CHAPTER 13 THE UNIT OPERATING AGREEMENT FOR FEDERAL EXPLORATORY UNITS
| Jurisdiction | United States |
(Dec 2007)
THE UNIT OPERATING AGREEMENT FOR FEDERAL EXPLORATORY UNITS
Lynn P. Hendrix
Attorneys
Holme Roberts & Owen LLP
Denver, Colorado
STEVEN B. RICHARDSON
Steven B. Richardson is a partner in the Denver Denver office of Holme Roberts & Owen LLP and has been with the firm since 1981. His practice emphasizes energy and natural resources law, project development, and finance, and general commercial and corporate law. His practice is transactional based and he represents a wide range of energy companies in entity formation, asset acquisitions and sales, mergers and combinations involving both private and public companies, project development, financing, and regulatory compliance for oil and gas exploration and development, pipelines, power projects (including alternative energy projects), and operational matters including product and energy sales, and processing and transportation arrangements. Steve is a past vice chair of the ABA Electric Power Committee, and has been a member of the University of Colorado Library Board since 1996. He earned his J.D., cum laude, from Harvard University (1981) and a B.A., magna cum laude, from the University of Colorado (1978). He was admitted to the Colorado Bar in 1981, and is also admitted in Colorado State and Federal Courts.
LYNN P. HENDRIX
Lynn P. Hendrix is a partner in the Denver office of Holme Roberts & Owen LLP and has been with the firm since 1978. His practice emphasizes intellectual property law (including trade secrets, copyrights, patents and trademarks), energy and natural resources law, finance and lending law and general commercial and corporate law. Lynn earned his B.S.E.E. (1973) and his J.D. (1978), with distinction, from the University of Nebraska. Lynn has authored or co-authored six law review articles and lectures on a variety of issues relating to intellectual property, energy and natural resources and finance. His affiliations include: Rocky Mountain Mineral Law Foundation, President (2006-present), Vice-President (2005-06), Treasurer (2003-05), Trustee (1992-94 and 1997-05); American Bar Association, Oil and Natural Gas Exploration and Production Committee, Chair (1994-95); Colorado Bar Association, Natural Resources and Energy Law Section, Chair (2000-01); American Bar Association, Section of Environmental, Energy and Resources Law; Denver Association of Petroleum Landmen; American Association of Professional Landmen; The Remember Foundation, President (2006), Director and Secretary (2005); Girls Club of Denver, Director and Secretary (1985-93); Nebraska Law Review Editor-in-Chief (1978), Executive Editor (1977); Tau Beta Pi, Sigma Tau, and Eta Kappa Nu (engineering honoraries); American Bar Association, Section of Intellectual Property Law; Colorado Bar Association, Patent, Trademark and Copyright Section; Computer Law Association; American Intellectual Property Law Association; Institute of Electrical and Electronics Engineers; and International Trademark Association. He is admitted to the Bars of Colorado; Nebraska; Wyoming; Montana; New York; U.S. Patent & Trademark Office and is admitted in the following courts: U.S. Supreme Court; U.S. District Courts of Colorado and Nebraska; and the U.S. Court of Appeals - 10th Circuit.
I. Introduction
It is important to understand the interplay between the unit agreement and the unit operating agreement because both agreements, taken together, constitute the unit arrangement and establish the contractual rights and obligations of the parties.
The provisions of the Mineral Leasing Act and the regulations relating to federal units generally apply to both proven and unproven areas. The vast majority of federal units have been formed for unproven areas2 and are referred to generally as exploratory units. A very brief overview of the unit agreement is presented below as background for understanding the interrelation of the unit agreement with the unit operating agreement.
The unit agreement prescribes the method of allocating production for purposes of determining royalties, overriding royalties, production payments and other non-cost bearing burdens. It does not address the allocation of costs or expenses (or the allocation of royalties and other lease burdens) among the working interest owners; those matters are covered by the unit operating agreement. The unit agreement sets forth the terms and conditions for the unit, which cannot be altered by the unit operating agreement, and the unit agreement controls with respect to any conflict between the provisions of the unit agreement and the unit operating agreement.
