ALLOCATION of COSTS Between PETROLEUM LIQUIDS and GASES

FEATURE ALLOCATION of COSTS between PETROLEUM LIQUIDS and GASES HUMBLE OIL & REFINING CO. E. E. HUNTER HOUSTON, TEX. Downloaded from http://onepetro.org/jpt/article-pdf/6/07/11/2237694/spe-292-g.pdf by guest on 02 October 2021 Introduction increased to a rate of about 7.5 trillion cu ft in 1951 and over 8 trillion in 1952. The increase in demand Petroleum producers have been engaged for many thus indicated has been close to 12 per cent a year years in supplying several different types of materials since 1946, more than twice as great as the rate of from the leases they operate. Some leases produce crude increase in demand for crude oil. oil and casinghead gas, others produce gas-well gas and condensate, and still others produce all four of these This extraordinary growth in the volume and value materials. Therefore, the problem of allocating costs of gas has raised it to a position of importance that com between these intermingled products is not a new one. pels recognition, even by companies interested princi pally in oil production, of its status as a joint product. While in some fields gas has been the dominant prod (For some companies and in some fields gas has for uct, most producers have been interested principally in many years been a primary product.) Good account oil. Consequently, little has been done about the cost allo ing practice and business prudence dictate that oil cation problem by oil producing companies. For account producers now adopt some method of allocating costs ing purposes, these companies have generally con to gas, or actually to all four of the joint products sidered gas a by-product, and whatever realization was involved - crude oil, casinghead gas, gas-well gas, and obtained from it was accounted for as a reduction of condensate. However, full industry recognition of this producing costs, which were all considered to be ap fact has come so recently that no generally accepted plicable to crude oil. The inadequacy of this procedure method of making the allocating has been found. under present day conditions, and the need for a more realistic approach to the problem of accounting for Difficulties Involved costs, can probably be illustrated best by a brief review The difficulties involved in allocating costs between of the growing importance of gas in the economic the various products supplied by petroleum producers structure of the industry. arise from the fact that the intermingled products are Need for Allocation so often produced at a cost that is common to all. Known natural gas reserves in the United States Liquid and gases are lifted through the same well bore, approximately doubled during the 10 years ending with by the same manpower, and under the same supervision. 1952, rising to a total of nearly 200 trillion cu ft at Under these circumstances costs cannot be traced exactly the beginning of 1953. In terms of heat value the 200 to each joint product. trillion cu ft of gas is approximately equal to the com This problem of allocating common costs is not bined heat content of the 28 billion bbls of crude oil peculiar to the petroleum producing industry. For and the 5 billion bbls of condensate in reserve at the example, the meat packing, milling, chemical, lumber, beginning of 1953. However, the heat units produced and petroleum refining industries all are faced with in the form of oil in 1952 were almost twice as great the problem of allocating common costs between two as those produced in the form of gas - a good indica or more joint products. The difficulty or impossibility, of tion that there is much more room for expansion in allocating such costs "exactly' by no means lessens production of gas than for crude oil. the need for some careful estimates of the cost of The rapid growth in demand for gas since the end each product for the purpose of measuring the relative of World War II has brought about a substantial in profitability of various operations and as a general crease in the wellhead price, despite increasing reserves. yardstick for testing the adequacy of sales prices. Each In the Southwest, for instance, the price doubled in industry has developed cost accounting procedures the period from 1943 to 1951, rising to an average of that are logical under the prevailing operating circum approximately 5.6 cents a thousand in the latter year. stances. As conditions change, the accounting pro Marketed production of gas in the United States had cedures change with them. There is no reason why petroleum producers cannot change their traditional custom of considering that all costs are applicable to Manuscript received in the Petroleum Branch office Oct. 19. 195:l. crude oil, just as other industries have changed their Paper presented at the Petroleum Branch Fall Meeting in Dallas. Oct. 19-21. 1953. customs when necessary. SPE 292-0 JULY, 1954 11 A Method of Allocation line with their heat value, and that costs thus allocated may appear distorted in relation to the realization. This The discussion that follows will be devoted principally is simply arguing that the realization method is a better to the method of allocating producing cost that has method of allocation, but the objection can be overcome been adopted by Humble Oil & Refining Co. In the to a large degree even if the realization method has search for a method that would take into account merit. Gas-well gas at 15 cents/Mcf is delivered to the peculiar characteristics of oil and gas producing industrial users on the Gulf Coast at a realization per operations and would provide reasonably accurate indi Btu of only half that of fuel oil, its chief competitor, cations of relative costs, two methods of allocation were which is presently selling for about $1.85 a barrel; and seriously considered. These can be termed the realiza gas at this price is even cheaper in relation to crude oil. tion method and the energy content method. The energy However, since costs directly identifiable with the pro content method is the one that was adopted, but the ducing activity are substantially less per Btu for gas realization method will be discussed briefly first because well gas than for crude oil, because of the wide spacing it is familiar to so many people. of gas wells and the natural flow of the gas, the profit Disadvantages of Realization Method per heat unit should equal that of crude oil when the selling price of gas per heat unit is less than that of The realization method of allocating costs assumes crude oil. Gas prices have advanced more rapidly in that costs are incurred in proportion to sales value. This recent years than crude oil prices, and are continuing method has a fundamental weakness. If the price of one to move upward. Consequently, an allocation of costs product declines relative to others, its allocation of costs between liquids and gas on the basis of heat content will is reduced correspondingly, although there may be no in time appear more realistic relative to prices. In addi Downloaded from http://onepetro.org/jpt/article-pdf/6/07/11/2237694/spe-292-g.pdf by guest on 02 October 2021 change in the costs incident to the total operation or in tion, it avoids the limitations and the constant changes the costs involved in handling the individual products. involved in the use of the realization method. This is not so much a method of allocating costs as of allocating profit or loss according to sales values. Modification of Energy Content Method The realization method has the additional disadvan The energy content method of allocation may be tage of providing no indication as to what may be a applied, if necessary, with modification designed to realistic cost basis and, therefore, a minimum level of fit the peculiar circumstances of individual operators or price for the various joint products, since it is keyed particular situations. One of the major problems in con to what the product is selling for and makes no attempt nection with allocation of costs relates to casinghead to determine what it should be selling for to return gas. Such gas frequently brings a lower price than a reasonable share of total costs. This method also gas-well gas because its supply is regulated by the pro differs in principle from the long established practice ductivity of oil rather than by the needs of the cus of determining certain unit costs of producing oil on tomers, and because of other problems incident to the basis of barrels produced without regard to realiza the handling of casinghead gas. In such circumstances, tion, even though the price may vary between grades the allocation of costs on a strict heat value basis of crude oil produced by the same operator from $2 may indicate a higher total cost for casinghead gas to $3/bbl and sometimes even more in case of special than can be realized from its sale. Nevertheless, if high or low grades of crude. the oil is to be produced and casinghead gas must also be produced, an economic advantage will be gained Advantages of Energy Content Method from selling the casinghead gas if a price is received The energy cont~.,t method, or principle, of allocat which more than covers the direct cost of handling ing costs is based on the fact that the petroleum industry the gas after it has come to the wellhead, even if is engaged in supplying energy in the form of heat.

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