structuring oil and gas joint operating and farmout...

Structuring Oil and Gas Joint Operating and Farmout Agreements Drafting and Negotiating Instruments to Control Costs, Reduce Risks, and Overcome Exploration and Production Challenges

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WEDNESDAY, JANUARY 29, 2014

Presenting a live 90-minute webinar with interactive Q&A

Brent D. Chicken, Partner, Burleson LLP, Denver

Timothy Dowd, Elias Books Brown & Nelson PC, Oklahoma City

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Burleson LLP © 2014 5

THE MODEL FORM JOINT

OPERATING AGREEMENT:

AN OVERVIEW FOR ACCURATE

COMPLETION AND

CONSIDERATIONS IN LIGHT OF

MODERN DEVELOPMENT

Presented by: Brent Chicken Partner Burleson LLP 303-801-3210 [email protected]


ROADMAP

• Accurate completion of the A.A.P.L. 610-1989 Model

Form

• Additions to consider to address modern horizontal

well oil and gas exploration and development

• Recent judicial interpretations


JOINT OPERATING AGREMENTS

• A contract between an operator and one or more

non-operators to jointly develop an area

• American Association of Petroleum Landmen Model

Form 610-1989 Joint Operating Agreement (“Model

Form JOA”)

– Can be freely added to or subtracted from, but

provides a basic uniform structure


MODEL FORM JOA STRUCTURE

• Five Main Model Form JOA Parts

– Title page

– Table of contents

– Preamble

– Articles

– Additional provisions in Article XVI (special

provisions)


ACCURATE COMPLETION OF

MODEL FORM JOA

• There are numerous blanks to fill-in and options to

choose from

• Each option has a proper application and potential

operational and legal consequences


MODEL FORM JOA: COVER PAGE

Date: Insert an effective date for the Model Form JOA,

which should be earlier than the date inserted in Article

VI.A (Initial Well)

Operator: Insert proper legal name and verify

consistency with operator named in Preamble and

Article V

Contract Area: Insert legal description of the lands

covered by Model Form JOA


MODEL FORM JOA: PREAMBLE

– Properly identify the operator of the contract area

by full and correct name


MODEL FORM JOA: ARTICLE II

• Model Form JOA Exhibits

– There are eight (8) exhibits included, in a check

box format, although common to run a strike

through line through unused exhibits

– Model Form JOA Exhibit A

• Identification of lands, wells and/or substances

covered, including depth or formation

restrictions

• Names, addresses & other contact information

of parties



• Model Form JOA Exhibits (cont.)

– Model Form JOA Exhibit A (con’t)

• Ownership of parties in contract area, and

listing of committed oil and gas leases and

respective burdens




– Model Form JOA Exhibit B

• A form oil and gas lease to be used for

acquisition of leasehold interests covering

unleased minerals in contract area, although

typically excluded




– Model Form JOA Exhibit C

• Council of Petroleum Accountant Societies

(“COPAS”) accounting procedure; sets forth

manner in which payment is made to service

vendors, how operations costs are remitted to

operator, and other financial matters




– Model Form JOA Exhibit D

• Covers insurance matters between parties,

setting forth type of coverage, applicable limits

and other matters

– Model Form JOA Exhibit E

• Gas balancing agreement; exclusion of this can

create future ambiguities so, although not

required, one is often included




– Model Form JOA Exhibit F

• Certification of non-discrimination and non-

segregation of facilities

• Often included just to ensure compliance with

federal government non-discrimination

mandates

– Model Form JOA Exhibit G

• Tax partnerships; typically not employed absent

disproportionate sharing of expenses




– Model Form JOA Exhibit H

• Miscellaneous additions, including extra maps

and plats, as well as recording forms; recording

memorandum is important, because it provides

record public notice of existence of terms

contained in the Model Form JOA


MODEL FORM JOA: ARTICLE III

• Interests of Parties

– A. Interests of Parties in Costs and Production

• Insert maximum leasehold burden amount

• Verify this amount to ensure accuracy


MODEL FORM JOA: ARTICLE V

• Operator

– A. Designation and Responsibilities of Operator

• Repeat the proper and correct name of the

operator designated on the Model Form JOA

Cover Page and Preamble


MODEL FORM JOA: ARTICLE VI

• Drilling and Development

– A. Initial Well

• Insert the anticipated date for commencement

of operations, legal description of the exact well

location and target subsurface formation


MODEL FORM JOA: ARTICLE VI • Drilling and Development (con’t)

