ORGANIZATIONAL STRUCTURE OF AN E&P COMPANYLike all enterprises, exploration and production (E&P) companies implement organizational structures to meet their needs. The structure establishes how authority is delegated and provides accountability in operations. Financial procedures, as well as the flow of paperwork, directly follow these lines of responsibility.Petroleum accountants should become familiar with the roles and functions of various departments within an E&P company. Such information is obtained by experience and inquiry, and by reviews of organization charts and company operating manuals.One important aspect of an organizations structure is the system of internal controls.This chapter discusses the source of internal control standards and suggests ways to assess and quantify risks.Organizational structures of companies in the petroleum industry vary widely. Much depends on their size and diversity of activities. Oil and gas producers are classified as either independents or integrated companies. Independents are typically viewed by the public as small companies with few employees, while integrated companies are thought of as the giants. In practice, however, several large oil companies have no refining or marketing operations, and some integrated companies are small in size.The size of a company and its degree of integration often determine the type of structure utilized. Geographical dispersion of activities is a factor also. It makes sense that an E&P company operating in a single region would have closer managerial control from its top officials. When operations expand geographically, top management can look to regionaland district managers to exert local control. The home office role becomes one of managing overall company activities. Similarly, an integrated company requires a greater degree of delegation of authority and responsibility from top management to those directly involved in its diverse operations.

SUMMARY OF KEY FUNCTIONS IN SMALLER E&P COMPANIESSmall and medium-sized oil and gas companies have much in common, especially at the executive level. Four distinct activities are represented in almost all producers: Exploration Marketing Drilling and production Administration

The organization chart in Figure 3-1 reflects this basic structure. (It should be noted that some companies have recently modified their approach by creating multidisciplinary teams of geologists, petroleum engineers, accountants, and other specialists to manage assigned fields or geographic areas of operations.)Typically, the president of a small oil and gas company is a petroleum engineer, geologist, or geophysicist who not only serves as CEO, but may also direct the exploration, development, or production activities. Small company CEOs may negotiate joint venture agreements, major property acquisitions and divestitures, and financing arrangements.The exploration department has the job of locating and acquiring oil and gas reserves.This includes obtaining mineral properties and conducting geological and geophysical (G&G) exploration, either through the use of company-owned equipment and personnel, or through contracts with exploration support companies. Many E&P companies, even very small ones, have one or more geologists on staff; most companies also hire outsideprofessionals or organizations to provide G&G services.The drilling and production department (or petroleum engineering department) is responsible for exploratory drilling, development drilling, enhanced recovery operations, and field production.Arranging the sales of produced oil and gas is the role of the marketing division. U.S. crude oil is usually sold near the well site. Natural gas is frequently sold to large gas consumers and utilities located far from the lease. Under this arrangement, gas pipelines provide transportation services.Various general office functions and stakeholder relations are handled by the administration department. It oversees human resources, finance, accounting, tax compliance, management information systems, public relations, and legal services. The vice president of administration may serve as the vice president of finance and chief financial officer (CFO). Some companies break these functions into separate departments,such as a finance department headed by the CFO, and have sub-departments for treasury, accounting, and taxation.

EXPLORATION DEPARTMENTThe exploration department is responsible for locating and acquiring properties that may contain oil and gas, conducting G&G studies, and in some cases, supervising the drilling of exploratory wells. Work of the exploration department is delegated to several sections as demonstrated in Figure 3-1. A brief description of the roles of each section follows.Geological and geophysical (G&G). The G&G division accumulates and analyzes geological and geophysical information that helps to decide:If leases should be obtained in an area of interest, and Whether exploratory wells should be drilled and in which locations.Land. Land departments have two major functions: (1) acquiring mineral properties, and (2) maintaining records of properties owned. As shown in Figure 3-1, the work is carried out by two divisionsthe land and lease acquisition section and the title and records section.The manager over the land department is called a landman. This term refers to a person who is responsible for identifying and locating mineral rights owners and negotiating leases. Landman also refers to an independent lease broker. Land departments may use independent lease brokers familiar with a particular state or region to represent the companyin negotiations with owners of mineral and surface rights and to check local title records.The land and lease acquisition section is responsible for contacting landowners and other mineral rights owners to obtain leases or other mineral rights. It advises exploration department managers on leasing activities and secures pooling and unitization agreements with lessees of properties adjoining the companys leases. The title and records sectionchecks all new leases for legal propriety, maintains a complete file for all properties, and ensures the timely payment of all lease rentals as authorized.

