Oil Industry Custom and the Model Form JOA: A Debate

Originally published by Charles Sartain.

Posted by Charles Sartain

We begin with an existential question:

“The philosophy behind all of the model form agreements is that aggressive drilling under the JOA should be promoted and rewarded.

Agree or disagree?

That was an issue in Talisman Energy v. Matrix Petroleum.  It was not resolved, but the decision is worth your attention because the court enjoined the operator from drilling and proposing wells pending trial on the merits.

The parties were drilling wells in LaSalle County, Texas, under a 1954 Model Form JOA. Section 15 (which the court refers to as Section ”16”; see V.D of the later forms) allows the operator to use its own equipment and tools only on a competitive basis, if it does not exceed prevailing rates, and after an agreement in writing with the non-operators. Evidence was presented that Talisman was exceeding the prevailing market rate and was not confirming the arrangement with Matrix prior to operations.

A procedural hurdle

Procedural wrangling prevented the court from answering our existential question. Talisman’s expert landman, and the source of the statement, was going to show certain customs and usages in the model form and how it is intended to work.

An expert can testify about, for example, the common understanding of “commencement of operations”. But the court viewed the testimony as being offered not to explain the meaning of an industry term, but rather to aid the trial court in construing sections 5 and 8 of the agreement.  A court doesn’t need an expert to help it construe an agreement. That’s what the judge is for. The testimony was not considered.

What about irreparable harm?

Lawyers: The decision discusses why there was irreparable injury and why it didn’t matter that Matrix wasn’t seeking a permanent injunction.

INTERMISSION

We’re usually done by now. Appropriate for an old-timey but still-breathing JOA are old-timey but timeless tunes. Today we have one with roots from 1860, and one originating in 1720 (you can look it up!).

If you elect to participate in a subsequent operation, you may now …

Consider the existential question

I conducted a random and unscientific survey of industry professionals (to-wit, people with whom I have lunch and drink whiskey, often not at the same time). The result: Some agreed with the statement, most did not.

These alternative “philosophies” behind the model form were presented:

• The JOA is an “outline for honorable men to follow in the development of oil and gas properties.”
• The purpose … or the “philosophy”, is to control the Operator to a certain extent and to ensure that WI owners understand and agree to costs and when and how payments are to be made.
• The efficient utilization and maximization of leasehold opportunities, along with effective production management should be the goal. Profit maximization and reasonable adherence to the prudent operator’s implied covenant to develop should govern the drilling philosophy.
• One of the reasons … [is] … to protect minority owners, to keep the major participants from expensing them out of the Agreement by not orderly and timely proposing drilling, completing and evaluating opportunities and risks … .
• The goal is to have prudent operations in all respects – financial, engineering, geologic, etc.
• The reason … is to provide those who elect to participate in the drilling of wells necessary to efficiently drain the reservoir with a proper return for assuming the risk and burden of those partners who elect not to participate.
• If they choose to do so, the parties can negotiate terms that clearly provide for an active drilling program as their primary objective.
• If you wanted “aggressive development” the non-consent penalty would be [more than] 300%.  Or there would be no non-consent … .  If the drafters truly wanted to reward “aggressive drilling”, the non-consent would have never been proposed.
• In contrast to a JOA, it could be argued that “aggressive drilling be promoted and rewarded” is the intent of an Oklahoma Forced Pooling Order [and that] such an Order is designed to punish anyone who does not aggressively drill or expend capital … by taking away subsequent interests.

But I also heard from who agree (including the expert, who stands by his opinion):

• The generation that came up in the 1950’s, ‘60’s and ‘70’s, plus committee members of the AAPL JOA task force who worked on the 1989 Model Form, asserted their “philosophy” that aggressive drilling is to be promoted and rewarded. That philosophy prevailed. Hence, the non-consent option.
• Article VI (Drilling & Development) sets forth the conditions for which one party can take on the risk of drilling with or without the participation of all parties. Oklahoma’s forced pooling statute revolves around the JOA. (A contrary view of Oklahoma forced pooling?)
• The pro-development bias is explained by the fact that any party, no matter how small its interest, can propose a well and force all other parties to either join or go non-consent, subject to the penalty.
• The alternative is to either 1) carry the non- consenting party  under common law co-tenancy (in which case there is no “penalty”; only recovery of costs), or  2) vote on operations, as with international, offshore, and onshore field wide unitization/secondary recovery.
• Unlike international or offshore arrangements, in the model forms there are no provisions for voting mechanisms, project teams, committees, and forced collaboration prior to a drilling proposal. Any party can move forward by AFE’ing the others and allowing them to invoke the non-consent penalty.  That reflects the aggressive drilling philosophy.
• The form certainly doesn’t discourage aggressive drilling. That is reflected in the non-consent option.

Why the discord? 

It’s no surprise. The “disagreers” tend to be smaller operators and non-ops (my eating buddies). The “agreers” tend to be larger, with bigger budgets.  The “small guys” tend to want to rein in the “big guys” and make them go about development in an orderly fashion with maximum collaboration. The big guys tend to favor agreements that allow them drill away; said less charitably, to force operations on the others at-will.

Who says the oil business is monolithic?

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