JVViews: February 2015 Issue
Editor's Note
A Call for Volunteers
Managing the Joint Account
Early Morning Sessions
January Luncheon Review: Time to Shape Up - Financially!
eStudies and Web Based Learning
JV Rep Tool + Role Opportunities
Looking for a New Opportunity?
PJVA Linkedin Group
Editor's Note
Starting this month in JV Views, we will endeavor to feature an article on some aspect of the oil and gas Joint Venture business. The intent is to provide some insight and education to the new and junior PJVA members as well as a reminder or refresher to the more seasoned members. This month’s article is titled “Managing the Joint Account – Important at $100/bbl, CRITICAL at $45/bbl”.
The article provides an overview of the various types of expenditures that can be incurred in our industry, how those expenditures are approved by and allocated to the owners, and some of the difference between Mineral Land and Joint Ventures. We hope you find this article and future ones to be informative and useful.
Thank you to Tracey Moore-Lewis, Lorie Caron and Grant Feddema for their assistance in drafting this first article.
A Call for Volunteers
Have you ever thought about getting involved in the PJVA? In a small way (as a volunteer) or in a bigger way (as Director)? Or have you never thought about this….until now? Either way, if you are interested in learning more about getting involved, contact any of the PJVA Directors and ask them about it. For a list of the PJVA Directors, go to the PJVA web site at www.pjva.ca and click on About PJVA / Board of Directors.
Managing the Joint Account
Important at $100/bbl, CRITICAL at $45/bbl
In 2015, with significantly lower commodity prices, we expect that the oil and gas industry will be watching every dollar it spends, and whether it should spend at all. Companies will scrutinize whether a project is economic or is really required for safe operations and what the Joint Venture contract provides for, exactly. It’s in these times of economic stress that we tend to monitor our properties, our partners and competitors, and our agreements with renewed intensity.
This month, the PJVA educational focus is on Managing the Joint Account; knowing what can and cannot be charged and seeking the appropriate partner approvals via Authority for Expenditures (AFE), Mail Ballots (MB), and Independent Operations Notices (ION).
Parties who are engaged in the joint exploration and development of oil and gas properties enter into agreements where costs are shared on a working interest basis or as otherwise agreed to between owners.
The focus of a producer is to economically produce oil and gas and to have its investment managed appropriately, whether it is self-managed, or managed through a joint venture, under the care and control of another party who acts as the Operator.
Regardless of who the Operator is, if a producer determines the most effective way to get their product to market is through a jointly owned or a third party facility, then this relationship is managed through a specific type of Land or Joint Venture (JV) agreement that defines the business principles, responsibilities, and division of expenses and revenues between the companies involved.
Land vs Joint Venture
There is a fine line between where the Mineral Land business ends and Joint Venture business begins or where the two reside hand in hand. This is often confused in our industry and gaining an understanding is very beneficial!
You may have heard this before, “Oh, it’s a piece of pipe, so it’s not Mineral Land’s responsibility.” So what makes a “piece of pipe” Joint Venture business rather than Mineral Land? If the pipeline was built to support only the well(s) governed under a particular Joint Operating Agreement (JOA) and no other well(s) are combined with it, then the pipeline would typically be governed under the Mineral Land Agreement because all working interests are exactly the same as the wells in the JOA. If the pipeline was built to service wells with varying working interests, then it likely would be governed by a Joint Venture arrangement. Likely before the pipe is built, Joint Ventures may negotiate business arrangements with the parties developing the area. Two options that likely would be covered are (1) do the well owners prefer to own and operate the facilities, or (2) do they prefer to pay a fee for service through the facilities? Either way, it is a Joint Venture agreement.
The Partners
When managing a joint venture with your partners, costs that are incurred are classified as either capital or operating expenses. These costs are managed through the joint account, pursuant to the governing JV Agreement. The joint account captures all debits and credits received as a result of joint operations and bills owners in accordance with the Agreement.
All companies have a mechanism to track capital and operating expenditures that exceed the Accounting expenditure limits, as well as day to day operating expenses for the property. These expenses are then billed to partners based on a specific division of interest and pursuant to the governing Agreement.
