Oil and Gas Accounting

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Oil & Gas Accounting Principles & Issues KABIR TAHIR

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Priniciples & Issues

Transcript of Oil and Gas Accounting

  • Oil & Gas

    Accounting

    Principles & Issues

    KABIR TAHIR

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    BAYERO UNIVERSITY, KANO FACULTY OF SOCIAL AND MANAGEMENT SCIENCES DEPARTMENT OF ACCOUNTING

    2nd July, 2012 COURSE: ACC 8211 (Oil and Gas Accounting) CLASS: M.Sc. Accounting SESSION/SEMESTER: 2011/2012 Session First Semester LECTURER: Kabir Tahir Hamid, PhD CONSULTATION: Strictly by Appointment OFFICE: A8, Department of Accounting, Aminu Alhassan Dantata School of Business, New Campus, Bayero University, Kano.

    A.COURSE DESCRIPTION This course is designed to introduce students to the fundamentals of oil and gas accounting, different accounting principles and procedures prevalent in the petroleum industry and accounting framework of the Nigerian petroleum industry. B. COURSE OBJECTIVES

    i) To develop an understanding of the nature and historical development of oil and gas accounting.

    ii) To develop an understanding of the basic characteristics and differences between the downstream and the upstream sectors and their activities.

    iii) To develop an understanding of accounting for exploration, ditching, and development costs.

    iv) To develop an understanding of petroleum products pricing, accounting standards and financial statement disclosures in the oil and gas industry.

    C. COURSE CONTENTS 1. History and Nature of Oil and Gas Operations 1.1 Definition of Petroleum 1.2 Origin of Petroleum, Its Industry Characteristic and Activities 1.3 The History of the Nigerian Oil and Gas Industry 1.4 The Nature of Petroleum Assets and the Process of Acquiring It 1.5 Accounting Dilemmas in Oil and Gas Accounting 1.6 The Upstream and the Downstream Sectors of the Nigerian Oil industry 1.7 NNPC and DPR and Their Roles 1.8 PPPRA and the Proposed Petroleum Industry Bill (PIB) 2011 2. Oil Prospecting and Reserves Valuation 2.1 Steps in Prospecting for Oil and Gas 2.2 Types of Oil and Gas Wells 2.3 Estimation and Valuation of Oil and Gas Reserves 2.4 Classification of Reserves 2.5 Oil and Gas Reserves Estimation

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    3. Arrangements, Agreements and Contracts in the Nigerian Petroleum Industry 3.1 Types of Operating Contracts in the Petroleum Industry 3.2 Contract Arrangements in the Nigerian Petroleum Industry and their Operations 3.3 Financial and Fiscal Monitoring Mechanisms of Agreements in the Petroleum Industry 4. Accounting Principles and Standards in the Oil and Gas Industry 4.1 Application of GAAPs in the Oil and Gas Industry 4.2 Classification of Costs in the Oil and Gas Industry 4.3 Methods of Accounting in the Oil and Gas Industry 4.4 Accounting Standards in the Oil and Gas Industry 5. Procedures in Oil and Gas Accounting 5.1 Basic Accounting Transactions 5.2 Depreciation, Depletion and Amortization (DD & A) 5.3 Accounting for Oil and Gas Exploration and Acquisition Costs 5.4 Accounting for Oil and Gas Development and Production Costs 5.5 Accounting for Crude Oil Refining, Petrochemical and Liquefied Natural Gas 5.6 Petroleum Products Pricing and Marketing 5.7 Typical Oil and Gas Financial Statements and Oil and Gas Accounting Disclosure

    D. RECOMMENDED TEXT BOOKS i) Fundamentals of Oil and Gas Accounting by Gallun, R. A., Wright J. C., Nichols, L. M.

    and Stevenson. J. W. ii) Financial Accounting and Reporting by Oil and Gas Producing Companies by FASB iii) Accounting for Oil and Gas Exploration, Development, Production and

    Decommissioning Activities by SORP v) International Petroleum Accounting by Wright, C. J. and Gallun, R.A. vi) Financial Reporting in the Oil arid Gas Industry by Pricewaterhousecoopers vii) Petroleum Accounting, Principles, Procedures and Issues by Gallun, R. A. and Wright viii) Fundamentals of Petroleum by Kate. V.D. ix) Petroleum Accounting: Principles, Procedures & Issues by Jennings, D. R., Feiten, J. B. and

    Brock, H. R.

    E. METHODOLOGY Discussion papers, covering the theoretical aspects of each topic, would be prepared and presented in the class, to be followed by discussion exercises. Some of the exercises would be attempted in the class, while the rest would be left to the students to practice on their own.

    F. GRADING FORMULA Continuous Assessment 40% Semesters Examination 60% Aggregate 100% The continuous assessment marks are to be absorbed through snap test (s) to be given without notice, scheduled test(s) and/or assignment(s).

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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 broadly defined, Petroleum (i.e. crude oil and natural gas) refers to mixture of hydrocarbons that are molecular in nature, in various shapes and sizes of hydrogen and carbon atoms, found in small connected pore spaces of some underground rock formations. While crude oil refers to hydrocarbon mixture produced from underground reservoirs that are liquid at the normal atmospheric pressure and temperature, natural gas refers to hydrocarbon mixtures produced from underground reservoirs that are not liquid but gaseous at the normal atmospheric pressure and temperature. Hydrocarbons are compounds containing only the elements hydrogen and carbon, which may exist as solids, liquids or gases.

    1.2 The Origin of Petroleum, Its Industry Characteristics and Activities

    1.2.1 The Origin of Petroleum

    Geologists and Geophysicists dealing with the earth crust propound that rock formations within the earths crust consist of igneous, metamorphic and sedimentary rocks. While, igneous rocks are rocks that are formed as a result of cooling and solidification of molten magma, sedimentary rocks, such as sandstone, developed as a direct result of erosion, transport and deposition of pre-existing igneous rock, along with remains of plants and animals. Eroded particles of igneous rocks are carried to low areas and are deposited into sedimentary layers through the action of wind and water. Metamorphic rocks develop when igneous or sedimentary rocks are subjected to heat and pressure resulting from the weight of overlying rocks stresses, thus converted into metamorphic slates and quartzite. Nearly all significant oil and gas reservoirs in the World today are found in sedimentary rocks, as the accumulation of oil or gas in igneous or metamorphic rocks is very rare; however petroleum can be reservoired in these types of rock under certain albeit rare conditions. The extreme heat and pressure associated with these types of rocks drives off or burns any organic material or hydrocarbons.

    It can therefore be said that, out of the three types of rocks explained above (namely, igneous, sedimentary and metamorphic rocks) only sedimentary rocks form the source in which hydrocarbons reservoirs are found. Even in the sedimentary rocks, hydrocarbons are possibly found in only sandstone (shale) and not limestone and dolomite. In other words, sandstones are the source rock in which oil and gas is formed and accumulated, while limestone and dolomite evolve through chemical processes. However, it is important to note that the various rock formations, as well as, the various changes in the earth's crust do not, by themselves, explain the evolution of oil and gas.

    The earth is made up of a core over 4,000 miles in diameter surrounded by the earth's mantle, which is approximately 2,000 miles thick. The earth's surface is underlain by the lithosphere, a relatively thin layer, some 125 miles in thickness, that is composed of the crust and upper mantle. Commercial oil and gas are found only in the crust of the earth.

    Explanations propounded on the origin of petroleum have their bases in geology and geophysics. Geology is the science that studies the planet earth, the materials it is made up of, the processes that act on these materials, the products formed, and the history of the planet and its life forms since its origin. Most geological studies are focused on aspects of the earth's crust because it is directly

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    observable and is the source of energy and minerals for today's modern industrial societies. On the other hand, geophysics is the science that studies the earth by quantitative physical methods.

