|
Article Excerpt
I. INTRODUCTION: OVERVIEW AND SCOPE OF ARTICLE
A. Introduction B. Legal Framework for Unitization: Overview C. Scope and Methodology 1. The Countries in the Survey 2. Methodology: Twelve-Country Survey D. Definitions E. Unitization: A Primer 1. The Unit Concept 2. In the United States 3. Outside the United States II. SURVEY AND ANALYSIS OF COUNTRY LAWS, REGULATIONS, AND MODEL CONTRACT PROVISIONS A. Summary Overview of the Twelve-Country Comparative Analysis B. Absence or Existence of Unitization Provisions C. Circumstances Triggering Unitization D. Voluntary or Compulsory Unitization E. Purposes of Unitization F. Oil versus Gas G. Area, Depth, and Number of Fields H. Factors Determining Unit Interests or Redetermination I. Recognition for Royalty and Fiscal Purposes J. Recognition for Purposes of Perpetuating the Contract K. Consequences of Failure to Unitize or Secure Approval of Unitization Plan L. Procedures and the Approval Authority M. Unique Provisions 1. Appointment of the Unit Operator 2. What the Unitization Agreement Must Contain 3. Joint Exploration and Drilling under a Service Contract 4. Provisions Dealing with International Boundaries N. Conclusions and Best Practices III. OTHER CONTRACTS RELEVANT TO THE LEGAL FRAMEWORK OF UNITIZATION A. Operating Agreements 1. Conduct of Petroleum Operations 2. Operator 3. Collective Decisionmaking B. Farmout and Acquisition Agreements C. Production Sales Contracts IV. DOCUMENTING THE UNITIZATION A. Pre-Unitization Agreements B. Unitization Agreements V. KEY ISSUES IN UNITIZATION AGREEMENTS A. Unit Area 1. Areal Extent 2. Depth 3. Changes in Unit Area B. Unitized Substances 1. Oil versus Gas 2. Other Substances Used for Enhanced Recovery 3. Diluent Used in Heavy Crude Oil Projects C. Effect of Unitization D. Determination of Tract Interests 1. Principal Basis for Tract Interests 2. Conversion Ratios Between Oil and Gas 3. Pre-Unitization Costs 4. Other Factors Affecting Tract Interests E. Determination of Unit Interests F. Redetermination of Tract Interests 1. Basis for Redetermination 2. Number of Redeterminations 3. Timing of Redeterminations 4. Data Used for Redetermination 5. Proposal and Approval of Redeterminations 6. Effects of Redetermination: Production 7. Effects of Redetermination: Costs 8. Effects on Host-Government Contracts 9. Trend Toward No Redetermination G. Unit Decisionmaking H. Nonunit Operations 1. Priorities 2. Drilling Through Unit Reservoirs 3. Joint Use of Infrastructure 4. Relationships with Unit Redeterminations and Expansions VI. CONCLUSIONS VII. APPENDIX I VIII. APPENDIX II
I. INTRODUCTION: OVERVIEW AND SCOPE OF ARTICLE
A. Introduction
Unitization is the joint, coordinated operation of a petroleum reservoir by all the owners of rights in the separate tracts overlying the reservoir. (2) Unitization of oil and gas fields is commonplace in the United States where private ownership of minerals has often resulted in fractionalized ownership of the oil and gas in a common reservoir, such that tens, hundreds, and even thousands, of private landowners (who have leased their tracts in exchange for royalty interests) and their lessees (working-interest owners) have interests in the same reservoir. Without unitized operation of the reservoir, the common law "rule of capture" results in competitive drilling and production with consequent economic and physical waste, as each separate owner attempts to secure his or her "fair share" of the underground resource by drilling more and pumping faster than his neighbor. (3) To conserve its petroleum resources, the United States became the "unitization capital" of the world as measured by the enactment and use of domestic (in international terms "municipal") unitization laws.
Outside of the United States, unitization has not been as prevalent simply because it has not been as necessary to the sound development of petroleum resources. Oil and gas resources in most countries are owned by the country, not by private individuals or entities. (4) When a country, as the single lessor or licensor, issues licenses or enters into production sharing agreements or similar contracts with enterprises to develop these resources, (5) the contracts awarded often cover large areas comprised of many thousands of acres. (6) In addition, government agencies may have used seismic surveys to define the license area to cover an entire geological structure or other trap, thus limiting the possibility of competitive drilling by rival licensees awarded adjacent acreage over a common reservoir. (7)
Nonetheless, interest in unitization outside of the United States has been growing in the past three decades for several reasons. First, the 1973 OPEC oil embargo imposed by Mideastern producing nations against many of the industrialized, oil-importing countries, led to a rapid rise in the price of oil. Western nations and their multinational oil companies sought to diversify their sources of oil imports. Exploration proceeded apace in many new areas of the world, such as the North Sea, South America, and Africa, and many new companies entered the international arena to compete for development rights against the major oil companies that had long dominated the global market. Additionally, state monopolies over exploration and production in host countries were loosened in the 1980s and 1990s, so more competitors could successfully enter to engage in resource development. (8) Second, over the years, exploration blocks offered by host governments have become smaller as host governments have sought to maximize revenue through a greater number of signing bonuses and more rapid development of reservoirs (more likely if there are fewer reservoirs per block). Third, relinquished areas from existing blocks have also increased the number of smaller blocks available. (9) As a result of all of these factors, increasing numbers of reservoirs are being discovered in locations outside the United States that underlie several license areas with different licensees on each area. Some of these reservoirs cross the borders between two or more countries. In addition, as offshore areas have become the new frontier promising the highest potential for large field discoveries, (10) licensees have moved into areas with undefined boundaries contested by rival coastal nations. For all these reasons, the development of petroleum resources between different licensees and different countries through cooperative rather than competitive mechanisms has assumed great importance globally.
