WELL TRADES

1
WELL TRADES

• BY
• DORSEY T. ROACH
• Area Land Manager
• Cheyenne Petroleum Company
• Presented to
• OU Energy Management Program
• September 27, 2007

2
WELL TRADES

• Philosophy behind well trades
• If Im about to commit time, expertise and funds
  to the drilling of a well, I want to own, control
  or at least obtain some support from the owners
  of the adjacent acreage.
• Own have a lease or own minerals
• Control option to drill earn
• Support funds to reduce cost risk

3

• The philosophy of well trades is simple and
  economic when we are about to drill a well, it
  is important that we own, control or get support
  from adjacent acreage owners.
• If we own it we either have a lease on it or
  actually own the minerals.
• If we control it, we have an option to drill on
  it after we drill our test well and earn a
  significant percentage of it.
• If we get support, we would either receive dry
  hole money, bottom hole money or receive a direct
  acreage contribution for drilling our well.

4

• We must, on exploratory drilling prospects, have
  the adjacent acreage tied up by on of these
  methods, or we will not have the right to reap
  the economic reward of our successful exploration
  well. Our acreage neighbors will develop our
  field to the extent that they own the adjacent
  acreage and they will do so without having taken
  any of the risk.

5

• To drill exploratory wells without proper
  ownership, control and support will without doubt
  lead to economic suicide.

6
COMMON WELL TRADES

• Farmout Agreement
• Option Farmout Agreement
• Acreage Contribution Agreement
• Dry Hole Contribution Agreement
• Bottom Hole Contribution Agreement
• Seismic Options/Farmouts
• Term Assignments

7
NEED FOR SUPPORT

• What if we drill exploratory well without tying
  up the adjacent, prospective acreage?

8

• We take the entire economic risk associated with
  our well and possibly end up proving or at least
  enhancing the prospect of the adjacent acreage
• We may end up losing a significant portion of our
  reserves through drainage
• We have been really stupid!! (or could not get
  ownership of, control of or support from the
  adjacent acreage even after trying to get it)

9
PURPOSE OF ENTERING INTO WELL TRADES

• Tie up interests owned by others in the
  prospective tract or area
• Obtain other participants to allocate the risk
• To share costs because of limited drilling funds
• Secure follow-up drill sites (protect the
  discovery)
• To create through trade development additional
  opportunities
• Etc.

10
Reasons to assign (or convey), farm out, or grant
other support

• Economic restrictions (budget issues)
• Too risky
• Target formation inconsistent with your
  philosophy
• Lease expirations/deadlines/demands

11

• Encourage drilling to prove up own acreage
• Fits philosophy, but dont like the GG of the
  prospect
• To get the well information
• Get your acreage evaluated

12
BASIC FARMOUT AGREEMENT TERMS

• The Concept
• A owns a lease. A farms out the lease (or
  portion thereof) to B in return for Bs agreement
  to drill (or commence drilling of) a test well
  within a specified period of time (e.g., 90 days)
  to a depth sufficient to test a specified
  formation (e.g., Morrow). By drilling (or
  perhaps completing as a producer), B earns
  assignment covering all or some portion of As
  interests in the lease.

13

• A owns a lease on all of the section.
• A farms out to B and B drills a well.
• B earns 100 of the spacing unit
• subject to a 5 ORRI, which is convertible to a
  30 WI at payout.
• Plus, B earns 70 of the
• acreage outside of the spacing unit
• (included in the agreement)

14

• Earnings are typically limited to either
• The depth drilled
• The stratigraphic equivalent of the depth drilled
  
• 100 below the depth drilled

15
Different kinds of farmout terms

• Earn spacing unit with back-in at payout of 30
  WI, plus earn 70 of outside acreage

16
Different kinds of farmout terms

• Earn spacing unit only with back-in APO of 30
  WI. Could have continuous drilling option to earn
  remaining spacing

17
Different kinds of farmout terms

• Earn checkerboard 40s with or without ORRI.
• Advantage No joint
• operations

18
FARMOUT AGREEMENT

• Party owning a lease (lessee) farms out certain
  interests in that lease(s) to the drilling party
  if the drilling party drills the required well at
  the specified location to the contract depth in
  conformance with the Farmout Agreement.