    Over the last two centuries, two theoriesthe inorganic theory and the organic theoryhave been advanced to explain the formation of oil and gas. Although no one theory has achieved universal acceptance, most scientists and professionals believe in the organic origin of petroleum. The inorganic theory recognizes that hydrogen and carbon are present in natural form below the surface of the earth (diamonds, for example, indicate the presence of carbon in the earth's mantle). Different related theories explain the combination of the two elements into hydrocarbons. These include the alkali theory, carbide theory, volcanic emanation theory, hydrogeneration theory, and the high temperature intrusion theory. Except for the intrusion theory, most of the inorganic theories have been largely discounted. The intrusion theory argues that high temperatures applied to carbonate rocks can produce methane gas and/or carbon dioxide. This theory applies only to gas, not to the heavier hydrocarbons (oil).

    Based on abundant direct and indirect evidence, most scientists accept the organic theory of evolution of oil and gas. According to geological research, the earth was barren of vegetation and animal life for roughly one half of an estimated five billion years of the earth's existence. Approximately 600 million years ago, an abundance of life in various forms began in the earth's oceans. This development marks the beginning of the Cambrian period in the Paleozoic era. Nearly 200 million years later (in the Devonian period), vegetation and animal life had spread to the landmasses. The Paleozoic (roughly 350 million years), Mesozoic (roughly 150 million years), and Cenozoic (roughly 1000 million years), eras have been labeled as successive and definitive geological time periods by geologists, which brings us up to the present. These time periods are shown in Table 1.

    Table 1: Geologic Time Period

    Era Period

    Approx. Duration in million yrs.

    Indicative New Life Forms

    Cenozoic "Modern Life"

    Quaternary 3 Large 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 4,000 Bacteria, 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 the rivers and, together with some forms of marine life, settle into the ocean floor. Most hydrocarbons are believed to be derived from tremendous volumes of plankton, algae, and bacteria

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    common in ocean basins and lakes, and other marine lives that lived millions years ago in low land areas, usually in the oceans. The theory posits that the remains of plants and animals were deposited along with the eroded particles of igneous rocks, which have been weathered through physical and chemical reactions. The weight and pressure of layer upon layer of the eroded particles of the igneous rocks resulted in the formation of sedimentary rocks, and some chemical and bacterial processes turned the organic substances in the sedimentary rock into oil and gas. The sedimentation process can be observed even within an individual's lifetime. For example, the delta area at the mouth of a large river is formed by sedimentation. Layer after layer of silt, mud, particles of sand, and plant and animal life are deposited on the ocean floor, with a great portion of the plant and animal life coming from the ocean itself. Anaerobic bacteria in the sediment aid in breaking up the organic material and releasing oxygen, nitrogen, phosphorus, and sulfur from the organic material, leaving the balance with a much higher percentage content of hydrogen and carbon and, thus, a more petroleum-like composition.

    After formation, oil and gas move upward through the layers of the sedimentary rock due to pressure and the natural tendency of oil to rise through water. The petroleum migrates upwards towards the earth surface through the porous rock formations until it becomes trapped by an impervious layer of rocks. When this occurs, the oil remains there and forms a petroleum reservoir. A reservoir is a rock formation with adequate porosity and permeability to allow oil and gas to migrate to a well bore at a rate sufficient as to be economically producible (most geologists believe the earth initially formed from molten rock, or magma, and cooled into solid igneous rocks. During the cooling and contraction processes, some rock solidified beneath the surface). The impervious layer formed a seal which prevent hydrocarbons from leaking to the surface. If the seal is inadequate, little quantity of the hydrocarbon escapes to the surface. This is known as oil seeps. Seeps at the surface are often used as indicator of potential hydrocarbon reservoirs in the subsurface.

    In some instances, oil and gas migrate directly to the reservoir area. More often, however, movements in the earth's crust caused additional shifting, folding, bends, and fissures, and a secondary migration of the oil and gas took place through porous layers until another impermeable seal was reached. This may occur when an area is subjected to new tectonic forces, earth quakes, tsunami, etc. To search for new oil and gas fields, therefore, geologists and geophysicists devote their efforts to understanding the distribution of rocks that could be sources, seals, and reservoirs in an attempt to develop locations for potential traps within petroleum systems. While it can be seen that oil and gas are formed through the sedimentary process, this does not necessarily mean that the oil and gas have remained in the source beds or places of origin. Hydrocarbons are known to have been preserved for hundreds of millions of years and the process of hydrocarbon formation is undoubtedly continuing, but much more slowly than is the rate of consumption of hydrocarbons. Generally, marine and lacustrine source rocks generate oil whereas coal source rocks commonly generate natural gas.

    The impervious rock that prevents further movement of the oil and gas is known as trap. There are four broad classifications of traps, namely: (1) structural strap (2) truncation trap (3) stratigraphic trap, and (4) a combination trap.

    Structural trap is a result of upheavals of the earth and may take the form of an anticline, fault or dome. Anticlines are the most significant reservoirs of hydrocarbons and are estimated to contain

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    around 80 per cent of the worlds oil. However, in order for an oil and gas reservoir to have been formed, four necessary conditions must have been met. These conditions are:

    (1) there must have been a source of oil and gas, i.e. the remains of plants and animals; (2) heat and pressure resulting in the transformation of the organic substances of the remains of

    plants and animals into oil and gas; (3) Porous and permeable sedimentary rock formations through which the oil and gas was able to

    migrate upwards after formation.

    Porosity is the measure of the pore openings in a rock in which petroleum can collect; none of the sedimentary rocks are completely solid. The greater the porosity, the more petroleum the rock can hold, and the closer the rock is to the surface, the more the porosity. It is within the pore spaces that the oil and gas initially accumulated, together with some water called connate water. The pore spaces may constitute up to 30 percent of the volume of the reservoir rocks that are relatively close to the surface. As depths increase, the porosity of the formation tends to decrease as the result of compaction from the weight of the overlying layers of sediment. Permeability, on the other hand, measures the relative ease with which the oil and gas can flow through the rocks and is expressed in millidarcies. The flow of oil and gas through a reservoir takes place in microscopic channels between pore spaces. In some cases fractures are also present that provide greater permeability. If there is high permeability, oil and gas can move through the formation with relative ease. Low permeability will decrease or even block the movement of fluids through the formation. Though, permeability may be improved through fracturing (i.e. introduction of a mixture of sand and water or oil into the formation under high pressure to clean the channels between the pores) and acidizing (i.e. introduction of hydrochloric acid into the formation to enlarge and clean the channels between the pores), porosity is difficult, if it impossible to be improved.

    There are two types of producing reservoirs, namely (1) oil reservoir and (2) gas reservoir. While the components of oil reservoir are crude oil, basic sediment, water and associated gas, the components of gas reservoir are non-associated gas, condensates and natural gas. To be commercially viable therefore, a petroleum reservoir must have adequate porosity and permeability and must have a sufficient physical area of rock that contains hydrocarbons. In other words, the reservoir must contain high quantity of oil and gas, so that when produced and sold, cover the cost of production (including payment of royalties to the government) and leave some profit margin for the producing company and tax revenue to the government. Condensate are hydrocarbons that are in a gaseous state at reserviour conditions but condense into liquids as they travel up the wellbore and reach surface conditions.

    (4) an impervious rock formations that a prevents the oil and gas from further migration, thereby enabling the oil to collect.

    Evidence Supporting the Organic Theory of Oil and Gas Formation The following are the evidence supporting the organic theory of the origin of oil and gas:

    1. sedimentary beds are rich in organic matter; 2. some of the chemical components of oil are the same as those found in plants and animals; 3. the chemical composition of oils and gases derived from so called source rocks match the

    observed composition of oils and gases in nearby reservoirs; and 4. the recent discovery of bio-fuel (a fuel that is derived from biomass-recently living

    organisms or their metabolic byproducts-from sources such as farming, forestry, and

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    biodegradable industrial and municipal waste) support the proposition that hydrocarbon itself is most likely to have been originated from the remain of plants and animals.

    1.2.2 Characteristics of the Petroleum Industry Although the primary purpose of this course is to deal with the accounting principles and practices in the oil and gas industry, it is considered that the appreciation of operational aspects of the industry is important for a better understanding of accounting practices in the industry. Basically, the objective of the oil and gas industry is to exploit and recover hydrocarbons (crude oil and gas) in its natural form from large sub-surface reservoirs, subject it to changes through chemical and physical processes in a refinery, gas plant or petrochemical plant in order to obtain products such as gasoline, diesel, kerosene, jet fuel, lubricants, asphalt, bitumen, petrochemicals and treated natural gas.

