CHAPTER 16 COPAS ACCOUNTING PROCEDURES, AND LEGAL AND PRACTICAL CONSIDERATIONS
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COPAS ACCOUNTING PROCEDURES, AND LEGAL AND PRACTICAL CONSIDERATIONS
Partner
McGinnis Lochridge & Kilgore LLP
Houston, TX
Karla Bower
Joint Interest Consultant
Houston, TX
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JONATHAN D. BAUGHMAN is a partner in the Houston office of McGinnis Lochridge. 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 chairs his firm's oil and gas practice group and represents clients in a wide variety of oil and gas litigation in federal and state courts. Mr. Baughman is AV (highest) rated by Martindale Hubbell and has been recognized as a Super Lawyer by Texas Monthly. Mr. Baughman has litigated disputes involving joint operating agreements, gas processing agreements, leases, and other agreements. He has litigated many oil and gas issues related to title, lease covenants, implied and express covenants to pool, royalty payments, COPAS, natural gas trading, reservoir damage, well blowouts, and misappropriation of seismic data. Mr. Baughman has written articles and spoken on numerous oil and gas issues before the American Association of Professional Landmen, the Rocky Mountain Mineral Law Foundation, and the Louisiana Mineral Law Institute as well as other organizations. Mr. Baughman previously served as the Chair of the Oil & Gas Section of the Houston Bar Association. He is also a member of the Rocky Mountain Mineral Law Foundation and most recently served as a Trustee at Large for the Foundation. Mr. Baughman was also appointed as one of twenty-five distinguished Advisory Board Members for the Louisiana Mineral Law Institute. Mr. Baughman also serves as one of nine council members of the Oil, Gas and Energy Resources Law Section for the State Bar of Texas.
KARLA BOWER is a Joint Interest Consultant employed by a large independent E&P company based in Houston. She began her career in the energy industry in 1979 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 business units across the U.S. on joint interest matters and provides guidance on emerging issues in the industry. Karla was a member of the Board of Directors for the Council of Petroleum Accountants Societies, Inc. (COPAS) from 2004 through 2009, and was the association's President in 2007. She also served on the Petroleum Accountants Society of Houston (PASH) Board of Directors, PASH and COPAS Joint Interest Committees, and has been COPAS's liaison to AAPL for a number of years. Karla co-led the task force that developed the COPAS 2005 Model Form Accounting Procedure and COPAS 2012 Deepwater Model Form Accounting Procedure, and has participated on numerous other COPAS task forces. She was the recipient of the COPAS Eagle Award in 2011 in recognition of her commitment and contributions to COPAS.
I. COPAS ACCOUNTING PROCEDURES1
A. Introduction & Purpose
The operating agreement establishes the overall structure and framework for conducting exploration and production operations and sharing the costs of such operations among the parties to the agreement. 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 contain some specifics on what costs can be charged to the joint account. For example, cost issues addressed by the American Association of Professional Landmen (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 and 2015 operating agreements also address the cost of regulatory hearings (Article IV.A). However, these provisions represent only a small fraction of the costs involved in conducting oil and gas operations, and ones that tend to occur infrequently. For the most part, the operating 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 surrendering a lease, and occasionally the allocation of costs between zones.
The details surrounding the treatment of costs 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
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the exceptions in the operating agreement. The accounting procedure 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. HistoryAccounting 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 - 1938Petroleum Accounting Society - Los Angeles:PAS 1 - Unknown datePAS-1956PAS-1962Petroleum Accounting Society of Oklahoma:PASO-1949Petroleum Accounting Society of Oklahoma - Tulsa:PASO-T 1955Petroleum Accounting Society - Canada/Western Canada:PASWC-1953PASWC-1969PASWC-1976PASC-1983PASC-1986PASC-1988PASC-1996PASC-2011Council of Petroleum Accountants Societies, Inc. (COPAS):COPAS-1962COPAS-1968COPAS-1974COPAS-1976 (Offshore)COPAS-1984COPAS-1986 (Offshore)COPAS-1995COPAS-1998 (Project Team)COPAS-2005COPAS-2012 (Deepwater)[Page 16 - 3]
Accounting procedures have changed over the years in response to business needs as well as a need to clarify the forms. In early 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. Many changes to the accounting procedure, from one form to the next, simply clarify the intent and application of the form.
Accounting procedures have become more flexible over time to provide for automatic adjustment without the need for formal amendments. Gradually, many factors or percentages fixed in the accounting procedures have been replaced with provisions that allow the factors or percentages to be 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 anticipated that COPAS might eventually designate a source for vehicle rates other than the Petroleum Motor Transport Association (PMTA) rates. Indeed, when PMTA ceased publishing rates after 2013 and dissolved, COPAS designated Kelly Blue Book rates as an alternate source of rates.2
The 2005 COPAS accounting procedure added even more flexibility with a back-up interest rate on delinquent bills, and an adjustment to the overhead rates using a factor published by COPAS.3 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 may be amended from time to time.
The changes from one model form to another are best understood by comparing corresponding provisions of each form. In that way, the user becomes more familiar with, and develops a better understanding of, how the forms have evolved. Seemingly minor word changes can have significant impact, but it is beyond the scope of this paper to get into a detailed discussion of these differences. An explanation of some of these changes can be found in various COPAS publications.
C. Conflict between the Operating Agreement and Accounting ProcedureThe various AAPL 610 model form operating agreements for onshore operations state that the operating agreement will prevail over the accounting procedure in the event of any conflict.4 The few cost issues addressed in the operating agreement appear to reflect standard industry practice - e.g., charges for title work. Sometimes exceptions to the accounting procedure are added to the "Other Provisions" section of the operating
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agreement. Regardless of whether cost provisions in the operating agreement are specifically identified as exceptions to the general rules in the accounting procedures or standard provisions to the operating agreement, the parties are well advised to harmonize the operating agreement and exhibits rather than simply rely on the provision that states which form prevails.
The operating agreement seldom addresses conflicts between exhibits.5 For example, many gas balancing agreements (GBAs) allow an overproduced party to charge...
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