Royalty Audit and Compliance Processes Document

Royalty Audit and Compliance Processes Document Table of Contents

1.1.0 Audit and Compliance Management Overview...... 2 2.0.0 Audit & Compliance Project Management...... 2 2.2.1 Set & Maintain A&C project details...... 2 2.3.1 Audit & Compliance Activity Chart...... 4 3.0.0 Pre-Audit Analysis...... 5 3.1.1 Audit Scope Determination...... 5 3.2.1 Volume verification...... 5 3.3.1 Volume verification (Remittance)...... 5 3.4.1 Volume verification (Balancing)...... 6 3.5.1 Value verification...... 6 3.6.1.Value verification (Pricing)...... 6 3.7.1 Deduction verification...... 7 3.8.1 Suspense file analysis...... 7 3.9.1 Hidden royalty research...... 8 3.10.1 Duplicate Disposition Reporting...... 8 3.11.1 PUN Lease Allocation Research...... 8 4.0.0 Settlement Phase...... 8 4.1.1 Create audit assessment...... 8 4.1.2 Create interest assessment...... 8 4.1.3 Assessment distribution workup...... 9 5.0.0 Post Audit editing Routine...... 9 5.1.1 Set up selection criteria...... 9 5.2.1 Set up variance parameters...... 9 5.3.1 Post Audit Compliance Evaluation Process...... 9 6.1.1 Royalty Return Compliance ...... 10 7.1.1 Royalty Management Reports...... 12 8.1.1 Index Benchmarking...... 12

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 1 of 13 1.1.0 Audit and Compliance Management Overview

This sub-area will provide a basis for ensuring that all revenues from State Trust Lands are efficiently, effectively, and accurately reported, collected, accounted for, verified, and distributed in a timely fashion to the State Trust Land beneficiaries and in accordance with existing statutes, rules, and oil and gas lease terms.

The Royalty Management Division (RMD) of the New Mexico State Land Office (SLO) is responsible for all activities associated with royalty audits/desk reviews for oil and gas leases.

This sub-area will provide a description of audit/compliance assignments, projects, objectives, procedures; document findings, and provide a factual basis for drawing conclusions, making recommendations, and propose corrective actions with remitters and others.

2.0.0 Audit & Compliance Project Management

This subsystem provides for set-up, assignment and tracking of audit/desk review compliance projects. Audit/Desk Review projects originate from a number of sources both within and external to the Royalty Management Division (e.g. SLO other divisions, TRD, MMS, other Royalty owners). This subsystem must maintain a history or record of the PUNs Companies and time period that have been audited. This history record will be updated from the Audit Scope reports module. As the A&C projects are setup, the PUNs enter into the setup screen an error message will be flashed online is the PUN being entered has already been audited.

The project management subsystem for audit/desk reviews will provide: 1. compliance activities for company audits, 2. special projects, 3. review of refund and credit requests, 4. litigation support, 5. management audit referrals, 6. field inspections Details that are recorded about each project include the following:  Identify PUN(s),  Identify OGRID(s),  Products,  Time period,  Comments,  Auditor assigned etc.  Completion dates of projects are captured following successful review and approval.  Field inspection details may also be captured.

2.2.1 Set & Maintain A&C project details Process description

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 2 of 13 This online process provides for setup and assignment of A&C projects. Projects are maintained by type and identified by a reference number and by a suffix. This must be an online function for initial entry or updating activities. Update authority must be field based limiting some fields to supervisor authority only.

Types of projects are: 1. Desk Review 2. Field Audits 3. Gas Plant Inspection 4. Special Projects 5. Gas Plant Cost Methodology Review

A standard activities template exists for each Audit and Compliance project type. For a new project this process copies that template. Thereafter, this process enables one to modify that set of activities for a particular project. It also enables one to record start and end dates both planned and actual for all activities.

The universal or high-level scope of the project must be identified and personnel must be assigned to the project. Other information regarding the project may also be maintained in the audit project data store. The scope will indicate whether the project is an OGRID-based, PUN- based or Plant-based project: Either OGRID, PUN or Plant may be specified, but not more than one of them.

The kind of product under audit will also be specified; more than one product may be audited in the same project. The audit period will also be specified. The ability to enter, edit and delete project notes must be provided.

