ACC 8211 Oil and Gas Accounting

8/21/2019 ACC 8211 Oil and Gas Accounting

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BAYERO UNIVERSITY, KANO

FACULTY OF SOCIAL AND MANAGEMENT SCIENCES

DEPARTMENT OF ACCOUNTING

9th June, 2014COURSE: ACC 8211 (Oil and Gas Accounting)CLASS: M.Sc. Accounting

SESSION/SEMESTER: 2013/2014 Session — First SemesterLECTURER: Kabir Tahir Hamid, PhDCONSULTATION: Strictly by AppointmentOFFICE: 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 ofthe 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 arebeing accounted for. The nature and relevance of the Nigeria Petroleum industry, the differences betweendownstream and upstream sectors of the industry, accounting principles, practices and procedures relevantto various phases of oil and gas operations, petroleum products pricing and marketing, types of operatingcontracts in the Nigerian petroleum industry – JV, PSC and SC, financial and fiscal monitoringmechanism, 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; andviii) 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 Petroleum1.2 Origin of Petroleum, Its Industry Characteristic and Activities 1.3 The History of the Nigerian Oil and Gas Industry1.4 The Nature of Petroleum Assets and the Process of Acquiring It1.5 Accounting Dilemmas in Oil and Gas Accounting1.6 The Upstream and the Downstream Sectors of the Nigerian Oil industry1.7 NNPC and DPR and Their Roles1.8 PPPRA and the Proposed Petroleum Industry Bill (PIB) 20112. Oil Prospecting and Reserves Valuation


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2.1 Steps in Prospecting for Oil and Gas2.2 Types of Oil and Gas Wells2.3 Estimation and Valuation of Oil and Gas Reserves2.4 Classification of Reserves2.5 Oil and Gas Reserves Estimation3. Arrangements, Agreements and Contracts in the Nigerian Petroleum Industry

3.1 Types of Operating Contracts in the Petroleum Industry3.2 Contract Arrangements in the Nigerian Petroleum Industry and their Operations3.3 Financial and Fiscal Monitoring Mechanisms of Agreements in the Petroleum Industry4. Accounting Principles and Standards in the Oil and Gas Industry

4.1 Application of GAAPs in the Oil and Gas Industry4.2 Classification of Costs in the Oil and Gas Industry4.3 Methods of Accounting in the Oil and Gas Industry4.4 Accounting Standards in the Oil and Gas Industry5. Procedures in Oil and Gas Accounting

5.1 Basic Accounting Transactions5.2 Depreciation, Depletion and Amortization (DD & A)5.3 Accounting for Oil and Gas Exploration and Acquisition Costs5.4 Accounting for Oil and Gas Development and Production Costs5.5 Accounting for Crude Oil Refining, Petrochemical and Liquefied Natural Gas

5.6 Petroleum Products Pricing and Marketing5.7 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. andStevenson. J. W.

ii) Financial Accounting and Reporting by Oil and Gas Producing Companies by FASBiii) Accounting for Oil and Gas Exploration, Development, Production and Decommissioning Activities

by SORPi) 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 Wrightiv) 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 theclass, to be followed by discussion exercises. Some of the exercises would be attempted in the class, whilethe 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).


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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 broadlydefined, Petroleum (i.e. crude oil and natural gas) refers to mixture of hydrocarbons that are molecular innature, in various shapes and sizes of hydrogen and carbon atoms, found in small connected pore spaces ofsome 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 gasrefers to hydrocarbon mixtures produced from underground reservoirs that are not liquid but gaseous atthe normal atmospheric pressure and temperature. Hydrocarbons are compounds containing only theelements 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 earth’scrust 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 withremains of plants and animals. Eroded particles of igneous rocks are carried to low areas and are depositedinto sedimentary layers through the action of wind and water. Metamorphic rocks develop when igneousor sedimentary rocks are subjected to heat and pressure resulting from the weight of overlying rocksstresses, thus converted into metamorphic slates and quartzite. Nearly all significant oil and gas reservoirsin the World today are found in sedimentary rocks, as the accumulation of oil or gas in igneous ormetamorphic rocks is very rare; however petroleum can be reservoired in these types of rock under certainalbeit rare conditions. The extreme heat and pressure associated with these types of rocks drives off orburns any organic material or hydrocarbons.

It can therefore be said that, out of the three types of rocks explained above (namely, igneous, sedimentaryand metamorphic rocks) only sedimentary rocks form the source in which hydrocarbons reservoirs arefound. Even in the sedimentary rocks, hydrocarbons are possibly found in only sandstone (shale) and notlimestone and dolomite. In other words, sandstones are the source rock in which oil and gas is formed andaccumulated, while limestone and dolomite evolve through chemical processes. However, it is importantto note that the various rock formations, as well as, the various changes in the earth's crust do not, bythemselves, 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 isapproximately 2,000 miles thick. The earth's surface is underlain by the lithosphere, a relatively thinlayer, 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. Geologyis the science that studies the planet earth, the materials it is made up of, the processes that act on thesematerials, the products formed, and the history of the planet and its life forms since its origin. Mostgeological studies are focused on aspects of the earth's crust because it is directly observable and is thesource of energy and minerals for today's modern industrial societies. On the other hand, geophysics isthe science that studies the earth by quantitative physical methods.