B. Legal Framework for Unitization: Overview
Internationally, unitization takes place within a multilayered framework of law. When a reservoir straddles the boundaries of two or more sovereign countries, whether the boundaries are defined (often termed "delimited") or undefined, the layers look like this:
(i) international law--treaties, conventions, and international custom;
(ii) national laws and regulations of the host governments, and contracts between the host governments and the licensees, notably agreements authorizing development (such as a license agreement, concession, or production-sharing agreement). In some countries, the host-government contract has the force of law; and
(iii) private contracts among the licensees and interested third parties, such as operating agreements, farmout and acquisition agreements, and production sales contracts.
This Article examines this multi-layered legal framework from two different perspectives. Parts II and III analyze the unitization provisions of the national laws, regulations, and model contracts of a twelve-country survey (11) and describe the private framework of commonly used contracts that are affected by unitization. Parts IV and V review the unitization process, key issues addressed in a unitization agreement, and the typical treatment of those issues.
C. Scope and Methodology
1. The Countries in the Survey
The focus of the twelve-country survey in Part II of this Article is the legal framework for unitization in countries without a long history of unitization because those are largely the places where new sources of petroleum are being found and produced today. Twelve petroleum-producing countries were chosen for this comparative analysis, as follows:
Angola
Azerbaijan
Brazil
China
Colombia
Ecuador
Egypt
Indonesia
Nigeria
Russia
United Kingdom
Yemen
The United Kingdom was selected for purposes of comparison as one country with an extensive history of unitization under a system of sovereign ownership of mineral rights common to most of the world, in contrast to the private ownership system that prevails in the United States. The United States is less useful as a model for comparison because regulatory jurisdiction over petroleum conservation and unitization there is largely the preserve of each separate state and its conservation commission rather than the federal government. (12)
2. Methodology: Twelve-Country Survey
Several sources were used to collect the legal provisions related to oil and gas unitization in the twelve countries discussed in Part II: (i) the Barrows collection of international petroleum materials, which includes laws, regulations, model contracts, and some unitization agreements that have been negotiated and signed; (ii) the PEPS database of laws, regulations, and model contract provisions from IHS Energy; and (iii) unitization agreements submitted to the authors by members of the Association of International Petroleum Negotiators (AIPN), generally in redacted form without the names of the companies involved. The relevant portions of the laws, regulations, and model contract provisions of these twelve countries are included in Appendix I of this Article.
D. Definitions
To clarify the analysis that follows, the Authors adopted standardized definitions to use throughout this Article. The definitions, with commentary, are as follows:
Unitization: Unitization is the joint, coordinated operation of an oil or gas reservoir by all the owners of rights in the separate tracts overlying the reservoir or reservoirs. (13)
Unitization is generally acknowledged as the best method of producing oil and gas efficiently and fairly, for the following reasons:
***** It avoids the economic waste of unnecessary well drilling and construction of related facilities that would otherwise occur under the competitive rule of capture.
***** It allows sharing of development infrastructure, thus lowering the costs of production through economies of scale and operating efficiencies.
***** It maximizes the ultimate recovery of petroleum from a field according to the best technical or engineering information, whether during primary production operations or enhanced recovery operations.
***** It gives all owners of rights in the common reservoir a fair share of the production (in U.S. terminology, it "protects correlative rights").
***** It minimizes surface use of the land and surface damages by avoiding unnecessary wells and infrastructure. (14)
Outside of the United States (and to a limited extent, in a few other jurisdictions such as Canada), the applicable country is the sole owner and licensor of the petroleum resource and will receive production shares, royalties, taxes, and other contractual benefits from all license areas. (15) Thus, even though one licensee may be draining another under the rule of capture, the country itself does not usually suffer drainage (unless the reservoir extends across national boundaries).
Nonetheless, governments outside the United States are not immune from the economic incentives for the unitization of oil and gas fields. Competitive drilling can result in unnecessary wells being drilled and unnecessary surface infrastructure being installed to prevent drainage between licensees. The "economic waste" of higher costs can ultimately lead to the physical waste of oil or gas as the field is abandoned sooner because it is not commercially profitable in its later stages. (16) Both economic and physical waste have direct economic impacts on the country owning the resource, in the form of lower revenues from reduced ultimate recoveries and higher tax deductions or higher cost recovery by the licensee, reducing the country's share. Also, if the contractual benefits to be paid to the country by the different licensees (such as royalties, production shares, or taxes) are not identical, the country may well have a direct financial interest in preventing drainage from, say, a higher-royalty tract to a lower-royalty tract. In essence, while far fewer players will be involved in unitization outside the United States than on private lands within the United States, the motivations for unitization are quite similar in all parts of the world.
