Concluding two years of work by a drafting committee comprised of more than 160 industry representatives from 26 countries spread across five continents, the Association of International Petroleum Negotiators (AIPN) on 25 September 2014 published the new AIPN 2014 Model Unconventional Resources Operating Agreement (UROA) together with relevant guidance notes. The UROA is the first operating agreement specifically to cover joint operations in shale oil and gas, tight oil and gas, coalbed methane and other unconventional production methodologies involving wellbore operations.
Based on the AIPN 2012 Model International Joint Operating Agreement (JOA), the UROA includes key modifications to address issues unique to unconventional resources such as pilot projects, sub-areas, multi-pad drilling and production and other aspects of horizontal drilling. In addition to providing guidance notes on the various modifications to the JOA, the AIPN also highlights critical issues in negotiating and securing granting instruments for unconventional resources. The AIPN also held a workshop on the UROA at its International Conference in Budapest, Hungary on 8 October 2014.
Unconventional Resource Operations vs. Conventional Resource Operations
Addressing the need for the UROA, the AIPN assesses and highlights the key operational differences between a conventional and an unconventional resource development project.
Unlike conventional resources, unconventional resources do not involve reservoirs or accumulations of petroleum. Instead, shale gas deposits, for example, are located in low matrix impermeable source rocks which require significant manual manipulation in the form of hydraulic fracturing (fracking) in order to create permeability to allow migration of captive gas into an incoming well bore. As such, there is no 'discovery' but only identification of a geological horizon with hydrocarbon rich shales (i.e., resource plays).
Multi-pad drilling and vertical and horizontal wells
Conventional resource drilling is targeted to exploit reservoir high points near mature source rocks to allow hydrocarbons to flow to the surface. Unconventional shale gas drilling, on the other hand, involves multiple closely spaced vertical wells and horizontal wells (increasingly through the use of multi-pad drilling) to create maximum borehole surface area in contact with the shale to allow production of greater quantities of shale gas. Given the low permeability of shale resources, vertical and horizontal drilling techniques, together with fracking, are required to create production rates of sufficient levels to make a development economic.
Pilot projects and sweet spots
Every shale is different and every shale can react differently to varying technologies and techniques. The objective of a shale gas project is, therefore, to find the best producing locations (i.e., sweet spots) and determine the most effective techniques. This objective is achieved by undertaking pilot projects either as the final part of an appraisal programme or as a precursor to a development programme.
Gas production profile
Shale gas resource plays differ from conventional gas plays in that shale acts as both the source for the gas and also the zone in which the gas is trapped - gas may be held in a matrix of natural fractures or pores (similar to conventional resources) or attached onto organic material in the shale. As a result of the gas storage properties of shale, three processes are at play during production. Initial gas production is dominated by depletion of gas from the fractured network followed by depletion of gas stored in the matrix of pores. Thereafter, gas is released from the rock as pressure in the reservoir declines. The overlapping production processes results in the characteristic hyperbolic production profile of shale gas operations. Further, unlike conventional resource plays, shale gas plays provide less certainty as to how the project will perform over time.
Overall project profile
Conventional resource operations generally have well defined stages of exploration, appraisal, development and production. Unconventional resource operations, on the other hand, are less likely to be undertaken in series. Given that shale can react to different technologies and techniques, different stages can be ongoing and overlapping at any one time – the overall shale project is therefore continuously evolving. This, of course, further contributes to the variable production profile over the entire shale gas programme as wells deplete and new wells are drilled, appraised and brought on stream.
Granting Instrument Modifications
The AIPN also provides guidance on the necessary modifications to the underlying granting instrument in order to deal with the distinction between a conventional and unconventional resource project. Set out below are a few key considerations but note, however, that the contractor will be confined by the laws of the host country in this respect.
Term and project stages
The exploration and exploitation periods in an unconventional resource project should be longer in order to cater to the operational realities of unconventional resource projects. The exploration period should be as short as possible, however, in order that cost recovery (if available) can begin. The exploitation period, on the other hand, should be as long as possible in order to ensure commerciality. The AIPN suggests that this period extends for so long as there is production in paying quantities or for at least 35 years with a right to further extend (not subject to governmental discretion).
Further, the contractor must be able to delineate the resource play. Given the requirement of pilot projects to determine sweet spots and the best techniques for production, the contractor must also ensure that a pilot project is provided within the appraisal programme or, if production is not permitted prior to a declaration of commerciality and commitment to production under the granting law, is carried out during the first phase of development. Importantly, the failure of such pilot project should permit the contractor to terminate the development programme.
Contract area / relinquishment / exploitation area
The contract area should be as large as possible to cover sufficient resource to render the project commercial. Given the geological characteristics of shale gas and the operational requirements for commercialisation of such shale gas, the contractor should resist relinquishment altogether or consider delaying the requirement to relinquish until no earlier than such time commercialisation can be established. Surface facilities, however, should not be relinquished even if the underlying resource is relinquished.
Given that there is no 'reservoir' as such but instead many potential exploitation sub-areas within the contract area, exploitation sub-areas must be defined on some basis other than by accumulation - the AIPN suggests either the area drained by multiple wells from a single pad or an area defined as a grid (e.g., 3x3 km).
