Disclosures About Oil and Gas Producing Activities

Disclosures About
Oil and Gas Producing Activities
AICPA Oil and Gas Conference, Denver, CO
November 14, 2012

Joe Blice, CPA, Audit Partner, Dallas
Joe has 16 years of professional experience and serves as an Audit Partner in the Dallas
office of Hein & Associates LLP. He provides a wide range of audit and accounting
services for both public and privately held companies in the energy industry. Joe has
significant experience with Securities and Exchange Commission disclosure and
reporting requirements, and assists companies with mergers and acquisitions as well as
initial and secondary securities offerings. Joe also specializes in share-based payment
arrangements and foreign currency translation.
Joe serves as the Local Energy Niche Leader for the Dallas office and he is a member of
the Council of Petroleum Accountants Societies (COPAS) where he has served in various
capacities since 2003. He also serves on the conference committee of the North
American Petroleum Accounting Conference (NAPAC), and is a frequent speaker at
various energy related presentations.
Prior to joining Hein & Associates LLP in 2003, Joe served as the Controller of a publicly-
traded oil and gas company where he assisted with a merger and a private placement for
the organization. He began his career as a member of the audit staff of Ernst &Young
LLP after graduating from the University of Oklahoma.

© 2012 Hein & Associates, LLP. All rights reserved.

Learning Objectives

• SEC Disclosure Requirements
– Regulation S-K 1200
• US GAAP Disclosure Requirements
– FASB ASC Topic 932-235
– FASB ASC Topic 932-360
• SMOG Example
• Frequent SEC Comments interspersed


SEC Disclosure Requirements

• What goes in the front part of a document?
– Registration statements – Item 11 of Form S-1
– Annual reports on Form 10-K or equivalent - Item 2 -
Properties


Applicability of S-K 1200

• Material oil and gas producing activities
– 10% of revenue
– 10% of operating income
– 10% of total assets


General Note (S-K 1201)

• 15% Threshold related to geographic area
– By country
– By groups of countries within an individual content
– By continent
– Catch-all – ―as appropriate for meaningful disclosure in the
circumstances‖
• Aggregation is allowed
• Applies to practically all disclosures


Disclosure of Reserves (S-K 1202)

• Tabular Disclosure of Reserves
– Proved developed
• PDP
• PDNP
– Proved undeveloped
– Probable (optional)
– Possible (optional)



• Tabular Disclosure of Reserves (continued)
– Oil in barrels
– Natural gas liquids (if significant) in barrels
– Natural gas in cubic feet
– Synthetic oil
– Synthetic gas
– Any product intended to be upgraded into
synthetic oil or gas
• See Example 1



• Aggregated Totals and Equivalent Units
– Not required
– State basis of conversion
• Dollar values in table
– Frequently disclosed
– PV10 is a non-GAAP measure



• Technology Used to Establish Reserves
– Initial reporting
– Material additions
• See Example 2


• Internal Controls used in the Reserves Estimation
Effort
– Qualifications of the company representative responsible
– Qualifications of the person primarily responsible for the
preparation of the report if third party is used
– These are areas of frequent SEC staff comment
• See Example 3



• Third Party Reserves Reports
– Filed as an exhibit to the public document
– Letter at the front of the report
– Detail tables not required


• Requirements of Third Party Reserves Reports
– The purpose for which the report was prepared and for whom it
was prepared;
– The effective date of the report and the date on which the report
was completed;
– The proportion of the registrant’s total reserves covered by the
report and the geographic area in which the covered reserves
are located;
– The assumptions, data, methods, and procedures used,
including the percentage of the registrant’s total reserves
reviewed in connection with the preparation of the report, and a
statement that such assumptions, data, methods, and
procedures are appropriate for the purpose served by the report;


• Requirements of Third Party Reserves Reports
(continued)
– A discussion of primary economic assumptions;
– A discussion of the possible effects of regulation on the ability of
the registrant to recover the estimated reserves;
– A discussion regarding the inherent uncertainties of reserves
estimates;
– A statement that the third party has used all methods and
procedures as it considered necessary under the circumstances
to prepare the report;
– A brief summary of the third party’s conclusions with respect to
the reserves estimates; and
– The signature of the third party.


