An Overview of Participation Agreements, Exploration Agreements, and Development Agreements.
Every petroleum landman should be familiar with the different types of Participation
Agreements. Frequently companies desiring to pursue an opportunity with other companies do not want to incur liability for the others' obligations. Rather than forming a Joint Venture, industry participants enter contracts to govern the Joint Exploration and Development. However, does one size fit all?
Participation Agreements
The agreements are known as Exploration Agreements, Development Agreements, Joint Development Agreements, or Participation Agreements - here, we will refer to such agreements as Participation Agreements.
There is certainly no one form of Participation Agreement. Participation Agreements range in length from two-page letter agreements addressing one commitment well to sixty-plus page documents with numerous exhibits that cover thousands of acres of land. The simplicity or complexity of a Participation Agreement results from the size of the area to be covered by the Agreement and the business deal struck by the parties. In a typical Participation Agreement, the parties pursue an opportunity as Co-Participants.
A Participation Agreement almost always specifies that neither party has any fiduciary obligation to the other and that the parties specifically disclaim any joint liability or the creation of a Partnership or Joint Venture. Identifying the Exploration Area is a key issue. One of the fundamental business issues to be decided by companies entering into a Participation Agreement is what area of land will be covered by the Participation Agreement (herein called the “Exploration Area”).
Geological Exploration Areas
Defining the Geological Exploration Area is another key issue. The parties may want to jointly explore and develop a particular geological structure (a “zone”). For example, in South Texas, the industry has spent years developing the Austin Chalk Formation that is directly above the Eagle Ford Shale.
Now, development of the Eagle Ford formation, particularly with its “rich gas” that allows
producers to capture the value of liquids, is an attractive objective. To exploit this rich formation, parties are, therefore, entering into Participation Agreements that define the exploration area by the depths covered up by the Eagle Ford Shale Formation.
In describing an Exploration Area by geological structure, the structure needs to be described with some particularity, preferably using parameters established by a Geologist. A simple reference to the formation, such as the “Eagle Ford Shale Formation” is not sufficient. A formation may have different names in the same area.
Similar names may describe different formations. To adequately describe a formation, it must be identified and located, and its name must be clearly discernible. Parties often use the term “stratigraphic equivalent” of a formation as depth to be drilled. Defining a Geological Prospect Area by reference to a “stratigraphic equivalent” may pose issues.
Stratigraphic Equivalents
Professor John S. Lowe writes that “Reasonable geologists may disagree as to whether particular formations or zones are stratigraphic equivalents, and even articulate geologists may have difficulty explaining its applications to judges and jurors in terms that they can understand.” Further, the terms have three different meanings, time-stratigraphic (rocks formed during a specific time) bio stratigraphic (rocks that contain similar fossils), and rock-stratigraphic equivalents (mappable rock layers with distinctive top and bottom boundaries).
Lowe states that another potential issue is that “a stratigraphic equivalent may not exist.” John S. Lowe, Analyzing Oil and Gas Farmout Agreements, Vol. 41 SW. L. J. 759, 825- 26 (1987). The depths of the formation should be given, and it is preferable to include a reference to an existing well that has tested the intended formation. If a formation has been described in a publication by a state or federal geological surveyor, that description may be the best way to describe the formation.
An example of a definition for a Geologic Exploration Area would be: “Prospect” means the geological formation known as the Eagle Ford Shale Formation, as more particularly described by the zone between 10,340' and 10,590' measured depth on the Induction Electric Log of the H.R. Smith & Gulf Corporation, #1 George Sealy Estate, API #42-311-01237, underlying the Contiguous Geographic Area described in Exhibit A hereto.
What if a participant holds interests in a zone that is below or above the target zone? If the parties agree that each party will not be required to participate in all zones, the Participation Agreement needs to address how the parties will conduct operations so that they will not interfere with operations in the other zones. Participants need to consider whether assignments of varying zones will result in a violation of the maintenance of uniform interest provisions in the applicable Operating Agreement.
ExxonMobil Corp. v. Valence Operating Co.
In ExxonMobil Corp. v. Valence Operating Co., 174 S.W.3d 303 (Tex. App.--Houston [1st Dist.] 2005, pet denied), ExxonMobil assigned all its interest in an oil and gas lease, but only down to a certain depth. The Joint Operating Agreement required a party to assign either its (a) active interest in “all leases and equipment and production” or (b) an equal undivided interest in “all leases and equipment and production.”
The assignment by ExxonMobil did not expressly assign an interest in wells, equipment, or production. ExxonMobil argued that the absence of such assigning language caused the assignment to be in compliance with the maintenance of interest provision. The appellate court held that the plain language of the maintenance clause evidenced the interest of the parties not to partition the undivided interests in the leases, therefore, ExxonMobil breached the clause when it conveyed its interest in certain depths and retained its interest in all formations below those depths.
The issues to be addressed when parties are simultaneously developing different formations include the granting of reasonable access to the land for exploration and development and the use and allocation of costs of existing and new facilities that serve both formations. The drilling party should give the non-drilling party notice prior to the spud date. Parties often agree to share information if they obtain information about the zone the other party is developing.
To learn more about oil and gas contracts and agreements and the petroleum landman’s role, visit our website at www.InstituteOfEnergyManagement.com. View our course catalog and click on Advanced Oil and Gas Contracts.