Sole-Country Unitization: Unitization which takes place wholly within one country; the reservoir does not extend beneath state borders, but it does extend underneath the boundaries of different license areas, usually with different licensees. (17)
This unitization will be governed by the laws and regulations or contract provisions (if any) of the country where the reservoir is located. (18)
Cross-Border Unitization: Unitization which takes place for a reservoir underlying two or more countries that have a delimited border between them. Such unitization will typically involve two or more different licensees. (19)
The following are typical attributes of cross-border unitization (to distinguish it from the joint development agreements discussed next): (20)
***** Cross-border unitization is only required once a discovery is made. (21)
***** The area covered by the unitization agreement is defined by the extent of the individual reservoir or field.
***** The two countries collaborate (through a treaty or other international agreement) on issues related to optimum field development (including, for example, safety), but maintain their sovereign rights on each side of the border.
***** The groups of licensees prepare a single development plan and a unit operating agreement, which are then subject to the approval of both countries.
***** Each license group's share of production and costs is based on the proportionate share (called the participation factor) of the field's oil and gas in place underlying its license, regardless of the physical location of the production facilities. Each licensee pays its taxes and royalties in accord with the terms of its own contract as if its unit share of production had been produced from its own contract area.
***** The legal framework maintains two separate sets of regulations and fiscal terms. (22)
Joint Development Agreement for a Joint Development Zone: An agreement between countries that authorizes the cooperative development of petroleum resources in a geographic area that has (or had) disputed sovereignty. (23)
The joint development agreement (JDA) establishes the geographic contours of a joint development zone (JDZ) within which cooperative development of petroleum occurs despite disputes over sovereignty and the delimitation of the boundary between two or more sovereigns.
The characteristics of a JDA for the cooperative development of petroleum, especially as contrasted to the cross-border unitization, include the following:
***** The JDA defines the area of disputed jurisdiction and is generally much larger than any individual reservoir or field.
***** The JDA is ideally formed before any exploration occurs, in order to provide a stable and cooperative investment environment for future licensees to undertake exploration and development. (However, there can be exceptions to this ideal.)
***** Commonly, the JDA establishes a single body, which may have the authority to develop its own petroleum regulations and fiscal terms and to manage the jointly shared jurisdiction.
***** The benefits and burdens arising from future discoveries are shared between the countries and their respective licensees on a pre-defined basis (usually, but not always, on a fifty-fifty basis). (24)
It is possible to have a reservoir crossing the boundary between a JDZ and the defined border of another country. The reservoir can then be subject to a cross-border unitization agreement between the body responsible for managing the JDZ and the country that exercises sovereign rights over the other part of the reservoir. (25)
E. Unitization: A Primer
1. The Unit Concept
Before proceeding to analyze the legal framework in depth, the following subpart briefly summarizes the effects of unitization on the lessee/licensee, first in the United States and then outside of the United States. (26) In both scenarios, the broad concept is identical: The unitized area, usually a reservoir, is treated as a single unit for development purposes. It is as if the separate leases and licenses are merged into one single lease or license, with a single unit operator appointed to manage the development of the field, within the limits of the authority granted the unit operator by the unit operating agreement and the management committee composed of all the different lessees or licensees with interests in the unit. Those readers already familiar with unitization concepts may want to proceed directly to Part II.
2. In the United States
In the United States, with its pattern of private ownership, two agreements are usually signed to unitize a field: a Unit Agreement signed between the lessors (royalty-interest owners) and lessees (working-interest owners) to create the unit; and a Unit Operating Agreement (UOA) signed only by the lessee or working-interest owners to govern the actual operation of the unit. (27) In many ways, the UOA is similar to a Joint Operating Agreement (JOA) commonly used by lessees or licensees who jointly own fractional interests in one particular lease or license. The American Petroleum Institute has promulgated model unit agreements and unit operating agreements which have been widely used in the industry as the basis of many agreements in the United States, (28) although the parties are free to add special provisions or make modifications as they see fit. Any changes, however, must not violate the dictates of the particular laws and regulations of the individual state's conservation commission if the agreements are to be approved by that commission. (29)
Almost all unitization agreements are submitted to the conservation commissions for two reasons: First, the lessees often need to invoke the state's compulsory process to force recalcitrant owners, both royalty- and working-interest owners, into the unit; and second, the approval of the conservation commission usually shields the unit participants from allegations that their cooperative activity violates antitrust laws . (30))
In the United States, most unitization occurs many years after a field's discovery and primary production, when further production requires secondary recovery by repressuring the field with water flooding or other techniques (31) (although there are significant exceptions such as the Prudhoe Bay oil field on state-owned land in Alaska, the largest oil field in the United States, which was unitized before production began). (32) During the primary phase of production, the field is regulated by the state conservation commission through a wide variety of conservation laws, such as pooling, prorationing, well spacing, no-flare orders, and maximum gas-oil and water-oil ratios. While these conservation laws go far in assuring that physical waste of petroleum does not occur and that all interest owners are accorded fair shares of production from a common reservoir, these laws are inferior to unitization for these purposes and require more regulatory intervention than a unitized operation. Indeed, the U.S. experience with late and partial unitization is a lesson to avoid elsewhere. For example, the failure to agree to fieldwide units and the formation of only partially fieldwide units has been estimated to reduce recovery rates of original oil in place from forty-four percent to thirty-nine percent. (33)
On onshore federal lands in the United States, early unitization is sometimes practiced through laws authorizing the formation of federal exploratory units. (34) Strong arguments have been advanced that compulsory exploratory unitization on private lands in the United States would enhance the economic viability of the domestic exploration and production industry, leading it to resemble international operations more closely, but politicians do not appear willing to embrace proposals to achieve more effective unitization in the United States. (35)
Almost all of the states in the United States have compulsory unitization statutes which authorize their conservation commissions to order unwilling owners to join the unit on a basis approved after notice and hearing before the commission. (36) However, the proponents of unitization must first secure voluntary agreement of a supermajority of interests (both royalty and working interests) before resort to compulsory process. In some instances, the states have such high required percentages for voluntary agreement that unitization is still an arduous, if not impossible, task. (37)
Offshore, U.S. practice more closely resembles international practice, with some unique characteristics. Lessees often unitize at the development stage to allow rational development of very expensive prospects. It is often not feasible to separately develop two offshore blocks using two separate platforms and pipelines, given the enormous capital expenditures required. The U.S. Department of the Interior, through the Minerals Management Service division, has the authority to regulate offshore oil and gas development on federal lands. The Minerals Management Service allows voluntary unitization but can require unitization where it deems such unitization to be necessary to prevent waste, conserve natural resources, or protect correlative rights. (38) Units in the offshore United States may encompass many blocks with separate ownership by different lessees to allow use of common facilities; separate participating areas are formed to address sharing of costs and production for each reservoir that crosses lease boundaries. (39)
Once accomplished, unitization has the following important effects on the rights and duties of lessees and lessors in the United States:
***** Each lessee and its royalty-interest owners receive a percentage of production from the unit as a whole, regardless of where the wells are located. Thus, if a tract is used only for water injection wells and has no producing wells on it, the tract will nonetheless receive a fair share of production from the unit.