– B.2 Subsequent Operations; Operations by Less

than All Parties

• B.2(b)(i)-(ii): Insert desired non-consenting

party percentages

• Incentive to encourage development

• Percentages determined on a case-by-case

basis, but a 100%-400% non-consent penalty is

common

• B.2(c): Insert the consenting party recovery

percentage for reworking, recompleting or

plugging back



• Drilling and Development (con’t)

– C. Completion of Wells; Reworking and Plugging

Back

• C.1 Completion

– Select Option 1 or Option 2

– Option 1 is broader; generally elected if

there is intent to drill a horizontal well

– Option 2 contains a “casing point election;”

parties elect to participate in the completion

attempt by AFE




– D. Other Operations

• Insert the limit on operator’s single-project

budget on a single project

• Insert minimum ownership percentage for

consenting parties associated with other

operations




– F. Terminations of Operations

• Insert minimum consenting parties percentage

for commenced operation termination




– G. Taking Production In-Kind

• Select Option 1 or Option 2

– Option 1 attaches a gas balancing

agreement

– Option 2 gives operator the right to market

non-operator’s oil and gas, although this

option is not a substitute for having a gas

balancing agreement if needed


MODEL FORM JOA: ARTICLE VIII

• Acquisition, Maintenance or Transfer of Interest

– F. Preferential Right to Purchase

• Select if intent of parties, however:

– Often not included

– A method for non-transferring parties to buy

a greater interest in contract area

– A way to control the parties who are subject

to the Model Form JOA


MODEL FORM JOA: ARTICLE X

• Claims and Lawsuits

– Operator may usually settle claims without

approval of non-operators, up to a dollar amount

set by parties in this provision


MODEL FORM JOA: ARTICLE XIII

• Term of Agreement – Two (2) options:

• Option 1 maintains Model Form JOA for as long as any of the oil and gas leases committed to it remain or are continued in force as to any part of the contract area

• Option 2 terminates effectiveness of Model Form JOA within a specified period following cessation of production or abandonment of the last well

– Other provisions often dictate which option is best • Typically, Option 1 for multiple wells and Option 2 for a

single well


MODEL FORM JOA: ARTICLE XIV

• Compliance With Laws and Regulations

– B. Governing Law

• Insert state of governing law, typically where

majority of contract area lies

– Model Form JOA is subject to all local, state and

federal laws, ordinances, rules, regulations and

orders

• If lands straddle two or more states, parties can

elect which state’s law should govern

• Parties often do this to ensure predictability


MODEL FORM JOA: ARTICLE XVI

• Other Provisions (Special Provisions)

– There may be no need for this article if everything

is already covered, but it is often included and

may address special matters such as:

• Drilling and operation of horizontal wells

• Treatment of advance well cost payment

• Escrow agreements for payment of costs

• Specific rights against defaulting parties

• Additional obligation well requirements

• Additional relinquishment for non-consenting

parties, priority of operations, areas of mutual

interest


MODEL FORM JOA: HORIZONTAL

DRILLING EDITING

• The Model Form JOA does not address horizontal

drilling operations

• Modifications and additions should be considered if

horizontal drilling is contemplated



DRILLING EDITING

• Article I – Definitions

– Should be updated to include horizontal drilling

references and language

• AFE: Should include directional drilling costs

• Deepen, Sidetrack and Plug Back: Should

include language to address horizontal drilling

• Drillsite: Should include surface and bottomhole

locations



DRILLING EDITING

• Additional Article I Definitions

– Lateral: The horizontal segment of the wellbore

where the wellbore deviates from a vertical

orientation

– Horizontal Well: May cite to statutory or regulatory

definition of particular state, if available



DRILLING EDITING

• Additional Article I Definitions

– Multi-Lateral Well: A horizontal well containing

more than one lateral from the same wellbore

radiating in different directions or targeting

different subsurface formations (definition should

express the objective formation)