This process also maintains various dates: 1. Date the auditor was assigned to this project, 2. Date the project was set up, 3. Planned completion date of project 4. Actual completion date of the project.

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 3 of 13 2.3.1 Audit & Compliance Activity Chart The following chart provides a general idea of the types of activities required for an audit. The auditors are running various reports looking at the Royalty Return, Production and Disposition data for discrepancies and trends.

Company selection: 24 Companies representing 80% of state royalty are included in a four year audit plan

Pre audit

INITIAL CONTACT AUDIT SCOPE AUDIT QUESTIONNAIRE ENGAGEMENT LETTER OGRR is used to retrieve DETERMINATION Standard questionnaire A letter including the audit contact information: Several reports capturing related to business scope & documents to be company is contacted, field data reported to TRD, integrations is sent reviewed during the field audit is scheduled SLO,& OCD are analyzed audit is sent tom the to determine audit scope company

VOLUME REMITTANCE VALUE PRICE DEDUCTION BALANCING PUN, LEASE & COMPARISON REPORTS COMPARISON STATISTICAL STATISTICAL REPORTS ALLOCATION REPORTS Report identifying REPORTS REPORTS REPORTS Reports INQUIRY Reports royalty reported Reports Reports Reports comparing OCD SCREENS comparing OCD, data captured in comparing TRD & computing royalty computing royalty production and Screens SLO & TRD with ONGARD are SLO values prices & prices and data captured in identifying PUN, volumes captured generated using captured in percentages percentages ONGARD are Lease and in ONGARD are W EB applications ONGARD are captured in captured in generated using allocated data is generated using generated using ONGARD are ONGARD are W EB applications captured in W EB application W ED applications generated using generated using ONGARD and W EB W EB reviewed using W EB application

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 4 of 13 3.0.0 Pre-Audit Analysis

This process provides the various applications and inquiries which allow the auditor to identify problem areas in royalty reporting related to OGRIDS and PUNS. This area will allow auditors to identify audit scopes for field audits and desk reviews. The basis for the analysis of this section will include volume verification, value validation, and deduction review. The source of the data for this analysis is the three agencies; State Land Office, Taxation & Revenue and Oil Conservation Division. Comparing the oil & gas data filed with each of these agencies provides a basis for areas of interest for the auditors. The challenge is to insure that the data is consistent and the analysis is valid. The data is reported at different levels across the agencies. The production data (OCD) is at the API well/pool, Disposition data at the Property/Pool, taxes are paid at the Production Unit Number (PUN/Suffix) and royalties to the State Land Office at the PUN/lease.

3.1.1 Audit Scope Determination Process Description

Field audits require a good deal of planning and coordination prior to the actual audit. Annually the candidate companies are selected and the schedules and scope of the audits are developed. The volume and value variance and Remittance reports are used to guide the Land Office auditors in selecting the focus of the audits. These processes provide the auditors with a broad view of the reported data and trends of various aspects of the filings.

3.2.1 Volume verification Process Description

Volume comparison screens and reports which compare volumes reported to the Oil Conservation Division on form C-115 to the Volumes reported to the NMSLO on royalty returns and to volumes reported to the NMTRD on severance tax returns will be generated. In addition to volumes, these reports and screens will include State Net Interest information, Production Unit information, Property information and Company information.

The select parameters will include: (1) PUN(s) (2) OGRID (remitter and/or operator) (3) Sales year and Sales month (4) Product Kind

The reports and screens shall also group the data as follows: (1) Sales Period, OGRID summary level (2) Sales Period, OGRID, PUN summary level (3) Sales Period, OGRID, PUN monthly detail level (4) Sales Period, PUN summary level (5) Sales Period, PUN monthly detail level

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 5 of 13 3.3.1 Volume verification (Remittance) Process Description

Remittance reports and screens which include royalty return data (volumes, barrels, liquid gallons, BTU factors, gross proceeds, export and process deducts, gross and net price) will also be generated. The select parameters

These reports should group the data as follows: (1) Sales Period level (2) OGRID Sales Period level (3) PUN OGRID Sales Period level (4) PUN Sales Period level (5) Product Code level (6) Product Code Sales Period level (7) PUN Product Code Sales Period level (8) PUN OGRID Product Code Sales Period level (9) Line Detail level

The reports and screens shall also identify in-house amendments and rejected credit lines

3.4.1 Volume verification (Balancing) Process Description

Balancing reports and screens which compare production to disposition volumes reported on Production Form C-115 will be generated. Along with disposed and produced volumes, the reports will include vented, flared, and used on lease volumes along with oil inventories.