    It is important to add that although Exploration and Production (E&P) procedures and processes are more important to geologists and geophysicists, the knowledge of the procedures and steps involved in locating and acquiring mineral interest, drilling and completion oil and gas wells and producing, processing and selling petroleum products is necessary in order to understand their accounting implications. Hence, it is important that accounting students and accounting practitioners become familiar with the process.

    Oil and Gas industry is one of the vital industries in the world, largely because of its strategic role in every economy and the world, at large. The distinctive features that characterized the industry are derived from the nature of crude oil, its operations and commercial arrangements. Some of these characteristics of the oil and gas industry may include the following:

    1. High Level of Risk and Uncertainty: The level of risk in oil and gas operations can be both substantial in amount and wide in scope, and locating new well sites even in already established field is surrounded with high level of uncertainties. Exploration operations are risky because oil is hidden underground and the only conclusive evidence of its presence in any form, quantity and quality is drilling. There is therefore a geological risk of drilling and hitting a dry hole. In addition, there are market risk (the risk of not finding an outlet for production at a satisfactory price), sovereign/political risk (the risks of nationalization of operations, currency devaluation, licensing and exploration agreements), partner risk (the risk of partner default, distrust, unwillingness, inability or delay in paying due shares of cost of exploration and development), youth militancy risk (the risk of kidnapping of personnel and vandalisation of equipments by militant youths) and tax risk (the risk of unexpected change in tax provisions) . Consequently, the risk of loss of capital is very high.

    2. Dominance of the World Economy: The second feature of oil and gas industry is its dominance of the world economy, in terms of financial figures, unlimited potentials as raw material, global economy development and international politics and touches the lives of people in any more ways, anywhere on earth. Exxon Mobil, Saudi Aramco, Chevron and Shell B.P. are one of the largest companies in the World today in terms of financial figures and profitability.

    3. Long Lead-Time between Investment and Returns: Even in normal circumstances, upstream activities can take several years, thereby complicating the risk further in oil and gas operations. The operations are highly capital intensive, requiring large amounts of capital

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    investment up-front. The lead-time therefore stretches the capital outlay and brought about long gestation period between investment and return from the investment.

    4. Significant Regulation by Government Authorities: The petroleum industry, in any part of the world is subject to involvement, participation, intervention and regulation by various governments and its agencies. This is as a result of the indispensability of oil, its depletable nature and its influence in international politics.

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

    6. Specialized Accounting Rules for Reporting and Complex Tax Rules: There are fundamental dissimilarity between financial/tax accounting in the oil and gas industry and other industries. This arises from the nature of oil and gas industry, its highly technical operations and specialized activities.

    7. Lack of Correlation between Investment and the Value of Reserves: The amount invested in oil and gas operations usually does not bear any relationship with the value of oil and gas reserve, as a result of the inherent difficulties in estimating the value of reserves and the need for up-front large investments in petroleum exploration and production.

    Although, these characteristics are most evident in Exploration and Production (E&P) functions of the oil and gas industry, they are found in other segments of the industry in varying degrees.

    1.2.3 Activities/Segments in the Nigerian Oil and Gas Industry Nigerian oil and gas companies may be involved in four different types of functions or segments, namely Exploration and Production (E&P), storage and transportation, refining and hydro processing, and distribution and marketing. A company may decide to operate in any of the four segments or a combination thereof. The four segments are briefly explained below:

    1. Exploration and Production (E&P): Exploration is the search for oil with a view to discovering oil-in-place, while production is the removal of oil from the ground and surface treatment. In this segment, companies explore from underground reservoirs of oil and gas and produce the discovered oil and gas using drilled wells, through which the reservoir oil, gas and water are brought to the surface and separated. Companies that are involved in E&P are only to explore and produced the discovered oil and gas and sell it depending on the nature and conditions of the contract, i.e. concession, joint venture or production sharing contracts. This segment is an upstream activity.

    2. Storage and Transportation: This segment encompasses the storing and moving of petroleum from the production field to crude oil refineries and gas processing plants. Once crude oil and gas produced and treated, it is stored in tanks and later transported to refineries and gas processing plants by road tankers, railway tankers, sea oil tankers, and pipelines.

    3. Refining and Hydro Processing: Refining is the treatment of crude oil in order to form finished products and may extend to the production of petrochemicals. This segment required plants to be put in place for the separation and processing of hydrocarbon fluids and gases into various marketable products such as gasoline, diesel, kerosene, jet fuel, lubricants, asphalt, bitumen, petrochemicals and treated natural gas. Crude oil refining involves the breaking down of hydrocarbon mixture into useful products, through distillations, cracking, reforming and extraction process. The factors that determine the refinery configuration are:

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    (1) the domestic, regional or global economy; (2) availability of crude oil; (3) price of crude oil per barrel; (4) quantity of product to be developed and present technology; (5) regulations (i.e. government and OPEC regulations); (6) market trends; (7) environmental issues, competition; and (8) degree of integration.

    Petrochemical is a substance produced commercially from the feedstock derived from oil and gas. The functions of petrochemical plants, therefore, is to turn outputs of the refining process either in form of crude oil fractions or their cracked or processed derivatives into feedstock that will ultimately be used in the manufacture of a number of other products, e.g. plastics, detergents, nitrogen fertilizers, etc.

    The gas mixtures consist largely of methane (the smallest natural hydrocarbon molecule consisting of one carbon atom and four hydrogen atoms). Natural gas usually contains some of the next smallest hydrocarbon molecules commonly found in nature: Ethane (two carbon, six hydrogen atoms, abbreviated C2H6), Propane (C3H8), Butane (C4H10), and Natural gasolines (C5H12 to C10H22).

    These four types of hydrocarbons are collectively called natural gas liquids (abbreviated NGL) which are valuable feedstock for the petrochemical industry. When removed from the natural gas mixture, these larger, heavier molecules become liquid under various combinations of increased pressure and lower temperature. Liquefied petroleum gas (abbreviated LPG) usually refers to an NGL mix of primarily propane and butane typically stored in a liquid state under pressure. LPG (alias bottled gas) is the fuel in those pressurized tanks used in portable "gas" barbeque grills. Sometimes the term LPG is used loosely to refer to NGL or propane. The more natural gas liquids in the gas mixture the greater the energy, and the "richer" or "wetter" the gas. For various economic reasons, wet gas is commonly sent by pipeline to a gas processing plant for removal of substantially all natural gas liquids, before sale. The remaining gas mixture, called residue gas or dry gas, is over 90 percent methane and is the natural gas burned for home heating, gas fireplaces, and many other uses.

    Crude oil can be many different mixtures of liquid hydrocarbons. Crude oil is classified as light or heavy, depending on the density of the mixture. Density is measured in API degree (which is a measure of how heavy or light a petroleum liquid is compared with water). Heavy crude oil has more of the longer, larger hydrocarbon molecules and, thus, has greater density than light crude oil. Heavy crude oil may be so dense and thick that it is difficult to produce and transport to market. Heavy crude oil is also more expensive to process into valuable products such as gasoline. Consequently, heavy crude oils sell for much less per barrel than light crude oils but weigh more per barrel. Both natural gas and crude oil may contain contaminants, such as sulphur compounds and carbon dioxide (CO), that must be substantially removed before marketing the oil and gas. The contaminant hydrogen sulfide (H22S) is poisonous and, when dissolved in water, corrosive to metals. Some crude oils contain small amounts of metals that require special equipment for refining the crude.