• Primary economic assumptions – frequent SEC
comment area
– State the specific price used and how derived

• See Example 4



• Optional Sensitivity Analysis
– What-if summary of reserves
– State prices used
– State cost assumptions
– State why these are reasonable and useful to a reader


Proved Undeveloped Reserves (S-K 1203)

• Total quantities of PUD at year end
• Material changes during the year, including
conversion to PDP/PDNP
• Investments and progress made during the year in
converting PUD to PDP/PDNP
• Why material amounts remain booked for five years
or more after disclosure as PUD


Proved Undeveloped Reserves (S-K 1203)
• Frequent Areas of SEC Staff Comment
– Inadequate disclosure of reasons for material changes
– Inadequate disclosure of technologies used to book
additional PUDs
– Inadequate disclosure of progress toward converting
PUD to PDP/PDNP
– Mathematically impossible development rates
– Reserves remaining booked more than five years from
initial record
– Reserves scheduled to be developed more than five
years hence

• Be very specific in your discussion


Production, Prices and Costs (S-K 1204)

• Production by final product sold
• Average sales price
• Average production cost EXCLUDING severance
and ad valorem taxes

• See Example 5


Production, Prices and Costs (S-K 1204)
• Production Volumes
– Sales volumes only
– Compression and shrinkage excluded
• Net to the Entity’s interests
– Exclude royalties, except in certain circumstances, and with disclosure of
reasons
• Stated in Normal Units
– Barrels for oil, condensate and natural gas liquids
– Cubic feet for natural gas
– Synthetics in the final unit as sold
• Equivalent Units
– Express in same basis as used in depletion calculation
– Disclose equivalency ratio

Drilling and Other Exploratory and Development
Activities (S-K 1205)

• Drilling & exploratory activities by geographic area
for each of the last three fiscal years:
– Number of net productive and dry exploratory wells drilled
– Number of net productive and dry developmental wells
drilled
• Difference between developmental versus
exploratory
• Wells completed during the year irrespective of spud
date
• See Example 6


Present Activities (S-K 1206)

• Wells in process
– Gross and net
– Undrilled locations – rules say not to disclose, but many do
• Improved recovery efforts
• Pressure maintenance operations
• Any other material activities


Delivery Commitments (S-K 1207)
• Wells in process
– Gross and net
– Undrilled locations – rules say not to disclose, but many do
• Improved recovery efforts
• Pressure maintenance operations
• Any other material activities

• See Example 7 for Present Activities and Delivery
Commitments


Oil and Gas Properties, Wells, Operations and
Acreage (S-K 1208)

• Wells by geographic area, gross and net
• Example:

Oil Natural Gas Total
Gross Net Gross Net Gross Net
France 11 10.5 43 16.8 54 27.3
Asia 6 5.9 78 70.3 84 76.2
USA — — 132 39.0 132 39.0
Total 17 16.4 253 126.1 270 142.5


Acreage (S-K 1208)

• Gross and Net Undeveloped Acreage by geographic area
– Leases
– Concessions
• What does undeveloped mean?
– Acres on which wells have not been drilled
– Presence of reserves is irrelevant
• Example:
– Assume 1,000 acre plot with two wells, and 40 acre spacing
– Assuming full development, there would be 25 locations
– 920 undeveloped acres (25 total less two drilled times 40 acres)


Acreage (S-K 1208)