3.5.1 Value verification Process Description

Value comparison reports and screens which compare Gross/Net proceeds and Gross/Net prices reported and computed from NMSLO royalty returns to Gross/Net values and Gross/Net prices reported on NMTRD severance tax returns will be generated. In addition to proceeds, values and prices, these reports and screens will also include State Net Interest information, Production Unit information, Property information and Company information.

The select parameters will include: (1) PUN(s) (2) OGRID (remitter and/or operator) (3) Sales year and Sales month (4) Product Kind

The reports shall also group the data as follows: (1) Sales Period, OGRID, PUN summary level (2) Sales Period, OGRID, PUN monthly detail level (3) Sales Period, PUN summary level

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 6 of 13 (4) Sales Period, PUN monthly detail level

3.6.1.Value verification (Pricing) Process Description

Pricing Statistical Reports which identify royalty lines given selected conditions and parameters will be generated. The selected parameters will include PUN, OGRID Code, Sales Period, and Product Kind.

The conditions will include: (1) Greater than or equal to a given price (2) Less than or equal to a given price (3) Equal to a given price (4) Not equal to a given price

The reports shall also group the data as follows: (1) OGRID, Sales Period level (2) PUN Sales Period level (3) PUN, OGRID, Sales Period level (4) OGRID, Sales Period, Product Code level (5) PUN Sales Period, Product Code level (6) PUN, OGRID, Sales Period, Product Code level

3.7.1 Deduction verification Process Description

Deduction Statistical Reports which identify royalty lines given selected conditions and parameters will be generated. The selected parameters will include PUN, OGRID Code, Sales Period, and Product Kind. The lines identified on the report will compute a processing/transportation deduction as a percentage of gross proceeds and will satisfy the following selected conditions: (1) Greater than or equal to a selected percentage (2) Less than or equal to a selected percentage (3) Equal to a selected percentage (4) Not equal to a given price

3.8.1 Suspense file analysis Process Description

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 7 of 13 This process would search the suspense records, which are return line items which have been suspended due to a critical error. The critical errors are related to invalid or inactive PUN, Lease, or PUN/Lease combinations, product code, transaction code and sales month and year. This function would allow the auditor to determine if some of the discrepancies identified in the other reports might be explained by these suspended line items. (i.e. what might appear as an under reporting may be due to the use of an invalid or inactive PUN, Lease or PUN/Lease combination.

The select parameters will include: (1) OGRID (2) Sales year and Sales month (3) Product Kind

The reports and screens shall also group the data as follows: (6) Sales Period, OGRID summary level (7) Sales Period, OGRID, PUN summary level (8) Sales Period, OGRID, PUN monthly detail level (9) Sales Period, PUN summary level (10) Sales Period, PUN monthly detail level

3.9.1 Hidden royalty research Process Description

This process addresses the situation where a PUN has been deactivated retroactively. In this situation the returns detail lines would be associated with a PUN that is not active for the time period in which the lines were filed. An example would be where a well completion was plugged back to different pool but the reporting continues to be to the original PUN. The details of this situation would be reported to the Analyst for resolution. This process would search for records in this situation and presented them to the Analysis for resolution.

3.10.1 Duplicate Disposition Reporting Process Description

This online process researches the database to identify when multiple PUN’s possess the same property and pool. This process will alert the auditor that these PUN’s must be reconciled and reviewed together. Included is the requirement for a selection process to indicate the sales periods under consideration.

3.11.1 PUN Lease Allocation Research Process Description

This process provides a suite of on-line research tools for reviewing the history of PUN, Unit agreement, Communitization agreement and related activities. This involves many different views of PUN and others objects which are attached to them. (i.e. history of operators of a PUN, PUNs by API and pool, Beneficiaries and %’s by lease number, Leases and allocation %’s.)

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 8 of 13 4.0.0 Settlement Phase

These requirements are focused on the period of time after the Auditors have completed their field work and are working on getting closure of the audit issues. Typically this would involve a proposal from the auditor to the audited company and some back and forward discussions. After these discussions are complete, the following processes are required from the system to initiate the assessments and prepared for the proper distribution of the funds.

