Revenue Accounting Issues
For Royalty Owners
Donald A. Phend, CPA
Phend & Company, LLC
8500 W. Bowles Ave., Suite 301
Littleton, CO 80123
(303) 298-7908 Phone
(303) 292-4663 Fax
phendcpa@aol.com
Objectives
• Gain a basic understanding of how oil and gas
is valued for royalty payment calculations.
• Basic tips royalty owners can use to determine
if deductions are being taken from their
royalty payment.
• Current issues affecting Colorado Royalty
Owners
Accounting Terms – Oil
• BBL
Barrel – 42 US Gallons
• BS&W
Basic Sediment and Water, an
analysis of contaminants in oil
• Gravity Viscosity of oil – higher gravity is
thinner and usually more valuable
Accounting Terms - Gas
• MCF
• MMBTU
• Chromatograph
Measurement of Volume
(1,000 cubic feet at
standard temperature and
pressure)
Measure of heating
content of gas
Theoretical content of
various liquids (Gallons
per MCF)
Accounting Terms – Gas
• Pooled Accounting
– All wells in pool receive same valuation for gas
and liquids
– Pool can be various definitions,
• Field
• Geographic Area
• All wells going to a specific plant, etc.
Accounting Terms - Gas
• Netback Method
– Deductions reduce stated value of gas, rather than
being shown as a separate deduction
– Example
– Sales Price
$3.15 MMBTU
– Deductions
(0.15) MMBTU
– Netback Price $3.00 MMBTU
–
Typically the Netback Price will be shown on royalty
check detail
Oil Valuation
• First step: measure the oil sold
– Run Ticket Method
• High and low tank measurements manually recorded
when oil is run (sold) into tank truck
– LACT Meter (Lease Automatic Custody Transfer)
• Automatically records volume transferred (sold) to
pipeline connection
Run Ticket
Plumb Bob
LACT Meter
Oil Valuation
• Second step: Determine quality of oil
– Sample taken (using “oil thief” device) for analysis
• Gravity
• BS&W- Basic Sediment and Water
Oil Thief
Pricing Calculation
• Posted Price
– Purchasers publish a daily or monthly field price
• Spot Price
– Based on market
Purchase contract may specify + or – from the above
referenced prices
Issue for Royalty Owner
• Is the price an arms-length price?
• Is posted price (if related party) truly a
representative price for that area and time?
Gas Valuation
• First step: Measure the gas sold
– Paper chart meter
– Electronic meter
Paper Chart Meter
Electronic Meter
Gas Valuation
• Second Step: Determine quality of gas:
– Sample taken for analysis:
• BTU Content – Heating content of gas sample
• Content Analysis (Chromatograph) – Content of various
potential liquids contained in gas sample
Gas Analysis Report
Heating Content
• MMBTU / MCF
1.267
Theoretical Liquid Content
(Chromatograph)
Gallons per MCF
• Ethane
• Propane
• Isobutane
• Normal Butane
• Isopentane
• Normal Pentane
• Hexane
3.382
1.383
0.256
0.486
0.194
0.170
0.342
Physical Flow of Gas and Liquids
Wells
End
User
Market
Pipeline
Gas Plant
Gathering
System
Unprocessed
Gas
Field
Compressor
Processed
Gas
Liquids
Who Processes Gas?
• Independent processing companies provide
processing for a fee
• Some large operators may have their own gas
plants
Why Process Gas?
• The raw gas at the wellhead may not meet
pipeline specifications
Too high heating content (MMBTU/MCF )
Impurities (water, CO2, H2S)
Why Process Gas?
Additional Revenue
• Liquids sell at a premium price.
• At times, some liquids command 2X the price
per MMBTU as residue (processed) gas.
