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GENERAL COMMENTS
The exceptions that are included in the reports, in most
cases, reflect common occurrences normally observed when
reviewing the records of other operators. Large dollar amounts
or quantities of exceptions are not considered a reflection
against any operator; it is a representation of the exceedingly
complex nature of oil and gas industry activities, combined
with years of experience, expertise and tedious review procedures.
Although recoveries normally exceed review expenses in an
active review program, the objective should not necessarily
be limited to obtain recoveries of money from the Operator.
More importantly, valuable information can be made available
to the investors about the Operator; the investor can better
determine which Operators are making the best attempt to
deal fairly with the investors.
It should be noted that standard oil and gas industry practice
and procedures bear a significant relevance to our overall
review scope. Also, if a contractual clause is found to
be contradictory and/or to the disadvantage of the client
Non-Operator and/or the Operator, information which we consider
to be most essential and beneficial will be reported in
either a direct formal exception or included in the body
of a letter. In many cases, this indicates a need for an
extended investigation in the oil field and/or a review
of the vendor(s) to assure the results of the joint account
as a whole are fairly presented. Vendor reviews help keep
honest vendors honest.
BCP/ACP means BEFORE CASING POINT / AFTER CASING POINT.
In this case, the Operator's share of the cost may be carried
or shared by the Non-Operators until casing point is reached.
This promote rewards the Operator for putting the deal together.
Per industry practice, the BCP normally changes to ACP after
the log has been completed and a decision is made to either
plug or complete the well. Exceptions normally ask the Operator
to change the charge from BCP to ACP. It should be kept
in mind that BCP/ACP exceptions do not result in full credits
to the Non-Operators, but result only in a lower working
interest cost for the Non-Operators. These types of exceptions,
therefore, can inflate the report results. There are other
forms of promotions besides ACP/BCP, e.g., carried through
tanks, promotion by the Operator charging 110% vs. 100%
costs to the Working Interests, and carrying another working
interest in order to obtain a farmout of a lease.
TBD means TO BE DETERMINED and is used in place of amounts:
(1) to present items which can not be quantified with a
dollar amount and, therefore, can never be treated lightly
- sometimes a TBD can be the largest recovery; (2) to present
items which are exceptions and must be addressed, but may
only require a reply by the Operator; (3) to present miscellaneous
items which may fall into gray areas; or (4) to obtain additional
information before the item can be properly resolved.
Turnkey or footage contracts are considered by some to limit
the available exceptions; however, it can be just the opposite
since they can create large dollar exceptions, e.g., the
rig contractor should have furnished the surface casing
or the logging, which was erroneously charged to the Joint
Account. Every well is different and the results are always
unknown, until actually reviewed.
Substantial discounts have been available
from most vendors since early 1982 in order to be more competitive.
Discount information can be difficult to obtain since the
Operator can only compare discounts within their own company;
whereas we are able to document these discounts for the
same, or like, vendors in different companies. Discounts
are not limited by the size of the vendor or Operator. The
final result can mean that the drilling of every future
well can be for less than price list costs. Operators who
pay invoices late, will receive fewer discounts from vendors
- Operators may take a temporary interest gain, but will
no longer receive favorable discounts from some vendors
on future wells drilled.
OPINION AND FINDINGS
This contract compliance review consists
of an examination of all significant charges and credits
to the Joint Account. We perform sufficient test checks
and other review procedures to assure that the Operator
satisfactorily maintains the accounts and the supporting
records for the Joint Account for the subject properties
in an acceptable manner. The charges and credits are reviewed
and considered for reasonableness and proper inclusion in
the Joint Account. Items considered to have a lack of impact
are reviewed on a selective basis, depending on proven,
prior-exception experience as to specific categories which
bring about larger exceptions in related areas.
Operators do not allow a review of
the Operator's financial statements. Accordingly, an opinion
is not expressed on them. We receive very limited time and
information, whereas public auditors have full access to
the Operator's records and personnel since they are employed
specifically by the Operator for the Operator's benefit,
providing financial statement services. Public auditors
almost always have totally different training and expertise.
