ACC 8211 Oil and Gas Accounting

BAYERO UNIVERSITY, KANO
FACULTY OF SOCIAL AND MANAGEMENT SCIENCES

DEPARTMENT OF ACCOUNTING
9th June, 2014
COURSE: ACC 8211 (Oil and Gas Accounting)
CLASS: M.Sc. Accounting
SESSION/SEMESTER: 2013/2014 Session First Semester
LECTURER: Kabir Tahir Hamid, PhD
CONSULTATION: Strictly by Appointment
OFFICE: A8, Department of Accounting, Aminu Alhassan Dantata School of Business, New Campus,
Bayero University, Kano.
A.COURSE DESCRIPTION
This course is designed to introduce students to the accounting system in use in the petroleum industry of
the Nigerian economy, with particular emphasis on the system in the upstream sector of the industry.
Students will also be exposed to the various types of operating contracts in the industry and how they are
being accounted for. The nature and relevance of the Nigeria Petroleum industry, the differences between
downstream and upstream sectors of the industry, accounting principles, practices and procedures relevant
to various phases of oil and gas operations, petroleum products pricing and marketing, types of operating
contracts in the Nigerian petroleum industry JV, PSC and SC, financial and fiscal monitoring
mechanism, accounting standards and auditing in the petroleum industry.
B. COURSE OBJECTIVES
The Objectives of this course are to:
i) expose students to the nature and historical development of oil and gas accounting;
ii) develop an understanding of the basic characteristics and differences between the downstream and
the upstream sectors and their activities;
iii) develop an understanding of accounting principles, practices and procedures relevant to various
phases of oil and gas operations;
iv) develop an understanding of accounting for exploration, ditching, and development costs;
v) develop an understanding of petroleum products pricing, accounting standards and financial
statement disclosures in the oil and gas industry;
vi) develop an understanding of the various types of operating contracts in the petroleum industry and
how they are being accounted for;
vii) develop an understanding of petroleum products pricing and marketing; and
viii) develop an understanding of financial and fiscal monitoring mechanism, accounting standards and
auditing in the petroleum industry.
C. COURSE CONTENTS
1. History and Nature of Oil and Gas Operations
1.1 Definition of Petroleum
1.2 Origin of Petroleum, Its Industry Characteristic and Activities
1.3 The History of the Nigerian Oil and Gas Industry
1.4 The Nature of Petroleum Assets and the Process of Acquiring It
1.5 Accounting Dilemmas in Oil and Gas Accounting
1.6 The Upstream and the Downstream Sectors of the Nigerian Oil industry
1.7 NNPC and DPR and Their Roles
1.8 PPPRA and the Proposed Petroleum Industry Bill (PIB) 2011
2. Oil Prospecting and Reserves Valuation
1
2.1 Steps in Prospecting for Oil and Gas

2.2 Types of Oil and Gas Wells
2.3 Estimation and Valuation of Oil and Gas Reserves
2.4 Classification of Reserves
2.5 Oil and Gas Reserves Estimation
3. Arrangements, Agreements and Contracts in the Nigerian Petroleum Industry
3.1 Types of Operating Contracts in the Petroleum Industry
3.2 Contract Arrangements in the Nigerian Petroleum Industry and their Operations
3.3 Financial and Fiscal Monitoring Mechanisms of Agreements in the Petroleum Industry
4. Accounting Principles and Standards in the Oil and Gas Industry
4.1 Application of GAAPs in the Oil and Gas Industry
4.2 Classification of Costs in the Oil and Gas Industry
4.3 Methods of Accounting in the Oil and Gas Industry
4.4 Accounting Standards in the Oil and Gas Industry
5. Procedures in Oil and Gas Accounting
5.1 Basic Accounting Transactions
5.2 Depreciation, Depletion and Amortization (DD & A)
5.3 Accounting for Oil and Gas Exploration and Acquisition Costs
5.4 Accounting for Oil and Gas Development and Production Costs
5.5 Accounting for Crude Oil Refining, Petrochemical and Liquefied Natural Gas
5.6 Petroleum Products Pricing and Marketing
5.7 Typical Oil and Gas Financial Statements and Oil and Gas Accounting Disclosure
D. RECOMMENDED TEXT BOOKS
i) Fundamentals of Oil and Gas Accounting by Gallun, R. A., Wright J. C., Nichols, L. M. and
Stevenson. J. W.
ii) Financial Accounting and Reporting by Oil and Gas Producing Companies by FASB
iii) Accounting for Oil and Gas Exploration, Development, Production and Decommissioning Activities
by SORP
i) International Petroleum Accounting by Wright, C. J. and Gallun, R.A.
ii) Financial Reporting in the Oil arid Gas Industry by Pricewaterhousecoopers
iii) Petroleum Accounting, Principles, Procedures and Issues by Gallun, R. A. and Wright
iv) Fundamentals of Petroleum by Kate. V.D.
v) Petroleum Accounting: Principles, Procedures & Issues by Jennings, D. R., Feiten, J. B. and Brock,
H. R.
E. METHODOLOGY
Discussion papers, covering the theoretical aspects of each topic, would be prepared and presented in the
class, to be followed by discussion exercises. Some of the exercises would be attempted in the class, while
the rest would be left to the students to practice on their own.
F. GRADING FORMULA
Continuous Assessment
40%
Semesters Examination
60%
Aggregate
100%
The continuous assessment marks are to be absorbed through snap test (s) to be given without notice,
scheduled test(s) and/or assignment(s).
1.0 HISTORY AND NATURE OF OIL AND GAS OPERATIONS

1.1 Definition of Petroleum
The term petroleum is said to have been derived from two Latin words, Petra, meaning rock, and Oleum,
meaning oil. Eventually, the term petroleum came to refer to both crude oil and natural gas. More broadly
defined, Petroleum (i.e. crude oil and natural gas) refers to mixture of hydrocarbons that are molecular in
nature, in various shapes and sizes of hydrogen and carbon atoms, found in small connected pore spaces of
some underground rock formations. While crude oil refers to hydrocarbon mixture produced from
underground reservoirs that are liquid at the normal atmospheric pressure and temperature, natural gas
refers to hydrocarbon mixtures produced from underground reservoirs that are not liquid but gaseous at
the normal atmospheric pressure and temperature. Hydrocarbons are compounds containing only the
elements hydrogen and carbon, which may exist as solids, liquids or gases.
1.2 The Origin of Petroleum, Its Industry Characteristics and Activities
1.2.1 The Origin of Petroleum
Geologists and Geophysicists dealing with the earth crust propound that rock formations within the earths
crust consist of igneous, metamorphic and sedimentary rocks. While, igneous rocks are rocks that are
formed as a result of cooling and solidification of molten magma, sedimentary rocks, such as sandstone,
developed as a direct result of erosion, transport and deposition of pre-existing igneous rock, along with
remains of plants and animals. Eroded particles of igneous rocks are carried to low areas and are deposited
into sedimentary layers through the action of wind and water. Metamorphic rocks develop when igneous
or sedimentary rocks are subjected to heat and pressure resulting from the weight of overlying rocks
stresses, thus converted into metamorphic slates and quartzite. Nearly all significant oil and gas reservoirs
in the World today are found in sedimentary rocks, as the accumulation of oil or gas in igneous or
metamorphic rocks is very rare; however petroleum can be reservoired in these types of rock under certain
albeit rare conditions. The extreme heat and pressure associated with these types of rocks drives off or
burns any organic material or hydrocarbons.
It can therefore be said that, out of the three types of rocks explained above (namely, igneous, sedimentary
and metamorphic rocks) only sedimentary rocks form the source in which hydrocarbons reservoirs are
found. Even in the sedimentary rocks, hydrocarbons are possibly found in only sandstone (shale) and not
limestone and dolomite. In other words, sandstones are the source rock in which oil and gas is formed and
accumulated, while limestone and dolomite evolve through chemical processes. However, it is important
to note that the various rock formations, as well as, the various changes in the earth's crust do not, by
themselves, explain the evolution of oil and gas.
The earth is made up of a core over 4,000 miles in diameter surrounded by the earth's mantle, which is
approximately 2,000 miles thick. The earth's surface is underlain by the lithosphere, a relatively thin
layer, some 125 miles in thickness, that is composed of the crust and upper mantle. Commercial oil and
gas are found only in the crust of the earth.
Explanations propounded on the origin of petroleum have their bases in geology and geophysics. Geology
is the science that studies the planet earth, the materials it is made up of, the processes that act on these
materials, the products formed, and the history of the planet and its life forms since its origin. Most
geological studies are focused on aspects of the earth's crust because it is directly observable and is the
source of energy and minerals for today's modern industrial societies. On the other hand, geophysics is
the science that studies the earth by quantitative physical methods.
Over the last two centuries, two theoriesthe inorganic theory and the organic theoryhave been
advanced to explain the formation of oil and gas. Although no one theory has achieved universal
acceptance, most scientists and professionals believe in the organic origin of petroleum. The inorganic
theory recognizes that hydrogen and carbon are present in natural form below the surface of the earth
(diamonds, for example, indicate the presence of carbon in the earth's mantle). Different related theories
explain the combination of the two elements into hydrocarbons. These include the alkali theory, carbide
theory, volcanic emanation theory, hydrogeneration theory, and the high temperature intrusion theory.
Except for the intrusion theory, most of the inorganic theories have been largely discounted. The intrusion
theory argues that high temperatures applied to carbonate rocks can produce methane gas and/or carbon
dioxide. This theory applies only to gas, not to the heavier hydrocarbons (oil).
Based on abundant direct and indirect evidence, most scientists accept the organic theory of evolution of
oil and gas. According to geological research, the earth was barren of vegetation and animal life for
roughly one half of an estimated five billion years of the earth's existence. Approximately 600 million
years ago, an abundance of life in various forms began in the earth's oceans. This development marks the
beginning of the Cambrian period in the Paleozoic era. Nearly 200 million years later (in the Devonian
period), vegetation and animal life had spread to the landmasses. The Paleozoic (roughly 350 million
years), Mesozoic (roughly 150 million years), and Cenozoic (roughly 1000 million years), eras have been
labeled as successive and definitive geological time periods by geologists, which brings us up to the
present. These time periods are shown in Table 1.
Table 1: Geologic Time Period
Era
Cenozoic
"Modern Life"
Mesozoic
"Middle Life"
Paleozoic
"Ancient Life"
Period
Quaternary
Tertiary
Cretaceous
Jurassic
Triassic
Permian
Carboniferous
Devonian
Silurian
Ordovician
Cambrian
Approx.
Duration in
million yrs.
3
63
71
54
35
55
65
50
35
70
70
Indicative New
Life Forms
Large Mammals
Large Dinosaurs
Early Reptiles,
Amphibians and
Fish
Bacteria, Algae
and Jellyfish
Crypotozoic or Precambrian
4,000
Approximate age of the earth
4,600,000,000 years
The basic premise is that oil and gas are formed from chemical changes taking place in plant and animal
remains. Through the process of erosion and transportation, sediments are carried from the land down the
rivers and, together with some forms of marine life, settle into the ocean floor. Most hydrocarbons are
believed to be derived from tremendous volumes of plankton, algae, and bacteria common in ocean basins
and lakes, and other marine lives that lived millions years ago in low land areas, usually in the oceans. The
theory posits that the remains of plants and animals were deposited along with the eroded particles of
igneous rocks, which have been weathered through physical and chemical reactions. The weight and
pressure of layer upon layer of the eroded particles of the igneous rocks resulted in the formation of
sedimentary rocks, and some chemical and bacterial processes turned the organic substances in the
4
sedimentary rock into oil and gas. The sedimentation process can be observed even within an individual's
lifetime. For example, the delta area at the mouth of a large river is formed by sedimentation. Layer after
layer of silt, mud, particles of sand, and plant and animal life are deposited on the ocean floor, with a great
portion of the plant and animal life coming from the ocean itself. Anaerobic bacteria in the sediment aid in
breaking up the organic material and releasing oxygen, nitrogen, phosphorus, and sulfur from the organic
material, leaving the balance with a much higher percentage content of hydrogen and carbon and, thus, a
more petroleum-like composition.
After formation, oil and gas move upward through the layers of the sedimentary rock due to pressure and
the natural tendency of oil to rise through water. The petroleum migrates upwards towards the earth
surface through the porous rock formations until it becomes trapped by an impervious layer of rocks.
When this occurs, the oil remains there and forms a petroleum reservoir. A reservoir is a rock formation
with adequate porosity and permeability to allow oil and gas to migrate to a well bore at a rate sufficient
as to be economically producible (most geologists believe the earth initially formed from molten rock, or
magma, and cooled into solid igneous rocks. During the cooling and contraction processes, some rock
solidified beneath the surface). The impervious layer formed a seal which prevent hydrocarbons from
leaking to the surface. If the seal is inadequate, little quantity of the hydrocarbon escapes to the surface.
This is known as oil seeps. Seeps at the surface are often used as indicator of potential hydrocarbon
reservoirs in the subsurface.
In some instances, oil and gas migrate directly to the reservoir area. More often, however, movements in
the earth's crust caused additional shifting, folding, bends, and fissures, and a secondary migration of the
oil and gas took place through porous layers until another impermeable seal was reached. This may occur
when an area is subjected to new tectonic forces, earth quakes, tsunami, etc. To search for new oil and gas
fields, therefore, geologists and geophysicists devote their efforts to understanding the distribution of
rocks that could be sources, seals, and reservoirs in an attempt to develop locations for potential traps
within petroleum systems. While it can be seen that oil and gas are formed through the sedimentary
process, this does not necessarily mean that the oil and gas have remained in the source beds or places of
origin. Hydrocarbons are known to have been preserved for hundreds of millions of years and the process
of hydrocarbon formation is undoubtedly continuing, but much more slowly than is the rate of
consumption of hydrocarbons. Generally, marine and lacustrine source rocks generate oil whereas coal
source rocks commonly generate natural gas.
The impervious rock that prevents further movement of the oil and gas is known as trap. There are four
broad classifications of traps, namely:
(1) structural strap
(2) truncation trap
(3) stratigraphic trap, and
(4) a combination trap.
Structural trap is a result of upheavals of the earth and may take the form of an anticline, fault or dome.
Anticlines are the most significant reservoirs of hydrocarbons and are estimated to contain around 80 per
cent of the worlds oil. However, in order for an oil and gas reservoir to have been formed, four necessary
conditions must have been met. These conditions are:
(1) there must have been a source of oil and gas, i.e. the remains of plants and animals;
(2) heat and pressure resulting in the transformation of the organic substances of the remains of plants
and animals into oil and gas;
(3) Porous and permeable sedimentary rock formations through which the oil and gas was able to
migrate upwards after formation.
Porosity is the measure of the pore openings in a rock in which petroleum can collect; none of the
sedimentary rocks are completely solid. The greater the porosity, the more petroleum the rock can
hold, and the closer the rock is to the surface, the more the porosity. It is within the pore spaces that
the oil and gas initially accumulated, together with some water called connate water. The pore
spaces may constitute up to 30 percent of the volume of the reservoir rocks that are relatively close
to the surface. As depths increase, the porosity of the formation tends to decrease as the result of
compaction from the weight of the overlying layers of sediment. Permeability, on the other hand,
measures the relative ease with which the oil and gas can flow through the rocks and is expressed in
millidarcies. The flow of oil and gas through a reservoir takes place in microscopic channels
between pore spaces. In some cases fractures are also present that provide greater permeability. If
there is high permeability, oil and gas can move through the formation with relative ease. Low
permeability will decrease or even block the movement of fluids through the formation. Though,
permeability may be improved through fracturing (i.e. introduction of a mixture of sand and water or
oil into the formation under high pressure to clean the channels between the pores) and acidizing (i.e.
introduction of hydrochloric acid into the formation to enlarge and clean the channels between the
pores), porosity is difficult, if it impossible to be improved.
There are two types of producing reservoirs, namely (1) oil reservoir and (2) gas reservoir. While the
components of oil reservoir are crude oil, basic sediment, water and associated gas, the components
of gas reservoir are non-associated gas, condensates and natural gas. To be commercially viable
therefore, a petroleum reservoir must have adequate porosity and permeability and must have a
sufficient physical area of rock that contains hydrocarbons. In other words, the reservoir must
contain high quantity of oil and gas, so that when produced and sold, cover the cost of production
(including payment of royalties to the government) and leave some profit margin for the producing
company and tax revenue to the government. Condensate are hydrocarbons that are in a gaseous
state at reserviour conditions but condense into liquids as they travel up the wellbore and reach
surface conditions.
(4) an impervious rock formations that a prevents the oil and gas from further migration, thereby
enabling the oil to collect.
Evidence Supporting the Organic Theory of Oil and Gas Formation

The following are the evidence supporting the organic theory of the origin of oil and gas:
1. sedimentary beds are rich in organic matter;
2. some of the chemical components of oil are the same as those found in plants and animals;
3. the chemical composition of oils and gases derived from so called source rocks match the
observed composition of oils and gases in nearby reservoirs; and
4. the recent discovery of bio-fuel (a fuel that is derived from biomass-recently living organisms or
their metabolic byproducts-from sources such as farming, forestry, and biodegradable industrial
and municipal waste) support the proposition that hydrocarbon itself is most likely to have been
originated from the remain of plants and animals.
1.2.2 Characteristics of the Petroleum Industry
Although the primary purpose of this course is to deal with the accounting principles and practices in the
oil and gas industry, it is considered that the appreciation of operational aspects of the industry is
important for a better understanding of accounting practices in the industry. Basically, the objective of the
oil and gas industry is to exploit and recover hydrocarbons (crude oil and gas) in its natural form from
large sub-surface reservoirs, subject it to changes through chemical and physical processes in a refinery,
gas plant or petrochemical plant in order to obtain products such as gasoline, diesel, kerosene, jet fuel,
lubricants, asphalt, bitumen, petrochemicals and treated natural gas.
It is important to add that although Exploration and Production (E&P) procedures and processes are more
important to geologists and geophysicists, the knowledge of the procedures and steps involved in locating
and acquiring mineral interest, drilling and completion oil and gas wells and producing, processing and
selling petroleum products is necessary in order to understand their accounting implications. Hence, it is
important that accounting students and accounting practitioners become familiar with the process.
Oil and Gas industry is one of the vital industries in the world, largely because of its strategic role in every
economy and the world, at large. The distinctive features that characterized the industry are derived from
the nature of crude oil, its operations and commercial arrangements. Some of these characteristics of the
oil and gas industry may include the following:
1. High Level of Risk and Uncertainty: The level of risk in oil and gas operations can be both
substantial in amount and wide in scope, and locating new well sites even in already established
field is surrounded with high level of uncertainties. Exploration operations are risky because oil is
hidden underground and the only conclusive evidence of its presence in any form, quantity and
quality is drilling. There is therefore a geological risk of drilling and hitting a dry hole. In addition,
there are market risk (the risk of not finding an outlet for production at a satisfactory price),
sovereign/political risk (the risks of nationalization of operations, currency devaluation, licensing
and exploration agreements), partner risk (the risk of partner default, distrust, unwillingness,
inability or delay in paying due shares of cost of exploration and development), youth militancy
risk (the risk of kidnapping of personnel and vandalisation of equipments by militant youths) and
tax risk (the risk of unexpected change in tax provisions) . Consequently, the risk of loss of capital
is very high.
2. Dominance of the World Economy: The second feature of oil and gas industry is its dominance
of the world economy, in terms of financial figures, unlimited potentials as raw material, global
economy development and international politics and touches the lives of people in any more ways,
anywhere on earth. Exxon Mobil, Saudi Aramco, Chevron and Shell B.P. are one of the largest
companies in the World today in terms of financial figures and profitability.
3. Long Lead-Time between Investment and Returns: Even in normal circumstances, upstream
activities can take several years, thereby complicating the risk further in oil and gas operations.
The operations are highly capital intensive, requiring large amounts of capital investment up-front.
The lead-time therefore stretches the capital outlay and brought about long gestation period
between investment and return from the investment.
4. Significant Regulation by Government Authorities: The petroleum industry, in any part of the
world is subject to involvement, participation, intervention and regulation by various governments
and its agencies. This is as a result of the indispensability of oil, its depletable nature and its
influence in international politics.
5. Technical and Operational Complexity: Finding oil has proved to be a difficult task and
therefore demands the best technology possible. This results from the complexity of operations,
especially in the offshore terrain.
6. Specialized Accounting Rules for Reporting and Complex Tax Rules: There are fundamental
dissimilarity between financial/tax accounting in the oil and gas industry and other industries. This
arises from the nature of oil and gas industry, its highly technical operations and specialized
activities.
7.
Lack of Correlation between Investment and the Value of Reserves: The amount invested in
oil and gas operations usually does not bear any relationship with the value of oil and gas reserve,
as a result of the inherent difficulties in estimating the value of reserves and the need for up-front
large investments in petroleum exploration and production.
Although, these characteristics are most evident in Exploration and Production (E&P) functions of the oil
and gas industry, they are found in other segments of the industry in varying degrees.
1.2.3 Activities/Segments in the Nigerian Oil and Gas Industry
Nigerian oil and gas companies may be involved in four different types of functions or segments, namely
Exploration and Production (E&P), storage and transportation, refining and hydro processing, and
distribution and marketing. A company may decide to operate in any of the four segments or a
combination thereof. The four segments are briefly explained below:
1. Exploration and Production (E&P): Exploration is the search for oil with a view to discovering
oil-in-place, while production is the removal of oil from the ground and surface treatment.
Companies that are involved in E&P are only to explore and produced the discovered oil and gas
and sell it depending on the nature and conditions of the contract, i.e. concession, joint venture or
production sharing contracts. This segment is an upstream activity.
2. Storage and Transportation: This segment encompasses the storing and moving of petroleum
from the production field to crude oil refineries and gas processing plants. Once crude oil and gas
produced and treated, it is stored in tanks and later transported to refineries and gas processing
plants by road tankers, railway tankers, sea oil tankers, and pipelines.
Table 1: Crude oil pipelines in Nigeria, 2012
Source: OPEC Annual Statistical Bulletin, 2013 Pp 72-73
Table 2: Gas pipelines in Nigeria, 2012

Table 3: Petroleum Product Pipelines in Nigeria, 2012
Source: OPEC Annual Statistical Bulletin, 2013 Pp79-80

