Working interests

From CEOpedia | Management online

Working interest means a type of investment or interest in oil and gas. It gives the owner the right to:

  • explore,
  • drill
  • produce gas.

Such operations are related to investor's liability for a portion of the costs connected to exploring, drilling and producing. Similarly, owners of the working interest fully take advantage of the profits of any successful well. The share of profit for the owner of a working interest constitutes the residual amount after deducting royalty interest and nonworking interests. There can be a situation when company may not have an interest anymore in having a working interest in a property, for example do to the fact that it does not have managerial or financial expertise to develop and explore the property. In such a situation it can exchange its working interest to another party for a nonworking interest, and thus shifting all their responsibility to someone else [1].

Connection with the operating interest

Working interest may be also referred to an operating interest. It provides the investors with a percentage ownership of operations related to drilling activities and the right to the products from such activity. Apart from the income from the production of the resource, investors are also responsible for the proportion of the expenses related to obtaining it. To be more precise, the share of production of the working interest to which the owner is entitled is always smaller than the share of costs, which the owner of the working interest is required to bear. For instance, owner of a 100% working interest in a lease encumbered by a landowner's royalty of 25% would have to pay 100% of the costs of the well but in turn he or she would be entitled to keep 75% of the production [2].

Lease

The most widely used way to produce a working interest is the use of the lease. A product owner leases his or her rights to an operator. On the basis of the lease, the operator is able to:

  • explore,
  • drill
  • produce products at his or her own cost.

In return, product interest owner:

  • receives upfront bonus,
  • royalty on production
  • even sometimes delay rental fees.

The lease usually lasts from one to five years, during the period of which the Operator is entitled to drill and obtain production. The moment production is obtained, the lease is intact as long as production is continued [3].

Categories of working interest

Categories of working interest According to some sources working interest may be classified into two categories:

  • an undivided
  • divided interest.

In terms of an undivided interest, two or more holders of a working interest share profits and costs according to their proportional interest. In case of a divided interest, the holders of a working interest obtain revenue and pay for expenses on the basis of their ownership of certain acreage. Other sources stipulate that working interest may be divided into two groups:

  • operated interest
  • non-operated interest.

Often, the working interest of the lease of oil or natural gas is divided between various owners in varying percentages. The owner of the working interest named as the "Operator" finds wells, watches over drilling and is involved in managing day-to-day operations, such as marketing and accounting activities related to the lease. In turn, owners of the non-operating working interest are usually consulted on production decisions and bear some of the costs according to the agreements concluded between owners. Nevertheless, owners of non-operating working interest do not take part in actual operations [4].

Where most of working interest comes from?

Most working interest income is regarded as the income from self-employment income. Due to the fact that regular income tax payments are not automatically withheld from such funds, investors should make estimated tax payments on the basis of the current Internal Revenue Service (IRS) standards and rates. Investors with working interests are held liable for some tax deductions on the basis of the operating costs connected to the business. It may involve expenses, which are of tangible or intangible nature. For example, equipment costs or utility payments [5].

Examples of Working interests

  1. Drill a well and produce oil and gas from it.
  2. Receive a share of any oil and gas production from that well, as well as any associated revenue.
  3. Participate in the day-to-day operations of the well, such as hiring a drilling company or negotiating leases.
  4. Participate in any decision-making related to the well, such as developing a production plan or setting up a marketing strategy.
  5. Share in the costs associated with the well, such as drilling and operating expenses.
  6. Assume some of the risks associated with the well, such as the possibility of a dry hole or a low-producing well.
  7. Benefit from any bonuses or royalties associated with the well.
  8. Assign, sell, or lease their working interest to other parties.

Advantages of Working interests

A working interest is an investment or interest in oil and gas, giving the owner certain rights and privileges. The advantages of working interests include:

  • The right to share in the profits of the oil and gas production, based on the percentage of the working interest held.
  • The right to vote on important decisions and actions related to the oil and gas operations.
  • The right to inspect and review all books and records of the oil and gas operations.
  • The right to participate in the planning and execution of the oil and gas operations.
  • The right to participate in the decision making and voting on such matters as the hiring and firing of personnel and the purchase and sale of assets related to the oil and gas operations.
  • The right to receive periodic reports from the operator relating to the performance and operation of the oil and gas operations.
  • The right to receive periodic payments of royalties and other income from the oil and gas operations.

Limitations of Working interests

Working interests are an investment or interest in oil and gas, giving the owner the right to take part in exploration and development activities. However, there are several limitations to this type of investment:

  • The working interest owner does not have any control over or ownership of the underlying mineral rights.
  • The owner of the working interest does not have any rights to the oil or gas produced from the property, but only a portion of the proceeds from its sale.
  • The owner of the working interest may be liable for costs associated with the exploration and development activities, such as drilling and production costs, even if the project is unsuccessful.
  • The working interest owner cannot transfer ownership of the working interest to another party without the written consent of the surface owner.
  • The working interest owner may be subject to additional regulations depending on the jurisdiction where the property is located.

Other approaches related to Working interests

A working interest is an investment or interest in oil and gas that gives the owner the right to participate in the activities related to the development and production of oil and gas. Other approaches related to working interests include:

  • Joint Operating Agreement (JOA): This is a legal agreement between two or more oil and gas companies that outlines the roles and responsibilities of each company in the development and production of oil and gas. It also outlines the terms of the working relationship between the companies, such as the sharing of costs and profits.
  • Royalty Interest: This is an ownership interest in oil and gas that gives the owner the right to receive a share of the production revenues from the well or property. The royalty owner does not have to bear the costs of production or exploration.
  • Service Contracts: This is an agreement between the oil and gas company and a service provider that outlines the services to be provided by the service provider in exchange for a fee.

In summary, working interests are an investment or interest in oil and gas that gives the owner the right to participate in the activities related to the development and production of oil and gas. There are other approaches related to working interests, such as joint operating agreements, royalty interests, and service contracts.

Footnotes

  1. ↑ Wright C. J (2017) Fundamentals of oil & gas accounting, Tulsa Penn Well Corporation, Oklahoma
  2. ↑ Libecap, G.D., Smith, J. L. (1999). The Self-Enforcing Provisions of Oil and Gas until operating agrements:theory and evidence
  3. ↑ Meyers, C.J. (1954). Two Drilling Covenants Implied in Oil and Gas Leases
  4. ↑ Shah, S. M., Sana A. (2006). Impact of Working Capital Management on the Pofitability of Oil and Gas Sector of Pakistan
  5. ↑ Zhu, L., Zhang, Z., & Fan, Y. (2015). Overseas oil investment projects under uncertainty: How to make informed decisions?


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References

Author: Pola Ligaj

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