Jolisa Melton

Cowboy COPAS: A Primer for Attorneys

27th Annual

Ernest E. Smith Institute

Houston, Texas

March 30, 2001

By Jolisa Melton

Thompson & Knight LLP

1700 Pacific Avenue

Suite 3300

Dallas, Texas 75201

214/969-1675

214/969-1751 (Fax)

1

Jolisa Melton

TABLE OF CONTENTS
I.COPAS
A.Formation
  1. Organizational Structure
  1. COPAS Documents
  1. Accounting Procedure
  2. Bulletins
  3. Interpretations/Education Documents
  1. COPAS and Industry Custom and Practice
  2. Accounting Procedure Areas
  1. No Gain or Loss Principle
  2. Direct and Indirect Charges
  1. Labor
  2. Facilities
  3. Mega Fixed rate
  4. Overhead
  1. Operator Changes to the Accounting Procedure
  2. 1995 COPAS Accounting Procedure Improvements
  3. Payments, Audits and Exceptions
  4. Areas for Improvement
  1. No Gain or Loss Principle
  2. Conflict between the Joint Operating Agreement and the COPAS Accounting Procedure
  3. Auditing Standards

D.Overhead

E.COPAS Bulletins

IX. Conclusion

1

Jolisa Melton

Cost allocation among interest owners is inherently a litigious issue, especially when oil and gas questions are concerned. Naturally, an individual owner, who is not operating the well, wishes to maximize the return on their investment. This can be accomplished by minimizing the costs that the owner must bear in developing and producing the property.

When multiple owners or co-tenants of a potentially producing property join together, they typically enter into a Joint Operating Agreement. This agreement specifies who will be the operator of the property. The operator’s goals sometimes conflict with the non-operating owners. The operator also wants to maximize the return on its investment. In so doing, the operator will want to be sure that it has passed on a proportionate share of all costs incurred in the development and production of the property to non-operators. The operator will have to “eat” all costs not passed on to others. This becomes a downward spiral for the operator if these costs also exceed the operator's share of production revenue, resulting in the operator incurring a loss solely because each owner is not paying their share of the costs.

The possibility for conflict between the parties is clear to see. With each party fiercely protecting their investment, such conflicts can quickly escalate into litigation. There is a greater likelihood for dispute when oil and gas prices are depressed because owners may not be struggling to maximize their return on the investment, but rather fighting to minimize their losses. These conflicts often involve accounting disputes that arise under The Council of Petroleum Accountants Societies’ (COPAS) accounting procedure. This procedure is included in the form of an incorporated exhibit to the Joint Operating Agreement. It provides what costs are allowable, and how these costs will be allocated. COPAS and the COPAS accounting procedure have a rich history of evolution and litigation.

I.COPAS

A. Formation

Standardization was the driving force behind the formation of The Council of Petroleum Accountants Societies, Inc. (COPAS). COPAS was formed in 1961 and initially named The Council of Petroleum Accountants Societies of North America. The phrase of “of North America” was removed in 1980.[1] Initially, there were twelve local societies comprising COPAS.[2] Now, this number has grown to twenty-three.[3] In 1979, a National office was established, and in 1985, a Board of Directors was elected.[4]

The National Council was formed to avoid duplication and inconsistencies that may result from having multiple individual societies trying to solve common problems in the oil and gas industry.[5] Another reason for its formation was to consolidate the authority of the individual societies into a stronger voice of understanding in petroleum accounting.[6] The formation resulted not only in a stronger and more thorough understanding, but also in a common source of industry custom and practice.

The goal of COPAS is to “enhance competition by suggesting model forms, interpretive bulletins, and guidelines for the most practical methods of accounting, auditing, and record keeping in the oil and gas industry.” Anti-Trust, (visited March 12, 1999) < This is accomplished through the following objectives, as detailed in Article I of the Bylaws of The Council of Petroleum Accountants Societies:

“…

(B)Study and analyze accounting and other problem areas of the petroleum industry

(C)Formulate and disseminate petroleum industry accounting practices, procedures and pronouncements through the use of bulletins and interpretive statements …

(F)Cooperate in the education of the public concerning the petroleum industry

(G)Assist educational institutions through contributions of papers, books, speakers and scholarships…” Bylaws, (visited March 12, 1999) <