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    Liquefied natural gas operations encompasses a number of interdependent activities ranging from gas gathering from the field, transmitting the gas to plants, treating the gas, compressing the gas into liquid, transporting the gas by ship to buyers, receiving the compressed gas at the buyers terminal and packing the gas into cylinders for storage and distribution. Different mixtures of petroleum have different uses and economic value. Numerous useful products that are derived from petroleum include the following: (a) Transportation Fuels [Automotive Gas Oil (AGO), popularly known as diesel and

    Premium Motor Spirit (PMS) popularly known as petrol, etc]. (b) Heating Fuels, like the Dual Purpose Kerosene (DPK), popularly known as kerosene.

    Kerosene (DPK) is a thin, clear combustible hydrocarbon liquid with a density of 0.780.81g/cm obtained from the fractional distillation of petroleum between 150 and 275 C. Kerosene is widely used to power jet fuel engines, rockets and as a heating fuel in households. The combustion of Kerosene is similar to that of diesel with Lower Heating Value of around 18,500 Btu/1b, or 43.1 MJ/Kg, and its Higher Heating Value is 46.2MJ/kg.

    (c) Liquefied Petroleum Gas (otherwise known as cooking gas is made up of 70% propane- C3 and 30% butane-C4). It is a product of petroleum refining and, it can also be obtained from natural gas processing. It consists of hydrocarbons as vapors, at normal temperatures and pressures, but turns liquid at moderate pressures. LPG uses include; cooking, heating in households, fuel for transport etc.

    (d) Natural gas and residual fuel can be burned to generate electricity. (e) Petrochemicals from which plastics, as well as clothing, building materials, cream,

    pomade, soap, petroleum jelly, etc are produced.

    4. Distribution and Marketing: Distribution and marketing involve the activities associated with getting finished products from distribution points into the hands of end users. Marketers are of different categories, namely major marketers (like Oando PLC, Mobil Unlimited, Con Oil, Texaco, etc.), independent markets (like Azman oil and gas, Sani Brothers Ltd., Pure Oil, Dan-Kano Petroleum, etc) and part-time marketers.

    The first activity is above is referred to upstream activity, while the last three activities are downstream activities. It is worthy to note that an oil company can either be integral or independent. While an independent oil company is one involved primarily in Exploration and Production (E&P) activities only. An integral oil company is one involved in Exploration and Production (E&P) activities as well as at least one of the other segments, namely storage and transportation, refining and hydro processing and marketing and distribution. An integrated company is also known as mid- stream.

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

    Controller

    Field Clerical

    and Services

    Equipment and

    Supplies Inventory

    Taxes and Regulatory Compliance

    General Accounting

    Revenue Accounting

    Joint Interest

    Accounting

    Property Accounting

    Accounts Payable

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    Equipment and Supplies Inventory 1. Maintains equipment and supply inventory records. 2. Prices and records warehouse receipts, issues, and field transfers. 3. Oversees physical inventory taking. 4. Prepares reports on equipment and supplies inventory.

    Accounts Payable 1. Maintains accounts payable records. 2. Prepares vouchers for disbursements. 3. Distributes royalty payments. 4. Maintains corporate delegated limits of authority and verifies that disbursements are made within

    those limits.

    Property Accounting 1. Maintains subsidiary records for (a) Unproved properties, (b) Proved properties, (c) Work in progress, (d) Lease and well equipment, and (d) Field service units. 2. Accounts for property and equipment acquisition, reclassification, amortization, impairment,

    retirement, and sale. 3. Compares actual expenditures of work in progress to authorized amounts.

    Joint Interest Accounting 1. Maintains files related to all joint operations. 2. Prepares billings to joint owners. 3. Reviews all billings from joint owners. 4. Prepares statements for jointly operated properties. 5. Prepares payout status reports pursuant to farm-in and farm-out agreements. 6. Arranges or conducts joint interest audits of billings and revenue distributions from joint venture

    operations. 7. Responds, for the company as operator, to joint interest audits by other joint interest owners.

    Revenue Accounting 1. Accounts for volumes sold and establishes or checks prices reflected in revenues received. 2. Maintains oil and gas revenue records for each property. 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.

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    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

    Controller Production Division

    Budgets & Internal Reports

    Financial Accounting & Investments

    Policy Planning & Support

    Revenue Accounting

    Compliance &

    Taxation

    Budgets

    Internal Reports

    Performance Management

    Internal Control

    Regulatory Compliance

    Taxes

    Oil

    Gas

    Recruitment and Development

    Administrative Support

    Management Information

    System

    Accounting Policies

    General Accounting

    Investments

    Joint Interests

    External Reports

    Corporate Controller

    Financial Accounting

    & Considerations

    Budget, Cost

    Analysis & Reports

    Marketing Accounting

    Pipeline & Crude oil Trading

    Accounting

    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 order to understand the importance and nature of financial accounting and reporting in the petroleum industry, it is helpful to briefly review the industry's history, particularly in Nigeria, right from its inception to date.

    In ancient history, pitch (a heavy, viscous petroleum) was used for ancient Egyptian chariot axle grease. Early Chinese history reports the first use of natural gas that seeped from the ground; a simple pipeline made of hollowed bamboo poles transported the gas a short distance where it fueled a fire used to boil water. Seventeenth century missionaries to America reported a black flammable fluid floating in creeks. From these creeks, Indians and colonists skimmed the crude oil, then called rock oil, for medicinal and other purposes. Later, the term rock oil would be replaced by the term petroleum from petra (a Latin word for rock) and oleum (a Latin word for oil). Eventually, the term petroleum came to refer to both crude oil and natural gas. By the early 1800s, whale oil was widely used as lamp fuel, but the dwindling supply was uncertain, and people began using alternative illuminating oils called kerosene or coal oil extracted from mined coal, mined asphalt, and crude oil obtained from surface oil seepages. Therefore, the petroleum exploration and production industry may be said to have begun in around mid 1800s. There was mention of an oil discovery in Ontario, Canada, in 1858, and Pennsylvania, in USA in 1859, with a steam-powered, cable-tool rig with a wooden derrick used in drilling. Shortly thereafter, a number of refineries began distilling valuable kerosene from crude oil, including facilities that had previously extracted kerosene from other sources.

    Transportation of crude oil was a problem faced from the earliest days of oil production. The coopers union constructed wooden barrels (with a capacity of 42 to 50 US gallons) that were filled with oil and hauled by teamsters on horse-drawn wagons to railroad spurs or river barge docks. At the railroad spurs, the oil was emptied into large wooden tanks that were placed on flatbed railroad cars. The quantity of oil that could be moved by this method was limited. However, the industry's attempts to construct pipelines were delayed by the unions whose members would face unemployment and by railroad and shipping companies who would suffer from the loss of business by the change in method of transportation. Nevertheless, pipelines did come into existence in the 1860s; the first line was made of wood and was less than a thousand feet long.

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

    The search for oil in Nigeria dates back to 1908 when a German Company, by name the Nigerian Bitumen Corporation, obtained a licence to explore for oil in Okitipupa area of Ondo State. The companys efforts were unsuccessful and with outbreak of the First World War, its operations were disrupted.

    Two decades later, Shell DArcy (the predecessor of Shell Petroleum Development Company of Nigeria Ltd) started exploration of Niger Delta in 1937 having acquired exploration right from the British Colonialists over the entire Nigerian territory under an exclusive exploration licence. The company operated under the Mineral Ordinance No. 17 of 1914 which gave companies registered in

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    Britain or any of its protectorates the right to prospect for oil in Nigeria. Except for a brief disruption of operations of the company in 1941 to 1946 because of the Second World War, it continued as the sole concessionaire in Nigeria until 1959 when exploration rights became available to oil companies of other nationalities.

    The first deep exploration well was in 1951 at Iho, 10 miles North-east of Owerri to a depth of 11,228 feet, but it was a dry hole. Shell discovered oil in a commercial quantity at Oloibiri, Rivers State (presently in Bayelsa State), in 1956, after half a century of exploration, with an equivalent investment of N120 million. This oil field came on stream in 1958 producing 5,100 bpd. From 1938 to 1956, almost the entire country was covered by concession granted to the Company (Shell-BP) to explore for petroleum resources. This dominant role of Shell in the Nigerian oil and gas industry continued for many years, until Nigerias membership of the Organization of the Petroleum Exporting -Countries (OPEC) in 1971. After which the country began to take firmer control of its oil and gas resources, in line with the practice of other members of OPEC.

