CHAPTER 2 DEEPWATER IN THE GULF OF MEXICO: CONTINUING WORK TOWARD A MODEL FORM OPERATING AGREEMENT

• Jurisdiction: United States

Oil and Gas Development on the Outer Continental Shelf
(Oct 1998)
CHAPTER 2
DEEPWATER IN THE GULF OF MEXICO: CONTINUING WORK TOWARD A MODEL FORM OPERATING AGREEMENT
R. Thomas Jorden, Jr.
Perret Doise
Lafayette, Louisiana
SYNOPSIS

I. Introduction

II. The Outer Continental Shelf Deepwater Royalty Relief Act ("DWRRA")

III. The Deepwater Operating Agreement

A. Contract Application

B. Selection and Duties of Operator

C. Exceptions and Annual Operating Plan

D. Approvals and Notices

E. Phased Development

F. Exploratory Operations

G. Development Plan

H. Project Team

I. Underinvestments

J. Other Provisions

IV. Conclusion

Appendix 1

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I. Introduction

The 90s will be remembered as the frontier days of deepwater exploration and development. This decade has witnessed an intense focus upon the oil and gas potential of the deepwater areas of the Outer Continental Shelf ("OCS") underlying the Gulf of Mexico. This increased interest and activity prompted the American Association of Professional Landmen ("AAPL") in 1996 to begin work on what will be the first model form operating agreement specifically intended for deepwater application. This paper is intended to briefly outline the factors contributing to the revitalization of exploration and development activities in the Gulf of Mexico, describe the efforts of the AAPL in promulgating a model form, and discuss some of the many conceptual and operational issues that must be faced in drafting a model form deepwater operating agreement intended for general application.

Oil and natural gas have been produced from the Gulf of Mexico OCS for fifty years, and this production has contributed to a significant portion of the total United States oil and gas production. Nonetheless, according to the MMS, a long, slow decline had been forecast for production from the Gulf of Mexico because it was thought that all of the most promising shallow water fields had already been found and were approaching or past their peak production levels. The thoughts of declining Gulf of Mexico production have ended and a new era has begun because of the tremendous oil and gas potential of the deepwaters of the OCS.

Favorable economics, the development of 3-D, 4-D and subsalt geophysical technologies, the announcement of several very significant deepwater discoveries in the 200+MMBO range, the development of new deepwater drilling and development technologies, opportunities to lease new prospects, and passage of the Deepwater Royalty Relief Act have all contributed to the revitalization of exploration and development in the Gulf of Mexico.

The high level of interest in the deepwaters of the Gulf is apparent from recent OCS lease sale results. In 1995, the leasing of tracts in waters deeper than 400 meters quadrupled from the average of the previous two years and the deepwater leases accounted for 33% of all leases awarded. The Spring 1996 record breaking Central Gulf of Mexico lease sale resulted in ninety-three companies submitting bids for 924 tracts, almost half of which were in water depths more than 400 meters. The Central Gulf record was again broken at the March 1997 sale, at which

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more than half of the tracts receiving bids were in water depths exceeding 800 meters.¹

Then in March 1998, the day before the Central Gulf Lease Sale, the price of West Texas Intermediate Crude dropped to $13.35, the lowest oil price recorded in nearly 10 years. There was speculation that the U.S. offshore energy industry might retreat from the highly competitive bidding at the two previous Central Gulf Sales. Although not a record breaker, the sale compared favorably to the two prior sales and clearly demonstrated that diminished prices had not ended the frenzy. More than 67% of the 794 tracts bid on were in water depths greater than 800 meters. In addition, the bidders paid more for the leases than in the previous two years. The highest price paid per acre soared from $1482, paid in the 1997 Central Gulf Lease Sale, to $4862 for the sale's highest bid. The high bid totaled $28 million.²

Although smaller in terms of the number of tracts receiving bids, the August 1998 Western Gulf of Mexico Lease Sale "completely amazed" an MMS spokesperson. The average high bid was $1.38 million, compared to $766,000 the prior year. The highest bid was in excess of $37 million. Although bids were received on only 402 tracts at the 1998 Western Gulf Sale, compared to 804 in 1997, the high bids totaled $553 million, compared to $616 million in 1997. In other words, in 1998, half as many blocks generated 90 percent of the revenues raised in 1997. Again, almost 70 percent of the blocks receiving bids were in waters deeper than 800 meters.³

