IMPACT OF RISK MANAGEMENT ON PETROLEUM ACCOUNTING

By

Emmanuel Nelson Bassey (MBA,CNA,ACTI,NIAFA)

COLLEGE OF ACCOUNTANCY AND COMPUTER TECHNOLOGY BLOCK B, FLAT 8, MASOJE ESTATE, 139 PTI ROAD. EFFURUN- DELTA STATE. NIGERIA PHONE.....234 8028756984 ---1---

Section A AN OVERVIEW OF PETROLEUM IN NIGERIA Petroleum refers to crude oil and natural gas or simply oil and gas. Oil exploration in Nigeria dates back to 1908 with the appearance of oil at Araromi in the present Ondo State. A German company Nigeria Butmen Corporation started this pioneering effort that was short-lived as a result of the outbreak of the 1914-1918 First World War. Another exploratory activity took off in 1937 by an Anglo-Dutch consortium that served as a forerunner of the present-day Shell DArcy. The exploratory activity started in 1937 after Shell DArcy had been awarded the sole concession rights that covered the whole territory of Nigeria. The company operated under the Mineral Oil Ordinance of No. 17 of 1914 and its amendments of 1925 and 1950 which allowed only companies registered in Britain or any of its protectorates the rights to prospect for oil in Nigeria and further provided that the principal officers of such companies must be British subjects. As Nigeria gained independence in 1960, oil production had been established in the country and it was exporting over 170,000 barrels per day (bpd). It was Gulf Oil Company that first struck offshore oil on the Okan structure of Bendel State in 1964. The licenses that were granted these companies were both offshore and onshore. With these commercial discoveries in petroleum products, the socio-economic and political development of Nigeria began to crystallize. The petroleum industry in Nigeria is the largest industry and main generator of GDP in the West African nation which is also the continent's most populous. The petroleum industry in Nigeria, has four major segments: 1. Exploration and Production, or E&P, by which petroleum companies explore for underground reservoirs of oil and gas and produce the discovered oil and gas using drilled wells through which the reservoir's oil, gas, and water are brought to the surface and separated ---2---

2. Hydrocarbon Processing by which crude oil refineries and gas processing plants separate and process the hydrocarbon fluids and gases into various marketable products. Refined products and NGL (liquefied natural gas) may be processed further in "petrochemical plants" for making petrochemicals. Some petrochemicals may, in turn, be sent to the crude oil refineries for mixing or processing with other liquid hydrocarbons to make various refined products, such as gasoline. 3. Transportation, Distribution, and Storage by which petroleum is moved from the producing well areas to the crude oil refineries and gas processing plants. Crude oil is moved by pipeline, truck, barge, or tanker. Natural gas is moved by pipeline. Refined products and natural gas are similarly transported by various means to retail distribution points, such as gasoline stations and home furnaces. 4. Retail or Marketing which ultimately markets in various ways the refined products, natural gas liquids, and natural gas to various consumers. Methods of accounting in petroleum industry in Nigeria Companies involved in the exploration and development of crude oil and natural gas in Nigeria have two primary accounting approaches. These two approaches are: the successful efforts (SE) method and the full cost (FC) method. SECTION B This section provides an overview of risk management, its importance to the success of E&P organizations, and its significant impact on petroleum accounting What is risk? The Merriam Webster Dictionary defines risk as exposure to possible loss or injury. In business, risks are everywhere. Many at times managers talk about exploration risk, competitive risk, market risk, financial risk, operating risk, technology risk, environmental risk, regulatory ---3---

risk, litigation risk, political risk, etc. But managers are rarely clear, even in their own minds, about just what they mean. The term risk is used in many different ways, depending upon the type of risk under discussion. Three risk frameworks for the petroleum accountant For the petroleum accountant, there are three general frameworks in which the term risk is defined differently: An industry or business framework in which risks are uncertain future events which could influence the achievement of the organizations objectives, including strategic, operational, financial and compliance objectives. Risk defined in this way can be linked to return. An organization takes risks in order to pursue opportunities to earn returns for its owners; striking a balance between risk and return is key to maximizing shareholder wealth, An internal control framework in which risk generally refers to exposure to hazards and information error, and A financial audit framework in which risk refers to audit risk (the possibility of misstating the independent auditors report) consisting of (1) inherent risk (the susceptibility of a financial assertion to misstatement), (2) control risk (risk that a material misstatement in the financials will not be detected by the companys internal control system), and (3) detection risk (risk that the independent auditor will not detect material misstatements). Features of risk management in petroleum accounting Oil and gas exploration and development activities have several distinctive features: - the risks of exploration are high and there is often a low probability of discovering commercial reserves in any individual location; - the elapsed time between initial exploration, the assessment of whether commercial reserves exist and the bringing of such reserves, if any, into production may be several years, particularly in offshore ---4---

environments; there is no necessary correlation between exploration and development expenditure incurred, whether capitalised or otherwise, and the value of oil and gas reserves discovered as a result of those activities; and the major economic value lies in the underlying oil and gas reserves which typically are not recorded in company balance sheets.

