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Oil and Gas Industry Audit Technique Guide Internal Revenue Service Books

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Petroleum companies obtain the rights to explore, drill, and produce subsurface minerals by entering into an oil and gas agreement or "lease" with the landowner. An oil and gas lease embodies the legal rights, privileges and duties pertaining to the lessor and lessee. The lessor is the mineral interest owner who transfers the working interest to the lessee who retains a royalty interest. The mineral lease is a very important legal document to the petroleum industry and provides the framework for all the activities that follow. It can be a useful auditing tool, because it provides a description of the property, identifies the royalty owner, and can give details of such items as delay rentals, lease bonus, unitizations, and primary terms. When a joint interest situation is created, the parties involved (i.e., the operator and nonoperators) generally execute an operating agreement. The normal form used for the operating agreement is AAPL Form 601. The joint operating agreement delineates the responsibilities and duties of the operator and nonoperators. It may cover only drilling operations, or it may cover both, exploration and production. Prior to the sale of oil or gas covered by a particular lease, a division order is prepared and signed by all interest owners. The division order is a necessary instrument in order for the operator to orderly and legally collect the oil and gas revenues and to pay the correct owners of the minerals. For accounting purposes, the information on the division order is usually condensed into a more usable format that can be put into the lease file for easy reference. Such a "division of interest" will be prepared for each property and shows each owner's name, identification number, and fractional interest.