    In 1960 the Organization of Petroleum Exporting Countries (OPEC) was formed by Saudi Arabia, Kuwait, Iran, Iraq, and Venezuela. Later, eight other countries joined OPECthe United Arab Emirates and Qatar in the Middle East; the African countries of Algeria, Gabon, Libya and Nigeria; and the countries of Indonesia and Ecuador. Ecuador, who joined OPEC in 1973, suspended its membership from December 1992 to October, 2007. By 1973 OPEC members produced 80 percent of world oil exports, and OPEC had become a world oil cartel. Member countries began to nationalize oil production within their borders.

    Table 2: GDP Per Capita and Population Estimates of OPEC 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 East 7. 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 Arab

    Emirates 1967 Middle East

    13. Venezuela* 1960 South America

    Source: OPEC at http://www.opec.org/library/

    Notes: # as at 2006 * Founder members (**) Ecuador joined OPEC in 1973, suspended its membership from December 1992 to October, 2007

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    Figure IV:

    2010/2011 statistics shows that the bulk of OPEC oil reserve is located in Venezuela with 24.8% and Saudi Arabia with 22.2% , followed by four middle East countries, namely Iran 12.7%, Iraq 12.0%, Kuwait 8.50% and United Arab Emirates 8.2%. The statistics show that two third of the OPEC oi reserve (65.70%) is located in the Middle East countries. OPEC (2011) shows that Nigeria has proven oil reserve of 3.1% of total OPEC reserve.

    Figure V:

    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

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    Oil and Texaco (now ChevronTexaco), Elf Petroleum (now Total), Mobil (now ExxonMobil), and Agip, in addition to Shell, which was already playing a dominant role in the industry. To date, these companies constitute the major players in the Nigerian oil industry, with Shell still maintaining a leading role. Joint Venture Agreements (JVAs) and Production Sharing Contracts (PSCs) also dominate the production agreements between the oil companies and the NNPC. Similarly, it is worth noting that the exploration of oil and gas in Nigeria had taken place in five major sedimentary basins, namely, the Niger Delta, the Anambra Basin, the Benue Trough, the Chad Basin and the Benin Basin. But, the most prospective basin is the Niger Delta which includes the continental shelf and which makes up most of the proven and possible reserves. All oil production to date has occurred in this basin.

    In 1971, as oil became more important to the economy, the country established the Nigerian National Oil Corporation (NNOC) and joined OPEC as the 11th member. It acquired 33 /3% in Nigerian Agip and 35% in Elf. NNOC ran as an upstream and downstream company and the petroleum ministry had a regulatory function. On April 1, 1977, a merger between NNOC and the ministry of petroleum created Nigerian National Petroleum Corporation (NNPC). This was to combine the ministrys regulatory role and NNOCs commercial functions: exploration, production, transportation, processing, oil refining and marketing. The Nigerian National Petroleum Company (NNPC) was established as a state owned and controlled company, as a dominant player in the downstream sector and a major player in the upstream sector through joint venture agreements with all major international players. The regulatory role was later to be assumed by the Petroleum Inspectorate, a unit of NNPC. Through the years, NNPC has been active in seismic exploration onshore and offshore. Its seismic crew, known as Party X, has made several discoveries such as a field in block OPL- 110 in the Niger Delta, the Oredo field, etc. It also carried out work on contract for Phillips Petroleum and other E&P companies in the Chad, Anambra and Benue Basins. But NNPC has depended on the technological capabilities of the major operators, like Shell, Mobil, Gulf (Chevron) and others, which produced the bulk of Nigerian oil and did most of the exploration work.

    The NNPC in 2010 developed a comprehensive framework designed to herald the intensification of exploration activities in the Chad Basin. The move was seen as a fresh boost to the Federal Government's efforts to build up the nation's proven oil reserve through exploration of new frontiers for oil and gas production. Oil may be found in commercial quantity in the Chad Basin, because of the discoveries of commercial hydrocarbon deposits in neighboring countries of Chad, Niger and Sudan which have similar structural settings with the Chad Basin. Discoveries made in neighbouring countries in basins with similar structural settings are: Doba, Doseo and Bongor all in Chad amounts to over 2 Billion barrels (Bbbls); Logone Birni in Southern Chad and Northern Cameroun, over 100 Bbbls; and Termit-Agadem Basin in Niger totals over 1bbbls. The search was not limited to the Chad Basin alone but covers extensive inquest in the entire Nigerian Frontier Sedimentary Basins which include- The Anambra, Bida, Dahomey, Gongola/Yola and the Sokota Basins alongside the Middle/Lower Benue Trough. Petroleum has recently (i.e. in 2012) discovered in Anambra Basin, which is now to join the league of oil producing states.

    The NNPC New Frontier Exploration Services (NFES) Division which is leading the search for crude oil find in the entire Inland Basins acquired 3,550 sq km of 3- D seismic data for processing and interpretation in addition to the already acquired 6000km of 2-D data that was reprocessed. Over 600,000 seismic section and 30,000 well logs were scanned and vectorised for the eventual drilling. Before, 2010, 23 wells have been drilled with two of the wells, Wadi-1 and Kinasar encountering non-commercial gas.

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    1.4 The Nature of Petroleum Assets and the Process of Acquiring it Before an oil company drills for oil, it first evaluates where oil and gas reservoirs might be economically discovered and developed. The procedure involved in acquiring petroleum assets includes the following:

    (i) Leasing the Rights to Find and Produce: When suitable prospects are identified, the oil company determines who (usually a government in international areas) owns rights to any oil and gas in the prospective areas. In the Nigeria the government own both the surface and the subsurface, as all lands are granted by the government on rent for 99 years. In contrasts, in United States, whoever owns "land" usually owns both the surface rights and mineral rights to the land. Whoever owns, (i.e., has title to), the mineral rights negotiates a lease with the oil company for the rights to explore, develop, and produce the oil and gas. The lease requires the lessee (the oil company), to pay all exploration, development, and production costs, and pays royalty to the lessor. The oil company may choose to form a joint venture with other oil and gas companies to co-own the lease and jointly explore and develop the property.

    (ii) Exploring the Leased Property: To find underground petroleum reservoirs requires drilling exploratory wells. Exploration is risky, as a number of exploration wells may have to be abandoned as dry holes, i.e., not commercially productive. Wildcat wells are exploratory wells drilled far from producing fields on structures with no prior production. Several dry holes might be drilled on a large lease before an economically producible reservoir is found. To drill a well, an oil company typically subcontracts much of the work to a drilling company that owns and operates rigs for drilling wells, who can do the drilling more effectively, efficiently and economically because of experience. Drilling contracts may take the form of footage rate contract (requiring installmental payment per foot of hole drilled until the required depth is reached), day rate contract (requiring daily payment of specified amount in respect of the number of feet drilled) or turnkey contract (where the contractor is paid only after satisfactory drilling of well to the required depth and other conditions specified in the contract).

    (iii)Evaluating and Completing a Well: After a well is drilled to its targeted depth, sophisticated measuring tools are lowered into the hole to help determine the nature, depth, and productive potential of the rock formations encountered. If these recorded measurements, known as well logs, along with recovered rock pieces, i.e., cuttings and core samples, indicate the presence of sufficient oil and gas reserves, then the oil company will elect to spend substantial sums to "complete" the well for safely producing the oil and gas.

    (iv) Developing the Property: After the reservoir (or field of reservoirs) is found, additional wells (known as development wells) may be drilled and surface equipment installed to enable the field to be efficiently and economically produced.

    (v) Producing the Property: Oil and gas are produced, separated at the surface, and sold. Any accompanying water production is usually pumped back into the reservoir or another nearby underground rock formation. Production life varies widely by reservoir between over 50 years to only a few years, and some for only a few days. The rate of production typically declines with time because of the reduction in reservoir pressure from reducing the volume of fluids and gas in the reservoir. Production costs are largely fixed costs independent of the production rate. Eventually, a well's production rate declines to a level at which revenues will no longer cover production costs. Petroleum engineers refer to that level or time as the well's economic limit.