3. Refining and Hydro Processing: Refining is the treatment of crude oil in order to form finished
products and may extend to the production of petrochemicals. Crude oil refining involves the
breaking down of hydrocarbon mixture into useful products, through distillations, cracking,
reforming and extraction process. Different mixtures of petroleum have different uses and
economic value. Numerous useful products that are derived from petroleum include the following:
(a) Transportation Fuels [Automotive Gas Oil (AGO), popularly known as diesel and Premium
Motor Spirit (PMS) popularly known as petrol, etc].
(b) Heating Fuels, like the Dual Purpose Kerosene (DPK), popularly known as kerosene.
Kerosene (DPK) is a thin, clear combustible hydrocarbon liquid with a density of
0.780.81g/cm obtained from the fractional distillation of petroleum between 150 and 275 C.
Kerosene is widely used to power jet fuel engines, rockets and as a heating fuel in
households. The combustion of Kerosene is similar to that of diesel with Lower Heating
Value of around 18,500 Btu/1b, or 43.1 MJ/Kg, and its Higher Heating Value is 46.2MJ/kg.
(c) Liquefied Petroleum Gas (otherwise known as cooking gas is made up of 70% propane- C3
and 30% butane-C4). It is a product of petroleum refining and, it can also be obtained from
natural gas processing. It consists of hydrocarbons as vapors, at normal temperatures and
pressures, but turns liquid at moderate pressures. LPG uses include; cooking, heating in
households, fuel for transport etc.
(d) Natural gas and residual fuel can be burned to generate electricity.
(e) Petrochemicals from which plastics, as well as clothing, building materials, cream, pomade,
soap, petroleum jelly, etc are produced.
Figure I: World Refinery Capacity (m b/cd)
Source: OPEC Annual Statistical Bulletin, 2013 Pp 43
10
4. Distribution and Marketing: Distribution and marketing involve the activities associated with
getting finished products from distribution points into the hands of end users. Marketers are of
different categories, namely major marketers (like Oando PLC, Mobil Unlimited, Con Oil,
Texaco, etc.), independent markets (like Azman oil and gas, Sani Brothers Ltd., Pure Oil, DanKano Petroleum, etc) and part-time marketers.
Table 4: Output of petroleum products by type in Nigeria (1,000 b/d)

Table 5: Oil Demand by main petroleum products in Nigeria (1,000 b/d)

Figure II: World Output of Petroleum Products (m b/d)
11
Table 6: OPEC Reference Basket (ORB) and Corresponding spot components prices ($/b)

The OPEC Reference Basket (ORB) price was introduced on January 1, 1987. Up to June 15, 2005, it was
the arithmetic average of seven selected crudes. These were: Saharan Blend (Algeria); Minas (Indonesia);
Bonny Light (Nigeria); Arab Light (Saudi Arabia); Dubai (United Arab Emirates); Tia Juana Light
(Venezuela); and Isthmus (Mexico). Mexico is not a Member of OPEC. As of June 16, 2005, the ORB is
calculated as a production-weighted average of the OPEC Basket of crudes. These are: Saharan Blend
(Algeria); Girassol (Angola-as of January 2007); Oriente (Ecuador- as of October 19, 2007); Iran Heavy
(IR Iran); Basrah Light (Iraq); Kuwait Export (Kuwait); Es Sider (Libya); Bonny Light (Nigeria); Qatar
Marine (Qatar); Arab Light (Saudi Arabia); Murban (United Arab Emirates); and Merey (Venezuela).
12
Table 7: Retail prices of petroleum products in OPEC Members ($/b)

The first activity is above is referred to upstream activity, while the last three activities are downstream
activities. It is worthy to note that an oil company can either be integral or independent. While an
independent oil company is one involved primarily in Exploration and Production (E&P) activities only.
An integral oil company is one involved in Exploration and Production (E&P) activities as well as at least
one of the other segments, namely storage and transportation, refining and hydro processing and
marketing and distribution. An integrated company is also known as mid- stream.
13
Figure I: Organization of the Accounting Function in an Independent Oil Company
Controller
Field
Clerical
and
Services
Equipment
and
Supplies
Inventory
Accounts
Payable
Property
Accounting
Joint
Interest
Accounting
Revenue
Accounting
General
Accounting
Taxes and
Regulatory
Compliance
Equipment and Supplies Inventory

1. Maintains equipment and supply inventory records.
2. Prices and records warehouse receipts, issues, and field transfers.
3. Oversees physical inventory taking.
4. Prepares reports on equipment and supplies inventory.
Accounts Payable
1. Maintains accounts payable records.
2. Prepares vouchers for disbursements.
3. Distributes royalty payments.
4. Maintains corporate delegated limits of authority and verifies that disbursements are made within
those limits.
Property Accounting
1. Maintains subsidiary records for
(a) Unproved properties,
(b) Proved properties,
(c) Work in progress,
(d) Lease and well equipment, and
(d) Field service units.
2. Accounts for property and equipment acquisition, reclassification, amortization, impairment,
retirement, and sale.
3. Compares actual expenditures of work in progress to authorized amounts.
Joint Interest Accounting
1. Maintains files related to all joint operations.
2. Prepares billings to joint owners.
3. Reviews all billings from joint owners.
4. Prepares statements for jointly operated properties.
5. Prepares payout status reports pursuant to farm-in and farm-out agreements.
6. Arranges or conducts joint interest audits of billings and revenue distributions from joint venture
operations.
7. Responds, for the company as operator, to joint interest audits by other joint interest owners.
Revenue Accounting
1. Accounts for volumes sold and establishes or checks prices reflected in revenues received.
2. Maintains oil and gas revenue records for each property.
14
3. Maintains records related to properties for purposes of regulatory compliance and production taxes.
4. Computes production taxes.
5. Maintains Division of Interest master files, with guidance from the land department, as to how
revenue is allocated among the company, royalty owners, and others.
6. Computes amounts due to royalty owners and joint interest owners and prepares reports to those parties.
7. Invoices purchasers for sales of natural gas.
8. Maintains ledgers of undistributed royalty payments for owners with unsigned division orders, owners
whose interests are suspended because of estate issues, and other undistributed production payments.
9. Prepares revenue accruals.
General Accounting
1. Keeps the general ledger.
2. Maintains voucher register and cash receipts and disbursements records.
3. prepares financial statements.
4. Prepares special statements and reports.
5. Assembles and compiles budgets and budget reports.
Taxes and Regulatory Compliance
1. Prepares required federal, state and local tax returns for income taxes, production taxes, property taxes,
and employment taxes.
2. May prepare other regulatory reports.
3. Addresses allowable options for minimizing taxes
Figure II: Organization of Accounting Functions in Small Integrated Oil Company
Corporate
Controller
Financial
Accounting
&
Considerations
Budget,
Cost
Analysis &
Reports
Pipeline
Corporate
Tax
Accounting
Policy &
Research
Production
Accounting
Refining
Accounting
&
Crude oil
Trading
Accounting
Marketing
Accounting
Figure III: Organization of Accounting Functions in Production Division of Large Integrated

Company
15
Controller
Production
Division
Budgets &
Internal Reports
Compliance
&
Taxation
Budgets
Revenue
Accounting
Policy Planning
& Support
Financial
Accounting &
Investments
Regulatory
Compliance
Oil
Recruitment and
Development
General
Accounting
Taxes
Gas
Administrative
Support
Investments
Internal Reports
Performance
Management
Management
Information
System
Accounting
Policies
Internal Control
Joint Interests
External Reports
1.3 The History of the Nigerian Oil and Gas Industry

In ancient history, pitch (a heavy, viscous petroleum) was used for ancient Egyptian chariot axle grease.
Early Chinese history reports the first use of natural gas that seeped from the ground; a simple pipeline
made of hollowed bamboo poles transported the gas a short distance where it fueled a fire used to boil
water. Seventeenth century missionaries to America reported a black flammable fluid floating in creeks.
From these creeks, Indians and colonists skimmed the crude oil, then called rock oil, for medicinal and
other purposes. Later, the term rock oil was replaced by the term petroleum from petra (a Latin word for
rock) and oleum (a Latin word for oil). Eventually, the term petroleum came to refer to both crude oil and
natural gas. By the early 1800s, whale oil was widely used as lamp fuel, but the dwindling supply was
uncertain, and people began using alternative illuminating oils called kerosene or coal oil extracted from
mined coal, mined asphalt, and crude oil obtained from surface oil seepages. Therefore, the petroleum
exploration and production industry may be said to have begun in around mid 1800s. There was mention
of an oil discovery in Ontario, Canada, in 1858, and Pennsylvania, in USA in 1859, with a steam-powered,
cable-tool rig with a wooden derrick used in drilling. Shortly thereafter, a number of refineries began
distilling valuable kerosene from crude oil, including facilities that had previously extracted kerosene
from other sources.
Transportation of crude oil was a problem faced from the earliest days of oil production. The coopers
union constructed wooden barrels (with a capacity of 42 to 50 US gallons) that were filled with oil and
hauled by teamsters on horse-drawn wagons to railroad spurs or river barge docks. At the railroad spurs,
the oil was emptied into large wooden tanks that were placed on flatbed railroad cars. The quantity of oil
that could be moved by this method was limited. However, the industry's attempts to construct pipelines
were delayed by the unions whose members would face unemployment and by railroad and shipping
companies who would suffer from the loss of business by the change in method of transportation.
Nevertheless, pipelines came into existence in the 1860s; the first line was made of wood and was less
than a thousand feet long.
16
New demands for petroleum were created in the 1920s, largely because of the growing number of
automobiles, as well as, the use of petroleum products to generate electricity, operate tractors, and power
automobiles. The oil industry was able to increase production to meet the greater demand without a sharp
rise in price. Compared with World War I, World War II which had its onset in 1939, used more
mechanized equipment, airplanes, automotive equipment, and ships, all of which required huge amounts
of petroleum.
The search for oil in Nigeria dates back to 1908 when a German Company, by name the Nigerian
Bitumen Corporation, obtained a licence to explore for oil in Okitipupa area of Ondo State.
The companys efforts were unsuccessful and with outbreak of the First World War, its
operations were disrupted.
Two decades later, Shell DArcy (the predecessor of Shell Petroleum Development Company of Nigeria
Ltd) started exploration of Niger Delta in 1937 having acquired exploration right from the British
Colonialists over the entire Nigerian territory under an exclusive exploration licence. The company
operated under the Mineral Ordinance No. 17 of 1914 which gave companies registered in Britain or any
of its protectorates the right to prospect for oil in Nigeria. Except for a brief disruption of operations of the
company in 1941 to 1946 because of the Second World War, it continued as the sole concessionaire in
Nigeria until 1959 when exploration rights became available to oil companies of other nationalities.
The first deep exploration well was in 1951 at Iho, 10 miles North-East of Owerri to a depth of 11,228
feet, but it was a dry hole. Shell discovered oil in a commercial quantity at Oloibiri, Rivers State
(presently in Bayelsa State), in 1956, after half a century of exploration, with an equivalent investment of
N120 million. This oil field came on stream in 1958 producing 5,100 bpd. From 1938 to 1956, almost the
entire country was covered by concession granted to the Company (Shell-BP) to explore for petroleum
resources. This dominant role of Shell in the Nigerian oil and gas industry continued for many years, until
Nigerias membership of the Organization of the Petroleum Exporting -Countries (OPEC) in 1971. After
which the country began to take firmer control of its oil and gas resources, in line with the practice of
other members of OPEC.
In 1960 the Organization of Petroleum Exporting Countries (OPEC) was formed by Saudi Arabia, Kuwait,
Iran, Iraq, and Venezuela. Later, eight other countries joined OPECthe United Arab Emirates and Qatar
in the Middle East; the African countries of Algeria, Gabon, Libya and Nigeria; and the countries of
Indonesia and Ecuador. Ecuador, who joined OPEC in 1973, suspended its membership from December
1992 to October, 2007. By 1973 OPEC members produced 80 percent of world oil exports, and OPEC
had become a world oil cartel. Member countries began to nationalize oil production within their borders.
17
Table 8: OPEC Member Countries

S/No.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Name of Country
Date joined OPEC Location
Algeria
1969
Africa
Angola
2007
Africa
Ecuador **
Rejoined 2007
South America
Indonesia ***
1962
Asia
Iran*
1960
Middle East
Iraq*
1960
Middle East
Kuwait*
1960
Middle East
Libya
1962
Africa
Nigeria
1971
Africa
Qatar
1961
Middle East
Saudi Arabia*
1960
Middle East
United Arab
1967
Middle East
Emirates
13.
Venezuela*
1960
South America
Source: OPEC at http://www.opec.org/library/
Notes: * Founder members
** Ecuador joined OPEC in 1973, suspended its membership from Dec. 1992 to Oct., 2007
***Indonesia suspended its membership effective January 2009
The Organization of the Petroleum Exporting Countries (OPEC) was founded in Baghdad, Iraq, with the
signing of an agreement in September 1960 by five countries namely Islamic Republic of Iran, Iraq,
Kuwait, Saudi Arabia and Venezuela. They were to become the Founder Members of the Organization.
These countries were later joined by Qatar (1961), Indonesia (1962), Libya (1962), the United Arab
Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), Gabon (1975) and Angola (2007).
From December 1992 until October 2007, Ecuador suspended its membership. Gabon terminated its
membership in 1995. Indonesia suspended its membership effective January 2009. Currently, the
Organization has a total of 12 Member Countries.
18
Table 9: OPEC Members Facts and Figures, 2012
19
Table 10: OPEC Members Mid-Year Population (1,000 inhabitants)
20
Table 11: World Proven Crude Oil Reserves by Country (Million Barrels)

21
Table 12: World Proven Natural Gas Reserves by Country (Billion Standard cmf)

22
Figure III:
2013 statistics shows that the bulk of OPEC oil reserve is located in Venezuela with 24.7% and Saudi
Arabia with 22.0% , followed by four middle East countries, namely Iran 13.1%, Iraq 12.0%, Kuwait
8.4% and United Arab Emirates 8.1%. The statistics show that two third of the OPEC of reserve (65.70%)
is located in the Middle East countries. OPEC (2013) shows that Nigeria has proven oil reserve of 3.1% of
total OPEC reserve.
Figure IV:
23
However, as against what obtains in some OPEC member countries where National Oil Companies
(NOCs) took direct control of production operations, in Nigeria, the Multi-National Oil Companies
(MNOCs) were allowed to continue with such operations under Joint Operating Agreements (JOA),
clearly specifying the respective stakes of the companies and the Government of Nigeria in the ventures.
As a result, this period also witnessed the arrival on the scene of MNOCs such as the Gulf Oil and Texaco
(now ChevronTexaco), Elf Petroleum (now Total), Mobil (now ExxonMobil), and Agip, in addition to
Shell, which was already playing a dominant role in the industry. To date, these companies constitute the
major players in the Nigerian oil industry, with Shell still maintaining a leading role. Joint Venture
Agreements (JVAs) and Production Sharing Contracts (PSCs) also dominate the production agreements
between the oil companies and the NNPC. Similarly, it is worth noting that the exploration of oil and gas
in Nigeria had taken place in five major sedimentary basins, namely, (i) the Niger Delta, (ii) the Anambra
Basin, (iii) the Benue Trough, (iv) the Chad Basin and (v) the Benin Basin. But, the most prospective basin
is the Niger Delta which includes the continental shelf and which makes up most of the proven and
possible reserves. All oil production to date has occurred in this basin.
In 1971, as oil became more important to the economy, the country established the Nigerian National Oil
Corporation (NNOC) and joined OPEC as the 11th member. It acquired 33 /3% in Nigerian Agip and 35%
in Elf. NNOC ran as an upstream and downstream company and the petroleum ministry had a regulatory
function. On April 1, 1977, a merger between NNOC and the ministry of petroleum created Nigerian
National Petroleum Corporation (NNPC). This was to combine the ministrys regulatory role and NNOCs
commercial functions: exploration, production, transportation, processing, oil refining and marketing. The
Nigerian National Petroleum Company (NNPC) was established as a state owned and controlled company,
as a dominant player in the downstream sector and a major player in the upstream sector through joint
venture agreements with all major international players. The regulatory role was later to be assumed by
the Petroleum Inspectorate, a unit of NNPC. Through the years, NNPC has been active in seismic
exploration onshore and offshore. It also carried out work on contract for Phillips Petroleum and other
E&P companies in the Chad, Anambra and Benue Basins. But NNPC has depended on the technological
capabilities of the major operators, like Shell, Mobil, Gulf (Chevron) and others, which produced the bulk
of Nigerian oil and did most of the exploration work.
The NNPC in 2010 developed a comprehensive framework designed to herald the intensification of
exploration activities in the Chad Basin. The move was seen as a fresh boost to the Federal Government's
efforts to build up the nation's proven oil reserve through exploration of new frontiers for oil and gas
production. Oil may be found in commercial quantity in the Chad Basin, because of the discoveries of
commercial hydrocarbon deposits in neighboring countries of Chad, Niger and Sudan which have similar
structural settings with the Chad Basin. The search was not limited to the Chad Basin alone but covers
extensive inquest in the entire Nigerian Frontier Sedimentary Basins which include- The Anambra, Bida,
Dahomey, Gongola/Yola and the Sokota Basins alongside the Middle/Lower Benue Trough. Petroleum
was recently (i.e. in 2012) discovered in Anambra Basin, which is now to join the league of oil producing
states.
1.4 The Nature of Petroleum Assets and the Process of Acquiring it
Before an oil company drills for oil, it first evaluates where oil and gas reservoirs might be economically
discovered and developed. The procedure involved in acquiring petroleum assets includes the following:
(i) Leasing the Rights to Find and Produce: When suitable prospects are identified, the oil company
determines who (usually a government in international areas) owns rights to any oil and gas in the
prospective areas. In the Nigeria the government owns both the surface and the subsurface, as all
lands are granted by the government on rent for 99 years. In contrasts, in United States, whoever
owns "land" usually owns both the surface rights and mineral rights to the land. Whoever owns,
24
(i.e., has title to), the mineral rights negotiates a lease with the oil company for the rights to explore,
develop, and produce the oil and gas. The lease requires the lessee (the oil company), to pay all
exploration, development, and production costs, and pays royalty to the lessor. The oil company
may choose to form a joint venture with other oil and gas companies to co-own the lease and jointly
explore and develop the property.
(ii) Exploring the Leased Property: To find underground petroleum reservoirs requires drilling
exploratory wells. Exploration is risky, as a number of exploration wells may have to be abandoned
as dry holes, i.e., not commercially productive. Wildcat wells are exploratory wells drilled far from
producing fields on structures with no prior production. Several dry holes might be drilled on a large
lease before an economically producible reservoir is found. To drill a well, an oil company typically
subcontracts much of the work to a drilling company that owns and operates rigs for drilling wells,
who can do the drilling more effectively, efficiently and economically because of experience.
Drilling contracts may take the form of footage rate contract (requiring installmental payment per
foot of hole drilled until the required depth is reached), day rate contract (requiring daily payment of
specified amount in respect of the number of feet drilled) or turnkey contract (where the contractor is
paid only after satisfactory drilling of well to the required depth and other conditions specified in the
contract).
(iii)Evaluating and Completing a Well: After a well is drilled to its targeted depth, sophisticated
measuring tools are lowered into the hole to help determine the nature, depth, and productive
potential of the rock formations encountered. If these recorded measurements, known as well logs,
along with recovered rock pieces, i.e., cuttings and core samples, indicate the presence of sufficient
oil and gas reserves, then the oil company will elect to spend substantial sums to "complete" the well
for safely producing the oil and gas.
(iv) Developing the Property: After the reservoir (or field of reservoirs) is found, additional wells
(known as development wells) may be drilled and surface equipment installed to enable the field to
be efficiently and economically produced.
(v) Producing the Property: Oil and gas are produced, separated at the surface, and sold. Any
accompanying water production is usually pumped back into the reservoir or another nearby
underground rock formation. Production life varies widely by reservoir between over 50 years to
only a few years, and some for only a few days. The rate of production typically declines with time
because of the reduction in reservoir pressure from reducing the volume of fluids and gas in the
reservoir. Production costs are largely fixed costs independent of the production rate. Eventually, a
well's production rate declines to a level at which revenues will no longer cover production costs.
Petroleum engineers refer to that level or time as the well's economic limit.
(vi) Plugging and Abandoning the Financial Property: When a well reaches its economic limit, the
well is plugged, i.e., the hole is sealed off at and below the surface, and the surface equipment is
removed. Some well and surface equipment can be salvaged for use elsewhere. Plugging and
abandonment costs, or P&A costs, are commonly referred to as dismantlement, restoration, and
abandonment costs or DR&A costs.
Equipment salvage values may offset the plugging and
abandonment costs of onshore wells so that net DR&A costs are zero. However, for some offshore
wells, estimated future net DR&A costs may exceed $1 million per well due to the cost of removing
offshore platforms, equipment, and perhaps pipelines. When a leased property is no longer
productive, the lease expires and the oil company plugs the wells and abandons the property. All
rights to exploit the minerals revert back to the lessor as the mineral rights owner.
1.5 Accounting Dilemmas in Oil and Gas Accounting
The nature, complexity, and importance of the petroleum E&P industry have caused the creation of an
unusual and complex set of rules and practices for petroleum accounting and financial presentation. The
nature of petroleum exploration and production raises numerous Accounting problems. Here are a few:
25
(1) Should the cost of preliminary exploration be recorded as an asset or an expense when no right or
lease might be obtained?
(2) Given the low success rates for exploratory wells should the well costs be treated as assets or as
expenses? Should the cost of a dry hole be capitalized as a cost of finding oil and gas reserves?
Suppose a company drills five exploratory wells costing $1 million each, but only one well finds a
reservoir and that reservoir is worth $20 million to the company. Should the company recognize
as an asset the total $5 million of cost, the $1 million cost of the successful well, the $20 million
value of the productive property, or some other amount?
(3) The sales prices of oil and gas can fluctuate widely over time. Hence, the value of rights to
produce oil and gas may fluctuate widely. Should such value fluctuations affect the amount of the
related assets presented in financial statements?
(4) If production declines over time and productive life varies by property, how should capitalized
costs be amortized and depreciated?
(5) Should DR&A costs be recognized when incurred, or should an estimate of future DR&A costs be
amortized over the well's estimated productive life?
(6) If the oil company forms a joint venture and sells portions of the lease to its venture partners,
should gain or loss be recognized on the sale?
1.6 The Upstream and the Downstream Sectors of the Nigerian Oil Industry
As earlier stated, Shell DArcy was the first to discover oil in commercial quantity in Nigeria at Oloibiri,
Rivers State (presently, Bayelsa State) in 1956. However intensified search for oil from 1957 to 1959
resulted in discovery of Ebubu and Bomu oil fields in Rivers State, and Ughelli in Delta State, which was
the first hydrocarbons find, west of the Niger. By 1961 Mobil, Gulf (now Chevron), Agip, Tenneco and
Amoseas (now Texaco) etc joined the search for both onshore and offshore oil and gas in Nigeria. This led
to the first offshore discovery in 1964 in Okan field in Delta State. Currently, all the early explorers have
discovered oil and are producing it, with an upwards of 3,000 producing oil wells in the country.
Prior to 1971, the Government had no joint venture participation in the operations of oil companies in
Nigeria. By 1971 all concessions earlier granted to the companies were converted to joint venture
agreements. In 1973, production sharing contract emerged between the NNPC and Ashland, followed by
risk service contract between NNPC and Agip Energy and Natural Resources in 1979 and agreements
involving these types of contracts were entered into between the NNPC and the oil companies. Foreign oil
companies largely dominated the upstream sector until the first discretionary allocation of acreages to
indigenous companies in 1990. Oil blocks were allocated to eleven (11) indigenous companies. The
companies who operated sole risk contracts, were encourage farm-out (i.e. to assign an interest in a licence
to another party) 40 per cent of their interest to foreign companies, mainly for financial and technological
back-up (the foreign companies who acquire interest in a licence from another party, are said to have
farm-in in indigenous companies minning interest). More allocations were made between 1991 and 1993
and there are now an upwards of forty (40) indigenous private sector companies licensed to prospect for
oil
in
Nigerias
upstream
sector.
Some of the companies, including Summit Oil, Consolidated Oil and Amni Petroleum Development
Company have made commercial discoveries and are already producing oil, while others are at various
stages of exploration and production.
In addition the NNPC through two of its subsidiaries- the Nigerian Petroleum Development Company
(NPDC) and Direct Exploration Services of the National Petroleum Investment Management Services
undertake oil exploration and production. In total, an upwards of 55 companies are operating in Nigeria
under joint venture, production sharing contract, service contract, sole risk contract and NNPC direct
exploration efforts.
26
Nigerias expertise in the upstream sector in the African Subregion, which is relatively superior, had
attracted a number of African countries to look up to it for assistance. For example in 2010 Uganda and
Nigeria have signed MOU on oil and gas industry. The agreement covers human resource training,
technological transfer, joint projects and offering support on evaluation of the crude oil. Crude oil and gas
production is expected to start by 2012. There will also be construction of a refinery with a capacity of
150,000 to 200,000 barrels of oil a day. Four companies, including Heritage, Dominion, Neptune and
Tullow Oil, are exploring for oil and gas in the Lake Albert basin. The MOU signed between Nigeria and
Uganda is a positive development. With increased E&P activities in the region, more countries would be
fortunate to discover Oil and Gas reserves in their territories.
Activities in the downstream sector were given boast in 1965 with the construction of the first refinery in
Port Harcourt by Shell-BP, with an initial capacity of 35,000 bpd, which was later increased. As the
economy grew, demand for petroleum products grew along with it necessitating the establishment of
Warri refinery in 1978, Kaduna refinery in 1980, and subsequently, another refinery, which is the forth
refinery, was built at Port Harcourt to supplement the old one. However, these refineries at various points
in time have been bedeviled with problems of sabotage, fire out breaks, poor management and lack of
regular turnaround maintenance, thereby making it difficult for the refineries to meet local demands for
petroleum products.
In similar vein, petrochemical plants were built in Warri and Kaduna in 1988 and subsequently, another
company was built in Eleme, near Port Harcourt. These companies were meant to produce polypropylene,
carbon black, linear alkyl benzene (LAB), heavy alkylate, benzene, polyethylene and chlorine, among
others.
Table 13: Installed Capacity of Nigerian Refineries

