Royalty Audit OUTLINE Types of Audits Difference between Field and Desk Audits Pre-Audit Audit Timeline Initial Contact Audit Challenges Common issues that can lead to an audit Common issues when conducting an audit Deductions

Goals of the Audit Working together with industry to ensure that all beneficiaries receive their fair share of royalties. Who are our Beneficiaries? Hospitals, Common Schools, and Universities…. Beneficiaries are defined by the type of Lease Compliance with Lease Terms Customer Education/Support Goal is to audit 80% of our royalties in 4 to 5 year cycles

Both Field and Desk Audits follow the same pre-audit procedures. Types of Audits Field Audit Scope large enough to warrant travel to the company Auditors on site for one or two weeks Desk Audit Company identified through a prior field audit on another company. Scope not large enough to warrant travel to the company Letter issued to company reporting audit findings as well as any schedules to support audit findings. Both Field and Desk Audits follow the same pre-audit procedures.

Time Line Pre-Audit One to three weeks Field Work One to two weeks Post Audit Two to four weeks

Pre - Audit Scope Selection Volume Review Review volumes reported on the C-115 and Severance Tax returns to volumes reported on the OGR2 Value Review Review of gross/net values reported to the New Mexico Taxation and Revenue Department to gross/net proceeds reported to the New Mexico State Land Office. W/H Price Review (Comparison to other remitters and other properties in same field or area). Deduction Review (% of Gross Proceeds, comparison to other remitters and other properties in same field or area).

Pre - Audit Unit/Communitization Agreements Review Review all Unit and State Communitization agreements on file with the New Mexico State Land Office. Compare tract allocations to remittance percentages Approximately 70% of royalties that the SLO collects are from Unit or Communitization properties.

Volume Comparison Volume Comparison Report

Value Review POSSIBLE AUDIT EXAMPLE 1.) Tax remitted price $2; royalty remitted price $2.67. 2.) Tax remitted price $2; royalty remitted price $2. Results: 1.) Volumetric discrepancy with no audit finding 2.) Volumetric discrepancy with audit finding Cause: 1.) Royalty return, -0- mcf reported on product code 7 line 2.) Various

Initial Contact The Auditor will contact the Company to inform the Company that they have been selected for audit and to develop a schedule of tentative field audit dates. Engagement Letter Objective of the audit Number of auditors Request for sample package Confirmation of field audit dates Attachments Listing of documents to made available for review

Field Audit Testing Closing Conference Field Work Opening conference Explanation of tests Business practice questions Sample packet questions System walkthrough Testing Volume, proceeds, deduction Closing Conference Explanation of tests performed Explanation of findings Questions/concerns

Issue letter Report Contents Audit Schedules Post Audit Indicated the completion of the field audit Deadline for response (30 days). Instruction on amendments Report Contents Company Information System summary Audit procedures performed Conclusion Audit Schedules Summary of Exceptions Detailed audit schedules

Affiliated Sales & Midstream Costs Audit Challenges Unit Accounting P/A Wells N/P Wells Unit/Com Wells Consent/Non-consent Wells CPD’s Settlement statements Allocation spreadsheets Netback Pricing Supply pools WASP calculations Affiliated Sales & Midstream Costs Tracing – First Arm’s length Sale Reasonable Costs (Actual Cost + ROI)

Reporting to Incorrect PUN(s) Audit Challenges Takes vs. Entitlements Uniform Land Owner, Royalty Rate, & Beneficiary Reporting to Incorrect PUN(s) Suspended money Volume comparison imbalances Operator Changes Effective dates of royalty burdens

Reporting: Value & No Volume, Incorrect Pressure Base Audit Challenges Reporting: Value & No Volume, Incorrect Pressure Base Volume comparison imbalances NM standard pressure base = 15.025 Product Code 7 reporting = Wellhead Mcf – Residue Mcf

Deductions Allowable Post production costs to make the product merchantable Non Allowable New Mexico Gas Processors Tax Low Volume Fees Penalties Marketing fees Any other costs not incurred to make product merchantable

Angela Romero - Audit Manager Royalty Audit Angela Romero - Audit Manager (505) 827-5863 aromero@slo.state.nm.us Melissa Chavez Royalty Auditor (505) 827-5740 mchavez@slo.state.nm.us Carmen Mora Royalty Auditor (505) 827- 5727 cmora@slo.state.nm.us James Romero Royalty Auditor (505) 476-4570 jromero@slo.state.nm.us