CHAPTER 10 THE TAKING PRODUCTION IN KIND PROVISIONS OF AAPL FORM 610

• Jurisdiction: United States

Joint Operations and the New AAPL Form 610-2015 Model Form Operating Agreement (Dec 2017)
CHAPTER 10
THE TAKING PRODUCTION IN KIND PROVISIONS OF AAPL FORM 610
Jamie L. Jost
Managing Shareholder
Jost Energy Law, PC
Denver, CO ¹

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JAMIE L. JOST is the Founder and Managing Shareholder of Jost Energy Law, P.C. in Denver. Her practice focuses primarily on exploration, production, and development of oil and gas in the Rocky Mountain region as well as local, state, and federal permitting and regulatory issues. Jamie represents clients in front of the Colorado Oil & Gas Conservation Commission, the Wyoming Oil & Gas Conservation Commission, the New Mexico Oil Conservation Division and the Interior Board of Land Appeals, as well as federal and state courts on eminent domain, subsurface trespass matters, and surface use issues. Jamie has served as a trustee for the Rocky Mountain Mineral Law Foundation and has authored several oil and gas related articles for the RMMLF. She is licensed to practice law in New Mexico, Colorado and Wyoming, the federal courts of each state and the Tenth Circuit Court of Appeals. Jamie received her J.D. from the University of Wyoming in 2002 and her undergraduate degree in Environmental Science from Indiana State University in 1998.

I. Introduction

At first blush, marketing the production from properties subject to the American Association of Petroleum Landmen's ("AAPL") Form 610 Model Form Operating Agreement ("Model Form JOA") is very straightforward because all four versions of the Model Form JOA require that each party "take in kind and separately dispose of its proportionate share of all Oil and Gas produced from the Contract Area." However, that is not always what happens, particularly as to gas production. If a party fails to take its proportionate share of oil and gas in kind, all four versions of the Model Form JOA give the operator "the right, subject to revocation at will by the party owning it, but not the obligation, to purchase such Oil and/or Gas or sell it to others" for the account of the non-taking party. Although not addressed in all versions of the Model Form JOA, if the operator does not exercise this right, then an imbalance occurs among the parties. This article will summarize and comment on the taking in kind provision found in each of the Model Form JOAs, including the 2015 minor revisions to the Model Form JOA, address issues that arise when imbalances occur and how courts have resolved those issues, review the AAPL and Rocky Mountain Mineral Law Foundation's forms of gas balancing agreements, discuss the operator's options if a party fails to take in kind, and make an alternative proposal for addressing the failure to take gas in kind.² Because of the relative higher value and ease in handling oil as compared to gas,³ the issues surrounding the failure to take in kind usually

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arise in the natural gas context and, therefore, this paper will discuss the failure to take in kind in that context.⁴

II. The AAPL Model Form JOA - Taking Production in Kind Provisions

There have been four versions of the Model Form JOA: 1956, 1972, 1982 and 1989. The taking production in kind provisions of each are similar in many respects, particularly for the first three versions. The 1989 provision differs most notably in the operator's standard of care if it exercises its right to purchase or sell the share of production of the non-taking parties. Given the overall similarities in the four versions of the Model Form JOA and the common misperception that the operator has the duty to market the production of non-taking parties, often very little thought is given to this provision of the Model Form JOA and the decision as to which version of the Model Form JOA to use does not typically turn on the taking production in kind provision.

A. The Duty to Take in Kind. All four versions of the Model Form JOA taking production in kind provision start out with the mandate that each party is to take in kind and separately dispose of its share of production. Article VI.G., Option No. 2, of the 1989 version of the Model Form JOA expresses this mandate as follows:

Each party shall take in kind or separately dispose of its proportionate share of all Oil and Gas produced from the Contract Area, exclusive of production which may be used in development and producing operations and in preparing and treating oil and Gas for marketing purposes and production unavoidably lost. Any extra expenditure incurred in the taking in kind or separate disposition by any party of its proportionate share of the production shall be borne by such party. Any party taking its share of production in kind shall be required to pay for only its proportionate share of such part of Operator's surface facilities which it uses.

