1. Percentage-of-Proceeds Contracts for Federal Production
Prepared by: Jeremy Norton
PASO Conference
February 2019

2. Disclaimer
Any opinions expressed in this presentation are those of the author only and do not represent the opinions, views, or positions of Devon Energy Corporation or any of its affiliates. The views are not intended to be legal or accounting advice. Each recipient should solicit their own legal or accounting counsel with respect to reporting.

3. Learning Objectives
Identification of contracts that should be reported as a POP for ONRR reporting. (Reporting to states and private parties not covered.)
Learn how a POP contract gets reported on a Federal lease.
Understand some of the common issues with POP reporting on Federal leases.

4. What is a POP Contract?
A POP contract is an agreement for the sale of gas prior to processing in which the value of the wet, unprocessed gas is based on a percentage of the proceeds the purchaser receives for the sale of residue gas and gas plant products attributable to processing the lessee’s gas.1
1ONRR Oil and Gas Payor Handbook, Volume III – Product Valuation
Release date: August 1, 2000
p. 4-56

5. Federal Gas Producing Lease
What is a POP Contract?
Residue to Sales
NGLs to Sales
Condensate to Sales
Gas sold – title transferred here
Value is determined
Here
Federal Gas Producing Lease
% of Sales
Note: These are purchaser sales
Adaptation from slide 47
2015 ONRR Federal Oil and Gas Valuation Training presentation

6. How do I know if I have a POP Contract?
Common misconceptions…..
If I have a statement that says percent of proceeds at the top, it’s a POP contract.
If the contract has a percentage listed anywhere in the agreement, it’s a POP contract.
Lessee received payment for 100% of the purchaser proceeds, so it’s not a POP.

7. How do I know if I have a POP Contract?
Things to look for…..(none of these items alone makes the contract a POP agreement)
Where did the title transfer, not custody, to the lessee’s gas stream or the products it contained?
What product(s) did the lessee sell?
If it was unprocessed gas based on the value of the purchaser’s proceeds, the lessee may have a POP.
If the lessee sold residue and plant products separately, it likely is not a POP.

8. How do I know if I have a POP Contract?
Things to look for…..(none of these items alone makes the contract a POP agreement)
What’s the title on the contract?
Percent of Proceeds Gas Purchase Agreement
Wellhead Gas Purchase Agreement
Gas Purchase Agreement
The lessee is selling what appears on a statement as Residue and Plant Products to the same purchaser and there’s a percentage.

9. What’s my situation?
The Payor Handbook outlines 3 potential situations for a POP Contract on Federal leases. Two will be outlined in the slides that follow that are post and then the example will focus on arm’s-length reporting.
ONRR Oil and Gas Payor Handbook, Volume III – Product Valuation
Release date: August 1, 2000
p. 4-56

10. What’s my situation?
Gas produced on or after November 1, 1991, and sold under an arm’s-length POP contract is valued as unprocessed gas. The value is based on the gross proceeds accruing to the lessee under the contract, provided that the value for royalty purposes is not less than a minimum value equivalent to 100 percent of the value of the residue gas attributable to the processing of the lessee’s gas.
ONRR Oil and Gas Payor Handbook, Volume III – Product Valuation
Release date: August 1, 2000
p. 4-56

11. What’s my situation?
Gas produced on or after November 1, 1991, and sold under a non-arm’s-length POP contract is valued as processed gas. The value is based on the full value of residue gas, gas plant products, and drip condensate recovered downstream from the point of title transfer without resorting to processing, less appropriate processing and/or transportation allowances.
ONRR Oil and Gas Payor Handbook, Volume III – Product Valuation
Release date: August 1, 2000
p thru 4-57

12. How do I report an Arm’s-Length POP?
As unprocessed gas, product code 04 with an APOP sales type. 30 CFR (a)(1):Valuation standards – unprocessed gas. This Section applies to the valuation of all gas that is not processed and all gas that is processed but is sold or otherwise disposed of by the lessee pursuant to an arm’s-length contract prior to processing (including all gas where the lessee’s arm’s- length contract for the sale of that gas prior to processing provides for the value to be determined on the basis of a percentage of the purchaser’s proceeds resulting from processing the gas).

13. How do I report an
Arm’s-Length POP?
Example Statement

14. How do I report an Arm’s-Length POP?
Locate the information needed to determine gross proceeds.
30 CFR
Gross proceeds (for royalty payment purposes) means the total monies and other consideration accruing to an oil and gas lessee for the disposition of the gas, residue gas, and gas plant products produced. Gross proceeds includes, but is not limited to, payments to the lessee for certain services such as dehydration, measurement, and/or gathering to the extent that the lessee is obligated to perform them at no cost to the Federal Government. Tax reimbursements are part of the gross proceeds accruing to a lessee even though Federal royalty interest may be exempt from taxation. Monies and other consideration, including the forms of consideration identified in this paragraph, to which the lessee is contractually or legally entitled but which it does not seek to collect through reasonable efforts are also part of gross proceeds.