    (vi) Plugging and Abandoning the Financial Property: When a well reaches its economic limit, the well is plugged, i.e., the hole is sealed off at and below the surface, and the surface equipment is removed. Some well and surface equipment can be salvaged for use elsewhere. Plugging and abandonment costs, or P&A costs, are commonly referred to as dismantlement, restoration, and abandonment costs or DR&A costs. Equipment salvage values may offset the

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    plugging and abandonment costs of onshore wells so that net DR&A costs are zero. However, for some offshore wells, estimated future net DR&A costs may exceed $1 million per well due to the cost of removing offshore platforms, equipment, and perhaps pipelines. When a leased property is no longer productive, the lease expires and the oil company plugs the wells and abandons the property. All rights to exploit the minerals revert back to the lessor as the mineral rights owner.

    1.5 Accounting Dilemmas in Oil and Gas Accounting The nature, complexity, and importance of the petroleum E&P industry have caused the creation of an unusual and complex set of rules and practices for petroleum accounting and financial presentation. The nature of petroleum exploration and production raises numerous Accounting problems. Here are a few:

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

    (2) Given the low success rates for exploratory wells should the well costs be treated as assets or as expenses? Should the cost of a dry hole be capitalized as a cost of finding oil and gas reserves? Suppose a company drills five exploratory wells costing $1 million each, but only one well finds a reservoir and that reservoir is worth $20 million to the company. Should the company recognize an asset for the total $5 million of cost, the $1 million cost of the successful well, the $20 million value of the productive property, or some other amount?

    (3) The sales prices of oil and gas can fluctuate widely over time. Hence, the value of rights to produce oil and gas may fluctuate widely. Should such value fluctuations affect the amount of the related assets presented in financial statements?

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

    (5) Should DR&A costs be recognized when incurred, or should an estimate of future DR&A costs be amortized over the well's estimated productive life?

    (6) If the oil company forms a joint venture and sells portions of the lease to its venture partners, should gain or loss be recognized on the sale?

    1.6 The Upstream and the Downstream Sectors of the Nigerian Oil Industry As earlier stated, Shell DArcy was the first to discover oil in commercial quantity in Nigeria at Oloibiri, Rivers State (presently, Bayelsa State) in 1956. However intensified search for oil from 1957 to 1959 resulted in discovery of Ebubu and Bomu oil fields in Rivers State, and Ughelli in Delta State, which was the first hydrocarbons find, west of the Niger. By 1961 Mobil, Gulf (now Chevron), Agip, Tenneco and Amoseas (now Texaco) etc joined the search for both onshore and offshore oil and gas in Nigeria. This led to the first offshore discovery in 1964 in Okan field in Delta State. Currently, all the early explorers have discovered oil and are producing it, with an upwards of 3,000 producing oil wells in the country.

    Prior to 1971, the Government had no joint venture participation in the operations of oil companies in Nigeria. By 1971 all concessions earlier granted to the companies were converted to joint venture agreements. In 1973, production sharing contract emerged between the NNPC and Ashland, followed by risk service contract between NNPC and Agip Energy and Natural Resources in 1979 and agreements involving these types of contracts were entered into between the NNPC and the oil companies. Foreign oil companies largely dominated the upstream sector until the first discretionary allocation of acreages to indigenous companies in 1990. Oil blocks were allocated to eleven (11) indigenous companies. The companies who operated sole risk contracts, were encourage farm-out (i.e. to assign an interest in a licence to another party) 40 per cent of their interest to foreign

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    companies, mainly for financial and technological back-up (the foreign companies who acquire interest in a licence from another party, are said to have farm-in in indigenous companies minning interest). More allocations were made between 1991 and 1993 and there are now an upwards of forty (40) indigenous private sector companies licensed to prospect for oil in Nigerias upstream sector. Some of the companies, including Summit Oil, Consolidated Oil and Amni Petroleum Development Company have made commercial discoveries and are already producing oil, while others are at various stages of exploration and production.

    In addition the NNPC through two of its subsidiaries- the Nigerian Petroleum Development Company (NPDC) and Direct Exploration Services of the National Petroleum Investment Management Services undertake oil exploration and production. In total, an upwards of 55 companies are operating in Nigeria under joint venture, production sharing contract, service contract, sole risk contract and NNPC direct exploration efforts.

    Nigerias expertise in the upstream sector in the African Subregion, which is relatively superior, had attracted a number of African countries to look up to it for assistance. For example in 2010 Uganda and Nigeria have signed MOU on oil and gas industry. The agreement covers human resource training, technological transfer, joint projects and offering support on evaluation of the crude oil. Crude oil and gas production is expected to start by 2012. There will also be construction of a refinery with a capacity of 150,000 to 200,000 barrels of oil a day. Four companies, including Heritage, Dominion, Neptune and Tullow Oil, are exploring for oil and gas in the Lake Albert basin. The MOU signed between Nigeria and Uganda is a positive development. With increased E&P activities in the region, more countries would be fortunate to discover Oil and Gas reserves in their territories.

    Activities in the downstream sector were given boast in 1965 with the construction of the first refinery in Port Harcourt by Shell-BP, with an initial capacity of 35,000 bpd, which was later increased. As the economy grew, demand for petroleum products grew along with it necessitating the establishment of Warri refinery in 1978, Kaduna refinery in 1980, and subsequently, another refinery, which is the forth refinery, was built at Port Harcourt to supplement the old one. However, these refineries at various points in time have been bedeviled with problems of sabotage, fire out breaks, poor management and lack of regular turnaround maintenance, thereby making it difficult for the refineries to meet local demands for petroleum products.

    In similar vein, petrochemical plants were built in Warri and Kaduna in 1988 and subsequently, another company was built in Eleme, near Port Harcourt. These companies were meant to produce polypropylene, carbon black, linear alkyl benzene (LAB), heavy alkylate, benzene, polyethylene and chlorine, among others.

    Table 3: Installed Capacity of Nigerian Refineries S/N NAME OF THE COMPANY Date

    Commissioned 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 35,000 4 Eleme Petrochemical Company Limited (EPCL). 1989 150,000 Total 445,000

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    1.7 NNPC, DPR and Their Roles

    1.7.1 Nigerian National Petroleum Corporation (NNPC) The NNPC occupies a central position in the Nigerian oil and gas industry. It was incorporated on April 1, 1977 through Decree No. 33 of 1977, by a merger of the defunct Nigerian National Oil Corporation (NNOC) created by Decree 18 of 1971, and the former Federal Ministry of Petroleum Resources, with Chief Festus Marinho, as the pioneer GMD. NNPC is charged with the responsibility of managing the Nigerias oil and gas resources in all segments of the petroleum industry (namely Exploration and Production (E&P), storage and transportation, refining and hydro processing and distribution and marketing). The roles of the corporation include the following:

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

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

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

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

    5. undertake such activities considered necessary or expedient for giving full effect to the provisions 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 its operational efficiency. These sectors were (1) oil and gas sector, (2) refineries sector, (3) petrochemical sector, (4) pipelines and products marketing, and (5) the petroleum inspectorate. Similarly, the Corporation was re-organized in 1988 with a view to putting it on commercial footing, with three basic areas of responsibilities. These are (1) corporate services (which include finance, administration, public affairs, personnel, legal and technology), (2) operations (which include exploration and production, refining, gas processing and petrochemicals) and (3) National Petroleum Investment Management Services (NAPIMS) -which supervises Government investment in joint venture companies, markets oil that accrues to the Government and engages in exploration activities in areas where oil companies consider too risky to venture in to.

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

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

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

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

    3. Warri Refinery and Petrochemicals Company Limited (WRPC) charged with the responsibility of refining petroleum and the production of carbon black and polypropylene petrochemicals.

    4. Kaduna Refinery and Petrochemicals Company Limited (KRPC) charged with the responsibility of refining petroleum and the production of linear alkyl benzene and heavy alkylalates.

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

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

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

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

    9. Nigerian Engineering Technical Company Limited (NETCO) charged with the responsibility of providing engineering services to the NNPC group and other oil companies in the country.