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Over the last two centuries, two theories—the inorganic theory and the organic theory—have beenadvanced to explain the formation of oil and gas. Although no one theory has achieved universalacceptance, most scientists and professionals believe in the organic origin of petroleum. The inorganictheory 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 theoriesexplain the combination of the two elements into hydrocarbons. These include the alkali theory, carbidetheory, 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 intrusiontheory argues that high temperatures applied to carbonate rocks can produce methane gas and/or carbondioxide. 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 ofoil and gas. According to geological research, the earth was barren of vegetation and animal life forroughly one half of an estimated five billion years of the earth's existence. Approximately 600 millionyears ago, an abundance of life in various forms began in the earth's oceans. This development marks thebeginning of the Cambrian period in the Paleozoic era. Nearly 200 million years later (in the Devonianperiod), vegetation and animal life had spread to the landmasses. The Paleozoic (roughly 350 millionyears), Mesozoic (roughly 150 million years), and Cenozoic (roughly 1000 million years), eras have beenlabeled as successive and definitive geological time periods by geologists, which brings us up to thepresent. These time periods are shown in Table 1.

Table 1: Geologic Time Period

Era Period

Approx.Duration inmillion yrs.

Indicative NewLife Forms

Cenozoic"Modern Life"

Quaternary 3Large Mammals

Tertiary 63

Mesozoic"Middle Life"

Cretaceous 71

Jurassic 54 Large Dinosaurs

Triassic 35

Paleozoic"Ancient Life"

Permian 55

Early Reptiles,Amphibians and

Fish

Carboniferous 65

Devonian 50

Silurian 35

Ordovician 70

Cambrian 70

Crypotozoic or Precambrian 4,000Bacteria, Algae

and Jellyfish

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 therivers and, together with some forms of marine life, settle into the ocean floor. Most hydrocarbons arebelieved to be derived from tremendous volumes of plankton, algae, and bacteria common in ocean basinsand lakes, and other marine lives that lived millions years ago in low land areas, usually in the oceans. Thetheory posits that the remains of plants and animals were deposited along with the eroded particles ofigneous rocks, which have been weathered through physical and chemical reactions. The weight andpressure of’ layer upon layer of the eroded particles of the igneous rocks resulted in the formation ofsedimentary rocks, and some chemical and bacterial processes turned the organic substances in the


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sedimentary rock into oil and gas. The sedimentation process can be observed even within an individual'slifetime. For example, the delta area at the mouth of a large river is formed by sedimentation. Layer afterlayer of silt, mud, particles of sand, and plant and animal life are deposited on the ocean floor, with a greatportion of the plant and animal life coming from the ocean itself. Anaerobic bacteria in the sediment aid inbreaking up the organic material and releasing oxygen, nitrogen, phosphorus, and sulfur from the organicmaterial, leaving the balance with a much higher percentage content of hydrogen and carbon and, thus, amore petroleum-like composition.

After formation, oil and gas move upward through the layers of the sedimentary rock due to pressure andthe natural tendency of oil to rise through water. The petroleum migrates upwards towards the earthsurface 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 formationwith adequate porosity and permeability to allow oil and gas to migrate to a well bore at a rate sufficientas to be economically producible (most geologists believe the earth initially formed from molten rock, ormagma, and cooled into solid igneous rocks. During the cooling and contraction processes, some rocksolidified beneath the surface). The impervious layer formed a seal which prevent hydrocarbons fromleaking 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 hydrocarbonreservoirs in the subsurface.

In some instances, oil and gas migrate directly to the reservoir area. More often, however, movements inthe earth's crust caused additional shifting, folding, bends, and fissures, and a secondary migration of theoil and gas took place through porous layers until another impermeable seal was reached. This may occurwhen an area is subjected to new tectonic forces, earth quakes, tsunami, etc. To search for new oil and gasfields, therefore, geologists and geophysicists devote their efforts to understanding the distribution ofrocks that could be sources, seals, and reservoirs in an attempt to develop locations for potential trapswithin petroleum systems. While it can be seen that oil and gas are formed through the sedimentaryprocess, this does not necessarily mean that the oil and gas have remained in the source beds or places oforigin. Hydrocarbons are known to have been preserved for hundreds of millions of years and the processof hydrocarbon formation is undoubtedly continuing, but much more slowly than is the rate ofconsumption 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 fourbroad 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 world’s oil. However, in order for an oil and gas reservoir to have been formed, four necessaryconditions 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.


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Porosity is the measure of the pore openings in a rock in which petroleum can collect; none of thesedimentary rocks are completely solid. The greater the porosity, the more petroleum the rock canhold, and the closer the rock is to the surface, the more the porosity. It is within the pore spaces thatthe oil and gas initially accumulated, together with some water called connate water. The porespaces may constitute up to 30 percent of the volume of the reservoir rocks that are relatively closeto the surface. As depths increase, the porosity of the formation tends to decrease as the result ofcompaction 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 inmillidarcies. The flow of oil and gas through a reservoir takes place in microscopic channelsbetween pore spaces. In some cases fractures are also present that provide greater permeability. Ifthere is high permeability, oil and gas can move through the formation with relative ease. Lowpermeability 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 oroil 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 thepores), 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 thecomponents of oil reservoir are crude oil, basic sediment, water and associated gas, the componentsof 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 asufficient physical area of rock that contains hydrocarbons. In other words, the reservoir mustcontain 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 producingcompany and tax revenue to the government. Condensate are hydrocarbons that are in a gaseousstate at reserviour conditions but condense into liquids as they travel up the wellbore and reachsurface conditions.

