Cowboy COPAS: A Primer for Attorneys
27th Annual
Ernest E. Smith Institute
Houston, Texas
March 30, 2001
By Jolisa Melton
Thompson & Knight LLP
1700 Pacific Avenue
Suite 3300
Dallas, Texas 75201
214/969-1675
214/969-1751 (Fax)
meltonj@tklaw.com
TABLE OF CONTENTS
I.
COPAS
A. Formation
B. Organizational Structure
II. COPAS Documents
A. Accounting Procedure
B. Bulletins
C. Interpretations/Education Documents
III. COPAS and Industry Custom and Practice
IV. Accounting Procedure Areas
A. No Gain or Loss Principle
B. Direct and Indirect Charges
1. Labor
2. Facilities
3. Mega Fixed rate
4. Overhead
V. Operator Changes to the Accounting Procedure
VI. 1995 COPAS Accounting Procedure Improvements
VII. Payments, Audits and Exceptions
VIII. Areas for Improvement
A. No Gain or Loss Principle
B. Conflict between the Joint Operating Agreement and the
COPAS Accounting Procedure
C. Auditing Standards
D. Overhead
E. COPAS Bulletins
IX. Conclusion
Jolisa Melton
Cost allocation among interest owners is inherently a litigious issue, especially
when oil and gas questions are concerned. Naturally, an individual owner, who is not
operating the well, wishes to maximize the return on their investment. This can be
accomplished by minimizing the costs that the owner must bear in developing and
producing the property.
When multiple owners or co-tenants of a potentially producing property join
together, they typically enter into a Joint Operating Agreement. This agreement specifies
who will be the operator of the property. The operator’s goals sometimes conflict with
the non-operating owners. The operator also wants to maximize the return on its
investment. In so doing, the operator will want to be sure that it has passed on a
proportionate share of all costs incurred in the development and production of the
property to non-operators. The operator will have to “eat” all costs not passed on to
others. This becomes a downward spiral for the operator if these costs also exceed the
operator's share of production revenue, resulting in the operator incurring a loss solely
because each owner is not paying their share of the costs.
The possibility for conflict between the parties is clear to see. With each party
fiercely protecting their investment, such conflicts can quickly escalate into litigation.
There is a greater likelihood for dispute when oil and gas prices are depressed because
owners may not be struggling to maximize their return on the investment, but rather
fighting to minimize their losses. These conflicts often involve accounting disputes that
arise under The Council of Petroleum Accountants Societies’ (COPAS) accounting
procedure. This procedure is included in the form of an incorporated exhibit to the Joint
Operating Agreement. It provides what costs are allowable, and how these costs will be
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allocated. COPAS and the COPAS accounting procedure have a rich history of evolution
and litigation.
I.
COPAS
A. Formation
Standardization was the driving force behind the formation of The Council of
Petroleum Accountants Societies, Inc. (COPAS). COPAS was formed in 1961 and
initially named The Council of Petroleum Accountants Societies of North America. The
phrase of “of North America” was removed in 1980.1 Initially, there were twelve local
societies comprising COPAS.2 Now, this number has grown to twenty-three.3 In 1979, a
National office was established, and in 1985, a Board of Directors was elected.4
The National Council was formed to avoid duplication and inconsistencies that
may result from having multiple individual societies trying to solve common problems in
the oil and gas industry.5 Another reason for its formation was to consolidate the
authority of the individual societies into a stronger voice of understanding in petroleum
1
COPAS History, (visited March 12, 1999) <http://www.copas.org/toolbox%20items/newpage24.html>.
2
The initial twelve societies were Denver, Colorado; Dallas, Fort Worth, and Houston, Texas; Wichita,
Kansas; Los Angeles, California; Midland, Texas; New Orleans, Louisiana; Oklahoma City, and Tulsa,
Oklahoma; San Antonio, Texas; and Canada. COPAS History, (visited March 12, 1999)
<http://www.copas.org/toolbox%20items/newpage24.html>. San Francisco joined in 1976. Id.
The additional societies making up today’s COPAS organization are Anchorage, Alaska; Lafayette,
Louisiana; Corpus Christi, Texas; Michigan; Mississippi; Artesia and Farmington, New Mexico; Utah;
Bakersfield, California; and Wichita Falls, Texas. COPAS Membership (visited March 12, 1999)
<http://www.copas.org/newpage7.html>.
3
4
Id.
5
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-4.
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accounting.6 The formation resulted not only in a stronger and more thorough
understanding, but also in a common source of industry custom and practice.
The goal of COPAS is to “enhance competition by suggesting model forms,
interpretive bulletins, and guidelines for the most practical methods of accounting,
auditing, and record keeping in the oil and gas industry.” Anti-Trust, (visited March 12,
1999) <http://www.copas.org/toolbox%20items/anti-tru.hmtl>. This is accomplished through the
following objectives, as detailed in Article I of the Bylaws of The Council of Petroleum
Accountants Societies:
“…
(B) Study and analyze accounting and other problem areas of the petroleum
industry
(C) Formulate and disseminate petroleum industry accounting practices,
procedures and pronouncements through the use of bulletins and interpretive
statements …
(F) Cooperate in the education of the public concerning the petroleum industry
(G) Assist educational institutions through contributions of papers, books,
speakers and scholarships…” Bylaws, (visited March 12, 1999)
<http://www.copas.org/toolbox%20items/newpage27.hmtl >.
B. COPAS Organizational Structure
COPAS has several different levels of membership for the individual societies.
Participating societies are those that adopt a set of bylaws, conduct at least 3 meetings per
year, have been in existence for at least one year, consist of at least thirty-five members
representing five or more companies, and have two accounting study committees.7 These
6
Id.
7
Bylaws of The Council of Petroleum Accountants Societies, Art. II, (visited March 12, 1999)
<http://www.copas.org/toolbox%20items/newpage27.hmtl>.
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societies are admitted into COPAS membership upon two-thirds approval of the current
Participating societies.8 Participating societies can vote and have full COPAS
participation rights.9
Associate societies have eligibility requirements similar to Participating societies
except they only have fifteen or more members representing 3 or more companies, and do
not have accounting study committees.10 Admission into COPAS is the same as for
Participating societies.11 However, Associate societies may not vote.12 Therefore, an
Associate society only has limited participation rights.
International societies are composed solely of members who reside outside of the
United States.13 Membership requirements for an International society are similar to the
Associate societies’ requirements except that an International society need not conduct at
least 3 meetings per year, and all members must not be a resident of the United States.14
Admission into membership is also the same.15 International societies have limited
participation rights and are not eligible to vote.16
8
Id.
9
Id.
10
Id.
11
Id.
12
Id.
13
Id.
14
Id.
15
Id.
16
Id.
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The last type of COPAS membership is the Individual membership. Individual
membership is available for limited members or academic members. A limited member
is someone who is involved in the petroleum industry but does not have a Participating
society in his area.17 “Involved in the petroleum industry” means that the individual must
be “actively engaged” in accounting, public accounting, or education – directly related to
the petroleum industry.18 Academic membership is open to accounting students who
want to learn more about the COPAS organization.19 The Executive Director of COPAS
admits Individual members into COPAS; a vote by the Participating societies is not
required.20 Individual members receive only limited participation rights and are not
eligible to vote.21
An individual society may be suspended, upon two-thirds vote by the
Participating societies, for any of the following reasons: failure to pay its assessed portion
of COPAS operating costs, failure to participate in national COPAS activities, becoming
an inactive society, or failure to meet membership requirements.22 A suspended society
has participation rights in COPAS functions but cannot vote.23
17
Id.
18
Id.
19
Id.
20
Id.
21
Id.
22
Id.
23
Id.
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II.
COPAS Documents
A. Accounting Procedure
A Joint Operating Agreement is the most common contract used when multiple
owners want to produce oil or gas, whether as cooperating owners of separate properties
or as co-tenants.24 The Joint Operating Agreement designates the operator of the
property, and also provides that the operator will bear the exploration and production
costs and then bill the other non-operators.25 The methods for allocating costs incurred
by the operator, defining which costs are allowable charges, and the procedures for
billing the other parties are set out in an accounting procedure. This procedure is often
attached to the Joint Operating Agreement as an exhibit.