    The three other subsidiaries that are jointly own with foreign oil companies are: 10. Nigeria Liquefied Natural Gas Limited (NLNG) owned jointly by the NNPC, Shell, Elf,

    Agip and International Finance Corporation (IFC) charged with the responsibility of harnessing, processing and marketing gas resources.

    11. Calson (Bermuda) Limited initially owned jointly by the NNPC and Chevron (but the Government has now divested from the company). Calson is charged with the responsibility of marketing the countrys excess petroleum products abroad.

    12. Hydrocarbon Services Nigeria Limited (HYSON Limited) owned jointly by the NNPC and Chevron, and charged with the responsibility of providing logistics and support services to Calson (Bermuda) Limited.

    In addition to these subsidiaries, the industry is also regulated by the Department of Petroleum Resources (DPR), a department within the Ministry of Petroleum Resources. The DPR ensures compliance with industry regulations; processes applications for licenses, leases and permits, establishes and enforces environmental regulations. The DPR, and NAPIMS (National Petroleum Investment Management Services), play a very crucial role in the day to day activities throughout the industry. In order to realize its vision and mission as well as provide optimal service to its customers, the Nigerian National Petroleum Corporation (NNPC) has been structured as follows:

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    Figure VI: Organizational Structure of NNPC

    1.7.2 THE DEPARTMENT OF PETROLEUM RESOURCES (DPR) Prior to independence in 1960, the Hydrocarbons Section of the Ministry of Lagos Affairs handled petroleum matters in the country. However, when petroleum activities gathered momentum in the country, a petroleum division (later named DPR in 1970) was created under the Ministry for Mines and Power. In 1971, Nigerian National Oil Corporation (NNOC) was created as the commercial arm of the DPR, while DPR itself continued as art of the Ministry of Mines and Power. In 1975, DPR was upgraded to a ministry and named the Ministry of Petroleum and Energy (later renamed the Ministry of Petroleum 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 act as the regulatory arm of the oil and gas industry. In 1985, the MPR was re-established. However, Petroleum Inspectorate remained with NNPC until its re-organization of March 1988 that resulted in the excision of the Inspectorate and its transfer back to the Petroleum Resources Department of the Ministry of Petroleum Resources. The functions of the DPR include the following:

    GROUP MANAGING DIRECTOR NNPC M1

    MD NETCO

    MD HYSON

    GGM AUDIT

    MD PPMC

    GGM PUBLIC AFFAIRS

    GED E&P GED R&P GED F&A GED CS

    GGM NAPIMS

    MD IDSL

    MD NPDC

    MD NGC

    GGM COMD

    MD PHRC

    MD WRPC

    MD KRPC

    GGM ACCOUNTS

    GGM FINANCE

    GM TREASURY

    GGM HR

    GGM MEDICAL

    GGM P&G

    GM INSURANCE

    GGM LONDON OFFICE

    GMDS SUPPORT STAFF

    GGM, LNG & POWER

    GGM ETD

    GGM CSLD

    GGM CPDD

    GGM INVESTMENT

    GGM NIG. CONTENT

    GGM ITD

    GGM RENEWABLE ENERGY

    GGM R & D

    GGM GREENFIELD EXPORT REF.

    GGM CORPORATE STRATEGY

    MD NIDAS MD NIKORMA

    GGM INTL VEN. OPP.

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    1. supervising all petroleum industry operations being carried out under 1iences and leases in the country, with a view to ensuring compliance with the established laws and regulations;

    2. monitoring the petroleum industry in order to ensure that operations are in line with national policies and goals;

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

    4. keeping and updating records on petroleum industry operations relating to reserves, production/exports, licences and leases, as well as rendering regular reports of them to the Government;

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

    6. processing all applications for licences to ensure compliance with laid down guidelines before making recommendations to the Minister of Petroleum Resources; and

    7. ensuring timely and adequate payments of all rents and royalties as and when due.

    1.8 PPPRA and the Proposed Petroleum Industry Bill (PIB) 2011

    1.8.1 Petroleum Products Pricing Regulatory Agency (PPPRA)

    The Government on 14th August 2000 set up a 34 member Special Committee on the review of Petroleum Products Supply and Distribution drawn from various Stakeholders and other interest groups to look into the problems of the downstream petroleum sector. It mission is to reposition Nigeria's downstream 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 was characterized by the following problems:

    1. Scarcity of petroleum products leading to long queues at the service stations 2. Low capacity utilization and refining activities at the nation's refineries (poor state of the

    refineries) 3. Rampant fire accidents as a result of mishandling of products- products adulteration 4. Pipelines vandalisation 5. Large scale smuggling due to unfavourable economic products borders' prices with the

    neighbouring countries 6. Low investment opportunities in the sector.

    Functions of PPPRA

    1. To determine the pricing policy of petroleum products; 2. To regulate the supply and distribution of petroleum products; 3. To create an information databank through liaison with all relevant agencies to facilitate the

    making of informed and realistic decisions on pricing policies; 4. To oversee the implementation of the relevant recommendations and programmes of the

    Federal Government as contained in the White Paper on the Report of the Special Committee

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    on the Review of the Petroleum Products Supply and Distribution, taking cognizance of the phasing of specific proposals;

    5. To moderate volatility in petroleum products prices, while ensuring reasonable returns to operators.

    6. To establish parameters and codes of conduct for all operators in the downstream petroleum sector;

    1.8 Petroleum Industry Bill (PIB) 2011 The Petroleum Industry Bill is an attempt to bring under one law the various legislative, regulatory, and fiscal policies, instruments and institutions that govern the Nigerian petroleum industry. The Bill is expected to establish and clarify the rules, procedures and institutions that would entrench good governance, transparency and accountability in the oil and gas sector. It aims to introduce new operational and fiscal terms for revenue management to enable the Nigerian government to retain a higher proportion of the revenues derived from operations in the petroleum industry. The government argues that, since the commencement of oil and gas production in Nigeria in 1958 after the discovery of oil in 1956 in Oloibiri (Bayelsa State), no comprehensive law has been put in place for effective administration of the Nigerian petroleum industry. The PIB therefore seeks to replace sixteen (16) petroleum industry Acts, which have many inadequacies, with an omnibus Act that provides for better fiscal and regulatory management of the oil and gas sector.

    Oil and gas production commenced in Nigeria in 1958 after the discovery of oil in Oloibiri (Bayelsa State) two years earlier. By the 1990s Nigeria engaged in a number of unincorporated joint ventures with international oil companies to develop the industry. However, the country had challenges funding its commitments to the joint ventures. As a result, Production Sharing Contracts (PSC) were introduced as alternative funding mechanisms. However, PSCs lack transparency, good governance practices, and are not in line with international best practices. For instance, Nigeria does not capture any part of windfall profits from increases in crude oil prices. Additionally, cost controls, accounting procedures, and acreage management are inadequate.

    In response to these challenges, the Obasanjo government in 2000 constituted the first Oil and Gas Reform Implementation Committee (OGIC) to recommend a policy for reforming the sector. The recommendations defined the need to separate the commercial institutions in the sector from the regulatory and policymaking institutions. In 2007, the YarAdua government reconstituted OGIC under the chairmanship of Dr. Rilwan Lukman to use the provisions of the National Oil and Gas Policy to setup legal, regulatory, and institutional structures for managing the oil and gas sector.The Lukman Report, submitted in 2008, recommended regulatory and institutional frameworks that when implemented will guarantee greater transparency and accountability. This report formed the basis for the first Petroleum Industry Bill (HB 159) that was submitted in 2008 as an Executive Bill.

    The controversy raised by the Bill prompted the constitution of a federal interagency team headed by Dr. Tim Okon (former NNPCs Group General Manager on Strategy) to review the Bill. The teams report submitted in 2010 (IAT 2010) is at the crux of the controversies around the PIB because it introduced more stringent fiscal provisions that guarantee a higher share of oil revenues to Nigeria.In 2011, the Senate submitted its version of the Bill (SB 236) that is seen as a muchweakened version. Subsequently, the House of Representatives submitted its version of the Bill (HB. 54) in 2011. The Bill was sponsored by six Honourable Members.