19
OPTIONAL FARMOUT AGREEMENT

• An agreement by which the party owning a lease(s)
  agrees to farm out certain interests in that
  lease to the drilling party if the drilling party
  drills a well (the option well) at a specified
  location to a depth sufficient to test a
  specified formation/horizon on adjacent or nearby
  acreage (not on the farmout acreage)

20
ACREAGE CONTRIBUTION AGREEMENT

• An agreement by which the party owning a lease(s)
  agrees to assign a portion of the working
  interest in his lease to the drilling party if
  the drilling party drills a well at a specified
  location to a depth sufficient to test a
  specified formation/horizon on adjacent or nearby
  acreage

21
DRY HOLE CONTRIBUTION AGREEMENT

• An agreement by which the party owning a lease(s)
  agrees to pay the drilling party a specified
  amount of money (usually based upon /foot
  drilled) if the drilling party drills a well at a
  specified location to a depth sufficient to test
  a specified formation/horizon on nearby or
  adjacent acreage and completes the well as a dry
  hole. If the well is drilled as a producer, then
  even if marginal, no contribution is made.

22
BOTTOM HOLE CONTRIBUTION AGREEMENT

• Same as Dry Hole Contribution Agreement, except
  money contribution is paid where drilling party
  drills to the specified depth, regardless of
  whether the well is completed as a producer or
  plugged and abandoned as a dry hole i.e., if the
  drilling party reaches bottom, he gets his money

23
SEISMIC FARMOUT

• Farmor earns leasehold from Farmee for agreed
  terms if Farmee conducts or acquires seismic
  covering a specified area.

24
SEISMIC OPTIONFARMOUT

• Farmee must conduct or acquire seismic covering a
  specified area in order to earn a farmout from
  Farmor.

25
TERM ASSIGNMENT

• Assignment made before well is drilled
• Assignment contains same provisions as a farmout
  agreement
• If well is not commenced within specified time,
  leasehold must be reassigned

26
EARNING PROVISION

• What rights are earned? (oil, gas, etc.)
• Does a dry hole earn an assignment?
• What depths are earned?
• Surface to Total Depth? 100 below TD?
• Surface to base of producing formation
• Can you drill deeper than Contract Depth and earn?

27
EARNING PROVISION(continued)

• What NRI?
• Reserved ORRI equal to the difference between __
  and existing leasehold burdens
• ORRI to be proportionately reduced
• ORRI applies to extension and renewals of leases
  taken within stated period after expiration of
  base leases

28
EARNING PROVISION(continued)

• Back-in for a working interest after payout
• Does Farmor have an option to convert ORRI to a
  WI, or is conversion automatic?
• Does ORRI convert to WI, or does Farmor retain
  ORRI in addition to WI after payout?
• When is election effective?

29
Substitute Well Provision

• Gulf Coast or Hazardous Drilling Clause
  (Impenetrable substance, salt or domal material,
  etc.)
• Substitute Well Provision broader application
  that also covers mechanical problems

30
ASSIGNMENT OBLIGATIONS

• Assignment form should be attached to Well Trade
• May have limited time to request assignment

31
RENTALS SHUT-INS

• Who pays?
• Farmor usually pays rentals and Farmee reimburses
  Farmor
• Farmee usually pays shut-ins

32
Miscellaneous

• Insurance provision
• Indemnification
• Performance Bond
• Proof of Payment of Bills

33
Miscellaneous(continued)

• Special tests or coring obligations
• Disclaimer of partnership intention
• Prohibition of us of Farmors name
• Compliance with leases, rules and regulations

34
Joint Use of Farmout Lands

• Protection of producing zone owned by Farmor or
  others
• Right of ingress and egress
• Location of surface equipment
• Joint use of roads
• Maintenance