Risk Management Like risk, the term risk management is also used in many ways. For example, an insurance agent is said to provide risk management. The term can also be defined narrowly as an element of risk assessment, which is a component of internal control. However, risk management entails a much broader range of activities, which expose the company to hazards, uncertainties and opportunities. Risk management addresses the full spectrum of risk in terms of: (1) Compliance and prevention (focusing on hazards), (2) Operating performance, and (3) Strategic initiatives (focusing on opportunities) IMPORTANCE OF RISK MANAGEMENT TO E&P INDUSTRY The E&P industry was built on risk management. Wells deplete; new reserves must be found; dry holes happen. The typical E&P company must focus on adding reserve value to be successful. There are many ways of managing risks to add reserve value, e.g.: Acquisition of lease rights in promising areas to improve opportunities for exploratory success, Use of the best suitable exploration technology, Spreading risk and gaining expertise via joint venture arrangements, Hedging oil and gas prices in line with management directives, Sophisticated approaches to valuing reserves, Strong engineering oversight of production, Geological, engineering, and management personnel with technical, financial and risk management perspectives, and Creative and assorted financing arrangements to provide capital at ---5---

the lowest cost for the degree of retained risks of property ownership. Given the ... (a) core nature of the industry to explore, (b) volatility of petroleum prices and exploratory success, (c) industry issues of globalization and global warming, and (d) rapid and substantial technology changes, a strong risk management process throughout an E&P company should be of significant benefit and importance. IMPACT OF RISK MANAGEMENT ON PETROLEUM ACCOUNTING Risk management drives many of the events and transactions that Petroleum accountants must address, e.g.: Use of joint venture arrangements to manage risk at the expense of complicating petroleum accounting, Globalization to enhance corporate opportunities at the expense of requiring additional or specialized accounting systems and policies for new foreign locations, Creative financing arrangements, such as conveyances of volumetric production payments, necessitating special petroleum accounting, Enhanced, secure internet communications of accounting transactions, Hedge accounting, Internal and external financial and tax reporting, and Internal auditing. Petroleum accounting is fundamentally a key element of risk management. As a companys risk management program increases in importance and sophistication, so too should the companys accounting department. Once a sound risk management culture have been established into the organisations business framework, it promote productivity in the sense that senior management and line managers can focus more on their primary responsibilities instead of squandering resources on firefighting the challenges that may arise due to the lack of such practices,

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Its strengthen the business planning processes by allowing decision-makers to make contingency plans to avert possible mishaps thereby producing more realizable opportunities for the organization on the whole and leading to increased shareholder value,

Its enhance shareholder value as it assist in reducing expenses as there are many direct and indirect cost of risk.

Management is able to avoid paying the direct and indirect cost of risk namely:

For Direct cost of risk, it comprises: cost of replacement, loss of revenue, damages paid. Indirect cost of risk comprises: loss of market, loss of reputation, management time, paid absence from work, effects on insurance premiums, product or service recall, write-offs of plant or material, medical expenses and effect on morale, Its provide a sort of peace of mind for senior management,

Its might be matter of business survival or failure,

The reputation of the organization for social responsibility has been enhanced in relation to another organization who ignores risk management which affects the overall community or society, The presence of sound and effective risk management and controls systems inspires confidence in the investing public and others.

It safe-guard an organizations credibility and goodwill.

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References Petroleum Accounting Principles, Procedures & Issues By..Dennis R. Jennings....PricewaterhouseCoopers LLP Accountants Handbook: Special Industries and Special Topics, Volume 2 By D. R. Carmichael, Paul H. Rosenfield K. K. Landes, Petroleum Geology of the United States (1970); S. Schackne and N. D. Drake, Oil for the World (2d ed. 1960); L. Mosley, Power Play: Oil in the Middle East (1973). http://basiccollegeaccounting.com/the-importance-and-benefits-ofmanaging-risk/#respond

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