Transcript About Jim Strawn

Lower Prices, Longer Laterals and
Modern Lease Clauses
Wednesday, July 25, 2012
Presented by:
Jim Strawn
Burleson LLP
724-743-3095
[email protected]
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Mr. Strawn is Of Counsel to Burleson's Pittsburgh office.
He has over 30 years of experience as an oil and gas
attorney focusing on all areas of law relevant to the oil
exploration and production business. His practice
includes mergers, acquisitions, divestitures, marketing
and midstream services, drilling, access and leasing, title,
royalty and division of interest issues, joint operations and
master service agreements. Prior to joining Burleson, Mr.
Strawn served as in-house counsel to several oil and gas
companies including Conoco Inc., Pennzoil Company,
Devon Energy and most recently Windsor Energy, an
Oklahoma City-based E&P investment company.
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Covenants
Conditions
(promises, money damages)
(rules, consequences)
Express
Royalty Payment
Shut-in Payment
Express
Production in Paying Quantities
Shut-in Payment
Implied
Protect from Drainage
Market Production
Further Develop
Further Explore
Implied
None
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Implied Covenants established 1889 PA Stoddard v. Emery
Implied Covenants – counters the tendency to hold property for
speculation
• Protect from Drainage
• Further Develop – commercial sources discovered should be
fully developed
• Further Explore – once commercial sources discovered, should
the lessee explore for others? Where does it end?
• Market Production
1. Oil is Easy – delivered in kind into tanks or pipeline, little post
production cost
2. Gas is Problematic – volatile, odorless, invisible, dangerous,
requires significant post production attention
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 Separation, treating, processing, transportation, cracking, marketing
 Significant cost to make marketable, increase value of components
Performance Standard established 1905 PA Brewster v. Layton
Zinc
• “the prudent operator under the same or similar circumstances”
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Does the covenant require the lessee to maximize the
marketability of the gas, free of cost to the lessor?
 “At the Well”
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(States: TX, LA, CA, NM, MI, MS, PA)
“to obtain the best and highest prices reasonably available”
 “Marketable Product”
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(States: CO, OK, WV, KS)
“to place production into a marketable condition”
 Can be overridden by Express Covenants….BUT
 Express Covenants can be overridden by Legislation
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 Implied Covenants (circa 1889) and the accompanying
prudent operator standard are Replaced with Express
Covenants or Express Conditions
• The subjective prudent operator standard factored in
changing circumstances.
• Express covenants use objective measures.
• Good: Objective, offers certainty, “win-win” if crafted to match
the circumstances
• Bad: Loses benefits of case law, becomes a “lose-lose” if
circumstances change
• Ask yourself: Do circumstances often change in the oil
and gas business?
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Drainage Covenant: New forms express as requirement
to offset if draining well is within pre-agreed distance
• Doesn’t change to reflect changed circumstances (technology,
geology)
• Doesn’t incorporate profitability considerations
 Marketing Covenant: New forms address value, cost
sharing and use of affiliates
• Doesn’t appreciate the value of using affiliates under certain
circumstances
 Primary Example: The Express Development Condition
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 OLD:
The Implied Development Covenant
• Commercial sources discovered should be developed in the
manner of a prudent operator under the same or similar
circumstances.
 NEW:
The Express Development Condition (The
Continuous Development Obligation (“CDO”))
• Once drilling starts, cessation of drilling for a given period of
time causes tracts and depths to be forfeited if:
1. They are undrilled, or
2. They are drilled but not producing in paying quantities
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 “Small” oil fields holding deep rights in large South Texas
Leases
• Sun v. Jackson, failed to establish implied covenant to further
explore (keep drilling)
 California forms historically similar due to land use
regulations and high surface value, more valuable
surface uses
 Some form of implied covenant of further exploration
may apply in CO, AR, KS, KY, PA and LA
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Loss of all acreage and zones except pro-ration units
surrounding each producing well
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Each retained tract treated as a separate, isolated lease
Only implied covenant to survive is the covenant to market
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Shallow zones behind pipe are retained
Producing zones are retained
Development covenant usurped by pre-defined retained unit size
Drainage covenant usurped by pre-defined area “to be drained or
fully developed by one well”
1. Change in condition or knowledge of condition (geo or tech) could
activate?