***** Leases that would otherwise terminate because they have no production at all or production less than that required by the typical lease (production in paying quantities sufficient to recover operating costs after paying royalties) remain in effect as long as there is production in paying quantities from the unit.
***** The unit operator is free to place wells in the most advantageous position from an engineering standpoint to maximize recovery in the field, and many conservation regulations, such as well spacing and prorationing, are relaxed for unit operations. (40)
To illustrate with a simple example, assume the West family owns the West tract of 300 acres and the East family owns the East tract of 900 acres. The West family has leased to Bigg Oil for a one-eighth royalty, and the East family has leased to Littel Oil for a one-sixth royalty. During primary recovery, the field is drilled to a density averaging one well for every forty acres. The field is then unitized under a participation formula that accords twenty-five percent of unit production to West tract (300 West acres divided by 1200 total acres in the unit) and seventy-five percent of unit production to East tract. Bigg and Littel, the working-interest owners, share the costs of unit operations under the same formula. All the wells on the West tract are converted to injection wells that drive the oil toward the East tract. Production from the unit wells on the East tract keeps both leases alive and is allocated to the respective tracts under the twenty-five to seventy-five percentage formula. Once allocated, the West lease continues to define the relationship between the West royalty owners (who will be paid a one-eighth royalty on the twenty-five percent allocated to their tract) and their lessee; similarly the East family will receive a one-sixth royalty on the unit production allocated to their tract.
3. Outside the United States
Similar principles apply in international practice. When two or more groups unitize, they often sign a unitization agreement, which is essentially a "super Joint Operating Agreement" combining all of the acreage in the reservoir and defining how cooperative development will proceed among the licensees. The host country generally must approve the terms of the unitization agreement. Unitization has the following effects under the typical licensing, concession, or production sharing agreement:
***** Unitized shares of production and costs are allocated to each block.
***** Generally, cost recovery, (41) profit oil, and royalties continue to be calculated on a block basis, using the shares of production and costs allocated to each block. In some instances where one of the blocks is not yet licensed or is held entirely by the national oil company, unitization will be accomplished by giving the licensees from the other block rights over both blocks, perhaps at cost recovery and profit oil splits and royalty rates that vary from the splits and rates agreed under the agreement for the licensees' original block.
***** Taxes, if ring-fenced (42) by block, continue to be ring-fenced but will use the shares of production and costs allocated to each block for purposes of determining income and expenditures.
***** Domestic supply obligations continue to be calculated on a block basis.
***** Any remaining minimum work obligations (43) continue to apply on a block basis. (44)
Outside the United States, because unitization agreements usually involve larger prospects, bigger sums of money, and unitization at an early stage of a field's development, it is useful to think of three stages to unitization, as follows: (45)
(i) the pre-unitization agreement (entered into at the time of discovery [or appraisal] of a common reservoir, generally before commerciality is declared);
(ii) the unitization agreement (usually coincident with an agreed development plan); and
(iii) redetermination of participation factors (as specified in the unitization agreement) as more data becomes available from field development and production. (46)
Except in the case of offshore leases, redeterminations of participation shares in the United States are rare. Further, if a unit is enlarged or reduced in size or otherwise modified, no retroactive adjustments are made in the participation shares. (47)
Unitization agreements and the issues involved in negotiating them are discussed in more detail in Parts IV and V of this Article.
II. SURVEY AND ANALYSIS OF COUNTRY LAWS, REGULATIONS, AND MODEL CONTRACT PROVISIONS
This Part of the Article analyzes the laws, regulations, and model contract provisions of the twelve countries selected for this survey. After a brief overview of this legal framework, the subparts analyze the major types of issues that may arise under the different legal provisions. In all cases, the body of conservation law created by the twenty-nine different oil-producing states of the United States provides considerable comparative experience (unfortunately, often as the end result of litigation) about the meaning of the terms and provisions found in other countries' laws. (48) Each subpart opens with a brief overview of the legal implications of the issue as found in this body of U.S. conservation law. Some host governments outside of the historic oil and gas producing areas may be confronting some of these issues for the first time.
