What is Unitization?

A unitization is the pooling of assets by several parties in an oil and gas producing area in order to form a single operating unit, in exchange for receiving an interest in that unit. These arrangements are entered into to achieve operating efficiencies across the producing area, or because unitization is required by the government. Participation in the unit is typically proportionate to the oil and gas reserves being contributed to the unit by each of the entities.

Since the stages of development across the entities may differ when the unitization is enacted, the entities may pay or receive cash to equalize the contribution of wells and other assets with the ownership interests in reserves. When this happens, the recipients of cash treat the event as a cost recovery, while the payers of cash record it as an investment in wells and other assets. Thus, the cost of an entity’s interest in the assets of the unit is the cost of all assets contributed, plus or minus any cash paid or received.

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Oil and Gas Accounting

Example of Unitization

Two oil companies, Company A and Company B, own adjacent oil leases over a large reservoir. Their individual operations are inefficient due to overlapping infrastructure and suboptimal reservoir management. Both companies agree to unitize their interests to develop the field jointly. Here are the relevant facts:

Company A owns 60% of the reservoir area
Company B owns 40% of the reservoir area

Step 1: Establishing the Unitization Agreement

The companies sign a unitization agreement that defines:

Ownership Interests – Based on reservoir area:
- Company A: 60% interest
- Company B: 40% interest
Cost and Revenue Sharing – Costs and revenues are allocated proportionally to ownership interest.
Operator Selection – Company A is designated as the unit operator, responsible for managing operations.

Step 2: Accounting for Unitization

Capitalized Costs Adjustment:
- Before unitization, Company A had incurred $100 million in exploration costs, and Company B had incurred $70 million.
- After unitization, the total costs ($170 million) are allocated based on ownership percentage:
  - Company A's adjusted share = 60% × $170M = $102M
  - Company B's adjusted share = 40% × $170M = $68M
Revenue Allocation:
- If the unit generates $50 million in revenue in a period:
  - Company A receives 60% × $50M = $30M
  - Company B receives 40% × $50M = $20M
Operational Expenses:
- If operating expenses for the period are $10 million, they are split proportionally:
  - Company A pays 60% × $10M = $6M
  - Company B pays 40% × $10M = $4M