Loss of attendant surface rights on forfeited acreage
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Condition = “commencement”
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Definition? Dirt work, drilling, on-lease, off lease?
Condition = “completion”
•
Definition? Rig release (drilling rig vs. completion rig?) Perforation,
Capable of Flowing (shale problem). Fracking, Frac Resting, Toe
Fracking? Good Faith?
Longer laterals
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Involves increased proration unit size
Shut-in Clauses
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Check definition – condition or covenant?
1.
2.
3.
Capable of producing, completed? Unperforated? Unfracked? Resting?
Timing – what is the shut-in period and when does it start?
Oil or gas?
Drilling vertical wells
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Shallower, less expensive
Check definition of “drilling a well”
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Negotiate Extensions, Ratifications, or Larger Retained Units
(Beware Top Lease)
Farmout or Sell Down
Change Government Spacing – may increase retained unit size
under lease definition
Pool – check lease authorization, may require lessor approval
Create Production Sharing Arrangements (Cooperative Units) –
combines units
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First arose in East Texas Haynesville shale horizontals through older
shallower units pooled “for all depths” and vertical Haynesville units
Rule 86
Requires percentage of mineral owners to have signed the PSA
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May require lessor approval of PSA
Without 100% approval, allocation must be done on the basis of
actual production from each unit
If more than one lease, may require a new JOA to match the new
contract area
Tax consequences need to be managed
•
Depletion, depreciation, RR 77-176
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Pooling of capital
Allowable issues need to be managed
Additional surface rights may need to be acquired
Where is the well located for purposes of protection from drainage?
New unit is being drained by the old well?
Plugging old well could avoid the overlap and attendant issues
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Overlapping JOA Issues:
Insurance
Non-consent penalties
Joint vs. individual loss
Rights to well data
Balancing and marketing
Access to property
Operators title duty
Election deadlines
Shut-in notices
Spending limitations
Excess burdens sharing
Litigation & settlement
Obligation wells
Lease maintenance
payments
COPAS
Who will operate?
Voting
Which rigs, supplies and
pipe?
Marketing dedications
Farmout performance
AMI’s, pref. rights
Facilities
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 Forfeited tracts might still be pooled
• Where an authorized pooling describes pooling of “lands” or
“leased interests,” rather than “leasehold interests,” the
released tracts might still be subject to the prior pooling, even
though the lease has expired (whether in whole or in part).
1. The now unleased mineral interest owner’s interest remains
pooled, with an interest roughly equivalent to that of an unleased
cotenant.
2. The mineral owner becomes a working interest owner and is
liable for its share of cost of improvements, including prior drilling
costs if equity considerations require it.
• A new lessee of the unleased tract is also be subject to the
prior pooling, unless it could successfully prove to be a BFP.
• The mineral owner or its new lessee might also be subject to
the prior lessee’s JOA if it was part and parcel of the pooling.
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 Forfeited tracts, if unpooled, might not be drillable
• Lost tracts may not be drillable
1.
2.
3.
4.
5.
Need minimum number of acres to get full allowable
Need separate (new) infrastructure and facilities
Need capacity on existing downstream pipe, trucking
Need additional surface area
Need additional surface rights (to cross original lessee’s retained
tracts)
6. Immediate drainage question for new lessee
7. Previous completion may have drained lost acreage (frack
distance)
• Released tracts may be intersected by producing wellbores,
and vice versa
1. Trespass issues – incidental vs. bad faith, carry vs. no carry
2. Confusion of goods – burden of proof on producer
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 Marketing Consequences
• Acreage Dedications and Volume Commitments (Legal
Obligations)
1. Could result in breach of contract
2. Loss of transportation or processing could cause breach of sales
contracts
• Aggregation (marketing power)
• Capacity – pipe may be limited, trucking may be limited
 JOA Consequences
• Joint vs. individual loss
• Operator’s duty to prevent forfeiture (commonly is no duty)
• Sharing of replacement leases
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 Tax Consequences
• Depreciation and depletion
• Let low cost acreage go first?