When an Operator is proposing a project that exceeds the Accounting expenditure limit, they must engage partners for approval of the project and the funds. Mineral Land would engage partners through an Independent Operations Notice and Joint Venture would use a Mail Ballot.
So, what’s the difference between an Independent Operations Notice and a Mail Ballot?
Independent Operations Notice
Any party who is a participant in a JOA can propose a project by forwarding an Independent Operations Notice (ION) to the other parties in the JOA. The CAPL Operating Procedure is very specific as to what is required on the ION so the participants have a good understanding of the project and timelines. Once the proposing party (usually the Operator under the JOA, but not always) forwards the ION with accompanying AFE, it alerts the other participants that they have 30 days from receipt of the notice to elect whether or not to participate. If notice has not been received by the proposing party within the time frame, then the party or parties will be deemed to have elected not to participate. The parties electing to participate will return their election to participate as well as the executed AFE. Once the applicable response period has expired, the proposing party shall give notice to the other parties specifying how the costs, risks and benefits of the operation will be shared. Those not electing to participate will be assessed a penalty and, once paid, will have the option once again to participate. The proposing party is obligated to begin the project within 90 days or the process begins all over again. Only one Independent Operations Notice can be served at a time (although some exceptions do exist). All cost overruns exceeding 10% require a Supplemental AFE approval.
Mail Ballots
In a Joint Venture agreement, only the Operator of the property can propose an operation or project. This can be done in an Operating Committee Meeting or via a Mail Ballot. Typically a Mail Ballot consists of a Cover Letter, a ballot page and supporting documents such as an AFE. The AFE is sent as a courtesy and is referenced as “Information Only”. Once a Mail Ballot is sent, the owners generally have 15 days (depending on the terms in the JV Agreement) to vote either affirmative, negative or they may abstain from voting. If the ballot is not returned in the appropriate time frame, the owner is deemed to have voted affirmative. If a party abstains from voting, they are also deemed to have voted affirmative (check your Agreement for deeming provisions though!). Once the deadline passes, the Operator tallies the votes, determines whether the project was approved or defeated based on the voting provisions in the Agreement and is responsible to forward the results to the owners. If the Mail Ballot was approved, even those parties who voted negative are obligated to pay their proportionate share of the project. An Operator can also propose several motions on a single Mail Ballot.
What happens when a project changes or has a cost overrun?
Supplements
A supplement (S1) is where the scope of the project remains the same, but the costs, for whatever reason, have increased. In a Joint Venture Agreement, AFE supplements are forwarded to owners as supporting documentation or for “Information Only”, as the parties originally approved the scope of project on the Mail Ballot, not the exact cost of project. An example would be the number of days in the field expected to repair a pipeline were exceeded due to weather delays.
Revisions
A revision (R1) reflects a change in the project scope and that change requires further approval from owners. In such instances, the costs may or may not have changed, but the project requirements have. An example would be a facility that originally received approval to purchase one tank but a design re-evaluation determines that a tank and tank rack are required. The revisions would then be sent to the owners for approval.
Joint Account Costs
Capital Costs are, generally, expenditures incurred in connection with the Initial Construction of the Facility (including commissioning and testing immediately after Initial Construction), upgrades, engineering studies, Enlargements (increasing capacity), Modifications (including reducing capacity or “moth balling”) and other similar expenditures so designated by the Operating Committee. These costs are normally issued for approval under a Mail Ballot or AFE and agreed to by the joint owners. Check your Agreement for the terms and definitions applicable to your property/facility as they are often not “boiler plate”.
Operating Costs are, generally, expenditures associated with the ongoing operation and maintenance of the property/facility and are often considered “consumables”. These costs are the day-to-day expenses or ongoing costs associated with running a business, or an area, property, facility or well. Operating costs tend to include replacement of minor equipment parts, routine repairs, and maintenance expenses. Examples of operating costs are:
- company and contract labour
- chemicals
- electricity
- certain costs associated with facility turnarounds
Generally speaking, operating costs would not increase the original design life or productive capacity of the property, but should be an accurate reflection of what it costs to run the property. Check your Agreement for the terms and definitions applicable to your property as they are often not “boiler plate”.
