Archived - Independent Audits Relating to Oil Trucking Costs

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A. Introduction

The purpose of this Information Letter is to describe Indian Oil and Gas Canada's (IOGC) policies relating to oil and gas mineral leases that contain a clause requiring an independent audit of actual oil trucking costs.

B. Background

Many of the mineral lease agreements signed by Indian Oil and Gas Canada (the lessor), oil and gas companies (the lessees) and various Indian bands, have stated that the net royalty payable on oil is equal to the gross royalty on oil less the Trucking Costs for Oil. These trucking costs are then defined as either "…a written pre-agreed flat rate for trucking costs, or the actual trucking costs incurred on a monthly basis for trucking clean oil only, from the Point of Measurement (the production tankage) to the nearest available pipeline."

Pursuant to these leases, the lessee is required to pay for an independent audit of the actual trucking costs. This audit is to be carried out by a party agreeable to the lessor and shall occur every two years on or before the anniversary of the Effective Date of the lease. Copies of all completed audit reports are to be sent to the lessor and Band Council free of charge, and the lessee shall amend royalty statements and remit any monies owing within 60 days of the final audit report.

C. Circumstances Requiring an Independent Audit of Oil Trucking Costs

1. The mineral lease contains a clause that requires the independent
   audit.
2. None of the situations in section D exist.

D. Circumstances in Which an Independent Audit of Oil Trucking Costs Is Not Required

This Information Letter does not apply to situations where the terms of the mineral lease do not state that an independent audit is required. Examples of such leases include the following:

1. leases that incorporate either the Saskatchewan Treaty Land Entitlement Framework Agreement (TLE Leases) or the Alberta Oil Sands Royalty Regulation – 1997;
2. leases requiring oil transportation costs to be approved by the Band Council;
3. leases that require oil transportation costs be approved by IOGC or
4. leases that provide for an oil trucking deduction at a fixed rate expressed in dollars per cubic metre.

In addition, an independent audit will not be required if the lessee and IOGC have signed a Letter Agreement as described in section E 3 below.

E. Leases Requiring an Independent Audit of Oil Trucking Costs

1. Notification Letter Sent to Lessees

Leases with the independent audit clause require the audit to occur every two years. For practical purposes, the initial audit period was January 1, 2004 to December 31, 2005, with subsequent audit periods occurring every two calendar years thereafter. In the years an independent audit is required, IOGC will send a letter to the lessee providing relevant details approximately four months prior to the audit report due date of June 30. See Appendix 1 for an example of a table detailing the type of information that will be provided.

2. Independent Audit Option

The notification letter will require the lessee to choose between having the independent audit performed or signing a Letter Agreement. When the independent audit is chosen, it must be conducted in accordance with Appendix 2 "Guidelines Relating to Independent Audits of Oil Trucking Costs."

In addition, the audit report must conform to the requirements specified in Appendix 5, "Contents of the Independent Audit Report." Appendix 6 provides definitions of key terms and guidance on eligible and ineligible oil trucking costs, while Appendix 7 indicates the expected format of the audit opinion.

3. Letter Agreement Option

The second option for the lessee is to sign the Letter Agreement, a sample of which is attached as Appendix 3.

IOGC recognizes that in situations where minimal trucking deductions have been claimed by the lessee, or a company paying royalties on behalf of the lessee, the cost of the audit may exceed the total amount of deductions claimed over the two year audit period. In these situations, it would not be cost-efficient to perform the independent audit. Accordingly, IOGC will allow all lessees the option of signing a Letter Agreement, the effect of which is to waive the requirement for the independent audit on condition that a payment equal to the trucking deductions claimed during the audit period is made to IOGC on the 25th day of the month following the date the Letter Agreement is executed. This payment is in addition to the normal oil royalties due on that day.

Every two years a lessee will have the choice of deciding whether to have the independent audit performed or signing the Letter Agreement. As a result, signing the Letter Agreement for one audit period does not preclude the lessee from electing to have an independent audit performed for the succeeding audit period.

4. Documenting the Option Chosen

IOGC requires confirmation of the option chosen. Accordingly, the form entitled "Election for Trucking Deductions" (Appendix 4) must be received by IOGC on or before April 30 of the year in which the independent audit report is due.

