In a previous post, I discussed several issues surrounding joint interest auditing and the joint interest accounting in question. Here are some initial steps once you have considered the necessity of a joint interest audit:

• Review your joint interest agreement and the accounting procedure.  While many of the agreements are standard, ensure you are aware of the audit provisions and other pertinent facts such as the allowed overhead allocation method. The more complexities in the agreement, the more likely there could be errors.
• Consider the size of the interest and amounts at stake.  A joint interest audit will likely produce some results for all wells, but only certain wells would be worth the cost.
• Contact other nonoperating joint owners to share the costs.  Unfortunately for the initiator of the joint audit, you don’t receive all the reward for being diligent on your investment. When an error is found in a joint interest audit, the error is corrected and all affected parties receive remedy even if they didn’t help foot the bill for the audit. This should not necessarily prevent you from pursuing the audit assuming you followed the previous two steps.
• Utilize a professional. The individuals who perform a joint interest audit need to have appropriate training and experience resolving the issues typically uncovered in an audit. Many of the large oil and gas companies have a joint interest audit department and conduct most, if not all, of the procedures themselves. If you do not have those resources or lack the expereince to perform a joint interest audit, engaging an independent auditor may be appropriate. 
• Consider the timing of the audit. Attempting a joint interest audit during the first three months of the year may lead to higher fees, less cooperative staff at the operator, and less timely completion of the audit. When beginning the audit process under any timing, you should prepare for an extended timeline due to the various communications between the auditor and the operator from initial testing all the way down the road to multiple discussions over the reported findings before resolution. 
• Open up communications with other nonoperators and the professional performing the audit. You should consult with the other nonoperators, whether they are participating in the audit or not, about specific concerns related to their joint interest billings. You should communicate their concerns and your own to the professional when engaging them to perform the audit. 

We enjoy partnering with our oil and gas clients in all facets of their business needs. We would be happy to discuss joint interest audits or other accounting services with you.

Anyone…at least that is how one should think when analyzing fraud risks.

Fraud is a hot topic. If you don’t think so ask someone who used to work for Enron or invested in Madoff’s investment company - they might change your mind. Because of instances like these, people often think of fraud in large terms, and the mention of the word carries a lot of weight. But fraud can occur in all sizes and forms.

Who is likely to commit fraud? Most people use what is commonly known as the fraud triangle to identify areas where one can commit fraud. The three criteria are Pressure/Incentive, Opportunity, and Rationalization.

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There have definitely been tougher economic times in our country’s history, but the recession we are in now calls for effective leadership. A very important characteristic of managing in hard times is true leadership. A leader’s role changes drastically when business is not booming and there is more down time than usual. Leaders have to make tough, maybe even controversial, decisions. A leader has to be assertive and lead more directly than in good times where delegating responsibilities might be more effective. Mark Cook wrote in the Fort Worth Business Press that leaders have to assert different skills in tough times.

Honesty and Authenticity- communications with employees should show your understanding of the current events and seek input from talented people. Being honest about your concerns and opening communications will help employees see the reality and help them take ownership of the solutions.

Day-to-day Operational Presence- this is not to be confused with micromanagement. This process is more about understanding the impact of the current times at a lower level in order to dissect problems and continue high-level strategy. Top employees will respond to this involvement if it is seen as high-level investigation to make their processes easier and more efficient. These hard times require leadership focus in all facets of the organization.

Optimistic Realism- being either too optimistic or too pessimistic create doubt in employees. Focus on the solutions to the problems and do not dwell in the problems as they appear. Be realistic about performance measures and reward smart solutions and outcomes. Do not give employees a false sense of security or a false sense of insecurity due to business slow downs. You can lose talented employees if they feel uncertainty.

Smart People Decisions- leaders have to make tough personnel decisions in hard times. Be certain changes are made based upon performance and contribution to the company. Develop or better implement performance guidelines to grade your employee group. Hard times are not forgiving to decisions made based on loyalty or politics. Your company cannot afford to keep or hire a liability in this market. You may be able to replace low performers with talented individuals who are currently in an uncertain job or have been laid off due to the current economic climate.

Future Watch- build with the future in mind knowing that the economy will turn around at some point. Can you make key acquisitions now and exploit these when the economy recovers? Use this time to innovate processes, learn new techniques for operations, and look for gaps in your current processes. You can come out on the other side of this economic chasm in much stronger position operationally.

Being a strong leader includes being willing to change current practices. The skills Mark Cook focuses on could help you improve your company for the long term.

On February 2, T. Boone Pickens made the following prediction:

“We got a break here, a little bit of a breather (with current oil prices), but within 60 days we’ll be back up to $60 oil and by end of the year we’ll be on our way … at $75.”  Full article.

This prediction seems to presume either a declining supply, an increasing demand or both for oil in the very near future.  Just six months ago the fear (and focus of much of the political speak during the election campaigns) was that we had too much demand for the supply that could be produced causing prices to soar.  This sparked the debate about alternative sources of energy to decrease our dependence on foreign oil, and the complaints that the U.S. oil producers were making too much money in the process of trying to keep up with this demand. 