Capital and Operating Costs are generally classified into four categories:
- Direct Costs are those directly attributable to a joint operation and shared amongst the parties and includes allocated costs (see below). These costs are generally referred to as “directly chargeable”. Check the JV Agreement in the Accounting Procedure (which may be a stand-alone attachment or referenced as a particular version of the PASC Accounting Procedure).
- Indirect Costs are those that are applied to a joint operation usually on the basis of a percentage applied to the direct costs and shared amongst the parties. These costs are generally referred to as “Overhead”. Overhead is relevant to both capital and operating expenditures. The Accounting Procedure defines these costs and will set out the negotiated overhead rates.
- Operator’s Costs are those that are for the sole account of the joint venture operator. These costs are not flowed through to the joint account and therefore are not shared amongst the parties (eg. a 100% facility that is within the joint area or certain employee costs in head office.)
- Allocated Costs are typically lower dollar direct costs (see above) for an area that may not be easily attached to a specific well or facility. They tend to be grouped in an area cost centre and periodically during the year are distributed among all operations within a given area. Allocated costs may also include bulk purchased items; for example, chemicals. An Operator may receive one bill from its supplier, and then the accountants allocate a share of that product invoice to each property that uses the chemicals.
Fixed vs. Variable Operating Costs
In addition, when operating expenses are charged to a joint account they can be further subdivided into fixed or variable operating expenses. The distinction is important as the two costs can sometimes be allocated differently. In the PJVA model CO&O Agreement, Appendix IV outlines the definition of fixed and variable operating costs and they are usually described as:
"Fixed Operating Costs" means those Operating Costs that do not vary with production or throughput volume, such as, but not limited to, property taxes, insurance and surface lease rentals. These are often referred to as “costs of ownership” (costs that must be paid regardless of the amount of throughput) and are usually (but not always) shared based on the owners’ working or “capital” interest in the facility.
"Variable Operating Costs" means those Operating Costs that remain after excluding Fixed Operating Costs and that vary with throughput volume of Inlet Substances. These can be referred to as “costs of operation” and are usually (but not always) shared based on each producer’s pro-rata share of throughput through the facility. So if an owner has zero throughput, that owner would pay no Variable Operating Costs. Doing a year-end equalization or “13th month adjustment” can also be used to adjust the allocation of costs at the end of a production year.
Fixed Operating Costs can be allocated based on capital interest or throughput interest. It will usually depend on how significant these costs are compared to the Variable Operating Costs and how significantly the capital interest can vary from the throughput interest. Variable Operating Costs are usually allocated based on the throughput interest (to account for different wells with different ownerships and different production rates) but can sometimes be allocated based on capital interest (for example, if all wells tied in to a facility have the same ownership). It is very important to check the governing JV Agreement to verify how these costs are actually supposed to be shared.
The following diagram is a visual representation of the various operating cost splits:
Auditing the Joint Account
Audits of the Joint Account are important! They are conducted against the Land and/or Joint Venture Agreements to determine if capital and operating costs have been allocated correctly and accurately. The Agreements contain clauses detailing specific audit provisions, timelines that they must be conducted within and review parameters by non-operators. This process helps protect the interests of all parties (i.e. a second set of eyes).
It is important to do things right the first time – it saves time and money in the long run (G&A costs). Stewarding to your agreements may alleviate partner concerns which, if unresolved, may affect your profit and net income. The bottom line is, create value rather than destroy it! Depending on the agreement (Mineral Land or Joint Ventures) the Land Negotiator or Joint Venture Representative should work closely with its Joint Venture Accountants and review everything relating to costs and allocation under the governing agreements to ensure that the expenses, whether capital or operating, are in accordance with the terms of the governing agreement.
Tracey Moore-Lewis (Education Director – PJVA)
Lorie Caron (Administration Director – PJVA)
Grant Feddema (Marketing Director – PJVA)
Kent Black (Publicity Director – PJVA)
Early Morning Sessions
We kicked off the New Year of Early Morning Sessions in new digs. After many years of gathering at the Suncor Energy Center boardroom to hold our discussions, we moved our act a few blocks west, to the confines of The Petroleum Club.
