Hedging Against Oil Price Volatility?

Wrong, Operating Expenses Are Equally Precarious

If legally not understood, the lease operating expense can be more prone to volatility than the oil prices. LOE as it is also referred to in the US energy sector and is the foundation on which Texas companies depend upon for daily functions. In fact, it is completely divergent from the leases required by the real estate sector in the state. Automation had made it more specific as upstream companies look at it in a unique way. So do lawyers as many minerals are privately owned in the USA. Will the owners be willing to risk their capital to get oil-rich? It is essential to understand the other factor also that shapes the LOE- the direct costs that will be required to maintain a production site-keeping in mind the history of the well.

More E & P companies choose lease operating expense software to reduce the instability associated with production and pricing. Instead of hedging against both, the engineering prospect and legal aspects offer some valuable insights.

The engineering perspective

Engineers working on the oil fields have their own reasons for defining the lease operating expense as they head the overall operations. As profit margins have reduced, they need to adapt to different strategies to maintain expenses, change to changing prices, deal with production volumes, and not tamper with the capital investment. For them, the lease operating expense is simply dealing with the direct costs that affect the good cycle. For example, an owner may wish to add a wellhead compressor after a decade for a high-pressure gathering system. The wellhead would ideally reduce the pressure on the active well to increase the production rate. In such a scenario the original would be considered the development cost and addition of the wellhead would be entered into a lease operating cost for maintenance and ongoing production. The costs are paid in installments and if not paid they become a burden to the capital investment. Fuel and maintenance activity keep the compress in good shape

The legal perspective

On the other hand, the legal eagle will look at the LOE with a different eye.  A lawyer will look at the ownership and the land from which the minerals are bought up from the subsurface to ground level. When they are turned as market commodities they are valued. A typical LOE will not add the transportation of the market commodity for selling. Decades ago in Texas, real estate attorneys made the LOEs for O & G companies. But now the scene has changed. With digitization, the entire system has been overhauled. The definitions have changed to be complainant with the industry norms and standard specifications.

Removing conflicts between legal and engineering views

Depending on the long-term well cycles, often there are situations when the two overlap. Some expenses may come under LOE, but others may not. E & P companies will have to recognize the conflicts and address them either from the engineering or legal viewpoint.

There are several components that are variable in meeting the expense records.

Water [procurement]Trucking & Land Transportation Boats,Water Transportation Helicopter, Air Transportation
Company LaborPayroll BurdenEmployee Pension
Contract LaborConsultants & Professional ServiceMeals/Entertainment
Other Employee ExpenseChemicals & Treating Supplies & Tools GatheringTransportation
Fuel & ElectricSaltwater DisposalGas Marketing
Service & RepairSafety & SuppliesPollution Control
Compressor PartsSurface Repairs & MaintenanceGroceries & Food
Other RentsMeasurements & Testing CommunicationsRoad & Location Maintenance
Controllable EquipmentSubsurface Repairs & MaintenanceWell Workover
Well ServicesAbandonmentLegal Equipment
Rental & ServiceCompressor RentalsAd Valorem Tax
Production/Severance TaxFederal Fuel Use Sales TaxState Fuel Use Sales Tax
Prod./Severance Tax (20% prop.)Field ExpenseFacility Operations
Net ProfitsInterest OverheadDistrict Expense
MiscellaneousNon-operating Joint CostAdvances to Operators
Cutback on InsuranceCharges to Joint Owners

Source: Fundamentals of Oil & Gas Accounting, 5th ed., Charlotte J. Wright and Rebecca A. Gallun, 2008

The lease can be a conveyance and a contract

E & P companies need to simplify the process with automation. The lease operating software can become the template for current and future uses. Some payments can be complex but with legal procedures, they can be outlined with clarity. Best practices followed by shale oil companies especially when there is a shut-in. There will have to be synergy between the operations team and the land admin to handle the complexities. Even if the well is producing gas and not oil it is still an operating expense to consider. Does your lease have a provision for shut-in? Or do you have a record of wells attached with leases and without them? Having a clear database will be required. If you have already opted for automation, there will be no sleepless nights.

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