CHAPTER 15 COPAS ACCOUNTING PROCEDURES, THE 2005 COPAS ACCOUNTING PROCEDURE, THE AUDIT PROCESS, AND LEGAL AND PRACTICAL CONSIDERATIONS

• Jurisdiction: United States

Oil & Gas Agreements: Joint Operations
(Dec 2007)
CHAPTER 15
COPAS ACCOUNTING PROCEDURES, THE 2005 COPAS ACCOUNTING PROCEDURE, THE AUDIT PROCESS, AND LEGAL AND PRACTICAL CONSIDERATIONS
Karla Bower
ConocoPhillips Company
Houston, Texas
Howard Blunk
OGC Consulting
The Woodlands, Texas
Jonathan D. Baughman
McGinnis, Lochridge & Kilgore, L.L.P.
Houston, Texas

KARLA BOWER

Karla Bower is a Joint Interest Consultant at ConocoPhillips. She joined the Company over 25 years ago after graduating from the University of Kansas. Most of her career has been spent in various Joint Interest positions, coordinating issues involving Land and Joint Interest Accounting. She currently advises several business areas within ConocoPhillips on Joint Interest matters and provides guidance on emerging issues within the industry. Karla has been a member of the Board of Directors for the Council of Petroleum Accountants Societies, Inc. (COPAS) since 2004, and is the association's President for 2007. From 1998-01 she served on the Board of Directors of the Petroleum Accountants Society of Houston (PASH). She has chaired both the COPAS and PASH Joint Interest Committees and served as COPAS' AAPL Liaison for six years. Karla co-led the task force that developed the COPAS 2005 model form accounting procedure. She has participated on numerous other COPAS task forces, including the Project Team Accounting Procedure, Overhead Interpretation, Allocation of Rig-Related Expenditures Guideline, Material Pricing Manual, Overhead Negotiation & Calculation Guideline, Drilling Overhead Interpretation, and the Awards Interpretation.

H. G. (HOWARD) BLUNK

H. G. (Howard) Blunk is founder and owner of OGC Consulting, located in The Woodlands, Texas. His company provides a variety of accounting/audit services focusing on the full range of Oil and Gas Contract negotiations, analysis and development of overhead recovery rates, compliance reviews, and dispute resolution. OGC is now in its ninth year of operations serving a variety of clients. With OGC's primary emphasis on joint interest agreements and related COPAS Accounting Procedures, Mr. Blunk offers a unique perspective as he is actively involved in COPAS and has personally helped develop many of their publications. He is the past National Audit Committee Chair for COPAS, has also chaired their Emerging Issues and Internal Review Sub-Committees, has served on the COPAS Board of Directors, and is a past President of COPAS. Mr. Blunk is a course instructor for the Professional Development Institute at the University of North Texas (PDI), and author of the course books used in PDI's National Accounting and Auditing School for Joint Interest Operations, and their Joint Interest agreements course for Landmen. Mr. Blunk has made a number of presentations to industry groups including COPAS, the American Association of Professional Landmen (AAPL), and the American Petroleum Institute (API) on joint interest accounting and auditing, and oil and gas contracting activities. With over three decades of experience in Oil and Gas Accounting/Auditing, Mr. Blunk has held a variety of supervisory and managerial positions in the United States and overseas. As Audit Manager (Non-Operated Joint Ventures) for Chevron, he was responsible for audit coverage of all non-operated properties in the United States and Canada. Working in London (England), Mr. Blunk was Assistant Audit Manager for the Middle East and Africa where he oversaw the full range of audit department activities including internal controls, joint venture agreements, and contractor/vendor reviews for all operations in the host countries.

JONATHAN D. BAUGHMAN

Jonathan D. Baughman is a partner in the Houston office of McGinnis, Lochridge and Kilgore, LLP. He is licensed to practice law in Texas and Louisiana and received his B.S. degree from Louisiana Tech University, magna cum laude, and his J.D., magna cum laude, from Loyola Law School where he was the managing editor of the Loyola Law Review. Prior to practicing law, Mr. Baughman worked as a certified public accountant in the energy section for a major international public accounting firm and later as an internal auditor for a major natural gas pipeline company. Mr. Baughman represents clients in a wide variety of litigation including oil and gas litigation in federal and state courts. For example, Mr. Baughman has litigated disputes involving joint operating agreements, gas processing agreements, and leases. He has litigated a multitude of oil and gas issues related to title, lease covenants, implied and express covenants to pool, royalty payments, COPAS, natural gas trading, reservoir damage, and well blowouts. Mr. Baughman has written articles and spoken before the American Association of Professional Landmen and other legal organizations related to the COPAS accounting procedure attached to most joint operating agreements. Mr. Baughman is currently the Treasurer of the Oil & Gas Section of the Houston Bar Association. He is also a member of the Rocky Mountain Mineral Law Foundation.