(4) an impervious rock formations that a prevents the oil and gas from further migration, therebyenabling 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; and4. 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 industrialand municipal waste) support the proposition that hydrocarbon itself is most likely to have beenoriginated 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 theoil and gas industry, it is considered that the appreciation of operational aspects of the industry isimportant for a better understanding of accounting practices in the industry. Basically, the objective of theoil and gas industry is to exploit and recover hydrocarbons (crude oil and gas) in its natural form fromlarge sub-surface reservoirs, subject it to changes through chemical and physical processes in a refinery,


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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 moreimportant to geologists and geophysicists, the knowledge of the procedures and steps involved in locatingand acquiring mineral interest, drilling and completion oil and gas wells and producing, processing andselling petroleum products is necessary in order to understand their accounting implications. Hence, it isimportant 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 everyeconomy and the world, at large. The distinctive features that characterized the industry are derived fromthe nature of crude oil, its operations and commercial arrangements. Some of these characteristics of theoil 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 bothsubstantial in amount and wide in scope, and locating new well sites even in already establishedfield is surrounded with high level of uncertainties. Exploration operations are risky because oil ishidden underground and the only conclusive evidence of its presence in any form, quantity andquality 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, licensingand 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 militancyrisk (the risk of kidnapping of personnel and vandalisation of equipments by militant youths) andtax risk (the risk of unexpected change in tax provisions) . Consequently, the risk of loss of capitalis very high.

2. Dominance of the World Economy: The second feature of oil and gas industry is its dominanceof 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 largestcompanies in the World today in terms of financial figures and profitability.

3. Long Lead-Time between Investment and Returns: Even in normal circumstances, upstreamactivities 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 periodbetween 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 governmentsand its agencies. This is as a result of the indispensability of oil, its depletable nature and itsinfluence in international politics.

5. Technical and Operational Complexity: Finding oil has proved to be a difficult task andtherefore demands the best technology possible. This results from the complexity of operations,especially in the offshore terrain.


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6. Specialized Accounting Rules for Reporting and Complex Tax Rules: There are fundamentaldissimilarity between financial/tax accounting in the oil and gas industry and other industries. Thisarises from the nature of oil and gas industry, its highly technical operations and specializedactivities.

7. Lack of Correlation between Investment and the Value of Reserves: The amount invested inoil 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-frontlarge investments in petroleum exploration and production.

Although, these characteristics are most evident in Exploration and Production (E&P) functions of the oiland 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, anddistribution and marketing. A company may decide to operate in any of the four segments or acombination thereof. The four segments are briefly explained below:

1. Exploration and Production (E&P): Exploration is the search for oil with a view to discoveringoil-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 gasand sell it depending on the nature and conditions of the contract, i.e. concession, joint venture orproduction sharing contracts. This segment is an upstream activity.

2. Storage and Transportation: This segment encompasses the storing and moving of petroleumfrom the production field to crude oil refineries and gas processing plants. Once crude oil and gasproduced and treated, it is stored in tanks and later transported to refineries and gas processingplants 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


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Table 2: Gas pipelines in Nigeria, 2012

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

Table 3: Petroleum Product Pipelines in Nigeria, 2012


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Source: OPEC Annual Statistical Bulletin, 2013 Pp79-80

3. Refining and Hydro Processing: Refining is the treatment of crude oil in order to form finishedproducts and may extend to the production of petrochemicals. Crude oil refining involves thebreaking down of hydrocarbon mixture into useful products, through distillations, cracking,reforming and extraction process. Different mixtures of petroleum have different uses andeconomic value. Numerous useful products that are derived from petroleum include the following:

(a) Transportation Fuels [Automotive Gas Oil (AGO), popularly known as diesel and PremiumMotor 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 inhouseholds. The combustion of Kerosene is similar to that of diesel with Lower HeatingValue 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- C3and 30% butane-C4). It is a product of petroleum refining and, it can also be obtained fromnatural gas processing. It consists of hydrocarbons as vapors, at normal temperatures andpressures, but turns liquid at moderate pressures. LPG uses include; cooking, heating inhouseholds, 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


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4. Distribution and Marketing: Distribution and marketing involve the activities associated withgetting finished products from distribution points into the hands of end users. Marketers are ofdifferent 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, Dan-Kano 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)


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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 wasthe 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 iscalculated 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); QatarMarine (Qatar); Arab Light (Saudi Arabia); Murban (United Arab Emirates); and Merey (Venezuela).


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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 downstreamactivities. It is worthy to note that an oil company can either be integral or independent. While anindependent 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 leastone of the other segments, namely storage and transportation, refining and hydro processing andmarketing and distribution. An integrated company is also known as mid- stream.


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

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 ventureoperations.

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.

Controller

FieldClerical

andServices

Equipmentand

SuppliesInventory

Taxes andRegulatoryCompliance

GeneralAccounting

RevenueAccounting

JointInterest

AccountingProperty

AccountingAccountsPayable


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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

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

Company

CorporateController

FinancialAccounting

&Considerations

Budget,Cost

Analysis &Reports

Marketing

Accounting

Pipeline &Crude oil

TradingAccounting

Refining

Accounting

Production

Accounting

Accounting

Policy &Research

Corporate

Tax


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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 pipelinemade of hollowed bamboo poles transported the gas a short distance where it fueled a fire used to boilwater. 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 andother purposes. Later, the term rock oil was replaced by the term petroleum from petra (a Latin word forrock) 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 wasuncertain, and people began using alternative illuminating oils called kerosene or coal oil extracted frommined coal, mined asphalt, and crude oil obtained from surface oil seepages. Therefore, the petroleumexploration and production industry may be said to have begun in around mid 1800s. There was mentionof 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 begandistilling valuable kerosene from crude oil, including facilities that had previously extracted kerosenefrom 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 oilthat could be moved by this method was limited. However, the industry's attempts to construct pipelineswere delayed by the unions whose members would face unemployment and by railroad and shippingcompanies 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 lessthan a thousand feet long.

