CHAPTER 4 CONFLICTING AGREEMENTS IN THE DRILLING OF HORIZONTAL WELLS
Jurisdiction | United States |
(Nov 2012)
CONFLICTING AGREEMENTS IN THE DRILLING OF HORIZONTAL WELLS
Elias, Books, Brown & Nelson, P.C.
Oklahoma City, OK 73102
TIMOTHY C. DOWD is an attorney with Elias, Books, Brown & Nelson, P.C., in Oklahoma City, Oklahoma. Mr. Dowd is a past President of the Oklahoma City Mineral Lawyers Society (1996-97) and is also the past Chairperson of the Oklahoma Bar Association Mineral Law Section (2005-06). Mr. Dowd is the author of the Oklahoma chapter of (the American Association of Professional Landmen's Nationwide Comparison of Laws on Leasing, Exploration and Production (2011). Mr. Dowd is also the author of the chapter on Oil and Gas Titles in West Publishing Company's Oklahoma Real Estate Forms and Practice. Mr. Dowd has written numerous articles for publication, including: Clearing Title of Long-Lost Mineral Owners, 54 Rocky Mountain Mineral Law Institute 30-1 (2008); Costs That Can Be Charged In Calculation of Risk Penalties Under Forced Pooling Actions and Non-Consent Penalties Under Operating Agreements, 25 Energy & Min. L. Inst. Ch 10. (2005); Preferential Rights to Purchase in Oil and Gas Transactions, 49 Rocky Mountain Mineral Law Institute 5-1 (2003); Common Problems in the Interpretation of Deeds and Conveyances, 48 Landman 67-75 (March/April 2003); and Oil and Gas Liens in Oklahoma, 51 Okla. L. Rev. 309 (1998). Mr. Dowd graduated from the University of Tulsa College of Law. Mr. Dowd is licensed to practice in Oklahoma, North Dakota, Pennsylvania and West Virginia. Mr. Dowd's primary area of practice is oil and gas law, including the rendering of title opinions and the drafting and negotiation of industry contracts.
INTRODUCTION
In present times, it is highly likely that an Operator seeking to drill a horizontal well will encounter areas that have been developed by previously drilled vertical oil and gas wells. With every well that has been drilled, there is likely to be different contractual arrangements impacting the drilled tracts.
A lessee is likely to encounter issues dealing with multi-unit development, where the prior wells were drilled on lease units as small as 40 acres, or perhaps as large as 640 acres. Therefore, when companies are planning to drill in 1280-acre units or larger, the concept that a lessee might run into differing contractual arrangements is very likely.
Although it may be obvious, one court noted the physical characteristics of a horizontal well. Horizontal wells traverse several tracts owned by different individuals, not all of which are contiguous; they include multiple points along the drain hole rather than a single drillsite; and they penetrate highly fractured formations that do not facilitate the natural migration of oil and gas.1
I. JOINT OPERATING AGREEMENTS
Joint operations are common in the oil and gas industry. When the interest in a property, or group of properties, is divided among more than one owner, the relationship between these co-owners is commonly governed by the AAPL Form 610 Model Form Operating Agreement ("JOA"), which standardizes the recurring problem of how to unify, control, and operate among the different participants in the project.2 A JOA provides for the development and operation of certain leasehold interests for the joint account of concurrent owners who share in the expense of drilling and operations in accordance with the terms of the agreement.3 It covers such diverse problems as the examination of title, the rendering of the property for ad valorem tax purposes, elections under the Internal Revenue Code, and the sale or transfer of any interest subject to the JOA.4
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The main functions of the JOA are pooling the parties' interest in the contract area, allocation of costs, expenses and production within the contract area, the conduct of operations within the contract area, including the designation of the operator, and defining the respective rights, duties and responsibilities of the parties to each other and third parties.
In the event a lessee is operating in an area in which there are conflicting or two separate Operating Agreements, it will be necessary for the parties to amend the existing Agreements or enter into a new Agreement as to the horizontal operation.
[A] TWO OR MORE OPERATING AGREEMENTS
The fact that there is more than one Operating Agreement does not render the second agreement invalid or ineffective. In two cases, courts have attempted to reconcile the two agreements.