• Discuss minimum remaining terms
• Frequent area of SEC comment
• See Example 8


US GAAP Disclosure Requirements


• Different requirements for public and private companies
• Some included in accounting policy footnote
• Remainder in Supplementary Information, which is NOT
required to be audited, and is not required for private
companies
• All disclosures generally required for each year in which a
balance sheet and an income statement or statement of
operations is required
• Same requirements for geographic areas as SEC rules



• Applicable to public and private entities
• Disclose method of accounting
– Full Cost (Regulation S-X, Rule 4-10)
– Successful Efforts (ASC 932)
• Usually appears on face of balance sheet,
accompanied by detail discussion in the summary of
significant accounting policies
• Depletion policy is an area of SEC comment focus
• See Example 9

Accounting Policy Disclosure (all entities)

• Areas to watch for
– Depletion policy – mineral interests versus all others
– Capitalized interest
– Capitalizing exploratory well costs
– Impairment – details on process for estimating fair value
– Process for monitoring and disposing of unproved mineral
interests



• Full Cost Method Companies
– Generally same disclosures required
– Add disclosure of costs excluded from depletion
• Unproved properties
• Major development projects not yet in service
• Aging of costs for the most recent three years and in the aggregate
for costs incurred more than three years ago


• Suspended Well Costs
• Successful Efforts Only
• Amount of capitalized costs pending the determination of
proved reserves
• Changes in those amounts
• Amounts capitalized for more than one year
– Aging of amounts and the number of projects
– Narrative discussion of progress toward evaluating reserves

• See Example 10


GAAP Disclosure for Public Companies

• Capitalized costs
• Costs incurred
• Results of operations
• Proved reserves, and changes thereto
• Standardized measure, and changes thereto


Capitalized Costs

• Aggregate capitalized costs
• Aggregate accumulated depletion, depreciation,
amortization and valuation allowances
– Disparity in impairment rules and oil and gas rules

• See Example 11


Costs Incurred
• Acquisition costs
– all costs incurred to purchase, lease or otherwise acquire a
property, whether proved or unproved.
• Exploration costs
– may be incurred before or after acquiring a property. Includes all
geological and geophysical costs, the costs of carrying and
retaining undeveloped properties such as delay rentals, taxes,
legal costs for title defense and the maintenance of land records.
• Development costs
– costs to drill and equip wells with proved reserves.

• See Example 12


Results of Operations

• Revenues
• Production costs
• Exploration expenses (generally N/A for Full Cost)
• DD&A (including accretion of ARO liabilities)
• Income tax expenses (statutory rate, reflect specific
credits)
• Results of operations
• Excludes corporate overhead and interest costs


Results of Operations

• May exclude separate table if:
– substantially all of the entity’s operations are oil and gas
production; and
– Geographic segment disclosures, if required are made
elsewhere.


Proved Reserves
• Net quantities at the beginning and end of each year
• Royalties included, if known. If not, state that fact
and the production received for the year
• Volume roll forward for all periods for which an
income statement is presented
• Such disclosures must be made
– In the aggregate and
– For the enterprises’ home country (if material) and
– For each foreign geographic area (countries can be
grouped)


Proved Reserves

• 100% of net reserve quantities attributable to the
parent and 100% of net reserve quantities of
subsidiaries, whether or not wholly owned
• If a significant portion of quantities are attributable to
minority interests, that fact and the approximate
portion
• If proportionate consolidation, then only include the
Company’s share
• If equity method, disclose separately


Proved Reserves

• Oil and natural gas liquids to be stated in barrels
• Natural gas in cubic feet
• Explain important economic factors or uncertainties
affecting particular components (high lifting costs,
facilities in process, punitive marketing arrangements


Proved Reserves
• Changes in proved reserves for last three years
– Revisions of previous estimates – either upward or downward,
can result from new information or changing economic factors.
– Improved recovery – if significant
– Purchases of minerals in place
– Extensions and discoveries – relates to extension of proved
acreage from existing reservoirs through additional drilling and
discovery of new fields
– Production
– Sales of minerals in place
• Narrative explanation for significant items noted above.


