JIB Expenses - Legit or Not?

Accounting and Taxes
1

I bought an Oklahoma WI well package over 15 years ago. On the THIRD operator now. Each operator has acquired and ALSO owns 70% of the package.

Same MO each time:

New Operator take over, JIB’s are reasonable and for operations only for a few months, BUT then they start loading JIBS with allocated Overhead, Employee Salaries, Employee Benefits, etc. and they turn a monthly profit into a loss for me. This “switch” to aggressive Overhead Loading just started with the 3rd producer now.

The first TWO PRODUCERS had the same result (BK it appears). Honestly I stop paying the JIBS when they start this aggressive OH loading. On advice of Atty he said to send a Certified Letter Requesting an full audit each year (my right as a WI Owner), and they never pursue past due, never send dunning, etc. Very strange. I have other WI where I don’t see this practice in play on the JIBs, however in those cases the Producers do NOT own 70% of the package.

My Guess/My Take:

  1. By owning 70% themselves, aggressive OH Loading effectively creates a situation where the operator can jack up the JIB amounts and “siphon” off the 30% of us non-Operators to pay for their business expenses.

  2. There must be some Tax Benefit to this for the Operators…effectively EXPENSE the OH on the fly immediately…is maybe better through the tax grinder?

I think this whole process is an egregious siphoning scam. I pay all my other JIBS, and would GLADLY pay the true Operating Costs of these JIBs on this well package as I have in the past.

Basically if the Operator owns 70%, and were to actually PAY THAT 70% JIB INVOICE AMOUNT to themselves, they’d be losing a ton of money and would shut down the wells. They don’t shut the wells down though…which makes be believe they aren’t really incurring those costs as represented, those costs are inflated so that when the 30% pay it is net more to the Operator and helps cover their 70% shares in the JIB. To me that is fraud and should be illegal if it is happening.

Just wondering if any advice on these situations:

  1. What IS legal for Operator to charge?
  2. Besides the “request for audit” approach, how can I drive costs back to realty (I’m just under 2%)
  3. Any low cost DA/legal/Industry Review Panels that I can complain to who have actual power?

When I go to my Printer (for example) and spend $2,000 on stationary/envelopes, etc., I pay $2,000, NOT $2,000 plus another $1,800 prorata share of the Printer’s Overhead.

Any input appreciated, Mike J.

2

Is there a Joint Operating Agreement (JOA)? If so that will give you some answers. If you don’t know then ask the Operator for it. They should comply. Typically your options are:

  1. Keep paying.
  2. Stop paying and Operator files a lien against your interest (Operator might sue you FYI).
  3. Assign your interest to Operator.
  4. Send a plugging proposal to Operator.

The JOA will usually give you options. Absent a JOA, your options are typically more limited.

Many Operators treat COPAS as income to feed other parts of their operations. It isn’t right. But it doesn’t stop them.

3

Also, I’m not sure what you mean by aggressive overhead loading, but COPAS is a reasonable expense in most cases (the exception being a well losing money). And once COPAS is set (usually when a well is drilled) then there’s a standard rate of escalation that’s used to compensate for inflation.

There’s other OH items that sometimes show up which almost are always JOA related. Example being district expense.

4

Thanks for reply. I have asked last two operators for JOA…they didn’t have one they said (at 70% owner they both said that they didn’t need one). Hmmm. Asking the current third Operator now.

The overhead amounts invoiced are MORE than other WI’s that I have…a broader range of detailed OH types: (eg., Employee Ins OH, Supervisor OH, Benefits, etc., etc.). All of this pretty much now causes a slight loss to Break Even situation each month (by design I imagine!). This is at least better than previous two Operators where losses were HUGE.

Atty advised to do the call for audit on a regular basis, and if they don’t facilitate the audit, they will never sue (Not a CPA, but I used to work for a Big 4 as a Consultant, and I let them know that :))

I just wish their was a watch-dog option for this behavior. Grumble Grumble.

5

Mike, my firm is involved with auditing operators. Besides knowing what your JOA and Accounting Procedure states, conducting an audit is the best way to understand what the operator is doing. Smaller operators generally charge specific invoices to wells whereas larger operators use allocation pools to spread costs across multiple wells. Often it is difficult to determine what costs are in the pool, but often when you do, you find costs intended to be recovered through the COPAS OH charge are included in the allocated cost pool. Unfortunately, operators will stall for years; ultimately, you may be left with taking legal action to resolve the issues. Dave

6

I had an opportunity to “sell” to them at slightly above $0. I took that route late last year. Good move with prices, but when I looked at the TAX LOSS that I could take for 2019 it was a good fit and time to dispose.

I have other interests. I will keep you in mind. How do you force an operator to comply with an audit?

mj

7

Largely, it depends on the integrity of the operator. If they have integrity, they will credit the joint account when mistakes are identified. There will always be disputes that need to be negotiated or litigated. Coding errors, reconciliations (OH, tubulars, etc.), and other similar issues are resolved quickly. Payroll charges (offsite technical) and costs included in allocation pools are more challenging even if the issue is pretty straight forward. Smaller operators often ignore the JOA / Accounting Procedure and charge everything to the joint account. Unfortunately, we often don’t have the ability to choose who we “get in bed with” in this industry. Often the decision is a cost vs benefit decision as to whether to conduct an audit. It sounds like you made the correct decision.