DRILLING AND PRODUCTION DEPARTMENTThe overall objective of the drilling and production department is to manage the companys wells and production operations in a safe manner. This group seeks to maximize production value while complying with applicable government regulations.It is often called the petroleum engineering department, and its anagement and core personnel are typically petroleum engineers.Larger companies may group petroleum engineers into categories such as exploitation engineers, reservoir engineers, and production engineers:Exploitation engineers address how to best exploit a field via drilling andenhanced recovery methods. They prepare or review justifications for drilling expenditures and advise on technical phases of exploitation, completion, fluid recovery, and remedial work.Reservoir engineers study oil and gas reservoir performance, calculaterecovery and profitability, and devise means of increasing ultimate recovery.Internal reports of estimated reserves by well, field, region, and company are prepared. They also work with independent engineering firms that produce independent reports of the companys reserves.Production engineers are concerned with the everyday management ofproducing fields, including drilling, well completion, production handling andtreatment, and equipment selection and design.Drilling operations. In most cases, an E&P company contracts its drilling operations to outside drilling contractors rather than maintaining its own equipment. It is not unusual, however, for the owners of a producing company to organize and operate a drilling company independent of the producing company. In this case, the drilling superintendent is responsible for all drilling activities including the oversight of rigs, tools, and equipment.Production operations. A typical oil and gas producing company has a production foreman or manager for each field. There are also pumpers or gaugers who measure and control production. Maintenance, infrequent repairs, and mechanical tasks are often carried out by specialist subcontractors.Enhanced recovery. Some companies distinguish between the routine operation of fields where normal reservoir pressure drives oil and gas into the wells, and those that supplement reservoir pressure to increase production. Enhanced recovery includes secondary recovery methods, such as water flooding, and tertiary recovery methods, such as steam flooding. Because of their technical natures and the extremely high costsinvolved, secondary and tertiary projects require special attention and supervision.Productive property purchases and sales. A separate department often handles the buying and selling of property with proved reserves (proved property). In some cases, the duties may be assigned to the production department since petroleum engineers are key to evaluating potential acquisitions and sales of proved property.Other department functions. Many support activities are necessary to efficiently operate an oil or gas company. For example, materials needed in the field are warehoused and trucks and other forms of transportation must be available. Field clerks are assigned to carry out routine functions such as correspondence and payroll. Although supervised by a production manager, field clerks are frequently under the functional supervision of theadministrative department of the company.

MARKETING DEPARTMENTDepending on the organization and size of the company, oil and gas are sold through one or more marketing departments or subsidiaries. Close coordination is required between marketing, production, and administration departments.Oil marketing. Oil marketing is in a mature stage, especially when compared with natural gas sales. For over a decade, no structural changes have been made in the way oil marketing is done. Generally, oil is marketed under 30-day contracts and sold at the lease site at wellhead prices posted (publicized) by the oil purchaser or a major oil company.Natural gas marketing. Many changes have occurred in recent years in how natural gas is sold. Historically, natural gas and casinghead gas (gas produced along with crude oil) were marketed to pipeline companies, which then sold the gas to others. Today gas is marketed by producers, large and small, to many types of gas customers (other than residential).

ADMINISTRATIVE DEPARTMENTIn an independent oil and gas company, the administrative department encompasses a variety of activities and may consist of a number of divisions, sections, or offices as shown in Figure 3-1. The administrative structure of an E&P company differs little from those found in other types of businesses. Accounting functions related to oil and gas companies are discussed briefly in the next section (see Figure 3-2).

ORGANIZATION OF THE ACCOUNTING FUNCTION

FIELD CLERICAL SERVICES Trains and supervises clerical personnel assigned to field operations Develops systems, forms, and procedures for field accounting and reporting

EQUIPMENT AND SUPPLIES INVENTORY Maintains equipment and supply inventory records Prices and records warehouse receipts, issues, and field transfers Oversees physical inventory taking Prepares reports on equipment and supplies inventory

ACCOUNTS PAYABLE Maintains accounts payable records Prepares vouchers for disbursements Distributes royalty payments Maintains corporate-delegated limits of authority and verifies thatdisbursements are made within those limits

PROPERTY ACCOUNTING Maintains subsidiary records for: Unproved properties Proved properties Work in progress Lease and well equipment Field service units Accounts for property and equipment acquisition, reclassification, amortization, impairment, retirement, and sale Compares actual expenditures of work in progress to authorized amounts

JOINT INTEREST ACCOUNTING Maintains files related to all joint operations Prepares billings to joint owners Reviews all billings from joint owners Prepares statements for jointly operated properties Prepares payout status reports pursuant to farmin and farmout agreements Arranges or conducts joint interest audits of billings and revenue distributions from joint venture operations Responds, on behalf of the company, to joint interest audits by other joint interest owners

REVENUE ACCOUNTING Accounts for volumes sold and establishes or verifies prices reflected in revenues received Maintains oil and gas revenue records for each property Maintains records related to properties for purposes of regulatory compliance and production taxes Computes production taxes Maintains Division of Interests (DOI) master files with guidance from the land department as to revenue allocations among the company, royalty owners, and others Computes amounts due to royalty owners and joint interest owners and prepares related reports Invoices purchasers for sales of natural gas Maintains ledgers of undistributed royalty payments for owners with unsigned division orders, owners whose interests are suspended because of estate issues, and other undistributed production payments Prepares revenue accruals

