Capital vs. LOE: what's the difference?
Every dollar spent on a well is either a capital expenditure or a lease operating expense. Getting it right drives how a cost is approved, coded, billed to partners and reported. This guide covers the difference, common examples, the gray areas and why it matters on a JIB.
The short answer
A cost to create, acquire or improve a long-lived asset. That means getting a well drilled, completed and equipped, or adding to its production capacity or reserves.
It is capitalized to the property and expensed gradually through depletion (DD&A) as the oil and gas is produced.
A recurring cost to keep an existing producing well running at its current level. That means labor, utilities, chemicals, water disposal and routine repairs.
It is expensed in the month it's incurred.
Side by side
| Capital | LOE | |
|---|---|---|
| Purpose | Create a new asset or improve an existing one | Maintain current production from an existing asset |
| Frequency | Project-based and one-time: drilling, completion, a facility build | Ongoing, usually every month |
| Approval | An AFE (Authority for Expenditure), approved by partners when it's over the JOA's dollar limit | The operating budget. Routine costs need no AFE, but a large expense workover may (see AFE types below) |
| JIB coding | Charged to an AFE number and intangible or tangible capital accounts | Charged to the well or lease cost center under LOE accounts |
| Book treatment | Capitalized to the balance sheet, then depleted through DD&A | Expensed on the income statement when incurred |
| Non-consent | Partners can usually elect to go non-consent on a capital operation, with a penalty | Partners can't go non-consent on routine operating costs |
| Key metrics | Finding and development cost, capex budget vs. actual | LOE per BOE, lifting cost |
Common examples
Capital
Intangible drilling costs (IDC)
- Rig day rates and mobilization
- Drilling mud, bits, fuel and water during drilling
- Cementing, logging and directional services
- Location and road construction for a new well
- Drilling-well overhead (COPAS drilling rate)
Completion
- Perforating and hydraulic fracturing
- Completion rig, frac water and proppant
Tangible equipment and facilities
- Casing, tubing and wellhead
- Pumping unit and artificial lift for a new well
- Tank batteries, separators, flowlines
Improvements
- Recompleting into a new zone
- Deepening or sidetracking a well
LOE
People and supervision
- Pumper or lease operator labor
- Field supervision and contract labor for routine work
- Producing-well overhead (COPAS producing rate)
Utilities and consumables
- Electricity and fuel to run equipment
- Chemicals: corrosion inhibitor, paraffin and scale treatment
- Compressor and equipment rentals
Water
- Saltwater hauling and disposal fees
Repairs and maintenance
- Like-for-like pump, rod and tubing replacements
- Well servicing rig to repair and return to production
- Lease road and location upkeep
- Routine equipment repairs
Production and severance taxes are usually tracked in their own category rather than in LOE, and plugging and abandonment costs are handled through asset retirement obligations (ARO).
AFE types beyond drilling and completion
After a well is drilled and completed, most of the AFEs a JIB accountant sees fall into four groups. Each carries its own approval, coding and billing considerations.
An AFE doesn't make a cost capital. An AFE is an approval and cost-tracking tool. A large repair can need an AFE because it's over the JOA spending limit and still be an expense. What decides the classification is the nature of the work, not whether an AFE was issued.
Workover – Expense
Work on an existing well to restore production to its prior level or keep it producing. It doesn't add reserves, open new zones or increase capacity.
- Examples
- Repairing a tubing leak, replacing failed rods or pumps, cleaning out sand or paraffin, fishing out stuck equipment, acidizing to remove scale in the existing zone
- Approval
- Small jobs run through the operating budget. Jobs over the JOA's spending limit need an AFE and partner approval, even though they remain an expense.
- JIB coding
- Charged to workover expense accounts. When an AFE is issued, it's tracked against that AFE number so actuals can be compared with the estimate.
Watch for: expense workovers coded to capital to keep LOE per BOE looking lower. Partners and auditors look for this.
Workover – Capital
Work on an existing well that adds reserves, extends its productive life or increases its capacity beyond what it produced before.
- Examples
- Recompleting to a new zone, deepening, sidetracking, adding perforations in a new interval, installing artificial lift or upgrading to a larger lift system
- Approval
- Usually requires an AFE with partner approval. Under most JOAs, a capital rework is a subsequent operation, so partners may be able to go non-consent and face a penalty.
