CHAPTER 10 ROCKY MOUNTAIN MINERAL LAW FOUNDATION FORM 6 GAS BALANCING AGREEMENT

• Jurisdiction: United States

Oil and Gas Joint Operating Agreement
(May 1990)
CHAPTER 10
ROCKY MOUNTAIN MINERAL LAW FOUNDATION FORM 6 GAS BALANCING AGREEMENT
David L. Motloch
Hunt Oil Company
Dallas, Texas

TABLE OF CONTENTS

SYNOPSIS

Page

INTRODUCTION

I. PROCEDURE FOR REVIEW

II. GENERAL DESCRIPTION OF FORM

III. TRADITIONAL PROVISIONS

A. Formation Balancing in a Well

B. MMBtu Balancing

C. FIFO Balancing

D. Make-up Rights

E. Cash Balancing at Depletion

F. Notice of Marketing Arrangements

G. Duty to Furnish Information

H. Operating Expenses, Royalties, and Audit Rights

I. Assignees Bound

IV. SPOT MARKET SENSITIVE PROVISIONS

A. Seasonal Make-up Rights Restricted

B. Production Limited to Reserves in Place

C. Operator Responsible for Estimating

D. No Periodic Cash Balancing

E. Obligation to Furnish Values to Operator

F. Penalty for Failure to Provide Information

G. Audit

H. Effect of Assignment

I. Binding Arbitration

J. Operator's Charges

V. AND THE TAX MAN COMETH

VI. COMPATIBILITY WITH RMMLF FORM

VII. CONCLUSION

Footnotes

Exhibits

1 Form 6

2 Guide to Articles and Papers on Gas Balancing

3 Guide to the Case Law on Gas Balancing

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About two years ago, the Rocky Mountain Mineral Law Foundation Forms Committee began work on a project to draft a gas balancing agreement. We began the project at the request of a number of Foundation members who felt that a standard form gas balancing agreement would facilitate negotiation of operating agreements since gas balancing issues had become sticking points in the process. The committee was composed of attorneys representing a cross-section of the industry including both major and independent oil companies, production companies with interstate pipeline affiliates and private practitioners. Among others, we asked company gas department personnel to help us identify problem areas, then had them critique our solutions. Some of our solutions were met with disbelief (of our detachment from administrative reality) if not outright alarm. We then tried to accommodate their concerns. Drafts of the agreement were subsequently circulated to a wider committee, and comments were incorporated in the final form. In my capacity, as chairman of the committee, I'd like to thank everyone who helped on this project, particularly the committee members who dedicated considerable time and effort to the cause.

In drafting the agreement, we spent considerable time identifying the controversial issues in gas balancing. There are less than a dozen major ones. Many of these have recently evolved and stem from the movement toward short term gas sales contracts and are complicated by seasonal fluctuations in prices and takes and by the differences in market access and cash flow requirements of producers. We made every attempt to address the more controversial issues in optional provisions of the agreement and, at the same time, tried to keep the number of optional provisions to a minimum to facilitate the negotiation process.

As those of you familiar with negotiating gas balancing agreements will attest, producers' demands differ based upon their respective market access or cash flow requirements. Many times these differences are irreconcilable. Our bias, when faced with irreconcilable differences, was to resolve the differences in a way which encouraged production. Where our bias generated problems for a party, we minimized or avoided the problem by including an optional provision limiting a party's right to produce more than its reserves in place. I will discuss the provision at length later. Though this provision is not found in all balancing agreements, its use is becoming more accepted, and I believe it will become a common feature in the future.

I am not here today to give a theoretical legal paper. Rather I am charged with the task of familiarizing you with Form 6. For the purposes of my presentation, I'm assuming that

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everyone has a working knowledge of the provisions contained in a typical gas balancing agreement. If not, I direct your attention to Exhibit 2 which is a complete list of previous articles written on the subject. A number of these articles discuss, at length, common gas balancing agreement features and include suggested forms of agreement.

I. PROCEDURE FOR REVIEW

To familiarize you with the Form 6, we'll go through it twice. During the first time through, we will focus on the non-controversial provisions of the form for which there are recognized standard variations. While making this first pass through the form, I will also point out provisions which contain language extracted from the 1989 AAPL Form 610 so that you can better understand the effect of modifying these provisions.