F. Failure to Comply

Failure to comply with the requirements specified in this Information Letter or the related Appendices will result in the process specified in section 46 of the Indian Oil and Gas Regulations being initiated. A Direction to Comply letter will be sent to the lessee. If the lessee fails to diligently remedy the deficiencies noted in the Direction to Comply letter, IOGC may take a range of actions, from setting the trucking deduction rate to zero for the audit period to cancelling the lease, based on the facts of each case.

G. Contact Person at IOGC

Any questions relating to this Information Letter should be directed to Harold Andrews, Audit Coordinator, by phone 403-292-6391, fax 403-292-5618 or email HaroldAndrews@inac-ainc.gc.ca.

Appendix 1 - Name of Lessee

Table Detailing the Submitted Oil Trucking Deductions for the Period
January 1, xxxx – December 31, xxxy

Indian Reserve No._____

Appendix 2 - Guidelines Relating to Independent Audits of Oil Trucking Costs

1. Circumstances Under Which Independent Audits of Oil Trucking Costs Are Required

Such audits are required when the following conditions are met:

1. The terms of the mineral lease signed by Indian Oil and Gas Canada (IOGC – the lessor), the oil and gas company (the lessee) and the applicable Indian band contain an "independent audit clause" in respect of actual trucking costs for oil. This includes certain leases issued under the Federal Real Property Act.
2. None of the situations in item 2 below exist.

2. Circumstances Under Which Independent Audits of Oil Trucking Costs Are Not Required

1. When the terms of the mineral lease signed by the lessor, the lessee and the band do not state that such an audit is required. Examples of such situations include the following:
   
   
   • Leases signed pursuant to the Saskatchewan Treaty Land Entitlement Framework Agreement (TLE Leases).
   • Leases which require oil transportation costs be approved by the Band Council.
   • Leases which require oil transportation costs be approved by IOGC .
   • Leases made pursuant to the Alberta Oil Sands Royalty Regulation – 1997
   • Leases which provide for a trucking deduction at a fixed rate expressed in dollars per cubic metre.
2. The lessee has signed a letter agreement (Appendix 3) with IOGC agreeing to:
   
   
   • not claim oil trucking deductions from the date of the agreement and
   • increase future oil royalty payments by the amount of the trucking deductions claimed on its behalf in the 3 prior calendar years.

3. Notification Process for Oil Trucking Deductions Relating to Leases Requiring an Independent Audit

IOGC will send a Notification Letter to the lessee (s) detailing the lease numbers, the oil royalty entities, the deductions claimed, the time period to be covered by the audit and other pertinent information approximately 3 months prior to the audit report due date of June 30th.

4. Independent Audit v. Letter Agreement

After receipt of the Notification Letter, the lessee(s) must decide whether it (they) wish to proceed with the independent audit or to sign the Letter Agreement (Appendix 3). This decision is to be documented on the Election for Trucking Deductions form (Appendix 4) which must be received by IOGC on or before April 30 of the year in which the independent audit report is due (see 8 below).

Payment of oil royalties pursuant to the Letter Agreement must be accompanied by a remittance advice explaining the reason for the payment and detailing the royalty entities and months/years to which the payment relates.

Where the Letter Agreement option is chosen, an independent audit(s) is not required for the period of time covered by the Letter Agreement. Sections 5 - 14 of this Information Letter relate to the situation where the lessee(s) decides to have the independent audit performed.

5. Party Required to Pay for the Independent Audit

The lease states the lessee shall pay for the independent audit. However, this provision does not preclude lessees and royalty payers from negotiating an alternative payment arrangement.

6. Party Performing the Independent Audit

Leases with the independent audit clause require the audit be conducted by a party agreeable to the lessor. To meet this condition, IOGC requires the audit opinion be signed by a professionally designated accountant (chartered accountant, certified management accountant or certified general accountant) who is a member in good standing of the applicable provincial regulatory body.

This individual or firm must also meet the regulatory body's independence requirements for audit engagements. This means the auditor chosen must be free of any interest, influence or relationship in respect of the lessee's or royalty payer's affairs (in those situations where another company pays the oil royalties on behalf of the lessee) which would impair his or her judgment or objectivity, or which, in the view of a reasonable observer, may have that effect. For example, the auditor chosen cannot be an employee of the lessee, the royalty payer or the company contracted to perform the crude oil transportation services.

