Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Six – The awkward squad
2.3 Oil company tax: Productions Sharing Agreements
Only in a relatively small number of countries do oil companies have title to the
oil that they produce, paying tax on the profit from extraction. These include the
USA, Canada, the UK, Australia, New Zealand and Norway, but they remain a
minority. Most oil production occurs under so-called production sharing
agreements (PSAs) or production sharing contracts (PSCs).
Under these agreements, the oil company has a contract entitling it to develop the
field. Early cash flows are used to reimburse its capital expenses (cost oil) and the
balance is split between the host state oil company and a smaller proportion that
accrues to it (profit oil). There are large numbers of variations on this basic theme.
Accounting for PSAs is complex. The company will book as its equity reserves
the proportion of the gross recoverable barrels that it expects to accrue to it as
cost or profit oil. Its turnover and profit will be high early in the life of the field,
but once payback has been reached, both will drop into line with its percentage
entitlement to profit oil, which will be much lower. Changes in oil prices will
have the perverse effect of changing depletion charges because a higher price
reduces the proportion of the oil that will accrue to the oil company as cost oil,
increasing its depletion charge per barrel.
Measures of company reserves and of its replacement cost of reserves must
therefore be constructed carefully to ensure that it is net entitlement barrels that
are counted in both cases. Tax rates will look very odd, since most of the state
tax-take is removed before the revenue line in the profit and loss account.
2.4 Oil company accounts: interpretation and modelling
For this section of the book we are going to break with our usual concentration
on IFRS accounting, and will model an operation that reports under US GAAP.
This is because all of the large international oil companies have their shares listed
on the New York stock market. They all file form 20Fs every year. And it is to
the form 20F that anyone who is interested in modelling them will go for detailed
information on their upstream (exploration and production) businesses. We will
however, refer to some IFRS driven accounting changes later in the chapter.
As discussed earlier, we shall concentrate merely on upstream operations, since
the downstream is similar to any capital intensive, cyclical industry. The US
GAAP requires that companies with upstream activities account for them
separately, and provide the following information: a profit and loss account, a
statement of capitalised costs, information about costs incurred during the year, a
statement of reserves with the components of movements in reserves, a discounted
net present value of the year end reserves, and a statement showing the drivers to
annual change in the discounted net present value of the year end reserves.
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