Federal Leases and Exploratory Units Tom McKee, Chelsey Russell and Scott Turner.

Federal Leases and Exploratory Units

Tom McKee, Chelsey Russell and Scott Turner

Federal Leasing Is Complex!

This presentation is a very basic overview For more information:

Two-day seminar in Federal Lease Pooling in 2009Week long Rocky Mountain Mineral Law Institute

course on Federal LeasingMany scholarly articles

Federal Leasing and Assignments – Scott Turner Federal Exploratory Units – Chelsey Russell Federal Exploratory Unit Issues – Tom McKee

Presentation Roadmap

U.S. Federal Lands andU.S. Gas & Oil Shale Plays

Source: http://www.eia.gov/

The BLM Leases Federal Onshore Lands

The Mineral Leasing Act of 1920, as amended, and the Mineral Leasing Act for Acquired Lands of 1947, as amended, grant the Bureau of Land Management (BLM),within the Department of Interior (DOI), responsibility for leasing onshore lands.

- See 30 U.S. §§ 181- 263 and U.S.C. §§ 351-359.

Federal Leasing Authority

BLM develops a Resource Management Plan (RMP)

Analyzes impact of “reasonably foreseeable development”

Identifies land as “open for leasing” and publishes Notice of Competitive Lease

Includes stipulations or development restrictions to protect sensitive resources in the plan area

Pre-Leasing Activities: Land Use Planning

A protest requests the BLM to reconsider its proposed decision to offer a parcel or parcels for development

A protest can be brought by anyone Upon denial of a protest, the protester may

appeal to the Interior Board of Land Appeals (IBLA)

Pre-Leasing Activities: Protests

Definition: A provision that modifies standard lease rights and is made an enforceable part of the lease.

Supersedes inconsistent standard lease terms or regulations.

Examples: Controlled Surface Use, Timing Limitations

Pre-Leasing Activities: Stipulations

The general public may nominate federal lands identified as “open for leasing” in the RMP

Expression of Interest (EOI)

BLM places nominated lands for leasing if:

1) The nominated parcels are actually available

2) The RMP stipulations are attached

Nominations of Lands

Federal leases are required to be offered for sale at competitive auction under the Federal Onshore Oil and Gas Leasing Reform Act 1987

Must be purchased for a minimum bid specified by the Secretary of the Interior (Not less than $2.00/acre)

Maximum Size: 2,560 acres in Lower 48, 5,760 in Alaska

Competitive Leasing

1. Notice of Competitive Lease Sale – 90 days prior Place and date, parcels to be offered, stipulations, and minimum bidding

requirements

2. BLM state offices must conduct an oral auction once per quarter if parcels are available

3. Lease awarded to highest bidder at or above minimum bidding requirement

4. The Successful Bidder must present: Properly executed lease bid form Payment of the administrative fee, the first years advanced rental ($1.50 per acre) Not less than $2-per-acre minimum bid

Competitive Leasing Process

Arises when no bid received for minimum acceptable bid during competitive bidding process

Available for leasing for two years following lease sale

Maximum Size: 10,240 acres in all states

Noncompetitive Leasing

1. Available for leasing for two years following the last day of the auction

2. Applicant must present: Properly executed lease offer form Payment of the administrative fee, the first year’s

advanced rental ($1.50 per acre)

3. Priority determined by the time of filing

Noncompetitive Leasing Process

Adult U.S. Citizens

Associations of U.S. Citizens - Includes trusts, joint tenants, joint ventures, married

parties

U.S. Corporations incorporated under U.S. state law

Restricted Ownership: Aliens, minors Prohibited Ownership: Congressman, DOI Employees, Sole Proprietorships

Federal Lessee Qualifications

Lessee Rights Explore and drill for, extract, remove, and dispose of oil and

gas deposits, except helium, that you may find on your lease

Term10 years, and “for as long thereafter as oil and gas is

produced in paying quantities”

BonusMinimum bid of not less than $2.00 per acre

Federal Leasing: Terms and Conditions

Bonding Bond of $10,000.00 to BLM prior to surface disturbance

RentalsRental Rate: $1.50 per acrePayment of first year filed with offerSubsequent payments are due annually on lease date