35
AREA OF MUTUAL INTEREST (AMI)

• Is there one?
• Whats covered (i.e. leases, minerals,
  producing properties)?
• Description of lands covered
• Procedures for offering acquisitions to
  non-acquiring parties
• Duration

36
OPERATING AGREEMENT (JOA)

• Recommend JOA be attached to Well Trades whenever
  Farmor and Farmee own, or may in the future own,
  a working interest in the lands covered by the
  Well Trade

37
OPERATING AGREEMENT(continued)

• JOA provisions should be negotiated in advance so
  that it is ready for execution when the need
  arises under the Well Trade
• Exhibit C used for calculating payout
• In the event of a conflict with the Well Trade,
  you should specify that the Well Trade will
  prevail

38
Call on Production

• Farmor may retain preferential right to purchase
  production
• Right to process gas

39
Illustration of Support Agreement

• Buy lease from I, then approach others
• 70/30 Farmout from E
• Buy lease from A _at_ 100/ac 5 ORRI
• Dry hole money from B _at_ 10/ft
• Bottom hole money from C _at_ 5/ft
• 50 Acreage contribution from D
• Option Farmout from F on 70/30 terms
• Seismic Option FO from G (shoot seis, have
  option to drill)
• Seismic Farmout from H (earn by shooting seis)

40
OTHER POSSIBILITIES

• Term assignment (purchase lease at reduced price
  with requirement to drill or reassign)
• Pool other working interest owners (working
  interest unit)

41
PROMOTED DRILLING DEAL

• Parties
• Generator/Promoter
• Investors/Participants/Operator/WI owners

42
PROMOTED DRILLING DEAL

• Involves
• Promoter (which may be 1 or several individuals
  or a company or partnership) generates a
  prospect
• Promoter solicits investors/participants
• Deal is sold, in whole or part
• Test well gets drilled
• Parties live by JOA they agree upon when deal
  sold

43
FARMOUT INTEREST CALCULATION PROBLEM

• A owns a 1/8th royalty lease covering all of
  Section 9 and farms out to B on the following
  terms
• B to drill a well in the SE (spacing unit)
• B Earns 100 of the spacing unit subject to a 5
  override which shall be convertible to a 30
  working interest at payout.
• B also earns 70 of A's interest in the balance
  of the section that is outside of the spacing
  unit.

44
PROMOTED DRILLING DEAL(continued)

• A's working interest in the first well (before
  payout) 0
• B's working interest in the first well (before
  payout) 100
• A's working interest in the first well (after
  payout) 30
• B's working interest in the first well (after
  payout) 70
• A's net revenue interest in the first well
  (before payout) 5 orri

Section 9 1/8th Royalty Lease
45
PROMOTED DRILLING DEAL(continued)

• B's net revenue interest in the first well
  (before payout) 82.5
• A's net revenue interest in the first well (after
  payout) 26.25
• B's net revenue interest in the first well (after
  payout) 61.25
• After the first well is drilled and completed
• A's working and net revenue interest in the
  outside acreage 30 WI, 26.25 NRI
• B's working and net revenue interest in the
  outside acreage 70 WI,
• 61.25 NRI

Section 9 1/8th Royalty Lease
46
The Promoted Deal

• Generators Costs
• 1. Geological consulting fees 10,000
• 2. Land brokerage costs 10,000
• 3. Lease bonus 32,000
• 4. Seismic purchase inter. 15,000
• 5. Prospect/overhead fee 15,000
• Total Costs 82,000
• Drilling Costs (Estimates)
• To Casing Point 300,000
• To Completion 300,000

47
Typical Deal (based on above facts)

• Promoter agrees to sell the deal to third parties
  on third-for-quarter basis - 1/3 for 1/4
• Participants pay 1/3 of the costs (usually
  through casing point) for a 1/4 interest in the
  well (and acreage)
• Example if participant acquires 45 WI from
  promoter, participant pays for 60 of the costs
  to casing point) thereafter, participant pays
  45 of costs and owns 45 interest in the well
  and all acreage and subsequent wells
• In effect, promoter is keeping a 1/4 interest
  that is carried to the casing point

48

• CONCLUSION