15. How do I report an Arm’s-Length POP?
Locate the information needed to determine gross proceeds.
NGL Value: $197,916.16
Residue Value: $103,680.40
Note: Both of these values are net of the POP % and any fuel and T&F Fees.
Fees: $934.44
[d]
[c]
[e]

16. How do I report an Arm’s-Length POP?
[b]
The below calculations assume that neither the POP percentage nor the fuels include costs of placing the gas in marketable condition.
If these values include any costs to place the gas in marketable condition, they should be increased to the extent that they were reduced for those costs.
[a]
[b]
[c]
[d]
[e]
[c] + [d] – [e] = [f]
Wellhead Volume MCF
Wellhead Volume MMBTU
Residue Value
NGL Value
NMGPT
Net Value
50,000.00
65,575.00
$103,680.40
$197,916.16
$934.44
$300,662.12

17. How do I report an Arm’s-Length POP?
Compare gross proceeds to 100% of the residue value.
[f]
[c]
[g]
[c] / [g] = [h]
Greater of [f] and [h]
Gross Proceeds
Residue Value
POP %
100% of Residue Value
Report Value
$300,662.12
$103,680.40
85.00
$121,976.94
[g]

18. How do I report an Arm’s-Length POP?
Calculate the implied processing cost.
Residue
[c]
[g]
[c] / [g] = [h]
[h] – [c] = [k]
Residue Value
POP %
100% of Residue Value
Implied Processing
$103,680.40
85.00
$121,976.94
$18,296.54
Note: This example assumes that the POP % is all processing cost. This may or may not be the case in reality. It’s possible that some of the POP % is for transportation. This also assumes that there are no costs included to place the gas in marketable condition.

19. How do I report an Arm’s-Length POP?
Calculate the implied processing cost.
Plant Products
[l]
[d]
[l]
[d] / [l] = [m]
[m] – [l] = [n]
NGL Value
POP %
100% of NGL Value
Implied Processing
$197,916.16
85.00
$232,842.54
$34,296.38
Note: This example assumes that the POP % is all processing cost. This may or may not be the case in reality. It’s possible that some of the POP % is for transportation. This also assumes that there are no costs included to place the gas in marketable condition.

20. Total Implied Processing
How do I report an
Arm’s-Length POP?
Compare implied processing allowance to 66 2/3% of the Plant Products value.
If the contract contains any transportation costs, the 50% cap on transportation allowances would apply as well.
[d]
[d] * 66 2/3% = [o]
[k] + [n] = [p]
Lesser of [o] and [p]
NGL Value
Processing Cap
Total Implied Processing
Implied Processing
$197,916.16
$131,944.11
$54,592.92
Note: This example assumes that the POP % is all processing cost. This may or may not be the case in reality. It’s possible that some of the POP % is for transportation. This also assumes that there are no costs included to place the gas in marketable condition.

21. How do I report an Arm’s-Length POP?
Assume lessee has a CA and a BLM lease covers 50% of the CA with a 12.5% royalty rate.
The above calculations assume that neither the POP percentage nor the fuels include costs of placing the gas in marketable condition.
[a] * 50%
[b] * 50%
[f] * 50% = [r]
[r] * 12.5% = [s]
[t]
[u]
[s] – [t] – [u]
ONRR
Prod
Code
Sales Type
Trans
ONRR Gross Volume
MCF
Gross
MMBTU
Sales
Value
Royalty
Prior to
Allow
Proc
After 04
APOP 01
25,000.00
32,787.50
$150,331.06
$18,791.38
$0.00

22. How do I report an Arm’s-Length POP? Other items to note:
Transportation allowances are not reported on arm’s-length POP contracts. It is possible to have a POP contract with fees for transportation.2
Processing is not separately reported as an allowance on arm’s-length POP contracts because the lessee is reporting unprocessed gas and processing cannot be reflected as an allowance on unprocessed gas.
2Slide 48
2015 ONRR Federal Oil and Gas Valuation Training presentation

23. Common Issues
Reporting a contract as POP just because the statement says “Percent of Proceeds” at the top.
Assuming that because there is a percentage listed either on the statement or somewhere in the contract that the contract is a POP agreement.
Not reviewing the contract for the title transfer point.

24. Reminders
A POP contract is the sale of unprocessed gas for which the lessee receives value based on processed gas.
Review the lessee’s contract, not just the statements.
Ensure that the lessee is paying no less than 100% of the residue value.

25. Questions
When paying royalties on wells that are sold on an arm’s- length percentage of proceeds contract (APOP), should the value of the drip condensate that falls out before the delivery point to the third party processor be added into the POP value for calculation of the wellhead gas value or should a separate line for drip condensate be reported?

26. Questions
Please explain how to apply UCAs in determining the value of unprocessed product code 04 under an APOP contract.   Additionally, if an APOP contract specifies that the producer must give up field fuel and/or plant fuel, is any portion of the fuel value(s) to be added to the value of the Residue and NGLs when calculating the unprocessed value?

27. Thank you!