4.1.1 Create audit assessment Process Description

Basically the assessment notice is created by processing a royalty return using the transaction code of “55” and without submitting any payment. The return processing module must create a specific type of assessment. This assessment is the vehicle the company use to attach their payment.

4.1.2 Create interest assessment Process Description

Using the above process to generate the audit assessment must also calculate and produce the interest assessment corresponding to the audit lines. This interest is unique versus the typical assessment of interest because it cannot be off-set or netted against any other credits on the return. The return process will be able to distinguish these detail lines on the return because of the transaction “55”.

4.1.3 Assessment distribution workup Process Description

In situations where there is a large settlement and it is not practical to adjust each line item, this process develops the allocation formula needed for the distribution of the dollars paid against the settlement type assessments. Basically this process will take the selection criteria matching the assessment and search the remittance data producing a report supporting the allocation of the assessment payment. The process must use lookup tables to relate the search to the earlier record formats in the situation where some of the historical data predates the ONGARD system (pre 1995). The ability to create and maintain the lookup tables must be provided.

5.0.0 Post Audit editing Routine Overview

After an agreement has been made with a Royalty remitter to revised their royalty filing, generally after an audit, this subsystem will allow the Royalty Management staff to verify the compliance with the agreement. This processing will be accomplished after the primary return processing for the month has been completed. This sub-system will provide for the selection criteria of the royalty detail lines needed and for the variance parameters to use in the evaluation process. The output would be reports listing the OGR2 detail lines which fail the specified tolerance parameters. This report would then be sent to the remitter with instructions for

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 9 of 13 remedying the violation. The remitter would file the appropriate detail lines using a code “55” and the return processing would produce the interest assessment for payment the following month.

5.1.1 Set up selection criteria Process Description

This online process is required to develop the selection criteria used for selecting the OGR-2 detail lines for validation against a audit agreement. The selection criteria will be at the OGRID, PUN, Product Code, Sales period or beginning sales period level. This process must provide add, edit and delete functionality for the selection criteria.

5.2.1 Set up variance parameters Process Description

This online process provides the functionality needed to establish the tolerances or formulas used to evaluate the OGR-2 detail lines. For example, the agreement maybe to not exceed a certain percentage of a specific deduction as compared to the Gross Proceeds. Generally the comparison will be between the various columns on the OGR2 form. Included should be a reference number to easily associate the results to the audit.

5.3.1 Post Audit Compliance Evaluation Process Process Description

The output from the Post Audit Evaluation process is a report containing the OGR2 detail lines which have exceeded the variance parameters. The report will be organized so that the individual pages can separated and sent with a cover letter to the offending company suggesting the appropriate remedy. Once the auditor is satisfied that the company is filing according to the audit agreement the selection criteria for that company can be deleted.

6.1.1 Royalty Return Compliance Process Description

This process which would be part of the monthly processing cycle, it would be scheduled after the returns processing and distribution have been completed. It begins with selecting out the non critical error records into to another database after the completion of each returns evaluation cycle. This database would contain a moving 12 months of non-critical error records, during each selection process the oldest month would be dropped and the most recent month’s records will be added.

The following table contains the Non-critical errors:

Error Code Description Action required E4172 MCF Volume required for Verification that entries are entered correctly Gas Product and no keypunch error exist. No other action taken