Members of the CO&O Task Force, Tim Reimer, Crawford Hutchinson and Lynda MacNeill updated a full house of attendees on their progress with revisions to the model CO&O Agreement. Task Force members have been working on the document for 3 years now, reviewing every clause and every section in an effort to make it more functional to fit operations. The last update to the CO&O was in 1999 so we can all agree the document needed to be looked at! Some of the concepts re-worked in the CO&O include capacity (the determination of), measurement, cost sharing (to actually define capital costs and operating costs), dispositions (requiring consent) et al. Formal roll-out of the agreement is expected by the end of the year, however, changes could still be made between now and then. Stay tuned.
The Task Force’s slide presentation will be added to the PJVA website shortly for anyone interested in viewing.
The Pad Sharing Agreement Task Force will be moderating the next EMS on February 25th, 2015. We hope to see you there.
January Luncheon Review: Time to Shape Up - Financially!
Enjoying another great turnout, PJVA’s January 20th luncheon featured Scotia Waterous’s David Baboneau and Scotia McLeod’s Brett Standen and Brad Stangeland who spoke about the current investment markets, Options and where to invest outside the Oil & Gas sector. Our members readily engaged with the issue and gained a much better perspective about our current economic landscape.
The presentation kicked off with a discussion of current Oil & Gas market perspectives as this was top of mind for many PJVA members. Highlighting an important distinction between our present downturn and the slump in 2008, the presenters pointed out that the world’s economy is doing comparatively well which is expected to provide a little more stability than what we faced in 2008. They explained why we are experiencing the current price drop in oil, zeroing in on the political situation, oversupply and OPEC’s decision to stay the course as some leading factors. David cautioned that the next six months will be volatile and it will be difficult to forecast what’s in store for NG and oil prices. However, energy is still worth investing in because it will rebound.
The discussion then turned to Options and, specifically, the ‘Call’ and ‘Put’ Options and how such investments would have played out for individuals. Through a couple of examples, Brad and Brett made it clear that a protective Put would have been a great investment in 2014. They concluded by highlighting some good investment opportunities outside Oil and Gas, mentioning companies such as Couche-Tard, Agrium and Canadian Tire as examples. What do these good investment opportunities have in common? The presenters pointed out, these companies have the ability to increase their dividend and pay down debt as they grow, and their business is not negatively impacted by lower oil and gas prices.
David, Brad and Brett touched on a wealth of good information and gave a great presentation. If you would like to view the slide deck from their talk, it will be available on the PJVA website at www.pjva.ca. If you would like to contact Brad or Brett, please find their contact information below:
Brad Stangeland
(403) 806-4107
Brad.Stangeland@scotiamclead.com
Brett J. Standen
(403) 213-7325
Brett.Standen@scotiamcleod.com
eStudies and Web Based Learning
PJVA is excited to offer customizable and accessible web-based learning options to industry professionals. PJVA has a suite of web based courses geared towards practicing and prospective JV professionals and personnel involved in the development and operation of a Joint Venture facility.These courses, available via the eStudies link at www.pjva.ca, are a supplement to the Joint Venture Certificate Program offered through PJVA and Mount Royal University. The courses offered on eStudies are identical to the courses offered at Mount Royal, the only distinction being that the Mount Royal courses are applicable towards the Joint Venture Certificates while eStudies are not. As well, the eStudies courses are offered in segments such that the student can customize and streamline their learning experience.
eStudies courses include Joint Venture Agreements, with modules in Construction, Ownership and Operating Agreements, Unit Agreements, and Service Agreements, Joint Venture Administration as well as Joint Venture Analyst Levels 1 and 2. The Agreements courses offer excellent background knowledge to anyone who works with or is bound by a Joint Venture Agreement. Joint Venture Administration details exactly how work is to be conducted within the legal framework of Joint Venture agreements. The Analyst courses provide understanding of Joint Ventures techniques and processes.
Check out www.pjva.ca today and click on eStudies!
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PJVA was incorporated in 1985 to represent individuals and organizations involved in petroleum joint ventures. JVViews is published to keep members informed about upcoming PJVA and industry events, courses and seminars offered and/or sponsored by PJVA and current projects being facilitated by the Association.