Depreciation Methods

In the case of oil and gas, capitalized items for depreciation include casing, tubing, flow lines, tanks, platforms, and other equipment. Tangible investments are basically related to any item that has a life in excess of one year.

Campbell, et. al. (1987) mention that the depreciation write-offs depend on the type of expenditures. The law presently divides investments into two categories: 5- and 7-year lives. The depre­ciation schedule for each project life is presented. The life year values under the 1987 laws in the USA are derived from a 200% declining value over 5 years, often referred to as a 40% declining value in Europe and Canada. Depreciation in the 7-year category converts to a 28.6 % declining balance in those countries. The 7-year category covers virtually every petroleum investment except for drilling equipment (5 years), oil refining equipment (10 years), and transmission pipeline and related equipment (15 years).

Depreciation begins when the project is classified as "ready for service." The definition of ready for service varies among compa­nies. Some define ready for service as capable of producing, while others require production actually to take place before deprecia­tion: gas wells, for example, are often completed but not hooked up. Processing plants take several years to build, and start-up off­shore platforms are constructed and wells are drilled, but produc­tion cannot commence until the product is disposed of. The same situation exists in remote, onshore areas. In each of these cases, a delay can be expected between technical completion of the project and the initial flow of revenue.

The question that arises here is whether a tangible investment capable of working, but not active, is ready for service and can be depreciated. Opinions and practice vary. Some argue that capable of working is the same as ready for service. Others take a more conservative position and begin depreciation only after products are sold. Decisions regarding the correct approach depend on the legal staff s opinion. The "capable of working" interpretation

Table 3.1 Financial life time

5 year life

Automobiles

Trucks

Drilling equipment

Computer

10 year life

Crude oil refining equipment

15 year life

Transmission pipeline and equipment

31.5 year life

Buildings

lowers the after-tax cost of investment by beginning depreciation write-offs earlier. The various depreciation methods will be as follows for different industrial projects: