Due Diligence. Ryan Nestor, CPA, CGMA

Transcription

1 Due Diligence Ryan Nestor, CPA, CGMA Arnett Carbis Toothman llp 2018

2 Lucrative Industry For Fraud Specific Risks Remote Locations Cultural Differences Poor Contract Management Lack of Employee Background Checks Incorrect information: Reserve Valuations Engineering Reports Recovery Rates Price Fluctuations 2

3 SEC Investor Alert Red Flags Highly publicized news high oil & gas prices Can t Miss wells Unsolicited materials Abnormally high rates of returns promised Sales Pitches limited or once-in-a-lifetime New Technology high production out of low producing wells Sales Person claiming to be an investor Asked to sign documents acknowledging securities laws do not apply to investments 3

4 Due Diligence - Acquisitions Items to address during Acquisitions: Property Taxes be current Plugging Reserves Suspense Accounts Severance Taxes be current General Due Diligence Joint Operations & Joint Accounting Agreements PA Impact Fees 4

5 Acquisition Due Diligence Investigate Revenue Distribution System Tax Withholding and Payments Lease Related Obligations Joint Operating Agreements Joint Accounting Agreements 5

6 Acquisition Due Diligence (cont d) Due Diligence as a Royalty Owner? Are you being allocated correct volumes? Conventional Wells Horizontal Wells and Pooling Provisions Line Loss, Free Gas, Fuel Charges, etc At What Price is your Production Being Sold? Are You Charged Costs Against Your Revenue? Transportation Regular and Firm Sales Commissions Production Taxes 6

7 Acquisition Due Diligence (cont d) Due Diligence as a Working Interest Owner? Can avoid later legal battles Suspense balances, plugging balances Provides purchaser with information that may need to be addressed before closing Unclaimed checks Increases level of assurance for purchaser Indication of housekeeping Aids in Data Conversion Potential discrepancies of properties/leases 7

8 Acquisition Due Diligence (cont d) Issues That Commonly Arise Properties that do not have a Joint Operating Agreement or Joint Accounting Agreements No defined management fee or fee not being adjusted per contract Flat Rate Royalties Additional obligations in excess of the 12.5% Allocation errors DOI s (division of interest) not totaling 100% 8

9 Acquisition Due Diligence (cont d) Issues That Commonly Arise Money Held Back plugging liabilities Is held money in an account receiving interest? If so is interest allocated yearly to investors? Do these funds remain w/ seller or transfer to buyer? Incorrect tax payments (severance) Are estimated payments balanced on the annual return? Are exemptions applied each year? 9

10 Acquisition Due Diligence (cont d) Issues That Commonly Arise Property Taxes 2 year lag when buying/selling properties, be sure to address at closing who is responsible for paying the property taxes (for instance, if you buy/sell in 2017, when the 2018 tax tickets are issued, they will be for 2016 production.) Be clear on who is responsible for paying the taxes and if that has been addressed in closing. 10

11 Due Diligence Non-Operating Items to address in Regards to Non-Operating Properties: Joint Interest, Joint Operating, & Joint Accounting Agreements Overhead Budgeted AFE vs. Actual AFE Costs Related Party Transactions 11

12 Non-Operating Due Diligence Joint Interest Agreement Lease Acquisition Joint Operating Agreement Drilling Operations 12

13 Non-Operating Due Diligence (cont d) Joint Interest Agreement Identifies the parties to the Agreement Identifies properties included in the Joint Interest Lease Acquisition Details working Interest owners percentages States effective date of the Agreement 13

14 Non-Operating Due Diligence (cont d) Joint Operating Agreements Actual operation of the joint interest property is governed by the JOA, which is executed in addition to the Joint Interest Agreement and governs drilling and operations. The JOA designates which party shall be the operator and its duties and responsibilities. Joint Operating Agreements are usually accompanied by accounting procedures. (COPAS) Most JOA s are executed using model forms developed by the American Association of Professional Landmen (AAPL).(w/modifications) 14

15 Non-Operating Due Diligence (cont d) Common Provisions in a JOA Exhibit A Listing of land & leases Duties & Obligations of Operator Non Consent Provisions Claims and litigation Effective date and term Allocation of production Taxes & Insurance Force Majeure **Other provisions 15

16 Non-Operating Due Diligence (cont d) Disagreements Although Joint Operating Agreements and supporting accounting procedures detail the obligations and rights of both parties involved, it is not always so easy to administer and account for these activities. The most commonly disputed charged item is what is and is not covered by Overhead. Contradicting Provisions in the JOA. 16

17 Non-Operating Due Diligence (cont d) Disagreements (Cont d) Additional Disputed Items: Twenty-Four Month Period Non Operators have 24 months following the end of the calendar year the operator billed the charges to request corrections to the joint account. Is not necessary to wait for an audit to take written exception to a given monthly bill or particular portion or charge appearing on a monthly bill Exceptions to the 24 month limitation Physical inventories of controllable material, Offsetting entries resulting from a joint interest audit, Adjustments arising from Government/regulatory audits, and Working Interest ownership adjustments 17

18 Non-Operating Due Diligence (cont d) Overhead Overhead is intended to provide the Operator compensation for indirect costs and G&A costs that are not easily identifiable to a specific joint operation, but are incurred by the Operator in a typical business day. Misunderstandings over the intent and impact of the various overhead elections are a major source of joint interest audit claims. 18

19 Non-Operating Due Diligence (cont d) Common Overhead Items Administration: Accounting, Accounts Payable, Accounts Receivable, Office Services, Data processing, Human Resources Operations Support: Purchasing, Inventory taking, Obtaining permits and certifications, Warehousing General Management: Supervision above first level, Negotiations with contractors, vendors, & landowners. General onsite inspections/periodic visits 19

20 Non-Operating Due Diligence (cont d) Items Not Covered by Overhead Rentals & Royalties Labor, Payroll, Personal Expenses Material Equipment and Facilities furnished by Operator Taxes, Insurance, Legal Suspense Communications & Environmental 20

21 Sequence of Due Diligence Events Decision to conduct the audit Confirmation of procedures with non-operator and operator Information request and preliminary work Opening conference with operator Audit testing and analysis Closing conference with operator Preparation and issuance of audit report Responding to exceptions and information requests Operator s rebuttal/acceptance of operator s reply Response/Rebuttal to operator Resolution meeting 21

22 Take Away Items Be Timely and Thoroughly Informed Pay Close Attention to ALL Agreements Compare AFE and Budgets to Actual Costs Review Bidding Process and Related Party Transactions Be Aware of Maximum Potential Costs Plan Through the Whole Process Consider total costs (monetary and nonmonetary) vs. potential returned compensation 22

23 THANK YOU