COPAS was organized to standardize the accounting procedure. Prior to the
formation of COPAS, each geographic area had their own accounting procedure.26 The
Petroleum Accountants Society of Oklahoma – Tulsa developed an accounting procedure
that was widely used in the mid-continent and gulf coast region, and also served as the
basis for the first COPAS accounting procedure.27 “COPAS was started in 1962 when
the need was recognized for an accounting exhibit to accompany the AAPL Operating
24
Gary W. Davis ET AL., 5 BUSINESS AND COMMERCIAL LITIGATION IN FEDERAL COURTS §79.4 (West
Group 1998)
25
Id.
26
The West Coast used the accounting procedure developed by the Petroleum Accountants Society of Los
Angeles. Canada used the accounting procedure developed by the Petroleum Accountants Society of
Canada. The mid-continent and gulf-coast region used the accounting procedure developed by the
Petroleum Accountants Society of Oklahoma-Tulsa. This latter form was modified by the Petroleum
Accountants Society of Texas, for use in Texas. John E. Jolly, The COPAS Accounting Procedures
Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1, 21-10.
27
Id.
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Agreement to be used in joint oil and gas operations." What is COPAS?, (visited Feb. 24,
1999) <http:///www.copas.org/copas.html>. Accounting procedures were issued by COPAS in
1963 (titled the 1962 Accounting Procedure), 1968, 1975 (titled the 1974 Accounting
Procedure), 1984, 1995 and 1998.28 Additional accounting procedures were developed
for offshore operations and issued in 1976 and 1986.29 These accounting procedures are
published by Kraftbilt Products (P.O. Box 800, Tulsa, OK 74101), and are also located
with their guidelines, the COPAS bulletins.30 The 1984 accounting procedure is the most
widely used procedure that currently regulates operational accounting today.31 The 1984
procedure was widely accepted by the industry because it was established through a
group effort by all of the societies.32
The 1995 and 1998 accounting procedures have not been well received.
Normally when a new accounting procedure is issued by COPAS, the previous
accounting procedure is no longer published. However the 1995 accounting procedure
was only issued by COPAS, upon narrow approval, as an alternative accounting
28
COPAS History, (visited March 12, 1999) <http://www.copas.org/toolbox%20items/newpage24.html>,
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 102 (unpublished manuscript on file
with Jolisa Melton), and Al E. McClellan, Joint Operating Agreements Part Two: Accounting Procedures
and Audits (unpublished manuscript on file with Jolisa Melton).
29
COPAS History, (visited March 12, 1999) <http://www.copas.org/toolbox%20items/newpage24.html>.
30
COPAS 1962 is located in Bulletin No. 5. COPAS 1968 is located in Bulletin No. 8. COPAS 1984 is
located in Bulletin No. 22. John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY
MTN. MIN. LAW INST. 21-1, 21-12. In addition COPAS 1995 is located in Bulletin No. 33.
31
John Burritt McArthur, A Twelve-Step Program for COPAS to Strengthen Oil and Gas Accounting
Protections, 49 SMU L. REV. 1447, 1449 (1996).
32
Id. at 1454.
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procedure.33 This accounting procedure contained provisions to accommodate the energy
task force which was mainly comprised of majors and large independents.34 A major
concern on this new accounting procedure was the ability of the operator, or its affiliate,
to charge commercial rates for services and materials and hence make a profit35  a
radical change from the No Gain or Loss Principle, discussed below. In addition, a 1998
accounting procedure was issued for use by project teams between large and major
companies and as a result of this special use, it is also an alternative accounting
procedure.36 Because of the limited applicability of the 1998 accounting procedure, the
1984 accounting procedure remains the most widely used accounting procedure today.
A standardized accounting procedure evens out the power between the parties to a
contract. This can be seen with the Association of International Petroleum Negotiators’
Model Form Joint Operating Agreement. The model form increased the non-operators
understanding by over 300%.37 An operator’s individual joint operating agreement form
was no longer forced upon the non-operator as the only option available. The nonoperator had a model form available – which provides all of the options that are available
33
Al E. McClellan, Joint Operating Agreements Part Two: Accounting Procedures and Audits
(unpublished manuscript on file with Jolisa Melton.)
34
Id.
35
Id.
36
Id.
37
Host Government Contracts Showcase, Lecture by Frank Alexander, Jr., AIPN April 1999 Conference
Presentation (April 8, 1999).
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to the non-operators.38 This information may not have been known to a non-operator
lacking the financial resources to perform extensive research.39
B. Bulletins
COPAS Bulletins are the highest level of COPAS documents. A majority of the
Participating Societies must approve of the bulletin for it to be issued.40 The process for
developing a bulletin begins with research into the accounting topic by a task force. The
task force recommendations are then forwarded to the committee, which performs a
review and forwards it to the Board of Directors. After review, the Board of Directors
makes a recommendation to the individual Participating societies, who then vote on the
bulletin.41
Because the oil and gas industry assists in the research and development of the
COPAS bulletins, these bulletins reflect, common but not necessarily exclusive, industry
practice and custom.42 Custom is a practice that is so widely used and accepted that it
acquires the force of law.43 The bulletins are intended to serve as an interpretational
guideline for the accounting procedures. However, some courts are using the bulletins as
industry standards – although they are not intended as such.44
38
Id.
39
Id.
40
Telephone interview with Jon Gear, National Director of COPAS (March 4, 1999).
41
Id.
42
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-4.
43
21A Am. Jur.2d Customs and Usages §1 (1998).
44
Telephone interview with Jon Gear, National Director of COPAS (March 4, 1999).
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To date, COPAS has issued 34 bulletins. A listing of these bulletins, including
date and title follows.45
Bulletin
Number
1
2
Date
Title
4/90
9/65
3
1/94
4
5
6
7
8
9
10/91
9/66
4/90
4/93
10/69
4/92
10
11
12
13
14
15
16
17
18
19
20
21
22
23
4/90
5/71
4/00
10/75
11/75
10/77
4/88
4/88
4/00
24
25
26
27
28
29
30
31
4/91
9/87
Classifications for use in summary form billing
Determination of values for well cost adjustments joint
operations
Expenditure audits in the petroleum industry: protocol and
procedures guidelines
Oil and gas accounting procedures
Accounting procedure joint operations (1962 COPAS)
Material classification manual
Gas accounting manual
Accounting procedure joint operations 1969
Accounting for Farmouts/Farmins, net profits interest, carried
interest
Petroleum industry accounting educational training manual
Accounting for unitizations
Field computer and communication systems
Accounting procedure joint operations 1975
Accounting procedure arctic operations 1974
Accounting procedure offshore joint operations
Overhead – joint operations
Oil accounting manual
Marine and aircraft offshore transportation
Merged into Bulletin 18
Shore base facilities and offshore staging areas
Material pricing manual
Accounting procedure joint operations 1984
Guidelines for revenue audits in the petroleum industry:
protocol and procedure guidelines
Producer gas imbalances
Accounting procedure offshore joint operations
Merged into bulletin 3
Guidelines for cash flow budgeting in the petroleum industry
Joint task force guidelines on natural gas administrative issues
Guidelines for contractor audits in the petroleum industry
Guidelines for investigation of suspected irregularities
Guidelines for an internal review of an oil and gas production
45
4/00
3/98
10/85
10/92
4/89
4/90
4/90
4/90
4/90
COPAS, Index (Kraftbilt 1999)
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32
33
34
12/96
12/96
7/98
and exploration division
Gas processing systems material classification manual
COPAS 1995 accounting procedure interpretation
COPAS Project team accounting procedure interpretation
C. Interpretations, Education Documents
An interpretation, or education document, is similar to a COPAS bulletin;
however, it does not provide a single guideline concerning the COPAS accounting
procedure. An interpretation is usually developed when a bulletin fails to receive a
majority vote by the Participating societies.46 When a majority is not reached, the
COPAS Board of Directors develops an interpretation which provides all of the
alternatives available for that specific accounting issue.47 An interpretation, therefore,
does not reflect industry custom and practice because there is not a majority of petroleum
accountants following one particular approach.
To date, COPAS has issued 31 interpretations. A listing of these interpretations,
including date and title follows.48
46
Id.
47
Id.
48
COPAS, Index (Kraftbilt 1999).
