CHAPTER 9 COMPREHENSIVE EXPLORATION AGREEMENTS
| Jurisdiction | United States |
(Mar 2010)
COMPREHENSIVE EXPLORATION AGREEMENTS
Peter D. Robinson
Holme, Roberts & Owen LLP
Denver, Colorado
Steven B. Richardson is a partner in the Denver Denver office of Holme Roberts & Owen LLP and has been with the firm since 1981. His practice emphasizes energy and natural resources law, project development and finance, and general commercial and corporate law. His practice is transactional based and he represents a wide range of energy companies in entity formation, asset acquisitions and sales, mergers and combinations involving both private and public companies, project development, financing, and regulatory compliance for oil and gas exploration and development, pipelines, power projects (including alternative energy projects), and operational matters including product and energy sales, and processing and transportation arrangements. Steve is a past vice chair of the ABA Electric Power Committee, and has been a member of the University of Colorado Library Board since 1996. He earned his J.D., cum laude, from Harvard University (1981) and a B.A., magna cum laude, from the University of Colorado (1978). He was admitted to the Colorado Bar in 1981, and is also admitted in Colorado state and federal Courts.
TABLE OF CONTENTS
I. Introduction
II. Structure; Potential Participants; Fundamental Tensions
A. Structure
1. Joint Venture
2. Contractual Arrangement
B. Potential Participants
1. BigOilCo
2. IndependentCo
3. WildcatCo
4. FundCo
5. MineralCo
C. Fundamental Tensions
1. High Risk
2. Incomplete Control of the Area
3. Limited, if any, Seismic Information
4. Significant Ongoing Unfunded Capital Commitments; Disparate Financial Strength Among Parties; Limited Remedies for Default
5. Disparate Risk Tolerance and Review Processes
III. Term Sheet (Among all Parties or Internal Only)
IV. The Exploration and Development Agreement
A. Form Agreement
B. Assumptions
C. Specific Provisions
1. Article I--Definitions
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2. Articles II and III--Acquisition of WildcatCo Assigned Assets; Seismic License; Title Review
3. Article IV--Existing Burdens; Operating Agreement; AMI
4. Article VII.--Acquisition of Exploration License; Additional Seismic Program
5. Article VIII--Obligation to Drill Commitment Wells; Delay Rental Administration
6. Article IX--Prospects
7. Article X--Feasibility Studies; Downstream Projects
8. Article XII Indemnifications
9. Article XIII Miscellaneous
APPENDICES
I. Form of Term Sheet
II. Form of Acquisition, Exploration and Development Agreement
III. Form of Special Provisions to Joint Operating Agreement
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I. Introduction
The exploration phase of the oil and gas industry, especially in remote, untested large plays, is one of the most exciting parts of the business. It often occurs in remote locations with harsh weather that may only be accessible for certain operations during certain months of the year, and involves the expenditure of tens of millions of dollars on risky geologic theories conjured from limited seismic data. The truly wildcat plays may be far from existing infrastructure to support drilling and other activities presenting challenging logistics, and far from any oil or gas pipelines and processing facilities to take production if the exploration efforts are successful. It is the phase that has made many fortunes, often after drilling many dry holes in a row, and has undone many others.
Unlike other common agreements in the oil and gas industry, there is no "standard form" of exploration and development agreement. Such agreements take many forms from three page simple farmout or participation agreements covering a few drilling locations, to multi-party, complex agreements covering hundreds of thousands of acres, in or outside of the United States, with multiple potential exploration targets at multiple depths and separated by many miles. As an alternative to the contractual form, such arrangements can be structured as a joint venture or partnership although this is less common than a contractual arrangement.