DRILLING EDITING

• Additional Article I Definitions (con’t):

– Total Measured Depth: The vertical depth of the

wellbore combined with the length of the lateral

segment of the wellbore

– Vertical Well: A well drilled, completed or

recompleted other than a horizontal or multi-lateral

well



DRILLING EDITING

• Article VI – Drilling and Development

– A. Initial Well: The surface location, depth and

horizontal depth should be provided

– C. Completion of Wells; Reworking and Plugging

Back: Option 1 should be checked if drilling

horizontal wells



DRILLING EDITING

• Article XVI – Special Provisions

– Priority of operations regarding horizontal wells

• A list of elections regarding the priority of

further operations in the event of non-consent

may be included

– Proprietary data and technology typically subject

to confidentiality


MODEL FORM JOA: RECENT

JUDICIAL INTERPRETATIONS

• Several recent cases have focused on the application

of the exclupatory language in Model Form JOA

Article V.A

– Relieves the operator of liability for its activities

under the Model Form JOA “except as may result

from gross negligence or willful misconduct”

– In the past, this provision was interpreted as

limited to operational, rather than contractual,

duties




• Reeder v. Wood County Energy, LLC, 395 S.W.3d

789 (Tex. 2012)

– Held that an exculpatory clause modeled from the

Model Form JOA exempts the operator from all

liability unless it arises from gross negligence or

willful misconduct; the court found no evidence of

gross negligence when the operator failed to offer

a well before plugging it




• IP Petroleum Co. v. Wevanco Energy, LLC, 116

S.W.3d 888 (Tex. App. 2003):

– The exculpatory clause in a Model From JOA

protected the operator from damages resulting

from operational ordinary negligence; without

gross negligence or willful misconduct, there was

not breach of contract entitling the plaintiff to

damages




• Southern Mgmt. Servs. v. SM Energy Co., 398

S.W.3d 350 (Tex. App. 2013):

– A claim for recovery of a non-operator’s

proportionate share of costs after the non-operator

elected to participate in the renewal of oil and gas

leases that it had been assigned a working

interest in, with one leasehold covered by the

Model Form JOA

– Held that the terms of payment were governed by

the Model Form JOA, which stated that each party

was liable for its proportionate share


CONCLUSION

• It is vital to:

– Pay close attention to accurate completion of each

section of the Model Form JOA

– Consider additions if horizontal drilling is

contemplated

– To ensure operation of the Model Form JOA that

comports with the intent of all parties, in an effort

to reduce potential future disputes


Houston

Pennzoil Place

700 Milam Street

Suite 1100

Houston, TX 77002

T: 713.358.1700

F: 713.358.1717

San Antonio

Weston Center

112 East Pecan

Suite 700

San Antonio, TX 78205

T: 210.820.2625

F: 210.820.2609

Pittsburgh

Southpointe Center

501 Corporate Drive

Suite 105

Canonsburg, PA 15317

T: 724.746.6644

F: 724.746.6645

Denver

Wells Fargo Center

1700 Lincoln Street

Suite 1300

Denver, CO 80203

T: 303.801.3200

F: 303.801.3201

Midland

Wall Tower East

201 W. Wall Street,

Suite 505

Midland, TX 79701

T: 432.695.6228

F: 432.695.6246

Timothy C. Dowd Elias, Books, Brown and Nelson P.C.

211 N. Robinson, Suite 1300 Oklahoma City, OK 73102

(405) 232-3722 [email protected]

January 29, 2014

mailto:[email protected]



A farmout agreement is a transaction wherein the owner of an oil and gas lease (farmor) agrees to an assignment of a part of a lease to a party (farmee) who agrees, as consideration for the assignment, to drill a well to a certain depth or condition.

