CHAPTER 5 THE MODEL FORM JOINT OPERATING AGREEMENT--THE INITIAL WELL AND SUBSEQUENT OPERATIONS: THE INITIAL WELL, PROPOSALS FOR SUBSEQUENT OPERATIONS AND CHANGES TO ARTICLE VI OF THE NEW AAPL 2015 MODEL FORM
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THE MODEL FORM JOINT OPERATING AGREEMENT--THE INITIAL WELL AND SUBSEQUENT OPERATIONS: THE INITIAL WELL, PROPOSALS FOR SUBSEQUENT OPERATIONS AND CHANGES TO ARTICLE VI OF THE NEW AAPL 2015 MODEL FORM
Vice President Land & Senior Counsel
Henry Resources LLC
Midland, TX
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I. Introduction.
Originally introduced as the Ross-Martin form 610 Model Form Joint Operating Agreement in 1956, the American Association of Professional Landmen model form operating agreement has been revised in 1977, 1982, 1989, in 2013 as the 1989 (Horizontal Revisions), and the new 2015 model form is set to be released in the 4th quarter of 2016.1 This set of forms has collectively become the industry standard beginning point for operating agreements in all producing regions of the United States. In every event, the model form operating agreement is designed only as a starting place intended to streamline negotiations by dealing with common, recurring issues in a predictable and consistent manner.
This paper is intended as an opportunity to discuss the subsequent operations provisions of the new 2015 model form as compared to the 1989 Horizontal Revisions version. For purposes of this paper, all references are to the 1989 (Horizontal Revisions) version and to the new 2015 version, unless expressly identified otherwise.
As originally written, all versions of the Model Form Operating Agreement through the 1989 version contemplated matters only in the context of a vertical well. Because technology does not stand still, the manner in which oil and gas wells have traditionally been drilled has changed dramatically so that the majority of new wells currently being drilled are horizontal wells. We are only beginning to understand the legal similarities and differences between vertical and horizontal wells, and we are continuing to develop and standardize terminology in a rapidly changing technical environment. One goal of the most recent model form revisions is to recognize the development of new terminology and to aid in adopting increased precision in the application of the new terminology.
Our primary focus in this paper will be to discuss and understand those provisions relating to proposals for operations taking place after the Initial Well has been drilled. Although this paper is intended to be presented to a diverse audience, including many who may work or operate in jurisdictions other than Texas, most of the case citations will focus on Texas oil and gas jurisprudence.
II. Art. VI.A -- The Initial Well.
Article VI.A addresses, the Initial Well. This well is obligatory and all parties must participate. Typically, the specifics relating to the Initial Well have been negotiated and are well understood by all the parties prior to entering into the operating agreement. One could safely postulate that in most cases, the Initial Well embodies the idea that brings all of the parties together to participate in the project. As a result, the specifics relating to this well are intimately known by the parties and typically need not be spelled out with great detail in the operating agreement.
Because the Initial Well is obligatory and all parties must participate, there is no provision for electing non-consent status with
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respect to the Initial well. Article VI.A describes the location of the well, the anticipated objective, and the time within which the well must be commenced and, if a horizontal well, the surface location and terminus. No Authority For Expenditure or other formal proposal is required. Article VI.A of the 2015 Model Form is unchanged from the 1989 Horizontal version of the Model Form operating agreement. Completing this provision typically requires only filling in a few blanks.
The exception to the premise of Article VI.A will be those instances where two or more owners of leases combine their interests under an operating agreement with no immediate intent of drilling. This may occur most often where (i) leasing activities are incomplete, (ii) geophysical operations are anticipated in advance of drilling, and in either instance the JOA is an appendage to a detailed exploration agreement, or (iii) where production already exists. In those instances, Article VI.A is frequently deleted in its entirety and replaced with the notation that "There is no Initial Well." Under these circumstances, unless the particular JOA expressly provides otherwise, the parties must rely on the provisions of Article VI.B for all operations such that the first well drilled in the Contract Area is drilled as a subsequent operation. This is not an uncommon approach.