II. Structure; Potential Participants; Fundamental Tensions
A. Structure
1. Joint Venture
Exploration and development activities are sometimes structured as separate legal entities which may include a partnership (of which a joint venture is a limited variety) or limited liability company. A limited partnership structure is a common vehicle for investor participation in drilling programs controlled by one industry participant but is less common between industry participants. One sometimes sees documents that casually and imprecisely refer to the arrangement between the parties as a "joint venture" or "venture" and refer to the parties as "venturers" or "partners" without intending to create a joint venture or partnership but which may unintentionally create such an arrangement under applicable law, with the associated fiduciary duties.1 A company finding itself in this situation, but without an agreement intended to cover such an arrangement and perhaps limit the scope of the fiduciary duties that would otherwise apply, is obviously to be avoided. The more common arrangement in current use is the contractual form of exploration and development arrangement.
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2. Contractual Arrangement
Most often, an exploration arrangement among industry participants takes the form of a contract, referred to variously as a "participation agreement," an "exploration agreement," an "exploration and development agreement," or a "joint development agreement." As indicated above, there is no published standard form in common use for such arrangements. Even though most industry participants will generally prefer to use a contractual arrangement, it may be necessary to cause such otherwise contractual arrangement to elect to be treated as a tax partnership (like a tax partnership under a standard form joint operating agreement) in order to allocate intangible drilling costs, depreciation and other tax items in a manner consistent with any carried interest or promote that are part of the arrangement.
B. Potential Participants
A wide variety of participants may be encountered in any particular exploration project, including the following prototypical companies:
1. BigOilCo
Major oil company ("BigOilCo") for whom billion dollar projects are in the usual course, not limited by capital constraints if it decides it wants to fully and quickly develop a prospect. BigOilCo is one of the participants under the Form Agreement discussed below.
2. IndependentCo
Large publically traded independent oil company ("IndependentCo") with somewhat greater capital constraints than the major oil companies and whose exploration budgets may be more cyclical than the major oil companies, but who are capable of fully participating in full scale, rapid development of a prospect if it is important to them.
3. WildcatCo
Closely held oil and gas exploration company ("WildcatCo") that has been in the business for many years, is experienced in the area, may have a very high risk tolerance relative to the other participants, has relationships (some good, some not so good) with regulators, governmental agencies and elected officials in the area, has successfully permitted and developed other projects in the area, and has survived many cycles in the business.
At any given time, WildcatCo may have significant capital available from its own production or investors or its may have limited available cash and borrowing capacity because of material continuing capital requirements for other exploration plays that have not been successful, but that WildcatCo is convinced will be, and because of declines in oil and gas prices and the effects thereof on WildcatCo's ability to service its debt and meet its borrowing base and debt service coverage tests. WildcatCo is one of the participants under the Form Agreement discussed below.
The Form Agreement assumes that WildcatCo is the party that had the original geologic idea (which may have been brought to it by an independent geologist), assembled the lease position in the project area and is looking to share further exploration risk, receive reimbursement for the
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costs it has incurred to date plus some modest premium, and get some kind of carry on additional seismic and the initial test wells.
4. FundCo
Private equity oil and gas production, exploration and infrastructure fund, structured as limited partnership ("FundCo"), with an experienced closely held oil and gas company, or a management team with similar experience, as its general partner or manager. FundCo typically focuses on development, and production plays and downstream infrastructure, and infrequently on exploration plays, but FundCo may have acquired an acreage position in the project area in connection with other acquisitions. FundCo typically has a set amount of capital (albeit potentially very large) to invest over a few years and will typically require some form of exit at the end of its investment cycle. Its investment and approval process may be more cumbersome for risky exploratory drilling than the other participants, other than a sovereign MineralCo.
5. MineralCo
An Indian tribe, a tribal oil and gas exploration company or other mineral owner (or the government or other sovereign entity in an international exploration project) ("MineralCo") that owns significant mineral interests in the prospect area and that may desire to participate in exploration and development instead of just leasing its minerals. Although many tribal exploration entities have very significant capital available, this paper assumes that MineralCo has significant illiquid assets and will have limited capital that it is willing to risk on the exploration prospect.
C. Fundamental Tensions
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