Lessees or royalty payers are not to send copies of trucking invoices to IOGC on the assumption that IOGC will perform the audit. Such invoices will be returned to the sender. It is the lessee's responsibility to ensure the independent audit is conducted in accordance with the provisions of both these guidelines and the applicable lease.

Where the lessee is not the royalty payer, the lessee will need to arrange for the audit of the oil trucking records maintained by the royalty payer.

7. Time Period to be Covered by the Independent Audit

Leases with the independent audit clause require the audit to occur every two years. For practical purposes, the initial audit period will be January 1, 2004 – December 31, 2005 with subsequent audit periods being every two calendar years thereafter.

8. Due Date of the Audit Report

Audit reports for the period January 1, 2004 – December 31, 2005 must be received by both IOGC and the applicable Band Council by June 30, 2007. Thereafter, audit reports will be due by June 30 of the year following the audit period. For example, IOGC and the applicable Band Council must receive the audit reports for the period January 1, 2006 – December 31, 2007 by June 30, 2008.

IOGC will allow a lessee to request one extension of the deadline to July 31. This request must be made in writing and must be received by IOGC prior to June 30th.

9. Contents of the Independent Audit Report

Leases with the independent audit clause require an audit report be sent to the lessor and Band Council without cost. This report must include the components specified in Appendix 5.

10. Definition of Eligible Oil Trucking Costs

Guidance on eligible and ineligible costs is provided in Appendix 6.

11. Calculation of the Oil Trucking Rate and the Oil Trucking Deduction

The oil trucking rate is expressed in dollars per cubic metre and is calculated by dividing the sum of the eligible costs incurred on a monthly basis by the volume of clean oil delivered in the month from the Point of Measurement to the nearest available pipeline.

This rate is included as part of the monthly electronic oil royalty submission made by the royalty payer to IOGC .

12. Definition of the Point of Measurement

It is the outlet valve of the production tankage.

13. Audit Results

Royalty payers may re-calculate the amount of net oil royalties payable based on the audit results. If an underpayment has occurred, IOGC encourages this amount be remitted by the next royalty due date (25th of the month) to avoid interest charges. The cheque must be accompanied by a remittance advice detailing the reason for the payment and the amount allocated to each oil royalty entity by production month/year.

If an overpayment has occurred, IOGC will work with the royalty payer to address this situation. Royalty payers should not deduct or otherwise offset the overpayment from future Oil Royalty Submissions. Royalty payers are not to amend previously filed Oil Royalty Statements or Submissions based on the audit results.

If the audit report conforms to the requirements specified in Appendix 5, IOGC will input the audited trucking rates into its computer system and recalculate the net oil royalties. IOGC will advise the lessee and royalty payer of the changes to the net oil royalties resulting from the audit.

14. Assignment or Expiry of the Lease

Depending on the wording of the Assignment Agreement, the assignor and/or the assignee, will have the responsibility for submitting to IOGC , by the required due date, any independent audit which relates to a time period either before or after the date IOGC approved the assignment.

When a lease expires, the lessee (s) at the date of expiry will have the responsibility for submitting to IOGC , by the required due date, any independent audit which relates to a time period prior to the date the lease expired.

15. Non-Compliance with the Requirements of this Guideline

Failure by the lessee to comply with the requirements specified in Appendices 2-6 will result in the compliance process detailed in section 46 of the Indian Oil and Gas Regulations being initiated. A Direction to Comply letter will be sent to the lessee(s).

If the lessee(s) fail to diligently remedy the deficiencies noted in the Direction to Comply letter, IOGC may take a range of actions, from setting the trucking deduction rate to 0 for the audit period, to cancelling the lease, based on the facts of each case.

16. Contact at IOGC for Questions Relating to this Guideline

Please contact Harold Andrews at: phone: 403-292-6391, fax: (403) 292-5618, or e mail: Harold.Andrews@inac-ainc.gc.ca.