Proved Reserves
• Changes in proved reserves for last three years
– Obtain volume roll forward from independent or internal
engineer.
– The volume roll forward will be the basis for certain
changes in SMOG.
• Disclose total proved developed reserves at the end
of each year for which an income statement is
required

• See Example


Standardized Measure of Oil and Gas Quantities
(SMOG)

• History lesson
– SMOG disclosures evolved due to disparity in oil and gas
property accounting methods
– ARAB Oil Embargo
– Reserve Recognition Accounting
– S-X Rule 4-10
– FASB 69 (now ASC 932)


SMOG

• Key Inputs
– Beginning and ending reserve reports
– Volume rollforward
– Specific reserves runs for all volumetric changes if
available
– Income statement
– Previously estimated development costs incurred
– Income tax basis of oil and gas properties, tax rates, and
NOL/other credit carryovers


SMOG Example

• Refer to handout
• Example is based on an example in Chapter 29,
Standardized Measure of Oil and Gas Reserves,
Petroleum Accounting Principles, Procedures, &
Issues, 7th Edition, available from PDI.
• This is ―A‖ way, not ―THE‖ way.


Components of SMOG
+ Future cash inflows (revenues from reserve report)
- Future production costs (LOE from and all operating
costs from reserve report)
- Future development costs (separate if material or can
be combined with production costs)
- Future income tax expenses (future pretax income
reflecting depletion estimates and credits, times
statutory rates)
- Discount, at 10%
= Standardized measure
See Example 14


Changes in SMOG

• Net change in sales and transfer prices and in
production (lifting) costs related to future production
• Changes in estimated future development costs
• Sales and transfers of oil and gas produced during
the period
• Net change due to extensions, discoveries, and
improved recovery
• Net change due to purchases and sales of minerals
in place


Changes in SMOG

• Net change due to revisions in quantity estimates
• Previously estimated development costs incurred
during the period
• Accretion of discount
• Other – unspecified
• Net change in income taxes


Net Change in Prices and Costs Related to
Future Production

• Computed by variance analysis:
– Calculate net revenue per equivalent unit at each year
end, adjusting current year end amounts for specific
additions, if known, and add-back current year sales
– Multiply the difference in the net cost per unit times
previous year’s equivalent quantities, adjusting current
year end amounts for specific additions, if known
– Multiply that product by the average discount factor
• Excludes future development costs

Previously Estimated Development Costs
Incurred

• Use actual costs incurred related to properties
included in the prior year report as proved developed
nonproducing or proved undeveloped.


Sales and Transfers of Oil and Gas Produced
During the Period

• Directly from the income statement
• Usually revenues less severance tax less LOE.


Volume-related Changes in SMOG

• Net change due to extensions, discoveries, and
improved recovery
• Net change due to purchases of minerals in place
• Net change due to sales of minerals in place
• Net change due to revisions in quantity estimates


Volume-related Changes in SMOG

• Two Methods:
– Obtain specific reserves run from internal or external
engineering to determine the undiscounted future net cash
flow attributable to each type of change; or
– Compute as a volume variance analysis.
• Multiply each volume change times the current period-end net
revenue per equivalent unit (careful to include or exclude future
development costs as appropriate)
• Multiply each of those products times the effective discount factor


Change in Income Taxes

• Two Methods:
– Change in undiscounted amounts times average discount
factor
– Change in discounted amounts


Other (Unspecified)

• Catch-all
• What it takes to balance
• Should be very small – my rule of thumb is 10% of
the prior year SMOG balance


Accretion of discount

• Shortcut method of last year’s SMOG times 10% is
inappropriate
• Two Methods:
– Multiply prior year’s net cash flows by the current period’s
effective discount rates
– Multiply prior year PV10 times 10%


Joe Blice
972-687-7818
jblice@heincpa.com

Disclosures About Oil and Gas Producing Activities

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