Gas Processing Agreement
Gas Processing Agreement
• Agreement between Producer (Well Operator)
and Processor (Gas Plant)
• Defines terms and fees for processing gas
• Various types include
– Percentage of Proceeds (POP)
– Keep Whole
– Fixed Fee
Example of POP Contract
• Producer receives 80% of sales proceeds for
processed gas
• Producer receives 60% of sales proceeds for
NGLs
• Producer pays “gathering fee” of 10 cents MCF
• Processor may use “without cost” 3% of
producer’s gas for compressor and plant fuel
• Producer pays 5 cents/gallon “frac fee”
POP Fees
Liquids 40%
Processed Gas 20%
Wells
End
User
Market
Pipeline
Gas Plant
Gathering
System
Unprocessed
Gas
Field
Compressor
Processed
Gas
Liquids
Gathering Fees
Wells
End
User
Market
Pipeline
Gas Plant
Gathering
System
Unprocessed
Gas
Field
Compressor
Processed
Gas
Liquids
Fuel (3% of Volume)
Wells
End
User
Market
Pipeline
Gas Plant
Gathering
System
Unprocessed
Gas
Field
Compressor
Processed
Gas
Liquids
Frac Fee (5 Cents / Gallon)
Wells
End
User
Market
Pipeline
Gas Plant
Gathering
System
Unprocessed
Gas
Field
Compressor
Processed
Gas
Liquids
Effect of Netback Method
• You can’t see all of the deductions being taken
by looking at your revenue check detail.
• Some of the deductions may be buried in the
“artificial” lower price.
Why is Netback Important?
• Producers often use the Netback price they
receive from the processors as a starting point
to pay royalty.
• Note, these deductions may or may not be
appropriate to charge to royalty owners.
– This is a legal issue, not an accounting issue.
Calculate Theoretical Gallons
•
•
•
•
•
•
•
Ethane
Propane
Isobutane
Normal Butane
Isopentane
Normal Pentane
Hexane
3.382 x 1000 =
1.383 x 1000 =
0.256 x 1000 =
0.486 x 1000 =
0.194 x 1000 =
0.170 x 1000 =
0.342 x 1000 =
Gallons
3382
1383
256
486
194
170
342
Why are Theoretical Gallons Important
• It is used to allocate the total “Actual Gallons”
produced at the plant to each well, to
determine payment to producer
Actual plant gal X
Theoretical Gal
Your Well
Theoretical Gal All Wells
in Plant
Allocation to Well
• In other words, if the your well has 5% of the
total theoretical plant production of Ethane, it
will get credit for 5% of the actual sales of
ethane.
• Note that this sales value will be net of the
40% POP fee.
Valuation of Ethane
• Actual Gallons of Ethane
Allocated to your well 3,111.44
• Price of Ethane (Gal)
$0.43175
• Gross Value of Ethane to Well
$1,343.36
• Less POP (40%)
(537.34)
• Net Paid Producer
806.02
Calculate Gross Value
Ethane
Propane
Isobutane
Normal Butane
Isopentane
Normal Pentane
Hexane
Residue Gas (MMBTU)
Gross Value All Products
Gallon
or MMBTU
3,111.44
1,272.36
235.52
447.12
178.48
156.40
314.64
816.00
Price per
Gal or MMBTU
0.43175
0.79617
0.97193
0.94603
1.0998
1.0998
1.0998
5.59
Gross
Value
1,343.36
1,013.01
228.91
422.99
196.29
172.01
346.04
4,561.44
8,284.06
Calculate Net Value
Ethane
Propane
Isobutane
Normal Butane
Isopentane
Normal Pentane
Hexane
Residue Gas (MMBTU)
Gross
Value
1,343.36
1,013.01
228.91
422.99
196.29
172.01
346.04
4,561.44
Total
8,284.06
Less Gathering ($0.10 / MCF) 1000 MCF X .10
Less Frac Fee ($0.05 / Gal)
6532 Gal X $0.05 x 60% POP
Net Value
POP
%
0.6
0.6
0.6
0.6
0.6
0.6
0.6
0.8
Net Value
806.02
607.81
137.35
253.79
117.78
103.21
207.62
3,649.15
5,882.72
-100
-195.96
5,586.76
Valuation on Check
• Net Value After Deduction
• MCF at Wellhead
• Calculated Price Per MCF
$5,586.76
1,000
$5.59
Other Issues
• Volumetric Loss
– Often known as “Fuel Lost and Unaccounted” or
“FL&U)
– Processor only pays on net volume sold at tailgate
of plant
– Can be easily calculated
Volumetric Loss
• MMBTU at Wellhead
• Less MMBTU in All Products
• Equals FL&U
• Note that liquids are stated in gallons, but
there are conversion factors to determine
MMBTU content
Volumetric Loss
