1. The Carve-Out Methodology to Unbundling
PASO Federal & Indian Royalty
Compliance Conference
The Carve-Out Methodology to Unbundling
Bob Wilkinson February 9, 2017 1

2. 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.

3. PURPOSE
At the end of this presentation, the attendee will understand the concept and benefits of unbundling their own transportation and processing contracts using the “Carve-Out Methodology.”

4. Keep in mind
When unbundling 3rd Party systems, whether you use ONRR’s UCA or you unbundle, it is still just an estimate.

5. Carve Out Methodology
Unbundling method most consistent with the federal regulations:
Allows all transportation costs (within 50% cap)
Allows all processing costs (within 66.67% cap)
CFR (f)(9) - Supplemental costs for compression, dehydration, and treatment of gas. ONRR allows these costs only if such services are required for transportation and exceed the services necessary to place production into marketable condition required under §§ (i) and (i) of this part.

6. Carve Out Methodology Unbundling method most consistent with case law:
Phillips IBLA
Mobil IBLA
Exxon IBLA
Shell IBLA
Devon Valuation Determination & ruling
Amoco vs Watson ruling

7. Carve Out Methodology Easiest/least costly unbundling method
Most engineering supportable method
Most accurate unbundling method
Does not result in placing gas into marketable condition twice or three times
Only disallows costs associated with placing gas into marketable condition
Calculates marketable condition for “your” gas
Uses replacement vs book value

8. Carve Out Methodology Process
Marketable condition is mainline pipeline specs for:
Compression
Dehydration
CO2 Removal (unless CO2 is being sold);
Sulfur Removal (unless sulfur is being sold)
Costs/fuel used to meet marketable condition is to be provided free of cost to the government
All other costs/fuel used for transportation or processing that exceed the services necessary to place the residue/ngls into marketable condition are deductible

9. Carve Out Methodology Process
Allocate services to the following functions:
Transportation
Processing
Meet mainline requirements (per ONRR regulations and case law)
Considers “function or purpose” of equipment regardless of location within the system.

10. ARMS-LENGTH THIRD PARTY TRANSPORTATION/PROCESSING SYSTEM
BOOSTING
COMPRESSION
CRYO UNIT
ARMS-LENGTH THIRD PARTY TRANSPORTATION/PROCESSING SYSTEM
100 psig
400 psig
375 psig
750 psig
PLANT INLET
RESIDUE
COMPRESSOR
700 psig
900 psig
(Royalty Measurement CDP Point)
COMPRESSOR TWO
COMPRESSOR ONE
7# H2O
2% CO2
300 psig
COMPRESSOR FOUR
600 Psi processing
25 psi tran
COMPRESSOR THREE
50 psi tran
GAS PLANT PROCESSING
GAS MAINLINE TRANSPORTATION
FIELD GATHERING SYSTEM

11. 700 psig

12. DEHYDRATION
Field dehydration is to protect the pipe going to the plant and minimize system maintenance (pigging, freezing)
Dehydration at the Plant after the amine unit is to get the gas into mainline pipeline specs and to allow cryogenic processing
Dehydration below mainline pipeline specs is for processing

13. WELLHEAD CONDITIONS
MAINLINE
SPECIFICATIONS
COSTS TO BE
CARVED-OUT
H2S: < .25gr/100/cf
CO2: 3.0%
H20: 40 lbs/mmcf
Pressure: 100 psig
H2S: .25gr/100/cf
CO2: 2%
H20: 7lbs/mmcf
Pressure: 700 psig
H2S: None
CO2: Amine Treater
H20: Glycol Dehydrator
Pressure:
Field compression
100 psig to 300 psig
Plant Recompressor psig to 700 psig
Compares composition/pressure of the gas at the wellhead to the mainline requirements at the plant tailgate to identify equipment needed to meet mainline pipeline specifications

14. Carve Out Methodology Determine Costs for Marketable Condition:
Uses public information for that plant/system
Uses published industry/engineering standards for:
Operating costs
Capital costs
Fuel requirements
Uses time-specific published standards indexed to the appropriate time period
Adjusts for oversizing; parasitic load; liquids lost; location; elevation; specific gravity; etc.