Royalties

Minimum of 12.5% for competitive and noncompetitive leases

Federal Leasing: Terms and Conditions

FilingLessee must file any assignment or transfer of interest with

BLM state office within 90 days of executionFiled in triplicate, $75.00 per lease

AcreageAt least 640 acres outside of AlaskaAt least 2,560 acres in Alaska

Federal Leasing: Assignments

Assignment of Record TitleUpon BLM approval of record title, the assignee steps into

the shoes of the assignorAssignee is treated as original lessee

Operating Rights TransfersAssignor retains title to the leaseAssignor responsible for all lease obligationsAn assignment of an ORT only filed after severance

Federal Leasing: Assignments

BLM Case FilesEach BLM Land office maintains a case file of all public land

transactionsThe case file contains information related to the issuance,

effectiveness, and current lease ownership

County RecordsCounty records provide constructive notice under state

recording actsBLM records do not impart constructive notice

Review Both!

Federal Leasing: Record Title

AdjudicationAgency process for decisions or orders, determination of

rights and liabilitiesDetermined by the BLM on a case by case basisRules are governed by the Administrative Procedure Act

Interior Board of Land Appeals Issues final decisions of the DOIReview appeals from BLM decisionsHeaded by Administrative Judges

Federal Leasing: Adjudication

“Production in paying quantities”

Unit Well: Section 9, Federal Form Unit agreement requires “quantities sufficient to repay the costs of drilling, completing and producing operations with a reasonable profit . . . .”

Yates Well: The Interior Board of Land Appeals holds “commercial costs” generally requires costs of production and marketing, but not drilling.

Yates Petroleum Corp., 67 IBLA 246 (1982)

A Yates Well will extend the leases within the Unit Term, But only a Unit Well will extend the life of the unit!

Federal Lease Extensions

Federal Exploratory UnitsProposal and Formation Under the Mineral Leasing Act the BLM may approve unit

agreements “for the purpose of more properly conserving the natural resources of any oil or gas pool, field, or like area, or any part thereof.” 30 U.S.C. § 226(m).

The BLM Website states that, “Unitization provides for the exploration and development of an entire geologic structure or area by a single operator so that drilling and production may proceed in the most efficient and economic manner.”

Important Resources Available on the BLM Website: Oil and Gas Unit Agreements (43 CFR 3180) Unitization Manual 3180 (Exploratory) Unitization Handbook H-3180-1 (Exploratory) Procedures for Submitting an Exploratory Unit Agreement

Federal Exploratory UnitsTwo Important Agreements1. Unit Agreement

Agreement between the BLM and the proponent (operator) of the unit.

2. Unit Operating Agreement Agreement between the operator and other working interest

owners within the unit boundary. Governs allocation of costs and production between the working

interest owners. All working interest owners must sign the operating agreement. A copy of the unit operating agreement must be filed with the

BLM – but – the BLM is not a party to the agreement and cannot control the terms of the agreement.

Federal Exploratory UnitsTwo Forms of the Unit Operating Agreement1. FORM 1

Working interest owners fix costs and share of production for the term of the unit

Interests remain constant despite expansion or contraction of participating areas

This form is generally used when the extent and uniformity of the prospect area are known

2. FORM 2 Working interest owner’s share in production and costs is determined

by its interests in a participating area This form is generally used when the extent and uniformity of the

prospect area are unknown Most commonly used form

The Application Letter Request for designation of unit area should include the following:

Identify the area proposed for unitization Identify the deepest formation to be tested and the depth to which the

initial well must be drilled to test that formation List the serial numbers of all Federal leases, lease offers, Indian leases and

lease expiration dates Must be in proper sequence Can be included as part of the land ownership map

Indicate whether geological and geophysical data is to be kept confidential

Federal Exploratory Units

The Application Letter Request for designation of unit area should include the following:

Geologic Report – Map showing unit boundary with structural and stratigraphic data and prior well data; cross sections and stratigraphic columns identifying productive formations; geophysical interpretations; geologic discussion supporting boundary.

Land Ownership Map – Show proposed unitization area; boundaries of each lease and each unleased tract of land including working interest owners and lease numbers of Federal and Indian leases (this will be the same info on Exhibit B to Unit Agreement); distinguishes between different types of land (Federal, Indian, State or Fee).