ControllerProductionDivision

Budgets &Internal Reports

FinancialAccounting &Investments

Policy Planning& Support

RevenueAccounting

Compliance&

Taxation

Budgets

Internal Reports

PerformanceManagement

Internal Control

RegulatoryCompliance

Taxes

Oil

Gas

Recruitment andDevelopment

AdministrativeSupport

ManagementInformation

S stem

AccountingPolicies

GeneralAccounting

Investments

Joint Interests

External Reports


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New demands for petroleum were created in the 1920s, largely because of the growing number ofautomobiles, as well as, the use of petroleum products to generate electricity, operate tractors, and powerautomobiles. The oil industry was able to increase production to meet the greater demand without a sharprise in price. Compared with World War I, World War II which had its onset in 1939, used moremechanized equipment, airplanes, automotive equipment, and ships, all of which required huge amountsof petroleum.

The search for oil in Nigeria dates back to 1908 when a German Company, by name the NigerianBitumen Corporation, obtained a licence to explore for oil in Okitipupa area of Ondo State.The company’s efforts were unsuccessful and with outbreak of the First World War, itsoperations were disrupted.

Two decades later, Shell D’Arcy (the predecessor of Shell Petroleum Development Company of NigeriaLtd) started exploration of Niger Delta in 1937 having acquired exploration right from the BritishColonialists over the entire Nigerian territory under an exclusive exploration licence. The companyoperated under the Mineral Ordinance No. 17 of 1914 which gave companies registered in Britain or anyof its protectorates the right to prospect for oil in Nigeria. Except for a brief disruption of operations of thecompany in 1941 to 1946 because of the Second World War, it continued as the sole concessionaire inNigeria 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 11,228feet, 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 ofN120 million. This oil field came on stream in 1958 producing 5,100 bpd. From 1938 to 1956 , almost theentire country was covered by concession granted to the Company (Shell-BP) to explore for petroleumresources. This dominant role of Shell in the Nigerian oil and gas industry continued for many years, untilNigeria’s membership of the Organization of the Petroleum Exporting -Countries (OPEC) in 1971. Afterwhich the country began to take firmer control of its oil and gas resources, in line with the practice ofother 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 OPEC—the United Arab Emirates and Qatarin the Middle East; the African countries of Algeria, Gabon, Libya and Nigeria; and the countries ofIndonesia and Ecuador. Ecuador, who joined OPEC in 1973, suspended its membership from December1992 to October, 2007. By 1973 OPEC members produced 80 percent of world oil exports, and OPEChad become a world oil cartel. Member countries began to nationalize oil production within their borders.


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Table 8: OPEC Member Countries

S/No. Name of Country Date joined OPEC Location

1. Algeria 1969 Africa

2. Angola 2007 Africa

3. Ecuador ** Rejoined 2007 South America

4. Indonesia *** 1962 Asia

5. Iran* 1960 Middle East

6. Iraq* 1960 Middle East7. Kuwait* 1960 Middle East

8. Libya 1962 Africa

9. Nigeria 1971 Africa

10. Qatar 1961 Middle East

11. Saudi Arabia* 1960 Middle East

12. United ArabEmirates

1967 Middle East

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 thesigning 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 ArabEmirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), Gabon (1975) and Angola (2007).From December 1992 until October 2007, Ecuador suspended its membership. Gabon terminated itsmembership in 1995. Indonesia suspended its membership effective January 2009. Currently, theOrganization has a total of 12 Member Countries.


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Table 9: OPEC Members’ Facts and Figures, 2012



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



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Table 11: World Proven Crude Oil Reserves by Country (Million Barrels)



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



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Figure III:

2013 statistics shows that the bulk of OPEC oil reserve is located in Venezuela with 24.7% and SaudiArabia with 22.0% , followed by four middle East countries, namely Iran 13.1%, Iraq 12.0%, Kuwait8.4% 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% oftotal OPEC reserve.

Figure IV:


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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 toShell, which was already playing a dominant role in the industry. To date, these companies constitute themajor players in the Nigerian oil industry, with Shell still maintaining a leading role. Joint VentureAgreements (JVAs) and Production Sharing Contracts (PSCs) also dominate the production agreementsbetween the oil companies and the NNPC. Similarly, it is worth noting that the exploration of oil and gasin 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 basinis 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 OilCorporation (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 regulatoryfunction. On April 1, 1977, a merger between NNOC and the ministry of petroleum created NigerianNational Petroleum Corporation (NNPC). This was to combine the ministry’s regulatory role and NNOC’s

commercial functions: exploration, production, transportation, processing, oil refining and marketing. TheNigerian 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 jointventure agreements with all major international players. The regulatory role was later to be assumed bythe Petroleum Inspectorate, a unit of NNPC. Through the years, NNPC has been active in seismicexploration onshore and offshore. It also carried out work on contract for Phillips Petroleum and otherE&P companies in the Chad, Anambra and Benue Basins. But NNPC has depended on the technologicalcapabilities of the major operators, like Shell, Mobil, Gulf (Chevron) and others, which produced the bulkof 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'sefforts to build up the nation's proven oil reserve through exploration of new frontiers for oil and gasproduction. Oil may be found in commercial quantity in the Chad Basin, because of the discoveries ofcommercial hydrocarbon deposits in neighboring countries of Chad, Niger and Sudan which have similarstructural settings with the Chad Basin. The search was not limited to the Chad Basin alone but coversextensive 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. Petroleumwas recently (i.e. in 2012) discovered in Anambra Basin, which is now to join the league of oil producingstates.

