Joint operating agreements in oil and gas

What is a joint operating agreement?

A contract between the holders of a licence that sets out each party's participating interest, appoints one party as operator, establishes an operating committee to approve work programmes and budgets, and contains an accounting procedure for charging costs to the partners. It also covers what happens if a partner defaults on a cash call, how partners may decline to join a project, and how each party takes its share of production in kind.

Is a joint operating agreement a joint operation?

Usually, yes. Most agreements are not structured through a separate company: the partners own undivided interests in the licence and facilities and are each liable for their share of costs. That makes the arrangement a joint operation if the partners have joint control, meaning key decisions need the unanimous consent of the parties that collectively control the field. Where decisions can be passed by different combinations of partners, there is no joint control, but each party still accounts for its share of the assets and liabilities if it has rights to the assets and obligations for the liabilities. See joint arrangements in construction and mining joint arrangements for the same analysis in other industries.

How does each partner account for its interest?

Each partner records its share of the field's assets, such as wells and facilities, its share of liabilities incurred jointly, such as the decommissioning provision, its share of costs, and its own revenue from selling its share of production. There is no single set of joint venture accounts to consolidate: the operator keeps joint account records, and each partner books its share from the operator's monthly billing statements.

Joint operating agreements: the operator's books

A field has three partners: the operator with 40%, and two partners with 30% each. In a month the operator pays US$ 200 million of development costs and 50 million of operating costs on behalf of the joint operation.

The operator does not report the full 250 million as its own assets and costs: the partners' shares are amounts it is owed. In practice, operators usually call cash from partners in advance, so the operator more often holds a liability for cash received before it is spent. Receivables from partners are financial assets, subject to expected credit losses, which matters when a partner is in financial difficulty.

How are overlift and underlift accounted for?

Partners take their oil in kind, usually in full tanker cargoes, so in any period one partner may lift more than its share and another less. In this example, the field produces 1,000,000 barrels in a year. A 30% partner is entitled to 300,000 barrels but lifts and sells 350,000 barrels, an overlift of 50,000 barrels.

The partner recognises revenue on the 350,000 barrels it sold to its customers, under IFRS 15. The 50,000 barrels it owes its partners are an overlift liability, typically measured at market value, US$ 3.5 million at $70 a barrel, with the charge in cost of sales so that profit reflects its entitlement. The underlifted partners record a matching asset. Some companies measure imbalances at production cost instead; the policy should be disclosed and applied consistently. See overlift and underlift for both measurements side by side.

Who recognises leases signed by the operator?

Operators often sign contracts for drilling rigs, vessels or offices in their own name for the joint operation. The IFRS Interpretations Committee confirmed in March 2019 that a joint operator recognises the liabilities it has incurred, including its share of any liabilities incurred jointly. If the operator alone is the lessee and primarily responsible for the payments, it recognises the whole lease liability and right-of-use asset under IFRS 16, and then considers whether its arrangement with the partners is a sublease or a recharge of costs. The other partners recognise a lease only if they also have obligations under it. See identifying a lease.

How are farm-ins and changes in interest handled?

Buying an interest in a joint operation that is a business is accounted for using the principles of IFRS 3, including recognising goodwill and deferred tax, while buying an interest in assets that are not a business is an asset acquisition. Exploration-phase farm-ins, where the incoming partner pays some of the existing partner's costs in exchange for a share, are commonly accounted for without a gain by the farmor; see IFRS 6 exploration and evaluation. When a partner defaults, the others may take on its share of costs and of the field under the agreement's forfeiture terms.

How does US GAAP compare?

US GAAP permits proportionate consolidation for undivided interests in oil and gas properties, so the result is similar: each partner records its share of assets, liabilities, revenue and costs. See decommissioning provisions and oil and gas accounting.

This guide is general information. It is not tax or legal advice for your situation.