A factor that plays into Pickens’ scenario is the rig count in the U.S.  For several months, due to a decreasing demand and the resulting drop in oil prices, we have seen an increase in the number of rigs taken out of service because it is now economically unfeasible to produce the reserves.  OPEC is also reducing production in an attempt to moderate global oil prices. 

Eventually, this reduced supply will drop below the level necessary to sustain the market’s demand.  This could be amplified if demand for oil also begins to increase.  Once prices begin to rise, it may be too late for U.S. producers to react quickly since bringing rigs back online will be expensive and time consuming.  As a result, prices will rise quickly at a time when the economy may still be struggling.  If OPEC can ramp up production faster that our U.S. producers, we may end up purchasing even more foreign oil to relieve the burden of rising prices on the U.S. consumer.

Instead of trying to find ways to penalize our domestic oil producers, it might be wise to begin removing barriers to their ability to produce enough oil domestically so we can keep more of these dollars invested in our own economy.

One of the common issues encountered in the setup of a drilling company is the handling of the economic deal of the partners in the drafting of the partnership agreement.

Many deals, especially those financed by investment funds, have a tiered or waterfall structure for allocating income and distributions.  It is normal for the partners who are putting the deal together and who will run the day-to-day operations to have a relatively small ownership percentage on the front end since most of the capital will come from an investment fund.

Over time, based on the entity’s performance and the increase in value of the enterprise, these “operations partners” may increase their ownership percentage in the income and profits of the partnership.  This will usually occur once certain return hurdles are met for the “investment partners.”  Unless provided for in the partnership agreement, this switch in sharing percentages will result in the “investment partners” being allocated more income and therefore more distributions over time that the parties intend.

Although there are several options, the best way to make sure all partners end up being allocated the income and distributions everyone intends each party to receive over time, is to handle income allocation and distribution provisions independently in the partnership agreement.

I got to attend the Shale Resource Workshop hosted by the TCU Energy Institute in January. Over the two-day workshop, several of the speakers offered advice for operating in a down market:

1. Plan for setbacks.  The poorest results in a development program are likely to occur in the initial wells.
2. Continuously invest in good science and R&D. Especially in a down market.
3. Don’t manage costs by cutting corners in your drilling budget. Accounting and cost considerations shouldn’t drive your drilling program.
4. Risk. Don’t spend capital, invest it.

Richard Moorman, who is the Manager of Strategic Analysis for the Economics, Planning, and Acquisitions Division of Southwestern Energy Company, closed the conference by saying, “Think long-term.  Don’t give up too early.”

Great advice in an uncertain market.

In the environment of oil and gas operations where the revenue and expense decks keep growing, how do you know if the operator is giving you your fair share? Joint operating agreements generally have an audit provision. Whether or not you should invest in the cost of a joint interest audit depends on several factors including:

• Do I have a large interest in this well?
• Do the joint interest billings look unusual or not provide detail?
• Are the costs well over budgeted or reasonable amounts?
• Are there several wells in the same area that have similar names but different ownership percentages?
• Are there carried interest provisions in the agreement?
• Is the overhead based on actual costs rather than an agreed upon rate?

The number of transactions processed by the operator can lead to data entry or allocation errors. While many of the occurrences mentioned could happen within normal operations, they could also be erroneous charges or calculations.

The scope of a joint interest audit can include expenditure testing, payout recalculation for carried interests, revenue allocation, overhead charge analysis, review of classification of expenditures as direct costs versus overhead, and more.

You may not have the resources to provide the time necessary to perform and follow-up on a joint interest audit. A consultant can be hired to perform these services for you. While you incur the cost of a joint interest audit, the returns often exceed the cost.

Feel free to contact us if you would be interested in pursuing a joint interest audit or have any questions concerning the audit process.

Having that “bad apple” in your workplace can be very distracting if not destructive.  So in response, candidates are run through an exhaustive process of evaluation.  This process may not be the most productive method for measuring an employee’s emotional intelligence.  Many people in the oil and gas industry have the luxury of hiring people they have worked with in the past.  This cuts out a lot of the guess work involved in determining how your employees will interact.  If you don’t have this familiarity with prospective employees, consider the following:

• Is the candidate self-aware and self regulated – you cannot have a loose cannon who does not understand how to control anger or anxiety.
• Is the candidate able to read others and see others’ reactions to their behavior – this can be defined as a social “radar”.
• Can the candidate learn from mistakes made – this is the best way to judge how a person responds to adversity.

Here is a short list of effective questions to detect the prospect’s emotional intelligence:

• Tell me about a conflict you had with a peer or supervisor, and how it started and became resolved?
• Tell me about a time you said or did something that had a negative impact on a peer, supervisor, or customer. How did you know the impact was negative?
• Tell me about a situation when you discovered that you were on the wrong track.  How did you recognize this, what did you do, and what did you learn?

If this approach interests you, see Adele Lynn’s book The EQ Interview: Finding Employees with High Emotional Intelligence.