CHAPTER 16 THE UNIT OPERATING AGREEMENT FOR FEDERAL EXPLORATORY UNITS
| Jurisdiction | United States |
(Nov 2006)
THE UNIT OPERATING AGREEMENT FOR FEDERAL EXPLORATORY UNITS
Attorney
Holme Roberts & Owen LLP
Denver, Colorado
STEVEN B. RICHARDSON
Steven B. Richardson is a partner in Holme Roberts & Owen LLP and has been with the firm since 1981. His practice in the Denver office emphasizes energy and natural resources law, project development, and finance, and general commercial and corporate law; the practice is transactional based and Steve 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 earned his J.D., cum laude, at Harvard University (1981); and B.A., magna cum laude, at the University of Colorado (1978).
He is a past vice chair of the ABA Electric Power Committee; Phi Beta Kappa, 1981; and past present of the Denver Chapter of the University of Colorado at Boulder Alumni Association. He has been licensed to practice in Colorado since 1981 and is a member of the American, Colorado, and Denver Bar Associations.
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 procedures, advantages and disadvantages of forming federal exploratory units, and of forming units covering proven areas for secondary recovery operations, are discussed in detail in other papers presented as part of this special institute.
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 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 (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.
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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 owner's share of production and costs is determined by its interests in the participating area and is adjusted as the participating area is expanded and contracted.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. These participating areas can expand or contract as a result of additional operations. In addition, a federal exploratory unit may contain several participating areas. The purpose of the participating area is to approximate the area capable of producing unitized substances in paying quantities.
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, 2005)) (Model Federal Unit Agreement). Any changes to the form of the Model Federal Unit Agreement must be approved by the authorized officer.
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 costs associated therewith. The arrangement among the working interest owners is, therefore, left to the 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 working interest owners to drill an initial test well in the unit and, if this well is capable of producing unitized substances in paying quantities,
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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 initial participating area, or create new participating areas, until the field 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 collectively 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 portion of the production as participating areas expand and contract, nor how to bear unit costs and royalty payments. Working interest owners must negotiate a unit operating agreement to define how their duties, obligations, costs, and production are shared and allocated.
III. Unit Operating Agreements
The unit operating agreement is entered into by the working interest owners who are committing their interests to the unit in conjunction with the execution of the unit agreement. Two copies of the unit operating agreement entered into with respect to the unitized lands are required to be filed in the proper BLM office before the unit agreement will be approved.5 The purpose of filing copies of the unit operating agreement is to demonstrate that the working interest owners have given the unit operator sufficient authority to conduct operations under the unit agreement and that the committed working interest owners have agreed upon the sharing of costs attributable to and production from the unit.
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Divided Type and Undivided Type Unit Operating Agreements
Unit operating agreements for federal exploratory units are commonly referred to as "undivided type" or "divided type" operating agreements. Under either type of operating agreement, royalty owners share only in production allocated to a participating area in which they have an interest. The differences between the two forms of operating agreements only affect the committed working interest owners.
A. Undivided Interest Unit Operating Agreement--RMOA--Form 1
RMOA--Form 1 sets forth one of the two ways to allocate the production attributable to the working interests and the costs associated therewith. RMOA--Form 1 is an "undivided type" operating agreement wherein the working interest owners participate in costs and...
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