ARO misdirection4 Sep 2024 17:35
hot topic of the moment seems to be aro. some back of *** packet calculations are not the answer here. there are corporate accounting standards that need to be applied when acquiring assets to ensure the acquisition covers the true estimated cost of the asset.
asc 410 is the relevant accounting law section, but an explanation of the situation is here:
https://finquery.com/blog/asset-retirement-obligation-aro-accounting-example-oil-and-gas/
there is a big difference between rrb's position of 'they must have all the cash put aside now' vs the industry accounting standard and legal obligations, plus the calculation of transaction prices.
it all comes down to expected life of the asset in the end, but what is also true is that the acquisition price of near end of life wells has to legally incorporate an amount to account for aro. each well in a portfolio will have been assessed as having a present value, that present value has to include the aro.
for example if a company buys a well that has just five years of remaining productive life at an initial $3,000p.a forecast to decline to zero in five years, and an aro of $20,000 then the cost of that well is the npv of the annual income discounted at 8% plus the aro cost, so the actual purchase cost of that well is something like -$12,500. ie the seller has to essentially pay you to take it off their hands. dec are not the only ones that have to account for these costs in the transaction, the irs has to approve them.
if in the same transaction a second well is sold that has a remaining productive life of 20 years at the same initial $3,000p.a. with the same aro then the net present value of that well is +$2,600 ish. ie you have to buy that one as despite having a large aro the cash flows produce a net positive value and positive cashflows.
across a large deal with hundreds or thousands of wells the aro has to be legally incorporated into the purchase price for each well, and as such each one will have had an npv calculation by both parties to meet irs accounting standards.
where dec try and make the deals work in their favour is by extending well life and extracting extra production at lower cost than the vendors do in their models. they may well also be kicking the can down the alley far enough for carbon capture and storage to negate the aro obligation for a portion of their wells, accepting that this may be years or even decades away.
the key point is that there is no legal obligation to retire wells that is not being met by dec, and the well purchase transactions have to legally account for aro in the purchase price of each well. there is no suggestion that is not the case.
rrb is suggesting all wells are the same, that is not the case, the shortest life ones have to be offset by the higher value ones in the transaction. that's why dec focus on always quoting a npv number for the deal, its their measure of the value of the deal.
i'm offline until next week from now. knoc
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