As a result of the increased deepwater leasing activity, the MMS expects OCS production to increase dramatically. By the year 2000, oil production is forecast to increase by as much as 70-100 percent over 1996 levels. The MMS Gulf of Mexico Region projects an increase in oil production from 0.9 million barrels per day to as much as 1.7-1.9 million barrels per day. Gas production is projected to increase from 13.9 billion cubic feet per day in 1995 to as much as 17.2 billion cubic feet per day in 2000. Additionally, drilling rigs operating in the deepwaters of the Gulf of Mexico more than quadrupled between 1991 and 1996, from an average of 4 rigs drilling monthly to 17 rigs. Deepwater oil and gas production increased respectively 260 and 375 percent from 1992 to 1996 and the number of producing deepwater fields more than tripled, from 5 to 18 fields. Fifteen new deepwater fields were discovered in 1997 and the productive capability of earlier deepwater discoveries is proving impressive.

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Initially, the significant players in the Gulf's deepwaters were a handful of major oil companies. In recent years other majors have been actively increasing their lease holdings and independents have gained a strong foothold as primary leaseholders, both individually and as partners with major oil companies. A number of foreign-owned companies have also shown an interest in the deepwaters of the Gulf. As a result of the expanded roster of players in the deepwater, there has been a substantial learning curve. Deepwater operations present significantly different economic, technologic and operational risks and challenges than do conventional operations in shallower waters on the shelf. As a result, operating agreements in use in deepwater operations are typically much different from either onshore agreements or offshore agreements intended for use in the shallow waters of the shelf. There has never been a model form of deepwater operating agreement and the agreements in use are the result of the evolution of offshore operations as they moved deeper and deeper.⁴ Industry efforts to develop suitable agreements for deepwater operations has produced a variety of agreements with substantial and fundamental differences.

It was against this backdrop that in 1996 the AAPL OCS Committee recognized the utility and formed a subcommittee to draft a model form deepwater operating agreement. The committee is comprised of representatives of 16 companies as voting members along with several companies who are participating as non-voting members. Four attorneys have served as counsel to the subcommittee to assist with legal analysis and drafting. The subcommittee obtained 18 different forms that have been used in deepwater operations. The agreement that contained the most commonly used provisions became referred to as the Alpha Agreement. The Alpha Agreement was used as a starting point in the drafting process.

In order to move the process forward, in April 1997, the general subcommittee was divided into a technical subcommittee and a drafting subcommittee. The technical subcommittee was charged with developing concepts and policies and the drafting subcommittee was to incorporate those concepts into an integrated agreement, both subject to general subcommittee approval. Beginning in April, the drafting subcommittee met in two-day sessions every two weeks to critically analyze and redraft the Alpha Agreement, which was completed after substantial alterations in August 1997. During this same period, the technical subcommittee was meeting and making decisions on concepts fundamental to the agreement.

After the drafting subcommittee's product was circulated, two things became clear: 1) the drafting subcommittee had broadly interpreted its authority in redrafting the Alpha Agreement,

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and 2) the policies and concepts envisioned by the technical subcommittee had evolved and were in many instances not reflected in the product of the drafting subcommittee. The resulting impasse could have derailed the process, but the subcommittee members put individual and company preferences aside and continued the difficult job of drafting a flexible, balanced agreement, appropriate for general application. The technical subcommittee redrafted several articles and then submitted them to the drafting subcommittee for review and revision, followed by general subcommittee approval. The resulting synthesized draft agreements began to reflect the consensus of the general subcommittee, and, in July 1998, the two subcommittees were deemed unnecessary and were terminated in favor of the general subcommittee continuing the process.

That process has not yet been completed. In late September 1998, drafts 9 and 10 were circulated and the general subcommittee met to consider and resolve a number of issues raised by the members.⁵ As a result of the subcommittee's decisions, substantial revisions to the Draft Agreement have been undertaken. Following completion and general subcommittee approval, it is envisioned that the Draft Agreement will be circulated for industry comments prior to submission to the OCS Committee for approval and publication. Given the state of flux, it...