Setting the Scene[1]
There are more than twenty bilateral unitization Treaties and Joint Development Agreements (JDAs) in place today between governments that share an international (usually maritime) boundary. These unitization Treaties and JDAs[2] create the framework for the development of an oil or gas reservoir that straddles the boundary of the two countries that are party to the Treaty (or JDA) – i.e. the cross-border unitization. A number of unitization agreements have been entered into pursuant to these Treaties and JDAs, including agreements for the Frigg field and the Stratjford field which straddle the boundary between Norway and the UK in the North Sea, and the Bayu-Undan field located within the Joint Petroleum Development Area established by the Governments of Australia and Indonesia in the Timor Sea.
In this article we consider some of the issues that are typically addressed in a unitization and unit operating agreement (UUOA) that may require particular attention in the context of a cross-border unitization.
What is Unitization and Cross Border-Unitization?
An oil or gas reservoir may straddle adjacent contract areas. Unitization is the process whereby the straddling reservoir is jointly developed by the interest owners in the adjacent contract groups. Joint development of a straddling reservoir is usually more economical and efficient than separate developments by the adjacent contract groups. A key principle of unitization is that the straddling reservoir is physically developed as though the boundary between the contract areas does not exist.
In most cases the unitized adjacent contract areas are located within a single country, and the parties to the UUOA must conduct the unitization process in accordance with the applicable laws of that country. There are, however, a number of examples where the reservoir straddles the agreed international boundary between two countries or is located within an agreed joint development area (where the boundary is not agreed), and in these scenarios the two host countries are likely to have different legal regimes for unitization. Bilateral unitization Treaties or JDAs between governments that have an agreed boundary, or in the absence of an agreed boundary have agreed a specific joint development area, overcome the problem of different legal regimes by creating a common framework for the cross-border unitization. However, notwithstanding the common framework, additional complexities arise where the unitization relates to a reservoir that is located across two countries.
There is a significant body of commentary on the application of international laws, such as the United Nations Convention on the Law of the Sea (UNCLOS), to reservoirs that straddle an international boundary and the rights and obligations of the host governments derived from international law.[3] This Article focuses, instead, on specific issues that may arise during the negotiation of a UUOA that may require particular attention, or special treatment, in a cross-border unitization context.
A range of factors has contributed to a steady increase in the number of unitizations across the world over the last three decades. The end of monopolies by national oil companies (NOCs) in many countries has led to more companies being given rights to conduct exploration and production activities in respect of defined contract areas in those countries. Exploration blocks offered by host governments have become smaller, in part due to relinquishments from prior awarded areas, which increases the likelihood of a reservoir straddling more than one contract area. Further, as host governments have become more sophisticated about global best practices they have promulgated laws that require developers to unitize straddling reservoirs. Concurrently, technical advances have led to earlier identification of a straddling reservoir.
The Unitization and Unit Operating Agreement – UUOA
The unitization agreement between the parties in the groups who hold the adjacent petroleum exploration and development contracts sets out the terms on which the straddling reservoir will be jointly developed. This typically results in a unit whereby all resources and facilities are jointly owned and each group’s share of production and costs is based on its proportionate share, regardless of the location of facilities. In some circumstances the parties will enter into separate agreements in respect of (i) the formation of the unit, and the allocation of unit costs and production between the contract groups; and (ii) the operation of the unit reservoir. However, it is more common for the commercial and operational provisions to be combined in a single agreement – a unitization and unit operating agreement – the UUOA. The UUOA creates an unincorporated joint venture among the groups and their participants.
The petroleum laws of most host countries require the parties to the UUOA to submit the UUOA to the host government for approval, and effectiveness of the UUOA is conditional on receiving that approval. In the case of a cross-border unitization the UUOA must be approved by both governments. UUOAs are private contracts between the interest owners, and even though they are usually subject to host government approval, they are not in the public domain.[4]
There is a significant volume of commentary available on the key terms of the UUOA – notably (i) creation of the unit; (ii) determination of Tract Participations; (iii) redetermination of Tract Participations; (iv) unit operating committee procedures and voting; and (v) non-unit operations. This article focuses on those provisions in a UUOA that may require attention in the case of a cross-border unitization, some of which (such as withdrawal and revocation of a contract) are not considered to be key commercial provisions and are therefore vulnerable to being overlooked.
AIPN Model Unit Agreement
In 2006 the Association of International Petroleum Negotiators (AIPN) produced a model form Unitization and Unit Operating Agreement (AIPN Model Unit Agreement).[5] The AIPN Model Unit Agreement is intended to apply to unitizations broadly, and the supporting guidance notes specifically state that the AIPN Model Unit Agreement is of single country application and is not jurisdiction specific.[6]
The AIPN Model Unit Agreement provides alternative provisions for many of the issues to be addressed in the UUOA,[7] which permit the parties to choose the provision that best meets their objectives. In addition, the AIPN Model Unit Agreement contains a number of optional provisions which the parties can adopt if they agree that it is appropriate to do so. These alternative and optional provisions provide the parties with a degree of flexibility when negotiating a UUOA based on the AIPN Model Unit Agreement.
