Gray Reed

With the plunge in commodity prices many formerly profitable wells are now in the red, and we don’t know for how long. This is causing non-operators to question the bona fides of the operations … and of the operator, and to search for a way out of their obligations.

The challenge: The operator is operating unprofitable wells where monthly costs exceed or barely equal revenues, making money on fixed COPAS overhead charges, and non-operators are going into the economic hole.  What can the non–operator do to stop the financial bleeding?

Two caveats

The result in each situation will depend upon your agreements (JOA, Participation Agreement, etc.). We have in mind seven generally-applicable options that non-operators may consider as leverage to help achieve their goal.

Don’t look for answers here. These are threats, ideas, and talking points, some of which can be successful in the right circumstance.

Option #1

Mr. Operator, I’m going to sue you for violating the operating agreement by failing to act as a reasonably prudent operator (Article V.A, AAPL Model Form 610). Your lust for money is ruining me. I’ll claim damages; I’ll take a top-lease and align with the mineral owner to sue you for lease termination; I’ll release the current lease to the lessor. I will do all of this if you refuse to lower the COPAS overhead. Failure to produce in paying quantities and no expectation of PPQ violates your duties.

Option #2

I’ll get the other non-ops to join me and we’ll vote to remove you (Article V.B.1, AAPL Model Form 610). Producing a well that is not PPQ is not operating as a reasonably prudent operator in a good and workmanlike manner.  Furthermore, a jury just might believe that intentionally profiting at the non-op’s expense ought to be good cause for your banishment. You will end up on the Wall with Jon Snow.

Option #3

I’ll get the other non-ops to join me and we’ll propose to P&A the well (Article VI.E.2/VI.F.2, depending on the JOA version).  Say bye-bye to your fixed overhead payments. If all of the parties don’t agree, there will be no P&A but we abandoning parties will no longer have responsibility or liability other than plugging costs. If the P&A costs exceed the Salvage value of the equipment, we abandoning parties know we are on the hook for our proportionate share of the excess. But we expect the opposite to be true. You will owe us money.

Option #4

As allowed by the Model Form, I’ll get the other non-ops to join me in proposing to amend the accounting procedure to reduce the currently confiscatory fixed overhead rate (2005 COPAS Section I.6.B).

Option #5

I’m going to audit you under the JOA and the COPAS. Who knows what hidden and unconscionable direct charges a good and long overdue scrubbing-down of your accounting practices might reveal?

Option #6

This little one-asset entity will just stop paying altogether. Go ahead and net me. It won’t make sense for you to sue on a non-cash flowing interest.

Option #7

If this well is as viable and valuable as you claim, just buy me out!

TOMORROW, THE OPERATOR’S RESPONSE …

for now, a musical interlude

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