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Interpretation
Number
1
Date
Title
4/80
2
3
4/80
4/80
4
5
4/80
4/80
6
7
8
6/82
4/80
4/80
9
10
11
7/84
5/81
1/94
12
13
10/82
11/90
14
12/84
15
16
17
18
19
20
5/86
10/86
9/87
9/88
9/88
7/89
21
22
23
24
2/90
8/91
5/92
12/96
25
4/96
26
27
28
29
30
1/97
1/97
1/97
7/97
7/97
Pricing tubular foods at Eastern Mill base price v. lowest
prevailing price
Definition of railway receiving point
Selection of mode of hauling – for computing freight – mill
to railway receiving point
Pricing of line pipe movements less than 30,000 pounds
Pricing of casing, tubing and drill pipe used for purpose other
than originally intended
Loading, transportation and unloading costs
Coating and wrapping costs
Repricing of transferred mill rejects and limited service
tubular goods
Transportation costs – zone priced material
Premium priced material
Employee benefits – chargeable to joint operations and
subject to percentage limitation
Employee benefits limitation
Valuation of crude oil volumes in the event of price changes
during the month
Definition of published price – tubular goods material
transfers
Computerized equipment pricing system
Definitions – Operator and related entities
Disposition of surplus joint account material and equipment
Freight rates: change of information source
Discounts
Freight rates: revised method of determining freight rates for
tubular goods
Documentation supporting joint interest expenditures
24 month audit period audit and accounting adjustments
Material transfer valuation
Cost of self-insurance for workers’ compensation and
employers’ liability insurance
Market adjusted – loading, transportation and unloading
costs
Transfer pricing for used materials
Charging of training costs to the joint accounts
Documentation requirements for electronic invoices
Audit rights for non participating, non consenting parties
Chargeability of incentive compensation programs
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31
III.
2/98
Documentation on requirements for procurement card
(P-Card) and convenience check charges
COPAS and Industry Custom and Practice
Industry involvement in COPAS’s understanding of oil and gas accounting issues
is reflected in all of the documents issued by COPAS. Such industry involvement, and
widespread use of COPAS procedures and related bulletins, has lead to COPAS bulletins
being regarded on the level of industry custom and practice. However, there are other
reasons that COPAS’s knowledge base reflects industry custom and practice.
One function that also enables COPAS to maintain such an extensive knowledge
of oil and gas accounting is participation in the establishment of the National Oil and Gas
Accounting School. COPAS assisted the Professional Development Institute (PDI) and
the American Institute of Certified Public Accountants (AICPA) in the establishment of
the school in 1979.49
Between 1994 and 1995 COPAS developed the Accredited Petroleum
Accountant Program.50 During that time, COPAS, with the assistance of industry
experts, established a comprehensive certification standard of what a petroleum
accountant should know.51 This certification process tests an accountant in the following
areas: Operations, Law, Financial Reporting, Revenue, Joint Interest, Tax, Managerial,
49
COPAS History, (visited March 12, 1999) <http://www.copas.org/toolbox%20items/newpage24.html>.
50
APA, (visited March 12, 1999) <http://www.copas.org/apa/newpage4.hmtl>.
51
Id.
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and Auditing accounting.52 Accountants wishing to sit for the exam must have 5 years
experience in oil and gas accounting, a four-year college degree with 12 hours of
accounting, and a CPA license.53 The certification program is intended to recognize the
special skills of petroleum accountants and to aid employers with employee selection.54
In addition, the COPAS bylaws establish standing committees to research and
report on industry custom and practice.55 These committees cover the areas of audit,
education, financial reporting, international, joint interest, refining and marketing,
revenue, small oil and gas companies, and tax.56
COPAS’ wealth of information places it in the unique position to portray industry
accounting custom and practice. COPAS constantly receives information from members
working in the industry and is always striving to keep this knowledge current. In
addition, the COPAS organization is continually researching various areas of oil and gas
accounting to not only understand and establish custom and practice but to assist in
solving accounting problems that arise. The best recommendation for COPAS comes
directly from the industry when it looks to COPAS bulletins as a source of industry
practice. In fact, the name COPAS sells. A previous President of COPAS and 32 year
veteran of the industry recognized that although the bulletins and interpretations lack
“legal standing” since they are not incorporated into the Joint Operating Agreement or
52
Id.
53
Id.
54
Id.
55
Bylaws of The Council of Petroleum Accountants Societies, Art. IV, (visited March 12, 1999)
<http://www.copas.org/toolbox%20items/newpage27.hmtl>.
56
What is COPAS?, (visited Feb. 24, 1999) <http://www.copas.org/copas.html>.
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COPAS accounting procedure, “most of those in the oil and gas industry believe that
anything COPAS publishes, without consideration of form or the approval process within
COPAS, establishes acceptable industry accounting practices and procedures.”57
Status as industry custom and practice is important because a court will look to
industry custom and practice to fill in the blanks of an ambiguous contract or one that is
silent on certain issues. See Luling Oil and Gas Co. v. Humble Oil and Refining Co., 191
S.W.2d 716, 724 (Tex. 1945) (holding that industry custom and practice can be used to
supplement obscure or silent portions of a contract). However, there are limitations
imposed by some courts on the extent industry custom and practice can be used. For
example, industry custom and practice cannot be used to add new terms to the contract.
See Smith v. Abel, 316 P.2d 793, 803 (Or. 1957); Barnard & Bunker v. Houser, 137 P.
227, 228 (Or. 1913).
The requirements for industry custom to be used as part of the contract were
explained in Montgomery v. United States National Bank of Portland, 349 P.2d 464 (Or.
1960). The first requirement is that an industry custom exist.58 The second is that the
party actually knows of the industry custom, either actually or constructively. 59
Constructive knowledge arises when the industry custom is of a general nature.60
Knowledge is implied because persons engaged in a particular trade or business are
57
Al E. McClellan, Joint Operating Agreements Part Two: Accounting Procedures and Audits
(unpublished manuscript on file with Jolisa Melton).
58
Id. at 565.
59
Id.
60
Simms v. Sullivan, 198 P. 240 (Or. 1921).
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imposed with the obligation to learn about the relevant industry customs and practices.61
The third is that the custom does not contradict the contract.62 The burden of proof for
applying industry custom and practice is clear and convincing evidence.63
In fact, one court has followed COPAS bulletins because they reflected industry
custom and practice. In Atlantic Richfield Co. v. Holbein, 672 S.W.2d 507, 507 (Tex.
App. – Dallas 1984), the parties argued over the proper calculation of royalty. The court
retrieved the correct calculation method from COPAS because it represented industrywide practice.64 ARCO was the party asking the court to apply the COPAS procedure.65
Therefore the court must have held that Holbein, a mineral trust, was a sophisticated
party because courts will not bind parties to industry custom and practice if the party is
not familiar with it, such as lessors.66 However, one cannot rely upon a court looking to
COPAS guidelines in reaching a decision because sometimes a court will not look
outside of the actual accounting procedure, and at other times, the court feels no need to
defer to COPAS.67
Another interesting question that comes to mind is whether unsophisticated
parties, such as lessors, can use industry custom and practice against the operator to their
61
Hazard’s Adm’r v. New England Marine Ins. Co., 33 U.S. 557 (1834).
62
349 P.2d at 565
63
Wendling v. Puls, 610 P.2d 580, 585 (Kan. 1980).
64
Id. at 515-516.
65
Id.
66
Garman v. Conoco, Inc., 866 P.2d 652, 660 (Colo. 1994).
67
Willard Pease Oil and Gas Co. v. Pioneer Oil and Gas Co., 899 P.2d 766 (Utah 1995), Torch Operating
Co. v. Louis Dreyfus Reserves Corp., 1994 WL 117786 (E.D.La. 1994).
16
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benefit. If they are not bound to industry custom and practice, can they enforce it? The
courts have yet to decide this issue.
It is interesting to note how some practitioners ask the courts to apply COPAS
bulletins. One Oklahoma practitioner has requested COPAS Bulletin #2, Determination
of values for well cost adjustments joint operations, for the allocation of costs under a
forced pooling order. The Oklahoma Corporation Commission granted the request and
allowed the COPAS Bulletin to control the relationship between the parties to the forced
pooling order relating to certain costs.68 The acceptance of COPAS as industry custom
and practice is far reaching.
IV.
Accounting Procedure Areas
A. No Gain or Loss Principle
The Former Executive Director of COPAS, John Jolly, best describes the
principle that the operator should neither profit nor suffer a loss from operating.