One Size Fits All?
There is no such thing as a “one-size-fits-all” UUOA due to inherent differences in (i) the characteristics of a particular straddling reservoir (e.g. oil or gas, large or small or different reservoir properties on either side of the boundary); (ii) the country in which the straddling reservoir is located (or countries in the case of a cross-border unitization); and (iii) the context in which the straddling reservoir is being developed (e.g. for LNG export in the case of the Bayu-Undan cross-border unit). Whilst the AIPN Model Unit Agreement is extremely useful and relevant as the basis for the negotiation of a UUOA, it is quite often the case that the parties will have to amend, supplement, discard or substitute certain provisions of the AIPN Model Unit Agreement in order to achieve their commercial and/or legal objectives.
Specific Issues for Cross-Border Unitizations
1. Redetermination
The UUOA sets out the unit equity interest of each group (typically described as the “Tract Participations”) based on an agreed basis for determination (e.g. hydrocarbons initially in place). The initial Tract Participations are determined after appraisal of the straddling hydrocarbon reservoir, but prior to its development, and are therefore an estimate based on the parties’ understanding of the unit reservoir at the time the parties enter into the UUOA.
Redetermination is the process whereby the Tract Participations are revised following the occurrence of one of the redetermination triggers set out in the UUOA. The most common triggers are (i) additional new data becoming available which indicates that the Tract Participations may not be “fair and equitable”; (ii) a specified anniversary after commencement of production of unit substances; and (iii) production of unit substances reaching a defined volume (or percentage of ultimate recovery of unit substances). Many UUOAs also adopt the AIPN Model Unit Agreement concept of an automatic redetermination if the “Unit Area” is enlarged.
Redeterminations are generally considered to be a major issue for parties to the UUOA. Whilst the concept of redetermination in itself is a simple one, the process tends to be contentious, time-consuming and costly. This is particularly so in cases where the redetermination is referred to an independent expert because the parties are unable to agree to the revised Tract Participations amongst themselves.
Due to the contentious, time-consuming and costly nature of redeterminations, there are examples of units (especially economically marginal units) where the Tract Participations are fixed for the full term of the UUOA. The UUOA for the Peik Field, which straddles the UK and Norway, for example, provides that the Tract Participations will not be adjusted or amended unless unanimously agreed by the parties, thereby removing the ability of one Group to call for a redetermination.
Where a unit area is entirely within a country (such as the Jubilee field in Ghana) the host government may not be concerned about the redetermination provisions in the UUOA because it may not be directly impacted economically by the redetermination. For example, if the initial Tract Participations are fifty percent (50%) for group A and fifty percent (50%) for group B, and a redetermination resulted in group A having a Tract Participation of forty five percent (45%) and group B having a Tract Participation of fifty five percent (55%), the government would not be affected economically by a change to the Tract Participations (assuming the government’s share of profit gas is the same under the Group A and B contracts). Although the share of profit gas allocated to the government under the Group A contract would be reduced, the share of profit gas allocated to the government under the Group B contract would increase proportionally - so the net allocation of profit gas allocated to the government remains unchanged.
On the other hand, in a cross-border unitization a redetermination of the Tract Participations is likely to be of concern for the host governments because they may be economically impacted by the redetermination. If (for example), the initial Tract Participations of the group in Country X and the group in Country Y are fifty percent (50%), and as a result of a redetermination the Tract Participation of the group in Country X is increased to fifty five percent (55%) and the Tract Participation of the group in Country Y is reduced to forty five percent (45%), the volume of gas (and therefore revenue) allocated to the government of Country X will increase, and the volume of gas (and therefore revenue) allocated to the government of Country Y will decrease. The host governments, therefore have a vested interest in making sure the redeterminations procedures are timely, fair and equitable, and are likely to pay close attention to the redetermination procedures in the UUOA when considering whether to approve it.
