CHAPTER 12 PAYING WELL DETERMINATIONS IN FEDERAL UNITS: CAPTURING A MOVING TARGET
| Jurisdiction | United States |
(Jan 1990)
PAYING WELL DETERMINATIONS IN FEDERAL UNITS: CAPTURING A MOVING TARGET
O'Connor & Hannan
1700 Lincoln Street, #4700 Denver, Colorado 80203 (303) 830-1700
The concept of Paying Well Determinations is critical to management of exploratory operations in a federal unit. While a Paying Well Determination is the first step in establishing equitable sharing of costs and benefits of production through construction of participating areas, and may be relevant, or even determinative, for purposes of lease extensions, it is most significantly a mechanism by which the statutory and contractual purposes of unitization are accomplished. No intellectual understanding of federal units can be complete, and no appreciation of unit operations fulfilled, without a thorough understanding of the purpose and application of Paying Well Determinations.
It is a premise of this paper that Paying Well Determinations should be made based upon whether or not the economic circumstances of a well at any given point in time reasonably indicate that a prudent operator would consider further exploration and development drilling in the unit area justified. At that time, and only at that time, can it be determined that a viable resource which is capable of production and realization on a reasonable basis has been found. If circumstances subsequently change which later indicate that any well may no longer be economical and that further development of a resource is not economically justified, the expectations of the parties at the time the well was drilled and the statutory purpose of authorizing unit operations are still fulfilled.
These basic purposes of unitization and the statutory intent will first be reviewed from the point of view of Paying Well Determinations. The expectations of the parties in relying upon and availing themselves of the benefits of unit agreements will also be discussed. On the basis of this analysis, the purpose and function of Paying Well Determinations will be identified. The legal significance of a Paying Well in the context of lease extensions, construction of participating areas, and unit expansion and contraction will be discussed. Analysis of the factors involved in Paying Well Determinations will be made and a proposal put forth for a frame work under which Paying Well Determinations can be made. Finally, procedural, and practice issues will be analyzed.
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This paper does not discuss in detail the statutory, regulatory or contractual bases for unitization of federal leases. Neither are the functions and practical applications of unit operations mentioned in any significant detail, expect to the extent that they are directly relevant to the issues related to Paying Well Determinations. The reader is therefore referred to other sources and other papers presented in this Institute for further background material.1 Rather, this paper will instead focus upon the specific issues that directly relate to the concept of Paying Well Determinations.
I. BACKGROUND
A. Statutory Intent
It is beyond the scope of this paper to set forth the multiple pressures and concerns which prompted Congress to amend the Mineral Leasing Act of 1920 to authorize unit agreements.2 It is safe to assume, however, that in so doing, Congress saw unit operations as a means to further its original goal to promote exploration of the public domain for oil and gas reserves, particularly given that most of the public domain lands were largely unexplored and highly speculative.3 First, unit agreements provided a system for conducting drilling for and testing of deposits of minerals in a controlled, organized fashion. In undeveloped areas, where little reliable information exists as to the location and extent of mineral deposits, parties compete for the most favorable places to drill. In an atmosphere of competition, lessees may attempt to exploit geologic information obtained by drilling and testing on a nearby lease which may not be accurate. Rather than sharing what precious little information might be available, lessees jealously guard their data and prospects. This results in drilling unnecessary wells, usually dry, until a discovery is made, and then allows for only tentative and sporadic development of a reservoir once found.
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Unitization allows for sharing of vital technical data and cooperative selection of well sites, allowing for drilling of fewer wells to obtain basically the same information. Once a discovery occurs, development can be controlled and proper reservoir management utilized, rather than each party's own competing self interest. The numerous advantages afforded lessees who commit their leases to unit agreements attest to the public policy of exploring the public domain through the mechanism of unit agreements.4
Second, unitization allows for the spreading of risks in exploring unproven areas. The lessees in a particular area, all of which stand to benefit by exploration activities, will share the risk of their development.
B. Parties to the Agreement
Parties entering into and committing their oil and gas leases to an exploratory unit clearly are doing so because they believe that unit operations will result in the most economically viable manner in which to explore and develop their acreage. They anticipate that drilling will occur in an attempt to locate a deposit of oil and gas which can be economically developed. Presumably, once a discovery is made, further drilling and development will occur if, and as long as, but only as long as, the results indicate that an economically viable resource in fact exists. The parties obviously do not anticipate expending drilling funds after it becomes apparent that the oil and gas production in an area is not sufficient to constitute a reasonable investment.
Given these intents and purposes, the unit agreement specified in applicable federal regulations essentially sets forth two instances in which decisions as to whether or not a paying well has been discovered become important. First, Article 9 of the Agreement provides that continuous drilling will occur with intervals of no longer than six months until a paying well is found, or until the unit, with the approval of the Bureau of Land Management, is abandoned.5 Second, Article 11 provides that
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the participating area (which determines a means in which costs and revenue are shared) will be established, expanded or contracted upon the completion of a paying well.6 Thus, a Paying Well Determination is a means to validate that a commercial discovery is found, and to identify the boundaries of that portion of the reservoir which is susceptible to economically reasonable development. Both functions are clearly related to the statutory intent to promote organized exploration, and serve to protect the reasonable expectations of the parties entering into the unit agreement.7
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These purposes and functions must be served in determining whether or not a particular well is a paying well in the context of the Federal Unit Agreement. If they are not served, the very essence of unit operations is frustrated, and the intent of the parties and the statutory purpose violated.
II. LEGAL CONSEQUENCES
A. Unit Operations
As described above, Paying Well Determinations perform two basic functions in the management of unit operations: (i) to determine if a commercial discovery has been found, and (ii) to consider if additional lands within the unit have been proven productive and the boundaries of a commercial pool expanded. Each of these functions will be discussed in turn.
1. Unit Validation. Article 9 of the Unit Agreement states in effect that continuous drilling will occur until a paying well is found. In the absence of a suspension of operations, or extension of time to be granted by the BLM, failure to continue to drill within the time schedule provided will result in termination of the unit.8 The BLM will give fifteen (15) days notice to the Unit Operator before declaring the Unit Agreement terminated.9 Operations conducted after the automatic termination are conducted outside the terms and provisions of the Unit Agreement and Unit Operating Agreement.
Once the first unit paying well has been drilled and completed, the unit converts to producing status, and a different scheme is put into place. The unit operator annually prepares and submits a unit plan of development, specifying and justifying the manner in which further exploration and development in the unit area will be conducted. In contrast to Article 9 of the Agreement, Article 11, dealing with development after a discovery, contains no specific time limits for further drilling. Rather, the good faith and judgment of the unit operator and working interest owners, as reviewed and approved by the BLM, determines when and how the unit area will be further developed. Thus, the legal obligations provided after discovery occurs are materially different than those that exist before discovery occurs.
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2. Configuration of Participating Areas. Article 11 of the Unit Agreement provides that the initial participating area will be constructed around completion of the first unit paying well, and that further revisions to the participating area will occur when additional paying wells are drilled and completed. The complex and difficult issues that exist in establishing a participating area have been the subject of other publications.10 It is important to note here that configuration of a participating area is not necessarily dependent upon a Paying Well Determination. In Davis Oil Co., a 160 acre tract was added to the participating area as the second revision, based upon the apparently successful completion of the Unit No. 4 Well.11 Only six months after completion of the well, and two months after approval of the...
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