CHAPTER 9 GAS BALANCING AGREEMENTS
| Jurisdiction | United States |
(May 1983)
GAS BALANCING AGREEMENTS
VINSON & ELKINS
Houston, Texas
I. INTRODUCTION
A contemporary Shakespeare should warn the Princes of the Oil Patch:
"Neither an over- nor an under-producer be for the difficulty of balancing oft looses both dollar and friend..."1
Preparation of this paper has convinced the writer of the wisdom of that fanciful warning and of the high probability that, if given, it would not be heeded.
The warning is wise, the writer believes, because, after substantial disproportionate production of gas, there are so many variables that it is unlikely that each producer can be put into the position it would have held if there had been no disproportionate production. One or more will not be satisfied.
The following discussion will touch on the reasons producers, even though they might wish to observe the warning, are not likely to do so voluntarily. A recent legislative proposal in Oklahoma and a similar regulatory proposal in Louisiana would, however, require the elimination of over and under production in some situations. If these proposals were adopted in all gas producing states and were successful, this paper would soon be out of date. These proposals will be mentioned further below.
Disproportionate production has not yet been eliminated and, therefore, this discussion of gas balancing agreements may be helpful. The writer is not aware of any articles on this subject only; however, several articles have included sections on gas balancing agreements.2
[Page 9-2]
A. Disproportionate Production
Disproportionate production results from (1) more than one party producing and selling gas from a well and (2) gas from one well being sold to more than one purchaser. Because of high exploration costs, high risk exploration, and a desire to spread the risk, most wells are drilled by multiple working interest owners. Each working interest owner usually retains, and, in fact, vigorously and jealously defends, the right to sell its gas. Each producer is eager to make the deal that is best for it and the wide differences in gas prices cause much shopping for sales contracts. If pipelines are not already constructed into the area, the capital cost of construction increases the probability that one purchaser will take all of the gas. If the pipelines are in place, however, the bidding can be wide-open and it is probable that there will be wells with multiple gas purchasers.
With the gas under contract to multiple purchasers, the production rate of each producer is dependent on its purchaser. It is seldom that multiple purchasers all make connections and are prepared to commence takes of gas at the same time. After production begins, it is frequent that purchasers are not able to take the full share of gas at all times during the life of the well.
SITUATION I-A-1
Producers A and B each own a 50% interest in the new Blackgold well. Producer A has contracted to sell its share of the gas to Ready Gas Company, which has completed its connection and is prepared to take gas. Producer B is still negotiating with Waiting Gas Company, which will require eight to ten months to complete its line and make a connection after a contract is signed. Production from the well commences and Producer A takes all of the gas produced and delivers it to Ready under its contract.
SITUATION I-A-2
Producers A, B, and C each own a 33-1/3% interest in the new Blackgold well. Producers A and C have contracted to sell their shares of the gas to Ready Gas Company. Producer B has contracted to sell its share of the gas to Waiting Gas Company. During the first two years of production A, B and C each sold 1/3 of the gas produced to its purchaser. At the start
[Page 9-3]
of the third year Waiting reduced by 50% its take of B's gas. During year three, B sold 1/6 of the gas produced from the Blackgold well to Waiting. During year three A and C each sold 5/12 of the gas produced to Ready.
These two Situations are typical in the industry. In each instance the producer, whose purchaser was ready to take, wanted to sell and did sell gas, while the other producer did not produce. They did not take and use or sell gas in proportion to their percentage ownership in the well. This disproportionate production made them over and under producers whether they wanted to be or not.
The nature of gas requires that all gas produced be sold into a pipeline, even if it is not sold in the same proportions that the producers had the right to take gas.3 The result is that gas production frequently is "out of balance" and producers often are "overproducers" or "underproducers" against their best wishes and better judgment. "Balance" and "in balance" are the conditions that are said to exist when each party entitled to receive a portion of the production has received its full portion of that production. If, for example, Party A is to receive 25% of the production and Party A has received 25% of the gas produced up to that time, Party A is "in balance". If Party A has received less than 25% of the gas produced up to that time, Party A is "out of balance" and is known as an "underproducer". If Party A has received more than 25% of the production, Party A is "out of balance" and is an "overproducer".