- JIB coding
- Charged to the AFE under intangible and tangible capital accounts. Equipment set on the well is tangible; labor and services are intangible.
Watch for: a single job with both kinds of work, such as repairing the existing pump while adding a new zone. Many operators split the costs between an expense AFE and a capital AFE.
Refrac
Re-stimulating an existing well's completion by fracturing it again, typically a horizontal well whose production has declined. The goal is to access reserves the original frac didn't reach and increase production.
- Examples
- Re-fracturing existing perforations, adding new stages, frac water, proppant, pressure pumping, isolation equipment or liners, and the rig and services to prepare the wellbore
- Approval
- Refracs are costly and get their own AFE with partner approval. Whether partners can go non-consent depends on how the JOA defines a rework or subsequent operation, and older JOAs may not address refracs clearly.
- JIB coding
- Generally capitalized as an intangible cost on the refrac AFE, with any new tangible equipment coded separately.
Watch for: production taken from nearby wells shut in during a frac (frac protection). Costs to shut in, protect or clean out offset wells may be billed to the refrac AFE or to each offset well's LOE, depending on the operator's policy and the JOA.
Facility
Surface equipment that gathers, separates, stores, compresses or disposes of production. A facility often serves several wells at once.
- Examples
- Central tank batteries, separators and heater treaters, compressor stations, saltwater disposal wells and facilities, gathering lines and flowlines, power lines and electrical infrastructure
- Approval
- New builds and expansions go on a facility AFE. Operating and maintaining the facility afterwards is LOE.
- JIB coding
- Capital costs are charged to the facility AFE. Since one facility can serve wells with different ownership, the costs are allocated to each well or lease, by well count, production volume or a method set out in the JOA or a facility agreement.
Watch for: allocation errors. When a new well ties into an existing facility, the allocation percentages must be updated or partners in the original wells keep paying the new well's share.
The gray areas
These items cause the most coding questions and audit exceptions. The deciding factor is usually whether the work restores what the well already did or adds something new.
Workovers
Pulling a well to fix a hole in tubing or replace a failed pump, then bringing it back to its prior rate, is usually LOE. Work that opens a new zone, adds reserves or meaningfully raises production above the prior level is usually capital. See Workover – Expense and Workover – Capital above.
Equipment replacement
Replacing a failed part with the same kind of part is maintenance. Installing new or upgraded equipment, such as converting a flowing well to rod pump or adding compression, is generally capitalized, especially above the company's dollar threshold.
Dry holes
Under the successful efforts method, the costs of an exploratory well that finds no commercial reserves are expensed. Under the full cost method they stay capitalized in the cost pool. The original AFE is still the billing vehicle either way.
Book vs. tax
Intangible drilling costs are capitalized for financial reporting, but U.S. tax rules let many producers deduct them in the year incurred. The same cost can be capital on the books and an expense on the tax return. Your tax department makes that call.
Company policy and thresholds
Many operators set a dollar threshold, so that repairs above a set amount, or work expected to extend a well's life by more than a year, get capitalized. These policies vary. Your company's capitalization policy and the JOA govern, not general rules.
Why it matters on a JIB
- Partners review AFE spending closely. Capital charges are compared against the approved AFE. Overruns past the variance allowed in the JOA can lead to questions, supplemental AFEs or disputes.
- The JOA sets approval limits. Most JOAs, including the AAPL Model Form 610, limit how much the operator can spend on a single project without partner consent. Coding a capital project as LOE can sidestep that approval and invite an audit exception.
- Non-consent and payout depend on it. Non-consent penalties and payout status are calculated from the capital costs of an operation. Miscoded costs throw off recoupment and the payout date.
- Overhead rates differ. COPAS drilling-well and producing-well overhead rates are different, and each goes to a different side of the ledger.
- Partners rely on your classification. Non-operators use your coding for their own books, reserve reports and tax returns. A miscoded item becomes their problem too.
- Joint interest audits target it. Misclassified charges, such as LOE billed to an AFE to stay under budget, or capital buried in LOE, are among the most common joint interest audit findings.
Practice: capital or LOE?
Scenarios a JIB accountant sees every month. Pick an answer to see the reasoning.
This guide is general educational information, not accounting, tax or legal advice. Classification depends on your company's capitalization policy, its accounting method and the terms of the applicable joint operating agreement and COPAS accounting procedure.