In the first case, two Operating Agreements were executed at different times. The court determined that the designation of Westland as Operator for the deep rights did not conflict with a 1945 Operating Agreement, designating Mobil as the Operator of the same field. The court held that the Operating Agreement between Mobil and Westland, wherein Westland was named as the Operator was no different from Mobil hiring an independent contractor. It did not relieve Mobil of its responsibilities under the 1945 Agreement to Getty and Texaco. The court held that the conflicting Joint Operating Agreements only created additional duties and responsibilities as between Mobil and Westland.5
In the second, case the Oklahoma Supreme Court upheld two different Operating Agreements between the parties.6 In Osborn v. Rogers, the parties entered into an Operating Agreement between all owners. Subsequently thereto, the Operator and a Non-Operator entered into an Amended Agreement which was not consented to by a second Non-Operator. The court indicated that the Operator was still subject to all the terms and provisions of both separate Operating Agreements between the parties.
[B] INTEREST OF PARTIES (ARTICLE III)
Under the Joint Operating Agreement, the parties agree that they will bear costs, own equipment and materials, and share production in the percentage specified on Exhibit "A" to the Agreement. The Exhibit "A" to the Agreement specifies the Contract Area. Two things should be noted. The first is that under the Agreement, the parties agree that costs and production from the Contract Area, absent an individual loss of title, will be shared as to all wells. Thus, if one party agrees to bear too much cost and receives too little production, that party
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can be held to be bound by the agreement that he signed regardless of ownership.
The second point to be noted is that there is no legal requirement that the Contract Area be only a drilling and spacing unit or that the percentages be based on the ownership of leasehold in the section or spacing units. A Contract Area can be multiple units or sections. The percentages used can be acreage contribution over a large area or even a specifically negotiated percentage.
While the parties may each have their individual ownership in their separate units, the combined horizontal unit will create ownership issues.
For example, if the parties enter into a 1280 acre unit, logic would suggest that the ownership would be the same based upon their leasehold ownership in the two 640-acre units.
Alternatively, if the horizontal unit does not fit with existing contract owners, the parties may wish to reach an agreement that the ownership would be only where it encompasses all of a section and that part of an area and that part of a second area in which it encroaches. For example, if the ownership is based upon their percentage of ownership. If so, in the event that you have parties who own in the old contract area, but are not underlying the newly created unit, then these parties may claim an interest in the new horizontal unit based upon their ownership in the former unit. In other words, if the parties create a unit of all of Section 1 and the north 320 acres of Section 12, then those parties who are subject to an Operating Agreement covering all of Section 12, but who only own in the south half of Section 12, may make a claim to production in the new horizontal unit in the absence of an agreement or compromise among the parties.
In a multi-unit situation, the ownership could be based on the length of the lateral underlying the geographical area.
[C] TITLES (ARTICLE IV)
Title examination is made on the Drillsite of any proposed Well unless the request is made on the whole unit. The 1989 Model Form is a change from the prior forms to require that title examination be made on the entire drilling unit if a majority of the drilling parties vote to do so, or if the operator elects.
In the Model Form Operating Agreement, Drillsite is defined in Paragraph G of Article I, Definitions, to mean the Oil and Gas Lease or Oil and Gas Interest on which a proposed well is to be located.
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When you are amending one or more Operating Agreements or preparing a new Agreement, it will be necessary for the term Drillsite to be revised. Each tract traversed by the horizontal wellbore is a Drillsite tract and each production point on the wellbore is a Drillsite.7 In horizontal wells, each separate tract penetrated by the vertical and horizontal completion leg of the wellbore should be considered a drillsite tract for purposes of allocating production and examining title.
One commentator suggests that the definition of "Drillsite" be revised to recite the following:
The term "Drillsite" when used in connection with a Horizontal or a Multi-lateral Well shall mean the surface location and the Oil and Gas Leases or Oil and Gas Interests within the spacing unit in which the wellbores including all Laterals are located.8
[D] OPERATOR
One purpose of a JOA is the appointment of an entity to be responsible for all operations in the contract area. That entity or individual is designated as the operator. The operator is given "full control" over all operations.
In the event parties encounter separate Operating Agreements with two (or more) separate Operators, then it will be necessary for the parties to enter into a...
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