“It has always been the intent of the operating agreement that the operator
should not make a profit or conversely suffer a loss just because he is the
operator. … When accountants first began developing printed accounting
procedures to be attached as exhibits to the operating agreement, as far
back as the early 1930’s, this concept was more pronounced. … When
COPAS began publishing their recommended accounting exhibits, this
concept remained unchanged even though the lengthy, descriptive, allinclusive detail has increased in recent years.” John E. Jolly, The COPAS
Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-26-27.
68
Order No. 436269, Oklahoma Corporation Commission (1999).
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One problem is that this principle is no longer expressly, nor clearly stated in the
COPAS accounting procedure. Why is such a principle so important? Preventing an
operator from making a profit merely because it is an operator makes its income
dependent upon the success of the joint operation. Therefore, the operator’s incentive is
the same as the other owners. This protects other owners, whose interests are similar to
investors, by enticing the operator to maximize the profit from the joint property – for the
benefit of all.69
A strong argument could be made for the operator deserving a profit. Operating
the joint property involves risks: the risk of nonpayment by financially troubled owners,
the risk of litigation by disgruntled owners, and the risk of not recovering all costs that
the operator was forced to bear. A typical investment offers a return commensurate with
the risk involved. Following this typical investment principle, shouldn’t the operator
receive some profit in return for the risk borne? Obviously, the industry has not felt the
same way. One industry contact argued that the operator actually bears minimal risk
because the Joint Operating Agreement dictates that all owners in the property will share
any costs from the risks described above. Therefore, the operator need not be
compensated for such risks. However in an unsuccessful development program and hard
times, the operator cannot get “blood from a stone.”
COPAS attempts to achieve an actual cost billing (no gain nor loss concept)
through the definition of allowable costs, and the allocation of those costs. Although this
no gain or loss principle is threaded throughout the principles in the COPAS accounting
69
John Burritt McArthur, A Twelve-Step Program for COPAS to Strengthen Oil and Gas Accounting
Protections, 49 SMU L. REV. 1447, 1459 (1996).
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procedure and guidelines in the COPAS bulletins, it is never stated directly. The problem
is multiplied because the COPAS publications provide rules and guidelines for a variety
of costs. Some of these costs are inherently more prone to litigation than others because
detection of errors or fraud is difficult. Others are more prone to litigation because
differences of opinion arise between the parties to the Joint Operating Agreement.
Misunderstandings may arise because of connotations or because of contract ambiguity.
Some of the more troublesome cost items are discussed below. Disputes over costs are
typically centered around whether they may be charged directly to the joint account and
borne by all owners, or whether they should be absorbed into the overhead rate that the
operator charges to cover indirect charges.
B. Direct and Indirect Charges
The differences between direct charges and indirect charges are easy to explain.
Direct charges are costs incurred by the operator which will be shared by all of the joint
property owners in proportion to their ownership percentages. This is accomplished by
establishing a joint account, into which all direct charges are placed. The account
balance is then billed out to the owners, in proportion to their ownership, at the end of
every month.
Indirect charges are not billed to all of the joint property owners. Instead, when
the Joint Operating Agreement is entered into, the parties negotiate an overhead rate,
This overhead rate is a fixed or variable monthly fee paid to the operator by the other
owners. Overhead is intended to compensate the operator for all other costs (indirect
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costs). The operator incurs and pays for all indirect costs, but these costs are not charged
to the joint account.
1. Labor
The history behind labor charges has a divided past. This is a common area of
dispute because it represents a large portion of the total exploration and development
costs. The classification of labor as a direct or indirect charge varies by geographic
region. Traditionally, in the mid-continent region, labor was considered a direct charge
only if the employee was physically located on the joint property while performing a
job.70 This is commonly referred to as “on the property.” The reason behind such a
stringent requirement was ease of audit. It provides a bright line test requiring only
verification of the physical location of an employee.
In contrast, the west coast region employed the “in the operation of” method. In
this function oriented approach, direct charges of labor are allowed if the employee’s task
was in the operation of the joint property.71 With this method, the physical location of
the employee is immaterial. The function of the employee is what matters. The only
problem with this method is the increased complexity of auditing labor charges. Every
labor charge must be traced back to what the employee was working on, versus where the
employee was working. The increased audit difficulty and chance for manipulation is
obvious.
70
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-20.
71
Id.
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Since the 1962 COPAS accounting procedure was based on Oklahoma’s regional
accounting procedure (i.e. used in the mid-continent region), it is not surprising that the
initial procedure provided for an “on the property” labor allocation. COPAS changed the
form in 1968 to include the “in the operation of” labor allocation as an option.72 This was
an effort to entice the west coast region to increase their use of the COPAS accounting
procedure.73 COPAS reversed itself again in the 1974 accounting procedure by removing
the “in the operation of” option out of the 1974 accounting procedure.74 COPAS must
have felt that the increased risk of manipulation and increased complexity of auditing was
not warranted as a trade off for increased use of the standard accounting procedure.
Then, in 1984, COPAS once again added “in the operation of” as an option.75
The driving force behind the change in the procedure this time was fairness to smaller
operators.76 Large operators have extensive in-house staffs focusing on individual
operations.77 This makes it easy to move the staffs to the location and thus be able to
charge their labor costs directly. However, smaller operators must outsource some of
their labor needs.78 These employees may not be dedicated solely to an individual
property, even though a portion of their activity is directly related to the property in
72
Id.
73
Id.
74
Id.
75
Id.
76
Id.
77
Id.
78
Id.
21
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question. Under the “on the property” approach to labor, because they are not physically
located on the property the labor charge is not allowed as a direct cost. The 1984
accounting procedure provides some flexibility by allowing the parties to the contract to
select either the “on the property” or the “in the operation of” clause.79
The 1995 accounting procedure introduces a creative solution to this dilemma.
Following suit with the flip-flopping between the two options, the 1995 procedure
switched back to a location determinative method. 80 However, it also allows for the
parties to the Joint Operating Agreement to agree that designated off-site facilities are to
be considered directly chargeable.81 Under such an agreement, a smaller operator could
directly charge for labor located at an agreed offsite facility. This is better than the “in
the operation of” option because the parties agree to what is chargeable before the
charges are incurred, and the bright line test for auditing is preserved.
2. Facilities
Historically, the COPAS accounting procedure has offered many choices for
charging facilities. The general concept was that the operator should charge an amount
that reflects the commercial fair market rental value.82 The 1995 accounting procedure
changed the facility cost allocation. First, facilities are divided into two types:
79
Id.
80
Id.
81
Id.
82
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-26.
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production facilities, and other facilities.83 Production facilities continue to follow the
previous accounting procedures – charging a commercial fair market rental value. 84 The
difference arises in the charging of the other facilities.85 They are not chargeable unless
agreed upon by the parties to the contract.86 If no agreement is reached, the default rule
is that the operator must absorb these costs into overhead. If the parties agree to directly
charge for a facility, a variety of methods are available. The operator may charge a fixed
rate, commercial fair market rental value, or actual costs.87 In addition, if any facilities
are added after the date of the Joint Operating Agreement, the parties must amend the
accounting procedure to include this facility and the way it will be charged.88 If direct
charges are not agreed upon and as a result the costs of other facilities are absorbed into
overhead, the operator may be placed in a bad position because its initial calculation of
the overhead rate may not have included the costs of an additional facility.
If an operator fears that unforeseeable additional facilities will be required, it may
also fear having to absorb the cost of these facilities into overhead. This is a risk. If this
forces the operator to bear a loss, it violates the principle that the operator should not
83
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 106 (unpublished manuscript on
file with Jolisa Melton).
84
Id.
85
Other facilities include, but are not limited to, roads, canals, clocks, laboratories, transportation, living
quarters, SCADA systems, shore bases, heliports, hangers, field offices, training, spill containment, health,
research, environmental, production platforms, telecommunication, and computer facilities per the 1995
Accounting Procedure Interpretation. See COPAS, Bulletin 33  COPAS 1995 Accounting Procedure
Interpretation R (Kraftbilt 1996).
86
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 106 (unpublished manuscript on
file with Jolisa Melton).
87
Id.
88
Id.
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profit nor bear a loss as a result of operating the property. In response, an operator may
wish to pad its overhead rate to protect itself from being saddled with these additional
charges. The level of padding would be proportionate to the operator’s risk aversion.