Cross-border UUOAs must comply with the terms of the relevant unitization Treaty (or JDA) between the host governments. Many bi-lateral unitization Treaties (and JDAs) do not address redetermination at all, and those that do, such as the Framework Treaty between the Government of Venezuela and Trinidad and Tobago,[8] tend to contain very high level principles for redeterminations. This is because most of the unitization Treaties (and JDAs) are intended to apply to all trans-boundary reservoirs and are not specific to a particular reservoir. It would be imprudent for a unitization Treaty (or JDA) that applies to all trans-boundary reservoirs to legislate how redeterminations should be conducted because appropriate redetermination procedures are specific to a field. Various unitization Treaties and JDAs do provide for a framework for redetermination, which must be taken into account in any UUOA, including the (i) unitization Treaties between the Governments of Norway and the UK in respect of the Frigg field[9], and the Stratfjord field,[10] and the Governments of the Netherlands and the UK in respect of the Markham field;[11] and (ii) the JDA between the Governments of East Timor and Australia in respect of the Greater Sunrise unit.[12] Because these unitization Treaties are field-specific and the Governments had some knowledge of the characteristics of these reservoirs at the time they entered into the relevant Treaty (or JDA in the case of the Greater Sunrise unit) it was possible to prescribe high level rules for redetermination in the relevant Treaty (or JDA). The 2005 unitization Treaty between the Governments of Norway and the UK, by contrast, which creates a framework for all straddling reservoirs, is not specific to a particular reservoir, and therefore does not prescribe rules for redeterminations. The absence of prescriptive rules on redeterminations in most Treaties (and JDAs) allows the parties to the cross-border UUOA to negotiate and agree the redetermination provisions without any constraints imposed by the relevant unitization Treaty (or JDA). Any governmental influence over the redetermination procedures in the UUOA would be exercised by the withholding of government approval of the UUOA.
2. Default
Article 10 of the AIPN Model Unit Agreement sets out the parties’ remedies in the event that a unit interest owner fails to pay its share of unit costs, or (if applicable) to provide security for its share of the decommissioning costs (a “ Defaulting Party”). In summary, the Unit Operator can require each of the other parties in the Defaulting Party’s group (a “Defaulting Group Party”) to contribute a share of the amount in default, and any Defaulting Group Party who fails to do so will also become a Defaulting Party. The procedure is repeated until the entire shortfall is met by the Defaulting Group Parties or all the Defaulting Group Parties become Defaulting Parties. If the Defaulting Group Parties contribute to the Defaulting Party’s default they can exercise their remedies against the Defaulting Party under the relevant JOA (which may include forfeiture of the Defaulting Party’s interest in favour of the contributing Defaulting Group Parties). If all the Defaulting Group Parties become Defaulting Parties, the Unit Operator can require the parties in the other Group to contribute a share of the amount due from the Defaulting Parties. And if the parties in the other Group contribute a share of the amount due from the Defaulting Parties, those contributing parties have the right to require the Defaulting Parties to withdraw from the UUOA and to transfer all of their interest in the UUOA (and the relevant JOA and contract) to the contributing parties. The rational for this provision is to ensure that the parties in the non-defaulting Group can continue to conduct unit operations in the situation whether there is a block default by the other Group.[13]
The remedies in the AIPN Model Unit Agreement (described in the preceding paragraph) contemplate the transfer (by sale or forfeiture) of the Defaulting Party’s interest as a remedy of last resort. In any unitization where this remedy exists, the parties to the UUOA should give consideration to the following issues:
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whether a forfeiture of the Defaulting Party’s unit interest would be construed as a penalty under the laws that govern the UUOA, and therefore potentially would be unenforceable;
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in case the Defaulting Party is insolvent (or equivalent), whether the transfer of the Defaulting Party’s interest (by forfeiture or otherwise) is enforceable in the context of the rights exercisable by the Defaulting Party’s creditors; and
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where the default provisions contemplate a transfer of unit interest between the Defaulting Group’s Parties to the parties in the non-defaulting Group, whether the underlying petroleum contracts would permit a transfer of rights across Groups.
In many jurisdictions the NOC has an interest in the underlying petroleum contract and JOA. The NOC is a unit interest owner under the UUOA by virtue of this interest. In a cross-border unitization, the NOCs of both countries may be party to the UUOA. In the cross-border unitization scenario, the parties may wish to consider whether a (last resort) remedy for default which requires a defaulting NOC to transfer its unit interest to a contributing (non-defaulting) NOC is viable – commercially and legally. It seems hard to imagine a situation where the host government of the defaulting NOC would approve the transfer of its NOC's unit interest to the NOC of a neighbouring country. In addition, the laws of the host government may not permit such a transfer. In Venezuela, for example, the Organic Law of Hydrocarbons requires the Venezuelan NOC to control crude oil operations, which would prevent its unit interest being transferred to a contributing party – as envisioned in the AIPN Model Unit Agreement.
3. Withdrawal
Similar issues arise in relation to withdrawal under the UUOA. Article 15(C) of the AIPN Model Unit Agreement provides that if all the parties in a Group elect to withdraw from the UUOA (and the underlying contract), all or some of the Parties in the other Group can elect to have the withdrawing Parties’ interests transferred to them without any compensation. The rationale for this provision is to allow the parties in the non-withdrawing Group to acquire the rights they need to continue to conduct unit operations under the UUOA in the event of withdrawal by the parties in the other Group. Whether this provision can be put into effect must be given particular consideration in the context of a cross-border unitization. We question whether the two host governments would approve withdrawal provisions in the UUOA that could result in the non-withdrawing Parties in Country X acquiring the rights of the withdrawing Parties in Country Y for no consideration.