A. Summary Overview of the Twelve-Country Comparative Analysis
The collected laws, regulations, and model contract provisions on unitization that were located for the twelve-country group, arranged alphabetically by country are contained in Appendix I. A review of the legal framework of unitization for these twelve countries results in the following summary observations, few of which would prove surprising to international lawyers who practice in the energy area:
***** Most countries have enacted some type of legal provision authorizing unitization. The preferred method is to use model host-government contract provisions rather than other types of laws and regulations as the vehicle for specifying unitization rules. (49)
***** Most of the countries require unitization, but compulsory process is used only after efforts at voluntary unitization have failed.
***** Compared to state unitization laws in the United States and to the actual unitization agreements completed and signed, the legal provisions on unitization assembled in Appendix I are often short. Ecuador is the only country surveyed that has written a Model Unitization Agreement, reminiscent of the American Petroleum Institute's efforts to write such agreements in the United States. (50) Most of the longer provisions in Appendix I govern procedural matters, not the substantive content of the ultimate unitization agreement. Thus, a fair amount of flexibility exists in the negotiation of actual unitization agreements.
B. Absence or Existence of Unitization Provisions
As noted above, all the producing states of the United States have enacted statutes on unitization, although the statutes differ in significant ways from each other. Elsewhere, legal provisions governing unitization are common, but not universal, and the countries certainly differ widely in the degree of detail governing unitization in their legal frameworks in the following ways:
***** Three of the twelve countries have substantive laws governing unitization: Azerbaijan, Brazil, and Ecuador.
***** Four additional countries--Egypt, Indonesia, Nigeria and the United Kingdom--have regulations governing unitization (the United Kingdom and Nigerian regulations are virtually identical).
***** Three additional countries--Angola, China, and Colombia--have unitization provisions in their model contracts, even though they have no other laws or regulations governing unitization. Thus, a total of ten of the twelve countries have legal provisions on unitization in at least one of the three sources of law. Several of the countries have multiple sources--laws, regulations, and model contract provisions.
***** Of the ten countries named directly above, six have unitization clauses in their model contracts: Angola, Brazil, China, Colombia, Ecuador, and Egypt. Egypt's provision is rather unusual in that it operates to merge two adjacent blocks experiencing drainage under the same operator for development purposes. The provision cannot rightly be called a unitization provision in the same category as the other countries' provisions, but it is unitization-related. Azerbaijan is the only country that has a law but no model contract. Clearly, model contracts are the most common source of unitization provisions.
***** Two countries--Russia and Yemen--seem to have no provisions dealing with unitization in any of the source material researched. (51) Yemen, although lacking a specific unitization requirement, has a provision on conservation (in its 1992 Red Eagle Production Sharing Agreement in the Ramah Block), which requires that the contractor "take all proper measures, according to generally accepted methods in the Petroleum Industry to prevent loss or waste of Petroleum above or under the ground in any form...." (52) Such a provision can be interpreted to require unitization to prevent waste (although not to protect correlative rights, which is not a listed purpose for unitizing in any of the twelve countries). Unquestionably, unitization is a proper and generally accepted measure in the industry to prevent waste. The search of the PEPS and Barrows databases did not include a systematic search for broader provisions on conservation, but to the extent that such provisions exist, unitization is arguably required when necessary to prevent waste. (53) Such a conservation provision is probably quite common in the international petroleum framework. (54)
***** In three countries--Azerbaijan, Egypt, and Nigeria--the search of Barrows' source material found unitization provisions in signed development contracts, such as licenses or production sharing agreements. The actual contract provisions add little detail to the legal provisions already extant in these countries. (55)
***** In contrast to the relatively sparse regulatory framework described above, many of the actual unitization agreements found through Barrows or collected from AIPN members are lengthy documents. For example, the unitization agreement entered into by parties developing the Caspian Sea area of Azerbaijan is well over 100 pages long. The unitization parties, through their agreement, supply much of the detail necessary to accomplish the unitization.
In sum, international practice, while generally requiring unitization, appears to allow the parties considerable flexibility in negotiating the unitization agreements under broad guidelines.
C. Circumstances Triggering Unitization
In the United States, the fractionalized pattern of private ownership of a common reservoir creates its own circumstance justifying unitization. The unitization statutes of the various states typically require a finding that persons own separate interests in a common field, a finding easily made in almost all instances. (56)
Similarly, in international practice, the universal trigger for requiring unitization is geological: A petroleum reservoir is found to extend underneath contiguous contract areas, so different parties have rights over the common reservoir (57) (although the language does differ among countries, and Angola and China in particular have two triggering events, as discussed further below).
Angola (1997 Model Production Sharing Agreement): Sonangol (Angola's national oil company) may require unitization under two circumstances: (i) if a commercially exploitable structure extends into another contract area with a similar unitization provision; and (ii) if fields inside a contract area may be commercially exploited only by joint development and production. (58)
The first provision is the customary geological trigger. However, the Angolan provision is narrower than most others by applying only to contract areas that have similar unitization provisions. It is not clear what happens when the structure extends into a contract area that does not have a similar provision. (Other countries have provisions which address this circumstance more fully, as discussed below for Azerbaijan, Brazil, and Egypt.)