Yet, this additional padding could result in a windfall to the operator. Any profit would
also violate the principle that the operator should not profit nor bear a loss as a result of
operating the property.
Additionally, if an item does not clearly fall into the classification of another
facility, a creative operator can directly charge the expense to the joint account by
classifying as an other expense. Such other expenses could be directly charged under a
classification of materials or equipment if sufficiently ambiguous.
3. Mega Fixed Rate
The 1995 accounting procedure allows for a mega fixed rate as a variation. The mega
fixed rate offers the huge advantage of cost control. With the mega fixed rate, the
operator charges one rate to cover most direct and all indirect charges.89 The mega fixed
rate is just as it sounds – one rate is charged for all costs, with a few exceptions. Direct
charges that are not absorbed into the mega fixed rate include: royalties, production or
severance taxes, ad valorem taxes, controllable material, downhole well work, and
drilling wells and projects.90 Royalties and production or severance taxes are excluded
because these costs are based upon production rates, which vary; thus, estimating these
89
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 107 (unpublished manuscript on
file with Jolisa Melton).
90
Susan R. Richardson, Joint Interest Audits in the Oil and Gas Industry: Provisions, Protocol,
Procedures and Precedent, December 17, 1996, Houston Bar Association, Oil, Gas & Mineral Law
Section, Luncheon Program.
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costs would be impossible.91 Ad valorem taxes are excluded because investment and tax
rate changes vary the amount that are chargeable to the individual parties and thus are not
amenable to fixed rate estimation.92 Controllable materials are excluded because all
owners in the well will need to know their basis and maintain asset records for
subsequent dispositions.93 Down hole well work and drilling wells are excluded because
they are considered non-routine expenses.94
The non-operator can easily budget their total investment if virtually all of the
costs are fixed, such as with the mega fixed rate. One problem with a fixed rate is that
the operator must have the ability to accurately estimate costs. Otherwise, they will bear
a loss or receive a gain from operating the joint property. This would violate the actual
cost recovery principle of the Joint Operating Agreement and accounting procedure.
Also, in the case of the loss, the operator may experience financial difficulty.
4. Overhead
Overhead is a constant source of dispute in the billing area. The source of the
conflict is readily apparent. Operator’s want to maximize the costs directly charged to
the joint account in order to minimize the indirect charges that must be absorbed into
overhead. On the other side of the coin, the other owners want to maximize the costs
classified as indirect charges and absorbed into overhead. This not only increases the
return on their investment but also provides them with the feeling that their payments
91
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 103 (unpublished manuscript on
file with Jolisa Melton).
92
Id.
93
Id.
25
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towards overhead are being put to good use. The Former Executive Director of COPAS
aptly described overhead as “probably the most misunderstood and mishandled charge in
the joint operation…” John E. Jolly, The COPAS Accounting Procedures Demystified, 34
ROCKY MTN. MIN. LAW INST. 21-1, 21-29. As a result of the inherent difficulties with
overhead, the methods of calculating overhead have changed over time.
The 1962 COPAS accounting procedure offered two methods of overhead
calculation – fixed rate or actual costs plus a mark-up.95 The mark-up is intended to
compensate the operator for hard to calculate expenses, such as administrative overhead.
The 1968 accounting procedure changed the method of calculating overhead to a
percentage of specific direct costs listed in specific sections of the accounting
procedure.96 This method, commonly referred to as percentage basis recovery, was
initially used by west coast operators, and subsequently picked up by the regions of
Alaska and Canada.97 A percentage overhead calculation method allows for automatic
rate adjustment. The rates will adjust to follow two economic assumptions: (1) inflation,
and (2) direct costs. Actual costs increase with inflation. The percentage method of
overhead calculation accommodates inflation because the overhead rate will also increase
in proportion to cost increases.98 Additionally, overhead is considered a variable cost.
That is, it shifts with the direct costs incurred. A basic assumption causing this shift is
94
Id.
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-30.
95
96
Id.; COPAS, Bulletin 33 – COPAS 1995 accounting procedure interpretation 25 (Kraftbilt 1996)
97
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-34.
98
Id.
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that as more costs are incurred, administrative costs will also increase. Why? Because
more manpower will be used to incur these costs (such as ordering materials, establishing
supplier relations, etc.), to track and pay these costs, to charge these costs to the joint
account, to allocate the joint account to the owners, and to track payment from the
owners. Therefore, indirect costs, represented by overhead, should increase as direct
costs increase. The percentage method for overhead calculation provides for the
automatic adjustment of the overhead rate to mirror changes in direct charges.99
However, this overhead calculation method is not without disadvantages. When
calculating overhead as a percentage of direct charges, an inefficient operator may
receive a windfall.100 The windfall results from direct charges being higher than those of
an efficient, and cost conscious, operator. Secondly, percentage overhead received by the
operator may exceed or be less than the operator’s actual costs, thereby violating the
actual cost recovery principle followed by the Joint Operating Agreement and accounting
procedure. The fixed rate overhead method also has the same disadvantage. The
percentage overhead calculation method also fails to offer an incentive for the operator to
operate at the lowest cost possible. This is in contrast to the fixed rate overhead which
provides an incentive for the operator to operate at a low cost.
The 1974 and 1984 accounting procedures offered the same overhead calculation
method – fixed rate. The fixed rate method is now the most accepted method in the
industry.101 The fixed rate is established during contract negotiations, and the operator
99
Id.
100
Id.
101
Id. at 21-33.
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charges this fixed amount on a monthly basis. The advantages of this method are that it
is easy to audit and allows for some cost control on the part of the non-operators. The
complexity of auditing is greatly reduced because the non-operator need only verify that
the operator charged the agreed upon rate. Any supporting data for charges need not be
verified – only direct charges need to be audited. Cost control is achieved in part because
the overhead charges will not vary. The 1995 accounting procedure changed gears to
allow percentage basis, or a variation of fixed fee.
One concern with a fixed rate is that the indirect charges of the operator will
change over time and the fixed rate provided for in the accounting procedure will not
properly compensate the operator for actual costs. If adjustments were not allowed, then
the fixed rate overhead calculation method would violate the actual cost recovery
principle. “All COPAS accounting procedures have provided that the overhead rates
shall be adjusted annually based on data received from the United States Department of
Labor.” John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN.
MIN. LAW INST. 21-1, 21-35. In addition, the 1995 accounting procedure allows the
operator to unilaterally recalculate the fixed overhead rate every two years.102 However,
the operator is required to either change or substantiate this recalculation if a majority of
non-operators have information contrary to the operator’s unilateral change.103 This
challenge can be made every four years.104 It is important that the accounting procedure
102
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 105 (unpublished manuscript on
file with Jolisa Melton).
103
Id. at 110.
104
COPAS, Bulletin 33 – COPAS 1995 accounting procedure interpretation (Kraftbilt 1996).
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provide for this ability to challenge, otherwise the non-operators may run the risk of
being bound to the unilateral change. Moreover, in Hondo Oil and Gas Co. v. Texas
Crude Operator, Inc., 970 P.2d 1433, 1437-1438 (5th Cir. 1992), the court held that if a
party to the accounting attachment consents to the unilateral change of the other party,
then they are bound to the modification.
V.
Operator Changes to the Accounting Procedure
Parties to the accounting procedure frequently make changes to the form in order
to customize the agreement. An industry contact has provided examples of offshore and
onshore accounting procedures with modifications. In the 1976 offshore accounting
procedure modifications were made to the interest rate and payment grace period. See
Appendix 1 for a copy of this accounting procedure. In the 1986 accounting procedure,
changes were made to accommodate the type of project involved, such as deep-water
prospects. As with the offshore accounting procedure, a modification was made for the
payment grace period, but other modifications were also made. For example, “subsea
production facilities and production facilities” were added to the equipment list to be
provided by the operator. Also, billing procedures and allocations were added for the use
of integrated project teams. See Appendix 2 for a copy of a 1986 accounting procedure
with modifications.
VI.
1995 COPAS Accounting Procedure Improvements
The latest provision of the accounting procedure contains several changes
intended to provide bright line rules to reduce disputes between the parties. Although the
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1995 accounting procedure has failed to receive wide acceptance, these improvements
could be made as revisions by the person negotiating a 1984 accounting procedure.