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 economicallydiscovered 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 companydetermines who (usually a government in international areas) owns rights to any oil and gas in theprospective areas. In the Nigeria the government owns both the surface and the subsurface, as alllands are granted by the government on rent for 99 years. In contrasts, in United States, whoeverowns "land" usually owns both the surface rights and mineral rights to the land. Whoever owns,


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(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 allexploration, development, and production costs, and pays royalty to the lessor. The oil companymay choose to form a joint venture with other oil and gas companies to co-own the lease and jointlyexplore and develop the property.

(ii) Exploring the Leased Property: To find underground petroleum reservoirs requires drillingexploratory wells. Exploration is risky, as a number of exploration wells may have to be abandonedas dry holes, i.e., not commercially productive. Wildcat wells are exploratory wells drilled far fromproducing fields on structures with no prior production. Several dry holes might be drilled on a largelease before an economically producible reservoir is found. To drill a well, an oil company typicallysubcontracts 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 perfoot of hole drilled until the required depth is reached), day rate contract (requiring daily payment ofspecified amount in respect of the number of feet drilled) or turnkey contract (where the contractor ispaid only after satisfactory drilling of well to the required depth and other conditions specified in thecontract).

(iii)Evaluating and Completing a Well: After a well is drilled to its targeted depth, sophisticatedmeasuring tools are lowered into the hole to help determine the nature, depth, and productivepotential 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 sufficientoil and gas reserves, then the oil company will elect to spend substantial sums to "complete" the wellfor 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 tobe efficiently and economically produced.

(v) Producing the Property: Oil and gas are produced, separated at the surface, and sold. Anyaccompanying water production is usually pumped back into the reservoir or another nearbyunderground rock formation. Production life varies widely by reservoir between over 50 years toonly a few years, and some for only a few days. The rate of production typically declines with timebecause 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, awell'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, thewell is plugged, i.e., the hole is sealed off at and below the surface, and the surface equipment isremoved. Some well and surface equipment can be salvaged for use elsewhere. Plugging andabandonment costs, or P&A costs, are commonly referred to as dismantlement, restoration, andabandonment costs or DR&A costs. Equipment salvage values may offset the plugging andabandonment costs of onshore wells so that net DR&A costs are zero. However, for some offshorewells, estimated future net DR&A costs may exceed $1 million per well due to the cost of removingoffshore 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. Allrights 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 anunusual and complex set of rules and practices for petroleum accounting and financial presentation. Thenature of petroleum exploration and production raises numerous Accounting problems. Here are a few:


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(1) Should the cost of preliminary exploration be recorded as an asset or an expense when no right orlease might be obtained?

(2) Given the low success rates for exploratory wells should the well costs be treated as assets or asexpenses? 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 areservoir and that reservoir is worth $20 million to the company. Should the company recognizeas an asset the total $5 million of cost, the $1 million cost of the successful well, the $20 millionvalue 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 toproduce oil and gas may fluctuate widely. Should such value fluctuations affect the amount of therelated assets presented in financial statements?

(4) If production declines over time and productive life varies by property, how should capitalizedcosts be amortized and depreciated?

(5) Should DR&A costs be recognized when incurred, or should an estimate of future DR&A costs beamortized 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 D’Arcy 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 1959resulted in discovery of Ebubu and Bomu oil fields in Rivers State, and Ughelli in Delta State, which wasthe first hydrocarbons find, west of the Niger. By 1961 Mobil, Gulf (now Chevron), Agip, Tenneco andAmoseas (now Texaco) etc joined the search for both onshore and offshore oil and gas in Nigeria. This ledto the first offshore discovery in 1964 in Okan field in Delta State. Currently, all the early explorers havediscovered 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 inNigeria. By 1971 all concessions earlier granted to the companies were converted to joint ventureagreements. In 1973, production sharing contract emerged between the NNPC and Ashland, followed byrisk 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 oilcompanies largely dominated the upstream sector until the first discretionary allocation of acreages toindigenous companies in 1990. Oil blocks were allocated to eleven (11) indigenous companies. Thecompanies who operated sole risk contracts, were encourage farm-out (i.e. to assign an interest in a licenceto another party) 40 per cent of their interest to foreign companies, mainly for financial and technologicalback-up (the foreign companies who acquire interest in a licence from another party, are said to havefarm-in in indigenous companies minning interest). More allocations were made between 1991 and 1993and there are now an upwards of forty (40) indigenous private sector companies licensed to prospect foroil in Nigeria’s upstream sector.Some of the companies, including Summit Oil, Consolidated Oil and Amni Petroleum DevelopmentCompany 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 Servicesundertake oil exploration and production. In total, an upwards of 55 companies are operating in Nigeriaunder joint venture, production sharing contract, service contract, sole risk contract and NNPC directexploration efforts.