S/N
NAME OF THE COMPANY
1
2
3
4
Kaduna Refinery and Petrochemical Company Limited

(KRPC).
Warri Refinery and Petrochemical Company Limited
(WRPC).
Port-Harcourt Refinery Company Limited (PHRC).
Eleme Petrochemical Company Limited (EPCL).
Total
Date
Installed
Commissioned Capacity (bpd)
1980
110,000
1979
125,000
1965
1989
35,000
150,000
445,000
1.7 NNPC, DPR and Their Roles

1.7.1 Nigerian National Petroleum Corporation (NNPC)
The NNPC occupies a central position in the Nigerian oil and gas industry. It was incorporated on April 1,
1977 through Decree No. 33 of 1977, by a merger of the defunct Nigerian National Oil Corporation
(NNOC) created by Decree 18 of 1971, and the former Federal Ministry of Petroleum Resources, with
Chief Festus Marinho, as the pioneer GMD. NNPC is charged with the responsibility of managing the
Nigerias oil and gas resources in all segments of the petroleum industry (namely Exploration and
Production (E&P), storage and transportation, refining and hydro processing and distribution and
marketing). The roles of the corporation include the following:
1. refining, treating, processing and handling of petroleum for the manufacture and production of
petroleum products and its derivatives;
27
2.
3.
4.
5.
6.
the conduct of research on petroleum and its derivatives and promotion of activities to utilize
the results of such research;
giving effects to agreements entered into by the Federal Government with a view to securing
participation by the Government or the Corporation;
engaging in activities which would enhanced the overall well being of the petroleum industry
in the overall interest of the country;
undertake such activities considered necessary or expedient for giving full effect to the
provisions of the law establishing it; and
managing Government investment in the oil companies in which the Government has a stake.
In l985 the Corporation was organized into five semi-autonomous sectors in the quest to enhance its
operational efficiency. These sectors were (1) oil and gas sector, (2) refineries sector, (3) petrochemical
sector, (4) pipelines and products marketing, and (5) the petroleum inspectorate. Similarly, the
Corporation was re-organized in 1988 with a view to putting it on commercial footing,
with three basic areas of responsibilities. These are (1) corporate services (which include finance,
administration, public affairs, personnel, legal and technology), (2) operations (which include exploration
and production, refining, gas processing and petrochemicals) and (3) National Petroleum Investment
Management Services (NAPIMS) -which supervises Government investment in joint venture companies,
markets oil that accrues to the Government and engages in exploration activities in areas where oil
companies consider too risky to venture in to.
Another important aspect of the 1988 re-organization was the transfer of the Petroleum Inspectorate back
to the Petroleum Resources Department of the Ministry of Petroleum Resources from which it was
originally brought to be part of the NNPC. In 1992, another reorganization of the Corporation was carried
out which led to the establishment of six directorates (namely (i) exploration and production, (ii) refining
and petrochemicals, (iii) engineering and technical, (iv) finance and accounts, (v) commercial and
investment and (vi) corporate services), which each headed by a Group Executive Director (GED) who
reports to the Group Managing Direct (GMD). The 1992 reorganization of the Corporation conferred on
the crude oil and marketing division of the exploration and production inspectorate the responsibility for
marketing the crude oil that accrues to the Government.
Similarly, twelve (12) strategic Business Units (SBUs) or subsidiary companies were also established in
the 1992 reorganization. Nine of the subsidiaries are fully owned by NNPC, while the remaining three
subsidiaries are jointly own with foreign oil companies. The ful1y owned subsidiaries of the Corporation
are:
1. The Nigerian Petroleum Development Company Limited (NPDC) charged with the
responsibility for exploration, development and production of petroleum.
2. The integrated Data Services Limited (IDSL) charged with the responsibility of seismic data
acquisition, processing and interpretation, petroleum reservoir engineering and data evaluation for
NNPC and other oil and gas companies in Nigeria and West Africa.
3. Warri Refinery and Petrochemicals Company Limited (WRPC) charged with the
responsibility of refining petroleum and the production of carbon black and polypropylene
petrochemicals.
4. Kaduna Refinery and Petrochemicals Company Limited (KRPC) charged with the
responsibility of refining petroleum and the production of linear alkyl benzene and heavy
alkylalates.
5. Port Harcourt Refining Company Limited (PHRC) charged with the responsibility of refining
petroleum especially for export.
28
6. Pipelines and Products Marketing Company Limited (PPMC) charged with the responsibility
of transporting crude oil to the refineries and refined products through its pipelines and deports to
markets both locally and internationally.
7. Nigerian Gas Development Company Limited (NGC) charged with the responsibility of
gathering, treating and developing gas resources for transmission to major industrial and utility
gas companies in Nigeria and neighbouring countries.
8. Eleme Petrochemicals Company Limited (EPCL) charged with the responsibility of
manufacturing a range of petrochemicals products such as polyethylene, polyvinyl chloride etc
from natural gas and refinery by-products and market them locally and internationally.
9. Nigerian Engineering Technical Company Limited (NETCO) charged with the responsibility
of providing engineering services to the NNPC group and other oil companies in the country.
The three other subsidiaries that are jointly own with foreign oil companies are:
10. Nigeria Liquefied Natural Gas Limited (NLNG) owned jointly by the NNPC, Shell, Elf, Agip
and International Finance Corporation (IFC) charged with the responsibility of harnessing,
processing and marketing gas resources.
11. Calson (Bermuda) Limited initially owned jointly by the NNPC and Chevron (but the
Government has now divested from the company). Calson is charged with the responsibility of
marketing the countrys excess petroleum products abroad.
12. Hydrocarbon Services Nigeria Limited (HYSON Limited) owned jointly by the NNPC and
Chevron, and charged with the responsibility of providing logistics and support services to Calson
(Bermuda) Limited.
1.7.2 THE DEPARTMENT OF PETROLEUM RESOURCES (DPR)
Prior to independence in 1960, the Hydrocarbons Section of the Ministry of Lagos Affairs handled
petroleum matters in the country. However, when petroleum activities gathered momentum in the country,
a petroleum division (later named DPR in 1970) was created under the Ministry for Mines and Power. In
1971, Nigerian National Oil Corporation (NNOC) was created as the commercial arm of the DPR, while
DPR itself continued as art of the Ministry of Mines and Power. In 1975, DPR was upgraded to a ministry
and named the Ministry of Petroleum and Energy (later renamed the Ministry of Petroleum ResourcesMPR).
The promulgation of Decree 33 of 1977 merged the MPR with NNOC to form the NNPC.
Under the Decree, an inspectorate arm (called the Petroleum Inspectorate) was set up to act
as the regulatory arm of the oil and gas industry. In 1985, the MPR was re-established. However,
Petroleum Inspectorate remained with NNPC until its re-organization of March
1988 that resulted in the excision of the Inspectorate and its transfer back to the Petroleum
Resources Department of the Ministry of Petroleum Resources. The functions of the DPR include the
following:
1. supervising all petroleum industry operations being carried out under 1iences and leases in the
country, with a view to ensuring compliance with the established laws and regulations;
2.
monitoring the petroleum industry in order to ensure that operations are in line with national
policies and goals;
3.
enforcing safety regulations and ensuring that operations conform to national, as well as,
international industry practices and standards;
29
4. keeping and updating records on petroleum industry operations relating to reserves,

production/exports, licences and leases, as well as rendering regular reports of them to the
Government;
5. advising the Government and relevant agencies on technical matters and public policies, which
may have impact on the administration and control of petroleum;
6. processing all applications for licences to ensure compliance with laid down guidelines before
making recommendations to the Minister of Petroleum Resources; and
7.
ensuring timely and adequate payments of all rents and royalties as and when due.
1.8 PPPRA and the Proposed Petroleum Industry Bill (PIB) 2011
1.8.1 Petroleum Products Pricing Regulatory Agency (PPPRA)
The Government on 14th August 2000 set up a 34 member Special Committee on the review of Petroleum
Products Supply and Distribution drawn from various Stakeholders and other interest groups to look into
the problems of the downstream petroleum sector. It mission is to reposition Nigeria's downstream subsector for improved efficiency and transparency. Its vision is to attain a strong, vibrant downstream subsector of the petroleum industry, where refining, supply, and distribution of petroleum products are selffinancing and self-sustaining. Prior to the setting up of the Committee, the downstream sector was
characterized by the following problems:
1. Scarcity of petroleum products leading to long queues at the service stations
2. Low capacity utilization and refining activities at the nation's refineries (poor state of the
refineries)
3. Rampant fire accidents as a result of mishandling of products- products adulteration
4. Pipelines vandalisation
5. Large scale smuggling due to unfavourable economic products borders' prices with the
neighbouring countries
6. Low investment opportunities in the sector.
Functions of PPPRA
1. To determine the pricing policy of petroleum products;
2. To regulate the supply and distribution of petroleum products;
3. To create an information databank through liaison with all relevant agencies to facilitate the
making of informed and realistic decisions on pricing policies;
4. To oversee the implementation of the relevant recommendations and programmes of the Federal
Government as contained in the White Paper on the Report of the Special Committee on the
Review of the Petroleum Products Supply and Distribution, taking cognizance of the phasing of
specific proposals;
5. To moderate volatility in petroleum products prices, while ensuring reasonable returns to
operators.
6. To establish parameters and codes of conduct for all operators in the downstream petroleum sector;
1.8 Petroleum Industry Bill (PIB) 2011
The Petroleum Industry Bill is an attempt to bring under one law the various legislative, regulatory, and
fiscal policies, instruments and institutions that govern the Nigerian petroleum industry. The Bill is
30
expected to establish and clarify the rules, procedures and institutions that would entrench good
governance, transparency and accountability in the oil and gas sector. It aims to introduce new operational
and fiscal terms for revenue management to enable the Nigerian government to retain a higher proportion
of the revenues derived from operations in the petroleum industry. The government argues that, since the
commencement of oil and gas production in Nigeria in 1958 after the discovery of oil in 1956 in Oloibiri
(Bayelsa State), no comprehensive law has been put in place for effective administration of the Nigerian
petroleum industry. The PIB therefore seeks to replace sixteen (16) petroleum industry Acts, which have
many inadequacies, with an omnibus Act that provides for better fiscal and regulatory management of the
oil and gas sector.
Oil and gas production commenced in Nigeria in 1958 after the discovery of oil in Oloibiri (Bayelsa State)
two years earlier. By the 1990s Nigeria engaged in a number of unincorporated joint ventures with
international oil companies to develop the industry. However, the country had challenges funding its
commitments to the joint ventures. As a result, Production Sharing Contracts (PSC) were introduced as
alternative funding mechanisms. However, PSCs lack transparency, good governance practices, and are
not in line with international best practices. For instance, Nigeria does not capture any part of windfall
profits from increases in crude oil prices. Additionally, cost controls, accounting procedures, and acreage
management are inadequate.
In response to these challenges, the Obasanjo government in 2000 constituted the first Oil and Gas Reform
Implementation Committee (OGIC) to recommend a policy for reforming the sector. The
recommendations defined the need to separate the commercial institutions in the sector from the
regulatory and policymaking institutions. In 2007, the YarAdua government reconstituted OGIC under
the chairmanship of Dr. Rilwan Lukman to use the provisions of the National Oil and Gas Policy to setup
legal, regulatory, and institutional structures for managing the oil and gas sector.The Lukman Report,
submitted in 2008, recommended regulatory and institutional frameworks that when implemented will
guarantee greater transparency and accountability. This report formed the basis for the first Petroleum
Industry Bill (HB 159) that was submitted in 2008 as an Executive Bill.
The controversy raised by the Bill prompted the constitution of a federal interagency team headed by
Dr. Tim Okon (former NNPCs Group General Manager on Strategy) to review the Bill. The teams report
submitted in 2010 (IAT 2010) is at the crux of the controversies around the PIB because it introduced
more stringent fiscal provisions that guarantee a higher share of oil revenues to Nigeria.In 2011, the
Senate submitted its version of the Bill (SB 236) that is seen as a muchweakened version. Subsequently,
the House of Representatives submitted its version of the Bill (HB. 54) in 2011. The Bill was sponsored
by six Honourable Members.
The draft Petroleum Industry Bill (PIB) was designed to act as an all-encompassing piece of legislation
and as a result, some 15 pieces of existing legislation will be revoked upon ratification. It will create a
number of new institutions with mandates over the upstream sector. Specifically, the policy making
function will reside with the Petroleum Directorate. The Petroleum Inspectorate will replace the
Department of Petroleum Resources (DPR), currently within the Ministry of Energy. This commission
will act as the independent regulatory body and licensing agency for the upstream sector. On the
operational side, NNPC will be replaced by the Nigerian National Petroleum Company Limited (NOC).
The vision is to turn NNPC into an integrated oil and gas NOC, and a limited liability company. The
National Petroleum Investment Management Services (NAPIMS), currently part of NNPC, will be
replaced by the National Petroleum Assets Management Agency (NAPAMA). This body will monitor and
approve all upstream costs and manage tax/royalty oil (but not profit oil). NAPAMA will exist outside of
the NOC as a separate and independent agency. The Research and Development division within NNPC
will be carved out into an independent entity, the National Petroleum Research Center. A separate Frontier
31
Service will also be created. The key objectives of the PIB include:
1. Enhance exploration, exploitation and production of oil and gas: The PIB will eliminate funding
bottlenecks, increase investments by comprehensive deregulation of the downstream sector to make
it attractive to investors, and increase acreage available for investment by reclaim acreage that is not
being developed by the current owners.
2. Increase domestic gas supplies: The Bill provides that all existing and future petroleum mining
lessees shall meet their domestic gas supply obligations for the specified periods as the gas will be
used for power generation and industrial development. Failure to meet this obligation attracts a stiff
penalty.
3. Create a peaceful business environment: The Bill seeks to align the interest of the host
communities to those of the oil companies and the government. The Petroleum Host Communities
Fund, which will be funded with 10% of the net profit of the oil companies operating in the
communities, shall be used to develop the economic and social infrastructure of the host
communities. Communities will forfeit contributions in the Fund when vandalism or unrest causes
damage to upstream facilities.
4. Fiscal Framework for increased revenue: The PIB establishes a progressive fiscal framework that
encourages further investment in the industry whilst increasing accruable revenues to government.
The Bill simplifies collection of government revenues from the oil assets, increases the share of
royalties in the case of high oil prices, etc.
5. Create a commercially viable National Oil Company: The Bill provides for the full
commercialisation of NNPC and the creation of other institutions that will ensure a restructuring of
the sector for improved efficiency.
6. Deregulate petroleum product prices: The Bill proposes the full deregulation of the downstream
oil sector. A number of the institutions will be responsible for developing the infrastructure to
support the sector, funding concessionaires and facility management operators. The Petroleum
Equalisation Fund will be phased out in line with the development of the support infrastructure.
7. Create efficient regulatory entities: The Bill provides for the creation of eight institutions to drive
greater transparency and accountability.
8. Create transparency: The Bill makes public the terms of the licenses, leases, contracts and
payments in the petroleum sector. When passed, the legislature will transform Nigeria from being
one of the most opaque oil industries in the world to one that sets the standards of transparency.
9. Promote Nigeria content: The PIB has farreaching local content components. No project will be
approved without a comprehensive Nigeria Content Plan including obligations of the investor to
purchase local goods and services, engage local companies, employ Nigerians, ensure knowledge
transfer and encourage Research and Development. The Nigeria Content Monitoring Board will
regularly verify compliance. Through the local content provisions in the Bill and the opportunity to
develop small indigenous oil and gas companies, Nigerians will begin to participate more actively in
the industry and jobs will be created.
10. Protect health, safety and environment: Every company requiring a license, lease or permit in the
upstream and downstream petroleum industry in Nigeria shall conduct their operations in accordance
with internationally accepted principles of sustainable development which includes the necessity to
ensure that the constitutional rights of present and future generations to a healthy environment is
protected.
Controversies in the PIB 2011
Different stakeholders have raised concerns about certain provisions of the Bill. Below is a list of the
most controversial issues.
32
1. Fiscal provisions may increase cost of doing business: The Bill provides for multiple taxes (Nigeria
Hydrocarbon Tax, Company Income Tax), higher rents and royalties, and levies (Niger Delta
Commission Levy, Petroleum Host Community Fund, Education Tax). This is most noticeable in the
deep offshore operations.
2. Retroactive reversal of contracts: The PIB advocates reversal of provisions of prior agreements and
contracts, and introduces new fiscal regimes even for old Petroleum Sharing Contracts.
3. Relinquish acreage: The PIB provides for the revocation of acreage that is yet to be developed by
the allocated owners. Opponents of this provision claim that it is an infringement on earlier
agreements while its proponents argue that it is required to bringing new investment to the industry.
4. Calculating payments: The Bill advocates that oil companies will pay for quantities produced
instead of quantities exported. The oil companies have argued that solving the security challenge and
fixing
sabotage
of
logistics
infrastructure
is
the
core
responsibility
of
government.
5. Duplication of roles: There are overlaps of roles and responsibilities with a number of the
institutions created under this Bill. For instance, the Nigerian Petroleum Inspectorate, Petroleum
Products Regulatory Agency, and Petroleum Infrastructure Development Fund have conflicting
responsibility for funding the development of infrastructure especially for the downstream sector of
the petroleum industry.
6. Deadline for Gas flaring: According to the PIB (HB.54), December 31st 2012 is the deadline for gas
flaring. The integrity of this date is questioned given that the Bill is yet to be passed.
7. Too much power to Minister of Petroleum: The Bill provides the Minister of Petroleum too much
power to grant, revoke and reallocate licenses.
8. Lack of Regulatory Independence: Regulators need to be fully independent and not under the
supervision of the Minister of Petroleum.
9. Potential delays in passing the Bill and its Consequences on Nigerian economy: Can the 7th
National Assembly continue debates from where the last Assembly stopped? This is possible
according to Rule 111 of the Senate but there are voices in the Senate that dissent to this
interpretation and want the Bill to be reintroduced and for the process to be started all over again.
There is also the challenge of harmonizing the different versions of the Bill (Executive, Senate, and
House). Failure to pass the PIB has and will lead to a reduction of investments in the Nigeria
petroleum industry. To date, most of the oil companies have ceased investments in the sector until
there is clarity as to what provisions will be contained in the final Bill and how it will affect the
industry. With the rise of other attractive petroleum industries in Africa (Angola, Ghana, etc), Nigeria
must understand that investments are fungible and will eventually flow to alternative countries that
are more receptive.
2. Oil and Gas Drilling, Cost Classification and Reserves Valuation
2.1 Oil and Gas Drilling
Oil and gas drilling is highly capital intensive, requiring a large number of technocrats with fantastic
remuneration, thus necessitating pre-drilling operations, before actual drilling. Drilling operations
basically comprised of: (i) staking (locating oil well site after dues consideration of a number of natural
surface attributes-terrain, body of water, marshy environment, etc) (ii) compliance with regulatory
requirements on spacing of oil wells (iii) providing access road to the drilling location, leveling of drill
site for placement of working equipments and erection of field offices, and increasing permeability
through fracturing, acidizing and thermal process.
Two methods of drilling have been used in the oil and gas industry, namely rotary-rig drilling and cabletool drilling. The cable-tool method is one of the oldest mechanical means known for drilling into the
earth's surface. Cable-tool rigs have long been used for drilling water wells and salt brine wells.
33
Cable-Tool Drilling
In the cable-tool method of drilling, a heavy piece of forged steel is lowered into the hole. The bit, which
weighs several hundred pounds, is raised and then dropped in the hole, literally pounding a hole in the
earth. Water is pumped into the hole to float the cuttings of rock away from the bottom of the hole.
Rotary Rig Drilling
Rotary drilling is by far the most widely used method of drilling for oil and gas today. In rotary
operations, the hole is drilled by rotating a drill bit downward through the formations.
The usual oil and gas drilling practice entails the engagement of an independent drilling
contractor, who can do the drilling more effectively, efficiently and economically because of experience.
Drilling contracts may take the form of (i) footage rate contract (requiring installment payment per foot of
hole
drilled
until
the
required
depth
is
reached),
(ii)
day
rate
contract
(requiring daily payment of specified amount respect of the number of feet drilled) or (iii) turnkey contract
(where the contractor is paid only after satisfactory drilling of well to the required depth and other
conditions specified in the contract). Presently, footage rate contracts are the most popular although day
rate contracts are also common, while turnkey contracts are less common.
Some of the major problems encountered in oil and gas drilling may include the following:
1. the excess of formation pressure which may lead to blowout which is dangerous to the ecosystem. For
example on 22 April 2010 estimated 550-900 kb of oil leaked into the sea in US very significantly
affecting local economic activities like fishing, farming and tourism. Similarly, in 1982, a high profile
blowout at Amoco Canada killed 2 workers and hundreds of cattle.
2. twisting off of part of drill string which may lead to the abandonment of oil well and the drilling of
another well;
3. collapse of part of the drilled hole may be experienced, leaving the pipe trapped in the depths; and
4. the formation may exude hydrogen sulphide, which is a gas with a very foul odour, thereby
necessitating abandonment of well. For example in 2003, 243 people in China were killed, and 3
workers of Abu Dhabi Company operating at Shah Oilfield in Iran were killed by the toxic hydrogen
sulphide gas emitted from crude oil. The gas is heavier than air, and even at low concentrations it can
cause respiratory failure and brain damage.
2.2 Types of Oil and Gas Wells
There are different types of oil and gas wells and the drilling methods and logistics usually depend on the
type of well to be drilled. Eight types of oil and gas wells can be identified. These are:
(1) Wildcat (exploratory) well (an oil well that is drilled to establish the presence or otherwise of oil and
gas, which may result in proved reserves or dry hole);
(2) discovery well (this is a wildcat well in which hydrocarbons is discovered in commercial quantity);
(3) appraisal well (this is a well that is drilled after successful exploratory drilling, to provide information
about the volume-customarily measured in acre-feet- and its commercial viability);
(4) development (production) well (this is a well that is drilled with a view to obtaining access to proved
reserved and to produce oil).
Other types of oil and gas wells include:
(5) deviated well (a well that is progressively digresses from the vertical due to inability to access the site
selected with a view to meeting the location that is most likely to yield oil);
(6) injection well (a well that is drilled to injecting subsurface water or gas for the purpose of using
secondary drilling methods;
34
(7) observation well (a well that is drilled in order to permit further survey and study of a reservoir as
production continues); and
(8) obligatory well (an exploratory well that is obligatorily drilled as part of the conditions for granting a
mineral licence).
As a single well will not permit timely and economical extraction of oil, development wells will have to
be drilled, after the successful drilling of exploratory wells. Because the fluids from the wells may contain
oil, gas, water, sand and other impurities such as hydrogen sulphide, the crude oil must have to be cleaned
to remove all impurities before it is piped to the refinery or gas plants. BHP that enables oil and gas to
flow to the surface diminishes as the reservoir is depleted. Recovery of hydrocarbons that occur by BHP
or simple artificial lift is known as primary recovery. When the oil can no longer flow to the surface due
to diminishing BHP, more complex techniques known as secondary and tertiary recovery methods may
have to be applied to enhance recovery from the reservoir oil. The enhancement techniques used may be
broadly grouped in to two, namely injection projects (which include water flooding, high pressure gas
drive, enriched gas drive, etc) and thermal processes (which include fire flooding and steam heating). In
2007,2008 and 2009 improved recovery increased oil volumes by 20, 37 and 86 million barrels
worldwide, respectively. In 2009, the largest addition was related to improved secondary recovery in
Nigeria.
Table 14: Wells Completed in OPEC Members
Source: OPEC Annual Statistical Bulletin, 2013Pp 26