Training charges are limited to training that the government requires.105 For legal
expenses, title and curative work are now directly chargeable.106 Shut-in wells no longer
qualify for overhead treatment; while source water wells do receive overhead
treatment.107 The exclusion of shut in wells for overhead treatment prevents the charging
of a flat fee for a well that receives little or no work and more closely follows the actual
cost approach. The interest rate charged for late payment by the non-operator and for
over-billing by the operator is now a floating rate tied to treasury bills.108 A floating rate
helps to avoid an outdated accounting procedure and more closely match the operator’s
cost of funds. Previously, this rate had been tied to a bank to be named by the parties. 109
Treasury bills eliminate the need for the parties to agree upon a bank, and provides a
ready source for the interest rate. Also, the 1995 accounting procedure dictates that the
books for an affiliate of the operator, who is performing services or providing materials,
are also open to audit.110
105
E.M. Wilson, COPAS-1995 Accounting Procedure: A New Direction 107 (unpublished manuscript on
file with Jolisa Melton).
106
Id. at 107.
107
Id.
108
Id. at 109.
109
Id.
110
Susan R. Richardson, Joint Interest Audits in the Oil and Gas Industry: Provisions, Protocol,
Procedures and Precedent, December 17, 1996, Houston Bar Association, Oil, Gas & Mineral Law
Section, Luncheon Program.
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VII. Payments, Audits and Exceptions
The accounting procedure provides for quick payment from the non-operators to
the operator. The reason for this is simple. The operator incurs all costs of development
and production, but does not serve as the bank for non-operators. If the operator is
intended to recover only actual costs, then it would be unfair to force the operator to
bankroll the operation. Also, such a financial burden on the operator may be more than
the operator can bear. The accounting procedure clearly states that even disputed charges
must be paid quickly.111 However, with such an absolute payment requirement, the
accounting procedure must also provide a dispute mechanism for charges.112
The COPAS accounting procedures have consistently provided an unambiguous
exception provision. This provision clearly provides that payment of the charges will not
prejudice any rights of the non-operator to dispute the charges.113 The COPAS
accounting procedure grants audit rights to non-operators, including the review of the
operators books and records.114 Most audits are conducted according to the terms of the
accounting procedure, or according to COPAS guidelines.115 However, the accounting
procedure also dictates that all charges to which an exception has not been made within
111
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-17.
112
Id.
113
Id.
114
Susan R. Richardson, Joint Interest Audits in the Oil and Gas Industry: Provisions, Protocol,
Procedures and Precedent, December 17, 1996, Houston Bar Association, Oil, Gas & Mineral Law
Section, Luncheon Program.
115
Id.
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24 months shall be conclusively presumed to be true and correct, and no longer open to
attack.116
This 24-month limitation period has been challenged as unlawfully limiting an
non-operators rights under statutory limitation periods. The argument is that state law
should trump the provision of the contract. However, courts tend to enforce the
accounting provision limitation period.
In Woods Petroleum Corp. v. Hummel, 784 P.2d 242 (Wyo. 1989), the Supreme
Court of Wyoming upheld the 24-month limitation period in the accounting procedure.
In this case, the operator filed suit to recover under-billed expenses incurred in drilling,
completing and operating an oil well.117 The court held that the operator is also bound by
the 24-month limitation period, just as the non-operators are bound, and therefore could
not challenge the accuracy of the billing after the limitation period.118 See also Anderson
v. Vinson Exploration, Inc., 832 S.W.2d 657 (Tex. App.-El Paso 1992).
One court has rejected the argument that the accounting procedure limitation
clause is unconscionable. The court in In re Antweil, 115 B.R. 299, 304 (Bankr. D.N.M.
1990), reasoned that the Joint Operating Agreement and the attached accounting
procedure were standard agreements in the oil and gas business. Both parties to the
contract were familiar with the contracts, and had used the same model form in previous
transactions.119 This, coupled with the fact that the parties to the agreement are industry
116
Id.
117
784 P.2d at 242.
118
Id. at 243.
119
115 B.R. at 304.
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participants, means that neither party was forced to use of the contract.120 Thus, the
limitation period of the accounting procedure does not violate public policy nor is it
grossly unfair and is not considered unconscionable.121 The court noted that it hated the
result in this case since the non-operator failed to receive credit for its contributions of
materials but a contract is a contract.
Other courts have upheld the limitation period by declaring that it does not
foreclose a party’s claim. The limitation period is avoidable with a showing a fraud, badfaith breach of contract, or misrepresentation. In Exxon Corp. v. Crosby-Mississippi
Resources, Ltd., 40 F.3d 1474 (5th Cir. 1995), the United States Court of Appeals for the
5th Circuit held that the accounting procedure limitation created a presumption, but did
not bar suit.122 The court reasoned that whether or not this clause restricted the statute of
limitations was not even an issue because although it was a conclusive presumption it
was rebuttable with evidence of fraud or bad-faith breach of contract.123 See also
Calpetco 1981 v. Marshall Exploration, Inc., 989 F.2d 1408 (5th Cir. 1993) (creating
exception to COPAS accounting attachment’s 24-month limitation period for fraudulent
concealment, waiver, or estoppel). In addition to the burden of proof that the nonoperator bears to show one of the exceptions, courts have added an additional
requirement of reliance upon the fraudulent misrepresentation. This additional
120
Id.
121
Id.
122
40 F.3d at 1485.
123
Id. at 1486.
33
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requirement was explained by the court in Dime Box Petroleum Corp. v. Louisiana Land
and Exploration Co., 717 F. Supp. 717, 723 (D.Co. 1989):
“In order to prevail on its claim of deceit based on fraud by
misrepresentation or concealment, plaintiff must prove, inter alia, that
plaintiff relied on the material false representation or took such action
relying on the assumption that the concealed fact did not exist or was
different from what it actually was and the plaintiff’s reliance was
justified.”
This case involved a non-operator who challenged the direct charges for supplies at
current fair market value. The non-operator claimed that the operator represented it had
inventory of the charged supplies, and therefore, should only have billed the supplies at
cost.124 The court rejected this argument finding that the non-operator was aware of the
operator’s lack of inventory. Thus, the non-operator could not rely upon the operator’s
misrepresentation.125 The additional requirement of proving reliance places a greater
burden on the non-operator to meet an exception to the limitation period.
In addition to upholding the 24-month limitation period, the 10th Circuit Court of
Appeals has held that the audit process does not toll the statute of limitation. In Meridian
Oil Production v. El Paso Natural Gas Company, 1992 U.S. App. LEXIS 28932 (10th
Cir. 1992) (unpublished opinion), Meridian filed suit against the operator for disputed
charges alleging charges for unused material and overcharging for materials.126 Meridian
had performed the audit provided by the COPAS accounting procedure and submitted an
exception. However, due to extended negotiations, the suit was not filed for over 6 years
124
717 F. Supp at 722-723.
125
Id. at 723.
126
Id. at 4.
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after the completion of the audit.127 The court affirmed the district court’s decision that
an audit was not a condition precedent to filing suit and therefore did not toll the statute
of limitations on the claim.128
However, some courts have addressed whether the accounting procedures
limitation period is void because it places a restriction on a parties enforcement of their
rights. For example, in Seim v. Krause, 83 N.W. 583, 584 (S.D. 1900), the Supreme
Court of South Dakota applied South Dakota Civil Code which provided that “every
stipulation or condition in a contract by which any party thereto is restricted from
enforcing his rights under the contract by the usual legal proceedings in the ordinary
tribunals … is void.” However, the facts of this case are different from those that
typically arise over the COPAS accounting procedure’s limitation period. In Seim v.
Krause, the contract involved billings by an architect that were considered final
charges.129 The court held that the charges were not final and therefore, the South Dakota
statute did not apply.130 However, this statute would likely be applicable to charges after
the accounting procedure’s limitation period because at that point they are conclusively
presumed correct, i.e. final. In fact, a South Dakota court has applied this statute to the
area of natural resources, specifically, to a royalty issue. In Maguire v. Richmond Hill,
Inc., 835 F. Supp. 1159, 1160 (S.D.W.S.D. 1993), the court invalidated the presumption
127
Id.
128
Id. at 9.
129
Id. at 584-585.
130
Id. at 585.
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of correctness for a royalty payment on the basis that it invalidated the South Dakota
statute.
