CHAPTER 8 SUGGESTED CHANGES TO THE 1989 AAPL FORM OPERATING AGREEMENT TO ADDRESS HORIZONTAL DEVELOPMENT1

• Jurisdiction: United States

Horizontal Oil & Gas Development
(Nov 2012)
CHAPTER 8
SUGGESTED CHANGES TO THE 1989 AAPL FORM OPERATING AGREEMENT TO ADDRESS HORIZONTAL DEVELOPMENT¹
Lamont C. Larsen
Davis Graham & Stubbs LLP
Denver, CO

LAMONT C. LARSEN is an associate in the Energy group at Davis Graham & Stubbs LLP in Denver, Colorado. Mr. Larsen's practice focuses primarily on transactional matters for the oil & gas industry. He represents clients in the drafting and negotiation of purchase and sale agreements, participation agreements, joint operating agreements, farm-outs and various other agreements pertaining to the exploration and production of oil & gas. Mr. Larsen also has extensive experience in the preparation of all forms of title opinions covering fee, federal and tribal lands. Mr. Larsen received a B.A. from Brigham Young University in 2002 and received his J.D., with honors, from The University of Texas School of Law in 2005. Mr. Larsen is a member of the Rocky Mountain Mineral Law Foundation, the Denver Association of Oil and Gas Title Lawyers, and the Denver Association of Petroleum Landmen. Prior to joining Davis Graham & Stubbs, Mr. Larsen practiced oil and gas law in Texas for two years. He is admitted to practice law in Colorado, Texas, and Pennsylvania.

I. Background.

The concept of drilling a horizontal well has been around the oil patch for longer than might be suspected. According to some reports, the first true horizontal well was drilled near Texon, Texas in 1929.² Plowever, it was not until the 1980's that the technology behind horizontal drilling really began to develop. At first, domestic horizontal drilling was primarily limited to the oil fields producing from the Austin Chalk Formation in south central Texas.³ This limestone oil-bearing formation is highly permeable and contains extensive naturally-occurring vertical fractures that facilitate the flow of oil into the wellbore. A conventional vertical well would at best intersect one of these vertical fractures. Operators soon realized that drilling a horizontal well would ensure that multiple fractures would be intersected, resulting in an exponential increase in oil production. By the early 1990's, operators drilling to the Austin Chalk Formation began to experience initial production rates of over a 1,000 barrels a day from horizontal wells.⁴

Snapshot of Horizontal Drilling for the Year 1990⁵

• More than 1,000 horizontal wells were drilled to date

• Roughly 850 were drilled in the Austin Chalk Formation

• Less than 1% of all domestic gas wells were horizontal wells

• 6.2% of all domestic oil wells were horizontal wells

As multi-stage hydraulic fracturing technology improved, horizontal drilling began to rapidly proliferate. Hydraulic fracturing enabled operators to artificially create fractures in the reservoir rock or enhance naturally occurring fractures. This technology led to an expansion of horizontal drilling techniques beyond naturally fractured formations like the Austin Chalk, into shale and other tight oil formations such as the Bakken Formation in North Dakota,⁶ the Eagleford Formation in South Texas, and more recently, the Niobrara Formation in Colorado and Wyoming. Hydraulic fracturing also enabled operators to apply horizontal drilling techniques to gas wells, causing a massive expansion of horizontal drilling into the Barnett Shale Formation in North Texas, the Haynesville Shale Formation in Texas and Louisiana, the Marcellus Shale Formation in the Northeastern states, and other prolific gas plays.

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The first table below shows the number of horizontal drilling permits approved in Texas from 2000 through 2011 compared to the total number of permits approved during such years. The second table shows the number of horizontal drilling permits approved in the Barnett shale from 2000 through 2011.⁷

Texas	Barnett Shale
Horizontal	Total	Pct.	Horizontal
2000	535	13,899	3.85%	2000	1
2001	644	14,410	4.47%	2001	3
2002	498	11,434	4.36%	2002	7
2003	908	14,654	6.20%	2003	185
2004	1,505	16,912	8.90%	2004	668
2005	2,602	19,548	13.31%	2005	1,555
2006	3,762	22,328	16.85%	2006	2,711
2007	5,871	23,917	24.55%	2007	4,566
2008	7,740	28,847	26.83%	2008	5,614
2009	4,730	15,989	29.58%	2009	3,003
2010	7,150	22,511	31.76%	2010	3,479
2011	10,333	28,291	36.52%	2011	3,512

This table shows the number of horizontal drilling permits approved in Colorado from 2009 through 2011 compared to the total number of permits approved during such years.⁸

