Prior Period Adjustments (PPA’s) are a relatively common occurrence in the oil and gas industry and typically result from changes in volumes of oil, natural gas, or NGL’s or adjustments in the prices paid for these products, or in some cases changes to the division of interest in your wells. The reason Prior Period Adjustments occur is because revenue must be dispersed in some cases before changes in ownership, changes in price, or small changes in volumes are settled in the operator’s books.
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Prior Period Adjustment Definition
In general, Prior Period Adjustments (PPA’s) are adjustments to income or expenses in the current year due to omissions or errors or changes to previous months books. While Prior Period Adjustments are not unique to oil and gas, in this context we are not talking about restated earnings to correct an error or to account for income tax changes which is how PPA’s are used in most other industries.
In this case we are talking about the small adjustments that are made to oil and gas royalty checks due to several factors. Specifically, there can be small changes to the actual volumes or allocation between wells, or it could be a change in realized price that isn’t settled until after the royalty owners are paid or a division of interest may change due to new information.
Why are Prior Period Adjustments Made?
There can be several reasons for PPA’s to show up on your royalty check. In fact, it is a common occurrence within the oil & gas industry due to several factors:
- Changes to volumes
- Changes in realized price
- Change in ownership
- Other reasons
- Changes to volumes: when the revenue accounting group closes the books at the end of the month, they may not have the final statements from the crude purchaser or midstream company for the final gas and natural gas liquid (NGL) volumes. They may have to use the best available information at the time in order to close for the month and when the final statements come in showing the exact volumes of oil, gas, and NGL’s that were sold, they make adjustments to those previous months production volumes to reflect the actuals.
- Changes in realized price – similarly, those same statements will have the prices that were paid for each product that was sold. This might vary slightly from the values that were paid before they had the statements.
- Change in ownership – in other scenarios, if you sold or purchased a royalty interest, it may take a few months for the Division Order analyst to update the pay decks to reflect the new division of interest. If the previous owner had been paid after the effective date of the transfer or sale then they will cancel this out in future months by crediting the new owner for the months where the old owner was incorrectly paid and then back out that amount from the old owner’s interest. Or, new information may come to light in terms of a curative measure to clear up a title issue and this might affect the division of interest going forward based on the interpretation of title that went into the Division of Interest vs. the ruling by the court as to who owns what going forward.
- While not as common, things like accounting errors or audit findings can be a reason that the operator makes a prior period adjustment.
How Common are PPA’s and is There a Difference for Oil vs. Gas?
It is very common and happens on many royalty checks. Most of the time it is only a few cents here or there that might be deducted or credited against future month’s royalties. In more rare cases where there is a major title issue that is discovered, it could have a material impact on your royalty check. If you feel like a Prior Period Adjustment is being handled incorrectly on your royalties, then contact the operator to ask for more information. There are many cases where you don’t receive prior period adjustments on your royalty checks except when there is a change but not frequently or you could have small PPA’s on almost every check. It seems like it depends on the area you are in and the operator as to whether or not it is a common occurrence.
- Oil – it can happen with oil as actual volumes or actual prices paid by third party crude oil marketers may not be known until after the books are closed for the month so they can pay royalty owners in a timely manner.
- Gas, marketing, processing, timing. In my experience, natural gas prior period adjustments seem to be more common. I think this has to do with the fact that the gas is delivered to the midstream company for processing at the gas plant and actual gas volumes and natural gas shrinkage after the gas is processed and sold as natural gas and natural gas liquids is not updated in the accounting system until after the gas plant statements are received by the operator.
What to Look For with PPA’s?
- Royalty audit
- Price changes, volume changes
Even if you don’t have many PPA’s on your royalty checks, you should periodically inspect or audit your royalties to make sure you are getting paid on the correct decimal interest, that the oil, natural gas, and NGL or plant product volumes are correct. Oil is easy to check against data reported to the state oil and gas commission, natural gas is a bit tricky. With natural gas you want to make sure you are at least paid the spot price for natural gas based on the nearest sales point taking into account the energy content of the gas, also called the BTU factor. To do this you multiply the price by the volume of gas that was sold and then by the BTU factor. For example, if 10,000 mcf were sold in a month at $3/MCF and the BTU factor is 1.3 then the total royalty paid for natural gas plus NGL’s (sometimes called plant products on your check statement) should be at least more than 10,000 x $3 x 1.3 x your decimal interest in that well. If not, you can contact the royalty owner department with the operator to find out more information. If the price you were paid is lower than the spot price for a given month, it could be that they hedged production at a lower price or have an unfavorable gas purchase agreement with the midstream company that they are locked into.
Can PPA’s Cause a Negative Royalty Check?
In most cases the operator will charge upfront vs. try to seek reimbursement later in the event you have negative royalties on gas due to post production costs and low market price for gas. Prior period adjustments are usually different than the scenario where you might receive negative royalty due to a glut of gas and high transportation and other post production costs that cost more than the operator was paid for the gas. This is usually only in basins with associated gas where the primary objective is to produce and sell crude oil and profit and take a small loss on the natural gas because of lack of takeaway capacity or local oversupply situation causing depressed local prices as we saw with Waha Hub in West Texas in previous years.
So, again, the small negative amounts you see on your royalty checks due to Prior Period Adjustments are usually different than the concept of negative royalties for the sale of gas. Prior period adjustments subtract the amount that was paid previously and pay you a new amount based on the new volumes, decimal interest, or price (or combination of these things) and if it results in a deduction on your current royalty check for payment in a previous month, it is usually fairly small.
The times where I have seen the largest prior period adjustments were because new information was discovered regarding my decimal interest and that change cause the bigger impact. Other times, PPA’s for say reduced actual volumes of crude oil might be a 1/10th of a barrel or something small like that.
We talked about negative royalties in MRP 53: Negative Royalties and What to Do When Your Well Gets Shut-in. In that episode we had attorney Spencer Cox back on the show to talk about this issue right around the time that crude oil went negative in 2020 for the first time ever. In that episode you can download a whitepaper by Burns Charest LLP that talks more about the issue of negative royalties and the royalty owners rights.
Conclusion
Prior period adjustments are a relatively common occurrence in the oil and gas industry and typically result from changes in volumes of oil, natural gas, or NGL’s that were actually sold v. what you were paid for, or adjustments in the prices paid for these products, or in some cases changes to the division of interest in your wells. The first two are more common and the frequency of PPA’s seems to vary greatly by operator, state, and basin or play.
No matter what, you should periodically check your royalty statements to make sure the amounts you are paid on are correct, that the prices paid seem reasonable, and that your decimal interest is correct. More information to help you with this can be found in MRP 97: How to Audit Your Oil and Gas Royalty Statements
Resources Mentioned in This Episode
- Understanding the Prior Period Adjustment
- MRP 13: Royalty Audits and Litigation with Attorney Spencer Cox
- MRP 97: How to Audit Your Oil and Gas Royalty Statements
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