2.3 Classification of Costs in the Oil and Gas industry
In the oil and gas industry, costs are classified either by nature and function of the costs (namely (i)
acquisition cost, (ii) exploration and appraisal costs, (iii) development costs, (iii) production costs and (iv)
supporting facilities and equipments costs) or by the physical characteristics of the assets acquired
(namely (i) tangible and (ii) intangible costs).
Acquisition Costs: These are incurred to purchase, lease or otherwise acquire a property (whether proved
or unproved). Example includes the cost of signature or lease bonuses, options to purchase or lease
properties, brokerage, legal fees, etc.
35
Exploration and Appraisal Costs: These are cost incurred to prospect for oil, before oil reservoir is
developed. Examples include costs associated with geological, geophysical and other pre-drilling costs,
including remuneration of personnel involved. It also include costs of drilling, dry hole and bottom hole
pressure enhancement. They also include depreciation, amortization and allocated operating costs of
support equipment facilities.
Development Costs: These are costs incurred to gain access to proved reserves and provide facilities for
drilling, lifting, treating, gathering and storing oil and gas. They include depreciation and allocated
operating costs of support equipment facilities.
Production Costs: These are costs incurred in lifting, treating, gathering and storing oil and gas. They
include costs of personnel engaged in operation of wells and related equipment facilities, repair and
maintenance of production facilities, materials, supplies, insurance, services and fuel consumed in such
operations. They also include allocated operating costs of support equipment facilities, but do not include
DD&A of license acquisition, exploration and development costs and cost of decommissioning.
Supporting Facilities and Equipment Costs: These are cost relating to trucks, drilling equipments,
workshops, warehouses, camps division and field offices. Usually, these facilities and equipment serve
one or more activity relation to acquisition, exploration, development and production. These costs are
therefore capitalized and apportioned to the different activities.
Tangible and Intangible Costs
Tangible costs are cost of assets, like machinery, equipment, vehicles, which have physical properties
(including the costs of labour to install them even though those costs do not result in a physical asset). On
the other hand, intangible cost is cost that result in assets that have no physical properties, or assets that
have physical properties but that cannot be salvaged at the end of an operation e.g. cost of drilling paid to
contractor, labour for clearing services such as acidizing, fracturing and thermal processes.
2.4 Estimation and Valuation of Oil and Gas Reserves
Despite the large figure for property, plant and equipment that the balance sheet of an oil and
gas companies usually show the true value of an oil and gas company is its proved oil and gas reserves in
the ground. The assets may not be worth much without the reserves. Therefore, the value of oil and gas
reserves is critical for the evaluation of financial position and results of oil and gas companys exploration
and production activities.
Oil reserves can simply be defined as the value of oil and gas recoverable from oil-in-place.
Oil-in-place is defined as the oil and gas in the earth, the presence of which is confirmed by drilling. It is
an estimation of the original volume of hydrocarbons that occupied the reservoir before production. The
importance of proper understanding of reserves and reserve estimates includes the following:
(i)
serves as a basis for financing or investment decision;
(ii)
serves as a basis for computing the depreciation, depletion, and amortization rates;
(iii) it is an important item of disclosure in annual reports and accounts (SAS 14);
(iv)
serves as a basis for managements estimate of internally generated cash flows and better
operational decisions; and
(v)
serves as a basis for determining cost ceiling (in companies using full cost method of
accounting) and finding cost (for all companies either using full cost and successful effort
method of accounting).
36
However, oil and gas reserves estimates are usually imprecise due to inherent uncertainties and limited
nature of information on which reserves estimation is based. Two or more petroleum reservoir engineers,
using the same data about a producing field may arrived at widely dissimilar estimates of the reserves.
Hence, the use of outside consultants by most large oil and gas companies to carry our reserve audit with
a view to adding credibility to estimates prepared internally. Usually, the reliability of reserves estimation
will increase after reservoir has been fully developed and the field goes into production.
However, in developing estimates of reserves the following information is essential. These are:
(a) area and thickness of the productive zone;
(b) porosity of the reservoir rock;
(c) permeability of the reservoir rock to fluid;
(d) oil, gas and water saturation, i.e. the portion of the pore space that is filled with oil, gas and water;
(e) physical characteristics of oil and gas, i.e. the shape and size of oil-bearing formation which affects
both porosity and permeability;
(f) depth of the producing formation;
(g) reservoir pressure and temperature;
(h) production history of the reservoir; and
(i) ownership of the oil and gas property.
After petroleum reservoir engineers have estimated reserve quantity, it must then be valued in monetary
terms. The following are the factors that may affect reserve valuation:
(i)
projected rate of inflation and expected future price changes;
(ii)
political stability of host countries;
(iii)
Macro economic conditions.
(iv)
Prospective changes in legislation and taxation.
(v)
Contractual obligations.
(vi)
Crude oil prices, especially OPEC Prices; and
(vii)
Discount rate and cost of capital
2.5 Classification of Reserves
Classifications of reserves are usually based on the professional judgments of petroleum reservoir
engineers and geologists arising from a range of geological and geophysical studies carried out. Oil and
gas reserves may be classified into (i) primary, (i) secondary and (iii) tertiary reserves.
Primary reserves are reserves that are recoverable using any method possible where the oil and gas enters
the well bore by the action of the natural reservoir pressure (BHP). Primary reserve may be classified
based on:
(i) degree of proof (comprising of proved, probable and possible reserves);
Proved reserve is further subdivided into proved developed and proved under-developed reserves.
Proved developed oil and gas reserves are reserves that can be recovered through existing wells with
existing equipments and operating methods. While, proved underdeveloped reserves are oil and gas
reserves that are expected to be recovered from new wells on undrilled acreage or from existing wells
where relatively major expenditure is required for completion. Probable reserves are estimated
quantities of commercially recoverable oil and gas reserves that may be estimated or indicated to exist
based on geological, geophysical, and engineering data. Possible reserve are estimated quantities of
commercially recoverable oil and gas reserves that are less well defined than probable reserves and
that may be estimated or inferred largely on the basis of geological and geophysical evidence.
(ii) development status (comprising of developed and under-developed reserves); and based on
37
(iii) production status (comprising of producing and non-producing reserves).

However, secondary and tertiary reserves are reserves that are recoverable through secondary and tertiary
recovery methods, involving injection projects and thermal processes.
The world's reserve values by country are not publicly disclosed, but estimated reserve volumes are.
Table 2 summarizes the world's proved oil and gas reserves, production, and oil wells by country. Over
92 percent of the world's proved oil and gas reserves are found in the 17 countries listed in Table 2. The
top ten countries have nearly 80 percent of the worlds oil and gas reserves and the majority of the worlds
current production. Sixty-four percent of the world's proved oil reserves are in five Middle East countries,
and the majority of the world's proved oil and gas reserves are in only four countriesSaudi Arabia,
Canada, Iran and Iraq.
Table 15: Daily crude oil production (average) (1000 b)
38
Table 16: Cumulative crude oil production up to and including year (1000 b)
39
Table 17: World crude oil production by country (1,000 b/d)
40

Table 18: Natural gas production in OPEC Members (million standard cu m)

41
Table 18: Natural gas production in OPEC Members (million standard cu m) Continuation
42
3. Arrangements, Agreements and Contracts in the Nigerian Petroleum Industry