B. Balancing
Balancing is "the process by which persons having an interest in production from a well, unit or reservoir adjust their take therefrom to insure that each such person receives his proportionate part of production."4 A gas balancing agreement is an agreement between the parties entitled to share in the gas produced setting forth the steps by which balancing will be accomplished. A balancing agreement usually provides, first, for the overproduced parties to reduce their takes of gas and for the underproduced to increase takes until balance is regained and, second, if balance is not regained, for the overproduced parties to pay the underproduced parties for the excess gas taken. These agreements also are called
[Page 9-4]
storage agreements, banking agreements, underlifting agreements, out of balance production plans, deferred production programs and, probably, by other, less polite names.5
It has been suggested that gas exchanges between purchasers or lease exchanges between producers could be alternatives to gas balancing.6 This paper will not go into those proposals other than to say they are not widely used.
Even though balancing has been accomplished for many years, written agreements to balance were seldom prepared. Balancing seems to have been accomplished under informal agreements between the producers.
Judicially settled disputes over gas balancing have been few, but in 1975 the courts of Oklahoma showed a willingness to step into these usually gentlemanly disputes. In Beren v. Harper7 the court noted that the parties had entered into an operating agreement but had made no arrangement to balance production among themselves. Even though the court noted the custom was to settle imbalances in kind, it ordered the overproduced party to give the underproduced party an accounting and to achieve balance through cash payments.
The specter of judicial balancing if no agreement were made between the parties encouraged the use of gas balancing agreements.
C. APPL Emphasis
The 1977 revision of Model Form Operating Agreement by the American Association of Petroleum Landmen provided in Article VI.C, that:
"in the event one or more parties' separate disposition of its share of the gas causes split-stream deliveries to separate pipelines and/or deliveries which on a day-to-day basis for any reason are not exactly equal to a party's respective proportionate share of total gas sales to be allocated to it, the balancing or accounting between respective accounts of the parties shall be in accordance with any Gas Balancing Agreement between the parties hereto whether such Agreement is attached as Exhibit "E" or as a separate Agreement".8
[Page 9-5]
The AAPL's decision to attach a gas balancing agreement as Exhibit "E" to its standard form operating agreement recognized the need for agreements under which balancing might be accomplished and emphasized that need to the oil and gas industry.
D. Dollar Burden of Balancing
The rapid increase in the price of gas during the 1970s also increased the dollar impact of disproportionate production and balancing. As the dollar burden of balancing increased, more attention was given to the methods of balancing. The verbal or very simple written gas balancing agreements that were used in the industry have since become comprehensive and complex. Most producers now have recognized and/or experienced the dollar impact that may result from gas balancing and they have focused much attention and effort on the preparation of the gas balancing agreements. Another noteworthy element of the Beren v. Harper case is the difficulty of reaching an agreement after an imbalance has occurred.9 Even though agreement on balancing is extremely difficult to develop prior to the drilling of a well, it is nearly impossible to develop after an imbalance exists.
E. Scope of This Paper
We, negotiators and draftsmen, often get caught up in a contest of wits, trying to provide clients an advantage in every probable and improbable situation. We may have gone too far. Currently, there seems to be a reaction against gas balancing agreements. The issues are so many and the proposed solutions so complex that some producers are taking the position that preparation of a gas balancing agreement is more trouble than it is worth.
During the writer's discussions of this proposed paper, several experienced and competent oil and gas lawyers expressed dismay and evidenced confusion over the provisions of these agreements. It was stated that both majors and independents have proceeded without a gas balancing agreement rather than adopt an agreement...
To continue reading
Request your trial