• In this example FL&U was calculated as
approximately 22.85 MMBTU
• Expressed in terms of residue gas this is
– 22.85 MMBTU X $5.59/MMBTU = $127.72
Summary
•
•
•
•
Gross Value Sold at Plant
Plus Value of FL&U
Value At Wellhead
Less
–
–
–
–
POP
Gathering
Frac
FL&U
Net
Percentage of Net to Gross
$8,284.06
127.72
8,411.78
(2,401.34)
(100.00)
(195.96)
(127.72)
$5,586.76
66%
Summary
• 10% Royalty Owner Effect
• Gross value of 10%
• Net Actually Received
$841.18
568.67
• Royalty Owner’s
share of deducts
$273.51
“Keep Whole” Contract
• Gas Processor pays Producer for the total
MMBTU produced at the wellhead
• Price is based on the sales price of residue gas
only
• Gas Processor keeps the enhanced value of
the MMBTU that was converted to liquids
“Keep Whole” Contract
• These contracts may also have an allowance
for fuel, (for example, 3%) in which case the
Gas Processor only pays on a net percentage
of the wellhead volume
• Other fees may also be charged by Gas
Processor
“Keep Whole” Contract
• Typically the Producer will begin with the
“Keep Whole” amount they receive from the
Gas Processor, when beginning to calculate
royalty payments
• Producer may also add other charges when
calculating royalty payment
“Keep Whole” Contract
• Effect on royalty owner payments
– Royalty owner does not receive benefit for higher
value of liquid products
– Royalty owner may be receiving payment on a
volume net of fuel allowances
– Royalty owner may be charged other deductions
by the operator
– Note that the above items may, or may not, be
evidenced on the royalty check detail
Fixed Fee Contract
• Gas Processor charges a per unit of volume
fee to the producer for providing processing
services
• Producers may calculate royalty payments net
of this fee
Other Issues
• Arms-Length Pricing
– It is possible for a processing company to sell to a
marketing affiliate at a lower than market price,
and settle with producer on this basis.
– Strategy - request documentation for first armslength sale
Strategies for Royalty Owners
• Look for slight variations of price for different
wells (if you have more than one well)
– This is indicative that various products are being
allocated differently based on well’s theoretical
content.
– While this isn’t proof that netback pricing is
occurring, it is at least a place to start .
Strategies for Royalty Owners
• If well was involved in a class action
settlement, the calculation methodology for
“future deductions” may be available in the
settlement agreement.
• This might be interesting for informational
purposes, but you may be bound by the
settlement agreement (not intended as legal
advice!)
Strategies for Royalty Owners
• Request copies of any Gas Processing Agreements
and Plant Statements for some sample months
• The Plant Statements show basically the same
calculations as in the prior example, and if you
are good with numbers, you can probably figure
it out, or at least make an estimate
• Down side is I have found most companies are
reluctant to provide this type of info absent legal
pressure
Strategies for Royalty Owners
• If you know your gas is being processed, and
• You have access to index prices in your area
for pipeline standard gas
• Then you should expect that the blended
value you receive should be higher than the
pipeline standard gas, due to the enhanced
value of the liquids (assuming no deductions)
Strategies for Royalty Owners
• Some royalty checks are becoming more
descriptive
• If they display a column of “Deducts”, ask
Royalty Relations Department for an
explanation
• Also ask them if they use “Netback Pricing”
and see if they give you an answer
Strategies for Royalty Owners
• Compare notes with friends and neighbors
who may have royalties with other companies
in the same geographic area
• Significant variances in stated prices may
merit further investigation