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Nigeria’s expertise in the upstream sector in the African Subregion, which is relatively superior, hadattracted a number of African countries to look up to it for assistance. For example in 2010 Uganda andNigeria 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 gasproduction is expected to start by 2012. There will also be construction of a refinery with a capacity of150,000 to 200,000 barrels of oil a day. Four companies, including Heritage, Dominion, Neptune andTullow Oil, are exploring for oil and gas in the Lake Albert basin. The MOU signed between Nigeria andUganda is a positive development. With increased E&P activities in the region, more countries would befortunate 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 inPort Harcourt by Shell-BP, with an initial capacity of 35,000 bpd, which was later increased. As theeconomy grew, demand for petroleum products grew along with it necessitating the establishment ofWarri refinery in 1978, Kaduna refinery in 1980, and subsequently, another refinery, which is the forthrefinery, was built at Port Harcourt to supplement the old one. However, these refineries at various pointsin time have been bedeviled with problems of sabotage, fire out breaks, poor management and lack ofregular turnaround maintenance, thereby making it difficult for the refineries to meet local demands forpetroleum 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, amongothers.

Table 13: Installed Capacity of Nigerian Refineries

S/N NAME OF THE COMPANY DateCommissioned

Installed

Capacity (bpd)

1 Kaduna Refinery and Petrochemical Company Limited(KRPC).

1980 110,000

2 Warri Refinery and Petrochemical Company Limited(WRPC). 1979 125,000

3 Port-Harcourt Refinery Company Limited (PHRC). 1965 35,0004 Eleme Petrochemical Company Limited (EPCL). 1989 150,000

Total 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, withChief Festus Marinho, as the pioneer GMD. NNPC is charged with the responsibility of managing theNigeria’s oil and gas resources in all segments of the petroleum industry (namely Exploration andProduction (E&P), storage and transportation, refining and hydro processing and distribution andmarketing). The roles of the corporation include the following:

1. refining, treating, processing and handling of petroleum for the manufacture and production ofpetroleum products and its derivatives;


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2. the conduct of research on petroleum and its derivatives and promotion of activities to utilizethe results of such research;

3. giving effects to agreements entered into by the Federal Government with a view to securingparticipation by the Government or the Corporation;

4. engaging in activities which would enhanced the overall well being of the petroleum industryin the overall interest of the country;

5. undertake such activities considered necessary or expedient for giving full effect to theprovisions of the law establishing it; and

6. 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 itsoperational efficiency. These sectors were (1) oil and gas sector, (2) refineries sector, (3) petrochemicalsector, (4) pipelines and products marketing, and (5) the petroleum inspectorate. Similarly, theCorporation 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 explorationand production, refining, gas processing and petrochemicals) and (3) National Petroleum InvestmentManagement 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 oilcompanies consider too risky to venture in to.

Another important aspect of the 1988 re-organization was the transfer of the Petroleum Inspectorate backto the Petroleum Resources Department of the Ministry of Petroleum Resources from which it wasoriginally brought to be part of the NNPC. In 1992, another reorganization of the Corporation was carriedout which led to the establishment of six directorates (namely (i) exploration and production, (ii) refiningand petrochemicals, (iii) engineering and technical, (iv) finance and accounts, (v) commercial andinvestment and (vi) corporate services), which each headed by a Group Executive Director (GED) whoreports to the Group Managing Direct (GMD). The 1992 reorganization of the Corporation conferred onthe crude oil and marketing division of the exploration and production inspectorate the responsibility formarketing the crude oil that accrues to the Government.

Similarly, twelve (12) strategic Business Units (SBUs) or subsidiary companies were also established inthe 1992 reorganization. Nine of the subsidiaries are fully owned by NNPC, while the remaining threesubsidiaries are jointly own with foreign oil companies. The ful1y owned subsidiaries of the Corporationare:

1. The Nigerian Petroleum Development Company Limited (NPDC) charged with theresponsibility for exploration, development and production of petroleum.

2. The integrated Data Services Limited (IDSL) charged with the responsibility of seismic dataacquisition, processing and interpretation, petroleum reservoir engineering and data evaluation forNNPC and other oil and gas companies in Nigeria and West Africa.

3. Warri Refinery and Petrochemicals Company Limited (WRPC) charged with theresponsibility 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 heavyalkylalates.

5. Port Harcourt Refining Company Limited (PHRC) charged with the responsibility of refiningpetroleum especially for export.


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6. Pipelines and Products Marketing Company Limited (PPMC) charged with the responsibilityof transporting crude oil to the refineries and refined products through its pipelines and deports tomarkets both locally and internationally.

7. Nigerian Gas Development Company Limited (NGC) charged with the responsibility ofgathering, treating and developing gas resources for transmission to major industrial and utilitygas companies in Nigeria and neighbouring countries.

8. Eleme Petrochemicals Company Limited (EPCL) charged with the responsibility ofmanufacturing a range of petrochemicals products such as polyethylene, polyvinyl chloride etcfrom natural gas and refinery by-products and market them locally and internationally.

9.

Nigerian Engineering Technical Company Limited (NETCO) charged with the responsibilityof 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 theGovernment has now divested from the company). Calson is charged with the responsibility ofmarketing the country‘s excess petroleum products abroad.