Each party shall execute such division orders and contracts as may be necessary for the sale of its interest in production from the Contract Area, and, except as provided in Article VII.B., shall be entitled to receive payment directly from the purchaser thereof for its share of all production. ⁵

B. The Failure to Take in Kind. All four versions of the Model Form JOA address the failure to take in kind in some way. The four versions of the failure to take in kind provisions are summarized below⁶ and are compared in the table at the end of this article.

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1956 Model Form: Article 14 of the 1956 Model Form JOA provides that if a party fails to take its share of oil and gas production in kind, the operator has the right, but not the obligation, to purchase the oil and gas or sell it to others at not less than the "market price prevailing in the area, which shall in no event be less than the price which Operator receives for its portion of the oil and gas produced from the Unit Area." Article 14 prohibits the operator from making a sale into interstate commerce of any other party's share of gas production without first giving such other party sixty days notice of such intended sale.⁷ It further provides that any purchase or sale by the operator is "subject to revocation at will by the party owning it" and "subject always to the right of the owner of the production to exercise at any time its right to take in kind, or separately dispose of, its share" of oil or gas production. The 1956 Model Form JOA does not address the situation where a party fails to take its share of production in kind and the operator does not purchase the production or sell it for the non-taking party. This situation is discussed in Section III of this paper.

1977 Model Form: Article VI.C. of the 1977 Model Form JOA provides that if a party fails to take its share of production in kind and dispose of it, an operator who exercises its right to temporarily sell the non-taking party's proportionate share of oil or gas has to do so "at the best price obtainable in the area for such production." A new provision was added to the 1977 Model Form JOA which provides that any purchase or sale by the operator can only be "for such reasonable periods of time as are consistent with the minimum needs of the industry under the particular circumstances, but in no event for a period in excess of one (1) year."⁸ The requirement of the 1956 version that the operator has to sell at no less than the price that the operator receives for its production had to be dropped. Given the reserved right of the non-taking party to take in kind at any time and the one year limitation under the 1977 Model Form JOA, an operator entering into a long-term contract typical of that era (the take-or-pay contract era) could not dedicate a non-operator's gas to such a contract and, therefore, could not necessarily sell the non-taking party's gas for the same price which the operator received for its share of production. The 1977 Model Form JOA does not address the situation where a party fails to take its share of production in kind and the operator does not purchase the production or sell it for the non-taking party.

1982 Model Form: The 1982 Model Form JOA introduced an alternative approach when a party fails to take its share of natural gas production in kind. There are

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two versions of page 8 of the 1982 Model Form. The standard page 8 has a taking production in kind provision that is the same as the 1977 Model Form JOA. The alternative page 8 of the 1982 Model Form JOA has the same taking production in kind provision as the 1977 Model Form JOA, but it only applies to oil, and separately provides for a gas balancing agreement to cover the situation where a party fails to take its share of natural gas in kind. Under a typical gas balancing agreement, a non-taking party's share of gas production is left "in the ground" and can be taken in kind at a later date. Gas balancing agreements are discussed in Section V of this paper.

1989 Model Form: The 1989 Model Form JOA replaces the alternative pages of the 1982 Model Form JOA with two "check the box" options which provide the same choices. Option No. 1 is "Gas Balancing Agreement Attached" and Option No. 2 is "No Gas Balancing Agreement." The provisions as to the failure to take oil production in kind are essentially the same under both options and are combined with the failure to take gas production in kind under Option No. 2.⁹ As discussed in connection with Option No. 2 below, these provisions are much more detailed than under prior versions and differ in some material respects from prior versions.

Option No. 1: Under Option No. 1, the parties are required to give timely written notice to the Operator of their gas marketing arrangements (excluding price), to maintain records of all gas marketing arrangements and of volumes actually sold or transported, and to make those records available to non-operators upon request. If the parties' separate disposition of the gas causes split-stream deliveries to separate pipelines or deliveries which are

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