4. Revocation of a Contract
Article 2 of the AIPN Model Unit Agreement provides that if either Contract is revoked the UUOA will terminate unless the parties to the remaining Contract vote (in accordance with the voting procedure in the UUOA) to keep the UUOA in effect, in which case upon the revocation of a contract the Tract Participation of the remaining Group is 100%. This implies that the remaining Group will have 100% of the rights and obligations under the UUOA (including the right to production). This provision ensures that the Parties to the continuing petroleum contract can acquire the rights they need to continue to conduct unit operations under the UUOA. Some view the AIPN approach as l problematic for any unitization because the Group which has the remaining contract does not have rights in respect of the contract area covered by the revoked contract. Further, the AIPN approach may be inconsistent with the petroleum laws of the host country which legislates how the rights under the revoked Contract are allocated upon revocation – typically the rights revert to the host government. The Jubilee field (Ghana) unitization and unit operating agreement (Jubilee UUOA), where the Ghanaian national oil company (GNPC) is a party to both contracts, provides that in the event of the expiration, termination or revocation of one contract the Jubilee UUOA shall remain in effect and GNPC shall become the Contract Group for the expired/terminated/revoked contract, and shall assume all rights and obligations of the Group to the expired/terminated/revoked contract. In this case it was possible to specify in the UUOA how the rights under the revoked contract would be allocated because GNPC has an interest in both Groups.
Close consideration should be given to the revocation provisions in cross-border unitization scenario. The AIPN approach is unlikely to be feasible in a cross-border unitization because the government which revokes the contract is unlikely to accept that the parties in the Group in the other country will acquire the interests of the parties to the revoked contract. The approach taken in the Jubilee UUOA does not offer a solution in the cross-border unitization context, as there is not an NOC with an interest in both Groups. The question then arises of who acquires the rights under the revoked contract so that unit operations can continue? This will be an issue for negotiation by the parties to the UUOA, having regard to applicable laws of the host country.
Conclusion
Unitization agreements (especially more recent ones) are typically complex and detailed agreements, and are often the result of long and difficult negotiations. In any negotiation each provision of the UUOA must be carefully scrutinized to ensure that it is viable in the circumstances and capable of being enforced. In the case of a cross-border unitization additional scrutiny may be necessary due to the complexities and limitations that arise due the reservoir being subject to the jurisdiction of two governments (whose commercial objectives may not always be exactly aligned).
[1] This article is the first of two articles on unitization – the second article is on unitization for gas/LNG projects.
[2] International unitization Treaties and JDAs are publically available.
[3] See for example, Section 6 of the AIPN paper “International Unitization of Oil and Gas Fields: the Legal Framework of International Law, National Laws and Private Contracts.”
[4] The UUOA for the Jubilee Field in Ghana dated 13 July 2009, and the HUFFCO/TOTAL Unitization Agreement in Indonesia for the Nilam Unit in East Kalimantan field dated 1 January 1980, are publically available.
[5] An AIPN drafting committee is currently undertaking the revision of the 2006 AIPN Model Unit Agreement.
[6] However, the AIPN Model Unit Agreement is not intended for use in the United States.
[7] For example, Article 5.5 of the AIPN Model Unit Agreement sets out five alternative bases for the redetermination of Tract Participations.
[8] Framework Treaty relating to the Unitisation of Hydrocarbon Reservoirs that extend across the delimitation line between the Republic of Trinidad and Tobago and Venezuela dated 20 March 2007.
[9] Agreement between the Governments of the UK and Norway relating to the exploitation of the Frigg Field dated 20 July 1978.
[10] Agreement between the Governments of the UK and Norway relating to the Exploration of the Stratjford Field dated 30 January 1981.
[11] Agreement between the UK and the Netherlands relating to the Exploitation of the Markham Field Reservoirs dated 3 March 1993.
[12] Agreement between the Governments of Australia and the Democratic Republic of Timor-Leste relating to the Unitization of the Sunrise and Troubadour Fields dated 6 April 2003.
[13] In addition to these remedies, the Defaulting Party’s share of unit production is allocated to the contributing parties during the period of the default, and the Unit Operator has the right to sell that unit production and to distribute the net proceeds to the contributing parties. In many (if not most) jurisdictions the transfer of a unit interest (and a corresponding interest in the JOA and Contract) will require the approval of the host Government, and therefore giving effect to the remedies for default in the AIPN Model Unit Agreement. The UUOA is ultimately conditional on the relevant host Government approving the transfer.