B.COPAS Organizational Structure

COPAS has several different levels of membership for the individual societies. Participating societies are those that adopt a set of bylaws, conduct at least 3 meetings per year, have been in existence for at least one year, consist of at least thirty-five members representing five or more companies, and have two accounting study committees.[7] These societies are admitted into COPAS membership upon two-thirds approval of the current Participating societies.[8] Participating societies can vote and have full COPAS participation rights.[9]

Associate societies have eligibility requirements similar to Participating societies except they only have fifteen or more members representing 3 or more companies, and do not have accounting study committees.[10] Admission into COPAS is the same as for Participating societies.[11] However, Associate societies may not vote.[12] Therefore, an Associate society only has limited participation rights.

International societies are composed solely of members who reside outside of the United States.[13] Membership requirements for an International society are similar to the Associate societies’ requirements except that an International society need not conduct at least 3 meetings per year, and all members must not be a resident of the United States.[14] Admission into membership is also the same.[15] International societies have limited participation rights and are not eligible to vote.[16]

The last type of COPAS membership is the Individual membership. Individual membership is available for limited members or academic members. A limited member is someone who is involved in the petroleum industry but does not have a Participating society in his area.[17] “Involved in the petroleum industry” means that the individual must be “actively engaged” in accounting, public accounting, or education – directly related to the petroleum industry.[18] Academic membership is open to accounting students who want to learn more about the COPAS organization.[19] The Executive Director of COPAS admits Individual members into COPAS; a vote by the Participating societies is not required.[20] Individual members receive only limited participation rights and are not eligible to vote.[21]

An individual society may be suspended, upon two-thirds vote by the Participating societies, for any of the following reasons: failure to pay its assessed portion of COPAS operating costs, failure to participate in national COPAS activities, becoming an inactive society, or failure to meet membership requirements.[22] A suspended society has participation rights in COPAS functions but cannot vote.[23]

II.COPAS Documents

A.Accounting Procedure

A Joint Operating Agreement is the most common contract used when multiple owners want to produce oil or gas, whether as cooperating owners of separate properties or as co-tenants.[24] The Joint Operating Agreement designates the operator of the property, and also provides that the operator will bear the exploration and production costs and then bill the other non-operators.[25] The methods for allocating costs incurred by the operator, defining which costs are allowable charges, and the procedures for billing the other parties are set out in an accounting procedure. This procedure is often attached to the Joint Operating Agreement as an exhibit.

COPAS was organized to standardize the accounting procedure. Prior to the formation of COPAS, each geographic area had their own accounting procedure.[26] The Petroleum Accountants Society of Oklahoma – Tulsa developed an accounting procedure that was widely used in the mid-continent and gulf coast region, and also served as the basis for the first COPAS accounting procedure.[27] “COPAS was started in 1962 when the need was recognized for an accounting exhibit to accompany the AAPL Operating Agreement to be used in joint oil and gas operations." What is COPAS?, (visited Feb. 24, 1999) < Accounting procedures were issued by COPAS in 1963 (titled the 1962 Accounting Procedure), 1968, 1975 (titled the 1974 Accounting Procedure), 1984, 1995 and 1998.[28] Additional accounting procedures were developed for offshore operations and issued in 1976 and 1986.[29] These accounting procedures are published by Kraftbilt Products (P.O. Box 800, Tulsa, OK 74101), and are also located with their guidelines, the COPAS bulletins.[30] The 1984 accounting procedure is the most widely used procedure that currently regulates operational accounting today.[31] The 1984 procedure was widely accepted by the industry because it was established through a group effort by all of the societies.[32]

The 1995 and 1998 accounting procedures have not been well received. Normally when a new accounting procedure is issued by COPAS, the previous accounting procedure is no longer published. However the 1995 accounting procedure was only issued by COPAS, upon narrow approval, as an alternative accounting procedure.[33] This accounting procedure contained provisions to accommodate the energy task force which was mainly comprised of majors and large independents.[34] A major concern on this new accounting procedure was the ability of the operator, or its affiliate, to charge commercial rates for services and materials and hence make a profit[35] a radical change from the No Gain or Loss Principle, discussed below. In addition, a 1998 accounting procedure was issued for use by project teams between large and major companies and as a result of this special use, it is also an alternative accounting procedure.[36] Because of the limited applicability of the 1998 accounting procedure, the 1984 accounting procedure remains the most widely used accounting procedure today.