Joint Operating Agreement Modifications
As mentioned above, the JOA requires a number of key modifications in order to meet the requirements of an unconventional resource operation. The AIPN proposes, among others, the amendments discussed below and provides relevant guidance notes.
The technologies and methodologies used in unconventional resource development are not adequately catered for in the current definitions of a conventional JOA. Many definitions, therefore, have been added or amended to reflect the physical requirements of unconventional resource operations such as, for example, pilot programme (and whether this forms part of the appraisal or development programme), horizontal well, multi-pad drilling facility (MPPF), sub-area and drilling pad drainage area. The AIPN advises, however, that the UROA definitions should be reconciled with the definitions in the relevant granting instrument together with the law of the host country and other applicable laws.
In a conventional JOA, property (e.g., an offshore platform) is owned by all the relevant parties jointly, so if a party transfers its interests under the granting instrument and the JOA to a third party, a corresponding proportional interest of the joint property will also be transferred to the third party. Some commentators suggest, however, that for an unconventional resource project, depending on applicable law and the granting instrument, it may be more feasible to establish a joint venture company to hold property interests.
In an onshore unconventional resource project, the key property interest of the parties is the ownership of, or a right of access to, the surface area land interests from which the drilling operations will be conducted and upon which the storage of any production will take place. In some jurisdictions, land interests may be held severally between parties (for example, in accordance with each party's corresponding participating interest) but this fractional entitlement could prove difficult in practice to effect, in particular where the title interest to the land rights must be transferred (which could involve a host of formalities including registration of land rights and ownership) as part of a wider transfer of interest to a third party of the unconventional resource project.
Where a proposed MPPF would be used to process production from more than one contract area or the capacity allocation would be different from the proportion corresponding to the participating interests of the parties, then such MPPF should be built, owned and operated under a separate arrangement to the UROA.
If property (including land) is held in a joint venture company within which each relevant party hold shares, future transfer by a party of its interests in the unconventional resource project could be simplified. Alternatively, such interests could be held by the operator on behalf of the co-venturers.
The decision making function of the operating committee should include the commerciality of unconventional resource, the conduct of a pilot project and the construction, installation and operation of MPPFs.
Parties should consider whether the customary non-consent right of a party under a JOA is appropriate in the context of unconventional resource projects. Commentators suggest that, given the variable economic and productive profile of unconventional resource projects, a party should not have a non-consent right in such projects – a party should be fully committed to the agreed joint operation that the agreed overall project development plan represents.
Similarly, parties should also consider whether a sole risk project is appropriate. Unconventional resource projects involve very careful management of the resource base in order to maximize the recovery of petroleum from a deposit that typically presents a very narrow range of realisable opportunity. Therefore, allowing a party to undertake sole risk operations could operate to the detriment of the wider interests of the project.
If parties wish to remove non-consent rights and sole risk operations, consideration should be given to the effect of such removal to ensure that no party should be compelled to participate in operations that it has not approved or be prevented from conducting the operations it wishes to perform. Further, parties should also consider including a mechanism to address any deadlocks in the decision making process in this respect.
Work Programmes & Budget
The work programme and budget should incorporate certain activities specific to unconventional resource operations such as the designation of an unconventional resource (rather than a discovery), the identification of sub-areas and the conduct of pilot programmes. Further, any development plan should include a description of applicable MPPFs.
Given the variable economic and operational profiles of an unconventional resource project, flexibility may be built into the work programmes and budget. For example, flexibility can be provided through increased over-expenditure limits or through defining work in terms of objectives rather than activities.
Further, the parties should consider providing the operator with a greater degree of flexibility in order that the operator may respond to changing circumstances as the unconventional resource project unfolds. The operator may be provided discretionary authority to adjust the approved development plan and the approved annual work programmes, together with the corresponding budgets, without the need for formal approval by the operating committee. Limits, however, should be applied to such greater flexibility.
As mentioned above, some commentators suggest that sole risk operations in unconventional resource projects are not appropriate due to the need to manage carefully the resource base in order to maximise the recovery of petroleum and the potential for any sole risk operations to operate to the detriment of the wider project interests. Other commentators, however, suggest the need for sole risk operations precisely for the same reasons. If sole risk operations are permitted, the sole risk operations should be expanded to also include the conduct of pilot projects and the construction, installation and operation of MPPFs. Further, consideration should be given to the timing of any right by a non-participating party to reinstate, and the premium attributable to reinstating in, such sole risk operations.
Disposition of Production
Regardless of whether a pilot programme is conducted during the appraisal period or the exploitation period, the parties require a mechanism to allocate revenues from the sale of pilot programme production of shale gas. In the UROA, the provisions on the disposition of production is simply amended to include pilot projects where applicable.
Given the key operational differences between a conventional and an unconventional resource development project, it is clear that the JOA must evolve to meet the needs of unconventional resource operations such as shale gas projects. Responding to this demand, the UROA is the first operating agreement specifically to cover joint operations in shale oil and gas, tight oil and gas, coalbed methane and other unconventional production methodologies involving wellbore operations. As a model contract, the AIPN emphasises that the UROA seeks to reflect current and evolving industry practices. The UROA does not, however, solve all the problems or is fitting in all situations; instead, it offers solutions including options and alternatives. The AIPN advises that local counsel advice should always be taken.