I. COPAS ACCOUNTING PROCEDURES¹

A. Introduction & Purpose

The operating agreement establishes the overall structure and framework for sharing the costs of the exploration and production deal. It establishes who is liable for the various operations and activities, and under what circumstances. The operating agreement also provides for the operator to pay the costs, and bill each non-operator for its proportionate share.

Operating agreements do contain some specifics on what costs can be charged to the joint account. For example, cost issues addressed by AAPL model forms include: cost of title work; penalty & interest on tax assessments; cost of providing certain information; cost of turning over operatorship; cost of non-operator access to property and records; cost of accounting if a non-operator's interest is divided among four or more parties; and the cost of taking production in-kind. The AAPL 610-1989 operating agreement also addresses the cost of regulatory hearings (Article IV.A). However, these provisions represent only a small fraction of the costs, and ones that tend to occur infrequently. For the most part, the operating

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agreement provisions dealing with costs address who pays, rather than the classification of costs as direct or overhead. Examples of these include the costs associated with non-consent operations, abandonment and surrender liability, and occasionally the allocation of costs between zones.

The details surrounding the accounting are left to the accounting procedure. Specifically, the accounting procedure sets out how the operator is to be compensated for all operations and activities conducted under the agreement, aside from the exceptions in the operating agreement. It is the accounting procedure that outlines the basis of direct charges and credits to the joint account, what is included in overhead and how it is to be recovered, and the handling of materials and inventory.

B. History

Accounting procedures have been in existence for many years, evolving in the early 1960s into the model form accounting procedures developed by the Council of Petroleum Accountants Societies, Inc. (COPAS) that are used today. Other petroleum accounting organizations that have published model form accounting procedures over the years, and their publications/dates, include the following:

Mid-Continent Oil and Gas Association - 1938

Petroleum Accounting Society - Los Angeles:

PAS 1 - Unknown date

PAS-1956.

PAS-1962

Petroleum Accounting Society of Oklahoma:

PASO-1949

Petroleum Accounting Society of Oklahoma - Tulsa:

PASO-T 1955

Petroleum Accounting Society - Canada/Western Canada:

PASWC-1953

PASWC-1969

PASWC-1976

PASC-1983

PASC-1986

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PASC-1988

PASC-1996

Council of Petroleum Accountants Society, Inc. (COPAS):

COPAS-1962

COPAS-1968

COPAS-1974

COPAS-1976 (Offshore)

COPAS-1984

COPAS-1986 (Offshore)

COPAS-1995

COPAS-Project Team (1998)

COPAS-2005

Accounting procedures have changed over the years in response to business needs as well as a need to clarify the forms. In really old agreements, the accounting procedures were very brief and sometimes embedded in the operating agreement. Even where the accounting procedure was a separate exhibit, it was sometimes no more than two pages long. By contrast, the 2005 COPAS accounting procedure is 15 pages long. The growth in the accounting procedure has much do with clarifying the intent and application of the form, rather than sweeping changes in joint interest accounting practices.

Another shift in the accounting procedures is that they have become more flexible over time to provide for automatic adjustment without having to amend the contracts. Gradually, many fixed factors or percentages have been replaced with factors or percentages that are adjusted by external indices/organizations. Examples of these include the employee benefits rate limitation, freight equalization threshold, interest rate on delinquent bills, loading and unloading costs, and the overhead adjustment factor. The 1995 and later forms even anticipate that, at some point, COPAS may designate a source for vehicle rates other than the currently used Petroleum Motor Transport Association (PMTA) rates.

The 2005 COPAS accounting procedure added even more flexibility. It provided a back-up for the interest rate on delinquent bills, and stated overhead will be adjusted using the rate published by COPAS, without further specifications on the source of that rate. The 2005 COPAS accounting procedure also tied the threshold for charging major construction and catastrophe overhead, as well as operator authority to dispose of certain materials, to the operator's expenditure limit, which tends to get amended from time to time.

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The...