12. Hydrocarbon Services Nigeria Limited (HYSON Limited)

owned jointly by the NNPC andChevron, 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 handledpetroleum 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. In1971, Nigerian National Oil Corporation (NNOC) was created as the commercial arm of the DPR, whileDPR itself continued as art of the Ministry of Mines and Power. In 1975, DPR was upgraded to a ministryand named the Ministry of Petroleum and Energy (later renamed the Ministry of Petroleum Resources-

MPR).

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 actas 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 March1988 that resulted in the excision of the Inspectorate and its transfer back to the PetroleumResources Department of the Ministry of Petroleum Resources. The functions of the DPR include thefollowing:

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 nationalpolicies and goals;

3. enforcing safety regulations and ensuring that operations conform to national, as well as,international industry practices and standards;


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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 theGovernment;

5. advising the Government and relevant agencies on technical matters and public policies, whichmay have impact on the administration and control of petroleum;

6. processing all applications for licences to ensure compliance with laid down guidelines beforemaking 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 PetroleumProducts Supply and Distribution drawn from various Stakeholders and other interest groups to look intothe problems of the downstream petroleum sector. It mission is to reposition Nigeria's downstream sub-sector for improved efficiency and transparency. Its vision is to attain a strong, vibrant downstream sub-

sector of the petroleum industry, where refining, supply, and distribution of petroleum products are self-financing and self-sustaining. Prior to the setting up of the Committee, the downstream sector wascharacterized by the following problems:

1. Scarcity of petroleum products leading to long queues at the service stations2. 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 adulteration4. Pipelines vandalisation5. 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 theReview 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, andfiscal policies, instruments and institutions that govern the Nigerian petroleum industry. The Bill is


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expected to establish and clarify the rules, procedures and institutions that would entrench goodgovernance, transparency and accountability in the oil and gas sector. It aims to introduce new operationaland fiscal terms for revenue management to enable the Nigerian government to retain a higher proportionof the revenues derived from operations in the petroleum industry. The government argues that, since thecommencement 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 Nigerianpetroleum industry. The PIB therefore seeks to replace sixteen (16) petroleum industry Acts, which havemany inadequacies, with an omnibus Act that provides for better fiscal and regulatory management of theoil 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 1990’s Nigeria engaged in a number of unincorporated joint ventures withinternational oil companies to develop the industry. However, the country had challenges funding itscommitments to the joint ventures. As a result, Production Sharing Contracts (PSC) were introduced asalternative funding mechanisms. However, PSCs lack transparency, good governance practices, and arenot in line with international best practices. For instance, Nigeria does not capture any part of windfallprofits from increases in crude oil prices. Additionally, cost controls, accounting procedures, and acreagemanagement 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. Therecommendations defined the need to separate the commercial institutions in the sector from the

regulatory and policy‐making institutions. In 2007, the Yar’Adua government reconstituted OGIC under

the chairmanship of Dr. Rilwan Lukman to use the provisions of the National Oil and Gas Policy to setuplegal, 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 willguarantee greater transparency and accountability. This report formed the basis for the first PetroleumIndustry Bill (HB 159) that was submitted in 2008 as an Executive Bill.

The controversy raised by the Bill prompted the constitution of a federal inter‐agency team headed by

Dr. Tim Okon (former NNPC’s Group General Manager on Strategy) to review the Bill. The team’s report

submitted in 2010 (IAT 2010) is at the crux of the controversies around the PIB because it introducedmore 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 much‐weakened version. Subsequently,

the House of Representatives submitted its version of the Bill (HB. 54) in 2011. The Bill was sponsoredby six Honourable Members.

The draft Petroleum Industry Bill (PIB) was designed to act as an all-encompassing piece of legislationand as a result, some 15 pieces of existing legislation will be revoked upon ratification. It will create anumber of new institutions with mandates over the upstream sector. Specifically, the policy makingfunction will reside with the Petroleum Directorate. The Petroleum Inspectorate will replace theDepartment of Petroleum Resources (DPR), currently within the Ministry of Energy. This commissionwill act as the independent regulatory body and licensing agency for the upstream sector. On theoperational 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. TheNational Petroleum Investment Management Services (NAPIMS), currently part of NNPC, will bereplaced by the National Petroleum Assets Management Agency (NAPAMA). This body will monitor andapprove all upstream costs and manage tax/royalty oil (but not profit oil). NAPAMA will exist outside ofthe NOC as a separate and independent agency. The Research and Development division within NNPCwill be carved out into an independent entity, the National Petroleum Research Center. A separate Frontier


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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 fundingbottlenecks, increase investments by comprehensive deregulation of the downstream sector to makeit attractive to investors, and increase acreage available for investment by reclaim acreage that is notbeing developed by the current owners.

2. Increase domestic gas supplies: The Bill provides that all existing and future petroleum mininglessees 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 stiffpenalty.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 CommunitiesFund, which will be funded with 10% of the net profit of the oil companies operating in thecommunities, shall be used to develop the economic and social infrastructure of the hostcommunities. Communities will forfeit contributions in the Fund when vandalism or unrest causesdamage to upstream facilities.

4. Fiscal Framework for increased revenue: The PIB establishes a progressive fiscal framework thatencourages 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 ofroyalties in the case of high oil prices, etc.

5.

Create a commercially viable National Oil Company: The Bill provides for the fullcommercialisation of NNPC and the creation of other institutions that will ensure a restructuring ofthe sector for improved efficiency.

