To Net, or Not to Net02/26/2019
What is netting? Derived from the terms and conditions in the operating agreement, revenue netting is the deduction of joint interest billing (JIB) expenses that are owed to the operator from the revenue distribution check that is sent to the working interest owners.
When operating a well, the operator indirectly has a lien against the working interest owners for costs of operations, which is billable based on these terms. The operating agreement addresses lien rights and the ability to offset revenues against expenses.
The difference between deductions (post-production costs) and netting is that deductions are costs deducted from revenue for items like taxes and fees, while netting costs are agreed upon within the operating agreement. Check out Council of Petroleum Accountants Societies, Inc. (COPAS) for accounting guidelines that relate to such operating agreements.
Revenue Netting Advantages
Years ago, purchasers were obligated to do revenue distribution. Operators would send expenses to purchasers, which purchasers would then deduct. Purchasers were required by the states to withhold and remit severance tax. Today, purchasers are no longer obligated to perform revenue distribution because of the expense and complexity involved in maintaining the division of interest. Operators now have the responsibility to manage both JIB and revenue distribution.
The responsibility for revenue netting adds a burden to the operating company via its very difficult manual processes. By using an oil and gas accounting system, an accounting department can gain many benefits.
Control Cash Flow & Get Paid for Expenses Faster
A big benefit of netting is the ability to control cash flow more effectively and get paid for JIB-able expenses in a timelier manner. This occurs because revenue is not distributed or reduced by the amount that is owed to the operator.
If you’re part of an upstream oil and gas accounting department that uses netting, you would also want an accounting system that is configurable to allow netting in a manner that supports upstream oil and gas companies. Netting statements include both the revenue detail and the JIB detail, so that it doesn’t generate issues and calls with the owner.
There are several different ways you can set up your accounting system configuration to net:
- Interest Type – You can net working interest but not royalty interest, which can be configured in an accounting system. Working interest is derived from the operating agreement, royalty interest is derived from the lease agreement, and obligation of payment is derived through the lease agreement. If you net a royalty interest, there’s a danger that you could lose the lease.
- Individual Property
- Cost Type – Some organizations don’t have the option to configure netting on working interest only, they must do it manually. They dump data from JIB and revenue, then manually net. In addition, they’re required to make manual journal entries to update the owner records for both JIB and revenue. Because this process is quite tedious, many in this situation chose not to net.
Owner Payment Advantages
Many owners prefer and even request that the operator net their JIB costs against their revenue. By doing so, they eliminate the need to make monthly payments to the operator. Additionally, the operator will gain efficiencies by not having to send invoices and checks separately to the individual owners, reducing the administrative burden of:
- Folding, stuffing, and mailing checks and statements (postage, envelopes, printing, and staffing costs)
- Monitoring payable and receivable accounts, and processing associated receipts and disbursements
If agreed to by all parties, operators can gain the added advantage of not needing to separately cash-call a partner on new drilling activity, provided the partner’s revenue exceeds the estimated drilling cost. The advantage is the ease of recovery from non-paying partners. This can be a huge administrative burden when netting systematically if it’s not available in the system. The operator also creates an inherent cash flow advantage in the process.
Another advantage to using an upstream oil and gas accounting system are the integrations. Netting statements can be generated with integrations through third parties, such as EnergyLink, Oildex, and other data exchange sites. A benefit of netting statements is that they’re provided to payment outsourcers to eliminate the need of separately processing checks through netting.
And lastly, some oil and gas accounting systems can now create workflows that notify across departments. Departments no longer miss information when someone is being netted that might impact other aspects of the business or transactions. Netting requires additional steps in revenue and those who chose to do so must understand when they need to complete those additional steps. This provides convenience for interest owners who don’t operate property but receive payments and only want to receive a net check, rather than a JIB invoice.
About The Author
Tim Wadle, Vice President of Product Management at P2, has more than 20 years’ experience developing software solutions for oil and gas companies and has served on many industry committees along the way, including the American Petroleum Institute’s Committee on Production Measurement & Allocation and the Energistics PRODML Executive Committee. His work has been published in Oilfield Technology magazine and he has also been a featured speaker at the Offshore Technology Conference and AICPA Conference. When he’s not behind his desk, you’ll likely find Tim skiing one of Colorado’s slopes or biking one of its trails.