The high risk, technology and capital intensiveness of oil and gas operations often require that
negotiations are made between the host country and foreign oil company for hydrocarbon exploitation,
disposal, risk sharing and pooling of capital. Similarly, because of the international politics of oil and
gas, as well as, its strategic position in the economy of the producing countries in particular and the
world at large, most Government prefer to work out participation arrangements with multinational oil and
gas company rather than just overseeing the operations. The conditions and term of the agreements result
in operating agreements, with varied modus operandi among countries.
3.1 Types of operating contracts in the petroleum industry
There are at least seven basic types of operating agreements in the international oil and gas industry.
These are (i) concession, (ii) joint venture, (iii) production sharing contract, (iv) service contract with or
without risk (v) indigenous contracts, (vi) direct exploration and (vii) hybrid contract.
3.1.1 Concession: In a concession agreement, a country grants to an oil company or a group of oil
companies the exclusive right to carry out certain types of petroleum operations within a given oil area of
its territory for a specified period of time for payment of royalties. This agreement, which was type of
agreement in many host nations, has the least advantages to the host government as it relinquishes its
sovereignty to operating oil company and its fiscal returns, state participation, and training of nationals is
at lowest level. As explained earlier, Shell DArey which was the first oil company to discover oil in
commercial quantity in Nigeria operated under a concession arrangement and an exclusive exploration
right. Others like Mobil, Gulf (now Chevron), Safrap (now Elf), Tenneco and Amoseas (now Texaco) also
operated under the concession agreement.
3.1.2 Joint Venture (JV): A JV is defined as a situation where one or more foreign oil companies enter
into agreement with the host government (through its agent like the NNPC) for joint development of
jointly held oil mining licenses and facilities. Each partner in the joint venture contributes to the costs and
shares the benefits or losses of the operation, in accordance with its proportionate equity interest in the
venture. One company is designated as the operator and is responsible for the day-today running of the
venture, and all budgets, work programmes and any contract awarded must, however, be agreed by all
parties. In addition, Memorandum of Understanding (MOU), governs the manner in which revenues from
the venture are allocated between the partners, including payment of taxes, royalties and industry margin.
The income derived from the operations is also shared in proportion to the equity interests of the parties to
the JV, with each party bearing the cost of its royalty and tax obligations in the same proportion.
Allocations are also made from the revenue to take care of operating cost.
Joint ventures are the agreements in place for shallow water and onshore exploration and for downstream
ventures. Production from JV accounts for approximately 95 percent of the Nigerias crude oil production.
The largest JV operated by Shell Petroleum Development Company of Nigeria Ltd and NNPC, produces
nearly half of Nigerias crude oil, with average daily production of approximately 1.1 million bpd.
Some of the constraints associated with JV are namely (i) poor funding and consequential loss in revenue;
(ii) allegations of gold plating of operating costs by the non-operators of the venture leading to mutual
suspicious; and (iii) pressure on the operator to meet incessant demands by oil producing communities.
However, the emergence of offshore oil and gas operations in Nigeria has witnessed a shift from JVA
regimes to Production Sharing Contracts (PSCs). This shift is attributed to a number of factors ranging
from the complexity of operations in the offshore terrain to (which makes regulations under the JVA more
43
difficult); to dwindling resources of the country (which makes funding under JVAs precarious for the
government).
3.1.3 Production Sharing Contract (PSC): In PSC, host government (through its agent) engages a
competent contractor to carry out petroleum operations Governments wholly owned acreage (oil block).
The contractor undertakes the initial exploration risks and recovers his costs only when oil is discovered
in commercial quantities. If no oil is found, the company receives no compensation. Under the PSC,
royalty oil is a first-charge item assigned to the government free of any exploration, development and
production costs. Thereafter, the contractor has the full right to only cost oil (i.e. oil to guarantee return on
investment). He can also dispose of the tax oil (oil to defray tax obligations) on Governments behalf. The
residual oil is the profit oil, if any, and the company shares with the concession holder in some agreed
percentage.
This form of contract which originates from Indonesia in 1996, was modeled along the lines of share
cropping in agriculture, where the landlord grants a farmer the rights to grow crops on his land and shares
the proceeds with the farmer in agreed proportions after the harvests. This type of agreement was first
signed in Nigeria with Ashland oil in June 1973. From the proceeds, up to 40 percent was set aside to
amortize the companys investment and pay royalties (cost oil), and about 55 percent was set aside for the
payment of Petroleum Profits Tax (PPT) (Tax oil). The remaining proceeds of 5 percent called profit oil
are then shared between the Government and the company in crude oil in a ratio of 65:35 respectively.
There was a proviso for the Governments percentage share of profit oil to increase to 70 percent when
production reaches 50,000 or more barrels per day. A barrel is a measure representing 35 Imperial gallons
or 42 US gallons. Companies engage in PSC in Nigeria include Statoil, Snepco, Elf, Model, Chevron etc.
The main law which regulates the operation of PSCs in Nigeria is the deep Offshore and Inland Basin
Product Sharing contracts Act No.9, LFN, 1999. Some of the advantages of PSC include relative
flexibility in the management of the operations, no financial burden on the host country, payment to the
contractor is made in oil after a commercial find, reliance on the technical know-how and experience of
the contractor oil company, etc. some of its drawbacks include risky nature of operations due to nontransferability of costs from now acreage to another when no oil is found and the allegations of gold
plaiting costs by the host country.
3.1.4 Service Contract with or without Risk: Service contract (SC) is an operating arrangement similar
to PSC whereby service contractor provides all the funds for exploration, development and production
activities, while the title to the oil is owned by the NNPC. Like in PSC, the initial duration of the contract
is usually 5 to 6 years and the contract terminates automatically if no commercial discovery is made. In
the event of such termination both the NNPC and the contractor owe each other no further obligation with
respect to the contract. If exploration is successful and production commences, the contractors
Exploration and development (E&D) costs are recovered in accordance with the conditions stipulated in
the contract. Usually the E&D costs are paid installmentally over an agreed period of time, usually 5
years. Unlike PSC, the contractor has no little to any of the portion of the crude oil produce, but may be
allowed the option to be given reimbursement and remuneration in oil as an additional incentive for the
risk taking. Similar, the contractor has the first option to purchase certain fixed quantities of crude oil
produced from Service Contract (SC) areas. At a point in time there was only one SC in place in Nigeria
between the NNPC and Agip Energy and natural resources, which covers only one oil mining lease.
Service Contract without risk is a contract agreement whereby an oil company carries out exploration,
development and production activities on behalf of and on account of the national oil company, with the
state bearing all risks and the exclusive right to all resources discovered. While, service contract with risk
is similar to service contract without risk, except that if no discovery is made, the contractor is negated
44
and the oil company loses all its investments. Similarly, if oil is located, the contractor oil company
receives monetary compensation, usually payment in crude oil.
3.1.5 Indigenous Contracts: Indigenous Contract is an arrangement whereby concessions are owned by
the NNPC but allocated to indigenous companies to operate. The NNPC regulate and approve technical
aspects of the operations and make no financial contribution to E&D activities. Unlike JV or PSC where
the NNPC is entitled to crude oil in one form or the other, the indigenous companies only pay royalties
and petroleum profits tax to the Government. It is a step taken by the Government to encourage
indigenous participation in the E&P of oil and gas in the country. There are an upwards of 38 companies
that are engage in this arrangement, among which are Summit oil, consolidated oil, General, Sufra, Union
dubri and Amni Petroleum development Company. Some of the companies have made commercial
discoveries and are already producing oil, while others are at various stages of exploration and production.
3.1.6 NNPCs Direct Exploration: The NNPC through its subsidiaries (NAPIMS and NPDC) carry out
all operations associated with the search, development and production of oil and gas resources in Nigeria.
3.1.7 Hybrid Agreement: It is usually common to find a hybrid agreement that combine elements of
different agreements. For example NNPC worked out an alternative funding arrangement with the oil
companies known as PSC hybrid NNPC carry arrangement, due to the inability of the Nigerian
Government to fund JVAs as a result of dwindling revenue. In this arrangement, which is a hybrid of JV
and PSC, the oil companies in the JV carry the NNP share of capital costs while the NNPC continues to be
cash called for operating expenses.
3.2 Financial and Fiscal Monitoring Mechanisms in the petroleum Industry
Monitoring mechanism can be defined as the procedures and controls (both internal and external) put in
place by the Government with the support of the operating partner with a view to ensuring that
exploration, development and production activities are hitch-free and are carried out efficiently and
effectively in the upstream sector. The monitoring mechanisms for the various types of contract
arrangements (i.e. JV, PSC and SC) are similar in nature and can be grouped into three broad categories,
as follows:
(i)Administrative Monitoring Mechanism (AMM);
(ii)Technical Monitoring Mechanism (TMM); and
(iii)Financial and Fiscal Monitoring Mechanism (F&FMM)
Administrative monitoring mechanism is mainly about ensuring due process, mutually beneficial
negotiations, appropriateness of contractual arrangement and appointment of the right contractor.
Technical monitoring mechanisms are meant to ensure that the production and development of oil is done
efficiently and is carried out in a hitch-free operating upstream sector. While financial and fiscal
monitoring mechanisms are instituted to ensure financial and fiscal accountability of oil and gas
operations, through the following measures:
(i)
Yearly Budget Preparation and Approval: Yearly budgets are prepared and submitted for
scrutiny and approval of the management committee, which is made up of representatives of
the operators, the Government and other parties that are involved, based on the participating
agreement. The committee is responsible for betting the budget, recommending for approval
(after amendments if any suggested by the committee), providing supervisory control and
monitoring on the implementation of the budget and comparing the actual budget results
against the standard at the end of the budget period. While the NNPC appoint the committees
chairman, the operator appoints the secretary. The committee is responsible for creating subcommittees to take care of finance, budget monitoring and other similar issues.
45
(ii)
Book-keeping, Financial Reports and Returns: The operator or contractor is responsible for
keeping proper books of accounts in line with modern petroleum industry accounting practices
and procedures and reports such information in accordance with stipulated format of reporting
in the industry. Members of the management committee have the right to access such books
and accounts which must be kept at the registered office of the contractor in Nigeria, along
with the statement of account in the stipulated format, within 60 days from the end of each
month and each quarter and 90 days from the end of the financial year. The operator must not
omit or amend any item of the budget without a written approval of the management
committee and its relevant sub-committee(s).
(iii) Internal Audit: The operator is obligated to establish an effective system of internal audit base
on well establish internal control system in respect of operations. Members of the management
committee have right of access to all the internal audit reports and replies to audit queries
raised by the internal auditor in respect of the operations.
(iv) External or Statutory Audit: The operators financial statements with respect to the
operations must be audited by the operators statutory auditors as examined and verified by
each of the non operators appointed auditors.
(v) Non-Operators Right of Audit: A non-operator may carry out or course to be carried out,
periodic audit of the books of accounts and all accounting records relating to the operation. Any
discrepancies in the account must be queried within 36 days from the date of receipt of the
account by the non-operator. This time limit does not apply in the case of fraud. The NNPC
today carry out value for money audit with a view to ascertaining the effectiveness, economical
and efficiency of all JV operations in which it is a partner.
(vi) Cost Oil Approval: In the case of PSC petroleum won from operation are classified into royalty
oil, cost oil, equity oil, tax oil and profit oil. While profit oil stipulates the percentage of
allocation of profit oil base on monthly average production, the contractor cannot recover any
cost oil unless there is prior approval by the NNPC.
(vii) Over Expenditure of Work Programme and Budget: When it is necessary to carry out agreed
work programme, an operator may during any calendar year over-expend any budget line item
by an amount not exceeding:
(a) 10% of the amount budgeted;
(b) In case of JV operation, either 10% of the amount budgeted or 2 million US Dollars,
whichever is less.
However, the foregoing shall not authorize the operator to over-expend the total amount of the budget for
any calendar year by more than 5%, without informing the other parties to obtain approval, as soon as the
over-expenditure is foreseen by the operator.
4. Accounting Principles and Standards in the Oil and Gas industry
4.1 Petroleum Accounting and Generally Accepted Accounting Principles (GAAPs)
Accounting principles could be defined as those rules of action or conduct, which are adopted by the
Accountants universally while recording accounting transactions. IAS I defined Accounting principles as
a body of doctrines commonly associated with theory and procedures of accounting, serving as an
explanation of current practices and as a guide for selection of conventions or procedures where
alternatives exist. The principles that impact most on oil and gas accounting practices can be classified
into two categories, namely:
a) accounting concepts; and
b) accounting conventions.
4.1.1 Accounting Concepts
46
This refers to those basic assumptions or conditions upon which the science of Accounting is based. They
are usually rules and conventions that lay down the way in which activities of a business are recorded.
These are:
1) Entity Concept: According to the standard, every economic entity regardless of its legal form of
existence is treated as a separate entity from parties having propriety or economic interest in it. In
Accounting, business is considered to be a separate entity from the proprietor(s). This concept is
applicable to all forms of business organizations, including the oil and gas companies.
2) Going-Concern Concept: This is the assumption that a business will continue to operate
indefinitely into the foreseeable future; that is, the business is not expected to liquidate in the near
future. The economic environment of oil and gas industry is highly political and the risk of
nationalization is high. Also, companies may be nearing the expiration of their lease periods
without any hope for renewal of the lease or obtaining another lease. Such events must be taken
into account in determining their going concern status.
3) Periodicity Concept: According to this concept, the life of the business should be divided into
appropriate segments for the purpose of determining its financial performance. In accounting, such
a segment or time interval is called accounting period. It is usually a period of twelve months,
which can start any time and end any time, without necessarily required to be in line of a calendar
year, which must start January and end 31st December. In the oil and gas industry, the financial
year is line with government fiscal year which must starts January 1 and ends December 31st and
companies do not mostly have the discretion to vary it.
4) Realization Concept: This concept states that revenue is recognized when a sale is made. Sale is
considered complete at the point when the property in the goods passes to the buyer and he
becomes legally liable to pay. The specific application of this principle is that in the petroleum
industry, crude oil is deemed sold as produced and therefore revenue may be recognized on crude
oil produced. However, on the basis of this principle, revenue cannot be recognized on oil and gas
reserves.
5) Matching Concept: According to this concept, the earned revenue and all the incurred costs that
generate that revenue must be matched and reported for the period with a view to determining the
net financial performance of a business. The term matching means appropriate association of
related revenues and expenses. This concept applied in oil and gas accounting more especially in
accounting for impairment and in computation of depreciation, depletion and amortization.
6) Historical Cost Concept: This concept states that the basis for initial accounting recognition of all
assets acquisitions, services rendered or received, expenses incurred, creditors and owners
interests is the actual cost for the transaction(s). This principle is greatly applied in computing
depreciation, depletion and amortization, allowances for impairments, and recognition of gain or
loss on conveyances. An extension of this principle in oil and gas accounting is the ceiling test
concept, which stipulates that the total capitalised cost in the oil and gas company books should
not exceed the estimated value of reserves at the reporting date, since the oil reserves are the most
important economic assets own by the company. The whole essence is to ensure that cots are not
capitalized in the books that are not backed up by economic assets.
7) Money Measurement: Accounting is only concern with those activities that can be measured in
money terms with fair degree of accuracy and objectivity. The peculiar nature of oil and gas
accounting is that its major economic asset, oil and gas reserves are not reflected in the balance
sheet, yet the final accounts provide a true and fair representation of the financial results.
8) Dual Aspect Concept: This states that there are two aspects of accounting; one represented by the
resources owned by a business and the other, by the claim against them. Double entry is therefore
meant to uphold this concept. This concept is applicable to all forms of business organizations,
including the oil and gas companies.
4.1.2 Accounting Conventions
47
These are customs or traditions, which guide the Accountant while preparing the accounting statements. In
other words, accounting conventions are approaches to the application of accounting concepts. These
include:
1) Conservatism/Prudence: This states that greater care in the recognition of profit should be
exercised whilst all known expenses, even those that cannot be accurately calculated with fair
degree of accuracy and objectivity should be adequately provided for by way of provision.
Prudence runs through the whole gamut oil and gas accounting and should be effectively applied
because oil operations are particularly more risky and has higher potentials for loss. Prudence in
oil and gas accounting requires that reserves should he estimated objectively and only the latest
reserve estimates should be used. It is also prudent to recognize impairment in the cost of
unproved properties and ensure that only valuable costs are retained in the books.
2) Materiality: The principle holds that only items of material values are accorded their strict
accounting treatment. This means that perfect accounting treatment may not be applied to
transactions that are of insignificant value both in amount, intention and effect on the user. In this
respect, a purely capital item may be expensed if it is not material. This convention applies to oil
and gas accounting.
3) Consistency Concept: This concept holds that when an enterprise has adopted an accounting
method of treating transactions, it should continue to use that method in subsequent periods so that
comparison of accounting figures overtime could be made possible. Oil and gas accounting
principles accommodate different practices based on defined assumptions, though the consistency
principle states that once an oil company adopts FC or SE, it should stick to the method, and
disclosure is required when change in an accounting method becomes inevitable, and the
consequences of such change on the financial statements should also be disclosed.
4) Substance over Form: This convention states that business transaction should be accounted for
and presented in accordance with their substance and financial reality and not merely with their
legal form. This convention applies in the oil and gas industry.
5) Objectivity/Fairness: According to this convention, data presented on the financial statements
should be supported by verifiable evidence and demand the independence of judgment on the part
of the Accountant preparing the financial statements. Similarly, it is required that accounting
reports should be prepared not to favour any group or segment of society. Because of its
peculiarities, financial statements of oil and gas companies require far more disclosures than that
of other industries. These disclosures are expected to corroborate the statements, provide
supporting information and provide details for the numbers on the financial statements.
4.2 Method of Accounting in the Oil and Gas Industry
Two methods of accounting are now generally accepted for the oil and gas industry. These are Successful
Efforts Method (SEM) and Full Cost Method (FCM). SEM is the method where all exploration costs
(namely acreage cost, costs of geological and geophysical surveys, cost of dry holes etc) are charged to
expenses, while those that lead to discovery of reserves are capitalized. It gives due cognizance to the
accounting concept of conservatism/prudence. On the other hand, the FCM is a method in which all
acquisition, exploration and development costs are capitalized whether they lead to the discovery of oil
reserves or not. Proponents of FCM are of the view that finding commercially producible hydrocarbons is
an overall objective that should not be evaluated on well by well basis, as such all costs incurred are part
of the cost of whatever reserves are found, because the good must support the bad. While advocates of
successful efforts method held that any drilling effort that proves to be unsuccessful is a loss that must be
expense immediately.
48
Prior to 1950, most oil and gas companies used some form of SEM to account for oil and gas exploration,
development and production. Generally, the practice was to expense dry hole costs and intangible drilling
costs on productive wells and capitalizes the costs of property acquisition, wells and equipment. These
capitalized costs are amortized if reverse were found or charged to expense if reserve were not discovered.
However, with emergence of more sophisticated exploration technology in the 1960s a new method of
accounting oil and gas activities know as full cost method, in which all cost incurred in exploration and
development of oil and gas reserves were capitalized in a cost centre regardless of whether reserves were
discovered or not.
While controversy raged, practical application of each of the two methods varied from company to
company. Some users of SEM capitalized all geological and geographical exploration costs, others
expense them. Similarly, while some users expense dry exploration wells, others capitalize dry
development wells, etc. In an attempt to ensure a decision-relevant financial reporting, the FASB issue an
explore draft in 1977 titled: Financial Accounting and Reporting by Oil and Gas Producing Companies:
which indicated the need for all companies to use the SEM in their reports. However, the FASBs effort
was scuttled by US SEC and other government agencies; and their argument were simply on the fact that;
not until the viability of the SEM over the FCM is proved, the call for adopting the SEM was uncalled for.
Therefore, oil and gas reporting practice has been a source of concern to stakeholders since the 1970s and
the recent accounting scandals of the 1990s have once again brought the issue into the limelight. One of
the major issues bedeviling the industry is the fact that the conventional cost accounting does not cater for
the information needs of various stakeholders. The non appearance of the most valuable assets i.e. oil
reserves, on oil and gas companies financial reports is unique to the industry. Consequently, since such
assets constitute the basis for determining the companys performance and the fact that the cost of such
assets are accounted for, differently by different companies puts the value-relevance of the reports into
question. The two methods used to account for costs in the industry result to a number of inconsistencies:
thus ensued the debate on which of the methods is most suitable to be used by the oil and gas companies.
Unlike many other industries, costs here are classified based on the nature of operations rather than the
nature of a particular cost itself. As such the costs that characterized the operations of the industry are
basically incurred at four stages which include (i) the costs incurred in acquiring the mineral interest in
property (leasing), (ii) exploring the property (drilling), (iii) developing the proved reserves, and (iv)
producing (lifting) the oil and gas.
However, the fundamental accounting issue lies at the exploration stage, i.e. whether to capitalize or
expense the exploration cost which do not result to proved reserves. Since all other costs are treated alike
by all companies, companies that capitalize only the exploration cost which result to proved reserves are
called SE companies, whereas companies that capitalize all exploration costs, even those that do not result
to proved reserves, are called FC companies. This is obviously a source of concern, since the two methods
used to account for exploration costs differ significantly. Consequently, accounting standard setters are
faced with a serious challenge that bedeviled the profession for decades.
4.3 Reserve Recognition Accounting (RRA)
Some concerned accounting practitioners were against the recommendation of FAS 19, which allow
companies to use either FCM or SEM. This made SEC to propose the development of a new method of
accounting for oil and gas known as RRA, with a view to remedy, the inherent weakness of SEM and
FCM. Under the RRA, companies would be allowed to recognize the value of proved oil and gas reserves
as assets and changes in such reserve values as earnings in the financial statement. Just like FCM or SEM,
RRA came under severe criticisms, because it ignore the fact that measurement of oil and gas reserves are
49
imprecise and merely an estimate, and the projected revenue and cost may not materialize. Similarly, RRA
is criticized for ignoring the realization concept, thereby recognizing revenue before receiving it.
4.5
Development of Accounting Standard in the Oil and Gas Industry
An accounting standard is a statement issued by the appropriate standard-setting body locally or
internationally on a specific area or topic in financial accounting, the acceptance/application of which is
mandatory for preparers and users of financial statements. Criticisms of FCM and SEM and RRA,
triggered SEC to search for solution, thus culminating in FAS 69 by FASB in November, 1982. Similarly,
the UK Oil industry Accounting Committee published four statements of recommended practice (SOR) to
be used by oil and gas companies. These statements are: (1) Disclosures of oil and gas E & P activities; (2)
accounting for oil and gas E & D activities (3) accounting for abandonment costs; and (4) accounting for
various financing revenue and other transactions of oil and gas E & P companies.
The Nigeria Accounting Standard Board (NASB) followed suit by issuing SAS 14 (Accounting in the
Petroleum Industry: Upstream Activities) through Chief R.U. Uches Committee. The standard came into
effect from January 1, 1994. Similarly, through the effort of the same committee, NASB issue SAS 17
(Accounting in the Petroleum Industry: Downstream Activities) which came into effect on January 1,
1998.
The standards which are applicable in Nigeria are Statement of Accounting Standards (SAS) issued by the
Nigerian Accounting Standards Board (NASB), International Accounting Standards (IAS) issued by the
International Accounting Standards Committee (IASC) and the International Financial Reporting
Standards (IFRS) issued by the International Accounting Standards Board (IASB). All the standards, IAS,
IFRS and SAS are applicable in Nigeria except that if an IAS/IFRS is inconsistent with an SAS, the
IAS/IFRS would be inapplicable to the extent of the inconsistency. This implies that on any matter on
which an IAS/IFRS and an SAS make conflicting pronouncements, the SAS shall supersede the IAS/IFRS
in Nigeria. However, with effect from first January 2012, when Nigeria adopted IFRS in financial
reporting, the reverse is the case. In other words, with effect from first January, 2012, IAS/IFRS was
adopted in Nigeria, and SAS will only be applicable where no IAS or IFRS is issued on the same item.
Sequel to this, IFRS 6 (and some aspects of SAS 14) and 17 are now applicable in Nigeria.
4.5.1 Required Practice and Disclosure by SAS 14
1. Method of accounting for cost incurred and the manner of disposing capitalized costs.
2. Policy on accounting for restoration and total amount relating to each.
3. Method of accounting use either FCM or SEM, which should be consistently applied and
disclosed.
4. Cost should be classified by nature and function of cost element e.g. mineral interest in proved and
unproved properties, wells and related equipment and facilities, wells and equipment in progress
etc.
5. For FC companies: (i) initial costs incurred relating to mineral rights acquisition, exploration,
appraisal and development activities should be capitalized; (ii) all capitalized costs (on countrywide basis) are to be depreciated on unit of production basis, using proved reserves; (iii) ceiling
tests should be conducted (using discounted values for revenue, costs, taxes and future
development costs) at least annually at balance sheet date, on a country-wide basis, using proved
reserves and price ruling as at the date of the balance sheet; (iv) where accounts are prepared in US
Dollars cash flows shall be discounted at 10%, otherwise if Naira is used, the CBN rediscount rate
should be used; (v) if net discounted revenue is lower than the capitalized costs, the difference
should be written off.
50
6. For SE companies: (i) initial costs incurred prior to acquisition of mineral rights not specifically
directed to an identifiable structure should be expensed in the period they are incurred; (ii) all costs
incurred relating to mineral rights acquisition, exploration, appraisal and development activities
should be capitalized initially on the basis of wells, fields or exploration cost centres, pending
determination and written off later if the well is dry; (iii) maximum of 3 years in offshore and 2
years in onshore are allowed as retention period for further appraisal cost pending determination;
(iv) capitalized costs should be amortized over the remaining life of the licence and the balance
should be reviewed annually for impairment on wells basis, and any impairment should be written
off; (v) drilling costs are to be amortized using unit-of-production basis using proved developed
reserves.
7. Cost of providing amenities for communities in areas of operation should be written off as
incurred.
8. Treatment of carrying interest and amount of carried expenditure to date.
9. Treatment of farmouts and similar arrangements.
10. Treatment of unitization and redetermination arrangements.
11. Treatment of joint venture
12. Accounting for over-lifts and under-lifts
13. Provision for restoration and abandonment cost
14. Recognition of gains or losses under conveyances/surrender/sold of unproved property.
15. Information on proved oil and gas reserve quantity.
16. Disclosure of standardize measure of discounting future net cash flows relating to proved oil and
gas reserves.
4.5.2 Requirements of IFRS 6 (Exploration and Evaluation of Mineral Resources)
IFRS stands for International Financial Reporting Standards. The international standards board (IASB),
and its predecessor committees developed the accounting standards that form IFRS. In fact the standards
consist of documents called IFRS as well as older standards called International Accounting Standards
(IASs). International standards were originally introduced to achieve two objectives:
(i) Produce high quality standards
(ii) Work to improve harmonization of preparation and presentation of financial statements
IFRS 6 applies to expenditures incurred by an entity in connection with the search for mineral resources. It
applies to exploration and evaluation expenditures including minerals, oil and natural gas. This includes
the determination of the technical feasibility and commercial viability. However, the following are
excluded from its scope:
(i) expenditures incurred before the entity has obtained legal rights to explore; and
(ii) expenditures incurred after technical feasibility and commercial viability demonstrable.
The objective of IFRS 6 is to specify the financial reporting for the exploration for and evaluation of
mineral resources.
IFRS 6 deals with only limited aspects of accounting for extractive activities. These include
(i) Assessment of exploration and evaluation assets for impairment (impairment is measured in
accordance with IAS 36, Impairment of Assets); and
(ii) Disclosures about exploration for and evaluation of mineral resources.
On the introduction of this standard the recognition and measurement of Exploration and Evaluation
Assets (E&E assets) fall outside the scope of IAS 38, Intangible Assets, and IAS 16, Property Plant, and
Equipment.
Selection of Accounting Policies for Exploration and Evaluation Assets
51
IFRS 6 does not require or prohibit any specific accounting policies but rather permits entities to continue
to use existing policies provided they comply with IAS 8. When developing accounting policies for E&E
assets, an entity is required to apply fundamental principles of selection and application of policies as
stated in IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. These principles are
(i) Relevance in the context of decision-making needs of users;
(ii) Providing faithful representation;
(iii)Reflecting economic substance;
(iv) Neutrality;
(v) Prudence; and
(vi) Completeness.
As per IAS 8, paragraphs 1112, management should normally refer to sources of authoritative
requirements and guidance in developing an accounting policy for an item if no IFRS applies specifically
to that item. However, these paragraphs of IFRS 8 are not required to be followed for recognition and
measurement of E&E assets.
IFRS 6 defines exploration and evaluation expenditures as the expenditures that are incurred by an entity
in connection with the exploration for and evaluation of mineral resources before the technical feasibility
and commercial viability of extracting a mineral resource are demonstrable. While, exploration and
evaluation assets are considered as the capitalized portion of exploration and evaluation expenditures
recognized as assets in accordance with the entitys accounting policy. They are measured at cost at the
time of initial recognition. Paragraph 11 of IFRS 6 requires an entity to recognize an obligation for
removal of the remains of the E&E activities and restoration of the site in accordance with the principle in
IAS 37, Provisions, Contingent Liabilities, and Contingent Assets.
Entities may change their accounting policies if more relevant or reliable using criteria in IAS 8
(Accounting Policies, Changes in Accounting Estimates and Errors) but a change must be justified as
closer to meeting IAS 8 criteria.
ACCOUNTING FOR E&E COSTS
Expenditures incurred in exploration activities are expensed unless they meet the definition of an asset
(see the IASB Framework, paragraphs 5359). An entity should recognize an asset when it is probable
that economic benefits will flow to the entity as a result of the expenditure. Expenditures on an
exploration property are expensed until the capitalization point. The capitalization point is the earlier of
either (1) when the fair value less cost to sell of the property can be reliably determined as higher than the
total of the expenses incurred; or (2) when an assessment of the property demonstrates that commercially
viable reserves are present and therefore, there are probable future economic benefits from the continued
development and production of the resource.
IFRS 6, paragraph 9, gives examples of expenditures incurred for E&E assets (the list is not exhaustive):
(i) Acquisition of rights to explore;
(ii) Topographical, geological, geochemical and geophysical studies;
(iii)Exploratory drilling;
(iv) Trenching;
(v) Sampling; and
(vi) Activities in relation to evaluating the technical feasibility and commercial viability of extracting a
mineral resource.
Expenditures related to the development of mineral resources do not relate to E&E assets. These are
covered under development assets. An entity has to take guidance from the IASB Framework and IAS 38
for recognizing and measuring development assets. While recognizing E&E assets, it becomes necessary
52
to recognize any obligations for removal and restoration that are incurred during a particular period as a
consequence of having undertaken the exploration for and evaluation of mineral resources under IAS 37,
Provisions, Contingent Liabilities and Contingent Assets.
Prior to the adoption of IFRS, a number of companies in the oil and gas industry used the full cost method
of accounting for E&E expenditure. Under this method all E&E expenditure is capitalized within cost
pools. Costs are then considered for impairment or depreciated on commencement of production as cost
pools rather than on the basis of an individual field. Applying full cost method, a dry well may be
capitalized as part of the cost pool, but the lack of associated reserves will be taken into account through
an increased depletion charge or through the impairment testing performed on the overall pool. Successful
efforts is an alternative method of accounting for E&E that is favored by many larger companies. Under
this method, the E&E expenditure is initially capitalized pending the determination of reserves on the
basis of an individual field. As companies opt to change from a full cost method to a successful efforts
method on adoption of IFRS, there will be generally a reduction in opening net assets; however, this will
result in lower amounts recognized through the statement of comprehensive income going forward in
respect of these assets by way of reduced depletion. In fact, IFRS 6 does not specify the full cost or
successful efforts method. It requires an entity to adopt an appropriate accounting policy within the broad
principles stated in IAS 8, paragraph 6. However, only expenses specified in IFRS 6, paragraph 9, can be
capitalized and the IASB Framework definition of an asset may not permit capitalization of some expenses
as E&E assets.
Figure V: Exploration and Evaluation Activities at a Glance
Source: Understanding IFRS Fundamental, Ankarath, N., Mehta, K. J., Ghosh, T.P. and Alkafaji, Y. A.
Pp 341
53
Measurement after Initial Recognition and Presentation

Subsequent to the initial recognition of E&E at cost, an entity shall apply either the cost model or
revaluation model. For the purpose of applying revaluation, the entity should follow the principles set out
in IAS 16 (Property, Plant and Equipment) or IAS 38 (Intangible Assets). An entity may change its
accounting policies relating to E&E assets. While doing so, it is necessary to judge the principles of
reliability and relevance in accordance with IAS 8. A change in accounting policy should make the
financial statements more relevant for the users decision making and should not be less reliable. It is
possible to present E&E assets either as tangible assets or intangibles depending on the nature of the
assets. For example, a drilling right is classified as an intangible asset, whereas vehicles and drilling rigs
are classified as tangible assets. E&E assets are no longer classified as such when technical feasibility and
commercial viability of extracting minerals is demonstrable. When an entity incurs obligations for
removal and restoration these must be recognized in accordance with IAS 37 (Provisions, Contingent
Liabilities and Contingent Assets).
Impairment
E&E assets are tested for impairment when the facts and circumstances suggest that the carrying amount
is more than the recoverable amount. In such a case, the entity should apply IAS 36 and measure the
impairment loss, if any. Then E&E assets should be presented net of such impairment loss. IFRS 6,
paragraph 20, explains those facts and circumstances that should be evaluated for assessing if there is any
impairment loss for E&E assets. IAS 36, paragraphs 817, are not applied for the identification purpose.
IFRS 6, paragraph 20, illustrates four indicators or facts and circumstances which may indicate that
impairment testing is required ((this list is not exhaustive)
(i) period of right to explore has expired and not expected to be renewed;
(ii) substantive expenditure on future exploration is neither budgeted nor planned;
(iii)exploration for and evaluation has not led to discovery of commercially viable quantities of
mineral resources and entity is discontinuing its activities in a specific area;
(iv) although development likely to proceed, the carrying amount is unlikely to be recovered in full
from successful development or by sale.
Disclosures
An entity shall disclose information that identifies and explains the amounts recognized in its financial
statements arising from the exploration for and evaluation of mineral resources. This requires:
(i) disclosures of accounting policies for exploration and evaluation expenditures including the
recognition of exploration and evaluation assets, and
(ii) the amounts of assets, liabilities, income and expense and operating and investing cash flows arising
from the exploration for and evaluation of mineral resources. An entity is required to treat E&E assets
as a separate class of assets, either under IAS 16 (classification as tangible assets) or IAS 38
(intangible assets), and make the disclosures required by either IAS 16 or IAS 38, consistent with how
the assets are classified.
Recent amendments to IFRS 1 (effective for annual periods beginning on or after January 1, 2010, with
early application permitted) allow a first-time adopter using full cost method of accounting under its
previous GAAP to elect to measure oil and gas assets at the date of transition to IFRS on the following
basis:
(i) E&E assets at the amount determined under previous GAAP
(ii) Assets in the development or production phases at the amount determined under previous GAAP,
allocated to the underlying assets pro rata using reserve volumes or reserve values as of that date
Upon measuring oil and gas assets on this basis, the E&E assets and those assets in the development and
production phases are required to be tested for impairment at the date of transition to IFRS in accordance
54
with the provisions of this standard and those of IAS 36, Impairment of Assets, to determine that the assets
are not stated at more than their recoverable amount. For the purpose of these exemptions, oil and gas
assets comprise only those assets used in the exploration, evaluation, development, or production of oil
and gas. If the exemption for oil and gas assets in the development or production phases accounted for
using the full cost method under previous GAAP is elected, a first-time adopter is required to disclose that
fact and the basis in which carrying amounts determined under previous GAAP were allocated.
Entity must classify exploration and evaluation expenditure assets as tangible or intangible according to
their nature. Examples of tangible assets include vehicles and drilling rigs and intangible assets include
drilling rights. Once technical feasibility and commercial viability become demonstrable any previously
recognized exploration and evaluation assets fall outside the scope of IFRS 6 and is reclassified in
accordance with other standards but they should be assessed for impairment first.
EXCERPTS FROM PUBLISHED FINANCIAL STATEMENTS
Royal Dutch Shell plc, Annual Report 2008
(Culled from understanding IFRS fundamental by Ankarath, N., Mehta, K. J., Ghosh, T.P. and Alkafaji, Y. A. Pp 342-343)
2. Accounting Policies
Exploration Costs
Shell follows the successful efforts method of accounting for oil and natural gas exploration costs.
Exploration costs are charged to income when incurred, except that exploratory drilling costs are included
in property, plant, and equipment, pending determination of proved reserves. Exploration wells that are
more than 12 months old are expensed unless:
(1) proved reserves are booked, or
(2) (a) they have found commercially producible quantities of reserves, and
(b) they are subject to further exploration or appraisal activity in that either drilling of additional
exploratory wells is underway or firmly planned for the near future or other activities are being
undertaken to sufficiently progress the assessing of reserves and the economic and operating
viability of the project.
3. Key Accounting Estimates and Judgments
Exploration Costs
Capitalized exploration drilling costs more than 12 months old are expensed unless:
(1) proved reserves are booked, or
(2) (a) they have found commercially producible quantities of reserves and
(b) they are subject to further exploration or appraisal activity in that either drilling of additional
exploratory wells is under way or firmly planned for the near future or other activities are being
undertaken to sufficiently progress the assessing of reserves and the economic and operating viability
of the project. When making decisions about whether to continue to capitalize exploration drilling
costs for a period longer than 12 months, it is necessary to make judgments about the satisfaction of
each of these conditions. If there is a change in one of these judgments in a subsequent period, then
the related capitalized exploration drilling costs would be expensed in that period, resulting in a
charge to income. Information on such costs is given in Note 11.
12. Property, Plant, and Equipment
Exploration and evaluation assets, which mainly comprise unproved properties (rights and concessions)
and capitalized exploration drilling costs, included within the amounts shown here for oil and gas
properties are as follows:
55
Capitalized exploration drilling costs are as follows:

Exploration drilling costs capitalized for periods greater than one year and representing 156 wells
amounted to $1,499 million at December 31, 2008. Information by year of expenditure is presented here:
These costs remain capitalized for more than one year because, for the related projects, either (1) firm
exploration/exploratory appraisal wells were executed in 2008 and/or are planned in the near future,
and/or (2) firm development activities are being progressed with a final investment decision expected in
the near future.
4.5.3 Required Practice and Disclosure by SAS17
The Accounting Standard comprises paragraph 44-59 of this statement covers the provisions as follows:
Accounting policies
44. All companies engaged in downstream activities in the petroleum industries shall state in their
financial statement all significant accounting policies adopted in the preparation of those statements.
45. The accounting policies should be prominently disclosed under one caption rather than as notes to
individual items in the financial statements.
Refining and petrochemicals operations
Catalysts
46. Costs of short life catalyst should be expensed in the year in which they are incurred while costs of
long life catalysts should be capitalised and written off over the life of the refinery. Where long life
catalysts are generated, the costs of regeneration should be capitalised and amortised over the life of
regeneration.
Turn-Around Maintenance
47. Turn-around maintenance costs should be capitalised and amortised over the expected period before
the next turn around maintenance will be due.
Stand-by Equipment
48. Stand-by Equipments should be depreciated over the expected useful life of similar equipment in use.
Depreciation of plants and Equipment
49. The costs of refining or petrochemicals plants and equipments should be depreciated on a straight line
basis over the useful life of the assets or, if operating at normal levels of production, on the basis of
expected throughput. The method used should be disclosed and consistently applied.
56
Debottlenecking, Major Plant Rehabilitation and Replacement of Major Components

50. Where major plant rehabilitation, debottlenecking or replacement of major components result in a
significant and identifiable increase in output or betterment of the plant, the cost should be capitalised and
amortised over the period over which the benefits is expected to last. In any other case, it should be
expensed as incurred.
Marketing and Distribution Operations
Bridging Costs Claims
51. Bridging costs which are recoverable from government through NNPC should be set up as claims
receivable. Where they remain outstanding for an unreasonable length of time, adequate provision should
be made for them. Claims not recovered within two years should be fully provided for.
ATK Overbilling Claims
52. ATK overbilling claims should be set up as a receivable. Where they remain unpaid for an
unreasonable length of time, they should be provided for claims not recovered within two years should be
fully provided for.
Liquefied Natural Gas Operation Take or Pay Contracts
53. Where a purchaser is unable to take his entitlement under a take or pay contract, with a right of makeup, the purchaser should treat the amount paid as receivable. Conversely, the supplier should treat the
advance received as deferred revenue. The deferred revenue should be recognized when the makeup right
is exercised by the purchaser.
54. Where a supplier is unable to deliver the quantity contracted, the amount received from the purchaser
should be treated as a liability by the supplier while the purchaser should treat the amount paid as
prepayment.
Disclosures
55. In addition to the disclosures requirements of SAS 2 Information to be Disclosed in Financial
Statements, companies operating in the downstream sector of the petroleum industry should disclose the
following the following as they relate to their activities;
(a) Refining and Petrochemical Companies
(i) Processing fees from third parties
(ii) Any amount of turn-around maintenance capitalized and or expensed split into material costs and
lab our costs and where capitalized the rate of amortization
(iii) Debottlenecking, major plants rehabilitation and replacement of major components costs incurred,
capitalized or expensed and, where capitalized, the rate of amortization
(iv) The cost of research and developments
(v) Basis of valuation of products and intermediates
(vi) For an integrated plant, revenue earned for each class of activities
(b) Marketing and Distribution Companies
(i) Bridging claims and related provision made
(ii) ATK overbilling claims and related provision made.
(c) Liquefied Natural Gas Companies
Details of Take or Pay contracts not yet fulfilled and the related deferred revenue or
prepayment.
Packaging and Non-core Businesses

56. The operating results of packaging and other non-core businesses owned by companies operating in
the downstream sector of the petroleum industry should be separately disclosed.
57
Transfer Pricing
57. The transfer pricing methods adopted should be disclosed.
58. The requirements of this standard are complementary to any accounting and disclosure requirements
of the companies and Allied Matters Decree, 1990 and relevant laws and regulations
5.0 Procedures in Oil and Gas Accounting
5.1 Impact of Order of Drilling on Petroleum Accounting Methods
There are two methods of accounting used in the oil and gas industry. These are SEM and FCM. The SEM
and FCM of accounting give significantly different results based on purely chance factors like the order or
chronology of successful and unsuccessful wells. Assuming that, a company in an attempt to develop an
oil reservoir, drills a total of four wells. The first two wells (A and B) are successful while the last two
wells (C and D) are unsuccessful. Under the SEM, the four wells will be capitalized as wells C and D are
now development wells. The income statement will show a buoyant picture. However, if the first two
wells drilled are unsuccessful and the last two wells are successful, the cost of wells A & B will be
charged to expense while the cost of wells C & D will be capitalized. Thus, merely changing the order in
which wells are drilled will result in a vast difference in the financial statements. With increased
exploration drilling, net income drops under the SEM when compared to the full cost accounting method.
When there is an increased rate of discovery, that is, a greater percentage of successful wells rather than
dry holes, this result in increasing net income under the SEM as fewer dry holes are written off. However,
all these have no effect on FCM companies.
5.2 Similarities and Differences between SEM and FCM
Two of the very few similarities between the two methods are in the treatment of development costs and
production costs. Development costs in both cases are capitalized whether successful or not while
production costs are expensed.
Table 5: Comparison between SEM and FCM and Compliance with GAAPs
Basis of
S/No. Comparison
1 Presenting a true
and fair view of the
result
of
the
operations of the
business.
2 Return on assets
Share values
Investment
Lenders.
Successful Efforts Method

As all exploratory costs that are
Successful are charged to expense,
financial statements present a true
and fair view of the result of
operations.
The accounting rate of return of the
business is higher as only
productive assets are capitalized.
Full Cost Method

Capitalizing the monetary values of
unsuccessful exploration costs impair
the true and fair view of the financial
statements of the company.
The accounting rate of return of the

business is lower because both
productive and non-productive assets
are capitalized. This may result in
takeover bids.
The share value may be higher The low rate of return may adversely
because the accounting rate of affect the share value.
return is higher.
and Net profit figures are generally Financial statements are more stable
lower and fluctuate drastically thereby attracting investors and
especially in years where huge write lenders into the business.
offs are made, This discourages
investors
and
lenders
from
providing funds for the business.
58
Basis of
Successful Efforts Method
S/No. Comparison
5 Survival of the new New
entrants
and
growing
entrants and growing companies cannot afford the huge
companies.
write offs of the exploration losses
of initial years and their corporate
survival is threatened.
6 Production
of Information on the performance of
information
for individual wells is more readily
managerial decision available to support managerial
making.
decision making.
7 Performance
Enables the performance of
evaluation
of managers to be evaluated.
managers
8 Comparison
of Because of the erratic movement of
financial statements. the net profit results, meaningful
comparison of the financial
performance over years is impaired.
9 Dividend decisions
Since all losses are recognized
before the net profit results are
arrived at, dividend decisions are
more prudent.
10
Compliance
GAAPs
with
This method is more in accord

With the prudence and matching
concepts of accounting.
11 Record keeping and Relatively simple to operate and
associated costs.
record keeping is less expensive as
only one set of records are kept.
12
13
Ceiling Test
Ceiling test is not mandatory.
Exploration
and Potential effect-of writing off dry
drilling activities
hole
expenses
may
affect
exploration and drilling activities.
Full Cost Method

New and growing companies can
thrive better under this method
because most of costs incurred are
capitalized.
Information on individual wells is
concealed in a country pool. Costs of
inefficiencies are therefore not easily
identified for managerial action.
Managerial performances cannot be
accurately determined as the costs of
inefficiencies are capitalized.
Because results are more stable,
performance
comparisons
are
enhanced.
Exploration losses not written off
may cause published profits to be
overstated, which, may lead to
dividends being declared on them.
The enterprise may be de-capitalized.
Full cost method does not strictly
accord with the accounting concepts
of prudence and matching.
Method is complicated, especially
the calculation of ceiling tests.
Record keeping is more expensive as
memorandum records have to be
maintained in order to provide
information for each well.
Ceiling test is mandatory.
Potential effect on exploration and
drilling activities is minimal as dry
holes are not charged to expenses in
the income statement.
Figure VI and VII give the accounting procedure of FCM and SEM.
59
Figure VII: Full Cost Accounting for Costs
60
Figure VIII: Successful Efforts Accounting for Costs
61
5.2.1 Differences in Balance Sheet and Profit & Loss Account of FCM and SEM
FCM
SEM
Balance Sheet
(Capitalized amounts)
Geological and geophysical costs
xx
--Carrying costs and overhead
xx
--Surrendered and impaired leases
xx
--Unimpaired leases
xx
xx
Exploratory wells
Successful
xx
xx
Unsuccessful
xx
-Development wells
xx
xx
DD& A
xxH
xxL
FCM
SEM
Profit And Loss Account
(Expensed amounts)
-xx
Carrying costs and overhead
-xx
Surrendered and impaired leases
-xx
Unimpaired leases
--Exploratory wells
Successful
--Unsuccessful
-xx
Development wells
--DD & A
xxH
xxL
xxH Comparably higher
xxL Comparably lower
5.3 Differences between Tangible Costs and Intangible Costs
Tangible costs relate to costs of assets that have physical properties. Tangible is said to have been derived
from the Latin word tangere meaning to touch, impling that such assets can be touched or felt. They
include machinery, equipment vehicles etc. Tangible costs also include labour to install equipment etc.
even though such costs do not result in a physical asset. Intangible costs relate to costs that result in an
asset that has no physical properties. Examples are contract costs paid to a contract driller for drilling a
well, mud pits etc. In oil and gas operations and accounting, a distinguishing feature between
classification as tangible and intangible is salvageability. If the property can be salvaged at the end of
operations, such properties are usually classified as tangible whereas those properties (the underlying
costs) that cannot be salvaged at the end of an operation are classified as intangible. The distinction
between both types of costs is usually important for tax purposes.
Examples of Intangible Drilling Costs
Drilling contractors charges
Site preparation, roads, pits
Bits, reamers, tools
Labour
Fuel, power and water
Drill stem tests
Coring analysis
Electric surveys and logs
62
Geological and engineering

Cementation
Completion, fracturing, acidizing, perforating
Rig transportation, erection and removal
Overhead
Other services
Examples of Tangible Drilling Costs
Casing (production and surface)
Tubing
Well head and subsurface
Pumping units
Tanks
Separators
Heater-treaters
Engines and automotives
Flow line
Installation costs of equipment
Sundry equipment
Question One
Janguza Oil Company, a joint venture operator, incurred the following costs in drilling an oil well. You
are required to classify them into tangible and intangible drilling costs.
N
i. Drilling (on footage basis)
675,256
ii. Cost of clearing and grading unpaved roadways to the drill site
23,560
iii. Construction of overflow mud pits
56,700
iv. Surface casing used in the well
675,908
v. Services such as acidizing and testing
246,200
vi. Cementing services for casing
17, 890
vii. Tubing and control valves
57, 500
viii. Flow lines, tanks and treaters
116, 700
ix. Labour to install lines and tanks
26, 500
Solution to Question One
Ii
Drilling (on footage basis)

Cost of clearing and grading
unpaved roadways to the drill site
Intangible Drilling
Costs (IDC)
675,256
Tangible Drilling
Costs (TDC)
23,560
Iii
Iv
Construction of overflow mud pits

Surface casing used in the well
Services such as acidizing and
V
testing
Vi Cementing services for casing
Vii Tubing and control valves
viii Flow lines, tanks and treaters
Ix Labour to install lines and tanks
56,700
675,908
246200
17, 890
1,001,716
63
57, 500
116, 700
26, 500
675,908
5.4 Accounting for Depreciation, Depletion and Amortization

Oil and gas companies classify costs incurred on oil and gas properties into two broad categories, namely
mineral acquisition costs and wells and related equipment and facilities costs. These capitalized costs are
written off to the profit and loss account through depreciation, depletion and amortization (usually
abbreviated as DD&A). Depreciation is associated to the decrease in the values of physical or tangible
assets, amortization is associated with the expiration of the cost of intangible assets, while depletion refers
to the reduction in the costs of natural resources of wasting nature resulting from the diminution in the
value of the resources. However, emphases here would be on amortization and depletion, as depreciation
is perhaps well known in other aspects of financial accounting.
5.4.1 Basis for Amortization
The most commonly used method of computing amortization of oil and gas properties is the unit of
production method. This is in line with the provision of SAS 14 and 17. The unit of production method
assigns a pro-rata portion of capitalized costs of oil and gas properties to each unit of reserves. The oil
company then expenses the pro-rata assigned amount as it produces each unit of reserves. These are
explained below:
1. Unit of Production (UOP) Method
The formula for the unit of amortization method is:
(C - AD S) P
R
Where: C= Capital cost of equipment
AD= Accumulated DD&A
S= Salvage Value
P= Production during the year (in barrels)
R= Reserves remaining at the beginning of the year
This concept may be expressed as follows: Unamortized cost at end of the period X Production for the period
Reserve at beginning of period
An alternative form of the above formula is:
Production for the period
X Unamortized cost at the end of period
Reserves at beginning of period
Question Two
Kabuga Petroleum Company PLC had the following data at end of its financial year ended 31st December,
2011. You are required to calculate the DD&A for that year.
Capitalized cost at the end of year
N 1,700,000
Accumulated amortization
N 100,000
Reserves estimate at beginning of the year 5,000,000 bbls
Production during the year
250,000 bbls
Solution to Question Two
Amortization would be calculated as follows:
250,000 bbls X (1,700,000- 100,000)= N 80,000
5,000,000 bbls
64
5.4.2 Revision of Reserve Estimates

Reserves of oil and gas companies are frequently revised and, in any event, should be reviewed at least
annually. This is in line with SAS 14. When the estimate of reserves is reviewed and a revision becomes
necessary at the end of a period, the estimate of reserves originally made at the beginning of the period is
ignored. In other words, the amortization rate per barrel may change due to revision of valuation of oil
reserves. Such changes in rates are made prospectively, affecting current and future periods, but
necessitating no adjustment in the accumulated amortization of prior periods.
Question Three
Kabuga Petroleum Company PLC had the following data at end of its financial year ended 31st December,
2011. You are required to calculate the DD&A for that year.
Capitalized cost at end of the year
N 1,700,000
Accumulated amortization in prior years
N 100,000
Reserves estimate at the beginning of the year
5,000,000 bbls
250,000 bbls
Reserves estimate at the end of the year
4,000,000 bbls
Solution to Example Three
DD&A =
DD&A =

X Unamortized cost (year end)
[Reserves estimate (year end) + Production during the year]
(1,700,000 100,000)
250,000
4,000,000 + 250,000
= 250,000 X 1,600,000 N 94,118

4,250,000
It should be noted that this question uses identical figures as the preceding illustration except for the
revision of the estimate of reserves carried out at the end of the year. This additional information changes
the reserves at the beginning of the year, the amortization rate, and consequently, the DD&A for the year
from N 80,000 to N 94,118.
5.4.3 Nature of Cost Centre

Amortization amount is also affected by the nature of the cost centre i.e. whether it is carried out on a
well-by-well, field-by-field, or countrywide basis. This is clearly illustrated in Question four below.
65
Example Four
Assume the following data are in respect of the entire leases owned by BUK Oil Company in Nigeria.
You are required to calculate the DD&A for the year Ended 31st December, 2011 on (i)property-byproperty basis and (ii) countrywide basis.
Concessions
Lease 1
Lease 2
Lease 3
Total
N
N
N
N
Capitalized cost - end of
the period (Net)
600,000
1,000,000
2,000,000
3,600,000
Estimated reserves - end

of the period (bbls)
4,000,000
3,000,000
6,000,000
13,000,000
Production during the

period (bbls)
1,000,000
500,000
1,200,000
2,700,000
Solution to Question Four

Computation of DD&A for BUK Oil Company
For the Year Ended 31st December, 2011
(i) Property-by-property Basis
Lease 1:
1, 000, 000 bbls

X 600,000 = N120, 000
4,000,000 + 1,000,000 bbls
Lease 2:
500,000 bbls
X 1,000,000 = N 142, 857
3,000,000 + 500,000 bbls
Lease 3:
X 2,000,000 = N 333, 333

1, 200, 000 bbls
6,000,000 + 1,200,000 bbls
.
N 596, 190
Total Amortization
(ii) Country-wide Basis

2, 700, 000 bbls
X N 3, 600,000
13,000,000 + 2,700,000 bbls
2, 700, 000 bbls

X N 3, 600,000 = N 619, 108
15,700,000 bbls
5.4.4 Amortization under SEM and FCM of Accounting
Amortization of capitalized costs under SEM of accounting is broadly similar to the FCM. Under both
methods, DD&A is usually based on the unit of production method. Acquisition costs of proved properties
are amortized on the basis of total estimated units of proved (both developed and undeveloped) reserves. If
significant development costs (such as offshore production platforms) are incurred in connection with a
planned group of development wells before all of the wells have been drilled, a portion of such
66
development cost is excluded until the additional development wells have been drilled. Similarly, the
proved developed reserves that will be produced only after significant additional developed costs are
incurred, such as enhanced recovery systems, are excluded in computing the DD&A rate. When a property
contains both oil and gas reserves, the units of oil and gas used to compute amortization are converted to a
common unit of measure on the basis of their relative energy content, known as the BTU (British Thermal
Units). Despite the broad similarities mentioned above, DD&A under the full cost and successful efforts
method of accounting differs fundamentally. The differences may be summarized as follows:
Successful Efforts Method (SEM)
1. Wells and related facilities costs are amortized using proved developed reserves.
2. The amortization must be on the basis of unit of production. Unit of revenue method is not permitted.
3. Future development costs are considered in the amortization computation.
4. Costs are accumulated for each cost centre. For the purpose of capitalizing costs and amortization, the
centre is essentially the individual lease, block, licence area, concession or field.
Full Cost Method (FCM)
1. Costs are accumulated separately for each cost centre. For this purpose, each country or continent
is considered a separate cost centre.
2. Costs are amortized using proved reserves (i.e. both developed and undeveloped).
3. Costs to be amortized include:
(a) Capitalized costs (net of previous depreciation, depletion and amortization);
(b) Future development costs to develop proved reserves are included in amortization base;
(c) Future dismantlement and restoration cost.
4. Unit of revenue method may be used.
5. A cost ceiling based on a standardized measure of underlying value of assets is mandatory.
5.4.5 Computation of Depletion
As earlier stated, both full cost and successful efforts companies deplete mineral acquisition costs using
proved reserves. However, a successful efforts company amortizes capitalized costs, other than acquisition
costs, using proved developed reserves, whereas a full cost company amortizes such costs using proved
reserves. This is because the mineral acquisition costs apply to all recoverable reserves in the field or
property whereas wells and related equipment relate only to the portion of reserves recoverable from the
wells already drilled-proved developed reserves.
Question Five
(i) Calculate DD&A for New-Site Oil and Gas Nigeria Limited, a full cost company, assuming the
following:
Abandonment costs
N 15,000,000
Development costs
N 5,000,000
Capitalized costs
N 30,000,000
Proved reserves
5,000,000 bbls
First year production
500,000 bbls
(ii) Calculate DD&A for above company for the second year, assuming that production is 300,000 bbls.
(iii) Calculate DD&A for New-Site Oil and Gas Nigeria Limited, a succesful cost company, assuming
the following:
Abandonment costs
N 15,000,000
Development costs
N 5,000,000
Capitalized costs: Wells and equipments
N 20,000,000
Acquisition costs
N 10,000,000
Proved reserves
5,000,000 bbls
67
Proved developed reserves

Production
Solution to Question Five
(i) Abandonment costs
Development costs
Capitalized costs
3,000,000 bbls
500,000 bbls
N 15,000,000
N 5,000,000
N 30,000,000
N 50,000,000
DD&A 500,000 X N50,000,000 = N 5,000,000

5,000,000
(ii) Second year DD&A
300,000
X [50,000,000-5,000,000]
[5,000,000 - 500,000]
300,000 X 45,000,000 = N 3,000,000
4,500,000
(iii) DD&A on Acquisition costs = 500,000 X 10,000,000
5,000,000
DD & A on wells & equipt. 500,000 X N20,000,000
3,000,000
Total DD&A
(1,000,000 + 3,333,333)
= N l,000,000
= N 3,333,333
= N4,333,333
5.4.6 Joint Production of Oil and Gas