Alternatively, the parties may wish to retain the obligation that participation in the first well to be drilled on the Contract Area is mandatory, but they have also agreed that the date is either undetermined or distant, and they wish to leave some flexibility in determining the exact location. In that situation, unless the JOA is appended to another definitive agreement, language should be added to Article V.A (or included in Article XVI Additional Provisions) relating to the timing in some general terms, the manner in which the well is to be proposed and which otherwise reflects the understanding and agreement of the parties with respect to the first well in the project.
III. Organization of Art. VI.B.
Article VI.B has 10 subparts. Generally, those subparts address proposed operations, operations by less than all of the parties, matters relating to issues arising once operations have begun, spacing, operations conducted on wells that are producing in paying quantities and issues relating to use of a spudder rig. The remainder of Article VI addresses completion, rework and plugging back, other operations, plugging and abandonment, taking production in kind, and in the 2015 version, Article VI includes a new provision relating to deviations from approved proposals.
IV. Proposed Operations.
The principal purpose of Article VI.B.1 is to require that the information necessary to make an economic decision is provided to the parties entitled to participate in operations to be conducted with respect to a new well, a dry hole, or a well that previously but no longer produces.2
Generally, any party to the agreement may propose an operation under Article VI.B.1, unless either (a) modified by an added provision under Article XVI or by revising Article VI.B.1,3 or, (b) the party has relinquished its interest in the objective Zone. Likewise, all parties who have not previously relinquished their interest in the objective Zone are entitled to receive the proposal.4
Under the forms that preceded the 1989 Horizontal Form, a well proposal could be relatively simple and need only contain the location of the well, the anticipated depth and objective formation, and an estimate of the cost.
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For example, a valid proposal might state only that the proposed well is to be drilled "at a legal location in the SW/4 of Section X, John Smith Survey A-123, Midland County, Texas, to an approximate depth of 8,300' to test the Spraberry Formation, and is estimated to cost $2,200,000." No further information and no AFE (authority for expenditure) is required.
In the past, when discussing operating agreements I have often stated that the AFE originated as a planning tool for engineers. The principal purpose of an AFE is to itemize the services and material needed to drill and complete a well, or to perform any other complex operation. In addition, an AFE has the benefit of providing a convenient and thorough means to estimate the cost of the individual services, materials and total cost. The basic questions that an AFE answers is "what does the operation consist of, and what is the cost?" The result is that AFE's are useful tools in determining the financial risk of any project. Although useful, and typically used as a component of well proposals, until the 1989 Horizontal Form, an AFE was never required as part of a valid proposal.
However, beginning with the 1989 Horizontal Form, an AFE is a required component of a valid proposal. Part of the reason for this change is that with the advent of horizontal drilling and multi-stage completion operations, the financial risk to the parties has increased significantly. A typical horizontal well often costs $9MM-$10MM or more, and more information is necessary to make good financial decisions. Accordingly, the 1989 Horizontal Form has added a definition of AFE, and to protect the operator, has made it clear that an AFE is merely an estimate of anticipated expenditures made in good faith, and not a specific contractual commitment. This approach is carried forward and continued in the 2015 version.
No particular form is required, but a valid AFE must contain certain information. First, the AFE must distinguish whether the proposal is for a vertical or a horizontal well. If the operation is for a vertical well, under the 1989 Horizontal and all prior versions of the model form, only the traditional information is required: the operation to be performed, the location, objective zone, depth, and estimated cost. The new 2015 greatly expands the required information for vertical wells. Under this new form, the proposal must also specify the bottom hole location if different from the surface location, the utilization of rigs for drilling and completion, the proposed stimulation operations, including staging and sizing information.5 In large part, this mirrors the 1989 Horizontal Form requirements for horizontal well proposals. A horizontal well proposal under both the 1989 Horizontal Form and the new 2015 version includes all of the required elements of the 2015 vertical well proposal and adds to the required information total measured depth, location of the terminus, anticipated displacement of the...
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