Oklahoma has a similar statute which provides that:
“Every stipulation or condition in a contract, by which any party thereto is
restricted from enforcing their rights under the contract by the usual legal
proceedings in the ordinary tribunals, or which limits the time within
which he may thus enforce his rights, is void.” 15 OKLA. STAT. ANN.
§216 (West 1998).
Therefore, Oklahoma courts may follow the decisions of the South Dakota courts. Thus
far Oklahoma courts, outside of the oil and gas area, have been split on the application of
this statute to a limitation clause. See Queenan v. Maryland Cas. Co. of Baltimore, 14
F.Supp 989 (N.D.Okla. 1936) (holding that a limitation set forth in a fidelity bond was
void because it violated this statute); U.S. Fire Insurance Co. v. Swyden, 53 P.2d 284
(Okla. 1935) (declaring all limitation clauses void unless the limitation period was
adopted by statute). But see Atchison, T. & S.F. Ry. Co. v. Cooper, 175 P 539 (Okla.
1918) (holding that parties can limit the time for remedy and such a contract clause will
be binding in absence of circumstances excusing non-compliance). In fact, one court has
even taken the application a step further and declared that an arbitration clause violates
the statute and is therefore void. See Cannon v. Lane, 867 P.2d 1235 (Okla. 1993).
Other provisions in the accounting procedures have been upheld. In Oklahoma
Oil & Gas Exploration Drilling Program 1983-A v. W.M.A. Corp., 877 P.2d 605 (Okla.
Ct. App. 1994), the court was faced with an argument on exactly what amounts due to the
operator will bear interest.131 The nonoperator contended that the COPAS accounting
131
Id. at 610.
36
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procedure only provided for interest on unpaid advances and not on unpaid monthly
expenses.132 The court rejected this argument and applied the plain language of the
accounting procedure. The accounting procedure provision providing for interest
described “Advances and Payments by Non-Operators” and the court held that interest is
due on either if not paid.133
As seen above, cases on the COPAS accounting procedures are few and far
between. One author explains:
“Litigation is time-consuming, expensive, and can virtually destroy
the business relationship between the parties. Often, for these
reasons, litigation is not pursued by the non-operators and the
claim or exception in dispute is automatically resolved in favor of
the operator. . . . . More times than not, the issues disputed in
litigation between the parties are settled, often at the eleventh hour
before trial, and the settlement agreement reached is sealed.”134
Another reason is that COPAS through its accounting procedures and related bulletins
and interpretations has really set up an alternative dispute resolution method. For
example, disputes to direct charges are discovered and objected to through the COPAS
audit process. Then the charges are hopefully resolved using the guidelines for charges
set forth in the COPAS bulletins. It is usually only when this entire process proves
unsuccessful that litigation is initiated. If the courts consistently uphold and apply
COPAS bulletins, the parties to COPAS accounting procedures will be more likely to
follow the bulletins as well. As a result, litigation will be further reduced.
132
Id.
133
Id. at 610-611.
134
Al E. McClellan, Joint Operating Agreements Part Two: Accounting Procedures and Audits
(unpublished manuscript on file with Jolisa Melton).
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VIII. Areas for Improvement
No paper would be complete without a section covering areas for improvement.
Several authors have provided numerous ideas for strengthening the COPAS
accounting procedure. These areas for improvement, in addition to other
suggested changes discussed throughout this paper, provide potential points of
negotiation on the COPAS accounting procedure. However, “as a practical matter
it is sometimes difficult to include non-standard provisions in a published
Accounting Procedure.”135
A. No Gain or Loss Principle
One idea was to include the actual cost principle (i.e. that the operator shall
neither suffer a loss or experience a gain from their role as operator) expressly in the
COPAS accounting procedure.136 This would provide clarity as to the intent for this
actual cost basis within the four corners of the document.
B. Conflict Between the Joint Operating Agreement and the COPAS Accounting
Procedure
Another suggestion is for the COPAS accounting procedure to trump the Joint
Operating Agreement.137 The problem with the accounting procedure being only an
exhibit to the Joint Operating Agreement, is that if there is a conflict between the two
135
Susan R. Richardson, Robert C. Bledsoe and David W. Lauritzen, 1995 COPAS Accounting Procedures
or It Is A Very Hard Undertaking To Seek To Please Everybody, August 21-22, 1997, Energy Law Section,
Dallas Bar Association, Review of Oil and Gas Law XII Seminar.
136
John Burritt McArthur, A Twelve-Step Program for COPAS to Strengthen Oil and Gas Accounting
Protections, 49 SMU L. REV. 1447, 1460 (1996).
137
Id. at 1477.
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documents, then the Joint Operating Agreement controls.138 With the accounting
procedure trumping, more authority would be shifted to the provisions of the accounting
attachment. However, the general intent of the Joint Operating Agreement is that all
costs in developing and producing a property should be borne proportionately by each
party thereto. If the provisions of the COPAS accounting procedure resulted in general
disproportionate allocation, the argument could be raised for the intent of the Joint
Operating Agreement to control. However such argument is unlikely as COPAS shares
the same intent.
C. Auditing Standards
Another suggestion for improvement is for the COPAS accounting procedure to
define what auditing standards should apply for any audits performed by the nonoperators.139 This would be beneficial for all parties to the contract by providing
consistency. Operators would be able to tailor their books and records to the type of
auditing guidelines prescribed (such as GAAP- Generally Accepted Auditing Principles)
to make retrieval of information easier and reduce audit disruption. Operators must also
attempt to tailor their books to the controlling Joint Operating Agreement or COPAS
accounting procedure. Since an operator could be subject to several different COPAS
accounting procedure versions, and because most accounting systems are set up to be
uniform, the accounting system typically only complies with a single accounting
138
Id. at 1478.
139
Harris E. Kerr and Susan R. Richardson, Auditing Problems Under the COPAS Accounting Procedure,
November 12, 1992, Petroleum Accountants Society of the Permian Basin Fall 1992 Oil and Gas Seminar,
Midland, Texas; and May 21, 1993, 20th Annual North American Petroleum Accounting Conference,
Dallas, Texas.
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procedure selected by the operator.140 This can lead to incorrect billing and the need to
audit. In addition, the accounting procedure should state whether the non-operators who
did not participate in the audit, but who will receive benefit from the audit exceptions,
should share in the costs of the performing the audit.141
Catching up with the times is another suggested improvement for auditing
guidance by COPAS. “Moving the gas from the wellhead to the burner tip has become
even more complex”142 as additional entities become involved and split up the revenue
pie. An auditing guideline facing these complexities is suggested.
D. Overhead
Given that COPAS does not provide the amount for any fixed rate overhead
charges if that overhead method is selected, this determination is left to the operator. The
operator is actually in the best position to estimate actual costs.143 However, as discussed
above, the incentive to the risk averse and profit minded operator is not to closely tie the
overhead rate with the actual costs. This also leaves the fixed rate charge vulnerable to
contract negotiations between the parties, and much more the result of joint efforts. The
importance of the negotiation for these rates which may bind all parties for several years
140
Al E. McClellan, Joint Operating Agreements Part Two: Accounting Procedures and Audits
(unpublished manuscript on file with Jolisa Melton).
141
Harris E. Kerr and Susan R. Richardson, Auditing Problems Under the COPAS Accounting Procedure,
November 12, 1992, Petroleum Accountants Society of the Permian Basin Fall 1992 Oil and Gas Seminar,
Midland, Texas; and May 21, 1993, 20th Annual North American Petroleum Accounting Conference,
Dallas, Texas.
142
McClellan, Joint Operating Agreements Part Two: Accounting Procedures and Audits (unpublished
manuscript on file with Jolisa Melton).
143
John E. Jolly, The COPAS Accounting Procedures Demystified, 34 ROCKY MTN. MIN. LAW INST. 21-1,
21-33.
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(until production and development cease) has been recognized by the American
Association of Professional Landmen.144 It is important that a landman, as the typical
negotiator of an accounting procedure, “be aware of the longevity of the agreement and
endeavor to cover all present and future contingencies.”145 Several accounting
procedures, including the 1984 accounting procedure, provide a method for adjusting
these fixed overhead rates. On April 1 of each year, the overhead rate is adjusted by the
percentage increase or decrease in the annual average of the weekly earnings of Crude
Petroleum and Gas Production Workers as compared to the previous year.146 In the last
36 years, the rate has decreased only twice  in 1988 and 1993.147 Continuous escalation
of overhead rates can lead to excessively high rates.
