19 December 2008

    In conducting a joint interest audit under the Accounting Procedure attached to a joint operating agreement, most of you have encountered Section I.5.A. of the Council of Petroleum Accountants Societies, Inc. (COPAS) 2005 Accounting Procedure (also in the previous COPAS 1984 and 1986 forms) which requires that all non-operators be notified of their right to participate in such audits. This balloting is meant to minimize the burden on the operator from having to host, pull records, and answer questions for what may be several audits in a year, given that each non-operator has the contractual right to conduct its own audit of the operator.

    Surprisingly, however, COPAS itself recommends that this requirement be ignored in certain situations. In its publication, “Accounting Guideline 19 (Expenditure Audits in the Petroleum Industry: Protocol and Procedures Guidelines),” reference is made to not informing all non-operators: “Although most COPAS Accounting Procedures require that all Non-Operators be notified of an audit, to minimize administrative costs incurred by the Audit Lead, accepted industry practice is that Non-Operators with an interest of less than one percent are not balloted.”

    Although this language contradicts the Accounting Procedure, each non-operator is contractually allowed to conduct its own audit of the operator’s books and records, so no party is ever specifically excluded from conducting or participating in an audit.

    Even with each non-operator having the obligation to protect its interest and either schedule or inquire about any audit which may be scheduled, but for which it may not have been balloted, the practice of not notifying small non-operators is risky. First, the results of the audit may not be binding on a non-participating non-operator as it could contractually conduct a separate audit covering the same time period with potentially different results. In such a case, the operator will likely contest the scheduling of a second audit of the same time period, citing the Section I.5.A. language requiring all non-operators to be balloted and suggesting that joint audits be conducted. This can cause bad relations at best, and legal involvement at worst.

    Regarding charges and credits resulting from an audit, experts in the field tell us that while a non-operator may not be invited to participate or declines to participate in an audit, all adjustments are required to be made to the joint account, not just to the accounts of the parties balloted or participating in the audit. Regardless of who participates or is balloted, the review is an audit of the Joint Account, a term defined in the Accounting Procedure as “…The account showing the charges paid and credits received in the conduct of the Joint Operations that are to be shared by the Parties.” Most disturbing would be a situation in which the benefits of the audit are not applied to the joint account but only to the accounts of those participating in the audit. In that case, if an adjustment is favorable to the auditing non-operator and other participating non-operators, but is not made to the joint account, the operator will have exposure to an excluded non-operator.

    The safer practice is to ballot all non-operators, even owners of a very small interest. This is the standard practice of many industry auditors. There is an obligation in the Accounting Procedure to notify all non-operators of the audit and doing so will afford greater protection to the auditing non-operator, the operator, and all other non-operators.

    Mr. Mike Cougevan of Martindale Consultants, Inc., a consulting firm specializing in COPAS compliance reviews and oil & gas related matters, co-authored this Alert