Farmout Agreement Depending on terms of agreement, farmee that complies with drilling obligation also may be: 1. entitled to an interest in additional acreage or 2. entitled to earn an interest in additional acreage by drilling on those acres
Farmout Agreement Farmor reserves overriding royalty , which is convertible to working interest if well pays out * Farmor can “back-in ” to working interest
WIIFM? Farmor : 1. Maintains lease by securing production 2. Obtains expense-free interest in production 3. Acquires geological information 4. Complies with implied covenants (e.g., drilling protects against drainage)
WIIFM? Farmee : 1. Acquires acreage a. not otherwise available and/or b. at lower cost than otherwise possible 2. Keeps workers & equipment employed
Effects of Farmout Spread costs and risks of drilling Share ownership of developed property if farmee complies with terms of agreement
Duty Imposed on Farmee Drilling: * A condition to earn acreage? If so, no liability for failing to drill (farmee does not earn ownership interest in land) or * A covenant (promise)? If so, farmee liable for failing to drill (farmor’s breach of contract claim)
Damages for Breach of Contract Farmor receives: 1. Difference between value of benefit promised and value of benefit received and 2. Cost of drilling well
What Do You Think? Landowner, in leasing acreage subsequently covered by farmout agreement, had reserved 3/16ths royalty Lessee, Reata Oil Co., assigned entire lease to Sabine Exploration Co., and reserved 1/16th overriding royalty Sabine entered into farmout agreement with Uvalde Drilling Co., and reserved overriding royalty of 1/16th of production until payout, at which time Sabine entitled to 50% working interest
What Do You Think? Farmout Agreement: “This agreement is subject to all existing lease burdens, overrides, and payments out of production relating to acreage covered by this Agreement, which obligations you (farmee) agree to assume”
What Do You Think? What proportion of production is Uvalde entitled to before payout ? What proportions of production are Sabine and Uvalde each entitled to after payout ?
Operating Agreements Drilling and development are expensive * Shale plays * Secondary recovery techniques Joint operations * Risks and costs shared
Operating Agreements Contracts among working interest owners * Joint operations - Define rights and responsibilities - Address initial drilling, additional development, operations, and accounting procedures
Key Provisions 1. Appointment of Operator a. Authority b. Liability 2. Initial Drilling a. Operating Decisions b. Costs 3. Additional Development
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