Negotiation of overhead rate provisions which provide for periods of readjustment
is the way to avoid excessive rates. Some suggested provisions include: (1) no overhead
rate escalation when well production declines by a specified percentage, (2) negotiating a
new rate when ownership or operation of the well changes, (3) decreasing the rate by the
percentage decrease in the sales prices of production, (4) delete or limit the COPAS
overhead rate adjustment provisions, and/or (5) set lower rates for gas wells than oil wells
since gas wells are cheaper to operate.”148 Other suggestions include: (1) negotiate 50 to
75% of average survey rates since they are typically too high, (2) require the operator to
144
R.G. Woodard, All About COPAS AAPL Update (January, 2000).
145
Id.
146
Id.
147
Id.
148
Id.
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consider current market rates each year based on the well economics, or (3) negotiate a
flat rate to be renegotiated each year.149
E. COPAS Bulletins
Most importantly, referencing COPAS bulletins in the accounting procedure,
brings these guidelines into the four corners of the document.150 Inclusion makes sense
because the parties to the agreement are well aware that COPAS issues bulletins as
guidelines to the accounting procedure, and the parties to the Joint Operating Agreement
intend to follow these guidelines.151 The 1995 accounting procedure is the first to
provide for incorporation of specific Interpretations or Bulletins.152 However, all
Bulletins could be incorporated. Interpretations may create confusion through
incorporation since they often provide multiple alternatives to follow but they could be
used to limit the decision of the court should litigation arise.
Courts have looked favorably upon the validity of the COPAS accounting
attachment and have generally found the terms of the procedure to be clear. In Willard
Pease Oil and Gas Co. v. Pioneer Oil and Gas Co., 899 P.2d 766, 770 (Utah 1995), the
court held that the COPAS accounting procedure was clear and unambiguous and
149
Robin Fort, COPAS: Tips For The Non-Operator In Interpreting, Negotiating and Drafting 41 ROCKY
MTN. MIN. L. INST. 21-1 (1995).
150
Harris E. Kerr and Susan R. Richardson, Auditing Problems Under the COPAS Accounting Procedure,
November 12, 1992, Petroleum Accountants Society of the Permian Basin Fall 1992 Oil and Gas Seminar,
Midland, Texas; and May 21, 1993, 20th Annual North American Petroleum Accounting Conference,
Dallas, Texas.
151
Id. at 2.
152
Susan R. Richardson, Robert C. Bledsoe and David W. Lauritzen, 1995 COPAS Accounting Procedure
or It Is A Very Hard Undertaking To Seek To Please Everybody, August 21-22, 1997, Energy Law Section,
Dallas Bar Association, Review of Oil and Gas Law XII Seminar.
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Jolisa Melton
therefore, extrinsic evidence is unnecessary to explain the intent of the parties to the
contract. See also Torch Operating Co. v. Louis Dreyfus Reserves Corp., 1994 WL
117786 (E.D.La. 1994) (holding that accounting procedure can be given clear and
definite legal meaning through the plain language of the agreement, and is therefore not
ambiguous).
Some courts, or administrative parties refuse to consider COPAS bulletins
because they are merely offered as guidelines. In C.F. Braun & Co. v. Corporation
Comm’n, 609 P.2d 1268, 1272 (Okla. 1980), the court heard recommendations that costs
on a pooled unit be allocated according to a COPAS bulletin. However, the court upheld
the Corporation Commission’s method of setting their own cost allocation method
without consideration of the COPAS bulletin’s allocations because the bulletin is simply
a guide.153 The court reasoned that the Commission is not restrained by these guidelines.
In deciding on whether bulletins should be used to determine the practices
between the parties, the courts must consider some additional factors: (1) bias, and (2)
bulletin availability. Because each COPAS society has one vote towards approving a
bulletin, the composition of the individual societies is a concern. Is the society operator
or non-operator oriented? The national COPAS office does not track this composition.
A review of the individual societies shows that a typical society is composed of mainly
operators.154 A bias towards operators is definitely possible and if found, should be
153
Harris E. Kerr and Susan R. Richardson, Auditing Problems Under the COPAS Accounting Procedure,
November 12, 1992, Petroleum Accountants Society of the Permian Basin Fall 1992 Oil and Gas Seminar,
Midland, Texas; and May 21, 1993, 20th Annual North American Petroleum Accounting Conference,
Dallas, Texas.
154
17 societies were contacted to obtain composition information. Some societies refused to release such
information. Other societies were more than willing to help. The statistics received consistently showed
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adjusted for by the courts. However, this bias may be mitigated by the fact that even
though an oil company may be an operator on one joint property, it may also be a nonoperator on another joint property. In which case, the company, through COPAS
membership, would vote on a bulletin that protects both interests.
Bulletin availability is another prevalent problem. If bulletins are to be used as
the source of industry custom and practice and binding to all parties to the contract, the
bulletins must be available to the parties. In researching this paper, the only way to
review copies of the COPAS bulletins was to purchase a set for approximately $500. The
bulletins were not available through community, university, or even school of accounting
libraries. For an operator, it is cost beneficial to maintain a library of the bulletins
because they are dealing with charges every day. However, for small non-operators the
cost may far outweigh the benefits. Spending $500 to look up the answer to infrequent
questions may be prohibitive. Therefore, if COPAS bulletins are to be considered the
source of industry custom and practice, they must be readily available to all parties to the
contract. If they are not available, then the custom and practice cannot be implied to all
parties, and will not be binding. If all parties are not bound, then the benefits of a
common source for answers to costing disputes will not be realized.
IX.
Conclusion
The benefit with creating a clear and airtight accounting procedure is that it will
reduce the need for litigation. The prohibitive costs of litigation often prevent fairness
that an individual society is composed mainly of operators. Here are examples of estimates for society
operator composition: Denver – 90%, San Antonio – 57%, Corpus Christi – 57%, Salt Lake City – 83%,
Wichita Falls – 74%, and Ohio – 59%. Note: these are approximations.
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from being achieved because the wronged party cannot afford to litigate. The major cost
of litigation is “expert witnesses, which are often required to testify regarding accounting
and billing procedures, industry standards, proper operations and petroleum engineering”
and can amount to more than the potential recovery of the suit.155 Both parties would
prefer to avoid litigation, and maintain smooth relations. In addition, “clearer and tighter
standards also reduce the area of disagreement and confusion. …they will reduce the
occasions for lawsuits and should make this industry more inviting for outside investors.”
John Burritt McArthur, A Twelve-Step Program for COPAS to Strengthen Oil and Gas
Accounting Protections, 49 SMU L. REV. 1447, 1506 (1996).
Tightening up the COPAS accounting procedure is one way to decrease the
amount of litigation. Increasing the use of COPAS bulletins is another. Using industry
custom and practice would be fair to all parties. COPAS provides a source of industry
custom and practice. The bulletins could be used as the definitive source for costing
disputes - reducing the need to resort to the courts to settle such disputes. A consistent
front must be forwarded by the courts to show that they will follow COPAS, or the
bulletins must be referenced in the accounting procedure to make them part of the Joint
Operating Agreement. If this occurs, then the parties to the Joint Operating Agreement
will know that COPAS bulletins will be used to settle the costing disputes, so the parties
would benefit through decreased litigation costs by attempting to resolve their conflict
through the bulletins before resorting to the courts. Why? Because the courts should
reach the same decision as the parties if the COPAS bulletins are applied.
155
Gary W. Davis ET AL., 5 BUSINESS AND COMMERCIAL LITIGATION IN FEDERAL COURTS §79.4 (West
Group 1998).
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Another way to achieve decreased litigation expenses would be arbitration. An
arbitration clause could be added to the Joint Operating Agreement or the attached
COPAS accounting procedure. Perhaps the arbitration panel could include a COPAS
member or officer who could assist with the application of industry custom and practice
and attempt to ensure that consistent results are achieved.
In whatever way COPAS is incorporated into the resolution of cost disputes,
COPAS' knowledge of industry custom and practice in the field of petroleum accounting
will be an asset. One benefit will be decreased litigation costs. Another, will be
consistency of decisions because one source - COPAS - provides the answer. A final
benefit is the opportunity for all industry participants to join in the formulation of
industry custom and practice. Participants can join a COPAS society and participate in
the bulletin and accounting procedure development and approval process.
46