Fundamentals of Oil & Gas Accounting 6th Edition

Book Preface

Oil and gas industry operations are generally classified as being either upstream or downstream. Upstream oil and gas operations include exploration, acquisition, drilling, developing, and production activities and are frequently referred to as exploration and production activities or E&P activities. Traditionally, downstream operations were defined to include transportation, refining, marketing, and distribution activities. However, recently it has become commonplace to further delineate downstream operations as being either midstream or downstream. Under this classification, midstream activities gener-ally include shipping and storage of oil and gas away from the point of production, while downstream refers to refining, marketing, and distribution of processed products. Inte-grated oil and gas companies are involved in upstream activities as well as midstream and/or downstream activities, whereas independent oil and gas companies are involved primarily in only upstream activities.

The US Securities and Exchange Commission (SEC) Reg. S-X details the require-ments relating to content and format of financial statements and reports filed by publicly traded companies in the United States. It specifically requires that financial statements be prepared in accordance with US Generally Accepted Accounting Principles (GAAP), with few exceptions. Reg. S-X Rule 4-10, “Financial Accounting and Reporting for Oil and Gas Producing Activities,” details the specific accounting rules and regulations that apply to companies engaged in “oil and gas producing activities.” Reg. S-X Rule 4-10 first appeared in Reg. S-X in 1978 and is continuously updated as needed.

The starting point for any discussion of upstream accounting and reporting is to under-stand specifically which activities are classified as oil and gas producing activities (as opposed to midstream or downstream activities). The SEC defines oil and gas producing activities in Reg. S-X Rule 4-10. Since Reg. S-X Rule 4-10 governs upstream oil and gas financial accounting and reporting for public companies in the United States, under-standing the SEC definition of oil and gas producing activities is critical. According to the SEC definition, oil and gas producing activities include the following:

• The search for crude oil, including condensate and natural gas liquids in their natural states and original locations.

• The acquisition of property rights or properties for the purpose of exploration and/or production of oil and gas.
• The construction, drilling, and production activities necessary to remove oil and gas from natural reservoirs, including lifting the oil and gas to the surface, gath-ering, treating, field processing, and field storage.1

In late 2008, the SEC significantly modified its definition of oil and gas producing activities to include the “extraction of saleable hydrocarbons, in the solid, liquid, or gaseous state, from oil sands, shale, coal beds, or other nonrenewable natural resources which are intended to be upgraded into synthetic oil or gas, and activities undertaken with a view to such extraction.”2 Until this time, the SEC had specifically excluded the production of hydrocarbons from nonconventional sources (i.e., oil sands, shale, and coal beds) from its definition of oil and gas producing activities. This change means that accounting for the cost of such operations must now conform to the rules and guidelines that govern accounting for oil and gas producing activities. Additionally, companies are now permitted to report reserves from nonconventional sources along with oil and gas reserves from conventional sources in their estimated oil and gas reserves. Oil and gas reserves are of critical importance in oil and gas accounting (i.e., depreciation, capitaliza-tion, impairment, etc.) and will be discussed throughout this book. Chapter 3 contains a thorough discussion of the SEC reserve definitions and classifications, while the SEC and the Financial Accounting Standards Board (FASB) oil and gas reserve disclosure require-ments are discussed in detail in chapter 16.

According to Reg. S-X Rule 4-10, oil and gas producing activities terminate at or near the point of production. Specifically, the SEC indicates that it is acceptable to define oil and gas producing activities as extending to the “first point at which oil, gas, or gas liquids, natural or synthetic, are delivered to a main pipeline, a common carrier, a refinery, or a marine terminal; or, in the case of natural resources that are intended to be upgraded into synthetic oil or gas, if those natural resources are delivered to a purchaser prior to upgrading, the first point at which the natural resources are delivered to a main pipeline, a common carrier, a refinery, a marine terminal, or a facility which upgrades such natural resources into synthetic oil or gas.”3 The SEC’s definition of oil and gas producing activities specifically excludes the following from its definition of oil and gas producing activities:

• Transportation, refining, or marketing of oil and gas
• Activities relating to the production of natural resources other than oil, gas, or natural resources from which synthetic oil and gas can be extracted
• Production of geothermal steam

Thus, in summary, the classification of oil and gas activities as being upstream oil and gas producing activities as opposed to midstream or downstream is of special significance in accounting. This is because the specialized financial accounting and reporting rules and standards that appear in SEC Reg. S-X Rule 4-10 apply only to upstream operations. These specialized accounting and disclosure standards are particularly complex. The standards apply to companies ranging in size from mega-majors to smaller US domestic producers who are either SEC registrants or privately held companies seeking to do their accounting in a manner that is consistent with generally accepted industry practices. These financial accounting and reporting rules and standards are the primary focus of this book.

Due to its long history of oil and gas production, the United States has a well-es-tablished petroleum-related operating infrastructure. Additionally, the legal environment under which oil and gas operations occur in the United States is relatively unique. This book provides the fundamentals of a broad range of accounting and reporting issues that relate to upstream E&P operations conducted in the United States.

It also provides an overview for oil and gas operations conducted outside the United States. A more detailed discussion of the accounting issues and challenges encountered in upstream oil and gas operations conducted outside the United States is given in chapter 18 of this book and also in International Petroleum Accounting.4