On the second pass through the agreement, we will discuss the optional and potentially controversial new spot market sensitive provisions which are scattered throughout the agreement. Because of time constraints we'll not mention the boilerplate provisions on either pass through the form. You needn't worry about noting cites since there will be few and all that I make are listed in Exhibit 3. As an aside which I found interesting, gas balancing is an area of the law where the number of articles exceed the number of reported cases—even though Ernie Smith only contributed one article. The ratio currently stands at about 2 to 1. There must be some underlying message in this peculiarity, but we can only speculate what it is.

II. GENERAL DESCRIPTION OF FORM 6

Form 6 is a traditional volumetric balancing agreement with cash balancing at depletion. Spot sales/market access issues are addressed in the provisions which are shaded in gray and designated "optional provisions." For ease of negotiation, these optional provisions may be deleted individually or in total without generating a conflict within the form.

III. TRADITIONAL PROVISIONS

A. Formation Balancing in a Well

First, let's look at the traditional provisions with recognized alternatives. Paragraphs 1(a) and 12 require balancing by formation in each well. This well and formation specific balancing extends to cash balancing at depletion. We provided for balancing on a formation basis in each well as opposed to "contract area" or regulatory category balancing to accommodate differences in ownership and differences in prices or marketability of gas due to its regulatory categorization. Since most gas has now been deregulated¹ or is expected to be in the not-to-distant future, an argument can be made that it is no longer necessary to balance in each formation on a well basis. Because there is no guarantee, however, that gas will not be re-regulated at some time in the future, the committee firmly believed in formation and well specific balancing.

B. MMBtu Balancing

Subparagraph 1(b), among other things, establishes MMBtu balancing while older balancing agreements typically provide for balancing on a Mcf basis. The committee, nevertheless, felt

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that Btu balancing was appropriate for two reasons. First, most gas sales contracts are now measured in MMBtu's and, second, the real value of gas is determined by its Btu content. Bear in mind though, that Cash balancing is affected by establishing MMBtu balancing. The overproduced party must account for and pay the underproduced party for Btus which are taken from the lease premises even if the overproduced party processed the gas off the lease premises for the extraction of the plant products. Under a typical Mcf balancing agreement, more often than not, the overproduced party is not required to account for the value of plant products extracted off the lease.

C. FIFO Balancing

Subparagraph 2(b) establishes FIFO balancing and contains a provisions that an overproduced party shall never have its rate reduced to less than 50% of its entitlements.

D. Make-up Rights

Subparagraph 2(c) allows an underproduced party to make up gas in the ratio that its interest bears to the interests of all underproduced parties then requesting make-up gas. This is more or less standard. It also provides that if an underproduced party calls for make-up gas but fails to take all it called for, the other underproduced parties have priority over overproduced parties to participate in the gas not taken.

Subparagraph 2(d) establishes that make-up rights are to be determined monthly. This comports with the typical short term marketing arrangements which are prevalent in gas markets today.

E. Cash Balancing at Depletion

Paragraph 3 of the agreement establishes the procedure for cash balancing upon depletion. Though the Operator is expected to collect money from the overproduced parties and distribute it to the underproduced parties in accordance with the final accounting, the Operator does not assume the duty of the banker or collection agency should an overproduced party fail to account and pay for its overproduction. Rather, the Operator can turn the problem over to the underproduced parties.

Cash balancing is at the price received by the marketing party. Earlier drafts of Form 6 provided for cash balancing at the lesser of the marketing party's price or the price which the underproduced party would have received. The concept is simple, but it doesn't play out very well if there are multiple parties in a well out of balance at depletion. To effect the accounting, you must first determine who is overproduced against whom for a specific month, then have these parties exchange price information. Because of the administrative burden associated with the exchange of information, the provision did not survive in the final Form 6.

I should also point out that under subparagraph 3(e), if overproduction is attributable to take-in-kind or affiliate sales, cash balancing is to be at market value, with the overproduced party's price in the affiliate sale not being determinative of market value. Again, under paragraph 3(e), settlement is on a...