6. Deregulate petroleum product prices: The Bill proposes the full deregulation of the downstreamoil sector. A number of the institutions will be responsible for developing the infrastructure tosupport the sector, funding concessionaires and facility management operators. The PetroleumEqualisation 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 drivegreater transparency and accountability.

8. Create transparency: The Bill makes public the terms of the licenses, leases, contracts andpayments in the petroleum sector. When passed, the legislature will transform Nigeria from beingone of the most opaque oil industries in the world to one that sets the standards of transparency.

9. Promote Nigeria content: The PIB has far‐reaching local content components. No project will be

approved without a comprehensive Nigeria Content Plan including obligations of the investor topurchase local goods and services, engage local companies, employ Nigerians, ensure knowledgetransfer and encourage Research and Development. The Nigeria Content Monitoring Board willregularly verify compliance. Through the local content provisions in the Bill and the opportunity todevelop small indigenous oil and gas companies, Nigerians will begin to participate more actively inthe industry and jobs will be created.

10. Protect health, safety and environment: Every company requiring a license, lease or permit in theupstream and downstream petroleum industry in Nigeria shall conduct their operations in accordancewith internationally accepted principles of sustainable development which includes the necessity toensure that the constitutional rights of present and future generations to a healthy environment isprotected.

Controversies in the PIB 2011

Different stakeholders have raised concerns about certain provisions of the Bill. Below is a list of themost controversial issues.


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1. Fiscal provisions may increase cost of doing business: The Bill provides for multiple taxes (NigeriaHydrocarbon Tax, Company Income Tax), higher rents and royalties, and levies (Niger DeltaCommission Levy, Petroleum Host Community Fund, Education Tax). This is most noticeable in thedeep offshore operations.

2. Retroactive reversal of contracts: The PIB advocates reversal of provisions of prior agreements andcontracts, 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 bythe allocated owners. Opponents of this provision claim that it is an infringement on earlieragreements 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 producedinstead of quantities exported. The oil companies have argued that solving the security challenge andfixing sabotage of logistics infrastructure is the core responsibility ofgovernment.

5. Duplication of roles: There are overlaps of roles and responsibilities with a number of theinstitutions created under this Bill. For instance, the Nigerian Petroleum Inspectorate, PetroleumProducts Regulatory Agency, and Petroleum Infrastructure Development Fund have conflictingresponsibility for funding the development of infrastructure especially for the downstream sector ofthe petroleum industry.

6. Deadline for Gas flaring: According to the PIB (HB.54), December 31st 2012 is the deadline for gasflaring. 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 muchpower to grant, revoke and reallocate licenses.

8. Lack of Regulatory Independence: Regulators need to be fully independent and not under thesupervision of the Minister of Petroleum.

9. Potential delays in passing the Bill and its Consequences on Nigerian economy : Can the 7thNational Assembly continue debates from where the last Assembly stopped? This is possibleaccording to Rule 111 of the Senate but there are voices in the Senate that dissent to thisinterpretation 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, andHouse). Failure to pass the PIB has and will lead to a reduction of investments in the Nigeriapetroleum industry. To date, most of the oil companies have ceased investments in the sector untilthere is clarity as to what provisions will be contained in the final Bill and how it will affect theindustry. With the rise of other attractive petroleum industries in Africa (Angola, Ghana, etc), Nigeriamust understand that investments are fungible and will eventually flow to alternative countries thatare 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 fantasticremuneration, thus necessitating pre-drilling operations, before actual drilling. Drilling operationsbasically comprised of: (i) staking (locating oil well site after dues consideration of a number of naturalsurface attributes-terrain, body of water, marshy environment, etc) (ii) compliance with regulatoryrequirements on spacing of oil wells (iii) providing access road to the drilling location, leveling of drillsite for placement of working equipments and erection of field offices, and increasing permeabilitythrough fracturing, acidizing and thermal process.

Two methods of drilling have been used in the oil and gas industry , namely rotary-rig drilling and cable-tool drilling. The cable-tool method is one of the oldest mechanical means known for drilling into theearth's surface. Cable-tool rigs have long been used for drilling water wells and salt brine wells.


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Cable-Tool Drilling

In the cable-tool method of drilling, a heavy piece of forged steel is lowered into the hole. The bit, whichweighs several hundred pounds, is raised and then dropped in the hole, literally pounding a hole in theearth. 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 rotaryoperations, 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 drillingcontractor, 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 ofhole 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 otherconditions specified in the contract). Presently, footage rate contracts are the most popular although dayrate 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. Forexample on 22 April 2010 estimated 550-900 kb of oil leaked into the sea in US very significantlyaffecting local economic activities like fishing, farming and tourism. Similarly, in 1982, a high profileblowout 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 ofanother well;

3. collapse of part of the drilled hole may be experienced, leaving the pipe trapped in the depths; and4. 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 3workers 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 cancause 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 thetype 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 andgas, 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 informationabout 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 provedreserved 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 siteselected 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 usingsecondary drilling methods;


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(7) observation well (a well that is drilled in order to permit further survey and study of a reservoir asproduction continues); and(8) obligatory well (an exploratory well that is obligatorily drilled as part of the conditions for granting amineral licence).

As a single well will not permit timely and economical extraction of oil, development wells will have tobe drilled, after the successful drilling of exploratory wells. Because the fluids from the wells may containoil, gas, water, sand and other impurities such as hydrogen sulphide, the crude oil must have to be cleanedto remove all i

ACC 8211 Oil and Gas Accounting

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