CHAPTER 12 CONSUMER FINANCED EXPLORATION
| Jurisdiction | United States |
(May 1979)
CONSUMER FINANCED EXPLORATION
Attorneys, Gorsuch, Kirgis, Campbell, Walker and Grover
Denver, Colorado
INTRODUCTION
In recent years, consumers of fuels, primarily large industrial concerns and public utilities, have entered the field of minerals exploration, development and production because the traditional suppliers of fuels have found it exceedingly difficult to meet the ever increasing demands of their customers. The fuel consumer, in an effort to obtain some control over prices, has found it necessary to attempt to compete with the traditional suppliers in order to obtain some bargaining power in the fuel supply markets, and more importantly, given the inability of the traditional suppliers to provide secure and reliable supplies, consumers are now attempting to secure their own guaranteed fuel supplies at a reasonable cost.1
For all of those reasons, but primarily for the need to secure adequate future supplies of fuels, the mineral consumer has determined that it is now necessary to participate in the risks associated with exploring for and developing minerals for fuel purposes.
The purpose of this discussion is to identify and discuss some of the more obvious problems one might expect to encounter when the mineral consumer finances exploration and/or development activities with/or for a party selected for its land position and/or its expertise in mining. We will also review some of the problems faced by coowners of mining properties when only one of the owners bears a major portion of the
[Page 12-2]
economic burden of exploration, development and production. The discussion is by no means a comprehensive treatment of all the problems which will no doubt arise in the usual joint venture relationship, but merely highlights problems that will arise in the vast majority of negotiations. Each transaction is, of course, unique and each will have its own special or particular problems which will require individual attention.
THE VENTURE
Fuel consumers, in seeking reliable supplies of coal, oil and gas or uranium for their future requirements have tended to become owners or more typically co-owners of mining properties which may have potential in fulfilling those future needs. The more or less typical approach utilized by the consumer in the acquisition of mining properties is co-ownership with some form of agreement governing the mechanics of exploration, development and, hopefully, production activities on those properties. The development of mining properties by co-owners can take many forms; the most common being the traditional partnership, the mining partnership,2 the limited partnership, the classic joint venture, joint ownership with an operating agreement or an exploration contract which provides for the acquisition of an ownership interest in the property being explored by the consumer if it elects to acquire such an interest. The most common approach may be the classic joint venture which has been defined as
"[A]n association of two or more persons based on contract who combine their money, property, knowledge, skills, experience, time and other resources in the furtherance of a particular project or undertaking, usually agreeing to share the profits and the losses and each having some degree of control over the venture."3
For the purposes of this discussion, the terms "joint ownership" or "joint operations" will include the legal relationships identified above as well as any other form of business arrangement comprised of two or more parties the purpose of which is to explore, develop and possibly produce a mining property. The use of the joint venture
[Page 12-3]
label to describe every conceivable form of joint ownership and operation is admittedly overbroad and the tax and other legal consequences of a particular form of legal relationship should be given specific attention before any form of exploration agreement or joint venture agreement is executed. When deciding upon the form of business entity to utilize in any particular circumstance, tax counsel should, of course, be consulted to insure that the tax objectives of the participants have been adequately considered.4
When considering the joint venture in any of its variations, one tends to focus on those matters which are common to each of the variations. Those matters include:
(1) The contributions of the parties to the venture.
(2) The manner in which the risks of the venture are to be shared between the parties.
(3) The management structure of the venture.
(4) The distribution of production from the venture.
In the case where a venture is being financed by the mineral consumer, most typically, the consumer will contribute the capital while the other venture partner will contribute the properties and/or mining expertise, and in most cases, the joint venture agreement will treat the remaining elements listed above, and other matters, in a manner which reflects the fact that less than all of the parties to the agreement are making direct, financial commitments to the project. Those considerations will be reviewed below.
WHAT'S DIFFERENT ABOUT THE CONSUMER — OBJECTIVES
Thusfar, we have briefly reviewed some of the basic forms the joint venture might take, and some of the considerations which must be addressed in any agreement forming the basis of the venture's activity. Those matters will have to be addressed and
[Page 12-4]
resolved when negotiating any agreement for the exploration and development of mining properties no matter who the parties to the agreement might be.
The fact that this discussion concerns itself with projects which are financed by the mineral consumer certainly suggests that there are special problems which must be addressed and resolved. Well, what's different about the mineral consumer?
In most circumstances, the participants in a joint effort for the exploration, development and production of mining properties have profit as their basic objective; that is, the participants in the mining venture are seeking to explore, develop and hopefully mine a property at the lowest possible cost and then sell the product at the highest price available. In most joint operation relationships, the profit motive and the pure economics of the project will be the primary controls on the activities of the venture and venture activities will be considered in the light of expected return on investment.
However, when the mineral consumer becomes involved from a financing point of view and/or in the ownership of the property, the emphasis or objective for participating in the venture in the first instance for one of the parties changes from maximization of profits to securing a more or less guaranteed supply of the particular fuel at a reasonable cost. The expectation of the consumer is that supplies of fuels will become more reliable and that the price of the unregulated fuels will at least show some improvement when compared to open market prices.5 Utility concern about future availability of fuel supplies was expressed in Profile, the publication of Pennsylvania Power & Light Company, as follows:
"It is obvious that the uncertainties of the energy marketplace are such that PP&L cannot just assume that someone will automatically be at our door with an adequate supply of coal, oil, or uranium that they are willing to commit to us for the life of a generating plant at a reasonable price.
Examples abound that the coal, oil, and uranium markets are no longer reliable. We have concluded that to have a long-term, assured supply
[Page 12-5]
of fuels we have to look thirty years ahead, see what is available and lock it up."6
The objectives expressed by PP&L have motivated the consumer to begin to vertically integrate its operations to include the exploration, development and production phases of the fuel supply industry, and to that end, the joint venture, in its varied forms, has been extensively utilized.
THE "TYPICAL" VENTURE
Given the basic difference in the primary objectives of the potential participants in a venture, we should consider a "typical" joint venture program in terms of the parties to the venture and their contributions to the effort.7 Generally, if the consumer is a public utility, the participant in the effort will likely be a wholly-owned subsidiary of the public utility formed to carry out the fuel acquisition program for the parent corporation, and the subsidiary will most generally have a financing arrangement with the parent. For example, Southern California Edison ("Edison") and its subsidiary Mono Power Company ("Mono") operate under a fuel service agreement. That agreement requires Mono to seek, find, develop, process, and deliver such energy resources as may be required by Edison, and Edison is obligated to compensate Mono for the fuel supply service at the cost incurred by Mono in providing that service. The service charge includes general and administrative charges, annual cost of funds provided to Mono by Edison or by third parties, annual amortization of unsuccessful projects and all of the annual operating and maintenance expenses and appropriate annual costs of investments, including costs for development, drilling and testing in producing projects.
In many cases, the arrangement between the parent and subsidiary will have to be approved in advance by the Public Utilities Commission ("PUC") with jurisdiction over the consumer, and in many other cases, the PUC will have to approve the specific
[Page 12-6]
transaction between the utility or its subsidiary and the property owner before the venture transaction can be completed by the consumer.
If you represent the property owner in an exploration joint venture, you should insure that the entity dealing with your client and its relationship with its parent corporation, if such a relationship exists, has been approved or that...
To continue reading
Request your trial