Appendix 3 - Letter Agreement

E-5855-4-1-PRB

Name and Address of Lessee

Letter Agreement Relating to
Independent Audit of Trucking Costs for Oil
Oil and Gas Lease OL -______, OL-______
_________________ Indian Reserve No. ____

Indian Oil and Gas Canada ("Lessor") and __________________ ("Lessee") are
parties to oil and gas leases OL-____, and OL-____ ("the Leases"). A review
conducted by the Lessor reveals that for the period noted in the table below, a total
of ___________________ dollars and ________ cents ($ _____.__) in oil trucking
costs were deducted by the Lessee on Oil Royalty Submissions filed in relation to
the Leases, as follows:

Section 4.2 of Appendix B - "Royalty Terms" of the Leases requires the Lessee to pay for an independent audit of the Trucking Costs for Oil. This audit is to occur every two years on or before the anniversary of the Effective Date of the Leases. The Lessee is also required to send copies of all completed audit reports to Lessor and Council free of charge, amend royalty statements and remit any monies owing within 60 days of the final audit report.

Where minimal trucking deductions are claimed by a lessee, Indian Oil and Gas Canada recognizes the independent audit requirement may not be in the best interest of the parties.

NOW THEREFORE, in consideration of the mutual covenants and promises herein contained, and the payment of One Dollar ($1.00) by each party to the other, receipt of which is acknowledged, the Lessor and Lessee agree as follows:

Letter Agreement Relating to
Independent Audit of Trucking Costs for Oil
Oil and Gas Lease OL-____, OL-____
______________ Indian Reserve No. ____

1. The independent audit requirements set out in Section 4.2 of Appendix B - "Royalty Terms" of the Leases are hereby waived for the period January 1, xxxx – December 31, xxxy.

2. At the time Lessee submits its next Oil Royalty Submission to Lessor, Lessee shall pay to Lessor, in addition to the oil royalties normally payable, the sum of ____________ dollars and __________ cents ($ ______.__) as payment of the submitted trucking costs previously deducted from oil royalties payable under the Leases for the period of time noted in the Table on page 1 of this Letter Agreement.

3. The Leases are amended only to the extent set out in this Letter Agreement.

INDIAN OIL AND GAS CANADA

______________________
Strater Crowfoot
Executive Director

ACCEPTED AND AGREED TO THIS ____ DAY OF ______________, xxxz.

Name of Lessee: __________________________

Name: __________________________

Title: __________________________

Appendix 4 - Election for Trucking Deductions

PART 1: Details Relating to Lease Holder

PART 2: Trucking Deduction Election

PART 3: Declaration

Appendix 4 - Instructions Relating to the Election for Trucking Deductions Form

1. Purpose

Lease holders must use this form to elect how they wish to discharge the lease obligation relating to independent audits of oil trucking costs. If the lease holder does not file this form or the filed form is incomplete, the lease holder will be deemed to have elected the independent audit option.

2. Timing

This form must be received by Indian Oil and Gas Canada on or before April 30 of the year in which the audit report is due.

3. Changing a Previous Election

A lease holder is permitted to change from the Independent Audit option to the Letter Agreement option. In this case, the Letter Agreement would apply to the period of time beginning with the end date of the most recent independent audit.

Lease holders are also permitted to change from the Letter Agreement option to the Independent Audit option. In this case, the beginning point of the Independent Audit would be the day after the Letter Agreement terminated.

Appendix 5 - Contents of the Independent Audit Report

Leases with the independent audit clause require an audit report be sent to the lessor and Band Council without cost. This report must include the following:

1. a statement the auditor is a member in good standing of the applicable provincial regulatory body and meets that body's independence requirements for audit engagements;
2. an audit opinion on whether the trucking rates reported on the monthly Oil Royalty Statements or Submissions are presented fairly, in all material respects, during the audit period;
3. where the audit results in changes to the reported trucking rates, the audit report must detail the revised and submitted oil trucking rates, expressed in dollars per cubic metre, by oil royalty entity, for each month in which the audited rate varies from the submitted rate. IOGC will not accept an average audited trucking rate, in dollars per cubic metre, encompassing all audited oil royalty entities for the entire audit period;
4. Where the audited trucking rate varies from the submitted rate, the audit report must also explain the reason for the difference. Examples of explanations are:
   
   
   1. inclusion of ineligible costs
   2. exclusion of eligible costs
   3. eligible costs relating to one production month were improperly allocated to another production month.
   4. errors in the calculation of the volume of clean oil trucked in the production month.