Less common is the second listed Angolan provision which requires unitized operations for fields that are enclosed within a single contract area, but which are not commercially viable to develop unless the fields are unitized and developed with other fields in adjacent contract areas. In this instance, joint development is authorized to allow operators to share the same infrastructure and to achieve operating efficiencies through economies of scale in developing a larger area. (59) Neither competitive drilling between rival contractors nor drainage is the problem being addressed.
China (1995 Onshore Model Contract & 1992 Offshore Model Contract): China's unitization provisions are short, simple, and broad. The first trigger to compulsory unitization is the customary one: A field is found to extend into a contract area held by others. The second is broader: Unitization is required if a discovery is noncommercial on its own, but would be commercial if developed by linking it with facilities located outside the contract area. (60)
The remaining countries have only a single trigger for unitization: the geological fact that a field is found to extend beyond a contract area. The laws, with commentary, are as follows:
Azerbaijan (2000 Oil and Gas Law): If part of a single oil and gas field is located in one contract area and extends into the contract area of a different contractor, the contractors may enter into an agreement with the proper Executive Authority to unitize the field. (61)
A second unitization-related provision appears in the 1999 Production Sharing Agreement (PSA) in the Padar Area. It provides that the State Oil Company of Azerbaijan Republic (SOCAR) shall be entitled, but not obligated, to grant an additional area to the contractor when the pool extends outside the contract area, such addition to then become part of the agreement. (62) This provision is included in Article 5.4 on discovery and can properly be considered an additional right of the existing contractor rather than a duty to unitize to prevent waste of the country's natural resource. Nonetheless, such a provision does solve, by pre-emption, problems of competitive drilling that might arise in a contract area, and so it is a "unitization-related" provision.
Brazil (Petroleum Law No. 9778): If fields extend under adjoining blocks operated by other contractors, the parties shall agree on splitting production. (63)
(2003 Model Concession Agreement): Brazil's Model Agreement provides an additional unitization procedure when the straddling reservoir extends into an area not yet granted to a contractor. In this case, Brazil's National Petroleum Agency (Agencia Nacional do Petroleo, or ANP) will play the role of a contractor on the adjacent tract, but without bearing any costs of appraising or developing this tract. (64) The cost burden will fall on the existing contractor, subject to a right to recover under certain circumstances. The ANP will offer the adjacent area for bid to investors. The effect of this provision can pose a dilemma to the existing contractor: It can wait until ANP promotes a bid on the adjacent area, or it can proceed with operations and bear, at its sole risk, the investment to appraise the relevant discovery. Once commerciality is declared, the existing contractor may recover its investment on the adjacent area by being reimbursed by the new contractor (or as a cost deduction for tax purposes). However, if commerciality is not declared, the existing contractor will bear the loss related to the appraisal. (65)
Colombia (2002 Model Contract (Frontier Areas)): If an economically exploitable field extends into another contract area, the operator, in agreement with Ecopetrol (Colombia's national oil company) and the other interested parties must implement a joint development plan. (66)
Ecuador (2002 Model Production Sharing Contract): Contractors are required to unitize when a common reservoir extends across two or more contract areas. (67) Interestingly, Petroecuador (Ecuador's national oil company) is also required to unitize if it is acting for itself in an affected area. The triggering event in Ecuador is a determination by the Ministry of Energy and Mines that a common reservoir exists. Until that time, the Model Production Sharing Contract (PSC) expressly states that a contractor has the right to exploit at its own account and risk as long as it does so within its contract area and has not submitted a request for the declaration of a common reservoir. (68)
Ecuador's provision appears to give the contractor that is most advanced in the development of the reservoir an opportunity to delay unitization by not submitting a request for the declaration of a common reservoir. Nothing in the surveyed laws appears to impose a duty on the contractor to submit such a request when it appears that a common reservoir situation exists. A contractor that is draining an adjacent area has an incentive to delay unless the authorities make unitization retroactive to the date that drainage is likely to have begun.
Egypt (Decree 758 of 1972, 1998 Model Concession Agreement, & 1997 Agreement between Egypt and Norsk Hydro (These last two are identical.)): The Egyptian General Petroleum Corporation, formerly the General Egyptian Petroleum Organization, (69) "may" ask concessionaires holding interests covering a common producing layer to reach an agreement on joint efforts toward best exploitation in accordance with industry norms. (70)
In addition, Egypt has a unitization-related provision in its form of model contract that favors the existing contractor by including additional acreage in the contractor's development block. This provision appears in Article III of the agreement titled "Grant of Rights and Terms." (71) It is not a true unitization provision in that unitization is not a duty required of the contractor by the state to prevent waste. Rather, under the contract provision, unitization is triggered upon an application from a contractor if oil or gas is being drained from an exploration block into a development block on an adjoining concession area held by the same contractor. In this event, the block being drained shall be considered as participating in the commercial production of the development block, and the drained block shall be converted into a development lease with the ensuing allocation of costs and production, calculated from the effective date of draining between the two areas. The allocation shall be in the same portion that the recoverable reserves in the drained structure bear to total recoverable reserves in the structure underlying both contract areas. (72)
Indonesia (Decree 402 of 1967): Under this decree, companies are prohibited from operating outside their contract areas, but exploration and exploitation may be carried out in a unitized way. (73) The provision seems to mean that companies must operate inside their contract area unless they have unitized their operations when the operations extend beyond the contract area. The decision to unitize is made by the Director General of Oil and Gas, based on his own judgment or at the request of one or more of the oil companies concerned. The Director General appears to have complete discretion over the approval or disapproval of the unitized exploitation. The regulations do not stipulate any criteria to serve as a basis for making such a decision.