A standardized accounting procedure evens out the power between the parties to a contract. This can be seen with the Association of International Petroleum Negotiators’ Model Form Joint Operating Agreement. The model form increased the non-operators understanding by over 300%.[37] An operator’s individual joint operating agreement form was no longer forced upon the non-operator as the only option available. The non-operator had a model form available – which provides all of the options that are available to the non-operators.[38] This information may not have been known to a non-operator lacking the financial resources to perform extensive research.[39]

B.Bulletins

COPAS Bulletins are the highest level of COPAS documents. A majority of the Participating Societies must approve of the bulletin for it to be issued.[40] The process for developing a bulletin begins with research into the accounting topic by a task force. The task force recommendations are then forwarded to the committee, which performs a review and forwards it to the Board of Directors. After review, the Board of Directors makes a recommendation to the individual Participating societies, who then vote on the bulletin.[41]

Because the oil and gas industry assists in the research and development of the COPAS bulletins, these bulletins reflect, common but not necessarily exclusive, industry practice and custom.[42] Custom is a practice that is so widely used and accepted that it acquires the force of law.[43] The bulletins are intended to serve as an interpretational guideline for the accounting procedures. However, some courts are using the bulletins as industry standards – although they are not intended as such.[44]

To date, COPAS has issued 34 bulletins. A listing of these bulletins, including date and title follows.[45]

Bulletin Number / Date / Title
1 / 4/90 / Classifications for use in summary form billing
2 / 9/65 / Determination of values for well cost adjustments joint operations
3 / 1/94 / Expenditure audits in the petroleum industry: protocol and procedures guidelines
4 / 10/91 / Oil and gas accounting procedures
5 / 9/66 / Accounting procedure joint operations (1962 COPAS)
6 / 4/90 / Material classification manual
7 / 4/93 / Gas accounting manual
8 / 10/69 / Accounting procedure joint operations 1969
9 / 4/92 / Accounting for Farmouts/Farmins, net profits interest, carried interest
10 / 4/90 / Petroleum industry accounting educational training manual
11 / 5/71 / Accounting for unitizations
12 / 4/00 / Field computer and communication systems
13 / 10/75 / Accounting procedure joint operations 1975
14 / 11/75 / Accounting procedure arctic operations 1974
15 / 10/77 / Accounting procedure offshore joint operations
16 / 4/88 / Overhead – joint operations
17 / 4/88 / Oil accounting manual
18 / 4/00 / Marine and aircraft offshore transportation
19 / Merged into Bulletin 18
20 / 4/00 / Shore base facilities and offshore staging areas
21 / 3/98 / Material pricing manual
22 / 10/85 / Accounting procedure joint operations 1984
23 / 10/92 / Guidelines for revenue audits in the petroleum industry: protocol and procedure guidelines
24 / 4/91 / Producer gas imbalances
25 / 9/87 / Accounting procedure offshore joint operations
26 / Merged into bulletin 3
27 / 4/89 / Guidelines for cash flow budgeting in the petroleum industry
28 / 4/90 / Joint task force guidelines on natural gas administrative issues
29 / 4/90 / Guidelines for contractor audits in the petroleum industry
30 / 4/90 / Guidelines for investigation of suspected irregularities
31 / 4/90 / Guidelines for an internal review of an oil and gas production and exploration division
32 / 12/96 / Gas processing systems material classification manual
33 / 12/96 / COPAS 1995 accounting procedure interpretation
34 / 7/98 / COPAS Project team accounting procedure interpretation

C.Interpretations, Education Documents

An interpretation, or education document, is similar to a COPAS bulletin; however, it does not provide a single guideline concerning the COPAS accounting procedure. An interpretation is usually developed when a bulletin fails to receive a majority vote by the Participating societies.[46] When a majority is not reached, the COPAS Board of Directors develops an interpretation which provides all of the alternatives available for that specific accounting issue.[47] An interpretation, therefore, does not reflect industry custom and practice because there is not a majority of petroleum accountants following one particular approach.