 Land and Financial Consequences
• Impact on covenants under Volumetric Production Payment
agreements
• Impact on Joint Development and Joint Venture Agreements
• Impact on loan covenants
 Procurement
• Pre-buys (pipe, fuel)
• Service contracts (rigs, other services)
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Lessor needs terms that promote development of forfeited
tracts
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Would like clarification in lease that pooling is of lands, not leasehold
interests (or vice versa).
Would like the automatic termination of undrilled acreage to be at
lessor’s option after notice from lessee upon cessation of the CDO.
Would like benefit/use of original lessee’s facilities, processing and
marketing deals
1. Include rights and obligations in original lease?
 Right to use facilities at cost plus a %? OR
 Obligation of lessee to continue to take production
o
Negotiate detailed terms as exhibit to lease
2. May still require pass-through rights under original lessee’s
tracts and surface (road and pipe) to benefit forfeited tracts
 Include in original surface use agreement, requires coordination with
original lessee
3. Require contiguous development of tracts (no checkerboards) so
that forfeited tracts are not surrounded and drained
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Lessee needs to minimize interference with its surface use
and productivity of retained wells
And maximize use of facilities and marketing arrangements
Lessee should seek1. Clarification in lease that pooling is of leasehold interests, not
lands (or vice versa)
2. ROFR on forfeited tracts
 ROFR’s addressing top-leases need to be expanded
3. A call on production on forfeited tracts
 Allows lessee to maintain volume dedications under processing,
gathering, transportation and sales arrangements
4. Clarification that there are no implied drainage of development
covenants on retained tracts
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Lessee should seek- (continued)
5.
Rights to use of surface and subsurface under forfeited tracts
 Ideally included in Surface Use Agreement negotiated at time
of initial lease
 Surface Damages Acts do not address (only there to protect
servient estate)
 SDA’s in the West
o Compensatory Acts: NM, WY, OK, ND, MT, SD
o Good Faith Negotiation: CO
 Include clarification that right to grant surface easements and
pass through rights to benefit forfeited acreage is included
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
Perhaps the best example of a lack of flexibility wrought by
the new lease clauses is the inescapable obligation to drill
marginally commercial wells to avoid forfeiture of prospective
acreage under producing leases, and the unanticipated lack
of development value of these forfeited tracts.
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Drilling Marginal Wells
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Contributes to high cost of supplies and services
Contributes to increase in gas supply glut
Using Longer Laterals
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Symptom of need to hold more acreage with less drilling
Flaring gas
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Symptom if overdrilling (lack of infrastructure)
Orphaned Acreage
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Forfeited tracts often prospective, but not practical to develop. Exacerbated
by public companies’ need to book reserves, spread out drilling windows
rather than contiguous development
Curtailing, Shutting in Production
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Consequence of other symptoms, industry drilling marginal wells, straining
infrastructure, flaring gas, straining services
Unpooling, repooling and production sharing agreements
Multiplying infrastructure
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Forfeited tracts require independent infrastructure
Revisiting the lessor and surface owner
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Know your play
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Land acquisition plan – landmen need to know all six up front, before
crafting lease clause and instructing brokers as to what terms are
acceptable.
Development plan – what is the plan and how will it be carried out?
1. Contiguous development, simultaneous fracs, checkerboard?
2. Timing, drilling schedule, spacing, crews
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Marketing plan – Take away, infrastructure, facilities, limitations (flaring)
Administrative plan – staffing and outsourcing
Procurement plan – rigs, services, sand, water, pipe, crews, habitation
Financing plan – operations, joint development, funding, timing
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Craft your lease to match your play
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Know your lease
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Questions?
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