questions:

1)  If an Operator fails to issue JIBs on a monthly basis, are they precluded from charging producing overhead for that particular month? In other words, is producing overhead directly tied to and dependent upon the issuance of a JIB each month?

Case Study 3

Proppant (Sand) Reconciliation

A Non-Operator issues an exception to the Operator for a proppant or sand reconciliation based upon the amount of sand charged to a well and the amount of sand reported to the state as used during fracturing operations. The Operator’s response to the exception states that proppant reconciliations have yet to become common practice among Operators in the industry. Further, the auditor should consider the fact that sand is a consumable material, as such not identified in COPAS MFI-28 as controllable.

Discussion Questions:

1)  Does an exception have to be a common practice in the industry in order to be considered a valid exception by the Operator?

2)  Is the listing of controllable materials in COPAS MFI-28 considered all-inclusive? In other words, does the fact that a material is not listed as controllable in MFI-28 preclude the Operator from tracking and reconciling the expenditures related to that material?

Case Study 4

Rig Cancellation (Follow-Up to Previous Case Study)

ABC Rig Company and Operator XYZ entered into an agreement whereby Operator XYZ will use Rig #101 for a time period of 3 years. After the completion of terms of the contract (3 years), Rig #101 would continue to be used by Operator XYZ on a year to year basis. In order to be released from the agreement, either party would need to submit a letter 30 days in advance to cancel the agreement. If the Operator failed to do so, ABC Rig Company would charge Operator XYZ $10,000 per day, with a max of $300,000 to be charged for the late notice.

In 2016, Non-Operators in Well #1A audited Operator XYZ. One of the charges was for expenses related to the early termination of Rig #101. Those charges were allocated back to the most recent 10 wells that used the rig. The total amount of the expense was $300,000 and was charged in 2015. The auditors took exception to the charge stating that the Operator was acting in its role and made the decision as the Company as opposed to its capacity as an Operator, as explained in MFI-56, Section XXI.

The Operator denied the claim and stated that it was reacting to market conditions and was acting as any prudent Operator would.

Discussion Questions:

1)  What defines a prudent Operator?

2)  Do the Non-Operators have a valid claim?

Case Study 5

Wellbore Mitigation

Discussion Questions:

1)  Operator ABC has 40% WI in well 1, and 30% WI in well 2. Operator ABC is planning to frac well 1. Nearby, well 2 is isolated to protect it from the frac operations. Which well should pay for the isolation/de-isolation costs? If well 1, would you capitalize these costs?

2)  Now assume Operator ABC has 40% WI in well 1, and no interest in well 2 Operated by DEF. Operator DEF protects his well after ABC notifies other operators in the area of the impending frac operation. Should DEF bill ABC for the costs to protect well 2 or are they DEF’s to bear? If billed and ABC refuses to pay, would DEF expense these costs to well 2?

3)  Now assume 6 other wells are impacted by the impending frac operation ABC is performing on well 1. ABC has WI in 4 of the wells and no WI in 2. Which well pays for isolation/de-isolation costs of the 6 wells in question?

4)  What if well 2 was deeply sanded in and required a workover to bring it back on line. It was on line prior to the frac job, and operations determine the cause of the needed workover was the frac job. Should well 1 be charged for the workover on well 2?

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