While the regulations prohibit the companies from conducting activities outside the contract area, no provision prevents such companies from continuing activities within the contract area once it has been determined that the structure underlies other contract areas. In such a case the regulations can be interpreted to allow drainage, until and if a decision is made by the Director General. Also, the regulations seem to provide only for the unitization of structures that underlie several contiguous contract areas and not for the unitization of structures extending beyond the boundaries of a contract area into open acreage in which no contracts have yet been awarded.
D. Voluntary or Compulsory Unitization
In the United States, as noted above, all producing states except Texas have compulsory unitization laws to overcome the virtually impossible hurdle of securing unanimity, particularly on participation factors, from so many private owners and their lessees. (74) This pattern is repeated internationally. Even though fewer participants are involved, finding the "perfect" participation formula is still both technically complex and subject to different opinions of what is fair. (75) Compulsory process as a backstop to failed voluntary efforts to unitize seems to be a near-universal necessity.
In the ten countries that have unitization provisions, eight clearly authorize the government to require unitization--Angola, Brazil, China, Colombia, Ecuador, Egypt, Nigeria, and the United Kingdom--and a ninth, Indonesia, appears to do so, although the decree is vague. In the first eight countries named, the provisions require that the parties first attempt to secure unitization by voluntary agreement. If the parties cannot agree voluntarily, some countries specify how a unitization plan will be imposed on them, usually through government intervention, as discussed above in subpart II.C. Few private parties will welcome such government intrusion. Thus, the typical unitization framework may be more aptly characterized as "compulsory voluntary unitization." Azerbaijan is the sole country that relies entirely on voluntary methods of securing a unitization agreement. (76)
China's Model Contracts use rather indirect language, but appear nonetheless to require unitization: If an oil or gas field straddles a boundary, or if linking facilities in two contract areas makes a noncommercial development commercial, then the CNOOC (China National Offshore Oil Corporation) "shall arrange for the Contractor and the neighboring parties involved to work out a unitized Overall Development Program for such Field and to negotiate the provisions thereof." (77) The provision contains no mention of approval by a ministry or any other approval procedures. However, the Overall Development Program would have to be approved by CNOOC and ultimately the relevant government authorities.
E. Purposes of Unitization
As noted in subpart I.D, unitization serves three essential purposes: (i) preventing physical waste; (ii) preventing economic waste; and (iii) protecting correlative rights (fair shares). While some unitization statutes in the United States include all three purposes, (78) most state conservation commissions cannot order unitization solely for the purpose of protecting correlative rights. (79) Unitization approval almost always requires a finding that increased recovery of oil and gas will occur under the proposed unit plan. Moreover, a body of case law has developed in the United States that makes the prevention of waste (increasing the size of the "petroleum pie") a more important purpose than protecting correlative rights (dividing shares of the pie) in cases when the conservation commission must choose between the two purposes. (80)
Outside the United States, only a few of the countries in this survey even specify the purposes unitization is to serve. In no country is the protection of correlative rights a purpose of unitization, although several countries' provisions require that the agreement ultimately be fair and equitable as discussed below in subpart II.H. This failure to mention correlative rights protection as a purpose of unitization is perhaps not surprising in the international context where the country is the only landowner and will receive its share of royalties, taxes, and other payments regardless of which contract area is produced and developed, absent different royalty, production sharing fractions, or tax rates applicable to the affected contract areas.
The country provisions that address the purposes of unitization are as follows:
Angola and China: As discussed above in subpart II.C, these two countries can require unitization of separate fields to achieve operating efficiencies that render commercially viable a field that would not be viable unless jointly developed.
Nigeria and the United Kingdom: Nigeria's 1969 Petroleum Regulations require unitization if it is in the national interest for the grantee, licensee, or lessee to secure the maximum ultimate recovery of petroleum. (81) Nigeria's 1979 Service Contract authorizes unitization to secure "as far as is practicable minimum total expenditure and maximum oil recoveries and economic efficiency ... to prevent waste of reservoir energy and consequently prevent the loss of recoverable hydrocarbons." (82) The U.K. Petroleum Regulations are similar: Unitization is authorized if it is in the national interest "to secure the maximum ultimate recovery of petroleum and in order to avoid unnecessary competitive drilling." (83)
Ecuador: Ecuador's 2002 Petroleum Regulations authorize unitization to "improve the efficiency and economy of the operation." (84)
F. Oil versus Gas
In the United States, unitization statutes are often limited to oil fields or to certain types of gas operations. (85) A major reason for this is that unitization was usually sought only for secondary recovery operations in oil fields. For decades in the early development of the U.S. petroleum industry, gas was an unwanted by-product of oil production, often flared at the wellhead or used to repressure oil fields to extract more oil. (86) Secondly, in nonassociated gas fields, the basic displacement mechanism is simple expansion of the gas when pressure is released at one or more wells. (87) Recovery rates of ninety percent or more are routine, without conservation regulations such as maximum production rates and well placement that are required in oil fields, and without unitized operations. (88) Because gas drains from a wider radius than oil, the principal effect of unitizing gas fields is the protection of the correlative rights of rival operators, not the prevention of physical waste of gas. (89) While unitized operations can also prevent drilling unnecessary gas wells by adjacent operators, the prevention of physical waste, not economic waste, was the preeminent reason that states enacted compulsory unitization. (90) Indeed, politicians rather like the jobs created by drilling unnecessary wells. (91)
Yet, there are good reasons to allow the unitization of gas fields as well as oil fields, especially in deepwater gas fields and frontier areas where infrastructure development is extremely costly. Gas processing, distribution, and marketing are often more difficult and expensive tasks than similar oil activities, and cooperative agreements to perform these tasks could allow greater ultimate recoveries. For example, joint processing of gas condensate in a large plant owned by many operators in a field is much more efficient than if each operator constructed a separate plant. (92) This substantial cost saving can allow operators to develop a field that would be uneconomic if developed on a stand-alone basis and to continue to produce the field for a longer time, thus recovering condensate that otherwise would have been abandoned as uneconomic.