GENERAL ACCOUNTING Maintains the voucher register, cash receipts and disbursement records, and general ledger Prepares financial statements and other special reports Assembles budget information; prepares budgets and budget reports

TAXES AND REGULATORY COMPLIANCE Prepares required federal, state, county, and local tax returns for income taxes, production taxes, property taxes, and employment taxes Prepares other regulatory reports as required Addresses allowable options for minimizing taxes

INFORMATION SYSTEMSE&P information and accounting systems vary in the type of technology utilized. System platforms may be mainframe, mid-size, or desktop computers, and several third-party software packages are available.An E&P information system typically employs a master file of divisions of interests known as a DOI file. This file reflects how revenues and costs are to be shared for each well or other accounting unit for a designated time period, usually several months or years. The land department is typically responsible for maintaining the accuracy and completenessof the DOI file. Departments that use the file include property, payables, revenue, and joint operations accounting.A revenue information system must also encompass a means of distributing the incoming sales proceeds to appropriate owners, such as the company, joint venture partners, royalty owners, and production taxing authorities. The purchasing component of the system will include functions for distributing costs to appropriate parties, such as the company andjoint venture partners. Thus, the revenue system must account for incoming cash as well as outgoing distributions of such revenue, and the purchasing system must account for the outgoing cash for purchases and the billing to other parties for their rightful shares of such costs.The E&P information system and its chart of accounts are complicated by the need to account for:Revenue and cost DOI at a well or smaller levelTax accounting that varies from financial reportingEach well and each fields gross revenues and cost activity for management review and their net revenues and costs to the company for external reporting The typical IT expenditure for a small E&Pcompany is $1 million - with 49% on exploration IT, 23% on productionand 28% on administrative activities.... A very large E&P company wouldtypically commit to $37 million of IT expenditure per annum - split 36%on exploration, 32% on production and 32% on administration.

GENERAL ACCOUNTING STRUCTURE OFAN INTEGRATED COMPANYThe organizational structure for an integrated oil companys accounting department includes several corporate accounting sections as well as functional accounting sections as shown in Figure 3-3.

Organization of accounting activities in the production division is similar to that of an independent producing company. Figure 3-4 shows a modified organization chart of the accounting department in the production division of an integrated company.

INTERNAL CONTROL FRAMEWORKAs for many enterprises, internal controls are important to an E&P company. A report called the Internal ControlIntegrated Framework (commissioned by the Committee of Sponsoring Organizations of the Treadway Commission) documented the internal control framework standard to be followed. Known as the COSO Report1, it defined internalcontrol as: a process, effected by an entitys board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: Effectiveness and efficiency of operations, Reliability of financial reporting, and Compliance with applicable laws and regulations.The report made it clear that internal control is not a back-room function relegated to internal auditors. Instead, it should be a process that involves employees at every level of the organization. The controls play a role in meeting a companys overall objectives, such as increased profitability from greater efficiencies.The framework addresses three hazards if internal control objectives are lacking: Possible material misstatement(s) of financial statements Possible reduction(s) in the effectiveness and efficiency of operations Possible violation(s) of laws and regulationsThe following five components of internal control are outlined in the COSO report:1. The control environment2. Risk assessment3. Control activities4. Information and communication5. Monitoring

Control environment. The control environment sets the tone for an organization and influences the control consciousness of its people. It is the foundation for all other components of internal control because it provides discipline and structure. Control environment factors include the integrity, ethical values, and competence of the entitys people; managements philosophy and operating style; the way management assigns authority and responsibility, and organizes and develops its people; and the attention and direction provided by the board of directors.

Risk assessment. Risk assessment is the identification and analysis of current and future risks faced by an organization. Management must identify and analyze risks, quantify them, and project their likelihoods and possible consequences. How much risk is considered tolerable and at what costs are decisions to be made at the executive level.The following example addresses a companys risk tolerance for fluctuations in oil prices.With oil selling for $60 per barrel, the management group of ABC Petroleum expects prices to rise. However, the company recognizes it could not survive if prices fell below $20 and the two-year outlook remained in that range. Despite an expectation of rising prices, management may decide to use derivatives (discussed in Chapter 33) to hedge against falling oil prices. The derivatives cost may be in the form of cash (via purchaseof a put option) or in foregoing gains from price increases (via derivative instruments that create a price floor and a price ceiling).Managers of E&P companies should set clear objectives and understand the risks in their areas. In too many cases, risk evaluations are done informally and controls are assumed to be adequate. One tool designed to help document organizational risks is a risk matrix. It lists major business components or processes across the top axis and related major risksdown the left side. Once the risks are identified within the matrix, they can be evaluated as to the probability of occurrence and potential impact on the company.

Control activities. Control policies and procedures to minimize identified risks are established and executed in accordance with managements objectives.Information and communication. Information and communication systems must be implemented by the company to support its risk management activities.Monitoring. Internal control processes should be monitored and modified as necessary to allow the internal controls to respond to a changing environment.13