15. Carve Out Methodology Determine Costs for Marketable Condition:
Adds return on investment of marketable condition equipment
Adds required fuel to run equipment used for placing gas into marketable condition

16. Carve Out Methodology
The costs associated with placing the gas & ngls into marketable condition are then monetized
The disallowed transportation and/or processing costs are then carved out of the total transportation and processing costs, leaving only the allowed costs as a deduction on the ONRR-2014

17. What are the Benefits of using the carve-out methodology?

18. Benefits
Reduces data needs from 3rd Parties:
300-6,000 miles of pipe – 2” to 36”
1-30 field/straddle compressors - company operated and/or 3rd party – Gas or Electric
Field/Plant dehydrators – glycol/mol sieve
Amine/Glycol treating
Inlet/Residue compressor/s
Turbo Expander/Demethanizer
NGL Treating/Dehydration/DeEthanizer
Vintage of equipment/Replacement cost
Interim gas quality measurements

19. Benefits (continued)
Marketable condition equipment & related fuel requirements are easier to calculate:
CO2: Amine Treater
H20: Glycol Dehydrator
Field compression psig to 300 psig
Plant Recompressor psig to 700 psig

22. Benefits (continued)
Doesn’t require tracking gas quality throughout the transportation system or plant:

23. Benefits (continued)
More accurate than other unbundling methods:
Eliminates need to identify costs of every piece of equipment used in the system
Eliminates need to identify the costs of the more complex portions of the transportation system and plant
Calculates the marketable condition costs applicable to your gas
Does not require you to compress or dehydrate gas more than once

24. Benefits (continued)
Less likely to overstate costs to place gas/ngls into marketable condition
Total Marketable
Condition Costs = 95% = % overstatement
Total System Costs 80%
Condition Costs = 95% = % overstatement
Total System Costs 90%

25. Items to note:
Use actual data on company operated plants and systems
If negotiated 3rd party rate is for an old system that is below market (cost of service vs market rate) or has decommissioned/obsolete equipment, you may be carving out too much
On 3rd party systems, no matter which method you use, it is still just an estimate:
ONRR’s Published UCA
Full System Unbundling
Carve-Out

26. ONRR Challenge:
During the comment process for the new Federal Oil & Gas Valuation Rule, ONRR requested comments for “potential for creating standardized “schedules” for transportation & processing allowances
COPAS responded they were interested to discuss the possibility of ONRR creating standardized tables which could be used to identify the disallowable component costs for compression, dehydration, CO2 & H2S removal

27. ONRR Challenge:
At February 2012 meeting with API & ONRR, a suggestion was made for ONRR to simply calculate a fee per mmbtu for compression & dehydration that the lessee could reduce their transportation or processing fee by
The Deputy Director said they look forward to the proposal

28. ONRR Challenge:
Similar to ONRR’s new Index valuation methodology, ONRR calculates the “carve-out” amounts and posts on their website:
Various levels (field/residue) of compression
Related fuel requirements
Field Compression
$/mcf or
mmbtu
Fuel
100 psi
$0.020
0.50%
200 psi
$0.035
1.00%
300 psi
$0.060
1.25%
Residue Compression
$/mcf or
mmbtu
Fuel
300 psi
$0.030
1.00%
400 psi
$0.050
1.25%
500 psi
$0.060
1.50%

29. ONRR Challenge:
ONRR calculates the “carve-out” amounts and posts on their website:
Dehydration
Treating (CO2 Removal)
Related fuel requirements
Dehydration $/
mmbtu
Fuel
Glycol
$0.020
0.05%
Mol Sieve
$0.025
0.25%
Treating
(CO2 Removal) $/
mmbtu
Fuel
Remove 0.5%
$0.020
0.20%
Remove 1.0%
$0.040
0.40%
Remove 1.5%
$0.050
0.50%