In the United States, some unitization statutes prohibit the cooperative marketing or refining of oil or gas because such activities were not considered necessary for conservation of oil or gas and raised antitrust concerns. (93) Yet, joint marketing of gas can enable producers to negotiate better terms with buyers, which in turn can result in higher recoveries of gas. (94) Further, joint marketing of gas in the United States can solve the thorny problem of protecting correlative rights in gas fields where different lessees/licensees have different access to marketing outlets, resulting in drainage, both between license block owners and between different members of the joint operating agreement (JOA), triggering complicated issues of gas balancing. (95) Note, however, that even if antitrust objections to joint marketing are overcome, there still may be tax effects. (96)
Nonetheless, few unitization statutes in the United States provide for joint marketing or for gas balancing rights, even when the statutes authorize unitization of gas fields. The unitization order or agreement allocates shares of production, but does not force one lessee to share its marketing outlet or buyer's contract with other lessees in the unit. Producers must find gas-balancing rights either in their private contracts or in the common law.
In gas fields in the developing world, joint marketing is quite common because of the difficulty in finding or developing a market for the gas. The unitization provisions of the countries in this survey apply to both oil and gas fields, where their scope can be determined.
Angola (1997 Model Production Sharing Agreement & 1997 Standard Concession Decree Law): Article 27 of the Model PSA provides for the unitization of petroleum deposits. (97) The word "petroleum" as defined by the 1997 Standard Concession Decree Law and by various model agreements refers to both crude oil and natural gas. (98)
Brazil (2002 Model Concession Agreement): The unitization provisions apply to both oil and gas. The 2002 Model Concession Agreement for the exploration, development and production of oil and natural gas applies to a discovery, and discovery is defined to include both oil and natural gas. (99)
China (1995 Onshore Model Contract & 1992 Offshore Model Contract): Both the onshore and offshore model contracts provide for the unitization of both oil and gas fields. (100)
Colombia (2002 Model Contract & 2000 Model Association Contract): The unitization clause refers to an economically exploitable field, which is defined as a portion of the contracted area where there are one or several overlapping structures with one or more producing reservoirs, or in which the capacity to produce hydrocarbons in commercial quantities has been proven. (101) The word "hydrocarbons" is defined as including both liquid and gaseous hydrocarbons. (102)
Ecuador (2002 Model Production Sharing Contract): Clause 8.8.9 states that if the common reservoir discovered is a gas reservoir, the contractor must execute with Petroecuador an additional contract for gas before unitizing, implying that the unitization provisions of the Model Production Sharing Contract (PSC) cover both oil and gas. (103)
(2003 Operating Agreement): Ecuador's Model Operating (Unitization) Agreement is for oil only, and contains a provision in Clause 3.7 that if gas is produced but not used in unitized operations, then the gas shall be delivered to PetroProduccion (a subsidiary of Petroecuador) which can undertake investments to take advantage of this gas. (104)
Egypt (Decree 758 of 1972, 1998 Model Concession Agreement, & 1997 Agreement between Egypt and Norsk Hydro): Article 45 of Decree 758 speaks in terms of an "oilfield" when addressing unitization, but it is not clear whether the use of that term is intended to be limiting. The Decree itself covers both oil and gas. (105) The model contracts refer to both oil and gas. (106)
Nigeria (1969 Petroleum Act & 1969 Petroleum (Drilling and Production) Regulations): The unitization provisions relate to both oil and gas, although this conclusion requires some sleuthing. In Nigeria, the words "oil field" and "oil licence" are used to refer to both crude oil and natural gas. Under the 1969 Petroleum Act, the oil license grants the right to explore for and produce "petroleum," which is defined to mean "mineral oil (or any related hydrocarbon) or natural gas." (107) Likewise in Article 47 of the 1969 Petroleum Regulations on unitization, the term "oilfield" is used to refer to a petroleum reservoir, and hence to both oil and gas. (108)
United Kingdom (1998 U.K. Petroleum Act): In the United Kingdom as in Nigeria, a geological petroleum structure or petroleum field is referred to as an "oil field." Since the word "petroleum" is defined to include "natural gas existing in its natural condition in strata," the unitization provisions apply to both oil and gas. (109)
G. Area, Depth, and Number of Fields
The legal provisions of the survey countries generally require that the unitized area be specified, but no provisions expressly set limits on...
|