46

Many times, the company with the acreage position has determined it is not in their best interest to undertake the costs and risks of developing acreage (at the time), but does not want to have the leases expire.

47

The company willing to undertake the drilling has a prospect idea which it wishes to develop, but does not control the acreage. Under the farmout, the first company (the “farmor”) agrees to assign acreage it owns to the second company (the “farmee”) in return for the second company performing specified drilling and testing obligations.

48

“Farming out” makes sense if a company is unable to develop expiring acreage due to budgetary constraints or it wishes to reduce or eliminate risk and improve economics as a percentage of investment and is willing to accept in return a reduced acreage position (and thus a reduction in potential return.)

“Farming in” makes sense if a company’s budget can stand the costs of drilling and the company is willing to accept greater costs and risks to gain or increase its acreage position in the area and thus increase its potential aggregate return.

49

Areas of Negotiation – In General.

In negotiating the farmout, the parties will primarily be concerned with three basic issues:

1. The extent of the farmor’s maximum commitment (the “subject matter”determination);

2. What the farmee must do to earn an interest in the acreage (the “earning requirements”); and

3. What will be assigned to the farmee if these earning requirements are satisfied and what the farmor will reserve (“interests assigned and reserved”).

50

Frequently, the farmout agreement establishes that the farmee must satisfy certain minimum requirements if it is to earn anything under the farmout but its earning may be increased up to a specified maximum interest if it performs more than the “bare minimum” earning requirements.

Thus, the farmor must determine the maximum amount of acreage which it is willing to commit to the farmout, assuming maximum performance by the farmee (the “farmout area” designation), and the maximum depth to which it is willing to commit this acreage to the farmout (any “farmout depth” limitations).

51

The farmout agreement allows that the farmee “earns” its interest upon drilling or producing.

52

Drill to Earn Farmout:

The farmee earns the interest under the Farmout Agreement once drilling commences or reaches the contracted depth.

Produce to Earn Farmout:

The farmee must, generally, drill a well that produces in paying quantity to earn the interest in the farmout acreage.

53

It is common for the farmor to retain a non-operating interest or an overriding royalty interest in the farmed out acreage.

Frequently, the farmor has the right to convert the overriding royalty interest to the working interest after payout of a well. Payout may be on a well-by-well basis or a unit basis.

54

The farmor often is seeking an evaluation of the farmout area, both to determine whether or not to participate in further development of the farmout area after the earning wells have been completed and to decide whether or not to drill on other leases owned by it outside the farmout area.

Thus, the farmout agreement will normally call for specified testing of the well by the farmee through the taking of cuttings and core samples, the running of specified “logs”, drillstem testing and the like, and the providing of the resulting information to the farmor.

55

Few farmout agreements are recorded. However, once an agreement has been fully performed, the farmee is entitled to a recordable assignment of interest.

It is important that the terms of the farmout agreement and the terms of the assignment do not conflict or a dispute may arise as to which prevails.

56

The farmee may be assigned his interest in the farmout leases without any depth restrictions.

Far more customarily, however, the assignment will be limited to a depth which bears some relationship to the depth actually attained by the earning well(s). This “farmout/earned/ assigned depth provision is normally worded either as “[xx feet below] the depth drilled” or “to the stratigraphic equivalent of the depth drilled” in each earning well.

57

A frequent reason for a discrepancy between record title as shown in the County Clerk’s records and the interest shown to be paid in the deck is the absence of an executed assignment pursuant to a farmout agreement.

58

Companies have frequently turned to term assignments instead of farmout agreements.

The term assignments convey an interest from the assignor/farmor to the assignee/farmee for a specific term. The assigned interest is to revert to the assignor if the assignee doesn’t drill a producing well to a certain depth by a certain date.

59

structuring oil and gas joint operating and farmout...

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