OPERATOR'S TREATMENT AND TIMING OF THIS JOINT INTEREST REPORT
The operator is normally requested
to: (1) reply in writing to a report within a reasonable
period of time (not to exceed six months which is currently
recommended by COPAS); (2) furnish in response to a report
with the amount of credit allowed on each exception and
the month in which the credits will appear; (3) insure the
accounting department identifies on joint interest billings
and/or statements of the participating Non-Operators the
individual credits due, by the report date (or AFE #, etc.)
and exception number; (4) provide adequate documentation
should any exception be adjusted for an amount other than
that presented; (5) provide us and the investing Non-Operators
a copy of the Operator's response to the report and a copy
of any joint interest billing reflecting credits due to
the Non-Operator's - especially to assure the exception
results are controlled, summarized, monitored and ultimately
resolved for the benefit of both the participating Non-Operators
and the Operator. If the Operator fails to copy us, the
Non-Operator should be alerted that the Operator may be
attempting to circumvent our rebuttal to their reply. Also,
it has been shown that we were copied; however, no copy
was ever received by us.
It is important for both the Non-Operators
and the Operator's representatives to note, some reports
receive 100% credits; most will have one or more exceptions
denied due to inadequate or incorrect information furnished
to us. However, Operator replies to reports, which have
most or all credits flagrantly denied, will most likely
be unacceptable and should immediately alert the Non-Operators
as the Operator's sense of fair play. Some operators will
deny some of our report credits, but will later grant them
only to those Working Interests who exert pressure. If necessary,
the investor should complain to the Operator's highest management
level when treated unfairly by the author of the reply to
our report. One of the functions of the report is to obtain
refunds for overcharges; however, the primary function of
the report is to determine what kind of an Operator you
are investing with - past, present and future. Satisfied
Non-Operators can and will most likely invest future monies
with the Operator. The Operator should, therefore, be as
willing to fairly and promptly refund any credits due to
the Joint Account.
According to COPAS bulletin No. 3,
Expenditure Audits in the Petroleum Industry Protocol and
Procedures Guidelines, "Accordingly, non-action by
the auditee in excess of one year of the… final report
/ most recent substantive response should be viewed as acceptance…
and appropriate adjustments and/or payments will be expected
by the Non-Operators."
FOLLOW-UP
It is the ultimate responsibility of the Non-Operators to
follow up on all exceptions, unless we are specifically
paid to handle the follow-up work. Pressure exerted by the
individual or collective Non-Operators is far more effective
than any from our company. Once the Non-Operators have been
granted credits by the Operator, each Non-Operator should
make certain their individual credits actually appear on
their joint interest billings.
RECOMMENDATIONS
We recommend to any and all Non-Operators, and Operators
in a Non-Operator status that the following must be inserted
at the end of all operating agreements for properties operated
by other operators:
Any joint interest review report
will be resolved within sixty (60) days by binding arbitration
in accordance with the Commercial Arbitration rules of the
American Arbitration Association if:
1) The report is not answered by the Operator within one
year.
2) The report is not resolved within two years.
Each party is responsible for their own arbitration costs.
This need is due to A VERY LIMITED
NUMBER of Operators have adopted unwritten policies:
· To overcharge since most investors will not or
cannot afford to sue.
· To make scope limitations, e.g., charges under
$1,000 are considered to be immaterial, in order to make
unauthorized charges to the Joint Account.
· To not answer any reports.
· To answer reports only when pressured.
· To deny all or most exceptions.
· To deny any high-dollar or complicated exception.
· To attempt to make extra profits on Non-Operators
(exception hereby is taken).
· To delay the review process until forgotten.
· To never resolve reports (even major oil companies).
· To agree to credits, but never pass them.
· To not negotiate in good faith during legal mediations.
