Accounting, Awareness, Clarity & Inconsistency Issues Federal Oil & Gas Valuation - Final Rule Accounting, Awareness, Clarity & Inconsistency Issues Bob Wilkinson February 8, 2017 1 1

DISCLAIMER This presentation only reflects the views of the author/presenter and is not intended as legal, tax or accounting advice. Each recipient should solicit their own legal, tax or accounting counsel with respect to any of these issues.

PURPOSE At the end of the presentation the attendees will understand industry’s main issues and concerns associated with the Final Federal Oil & Gas Valuation Rule.

Final Rule – Oil & Gas Valuation Topics: Industry/COPAS comments/ONRR Training Eliminates/Caps actual transportation and processing costs “Misconduct” & “Default Provision” Sales Type Code Contracts must be written & signed S&P BBB Bond rate No netting of “Transportation Factors” Keepwhole Contracts Index Pricing Option

Final Rule – Oil & Gas Valuation Industry/COPAS Comments: Industry comments did not have much impact to the final rule Several of COPAS’s comments have been addressed in ONRR’s training ONRR training slides are included in your handouts and are an excellent resource

Final Rule – Oil & Gas Valuation Transportation and Processing Costs Eliminates/Caps Some Transportation and Processing Costs Eliminates Subsea transportation Eliminates ability to exceed the 50% transportation cap Eliminates ability to exceed the 66.67% processing cap Eliminates extraordinary processing allowance POP contracts now subject to 66.67% processing cap

Final Rule – Oil & Gas Valuation Definition for “Misconduct”: Does not have to be done willfully, intentionally, voluntary or knowingly Enables ONRR to invoke Default provision

Final Rule – Oil & Gas Valuation Default Provision: To be used when: Failure to provide documents; ONRR unable to determine value; Misconduct (broad); or Breach in duty to market; Will primarily be used during an audit You still have the right to appeal an Order Very broad on when ONRR can invoke and how they can revalue your royalties

Final Rule – Oil & Gas Valuation New reporting requirements: Sales Type Code (STC): Field fuel (PC15) Pre 1/1/2017 STC was NARMS Beginning 1/1/2017 use code associated with valuation basis NGL’s (PC7) Pre 1/1/2017 STC was POOL Most likely no ONRR edit check (yet)

Final Rule – Oil & Gas Valuation All Contracts must be written & signed “Failure” to provide a contract or documents is “misconduct” subject to default provision “Refusal” to provide contracts other information may be subject to civil penalties for “Failure to permit an audit” Positive - If company is unable to find 3rd party contract, ONRR now has way to determine royalty value Industry practice that not all contracts are written or signed

Final Rule – Oil & Gas Valuation Transportation Deductions: Reduces 1.3 multiplier on Standard & Poor BBB Bond rate (drops to 1.0 multiplier) Initially S&P BBB Bond rate was no longer available on ‘ad hoc’ extraction basis Due to numerous calls, S&P providing again: Roberta Sander Lead Product Support Consultant T: 1-800-523-4534, Option 2 Roberta.sander@spcapitaliq.com

Final Rule – Oil & Gas Valuation No Netting of Transportation Factors In the final rule preamble and ONRR’s training, ONRR says you must report a reduction in the base price by the transportation costs incurred by the purchaser in your transportation allowance New regulations only say you can not “improperly net a transportation allowance” New regulations only allow a transportation allowance for reasonable, actual costs that you or your affiliate incur FRN 7/1/2016 p. 43344

Final Rule – Oil & Gas Valuation No Netting of Transportation Factors - NGLs Transportation factors must be reported as transportation allowance Fractionation fees must be reported as processing allowance Marketing costs are not deductible Not all contracts/settlement statements provide this T&F information Factors must be split in “reasonable” manner

Final Rule – Oil & Gas Valuation No Netting of Transportation Factors - Oil Sales contracts will be accepted as support for transportation factors Location and quality differentials can continue to be netted Marketing costs are not deductible Knowing whether a location/marketing differential is simply a pricing mechanism or reimbursement for the purchaser’s transportation costs is difficult/impossible

Final Rule – Oil & Gas Valuation Keepwhole Accounting Issues  Lessee does not usually have information to value in manner instructed by ONRR Lessee only paid on mmbtu basis ONRR training materials say “If you do not sell any liquids from the lease you must use the index method” for the ngls

Final Rule – Oil & Gas Valuation Inconsistent Handling (volumes not sold): Field fuel - value using the same valuation method used for valuing the rest of your gas Keepwhole valuation - ngls – if you sell any ngls from the lease use that value, otherwise use index value Royalty bearing vented, flared or avoidably lost volumes - value using index; if not in an index zone, ONRR will value under the default provision

Final Rule – Oil & Gas Valuation Inconsistent Handling: 1206.142(e) – used, lost, unaccounted for, or retained as a fee – you should use the same value as the gas you sell 1206.142(f) – no written contract for sale of gas or no sale of gas subject to this section – use index or if no index, ONRR will use the default provision If you sell other volumes from that lease, you should be able to use that value for vented, flared or avoidably lost

Final Rule – Oil & Gas Valuation Index Pricing Option Applies to only non-arms-length sales. Election can be made at a property level Must use the highest index, even if your gas cannot contractually flow on that pipeline You must also value and pay royalties on all used or lost gas along a pipeline volumes and any disallowed plant fuel

Final Rule – Oil & Gas Valuation Index Pricing Option Standard Transportation/Processing Deducts Don’t know when ONRR will adjust Standard NGL deduction (based on average) Does not include theoretical transportation allowance to get NGLs to the plant

Final Rule – Oil & Gas Valuation Valuation Guidance versus Determinations Distinguishes between the two More companies may now want to seek valuation guidance

Final Rule – Oil & Gas Valuation Questions?

Final Rule – Oil & Gas Valuation Question How are the transportation (50%) and processing (66.67%) caps to be applied in the following example: Sales Price - $2.00/gallon Field Transportation - $0.20/gallon Processing (includes fractionation netted by purchaser) - $0.50/gallon Post Plant Transportation (includes any transportation netted by purchaser) - $0.10/gallon