Calculating DD&A for Oil&Gas Companies (2024)

DD&A is one of the biggest (if not the biggest) line items on the income statement of oil and gas companies because it represents the systematic allocation of the cost of physical assets (which includes tangibles and intangibles) of an oil and gas company over the economic life. In simple accounting terms, depreciation is the systematic allocation of the capitalized cost of physical assets, i.e property, plant, and equipment, over the economic life. Depletion is the gradual allocation of the value of non-renewable natural resources like oil/gas over the period as it continues to be extracted. Amortization follows the same principle, as already explained, except that it is applied to intangible assets. Remember that a good chunk of the proved property costs of oil and gas companies is attributable to acquisition costs (like legal fees, rental payments, G&G costs, etc). So, these acquisition costs are amortized over the economic life of the assets.

Having the most reasonable basis for calculating DD&A every year is very important to the top executives, regulatory bodies as well as statutory auditors of any oil and gas company. Any wrong approach or basis for calculation could have bizarre outcomes on the income statement and the overall annual report. The formula for the calculation is simply the net book value of assets (at end of the period) divided by the volume of estimated reserves (at the beginning of the period) and multiplied by the output/production for the period in question. I must hasten to add that, it is not as simple as that in reality because all things are not necessarily equal as we would want to assume in economics theory.

Some situations may normally arise every year that would mean careful consideration before the determination of the final numbers to calculate the final DD&A numbers that are chargeable to the income statement.

The first is the legal consideration which is dictated by the kind of agreement establishing the relationship among all the parties with interest in the O&G assets. The proportion of ownership by an oil and gas company in the reserves is determined by the working interest and the royalty interest. The royalty interest is attributable to the natural owner of the reserve—in this case, it is the state in most parts of the world. The working interest owner is the oil company that acquires this interest as a result of incurring certain costs and performing certain duties in accordance with the agreement. The royalty interest is deducted from the total stake before an oil company calculates its share of total reserves and production for the calculation of the chargeable DD&A for a period.

For instance, if the total reserves are 100M barrels with a royalty interest of 15% to the state, then the working interest stake that goes to the other oil companies is 85% of the total reserves. The oil companies would share this remaining interest in accordance with their respective ownership interests. So what reserve categories are used to calculate DD&A since there are several of them? Simple! —Proved reserves and proved developed reserves for successful efforts companies. Again, remember that proved reserves include proved developed and proved undeveloped, unless all proved reserves are developed when proved reserves will be equal to proved developed reserves. Please take your time to understand it because it could be confusing sometimes.

The next piece will look at the various scenarios that could arise and that need to be carefully examined and understood before calculating the DD&A numbers for a period. Please look forward to it.