With the adoption of this phraseology,
the Non-Operator will observe an increase in the number
of exceptions granted in most reports. This will also help
preclude potential lawsuits that are both expensive and
ruin excellent working relationship.
If any investor has a large working
interest, they should consider obtaining their own comparative
bids for: location, rig, equipment, tubulars, frac charges
and any other extremely-large, AFE-proposed charges. This
is to assure that the forthcoming charges from an operator
are not inflated. Also, after an investor has paid an operator
for large joint interest billing charges, he should consider
requesting documentation from an operator which proves that
the largest charges have been paid: otherwise, the investor
risks paying the charges twice if an operator goes out of
business without paying the vendors who can put a lien on
the well. Also, larger discounts might not have been received
since some vendors will allow the operator a year to pay
e.g., on a $250,000 frac job. This allows an operator use
of the investor's money, interest free for a year.
REVIEW NON-PARTICIPANTS
Non-operators have the right to not participate in a review
of the Joint Account for various reasons, e.g., they assume,
correctly or incorrectly, that the cost will exceed the
benefit; or they assume unethically that there is no need
to pay their fair share of review costs since the Operator
will probably pass them credit anyway. In any case, based
on the contract, i.e., COPAS Accounting Agreement, page
1, under the Adjustment paragraph: The statements "…
shall conclusively be presumed to be true and correct…"
unless "… a Non-Operator takes written exception
thereto and makes claim on Operator for adjustment."
Therefore, if Non-Operators do not
participate in obtaining recoveries, we are not authorized
to represent them and we do not request any adjustment for
them. However, we, not them, can reserve the right to take
exception for them in case we are able in some manner to
subsequently arrange for their participation in order to
lower the review cost for all participants. Exception should
be taken to revenue if it was not completely audited.
CONCLUSION
Per Joint Interest protocol, a formal
report, copies of all review memos with detailed schedules,
references, and copies of related documents to support exceptions
will be provided to the Operator's representative during
and/or after reviews to enable the retrace of proposed exceptions
for the timely adjustment of the joint interest account,
unless temporarily delayed by personal client review.
Although a Non-Operator might not
be in all wells within a report, he is greatly encouraged
to read the report in its entirety. The total information
can give the reader a more significant understanding of
the items which may pertain to their current and future
investments. The Non-Operator is encouraged to share some
of the information, as a by-product of this report, we developed
with other departments, e.g., Engineering, since many times
there is limited information available on outside operated
properties.
Operators receive free review services,
and in some cases receive most of the benefits and recoveries
when the Operator has the largest working interest, e.g.,
contractor's responsibility, duplicate payments, vendor
overcharges, coding errors to the wrong working interests,
and other items which can and do occur. Only when credits
are unusually large or important to the Operator, we request
the Operator to consider, per the COPAS Accounting Agreement,
crediting the Joint Account with the Operator's fair share
of beneficial review costs, especially since the overall
intent of the operating agreement is to equally share costs
according to the working interest percentages.
In some cases, there are exceptions
which we do not write since they would: be considered by
some to be immaterial, have resulted in costs exceeding
potential benefits, and/or have caused undue extra work
on the part of the Operator.
One of the intents of our review
is to clear up open and unresolved questions or problems
and to give the Non-Operators the necessary assurances concerning
their investments in a fair and professional manner, so
they may continue to make additional investments with the
Operator which will result in profits for all parties.
In advance, we wish to express our
sincere appreciation for the opportunity in representing
the Non-Operators as a profit center and information source.
Should either the Non-Operators or
Operator ever have any questions or need additional information,
please do not hesitate to call on us any time we can be
of service. We do the very best job we can in a very limited
time. We greatly value all feedback, both positive and negative,
both Operator and Non-Operator, since we are committed to
both achieving excellence and providing the best and most
fair report possible.
Most of our work comes from referrals;
therefore, all our referrals are always greatly appreciated.
Professionally,
Robert P. Malone, Owner
Malone Petroleum Consulting
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