Occidental Petroleum 2008 Annual Report Download - page 40

Oil and Gas Properties
Occidental uses the successful efforts method to account for its oil and gas properties. Under this method, costs of acquiring
properties, costs of drilling successful exploration wells and development costs are capitalized. The costs of exploratory wells are initially
capitalized pending a determination of whether proved reserves have been found. At the completion of drilling activities, the costs of
exploratory wells remain capitalized if a determination is made that proved reserves have been found. If no proved reserves have been found,
the costs of the related exploratory wells are charged to expense. In some cases, a determination of proved reserves cannot be made at the
completion of drilling, requiring additional testing and evaluation of the wells. Occidental's practice is to expense the costs of such exploratory
wells if a determination of proved reserves has not been made within a twelve-month period after drilling is complete. Occidental has no
proved oil and gas reserves for which the determination of commercial viability is subject to the completion of major additional capital
expenditures.
Annual lease rentals and geological, geophysical and seismic costs are expensed as incurred.
Proved oil and gas reserves are the estimated quantities of oil and natural gas that geological and engineering data demonstrate, with
reasonable certainty, can be recovered in future years from known reservoirs under existing economic and operating conditions considering
future production and development costs. Depreciation and depletion of oil and gas producing properties is determined by the unit-of-
production method.
Several factors could change Occidental’s proved oil and gas reserves. Occidental receives a share of production from PSCs to recover
its costs and an additional share for profit. Occidental’s share of production and reserves from these contracts decreases when oil prices rise
and increases when oil prices decline. Overall, Occidental’s net economic benefit from these contracts is greater at higher oil prices. In other
contractual arrangements, lower product prices may lead to a situation where production of proved reserves becomes uneconomical.
Estimation of future production and development costs is also subject to change partially due to factors beyond Occidental's control, such as
energy costs and inflation or deflation of oil field service costs. These factors, in turn, could lead to changes in the quantity of proved reserves.
An additional factor that could result in a change of proved reserves is the reservoir decline rates differing from those estimated when the
proved reserves were initially recorded. Occidental's revisions to proved reserves were negative for 2008, which was largely due to changes
in oil and gas prices from year-end 2007 to year-end 2008. Excluding price revisions, the negative revisions amounted to less than one
percent of the total proved reserves for 2008. Occidental’s revisions to proved reserves were negative for 2007 and amounted to less than
three percent of the total proved reserves for the year. Occidental's revisions to proved reserves have been positive for six of the last ten years.
If Occidental’s consolidated proved oil and gas reserves were to change based on the factors mentioned above, the most significant
impact would be on the DD&A rate, which is determined using the unit-of-production method. For example, a 5-percent increase in the
amount of consolidated oil and gas reserves would change the rate from $10.17 per barrel to $9.69 per barrel, which would increase pre-tax
income by $106 million annually. A 5-percent decrease in the oil and gas reserves would change the rate from $10.17 per barrel to $10.71 per
barrel and would result in a decrease in pre-tax income of $119 million annually. The change in the DD&A rate over the past three years due
to revisions of previous proved reserve estimates has been immaterial.
A portion of the carrying value of Occidental’s oil and gas properties is attributable to unproved properties. At December 31, 2008, the
net capitalized costs attributable to unproved properties were $2.3 billion. The unproved amounts are not subject to DD&A or impairment until
a determination is made as to the existence of proved reserves. As exploration and development work progresses, if reserves on these
properties are proved, capitalized costs attributable to the properties will be subject to depreciation and depletion. If the exploration and
development work were to be unsuccessful, or management's plans changed with respect to these properties, as a result of economic,
operating or contractual conditions, the capitalized costs of the related properties would be expensed in the period in which the determination
was made. The timing of any writedowns of these unproved properties, if warranted, depends upon management's plans and the nature,
timing and extent of future exploration and development activities and their results. Occidental believes its current plans and exploration and
development efforts will allow it to realize its unproved property balance. Additionally, Occidental performs impairment tests with respect to its
proved properties generally when prices decline other than temporarily, reserve estimates change significantly or other significant events
occur that may impact the ability to realize the recorded asset amounts. Impairment tests incorporate a number of assumptions involving
expectations of future cash flows, which can change significantly over time. These assumptions include estimates of future product prices,
which Occidental bases on forward price curves, estimates of oil and gas reserves and estimates of future expected operating and
development costs.
The steady increase in oil and gas prices over the past several years has also caused steep increases in capital and operating costs,
including costs of materials and supplies and oil field services. The rapid and significant decline in product prices in the second half of 2008
has resulted in capital and operating costs that are not aligned with current product prices. Current pricing, coupled with a sustained high
production cost environment, could cause management's plans to change with respect to unproved properties and could cause the carrying
values of proved properties to be unrealizable. Such circumstances could result in impairments in the carrying values of proved or unproved
properties or both.
Chemical Assets
The most critical accounting policy affecting Occidental’s chemical assets is the determination of the estimated useful lives of its
PP&E. Occidental's chemical plants are depreciated using either the unit-of-production or straight-line method, based upon the estimated
useful lives of the facilities. The estimated
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useful lives of Occidental’s chemical assets, which range from three years to 50 years, are used to compute depreciation expense and are