The Unit Agreement An executed unit agreement must be identical to the terms approved in the designation letter for unit area, objective formation and drilling depths.

1. Exhibit A to the Unit Agreement Describes the outline of the proposed unit and the amount and

percentage of Federal, State and Fee lands in the total unit area. Identifies individual tracts within the unit Usually in the form of a map


The Unit Agreement An executed unit agreement must be identical to the terms approved in the designation letter for unit area, objective formation and drilling depths.

2. Exhibit B to the Unit Agreement Schedule of ownership of all oil and gas interests within the unit lands

including total acreage and percentage of total unit area. Lands should be listed in the following order: Federal, Indian, State

and Fee Tracts should be identified by tract numbers and determined by order

of listing in Exhibit B and appear in appropriate place on Exhibit A.


Preliminary Approval of Unit Agreement

The Resources Management Group of the BLM will send a letter designating the outline of the unit as a reasonable unit area.

The letter will also confirm the application for the depth and formation of the initial obligation well and it will include any special provisions and requirements.


Composition of Unit – Federal, Indian, State and Fee

Generally, a federal unit is not comprised of only federal lands. A federal unit can include any combination of Federal, State, Indian and Fee tracts.

The rule of thumb is that at least 10% of the minerals in a federal unit are federal minerals.

After the proponent has received preliminary approval of the unit area and initial obligation well, the applicant must seek ratifications and joinders from each owner of an interest in the unit. Federal Indian State Fee Lands – Check lease for unitization clause


Tract Commitment

Rule of Thumb: The proponent of the unit must have at least 85% of all tracts committed to the unit to demonstrate to the BLM effective control of the unit area. The BLM recognizes four categories of commitment of a tract to the unit.

1. Fully Committed

2. Effectively Committed

3. Partially Committed

4. Not Committed


Commitment Categories1. Fully Committed (FC): All interest owners in the tract

have committed their interests to the unit Includes the following owners:

Lessee(s) of record, basic royalty owners in fee tracts, owners of overrides or production payments and working interest owners if different from the lessees of record

RIGHTS: FC Receives all the benefits of the unitization

2. Effectively Committed (EC): All interest owners EXCEPT owners of overrides or production payments are committed to the unit. RIGHTS: EC Receives all the benefits of the unitization


Commitment Categories3. Partially Committed (PC):

Fee Tract – Lessee and all working interest are committed but the royalty interest owners are not committed

Federal/State Tract – Operating rights owner (working interest owner) is committed but not the record title owner

RIGHTS: PC no segregation upon unit approval and no off lease drilling extension (within the unit area, must drill on the lease to receive a drilling extension) and no off lease production status (must be HBP on a leasehold basis)

4. Not Committed (NC): Less than 100% of the working interest owners in a tract have committed their working interest to the unit.


Approval of Unit

The BLM will issue a Certificate of Determination if a sufficient percentage (85% of more) of the land within the unit boundary is committed to the unit.

Depending on the size of the unit, additional initial obligation wells may be required.


Segregation of Leases Federal Leases: Segregation occurs when lands within a

lease are not included within the unit boundary. The lands outside of the unit boundary are segregated into a separate oil and gas lease dated effective as of the approval of the unit. Segregated leases continue for the term of the lease but not more than

two (2) years from the date of the segregation. Fee Leases: Fee leases are not subject to segregation

unless the Unit Agreement includes the optional paragraph 18(h).

State Leases: Whether a state lease can be segregated depends on the statute and regulation of each specific state.


Initial Obligation Well Upon approval of the unit the operator will have six (6)

months to commence to drill an initial test well at the approved location.

Must have diligent and continuous drilling of the initial obligation well.

Operator may drill additional test wells, with not more than six (6) months between the drilling of wells until a discovery of an unitized substance is made in paying quantities.

If the initial well is not capable of producing in paying quantities, the failure to drill additional wells until discovery will cause the unit agreement to terminate automatically.

Depending on the unit size, additional wells may be required.


Participating Areas (PAs) Definition: Land reasonably proven capable of producing

unitized substances in paying quantities, or if so provided in the unit agreement, that land necessary for unit operations. 43 C.F.R. 3180.5

Paying Quantities: “Quantities sufficient to repay the costs of drilling, completing and producing operations with a reasonable profit…”

Application to Establish PA: Generally an application to establish a PA is filed within 3 months after the completion of the unit well.