Appendix 6 - Eligible and Ineligible Oil Trucking Costs

a) Definitions

b) General Rules on Deductible Trucking Costs

In order to be deductible, trucking costs for oil or actual trucking costs must meet the following conditions:

1. the lessee or royalty payer has actually incurred the trucking charges
2. the reported sales price on the Oil Royalty Submission must be the purchaser's price at the point of sale
3. the sale did, in fact, take place

Terminal waiting time charges and truck terminal fees are deductible if they are part of the trucking costs paid by the lessee or royalty payer to the trucking company.

c) Arm's Length Transactions

1. Eligible Cost Components
   
   Actual direct "in-transit" costs for trucking clean oil, without interruption, from the production tankage to the nearest available pipeline.
2. Ineligible Cost Components
   
   
   • The cost of trucking clean oil to a cleaning facility or from a cleaning facility to any pipeline receipt point.
   • The cost of trucking clean oil from the production tankage to a pipeline receipt point which is not the nearest pipeline receipt point.
   • The cost of treating, processing or cleaning the oil
   • Goods and Services Tax (GST)
   • Any cost incurred subsequent to the point in time when the lessee had title to the oil.
   • The following types of expenses incurred by the lessee or royalty payer:
     
     
     • oil insurance costs
     • oil storage costs
     • water disposal costs
     • well servicing costs
     • administrative/overhead costs
     • oil marketing or commission fees
3. Clean Crude Oil Trucked to a Pipeline Which is Not the Nearest Available Pipeline
   
   Actual trucking costs per cubic metre cannot exceed the monthly rate available from the lowest cost competitive source for trucking clean crude oil only, without interruption, from the production tankage to the nearest available pipeline, as documented by letters from the competitive source.

d) Non - Arm's Length Transactions

Maximum Trucking Rate

Actual trucking costs per cubic metre cannot exceed the monthly rate available from the lowest cost competitive source for trucking clean crude oil only, without interruption, from the production tankage to the nearest available pipeline, as documented by letters from the competitive source.

e) Trucking of Oil/Water Emulsions

When oil is produced in an emulsion, trucking costs for the clean oil volume are calculated using the formula:

Clean Oil Trucking Costs = Clean Oil Sale Volume in Emulsion ÷ Volume of Emulsion × Trucking Costs for Emulsion

For Example:

The cost of trucking the emulsion is $ 1,500.00

Assume total emulsion volume = 100.0 m³ with 90% oil and 10% water

Trucking costs for 90.0 m³ of clean oil delivered and sold during the month would be

90.0 ÷ 100 × $ 1,500.00 = $ 1,350.00

f) Record Retention

Pursuant to the lease agreements, accurate and detailed records related to the calculation of the royalty payable under the lease must be retained by the lessee and its representatives (royalty payers) for a period of 6 years from the last day of the year in which the records were rendered or to which the records pertain. These records must be made available in Alberta.

Appendix 7 - Format for Audit Opinion

This audit opinion should be a separate page and should be in the following format:

I or We have audited (name of company) oil trucking rates for the period __________________ to _________________ used in the calculation of net oil royalties at the ___________________ Indian Reserve No. ______. Our audit was to determine whether the oil trucking rate claimed by (name of company) was in compliance with the Indian Oil and Gas Act, Regulations, and Leases. Compliance with the Act, Regulations and Leases is the responsibility of the management of (name of company). Our responsibility is to express an opinion on this compliance based on our audit.

We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether (name of company) complied with the Act, Regulations and Leases for the oil trucking rate referred to above. Such an audit includes examining, on a test basis, evidence supporting compliance, with the Act, Regulations and Leases, and where applicable, assessing the accounting principles used and significant estimates made by management.

We have identified variances to the oil trucking rates during the audit period as summarized on the attached schedules.

Except for the variances identified in schedules ___, (name of company) has complied, in all material respects, with the Indian Oil and Gas Act, Regulations, and Leases in respect of the oil trucking rate for the period ______________ to ____________ used in the calculation of net oil royalties at___________________ Indian Reserve No. ______.

Name of person or firm signing the opinion.
Print name of person or firm signing the opinion.