To date, COPAS has issued 31 interpretations. A listing of these interpretations, including date and title follows.[48]

Interpretation Number / Date / Title
1 / 4/80 / Pricing tubular foods at Eastern Mill base price v. lowest prevailing price
2 / 4/80 / Definition of railway receiving point
3 / 4/80 / Selection of mode of hauling – for computing freight – mill to railway receiving point
4 / 4/80 / Pricing of line pipe movements less than 30,000 pounds
5 / 4/80 / Pricing of casing, tubing and drill pipe used for purpose other than originally intended
6 / 6/82 / Loading, transportation and unloading costs
7 / 4/80 / Coating and wrapping costs
8 / 4/80 / Repricing of transferred mill rejects and limited service tubular goods
9 / 7/84 / Transportation costs – zone priced material
10 / 5/81 / Premium priced material
11 / 1/94 / Employee benefits – chargeable to joint operations and subject to percentage limitation
12 / 10/82 / Employee benefits limitation
13 / 11/90 / Valuation of crude oil volumes in the event of price changes during the month
14 / 12/84 / Definition of published price – tubular goods material transfers
15 / 5/86 / Computerized equipment pricing system
16 / 10/86 / Definitions – Operator and related entities
17 / 9/87 / Disposition of surplus joint account material and equipment
18 / 9/88 / Freight rates: change of information source
19 / 9/88 / Discounts
20 / 7/89 / Freight rates: revised method of determining freight rates for tubular goods
21 / 2/90 / Documentation supporting joint interest expenditures
22 / 8/91 / 24 month audit period audit and accounting adjustments
23 / 5/92 / Material transfer valuation
24 / 12/96 / Cost of self-insurance for workers’ compensation and employers’ liability insurance
25 / 4/96 / Market adjusted – loading, transportation and unloading costs
26 / 1/97 / Transfer pricing for used materials
27 / 1/97 / Charging of training costs to the joint accounts
28 / 1/97 / Documentation requirements for electronic invoices
29 / 7/97 / Audit rights for non participating, non consenting parties
30 / 7/97 / Chargeability of incentive compensation programs
31 / 2/98 / Documentation on requirements for procurement card (PCard) and convenience check charges

III.COPAS and Industry Custom and Practice

Industry involvement in COPAS’s understanding of oil and gas accounting issues is reflected in all of the documents issued by COPAS. Such industry involvement, and widespread use of COPAS procedures and related bulletins, has lead to COPAS bulletins being regarded on the level of industry custom and practice. However, there are other reasons that COPAS’s knowledge base reflects industry custom and practice.

One function that also enables COPAS to maintain such an extensive knowledge of oil and gas accounting is participation in the establishment of the National Oil and Gas Accounting School. COPAS assisted the Professional Development Institute (PDI) and the American Institute of Certified Public Accountants (AICPA) in the establishment of the school in 1979.[49]

Between 1994 and 1995 COPAS developed the Accredited Petroleum Accountant Program.[50] During that time, COPAS, with the assistance of industry experts, established a comprehensive certification standard of what a petroleum accountant should know.[51] This certification process tests an accountant in the following areas: Operations, Law, Financial Reporting, Revenue, Joint Interest, Tax, Managerial, and Auditing accounting.[52] Accountants wishing to sit for the exam must have 5 years experience in oil and gas accounting, a four-year college degree with 12 hours of accounting, and a CPA license.[53] The certification program is intended to recognize the special skills of petroleum accountants and to aid employers with employee selection.[54]

In addition, the COPAS bylaws establish standing committees to research and report on industry custom and practice.[55] These committees cover the areas of audit, education, financial reporting, international, joint interest, refining and marketing, revenue, small oil and gas companies, and tax.[56]

COPAS’ wealth of information places it in the unique position to portray industry accounting custom and practice. COPAS constantly receives information from members working in the industry and is always striving to keep this knowledge current. In addition, the COPAS organization is continually researching various areas of oil and gas accounting to not only understand and establish custom and practice but to assist in solving accounting problems that arise. The best recommendation for COPAS comes directly from the industry when it looks to COPAS bulletins as a source of industry practice. In fact, the name COPAS sells. A previous President of COPAS and 32 year veteran of the industry recognized that although the bulletins and interpretations lack “legal standing” since they are not incorporated into the Joint Operating Agreement or COPAS accounting procedure, “most of those in the oil and gas industry believe that anything COPAS publishes, without consideration of form or the approval process within COPAS, establishes acceptable industry accounting practices and procedures.”[57]