For properties that produce both oil and gas, the units of oil and gas used to compute amortization are
converted to a common unit of measure on the basis of their relative energy content known as the BTU,
except:
(a) the relative proportion of oil and gas are expected to continue throughout the life of the
property, in which case, the DD&A should be based on any one of the two minerals; or
(b) oil or gas is clearly dominant in both reserves and production, in which case, the unit of
production may be based on the dominant mineral.
Usually, one barrel of oil contains six million BTUs and one mcf of gas contains about one million BTUs.
Accordingly, it is generally accepted that six mcf of gas is equal to one barrel of oil in determining the
relative energy content for conversion. This ratio continues to be used despite the fact that the market no
longer reflects the relative energy contents in prices of oil or gas. For instance, based on this ratio, a barrel
of crude oil should sell for six times the price of one mcf of gas but in most cases, this is not the case. The
ratio may be as much as almost 20 times. Furthermore, because oil and gas are differentiated products,
their energy contents vary from reservoir to reservoir or even within different strata of the same reservoir.
An oil company may therefore have reasonable justification for using a conversion factor that more
precisely reflects the energy equivalencies of both minerals.
5.4.7 Revision of Reserve Estimates and Interim Financial Statements
It is sometimes necessary to revise the estimate of reserves because of new information, changes in
technology etc. The effects on amortization rates of such reserve revisions are usually adjusted
68
prospectively. Changes in reserve estimates impact significantly on companies that prepare interim
financial statements say on a quarterly or semi-annual basis.
5.4.8 DD&A through Addition and Disposal on Production Equipment
Changes often occur in the capitalized cost of production equipment after the initial investment. Addition
may be made through new purchases and transfers, while disposal may be made through sales,
retirements, catastrophic loss or transfer to another property. Additions to production equipment are
treated for accounting purposes the same way as the initial investment. When production equipment is
disposed, the difference between the book value of the equipment and disposal value i.e. fair market value
or sale price is adjusted through the accumulated amortization. No gain is to be recognized in this
transaction but a loss may be recognized, in compliance with the concept of conservatism.
5.4.9 Dismantlement, Restoration and Abandonment Costs
When oil and gas reserves are fully depleted or production falls to an uneconomically low level and it is
no longer feasible to produce minerals even under enhanced recovery techniques, equipments are salvaged
and operations are abandoned. Oil and gas operations regulations require that wells be plugged, all
facilities and equipment removed and the terrain restored, as much as possible, to its natural state.
Dismantlement and restoration costs can be quite enormous and sometimes may even exceed the cost of
the original installations, especially when account is taken of inflation and the time interval between the
commencement of production and abandonment of property. Some companies assume that the amount
realized from dismantled facilities less salvage costs, will offset dismantlement and restoration costs.
Accordingly, such companies either ignore making any provisions for such terminal costs or make the
provision in the year in which abandonment occurs. Clearly, by not making accruals, such companies
would not be achieving the matching of revenues with related costs. Sound accounting principles require
that estimated dismantlement, restoration and abandonment costs, if material, be included in the cost pool
in determining amortization rates.
The amortization relating to dismantlement, salvage and reclamation is usually charged to DD&A (or a
profit and loss account titled dismantlement, salvage and reclamation costs) and credited to a contingent
liability account. When the company abandons the property and incurs the dismantlement and restoration
costs, the costs incurred are charged to the liability account. Any difference between actual dismantlement
and restoration costs and the liability is charged or credited to income.
5.5 Ceiling on Capitalized Costs
In addition to capitalizing all acquisition costs, exploration costs (including G & G costs) a full cost
company carries development dry holes as an asset. There is therefore a distinct danger that the value of
proved reserves and other mineral assets in the cost centre may not be adequate to recover the unamortized
costs in the full cost pool. Consequently, a full cost company is required to perform a ceiling test annually.
A ceiling test is a determination of the upper limit of the total amount of costs that can be capitalized in
the books by taking into consideration an estimation of the value of underlying reserves. For each cost
centre, capitalized costs less accumulated amortization and related deferred income taxes should not
exceed the estimated fair market value of the reserves.
Where the capitalized costs exceed the ceiling, any excess over the ceiling is charged to expense and
disclosed separately in the financial statements. In accordance with the prudence concept, if in a
subsequent year, the capitalized cost is higher than the estimated value of reserves (ceiling), no write back
is permitted.
69
5.6 Impairment of Unproved Properties

At the time an oil company acquires an interest in an unproved property, the value of the property is
assumed to be equal to the cost. With the effluxion of time, certain events occur which may give rise to
reassessment of the value of the unproved property vis-a-vis the recorded costs.
Unproved properties are assessed periodically in order to determine whether they have been impaired
under successful efforts accounting. A property may be considered impaired if a dry hole has been drilled
in a part of it or nearby property and the company has no intention of further drilling on the property.
Also, as the expiration of the lease term approaches and the company has not commenced drilling on the
property or adjoining properties, the possibility of partial or total impairment of the unproved property
may increase.
Impairment may be assessed either on individually significant properties or on group of properties.
Impairment on individually significant unproved properties is assessed on a property-by property basis. If
a property is found to be impaired, an impairment provision is made and a loss is recognized.
Unproved properties whose costs are not individually significant may be aggregated and assessed in
groups. This is done on the basis of the experience of the company in similar situations and considering
such factors as the duration of the lease, the average holding period of unproved properties, and the
relative proportion of such properties that has become proved in the past. Factors such as acreage and
estimated future expenditures may also be considered. Determination of what is individually significant
can be a matter of individual judgement since it may not depend on relative costs or percentage of
portfolios alone. A basic rule of thumb for significance is 10 percent of the net capitalized cost of the cost
centre.
Occasionally, the value of a property on which impairment provision had earlier been made may exceed
the original cost of such property. Accounting prudence dictates that, in such situations, the impairment
provision previously made should not be reversed. No profit should be recorded for appreciation in value
of such properties.
5.6 Preparation for Development and Drilling
As earlier stated, investments in oil and gas assets can be quite enormous, requiring various levels of
approvals. Typically, an oil company plans and controls investment in oil and gas assets by requiring that
request for authorization to drill and equip oil wells be prepared and approved for each new well. Such
authorization is referred to as an authorization for expenditure (AFE).
AFE includes an estimate of costs to be incurred, by service or asset category and in total, whether the
company itself or an outside contractor is to conduct the drilling and development operations. An AFE
procedure assists in rational allotment of funds available for capital expenditure and provides an effective
cost control mechanism, through the comparison of budgets with actual costs and investigation of
variances. Where it becomes apparent that actual costs will exceed budgeted amounts, it may be
necessary to prepare a supplementary AFE. Most oil companies will require preparation of a
supplementary AFE when budget will be overrun by a specified percentage e.g. 10 percent. For drilling
and development AFEs, expenditure subheads may include:
70
Intangible Expenditure
Drilling contractors charges
Site preparation, roads, pits
Bits, reamers, tools
Labour
Fuel, power and water
Drill stem tests
Coring analysis
Electric surveys and logs
Geological and engineering
Cementation
Completion, fracturing, acidizing, perforating
Rig transportation, erection and removal
Overhead
Other services
Tangible Expenditure
Casing (production and surface)
Tubing
Well head and subsurface
Pumping units
Tanks
Separators
Heater-treaters
Engines and automotives
Flow line
Installation costs of equipment
Sundry equipment
Apart from details of estimates and actual costs under the above subheads, AFEs contain the following
additional information: (i) AFE number and date; (ii) approvals required both from company and joint
venture parties; (iii) purpose of expenditure i.e. whether exploratory drilling or development drilling; (iv)
location
of
project
or
well;
(v)
well
number;
projected
total
depth;
and
(vii) type of well i.e. whether oil, gas, or condensate.
5.7 Accounting for Exploration and Drilling Costs
Examples of exploration and drilling costs are: a) Costs of topographical, geological and geophysical studies, rights of access to properties to
conduct those studies, and salaries and other expenses of geologists, geophysical crews, and others
conducting those studies. Collectively, those are sometimes referred to as or G&G (geological
and geophysical) costs.
b) Costs of carrying and retaining undeveloped properties, such as delay rentals, tax on the
properties, legal costs for title defence and the maintenance of land and lease records.
c) Dry hole contributions and bottom hole contributions.
d) Costs of drilling and equipping exploratory wells
e) Costs of drilling exploratory-type stratigraphic tests wells.
Accounting treatment of exploration and drilling costs depends on whether the enterprise uses the
successful efforts method or full cost method of accounting.
71
5.7.1 Successful Efforts

An oil company which adopts the SEM of accounting will expense all G&G costs and carrying costs of
undeveloped properties, regardless of whether exploration activities led to discovery of reserves or not.
All other exploration and drilling costs such as costs of drilling wells and exploratory- type stratigraphic
test wells are charged to expense if they result in dry holes and capitalized if reserves are discovered in
them.
The reason for the divergent treatment of G&G costs and other exploration and drilling costs is because a
successful efforts company treats G & G costs as cost of obtaining information, similar to research and
development costs (R & D) which generally must be charged to expense as incurred. The costs that may
be capitalized are held temporarily in a well in progress account until a determination is made as to
whether the wells are productive or not. If an exploratory well is determined to be dry, the costs
accumulated in work in progress, less salvage value, are written off as expense.
5.7.2 Full Cost
Under the FCM, all exploratory and drilling costs are capitalized. The work in progress account is used
temporarily to accumulate costs of wells being drilled in the same manner as a successful effort company,
until the outcome of the well is known. If the well proves successful, the accumulated cost in the wells in
progress account is transferred to Wells and Related Facilities account and amortized. The work in
progress account can either be included or excluded from the amortization base. However, as soon as the
outcome of the well is known, it must be reclassified to wells and related facilities and included in the
amortization computation.
5.8 Accounting for Development Costs
Development costs are costs incurred to obtain access to proved reserves and to provide facilities for
extracting, treating, gathering, and storing the oil and gas.
Development costs are basically classified into two i.e. IDC (intangible drilling and development cost) and
LWE (Lease and well equipment cost). Generally intangible drilling cost are down hole costs up to and
including the wellhead. They include cost of preparation for drilling, drilling cost, well servicing
(fracturing, acidizing) and the cost of subsurface well equipment. Equipment includes cost of well
equipment and other lease equipment.
An oil company capitalizes all development costs. The costs of drilling development wells are temporarily
included in Wells in Progress account - Development Wells until drilling is complete. Upon completion,
the costs are re-classified to wells and related equipment account and amortized. In effect, development
well costs are capitalized whether or not they result in discovery of hydrocarbons. This is because
development wells are regarded as costs incurred to produce reserves already located by an exploratory or
discovery well. Accounting for development costs is the same under both full cost and successful efforts
method.
It is clear from the foregoing that a proper distinction must be made between exploratory wells and
development wells since the accounting treatments are not the same. An exploratory well is a well drilled
to find and produce oil in an unproved area, to find a new reservoir in a field previously found to be
productive.
72
Question Six
First Hydrocarbon Company Limited incurred the following costs for a development well drilled during
2011 in a recently acquired concession.
N
Site survey
150,000
Bush clearing
500,000
Road building and bridges
2,500,000
Tubing and casing pipes
1,400,000
Well head assembly and valves
2,100,000
Flow lines
4,000,000
Separators
10,000,000
Treaters and heaters
2,000,000
Desander
1,500,000
Required:
a) Prepare journal entries to record the cost of the development well, assuming BUK Hydrocarbon
Company uses successful efforts method of accounting.
b) Prepare journal entries to record the development well assuming that the full cost method of
accounting is used.
c) Would it make any difference if the development well were dry or productive? Comment.
Solution to Question Six
(a) Successful Efforts Company
General Journal
Particulars
Wells and related facilities (Intangible)
Wells and related facilities (equipment)
Bank Account
Being cost of development wells incurred.
(b)
(c)
Dr
3,150,000
21,000,000
Cr
24,150,000
Entry for full cost company is the same as for successful efforts company above.
It would not make any difference. Both full cost and successful efforts companies are required to
capitalize costs of development dry holes and producing development wells.
5.9 Production Accounting

Production accounting is the process of identifying and measuring the revenues, expenses and net income
or loss attributable to the operation of petroleum producing properties. Production accounting provides a
basis for sound property management and evaluation of profitability. A typical oil company may have
several producing properties with varying acreages, working and non-working interests. It is essential that
revenues and expenses (production or lifting costs) of individual properties be determined in order to
provide an effective measure of the profit margin on all wells.
5.9.1 Revenue from Oil
Broadly, revenue from oil and gas operating interest may be revenues from oil, revenues from gas and
miscellaneous revenue. Revenue from oil may or may not include inventory in tank batteries. Revenue
from gas is usually limited to revenue from gas sold. Miscellaneous revenue consists of such incidental
73
income as ullage fees, rentals, power sales, management fees etc. An important step in accounting for
revenue from oil is the determination of the volume lifted. Although field personnel such as gaugers,
perform the actual measurement of volume, the accountant must be familiar with measurement procedures
in order to meaningfully record revenues in the books of accounts.
Oil is usually produced in association with gas as only few reservoirs produce gas or crude oil only.
Therefore, after oil is produced from an oil well, it is passed through a separator to remove gas from
liquids (crude oil) or remove liquids (condensate) from gas. The oil is also passed through a heater-treater
to remove water and other impurities from the oil. The gas removed from the oil is referred to as
casinghead gas. The treated oil is then usually stored in large stock tanks, collectively referred to as tank
farms or tank batteries.
At the time a tank battery is put into operation each stock tank is strapped or measured. This measurement
or strapping determines exactly how many barrels of oil can be held in the tank for each fraction of an
inch of oil contained in the tank. Because the tanks have been strapped, it is possible to determine the
volume lifted by tankers or transferred to refineries through pipelines by using tank tables. Usually, the
task of recording the lifted volume rests with a gauger who records it on a run ticket. By the use of a
device known as a thief, samples of crude oil are taken at various levels from the tank, centrifuged and
measured to determine the B.S. & W content i.e. Basic Sediment (BS) and Water (W) content.
Other information included in the run ticket are the tanker or pipeline names, the lease or well
identification, tank number, the observed temperature, the observed gravity, B.S & W content, signatures
of the gauger and other witnesses such as Customs, Petroleum Inspectorate, Nigeria Port Authority
personnel and other interested parties. All of the foregoing data are necessary because the volume, and
consequently the value of a barrel of oil, can be significantly affected by a change in the oils gravity,
temperature, pressure, or, basic sediment and water content.
The specific gravity of oil is expressed in degrees API. The thinner (less viscous) the oil, the higher the
API gravity, and the higher the API gravity of the oil, the more valuable the oil. This is because higher
gravity oil usually produces a higher yield of white products and requires less complex operations to
refine into useable products. API gravity is related to specific gravity and oil with 10o API gravity will
have a specific gravity of 1, the same as the specific gravity of water. The formula for API gravity is:
141.5
APIo =
-131.5
Specific gravity
Temperature has a dual effect on the measurement of crude oil. Not only can temperature change the
gravity of oil, it can also change the volume. The gravity changes because oil will become lighter (less
viscous and thinner) when it is heated. Obviously, if no adjustment were made, the change in gravity
would affect the price of oil. The effect of temperature on volume can be appreciated when one considers
that 10,000 barrels of oil at 40F could increase to as much as 10,300 barrels at 90F. This is an increase
of 12,600 US gallons of oil. The standard unit of measurement of crude oil is a barrel of 42 US gallons at
a temperature of 60F. The composition of oil itself can also affect the volume of oil sold. Most
purchasers of crude oil set limits on the percent of B.S & W they will allow. Where B.S. & W exceeds
1%, the price is usually discounted.
The efficiency of production measurement has been enhanced by automated techniques using Lease
Automatic Custody Transfer (LACT) units to measure the volume and quality of crude oil adjusted for
temperature, gravity, compression and B.S & W content. After the adjusted volumes of oil have been
74
calculated or determined, they are valued on a property-by-property basis in accordance with the sales
contract with the purchaser. Each lifting is then valued for each purchaser, summarised for the month, and
billed.
5.10 Accounting for Refining and Petrochemical Operations
Operations in the oil and gas industry are broadly divided into two, namely upstream and downstream.
Refining and petrochemical production are therefore part of the downstream. Crude oil, which is the major
raw material of a refinery, is a mixture of a family of organic chemical compounds made up of hydrogen
and carbon in various proportions called hydrocarbons. The non-hydrocarbon materials that are usually
present in crude oil are sulphur, nitrogen, nickel, vanadium, and other metals or salt which is usually in
quantities less than one in a thousand. The distinguishing feature of a mixture (as distinct from a
compound) is that in a mixture the components retain their individual characteristics and can be separated
fairly easily. Crude oil almost has unlimited possibilities as a raw material.
The key drivers of profitability of refineries are:
1. Quality of Crude: A company that buys light crude will be more profitable. Light crude is
crude oil with API gravity that yields a high proportion of the lighter, more valuable products
after refining.
2. Conversion Capacity of Refinery Plant: A more complex refinery will produce a higher total
value of products from a given crude oil even though the total quantity will be reduced through
the greater use of fuel for process heating.
3. Other factors that affect refinery yields are
(a) Direct costs and yields
(b) Lead times for receipt of crude oil
(c) Storage considerations
(d) Spot markets considerations etc.
5.10.1 Types of Refineries
Refineries are classified according to their conversion capability. Refineries consisting of atmospheric
distillation units, reforming and hydro-treating units are often referred to as hydro-skimming refineries.
Those with any substantial units for changing the basic yield pattern of crude oil barrel through catalytic
or hydrocracking are referred to as complex or conversion refineries.
5.10.2 Petroleum Refining Processes
Refining may be defined as a means of producing fuels and lubricants, among others. Basically it involves
vaporizing crude oil by heating it to a high temperature, collecting the resulting gases and condensing
them back to a liquid state. Crude oil refining comprises of a series of interrelated processes, all involving
heating, and each producing several products. Some of these products can be put to end use without
further processing while others have to undergo considerable post-production refining, further cracking,
reforming, synthesis and molecular arrangement. Refinery operations are carried out in different
processing units that follow one another in processing sequence. Basic refining processes are:
i. Primary process or physical separation process (Crude distillation)
ii. Secondary or conversion processes
iii. Treating processes
iv. Blending
75
Primary Process (Crude Distillation)

The objective of distillation is to separate the many compounds contained in crude oil into groups of
similar compounds. The principle underlying this process is the fact that different liquids vaporize at
different temperatures (called boiling points). The separation of low and high boiling points materials in
this way is called fractional distillation (fractionation).
The process is accomplished by running the crude oil through a number of pipes lining a brick furnace
(heater/boiler). The crude oil is heated to a temperature of approximately 800o F after which it rises to the
top of the furnace as vapour and is then transferred to the fractionation tower. The points at which they
start to boil are called Initial Boiling Points (IBP) and where they stop boiling is called End Boiling Points
(EBP). At the EBP, the product would have been completely vaporized.
The fractions produced from this atmospheric fractionation towers can be used in their new state, blended
with other substances or further processed to make useful products. The maximum temperature at which
hydrocarbons can be separated in the atmospheric tower is 900oF. Steam keeps the oil hot and low
pressure allows the hydrocarbons to vaporize at temperatures below their cracking points enabling them to
be separated into fractions. The light and heavy gas oils are separated from the heaviest residue.
The primary process separates the various fractions, which may serve as inputs for the secondary process.
These inputs are otherwise known as charging stocks. The term charging stock refers to unfinished
products that are to be further processed in some secondary refining operation. These secondary processes
either result in new products or bring primary products to required quality standards. The intermediate
products, in order of increasing boiling range, are listed below.
(a) Fuel gas -to refinery fuel gas - below 100F
(b) Light straight run gasoline - to sweetening and then to gasoline blending (Boiling range 100F200F).
(c) Heavy straight - run gasoline -to hydrogenation, to catalytic reforming and then to gasoline
blending (Boiling range 200F-400F).
(d) Middle distillates to kerosene, jet fuel, furnace oils, diesel fuels (Boiling range 350F-600F).
(e) Catalytic cracking charge to fluid catalytic unit charge (Boiling range
450F -750F).
(f) Fuel residue vacuum distillation unit. (Boiling range about 700F)
76
Table 19: Refinery capacity in OPEC Members by type and location (1,000 b/cd)
77
Table 19: Refinery capacity in OPEC Members by type and location (1,000 b/cd) Continue

78
Table 20: World refinery capacity by country (1,000 b/cd)
Source: OPEC Annual Statistical Bulletin, 2013Pp 38
79
5.10.3 Petrochemicals
A petrochemical is a chemical substance produced commercially from feedstock derived from crude oil or
natural gas. Petrochemical plants are usually integral parts of large refining complexes and often
subsidiaries of major oil companies. Their function is to turn outputs of the refining process either in form
of crude oil fractions or their cracked or processed derivatives into feedstock that will ultimately be used
in the manufacture of a host of other products e.g. plastics, resins, synthetic rubbers, printing ink, paints,
acid, fertilizers, detergents, etc.
5.11 Accounting for Refinery Operations
Accounting for refinery operations begins with the costs incurred from the receipt of crude oil, to the costs
incurred in various refining processes, the cost of additives, investments in plant machinery and other
operating costs. The accounting treatment of costs incurred in a refinery operations are discussed under
various headings below:
5.11.1 Basis of Capitalization