The Bureau of Land Management (the "BLM") does not prescribe any particular form of unit operating agreement and the working interest owners are generally free to use whatever form of unit operating agreement they prefer. In order to streamline the negotiation of the form of unit operating agreement among the working interest owners, the Rocky Mountain Oil and Gas Association compiled two suggested forms of unit operating agreements in the 1950s. Form 1--Rocky Mountain Unit Operating Agreement--Oil and Gas (Undivided Interest) (May 1954) ("RMOA--Form 1") is intended for "undivided interest" type units, i.e., units in which the working interest owners share of production and costs is fixed through the life of the unit and is not adjusted as participating areas are formed, expanded and contracted.
Form 2--Rocky Mountain Unit Operating Agreement--Oil and Gas (Divided Interest) (Feb. 1994) ("RMOA-Form 2") is for "divided interest" type units, i.e., units in which a working interest
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owner's share of production and costs is determined by its interests in the participating area and is adjusted as the participating area is revised.3
These forms are now distributed by the Rocky Mountain Mineral Law Foundation. These forms are used extensively as the operating agreement in connection with unit agreements for unproven areas in the Rocky Mountain states.4
There is no standard form of unit operating agreement for units formed for proven areas. The terms of such agreement are negotiated and allocation of costs and production is generally based on a complex formula that takes into consideration geological data and other factors.
II. Federal Exploratory Units and the Unit Agreement
Federal exploratory units are unlike any other units. Federal exploratory units typically contain thousands of acres of land and combine them to conduct exploration activities. A major distinction from other units is reflected in the title, that being "exploratory" -- almost all federal exploratory units are formed prior to discovery of oil or gas. Federal exploratory units provide for an initial test well and, if that well is successful, the parties drill additional exploratory and development wells. Because the lands included in the federal unit are typically so expansive, smaller units, or "participating areas" are established within the unit upon completion of wells. The lands covered by the participating area are intended to approximate the area capable of producing unitized substances in paying quantities. These participating areas can expand or contract as a result of additional operations. In addition, a federal exploratory unit may contain several participating areas covering different lands or different depths within the same lands.
The unit agreement, designed for exploration prospects containing significant amounts of federal acreage, is prescribed by federal regulations (the Model On-shore Unit Agreement for Unproven Areas contained in 43 C.F.R. § 3186.1 (October 1, 2006)) (the "Model Federal Unit Agreement"). Any changes to the form of the Model Federal Unit Agreement must be approved by the authorized officer of the BLM.
The Model Federal Unit Agreement sets forth how the royalty owners share production within the unit and the resulting participating areas. The Model Federal Unit Agreement does not, however, dictate how the working interest owners share production or the allocation of costs or the royalty burden associated therewith. The arrangement among the working interest owners is, therefore, left to the unit operating agreement which sets forth the working interest owners' duties and obligations and how the working interest owners will share in the production attributable to the working interests and the costs associated therewith.
The Model Federal Unit Agreement requires the unit operator to drill at least one initial test well in the unit and, if this well is capable of producing unitized substances in paying quantities, an initial participating area is established. The working interest owners are required to continue drilling additional exploratory and development wells that may expand or contract the
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initial participating area, or create new participating areas, until the unitized area is fully developed. Many separate participating areas may exist within a single federal exploratory unit.
The Model Federal Unit Agreement dictates how royalty interest owners share in production from the expanding or contracting participating areas that are created. Royalty interest owners share unitized substances on an acreage basis in proportion to the number of acres each owns in the participating area. Each royalty interest owner's share of production from a participating area therefore changes as the participating area expands or contracts. The interests of the royalty owners are not affected by the form of unit operating agreement chosen by the working interest owners.
The Model Federal Unit Agreement imposes duties and obligations upon the working interest owners, requiring them to pay the royalty interest owners their respective shares of production and to bear the unit costs. The Model Federal Unit Agreement does not dictate how the working interest owners are to share their...
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