Colorado
Horizontal	Total	Pct.
2009	147	5,159	2.85%
2010	333	5,996	5.55%
2011	896	4,936	18.15%
2012	797	2,813	28.33%9

A. Disadvantages of Horizontal Prilling.

1. Increased Drilling Costs. The average cost to drill and complete a horizontal well can be as much as 1.5 to 3 times as much as a conventional vertical well.¹⁰ This is largely due to the increased total measured depth of a horizontal wellbore, which includes the total vertical depth of the wellbore plus the length of the horizontal wellbore segment. Since the objective formation is the same, a horizontal well will typically have the same vertical depth as a conventional vertical well, but the horizontal segment may extend an additional 8,000 feet or

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more.¹¹ Furthermore, each additional foot drilled at the deepest depths typically costs many times more than each foot drilled at the shallowest depths. The advent of multistage hydraulic fracturing and other completion techniques have also dramatically increased the cost of a horizontal well. An alternative method of drilling a horizontal well is to reenter and convert an existing vertical well into a horizontal well, which can cost on average 0.4 to 1.3 times the cost to drill a conventional vertical well.¹² Horizontal drilling and multistage fracturing also require sophisticated drilling rigs and equipment which are costly and may be subject to limited availability, as well as substantial amounts of water, sand and ceramic proppant.¹³ The need for these additional materials increases the cost of horizontal wells, and in areas where water is scarce, can create other difficulties.

B. Advantages of Horizontal Drilling.

1. Greater Exposure to Reservoir. Most oil and gas reservoirs are much more extensive in their horizontal dimension than in their vertical (thickness) dimension.¹⁴ For example, a reservoir may only be a few dozen feet thick, but could extend horizontally for thousands of feet. By drilling horizontally, the wellbore extends through the reservoir on a parallel plane, rather than a perpendicular plane, thereby exposing the wellbore to significantly more reservoir rock than with a conventional vertical wellbore.¹⁵ The longer the horizontal segment of the wellbore, the more reservoir exposure.

2. Higher Production Rates. Because of the greater exposure to the reservoir for horizontal wells, production rates and reserves are achieved at 2.5 to 7 times the rate of vertical wells.¹⁶ A higher production rate translates into a higher rate of return and results in payout status for a horizontal well being reached sooner.

3. Greater Recovery in Certain Reservoir Types. In addition to small pay-zone thickness, certain reservoir properties such as low permeability, natural fractures, and coning of water or gas limit the recovery that can be achieved with a conventional vertical well.¹⁷ By drilling horizontally through the reservoir, these limitations can be minimized, or in the case of natural fracturing, can even be exploited. In the Bakken Formation in North Dakota, the increase in technically recoverable reserves due to horizontal drilling has been dramatic. In 2005, the North Dakota Department of Mineral Resources estimated that 14 million barrels of oil were technically recoverable from the Bakken Formation. By 2008, after significant technological advancements in horizontal drilling, that figure increased to 2.09 billion barrels.¹⁸ It is expected that after accounting for further technological advancements from 2008 to date, particularly multistage hydraulic fracturing, that figure will increase much higher.¹⁹

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4. Less Wells Required to Drain Reservoir. Because of the greater exposure to the reservoir for horizontal wells, less wells are required to effectively drain the reservoir.²⁰ This is particularly true where multi-lateral wells are drilled containing multiple horizontal segments. The aggregate surface footprint can be significantly reduced by use of horizontal wells, which is particularly important in urban areas such as the Barnett Shale or environmentally sensitive areas.²¹ For example, it is estimated that to effectively drain a 640-acre section in the Barnett Shale using conventional vertical wells would take 4 times the number of wells and up to 10 times the surface disturbance than if horizontal wells were used.²²

5. Avoid Long Term Production Problems. Over time the wellbore and well equipment begin to deteriorate or wear out. Because production is obtained at a much higher rate, the reservoir is drained sooner.²³ This may enable the operator to avoid reworking the well or replacing production equipment which can be costly and inefficient.

In sum, horizontal wells make sense economically. Although a horizontal well can cost as much as three times or more to drill and complete as a vertical well, the higher production rates and reserves, greater recovery and the reduced number of wells required to drain the reservoir more than offset this additional cost.²⁴

II. Modifying the JOA Form for Horizontal Drilling.

Unfortunately, the AAPL 1989 Form Joint Operating Agreement (the "1989 Form JOA") does not address horizontal drilling, nor does any prior version.²⁵ As a result, there are a number of modifications to a standard joint operating agreement that should be considered when a horizontal well is contemplated. The balance of this paper will discuss the various...