The Different Phases of Due Diligence

Due Diligence

Written by David Melton

What is the Petroleum Landman's role?

Every petroleum landman should be familiar with the term ‘Due Diligence’ as it refers to the oil and gas industry and its role in performing it. Due Diligence covers a very broad set of research skills, some of which require specialized degreed training in that aspect of the research. Others do not such as, petroleum landmen reviewing the Seller’s property and lease files to determine which leases are valid or HBP as to what depth, determine if there any Joint Operating Agreement issues, reviewing courthouse filings to verify leasehold, mineral owner and surface owner title reports, and oil and gas commission research.

Due Diligence Review

A well organized and executed Due Diligence Review is a key component to a successful acquisition of oil and gas properties, particularly producing oil and gas properties.

  • It will determine whether there are any factors, such as loss of title, pending litigation, environmental problems, obligations, and liabilities which would have a material adverse impact on the assets that a Buyer, Investor, or Lender should know about.
  • It also serves to verify the basic business; economic and operational assumptions a Buyer has made to determine the value the assets will have to the Buyer and the purchase price a Buyer is willing to pay for those assets.
  • The basic structure of the Due Diligence Review will be determined by the nature of the transaction, the provisions of the Purchase and Sale Agreement, if there is one, and the issues that arise as the Due Diligence Process progresses.
  • Due Diligence is an organic process, and its course and scope can change as more information about the properties under review becomes available.

These factors will play a role in how smoothly the process will go, how long it will take, and how much it will cost.


An effective Due Diligence Review cannot be accomplished by simply pulling out copies of old Due Diligence Checklists and forms and distributing them to the Due Diligence Team. Although that may be a good place to start, an effective Due Diligence Review will include custom made,continually changing checklists designed specifically for the transaction. They will address the relevant issues unique to that transaction, such as the following examples.


• There should be a clear allocation of responsibilities among the participants.

• There should be a clear outline as to how to handle defects and the timing to correct

them.

• This allocation should be in writing.

• This written allocation of responsibilities will help reduce duplicative efforts.

• Review procedures and responsibilities regularly and modify as appropriate.

• The Due Diligence process is not static, and success will go to those who are able to

adapt to changing circumstances most efficiently.

• Establish written procedures for sharing information.

• It will not happen automatically.

• Gather information on the results of Due Diligence in a uniform format, which is easy

to read and understand.

• Team leaders must work closely together at all stages.

• Relevant issues must be shared.

• Oftentimes issues material to one team are discovered by the inquiries by the other

teams.

• Communicate significant issues immediately as they may have an impact on the

negotiations and may cause the transaction to be restructured or terminated.

• Follow good Due Diligence etiquette with Seller’s personnel.

• You will gain more information and quicker access to information if you are friendly

and cooperative.

• Due Diligence personnel are charged to gather information and should not usually be

adversarial.


A successful Due Diligence Review must also include the right people, the right goals and objectives, and the right processes to achieve those goals and objectives. These elements require a sophisticated knowledge of the principles and fundamentals of Due Diligence.

Conducting the Due Diligence Review is usually a daunting task and there must be a well thought out plan to assemble, report and evaluate all the issues that are significant for a successful transaction.


Client's Objective

One thing to consider when performing Due Diligence is your client’s objective.

  • An example of this is a Buyer is looking to purchase a company’s ARTI in their HBP leasehold, associated equipment and production for the purpose of re-entering a well capable of producing for the purpose of placing a short-radius horizontal leg out of the casing.

There are steps the Buyer can take to make the decision of moving forward with the

purchase which had nothing do with the normal Due Diligence process.

• The Buyer and Seller entered into a Preliminary Agreement whereby the Buyer

could run tests on the well before committing to purchasing the interest, such as a

‘casing integrity test’ and running a new cement bond log.

• The Agreement could have provisions that in the event the well was not to the

Buyer’s satisfaction, there would be no commitment on behalf of the Buyer to

move forward.

• The Agreement could state that in the event the initial test procedures where

satisfactory, the Buyer had the right to get everyone’s signature who was on the

Exhibit “A” of the JOA to allow them to drill this infield horizontal recompletion

and to have them sign off on all the provisions addressing these procedures in the

JOA.

• Once all initial testing and all parties had signed off on the proposed operations,

the Buyer would enter into a Purchase and Sale Agreement.


There is never enough time or enough people to accomplish a perfect Due Diligence Review. Success is measured by how well the Due Diligence Plan is and the team’s adaptability as to changing requirements and how well resources are allocated to accomplish as many of the goals and objectives as possible, within the time allotted.

The Due Diligence Process can cover a wide range of operational issues which the petroleum landman can be involved, such as some of the examples shown below:

JOA issues

  • Current Non-consent elections and the payment status/conversion status.
  • Preferential Right to Purchase.
  • Gas Balancing – pay schedules with conversions.
  • Title to the Contract Area and Title Failures.
  • AMI Agreements.

Oil and Gas Accounting Issues

  • Oil in the tanks at the time of sale.
  • Verification of the Stated Working Interest and Net Revenue Interest.
  • Verification of paid or outstanding Delay Rentals or Shut-in Royalties.
  • Production Royalties.
  • NPRI royalty payments.

Operational Issues

  • State and Federal Compliance.
  • Oil spills.
  • Injection well pressure testing.
  • Right of way permits.
  • Oil and Gas Purchase and Sale Agreements.
  • Gas Gathering Agreements.
  • Farmout Terms/Compliance.
  • Term Assignment Compliance.
  • Equipment Status.

Oil and Gas Lease Issues

  • Lease Terms (fee, federal, state and Indian Lands).
  • Lines, judgements, mortgages, any other encumbrances.
  • Title Issues.
  • Title Verification.

To learn more about the petroleum landman’s role in participating in the many different aspectsof performing Due Diligence, you should take the Institute of Energy Management’s Due Diligence Essential course. Enroll today at www.InstituteOfEnergyManagement.com and take advantage of our current discounts and special provisions.

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