1. Revenue Accounting Issues For Royalty Owners
Donald A. Phend, CPA
Phend & Company, LLC
8500 W. Bowles Ave., Suite 301
Littleton, CO
(303) Phone
(303) Fax

2. 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

3. 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

4. Accounting Terms - Gas
MCF Measurement of Volume (1,000 cubic feet at standard temperature and pressure)
MMBTU Measure of heating content of gas
Chromatograph Theoretical content of various liquids (Gallons per MCF)

5. 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.

6. 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

7. 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

8. Run Ticket

9. Plumb Bob

10. LACT Meter

11. Oil Valuation Second step: Determine quality of oil
Sample taken (using “oil thief” device) for analysis
Gravity
BS&W- Basic Sediment and Water

12. Oil Thief

13. Pricing Calculation Posted Price Spot Price
Purchasers publish a daily or monthly field price
Spot Price
Based on market
Purchase contract may specify + or – from the above referenced prices

14. 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?

15. Gas Valuation First step: Measure the gas sold Paper chart meter
Electronic meter

16. Paper Chart Meter

17. Electronic Meter

18. 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

19. Gas Analysis Report
Heating Content
MMBTU / MCF 1.267

20. Theoretical Liquid Content (Chromatograph)
Gallons per MCF
Ethane
Propane
Isobutane
Normal Butane 0.486
Isopentane
Normal Pentane 0.170
Hexane

21. Physical Flow of Gas and Liquids
Wells
End
User
Market
Pipeline
Gas Plant
Unprocessed
Gas
Processed
Gas
Gathering
System
Field
Compressor
Liquids

22. Who Processes Gas?
Independent processing companies provide processing for a fee
Some large operators may have their own gas plants

23. Why Process Gas?
The raw gas at the wellhead may not meet pipeline specifications
Too high heating content (MMBTU/MCF )
Impurities (water, CO2, H2S)

24. 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.

25. Gas Processing Agreement

26. 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

27. 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”

28. POP Fees Liquids 40% Processed Gas 20%
Wells
End
User
Market
Pipeline
Gas Plant
Unprocessed
Gas
Processed
Gas
Gathering
System
Field
Compressor
Liquids

29. Gathering Fees Wells End User Market Pipeline Gas Plant Unprocessed
System
Field
Compressor
Liquids

30. Fuel (3% of Volume) Wells End User Market Pipeline Gas Plant
Unprocessed
Gas
Processed
Gas
Gathering
System
Field
Compressor
Liquids

31. Frac Fee (5 Cents / Gallon)
Wells
End
User
Market
Pipeline
Gas Plant
Unprocessed
Gas
Processed
Gas
Gathering
System
Field
Compressor
Liquids

32. 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.

33. 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.

34. Calculate Theoretical Gallons
Ethane x 1000 = 3382
Propane x 1000 = 1383
Isobutane x 1000 = 256
Normal Butane x 1000 = 486
Isopentane x 1000 = 194
Normal Pentane x 1000 = 170
Hexane x 1000 = 342

35. 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
Theoretical Gal Actual plant gal X Your Well
Theoretical Gal All Wells in Plant

36. 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.

37. Valuation of Ethane Actual Gallons of Ethane
Allocated to your well 3,111.44
Price of Ethane (Gal) $
Gross Value of Ethane to Well $1,343.36
Less POP (40%) (537.34)
Net Paid Producer

38. Calculate Gross Value

39. Calculate Net Value

40. Valuation on Check Net Value After Deduction $5,586.76
MCF at Wellhead ,000
Calculated Price Per MCF $5.59

41. 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

42. 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

43. Volumetric Loss
In this example FL&U was calculated as approximately MMBTU
Expressed in terms of residue gas this is
22.85 MMBTU X $5.59/MMBTU = $127.72

44. Summary Gross Value Sold at Plant $8,284.06 Plus Value of FL&U 127.72
Value At Wellhead 8,411.78
Less
POP (2,401.34)
Gathering (100.00)
Frac (195.96)
FL&U (127.72)
Net $5,586.76
Percentage of Net to Gross 66%

45. Summary 10% Royalty Owner Effect Gross value of 10% $841.18
Net Actually Received
Royalty Owner’s
share of deducts $273.51

46. “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

47. “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

48. “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

49. “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

50. 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

51. 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 arms-length sale

52. 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 .

53. 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!)

54. 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

55. 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)

56. 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

57. 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