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 10 of 13 Error Code Description Action required E4038 Market preparation Verification that entries are entered correctly Deduction to Gross Proceeds and no keypunch error exist. Statistics are out of range provide to management. E4174 NGL volume required for Verification that entries are entered correctly Gas Plant products and no keypunch error exist. No other action taken E4037 Processing deduction to Verification that entries are entered correctly Gross proceeds are out of and no keypunch error exist. Statistics range provide to management. E4034 Product code mismatch with Verification that entries are entered correctly volumes and no keypunch error exist. No other action taken E4062 Report Date (YR/MTH) Analyst requests change in date from cannot be future date Revenue Processing Manager E4067 Total Royalty in the detail Verification that entries are entered correctly lines does not equal Royalty and no keypunch error exist. Rounding errors reported on OGR1 form. are corrected at this time to ensure that summary Royalty matches detail Royalty E4068 Total interest in detail lines Verification that entries are entered correctly not equal to summary and no keypunch error exist. Rounding errors interest. are corrected at this time to ensure that summary Interest matches detail Interest. E4069 Total credits reported not Verification that entries are entered correctly equal to summary credits and no keypunch error exist. If time permits, the remitter may be contacted to determine what credits were intended to be used. E4036 ALLOW-DEDN-PROC is Verification that entries are entered correctly valid only for Gas Product and no keypunch error exist. Statistics provide to management. E4035 ALLOW_DEDN_TRANSP Verification that entries are entered correctly / GRS_PROCD out of range and no keypunch error exist. Statistics provide to management. E4639 Allowable deduction is Verification that entries are entered correctly invalid and no keypunch error exist. Statistics provide to management. E4176 BBL Volume required for Oil Verification that entries are entered correctly Products and no keypunch error exist. Statistics provide to management. E4244 Credits claimed greater than Verification that entries are entered correctly lease credit available for the and no keypunch error exist. The royalty lease in database payment is taking credit from a lease in excess of their previous payments toward that lease. Follow-up activities could include notices to the remitter and the generation of an assessment satisfy this deficiency.

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 11 of 13 Error Code Description Action required E4039 Gross proceeds / Volume Verification that entries are entered correctly (Unit cost) out of range, and no keypunch error exist. Statistics provide to management. E4070 Total Assessments reported Verification that entries are entered correctly not equal to summary and no keypunch error exist. Remitter may be assessments contacted to determine what assessments were intended to be paid. E4071 Total lease credits reported Verification that entries are entered correctly not equal to summary lease and no keypunch error exist. Remitter may be credits contacted to determine what credits were intended to be used. E4072 Total Remittance not equal Verification that entries are entered correctly Payments / credit / advances and no keypunch error exist. Remitter may be contacted to determine whether credits or other payments were intended. E4073 Total royalty paid is not Verification that entries are entered correctly equal to Accl roy amt clmd and no keypunch error exist.

The output of this process would be a report by OGRID showing the trend of the various errors. The report would be organized by error code, listing in chronological order each of the individual OGR2 detail lines with that error code on the last 12 months. The auditor or compliance analyst will be able to see trends which will be useful in the selection of possible audit candidates. This will also provided in-sight into the validity of the tolerance parameters in evaluation process which generate these non-critical errors.

7.1.1 Royalty Management Reports

The following management reports are required at the conclusion of a royalty remittance cycle. These reports will be on-demand providing selection capacity to choose the reports needed. Oil prices based on Royalty remittance by calendar & fiscal years Gas prices based on Royalty remittance by calendar & fiscal years

Oil prices by basin based on Royalty remittance by calendar & fiscal years Gas prices by basin based on Royalty remittance by calendar & fiscal years

Oil prices by county based on Royalty remittance by calendar & fiscal years Gas prices by county based on Royalty remittance by calendar & fiscal years

Royalty Distribution reports by calendar & Fiscal years Royalty Distribution report by county by calendar & Fiscal years Royalty Distribution reports by basin by calendar & Fiscal years

Oil & Gas Production by calendar & fiscal years Oil & Gas Production by county by calendar & fiscal years Oil & Gas Production by basin by calendar & fiscal years

D:\Docs\2018-04-08\05ae1b0fdbec11e2e293e1e31f226451.doc Page 12 of 13 State Oil & Gas Production by calendar & Fiscal years State Oil & Gas Production by county by calendar & Fiscal years State Oil & Gas Production by basin by calendar & Fiscal years

8.1.1 Index Benchmarking Process Description

This process will allow Royalty Management to analyze the product prices reported on the royalty returns versus published benchmark prices less differentials. The benchmark prices are based on the two basins in New Mexico; San Juan and Permian. The capacity to create a benchmark database containing the published index prices and the appropriate netback differentials is required. Also there must be the ability to store a tolerance factor for use during the analysis.

This process will be an “on demand” function permitting the user to select a sales period range and product type for analysis. The requested analysis maybe limited selecting and individual OGRID and/or PUN. The input sources will be the Published prices (i.e. Nimex or Inside Ferc etc.) and the OGR2 detail lines. The OGR2 detail lines will have to be separated by basin, using the pools attached to the PUNs as key indicator. The output is a report of the OGR2 detail lines which are outside the range of the benchmark prices. These reports would be used to focus attention in areas where there may be pricing issues.

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