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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]
Burleson LLP © 2014 6
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
Burleson LLP © 2014 7
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
Burleson LLP © 2014 8
MODEL FORM JOA STRUCTURE
• Five Main Model Form JOA Parts
– Title page
– Table of contents
– Preamble
– Articles
– Additional provisions in Article XVI (special
provisions)
Burleson LLP © 2014 9
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
Burleson LLP © 2014 10
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
Burleson LLP © 2014 11
MODEL FORM JOA: PREAMBLE
– Properly identify the operator of the contract area
by full and correct name
Burleson LLP © 2014 12
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
Burleson LLP © 2014 13
MODEL FORM JOA: ARTICLE II
• 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
Burleson LLP © 2014 14
MODEL FORM JOA: ARTICLE II
• Model Form JOA Exhibits (cont.)
– 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
Burleson LLP © 2014 15
MODEL FORM JOA: ARTICLE II
• Model Form JOA Exhibits (cont.)
– 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
Burleson LLP © 2014 16
MODEL FORM JOA: ARTICLE II
• Model Form JOA Exhibits (cont.)
– 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
Burleson LLP © 2014 17
MODEL FORM JOA: ARTICLE II
• Model Form JOA Exhibits (cont.)
– 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
Burleson LLP © 2014 18
MODEL FORM JOA: ARTICLE II
• Model Form JOA Exhibits (cont.)
– 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
Burleson LLP © 2014 19
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
Burleson LLP © 2014 20
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
Burleson LLP © 2014 21
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
Burleson LLP © 2014 22
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
Burleson LLP © 2014 23
MODEL FORM JOA: ARTICLE VI
• 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
Burleson LLP © 2014 24
MODEL FORM JOA: ARTICLE VI
• Drilling and Development (con’t)
– 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
Burleson LLP © 2014 25
MODEL FORM JOA: ARTICLE VI
• Drilling and Development (con’t)
– F. Terminations of Operations
• Insert minimum consenting parties percentage
for commenced operation termination
Burleson LLP © 2014 26
MODEL FORM JOA: ARTICLE VI
• Drilling and Development (con’t)
– 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
Burleson LLP © 2014 27
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
Burleson LLP © 2014 28
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
Burleson LLP © 2014 29
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
Burleson LLP © 2014 30
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
Burleson LLP © 2014 31
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
Burleson LLP © 2014 32
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
Burleson LLP © 2014 33
MODEL FORM JOA: HORIZONTAL
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
Burleson LLP © 2014 34
MODEL FORM JOA: HORIZONTAL
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
Burleson LLP © 2014 35
MODEL FORM JOA: HORIZONTAL
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)
Burleson LLP © 2014 36
MODEL FORM JOA: HORIZONTAL
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
Burleson LLP © 2014 37
MODEL FORM JOA: HORIZONTAL
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
Burleson LLP © 2014 38
MODEL FORM JOA: HORIZONTAL
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
Burleson LLP © 2014 39
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
Burleson LLP © 2014 40
MODEL FORM JOA: RECENT
JUDICIAL INTERPRETATIONS
• 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
Burleson LLP © 2014 41
MODEL FORM JOA: RECENT
JUDICIAL INTERPRETATIONS
• 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
Burleson LLP © 2014 42
MODEL FORM JOA: RECENT
JUDICIAL INTERPRETATIONS
• 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
Burleson LLP © 2014 43
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
Burleson LLP © 2014 44
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
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
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