OIL AND GAS ACCOUNTING

PRODUCTION SHARING CONTRACT

1. The Western Fields Oil Company is a 35% partner in the Eastern Fields license. There has been a discovery on the license that been proven tom be commercial. However, Western Fields is heavily committed to the development of another field and does not have the finances to fund the development of this field at the present time. The Operator (Southern Fields) is very keen to proceed with a development as soon as possible and has offered to carry The Western Fields through the development of the field. The Western Fields will reimburse Southern Fields for the costs paid on their behalf by assigning a percentage of their interest to Southern Fields until the carry has been repaid. The full details of the carry arrangement are as follows; a. Southern Fields will pay Western Fields's 35% equity share of total development costs. b. When production from the field starts, Western Fields will assign 70% of their equity interest to Southern Fields until the debt has been repaid in full. c. The amount of the debt repaid shall be the actual realized price of the oil attributable to assigned interest less the average production costs per barrel, calculated on an annual basis. (That is to say, the net profit on the barrels assigned by Western Fields to Southern Fields). d. Southern Fields will pay the production costs directly associated with the assigned barrels. e. During the period when the carried interest is being repaid, Western Fields will retain 30% of his equity interest in the production from the field and will pay the costs directly associated with this production. f. When the debt has been repaid in full, Western Fields will be entitled to their full equity interest and Southern Fields will have no further claim on Western Fields. g. Any unpaid carried amount at the end of each year after taking the assigned revenue will attract interest at the rate of 6% per annum. A full year's interest is to be paid at the end of the year on the outstanding balance after offsetting the assigned net revenue. By agreement interest charges will start accruing from the end of year 2 h. Shouldtherevenuesfromthefieldfailtobesufficientfortherepayment of monies paid by Southern Fields on behalf of Western Fields, then Southern Fields will have no claim against Western Fields for any balance that may be outstanding. i. Based on the lifting schedule Western Fields only lift once in a year and the revenue from the sale of the product is only realized at the end of his financial year which is 31st December j. Western Fields's bankers have approached him to finance his share of the development and production costs at an annual interest rate of 5% for the same 70% revenue to be assigned until the debt is fully paid. k. Western Fields is expected to pay an arrangement fees at a rate of 0.3% on all facilities up to $ 1 billion dollars. Any financing in excess of this amount will attract an arrangement fees of 0.2%. l. Based on the offer from the bankers' arrangement fees payable by Western Fields will be accrued at the beginning of year one and interest charges would start accruing at the end of year one. m. Assume all annual development and production cost are to be paid in advance at the beginning of January. n. The following are additional data relating to the field. All figures are in thousands of dollars, except for oil price.

Year Capital Operating Production Oil Price Expenditure Costs (Mmbbls)

1 280,000 2 450,000

3 337,500

4 225,000 92,000 31,000 37

5 105,000 36,000 39

6 108,580 41,000 43

7 104,000 45,000 45

8 99,800 41,500 47

Required: 1. Calculate when the carry will have been repaid 2. Western Fields's yearly net cash flow in the period in which the Company was carried and the period after it was carried.

3. As a Finance Director for Western Fields, would you advise him to opt for the bank financing? What will be the gain or loss if he opts for the bank financing instead of being carried by Southern Fields. Demonstrating this by showing the yearly bank financing, repayment amounts and the net cashflows

Helpful hint: In the year in which the carry is finally repaid, it is advisable to calculate the profit per barrel (oil price minus the average production cost per barrel) and the divide the amount owing by the profit figure in order to derive the number of barrels needed to repay Southern Fields. Once these barrels have been handed over, the carry has been repaid and all other barrels relating to Western Fields's 30% remains with Western Fields.