Any amount expended in order to improve the earning capacity of the refinery is capitalized while any
expenditure incurred in order to maintain the earning capacity of the business is charged to the
operations of the particular period. However, the assistance of engineers may be required in determining
which expenditure is capital or revenue.
5.11.2 Transfer Pricing
As stated earlier, a refinery is frequently an integral part of an integrated oil company. It follows therefore
that, as in other integrated companies, inter-departmental transfers are common, hence, the need to
determine transfer price. It is also important to determine what the transfer prices of gasoline and other
products of the refinery transferred to the companys marketing division will be. Fixing of transfer prices
is a function of the management who rely heavily on the information supplied by the accountant. It is
important that transfer prices are fixed in order to ensure that:
i. the performance of the transferring divisions, departments or subsidiaries can be evaluated;
ii. goal congruence within the organization is enhanced;
iii. the autonomy of each division, department or is maintained;
iv. the overall organization is put at a tax advantage; and
v. the cost of inefficient operations or decision-making would be revealed for necessary corrective
action.
The following transfer pricing methods are frequently used .
(1) Market based pricing
(2) Cost based pricing
(3) Negotiated pricing
(4) Free market prices for both inputs and output
(5) Cost plus margin for value of services rendered
5.11.3 Processing of Crude Oil Belonging to Outsiders
Where the refinery receives crude oil belonging to third parties for processing, only memorandum records
are to be kept to control the quantity. The consideration received inform of processing fees should
however be treated as a deduction from operating costs.
Cost of Catalysts
The accounting treatment of the cost of acquisition of expensive catalysts in refinery operations is to
capitalize the costs of the initial supply and depreciate them in accordance with normal accounting
80
practices. The costs of reprocessing and replenishing them are however charged to the operation of the
period.
Cost of Periodic Turnaround Maintenance
Costs incurred in the periodic maintenance of the refinery are initially capitalized. A provision for
turnaround costs is then made monthly to operating expense.
Depreciation
Depreciation is computed on a composite straight-line basis for the entire plant. Total depreciation is then
distributed to production and other units on the basis of investment in the units.
Standby Equipment
Refineries have a considerable investment in standby equipment which may be used in case of
emergencies or when production operations increase. There are many ways of treating depreciation on
these equipments. The most acceptable treatment is to make periodic provision for standby wear and tear
on these equipments and exclude them from the composite depreciation base.
Inventory Valuation
In accordance with normal accounting practice, inventories are valued at lower of cost and net realizable
value. Inter-departmental profits must be eliminated from inventory.
Sundry Income
Outright crude oil sales and other incomes are included in sundry income.
5.12 Allocation of Costs
Total production cost must be determined and spread over units produced in order to determine unit
product costs and selling prices. Costs of service unit must be spread over production units before unit
product costs are determined. Costs also have to be allocated to joint products.
5.12.1 Service Department Cost Allocation
Three methods are used to allocate service department costs to production costs and subsequently to
production units. They are:
(1) Direct method
(2) Step method
(3) Simultaneous method
5.12.2Allocation of Cost to Joint Products: When the allocation of service costs to production units is
completed, there still remains the task of allocating costs to joint products. The methods commonly used
for this allocation are:
(i) physical method
(ii) market method
(iii) relative sales value method
(iv) replacement cost method
(v) alternative use method, and
(vi) by-product method.
81
DISCUSSION EXERCISES
Question One
During the first quarter of 2012, BUK Oil Company Nigeria Limited produced 50,000 barrels of
crude oil from field New-Site oil field, which is located onshore. 5,000 barrels out of the total
production were re-injected into the well to enhance crude oil recovery from an adjoining lease.
The power generators used for field operations consumed 1,000 barrels during the quarter and 500
barrels were lost through evaporation. Assuming that posted price for the crude stream is
US$21.00 per barrel and exchange rate of US$1 is equal to N152.00 You are required to
compute royalty liability for the quarter, assuming that the applicable rate of royalty is 20 per
cent.
Solution to Question One
BUK Oil Company Nigeria Limited
Computation of Royalty Liability for the First Quarter, 2012
Gross production of crude oil
Less:
Quantity of crude oil re-injected into the formation 5,000 bbls
Production used for field operations
1,000 bbls
Quantity lost through evaporation
500bbls
50,000 bbls
6,500 bbls
43,500 bbls
$21
$ 913,500
N 152
138,852,000
20%
N27,770,400
Net production
Posted price per barrel
Chargeable value of crude oil in Dollars
Conversion to Naira ($1=N152)
Chargeable value of crude oil in Naira
Applicable rate of royalty
Royalty payable
Question Two
Ramat Oil Company Limited is an integrated oil company whose operations include exploration,
production, refining, petrochemicals and transportation. During the year ended 31 December
2011, the company produced and transported 1,000,000 barrels of crude oil through its network of
pipelines. Out of the quantity produced 400,000 barrels were transferred to the companys
refineries in Nigeria.
The posted price of the crude oil transferred to the refinery was $22.00 per barrel and the standard
and actual API of the crude stream were 40 and 42 respectively. The pipelines cost was N
95,000,000 and are depreciated on a straight- line basis at the rate of 5 per cent per annum. N
8,000,000 were spent on repair and maintenance of the pipelines during the year. Exchange rate
of Naira to the Dollar is $1.00 = N 150.00
82
Required
Calculate the value of crude oil delivered to the refineries during year 2011, assuming that posted
price of crude oil are escalated or de-escalated by $0.03 for every API difference between
standard and actual API degree.
Solution to Question Two
Ramat Oil Company Limited
Computation of Value of Oil Delivered to Refinery
For the Year Ended 31st December , 2011
Quantity of oil transported to refinery
400,000 bbls
Posted price of crude oil per barrel
Standard API gravity
40
Actual API gravity
42
Difference
2
Escalation rate
$0.03
Escalation
Adjusted posted price per barrel (in Dollar)
Adjusted posted price per barrel (in Naira)
$22.00
$0.06
$22.06
N3,309
N
Value of oil for royalty purposes:

1,000,000 bbls @ N3,309/bbl =
3,309,000,000
Value of oil delivered to refinery

400,000 bbls @ N3,309/bbl =
1,323,600,000
Cost of extraction of oil deducted in determining

posted price:
Cost of maintenance of pipeline
N 8,000,000
Depreciation of pipeline
N 4,750,000
( 5% of N 95,000,000)
N 12,750,000
Add: Cost of transportation 4/10 X 12,750,000
Total cost of crude oil delivered to the refinery
5,100,000
N 1,328,700,000
83
Question Three
The following information relates to Gwarzo Oil and Gas Nigeria PLC for the year
ended 31 December 2009.
Trial Balance as at 31st December, 2009
Particulars
Dr.
Cr.
N' 000
N' 000
Crude oil Inventory at 1/1/2009
6,700,000
Export Sales
50,000,000
Local Sales
10,000,000
Production Cost
9,000,000
Transportation cost
1,500,000
Intangible oil and gas assets
117,000,000
Salaries and wages
300,000
Proved oil and gas properties
13,500,000
Unproved oil and gas properties
8,300,200
Accumulated DD&A: Oil and Gas Assets
5,200,500
Loan Interest
3,500,000
Bank interest
1,700,000
800,000
135,000
230,150
Unimpaired leases
1,500,000
Exploratory wells: Successful
15,672,000
Unsuccessful
2,250,000
Development wells
20,567,000
Wells in Progress
11,570,000
Expenditure for purchase of seismic data
683,650
Royalties
1,500,000
Derivative financial instruments
500,800
Loss on exchange
1,450,000
Trade and other receivables
3,500,000
2,503,200
Cash and cash equivalents
500,000
Trade and other payables
12,500,000
Investments in subsidiaries
14,500,000
Other current assets
50,250,100
Share capital
200,500,000
Share premium
9,850,000
Other reserves
560,000
289,111,300
289,111,300
The following additional information are also available (all the Naira figures are in
84
thousand N'000):
(i) Closing stock of oil and gas as at 31st December, 2009 N1,200,000
(ii) Accrued expenses as at 31st December, 2009 amounted to N3,500,700
(iii) Provision for decommissioning amounting to N564, 2000 is to be provided.
(iv) DD& A is to be provided on proved oil and gas properties. Production during the
year was 500,000 of oil and 600,000 mcf of gas. Reserves estimates of oil and gas at the
beginning of the year (i.e. 1st January 2009) were: oil 5,000,000 bbls and gas 1,800,000
mcf, and the relative proportion of oil and gas is not expected to continue throughout the
life of the property.
(v) All capitalized costs and intangible oil and gas assets are to be amortized at the rate
of 10% per annum.
(vi) The Director's proposed a dividend of N2, 000,000 on shares and Petroleum Profit
Tax is to be calculated at the rate of 70%.
(vii) All workings are to be made to the nearest Naira.
You are required to prepare the final accounts of the company in Horizontal form for
use of the Company's management for the year ended 31st December, 2009, using (i)
Full Cost Method, and (ii) Successful Efforts Method.
Solution to Question Three
(i) Full Cost Method
Gwarzo Oil and Gas Nigeria PLC

Trading, Profit and Loss Account for the Year Ended 31st December 2009
N'000
N'000
Opening stock
6,700,000 Export Sales
50,000,000
Production Cost
9,000,000 Local Sales
10,000,000
Transportation cost
1,500,000
Royalties
1,500,000
18,700,000
Less closing stock
1,200,000
17,500,000
Gross income from operations
c/d
42,500,000
60,000,000
60,000,000
Gross income from
Accrued expenses
3,500,700 operations b/d
42,500,000
Provision for decommissioning
5,642,000
DD&A on proved properties
939,566
Salaries and wages
300,000
Loan Interest
3,500,000
Bank interest
1,700,000
Purchase of seismic data
683,650
Loss on exchange
1,450,000
Amortization: Intangible assets
11,700,000
85
Other capitalized costs

Net income from operations c/d
4,115,415
8,968,669
42,500,000
42,500,000
Net income from

2,000,000
690,601
8,968,669
PP Tax 70%
Proposed dividend
Balance c/d
WORKINGS
(i) DD&A on proved properties
Production of oil and gas in bbls

Gas in bbls
600,000 X 1/6 =
Oil in bbls
Production of oil and gas in bbls
100,000
500,000
600,000
Opening reserves of oil and gas in bbls

Gas in bbls
1,800,000 X 1/6 =
bbls of oil
Opening reserves of oil and gas in bbls
300,000
5,000,000
5,300,000
Unamortized cost at the end of the year (13,500,000-5,200,500) =

8,299,500
DD&A
600,000
5,300,000
(ii) Other Capital Costs

Unimpaired leases
Exploratory wells: Successful
Unsuccessful
Development wells
Total
8,299,500=
N 939,566
N
800,000
135,000
230,150
1,500,000
15,672,000
2,250,000
20,567,000
41,154,150
86
8,968,669
8,968,669
Balance Sheet as at 31st December, 2009

N' 000
Share capital
Reserves
Share premium
Other reserves
P&L a/c balance
Shareholders' fund
Current Liabilities
Accrued expense
Provision for
decommissioning
Derivative financial
instruments
Petroleum profit tax
Proposed dividend
N'000
N'000
N'000
Accumlatd
Cost
DD&A
NBV
13,500,000 6,140,066
7,359,934
Fixed Assets
200,500,000 Proved properties
Unproved
properties
8,300,200
----8,300,200
Intangible assets 117,000,000 11,700,000 105,300,000
Other capitalized
9,850,000 costs (ii)
41,154,150 4,115,415 37,038,735
560,000 Wells in Progress 11,570,000
----11,570,000
690,601
191,524,350 21,955,481 169,568,869
211,600,601 Investment
2,503,200
14,500,000
Current Assets
3,500,700 Stock
1,200,000
5,642,000 Trade and other receivables
3,500,000
500,800 Cash and cash equivalents

Other current
12,500,000 assets
6,278,068
2,000,000
242,022,169
50,250,100
55,450,100
242,022,169
(i) Successful Efforts Method
Other Capital Costs

Unimpaired leases
Successful exploratory wells
Development wells
500,000
N
1,500,000
15,672,000
20,567,000
37,739,000
87
Gwarzo Oil and Gas Nigeria PLC

Trading, Profit and Loss Account for the Year Ended 31st December 2009
N'000
N'000
Opening stock
6,700,000 Export Sales
50,000,000
Production Cost
9,000,000 Local Sales
10,000,000
Transportation cost
1,500,000
Royalties
1,500,000
18,700,000
Less closing stock
1,200,000
17,500,000
Gross income from operations c/d
42,500,000
60,000,000
60,000,000
Accrued expenses
Provision for decommissioning
DD&A on proved properties
Salaries and wages
Loan Interest
Bank interest
Purchase of seismic data
Loss on exchange
Unsuccessful exploratory well
Amortization: Intangible assets
Other capitalized costs
Net income from operations c/d
PP Tax 70%
Proposed dividend
Balance c/d
Gross income from

5,642,000
939,566
300,000
3,500,000
1,700,000
683,650
1,450,000
800,000
135,000
230,150
2,250,000
11,700,000
3,773,900
5,895,034
42,500,000
Net income from
2,000,000
(231,490)
5,895,034
88
42,500,000
42,500,000
5,895,034
5,895,034
Balance Sheet as at 31st December, 2009

N' 000
N'000
Fixed
Cost
Assets
Proved
Share capital
200,500,000 properties
13,500,000
Unproved
properties
8,300,200
Intangible
assets
117,000,000
Reserves
Other
capitalized
Share premium
9,850,000 costs (i)
37,739,000
Wells in
Other reserves
560,000 Progress
11,570,000
P&L a/c balance
(231,490)
188,109,200
Shareholders' fund
210,678,510 Investment
instruments
Current Liabilities
Accrued expenses
Provision for
decommissioning
instruments

Petroleum profit tax
Proposed dividend
Current Assets
3,500,700 Stock
Trade and other
5,642,000 receivables
500,800 Cash and cash equivalents
Other
current
12,500,000 assets
4,126,524
2,000,000
238,948,534
89
N'000
N'000
Accumlatd
DD&A
NBV
6,140,066
7,359,934
----
8,300,200
11,700,000 105,300,000
3,773,900
33,965,100
---11,570,000
21,613,966 166,495,234
2,503,200
14,500,000
1,200,000
3,500,000
500,000
50,250,100
55,450,100
238,948,534
QUESTION FOUR
BUK Refinery and Petrochemical Ltd is one of the five companies that have recently been
granted licence by the Government to set-up independent refineries to augment the production
of the Government owned refineries located at Port Harcourt, Kaduna and Warri with a view to
reducing the scarcity of petroleum products (especially, PMS, DPK and AGO) in the Country.
The following information relates to the first year operations of the Company for the year
ended 31 December 2013.
Trial Balance as at 31st December, 2013
Particulars
Dr.
Cr.
N'
N'
000,000
000,000
Sales of refined oil and petrochemicals
187,520
Income from affiliated companies
28,850
Short-life catalysts
1,200
Turn-around maintenance
21,210
Long life catalysts, at cost
76,700
Salaries and wages
7,000
Machineries and equipments, at cost
122,090
Stand-by equipments, at cost
55,300
Minor plant rehabilitation and debottlenecking
1,750
Sales of excess crude oil
35230
Income from processing of crude oil to outsiders
7500
Purchase of crude oil, process material and
utilities
87,000
Direct refining expenses
13,000
Selling, general and admin. expenses
2,150
Pipelines
28,500
Cash and cash equivalents
44,402
Debtors
10,500
Investment in Affiliated companies
111,637
12,500
Bank
78,520
Other current assets
50,250
Share capital
255,413
Share premium
12,156
Other reserves
15,000
632,689
632,689
The following additional information were also made available as at 31st December, 2013 (all
the Naira figures are in million N'000,000)
i.
Closing stock as at 31st December, 2013 were: Crude oil, process materials and
utilities N12,500, Refine petroleum product N 13,500
ii.
The long life catalyst has an expected life span of 10 years from 1st January, 2013 to
31st December 2022. The cost of the catalysts written off annually is to be treated as a
refining overhead expense. The cost of the catalyst is to be treated in line with SAS 17.
iii. The company has a policy of carrying out turn-around maintenance every three years,
and first turn-around maintenance was carried out on 1st January, 2013. This is to be
treated in line with SAS 17.
iv.
Machineries and equipments and pipelines are to be depreciated at the rate of 10% per
annum on cost. Depreciation of pipelines is to be apportioned 50% as indirect refining
90
v.
vi.
vii.
viii.
expenses and 50% as general overhead expense.

N 2,000 was received in advance from outsiders for processing of crude oil.
Provision for bad and doubtful debt is to be provided for at the rate of 5% of debtors
and provision for discount is to be provided at the rate of 3%.
The Director's proposed a dividend of N 13,200 on shares and Company Income Tax
is to be calculated at the rate of 30%.
All workings are to be made to the nearest Naira.
You are required to prepare the final accounts of the company for the year ended 31st
December, 2013 for internal use by the Companys Management
SOLUION TO QUESTION FOUR
BUK Refinery and Petrochemical Ltd
Trading, Profit and Loss Account for the Year Ended 31/12/2013
Crude Oil:
Opening stock
Purchases
Cost of oil avail. for consumption
Less: Closing stock
Cost of oil consumed
Add: Direct refining expenses
Prime Cost
Refining Overheads
N'000,000
Cost of Oil Refined c/d
87,000
87,000
12,500
74,500
13,000
87,500
Depr. of pipelines (28,500X 10%/2)

Short-life catalysts
1,425
1,200
Long-life catalysts
7,670
Turn-around maintenance
7,070
Depr. of Mach and equipment
12,209
Depr. of stand-by equipment

Plant Rehabilitation and
debottlenecking
5,530
N'000,000
118,854
1,750
36,854
Less: Income from processing of

crude oil to outsiders (7,500-2,000)
5,500
31,354
118,854
91
118,854
Sales of refined oil and

petrochemicals
Refined Oil:
Opening stock
Cost of oil refining b/d
Cost of Oil Avail. for Sale
Less: Closing Stock
118,854
118,854
13,500
Cost of Oil Sold

Gross Income c/d
105,354
82,166
187,520
Provision for bad debt

Provision for discount
187,520
525 Gross income b/d

299 Sales of crude oil
82,166
35,230
Income from affiliated

7,000 companies
2,150
Salaries and wages

Selling, gen. & admin. expenses
Depr. of pipelines (28,500X
10%/2)
Net profit c/d
187,520
28,850
1,425
134,847
Company Income Tax 30%

Proposed dividend
Balance c/d
146246
146,246
40,454 Net profit b/d

13,200
81,193
134,847
134,847
134,847
Balance Sheet as 31/12/2013

N'000,000
Share capital
255,413 Non-Current Assets
Reserves
Share premium
Other reserves
P&L A/C Balance
Shareholders' fund
Turn-around
maintenance
Mach. & Equipment
Stand-by equipment
108,349 Pipelines
363,762 Investments
Long life catalysts
12,156
15,000
81,193
N'000,000
Acc.
Cost
Depr.
NBV
76,700
7,670 69,030
21,210
122,090
55,300
28,500
303,800
Current Liabilities
Prepaid crude oil processing
fee
Company Income Tax
Proposed dividend
Bank
7,070
12,209
5,530
2,850
14,140
109,881
49,770
25,650
111,637
35,329 380,108
Current Assets
2,000
40,454
13,200
78,520
12,500
Crude oil
Refine petroleum
Debtors
Less: PFBDD
146,674
Less: Prov. for discount
Cash
Other Current Assets
510,436
92
12,500
13,500
10,500
525
9,975
299
9,676
44,402
50,250 130,328
510,436
QUESTION FIVE
Below is the valuation of reserve of oil and gas of New-Site Oil and Gas Exploration Company, a multinational company which uses Full-Cost method of accounting.
(i) From the above valuation statement, what would be the basis of ceiling test by the Company?
(ii) Must the Company carry-out ceiling test and why?
(iii)What is the essence of ceiling test in financial reporting in the oil and gas industry?
QUESTION SIX
The following data are in respect of the entire leases owned by Kabuga Hydrocarbon Nigeria Plc.
You are required to calculate the DD&A for the year ended 31st December 2013 on:
(i) Property-by-property basis, and
(ii) Countrywide basis.
Leases
Lease 1
Lease 2
Lease 3
Total
N
N
N
N
Capitalized cost
31/12/2013
612,200
1,150,000
2,200,000
3,962,200
12,200
150,000
200,000
362,200
Estimated reserves
1/1/2013 (bbls)
4,500,000
5,000,000
7,100,000
16,600,000
Estimated reserves
31/12/2013 (bbls)
4,000,000
3,000,000
6,000,000
13,000,000
Production during the period

1/1/13 to 31/12/2013 (bbls)
1,000,000
500,000
1,200,000
2,700,000
Accumulated DD&A
31/12/2012
93

ACC 8211 Oil and Gas Accounting

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ACC 8211 Oil and Gas Accounting

Uploaded by

Copyright:

Available Formats

BAYERO UNIVERSITY, KANO

FACULTY OF SOCIAL AND MANAGEMENT SCIENCES

2.1 Steps in Prospecting for Oil and Gas

1.0 HISTORY AND NATURE OF OIL AND GAS OPERATIONS

Approximate age of the earth

Evidence Supporting the Organic Theory of Oil and Gas Formation

Source: OPEC Annual Statistical Bulletin, 2013 Pp 72-73

Table 2: Gas pipelines in Nigeria, 2012

Source: OPEC Annual Statistical Bulletin, 2013 Pp 76-77

Source: OPEC Annual Statistical Bulletin, 2013 Pp79-80

Source: OPEC Annual Statistical Bulletin, 2013 Pp 43

Source: OPEC Annual Statistical Bulletin, 2013 Pp 41

Source: OPEC Annual Statistical Bulletin, 2013 Pp 45

Source: OPEC Annual Statistical Bulletin, 2013 Pp 82

Table 7: Retail prices of petroleum products in OPEC Members ($/b)

Source: OPEC Annual Statistical Bulletin, 2013 Pp 90

Figure I: Organization of the Accounting Function in an Independent Oil Company

Equipment and Supplies Inventory

Figure III: Organization of Accounting Functions in Production Division of Large Integrated

1.3 The History of the Nigerian Oil and Gas Industry

Table 8: OPEC Member Countries

Table 9: OPEC Members Facts and Figures, 2012

Source: OPEC Annual Statistical Bulletin, 2013 Pp 11

Table 10: OPEC Members Mid-Year Population (1,000 inhabitants)

Source: OPEC Annual Statistical Bulletin, 2013 Pp 14

Source: OPEC Annual Statistical Bulletin, 2013 Pp 22

Source: OPEC Annual Statistical Bulletin, 2013 Pp 23

Table 13: Installed Capacity of Nigerian Refineries

Kaduna Refinery and Petrochemical Company Limited

1.7 NNPC, DPR and Their Roles

4. keeping and updating records on petroleum industry operations relating to reserves,

Table 14: Wells Completed in OPEC Members

Source: OPEC Annual Statistical Bulletin, 2013Pp 26

(iii) production status (comprising of producing and non-producing reserves).

Table 15: Daily crude oil production (average) (1000 b)

Source: OPEC Annual Statistical Bulletin, 2013 Pp 28

Source: OPEC Annual Statistical Bulletin, 2013 Pp 28

Table 17: World crude oil production by country (1,000 b/d)

Source: OPEC Annual Statistical Bulletin, 2013 Pp 30

Source: OPEC Annual Statistical Bulletin, 2013 Pp 31-32

Source: OPEC Annual Statistical Bulletin, 2013 Pp 31-32

3. Arrangements, Agreements and Contracts in the Nigerian Petroleum Industry

Measurement after Initial Recognition and Presentation

Capitalized exploration drilling costs are as follows:

Debottlenecking, Major Plant Rehabilitation and Replacement of Major Components

Packaging and Non-core Businesses

Successful Efforts Method

Full Cost Method

The accounting rate of return of the

This method is more in accord

Full Cost Method

Figure VII: Full Cost Accounting for Costs

Figure VIII: Successful Efforts Accounting for Costs

Geological and engineering

Drilling (on footage basis)

Construction of overflow mud pits

5.4 Accounting for Depreciation, Depletion and Amortization

5.4.2 Revision of Reserve Estimates

Production during the year

= 250,000 X 1,600,000 N 94,118

5.4.3 Nature of Cost Centre

Estimated reserves - end

Production during the

Solution to Question Four