    The draft Petroleum Industry Bill (PIB) was designed to act as an all-encompassing piece of legislation and as a result, some 15 pieces of existing legislation will be revoked upon ratification. It

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    will create a number of new institutions with mandates over the upstream sector. Specifically, the policy making function will reside with the Petroleum Directorate. The Petroleum Inspectorate will replace the Department of Petroleum Resources (DPR), currently within the Ministry of Energy. This commission will act as the independent regulatory body and licensing agency for the upstream sector. On the operational side, NNPC will be replaced by the Nigerian National Petroleum Company Limited (NOC). The vision is to turn NNPC into an integrated oil and gas NOC, and a limited liability company. The National Petroleum Investment Management Services (NAPIMS), currently part of NNPC, will be replaced by the National Petroleum Assets Management Agency (NAPAMA). This body will monitor and approve all upstream costs and manage tax/royalty oil (but not profit oil). NAPAMA will exist outside of the NOC as a separate and independent agency. The Research and Development division within NNPC will be carved out into an independent entity, the National Petroleum Research Center. A separate Frontier Service will also be created. The key objectives of the PIB include:

    1. Enhance exploration, exploitation and production of oil and gas: The PIB will eliminate funding bottlenecks, increase investments by comprehensive deregulation of the downstream sector to make it attractive to investors, and increase acreage available for investment by reclaim acreage that is not being developed by the current owners.

    2. Increase domestic gas supplies: The Bill provides that all existing and future petroleum mining lessees shall meet their domestic gas supply obligations for the specified periods as the gas will be used for power generation and industrial development. Failure to meet this obligation attracts a stiff penalty.

    3. Create a peaceful business environment: The Bill seeks to align the interest of the host communities to those of the oil companies and the government. The Petroleum Host Communities Fund, which will be funded with 10% of the net profit of the oil companies operating in the communities, shall be used to develop the economic and social infrastructure of the host communities. Communities will forfeit contributions in the Fund when vandalism or unrest causes damage to upstream facilities.

    4. Fiscal Framework for increased revenue: The PIB establishes a progressive fiscal framework that encourages further investment in the industry whilst increasing accruable revenues to government. The Bill simplifies collection of government revenues from the oil assets, increases the share of royalties in the case of high oil prices, etc.

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

    6. Deregulate petroleum product prices: The Bill proposes the full deregulation of the downstream oil sector. A number of the institutions will be responsible for developing the infrastructure to support the sector, funding concessionaires and facility management operators. The Petroleum Equalisation Fund will be phased out in line with the development of the support infrastructure.

    7. Create efficient regulatory entities: The Bill provides for the creation of eight institutions to drive greater transparency and accountability.

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

    9. Promote Nigeria content: The PIB has farreaching local content components. No project will be approved without a comprehensive Nigeria Content Plan including obligations of the investor to purchase local goods and services, engage local companies, employ Nigerians,

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    ensure knowledge transfer and encourage Research and Development. The Nigeria Content Monitoring Board will regularly verify compliance. Through the local content provisions in the Bill and the opportunity to develop small indigenous oil and gas companies, Nigerians will begin to participate more actively in the industry and jobs will be created.

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

    Controversies in the PIB 2011

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

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

    2. Retroactive reversal of contracts: The PIB advocates reversal of provisions of prior agreements and contracts, and introduces new fiscal regimes even for old Petroleum Sharing Contracts.

    3. Relinquish acreage: The PIB provides for the revocation of acreage that is yet to be developed by the allocated owners. Opponents of this provision claim that it is an infringement on earlier agreements while its proponents argue that it is required to bringing new investment to the industry.

    4. Calculating payments: The Bill advocates that oil companies will pay for quantities produced instead of quantities exported. The oil companies have argued that solving the security challenge and fixing sabotage of logistics infrastructure is the core responsibility of government.

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

    6. Deadline for Gas flaring: According to the PIB (HB.54), December 31st 2012 is the deadline for gas flaring. The integrity of this date is questioned given that the Bill is yet to be passed.

    7. Too much power to Minister of Petroleum: The Bill provides the Minister of Petroleum too much power to grant, revoke and reallocate licenses.

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

    9. Potential delays in passing the Bill and its Consequences on Nigerian economy: Can the 7th National Assembly continue debates from where the last Assembly stopped? This is possible according to Rule 111 of the Senate but there are voices in the Senate that dissent to this interpretation and want the Bill to be reintroduced and for the process to be started all over again. There is also the challenge of harmonizing the different versions of the Bill (Executive, Senate, and House). Failure to pass the PIB has and will lead to a reduction of investments in the Nigeria petroleum industry. To date, most of the oil companies have ceased investments in the sector until there is clarity as to what provisions will be contained in the final Bill and how it

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    will affect the industry. With the rise of other attractive petroleum industries in Africa (Angola, Ghana, etc), Nigeria must understand that investments are fungible and will eventually flow to alternative countries that are more receptive.

    2. Oil and Gas Drilling, Cost Classification and Reserves Valuation

    2.1 Oil and Gas Drilling Oil and gas drilling is highly capital intensive, requiring a large number of technocrats with fantastic remuneration, thus necessitating pre-drilling operations, before actual drilling. Drilling operations basically comprised of: (i) staking (locating oil well site after dues consideration of a number of natural surface attributes-terrain, body of water, marshy environment, etc) (ii) compliance with regulatory requirements on spacing of oil wells (iii) providing access road to the drilling location, leveling of drill site for placement of working equipments and erection of field offices, and increasing permeability through fracturing, acidizing and thermal process.

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

    Cable-Tool Drilling In the cable-tool method of drilling, a heavy piece of forged steel is lowered into the hole. The bit, which weighs several hundred pounds, is raised and then dropped in the hole, literally pounding a hole in the earth. Water is pumped into the hole to float the cuttings of rock away from the bottom of the hole.

    Rotary Rig Drilling Rotary drilling is by far the most widely used method of drilling for oil and gas today. In rotary operations, the hole is drilled by rotating a drill bit downward through the formations.

    The usual oil and gas drilling practice entails the engagement of an independent drilling contractor, who can do the drilling more effectively, efficiently and economically because of experience. Drilling contracts may take the form of (i) footage rate contract (requiring installment payment per foot of hole drilled until the required depth is reached), (ii) day rate contract (requiring daily payment of specified amount respect of the number of feet drilled) or (iii) turnkey contract (where the contractor is paid only after satisfactory drilling of well to the required depth and other conditions specified in the contract). Presently, footage rate contracts are the most popular although day rate contracts are also common, while turnkey contracts are less common.

    Some of the major problems encountered in oil and gas drilling may include the following:

    1. the excess of formation pressure which may lead to blowout which is dangerous to the ecosystem. For example on 22 April 2010 estimated 550-900 kb of oil leaked into the sea in US very significantly affecting local economic activities like fishing, farming and tourism. Similarly, in 1982, a high profile blowout at Amoco Canada killed 2 workers and hundreds of cattle.

    2. twisting off of part of drill string which may lead to the abandonment of oil well and the drilling of another well;

    3. collapse of part of the drilled hole may be experienced, leaving the pipe trapped in the depths; and

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    4. the formation may exude hydrogen sulphide, which is a gas with a very foul odour, thereby necessitating abandonment of well. For example In 2003, 243 people in China were killed, and 3 workers of Abu Dhabi Company operating at Shah Oilfield in Iran were killed by the toxic hydrogen sulphide gas emitted from crude oil. The gas is heavier than air, and even at low concentrations it can cause respiratory failure and brain damage.

    2.2 Types of Oil and Gas Wells There are different types of oil and gas wells and the drilling methods and logistics usually depend on the type of well to be drilled. Eight types of oil and gas wells can be identified. These are: (1) Wildcat (exploratory) well (an oil well that is drilled to establish the presence or otherwise of oil and gas, which may result in proved reserves or dry hole); (2) discovery well (this is a wildcat well in which hyd