The Upstream Oil & Gas Balancing Act
Find out why understanding an upstream oil and gas operator's balancing requirements, and having the tools to properly track them, requires a centralized solution.
From small E&P operators in a single play to large ones across the nation, all of them encounter the need to track imbalances. While pipeline imbalances are common in the midstream sector, in upstream oil and gas, imbalances typically occur at the wellhead. With production, land/division order, marketing and revenue departments all typically involved, understanding an operator’s balancing requirements and having the tools to properly track them requires a centralized solution.
From an operator/producer perspective, an imbalance occurs when a working interest partner in a well doesn’t take or receive their entitled share for a production month. Due to the more inexact measurements of flowing products, imbalances are common. Currently, gas imbalances are more common than oil imbalances. As oil pipelines become more common, oil balancing may become more off an issue. This article, however, is focused on wellhead gas imbalances.
"With production, land/division order, marketing and revenue departments all typically involved, understanding an operator’s balancing requirements and having the tools to properly track them requires a centralized solution."
A gas imbalance typically occurs as a result of one of three reasons:
- A working interest (WI) partner chooses to take in kind (TIK), meaning they’re taking their share of gas to market, either on their own or with someone other than the operator to gain a more favorable marketing agreement. The TIK partner’s gas is measured by a meter maintained by the marketer of their choice. This leaves the opportunity for discrepancies between volumetric readings and decimal maintenance between the operator’s meter measurements and third-party measurements. When the operator markets an energy commodity, they must ensure coordination between the marketing department and land department. Marketing (third-party or in-house) must send timely marketing decimals to allow for accurate monthly allocation. The operator’s marketing department will also have discrepancies with TIK partners in the event the operator decimal of record doesn’t match the decimal the TIK partner/marketer has recorded. As an example: At a well, an operator/marketer produced 10 MMcf of gas with a JOA percentage of 70% and a TIK percentage of 30%. The TIK owner/marketer may have the JOA percentage of 80% with their TIK share at 20%. At the end of the month, it was discovered that the JOA partners received 75% of the produced volume and the TIK partner received 25% of the volume. This leaves the operator underdelivered and the TIK partner overdelivered. While the operator and their WI partner investigate the issue that caused this differential, the imbalance would be recorded and tracked corresponding to the current production month.
- The total produced volume of an operated well doesn’t always agree with the volume delivered. Although rare, production of wellhead gas volume sometimes won’t tie to delivered volumes. This typically occurs because of inaccurate measurement of FL&U (fuel, loss and unaccounted), a poor location for sales points placed by marketers or a meter measurement failure. In a 100% Joint Operating Agreement (JOA) scenario, this would require an accurate reallocation of the under/over delivered volume based on their owner decimal. In a TIK scenario, further analysis would need to be done between marketers to determine the root cause while simultaneously tracking the over/under allocation of volumes.
- Gas balancing is a procedure based on shared information; therefore, any debate between WI partners involving active division order decimals, produced volumes or marketed statements alone can result in an imbalance. When a property is 100% joint operated, these scenarios stem from a lack of updated or consistent data between partners. Communication between WI partners is critical for maintaining accurate imbalance tracking.
Operator Responsibilities Regarding Imbalance
It's critical for the operator’s back-office to be aware of the Gas Balancing Agreements (GBAs), which can be found in the JOA of each well. These GBAs provide operator guidelines around required tracking and reporting of imbalances to WI partners, be it monthly, quarterly or yearly. This agreement also contains terms in the event of an imbalance settlement or cash out.
After a given period, an event or decision between an operator and their JOA partner may determine that they would like to resolve an outstanding imbalance. This usually comes in the form of an ownership transfer, company dissolution through bankruptcy or the imbalance simply becomes large enough that it makes financial sense to resolve.
Dependent on terms of the GBA, the most common forms of settlement include:
Cash Out Settlement – One of the most common forms of settlement whereby the operator and partner agree to become whole on an imbalance through a single cash payment. The price applied to the volumetric imbalance can either come from a single index price or weighted average sales price (WASP) of each month of historical imbalance up to the current month.
Volume Settlement Through Sale – Reserved mostly for interest sales or when a WI partner makes the decision to sell all or a portion of their WI in a well. When this occurs, it's the responsibility of the operator to update the DOI, marketing decimal, and balance forward of the total imbalance from the time of the sale. The new imbalance statement should reflect the decimal change in ownership, as well as the decision whether the seller has transferred all or a portion of the outstanding volume imbalance, with a percentage moving to the buyer and the rest being cashed out as mentioned above.
True Up – When an operator and owner decide to settle on an imbalance, but don’t wish to cash out, the most common method is to put the underdelivered owner in “true up” or “make up” position. The purpose of true up is to temporarily increase or decrease the marketing decimal until the imbalance is resolved to an agreeable tolerance. Subsequently, the WI partners notify the operator who’ll then update their marketing decimals of record on an imbalance statement until the imbalance is satisfied.
Revenue Considerations of Gas Imbalance
When accounting for monthly imbalances, an operator must consider their accounting preference for booking based on takes vs. entitlements. Booking a WI partner on takes, or actual sales volumes/values for an accounting period, requires revenue and financial teams to truly book all sales volumes and values, including any adjustments.
"In a perfect world, gas balancing wouldn’t be an issue for an operator. Unfortunately, in the real world, monthly measurement mistakes are made, which require a capable and proactive upstream accounting department to stay on top of these issues."
Doing so allows the operator to only book true sales without having entries on the books for overdelivered or underdelivered volumes. Booking entitlements involves the operator booking their volume and revenue share strictly based on their true entitlement decimal. Any imbalance is then booked to a separate imbalance account and then defined as a receivable or payable with the imbalance tracked monthly.
Dealing with gas Imbalance
In a perfect world, gas balancing wouldn’t be an issue for an operator. Unfortunately, in the real world, monthly measurement mistakes are made, which require a capable and proactive upstream accounting department to stay on top of these issues. By understanding what to look for and appropriate questions to ask from both internal and external marketers, in conjunction with the terms of the present gas balancing agreement, gas imbalance can become a truly level balancing act.
About the Authors:
Byrony Coan is a Director in Opportune’s Upstream Transactional Advisory group. Byrony has 18 years of experience in project management, oil and gas software, product management, process consulting and change management. In addition, she has upstream subject matter expertise from operations through the value chain to financial reporting. Byrony leads teams that support asset transactions (buy-side or sell-side) and the associated organizational and process adoption. Her client base has ranged from start-up companies to small independents to Fortune 500 companies. Prior to joining Opportune, Byrony worked with an upstream software company to coordinate an active user community to develop back-office software solutions.
Kyle Blair is a Manager with Opportune LLP’s Upstream Transactional Advisory practice. He has over 10 years of experience in the upstream sector, specializing in business analytics and process improvement. He has a deep understanding and thorough background in small- and large-scale ERP implementations, asset acquisition and divestiture transitions, as well as transactional due diligence.