CHAPTER 19 OTHER FEDERAL CONSERVATION MECHANISMS

• Jurisdiction: United States

Federal Onshore Oil and Gas Pooling and Unitization
(Nov 2006)
CHAPTER 19
OTHER FEDERAL CONSERVATION MECHANISMS
J. Matthew Snow
Lear & Lear L.L.P.
Salt Lake City, Utah

J. MATTHEW SNOW

Mr. Snow practices natural resources law as a partner in the Salt Lake City firm of Lear & Lear L.L.P. He earned his J.D. from the University of Utah College of Law in 1998, where he was Managing Editor of the Journal of Energy, Natural Resources and Environmental Law. Upon graduation Mr. Snow clerked for Justice Michael J. Wilkins of the Utah Supreme Court. His practice is concentrated on oil and gas law, including the acquisition, exploration, permitting and production of oil, gas, and mining properties; oil and gas conservation matters before the Utah Board of Oil, Gas and Mining; complex title examinations of Federal, fee, state, and Indian lands; administrative hearings and appeals; natural resources litigation and appeals; mergers and acquisitions; mineral financing; and natural resources law on Indian reservations. He is a member of the Utah State Bar as well as a past president of the Utah Association of Professional Landmen and a former chairman of the Utah State Bar's Oil and Gas Committee.

SYNOPSIS

Introduction

I. Operating, Drilling, or Development Contracts

[A] Statutory and Regulatory Framework

[B] Departmental Policy and Evolution of the Development Contract

[C] Preliminary Considerations

[D] Content and Requirements

[E] Currently Authorized Oil and Gas Development Contracts

II. Gas Storage Agreements

[A] Statutory Framework for Underground Storage

[B] Federal Model Form Gas Storage Agreement

[C] Currently Authorized Federal Gas Storage Agreements

III. Combination Agreements and Working Interest Units

[A] Combination Agreements

[B] Working Interest Units

Conclusion

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INTRODUCTION

In the Rocky Mountain West, the recent high price of hydrocarbon resources coupled with the increase in demand has led energy companies, at ever increasing numbers, to aggressively seek out new potential deposits. During the first six months of 2006, the Utah Division of Oil, Gas and Mining issued 1,017 new drilling permits compared to 728 issued during the first half of 2005.¹ A large part of the renewed interest in the Rocky Mountain States is occurring on federal lands and is based on new technology which has allowed companies to gather and evaluate data from ever more remote lands and geologic formations.² With this increase in both the scope and magnitude of exploratory activity, comes the need to understand the various types of conservation agreements available to federal lessees which can accommodate these unique types of projects.

The purpose of this paper is to present both the legal requirements and practical implications of four such federal conservation mechanisms. Those conservation agreements are: (1) operating, drilling, or development contracts, (2) gas storage agreements, (3) combination agreements, and (4) working interest units. Although these agreements are not often utilized and there is limited legal authority to define either their parameters or scope, agreements of this type offer a viable option for the creative practitioner to employ in oil and gas operations on federal lands and should not be overlooked.³

I. OPERATING, DRILLING, OR DEVELOPMENT CONTRACTS

[A] Statutory and Regulatory Framework

An operating, drilling, or development contract is a federal conservation agreement between the Bureau of Land Management ("BLM") and an operator which is designed to promote timely and full operations on lands where unique exploration incentives and relief from the federal acreage limitation are required if the reserves are to be efficiently developed.⁴ Although

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these types of contracts offer operators an alternative mechanism to undertake development of federal lands, both their use and implementation has been extremely limited. This is due at least in part to the uncertainty surrounding the purpose served by operating, drilling, or development contracts coupled with the fact the definition and application of these types of agreements has significantly evolved over time.⁵

The Mineral Leasing Act of 1920⁶ makes no reference to operating, drilling or development contracts. However, in 1931, section 27 of the Mineral Leasing Act was amended to provide, among other things, that:

[T]he Secretary of the Interior is hereby authorized, on such conditions as he may prescribe, to approve operating, drilling or development contracts made by one or more permittees or lessees in oil and gas leases or permits, with one or more persons, associations, or corporations, whenever in his discretion and regardless of acreage limitations, provided for in this Act, the conservation of natural products or the public convenience or necessity may require it or the interests of the United States may be best served thereby ....⁷

The obvious benefit to a proponent of an operating, drilling or development contract is the exemption from the statutory limitation prohibiting a party from owning or controlling more than 246,080 acres of Federal oil and gas leases in any one state.⁸ What is less clear from the statutory language is the purpose served by these types of contracts or how operating, drilling and development contracts differ, if at all. The legislative history of this provision provides some context, albeit limited, of the intended beneficiaries of these types of contracts, providing that: "This departure [from the acreage limitation] is intended to permit pipe-line companies to enter into contracts with permittees or lessees in numbers sufficient to justify the construction of such pipelines and to finance the same."⁹ In the past, the acreage limitation had posed problems for operators of large gas fields where leases acquired solely for the purpose of collection facilities would exceed the statutory limitation.¹⁰ Companies were precluded from joining together and consolidating gas collection and storage facilities under a single leasehold due to the acreage restriction.¹¹

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The regulations promulgated by the Department of Interior ("DOI") which implement the changes occasioned by the 1931 Act, mirror this legislative history:

The provision ... authorizing the Secretary of the Interior to approve operating, drilling, or development contracts without regard to acreage limitations is primarily intended to permit pipe-line companies or other operators to enter into contracts with permittees and lessees in numbers sufficient to justify operations on a large scale for the discovery, development, production or transportation of oil or gas and to finance the same.¹²

These regulations remain in effect today, essentially without change.¹³ Although the statutes and regulations governing operating, drilling, or development provide a general framework for their use and implementation, in order to understand what these agreements actually are, or more specifically, what they have become, it is necessary to examine the DOI's treatment, interpretation, and use of operating, drilling, or development contracts. This is particularly true in light of the fact that many of the current guidelines and approval prerequisites associated with development contracts arose through internal agency reports, studies, and memoranda.

[B] Departmental Policy and Evolution of the Development Contract

Due at least in part to the broad statutory grant and the lack of any associated guidance, the definitions applied to operating, drilling, or development contracts have been inconsistent over time and various states have interpreted the applicable policies and regulations differently.¹⁴ However, on October 23, 1968, the Secretary of DOI, Stewart L. Udall, published a poignant news release memorializing the department's policy on development contracts:

We regard ... [development contracts] primarily as an incentive for exploration and development in areas of high risk where relatively little is known about the oil and gas potential.

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Development contracts ... envision systematic exploration of lands in the contract area. Their principal advantage to the operator is the temporary exemption of a large block of Federal leases from the acreage limitation on holdings and control.¹⁵

This news release was the most definitive policy statement from the DOI to date and appeared to represent a shift by the department in narrowing the focus of development contracts to the exploratory phase of oil and gas operations rather than on broad "large scale ... discovery, development, production, or transportation" activities.¹⁶ A notice further clarifying the DOI's position was published in the Federal Register on the same day. The notice provides that:

The DOI will consider requests for approval of operating, drilling, or development contracts where the approved contract can be expected to stimulate exploration of an area which is relatively unexplored for oil and gas.¹⁷

Although development contracts were now clearly an option for oil and gas operators contemplating exploratory activities in frontier areas, they were only rarely used until the mid-1980s, at which time, multiple proposals were submitted in New Mexico, Wyoming, and particularly Nevada.¹⁸ This increased activity prompted the creation of a task force comprised of BLM employees who were charged with formulating agency policy regarding development contracts.¹⁹ The task force issued a written report in March of 1988 ("Task Force Report") which specifically concluded that the main object of a development contract should be to provide for exploration of relatively unexplored areas or to provide for other large scale development. The Task Force Report emphasized the utility of development contracts to the DOI since they reveal useful information about oil and gas potential that would otherwise be unavailable for developing land use...