Determination of PA: Once the BLM is satisfied that a well is producing in paying quantities it will approve a PA surrounding that well.


Participating Areas (PAs) Cont. Effective Date of PA: The effective date is usually the date

the well was determined to be capable of producing the unitized substances in paying quantities.

Method for Establishing Size PA: There are no regulations that dictate the size or shape of a PA – scientific evidence controls. In most states the BLM uses the circle/tangent method for radial drainage.

Circle/Tangent – Draw a circle around the well in the size of the drainage area.

Subdivision – If the unit covers a 40-acre subdivision of which at least 50% of the lands are within a drainage circle, the entire subdivision will be included.


Participating Areas (PAs) Cont.Revising a PA

A PA is revised pursuant to the terms of the Unit Agreement (Section 11) when additional wells capable of producing in paying quantities in the unitized formation are completed.

Any addition of lands to a PA must be lands that are contiguous to the existing PA.

Similarly, the completion of a well that is NOT capable of producing in paying quantities can result in a contraction of the PA.


Participating Areas (PAs) Cont. Supporting Documents: Must have comprehensive engineering and geologic

data to support/justify the request.

Revised Exhibits A and B should be submitted concurrently with revisions so that commitment status of the new unit tracts can be established.

Plan of Development

Once a PA is approved, the unit operations must be conducted in accordance with a Plan of Development (“POD”) that is filed by the unit operator with the BLM annually.

Annual Summary of Operations

When a unit has been fully developed the operator may be required to file an annual summary of operations in lieu of an annual POD.


Participating Areas (PAs) Cont.

Contraction of PA

If continuous operations are not occurring on non-PA lands, the unit will automatically contract to the boundaries of the PA on the fifth anniversary of the initial PA.

If operations are occurring on non-PA lands after the fifth anniversary the unit will remain in effect so long as diligent operations are being conducted with not more than 90 days elapsing between the completion of one well and the commencement of the next.

Revised Exhibits A and B should be submitted concurrently or shortly after approval for contraction.


Termination of a Federal Unit

The Term of a Unit: The unit will remain in effect for five years (5) from the effective date of the Initial PA. After the initial well is drilled and proven there is no drilling obligation during the initial five (5) year term.

If the initial well is a dry hole or a Yates well, then the unit operator must commence operations for a second well within six (6) months after completion of the first well in order to keep the unit in effect.

An operator can diligently and continuously develop the unit for an additional five (5) years, for a total of ten (10) years. The ten (10) year term can then be extended for a single two (2) year term with the consent of 90% of the working interest owners in the non-participating land and 60% of the landowner’s royalty interest in the non-participating lands.


Termination of a Federal Unit

Automatic Termination: A Federal unit will automatically terminate five (5) years after its effective date unless the operator has proven there is production of the unitized substance in paying quantities.

There are always exceptions!


Madden Deep Unit

Wind River Basin – Fremont and Natrona Counties, WyomingSize: Approximately 70,000 Acres

Madden Deep Unit OPERATOR - CONOCOPHILLIPS (BURLINGTON RESOURCES OIL & GAS COMPANY)

1968 NON-OPERATORS STONEHENGE OIL COMPANY (W. A. MONCRIEF) SENTINEL DEVELOPMENT COMPANY (MONSANTO)

SOHIO PETROLEUM COMPANY NORTH CENTRAL OIL CORPORATION

YATES DRILLING COMPANY W. R. GRACE & CO. INTERNATIONAL NUCLEAR (INEXCO)

HAROLD B. EHRLICH

FORMATIONSFORT UNION

LANCECODY BIGHORN

SPRATT FAMILY - OKIE FAMILY - TOWNS OF LYSITE AND LOST CABIN

Multiple Formations and Participating Areas

LARGE PARTICIPATING AREAS WITH MANY WORKING INTEREST OWNERS

TRACT ALLOCATION OF PRODUCTION

PARTICIPATING AREA WI AND NRI CALCULATION

(TRACT WI AND NRI TIMES TRACT PERCENT OF PARTICIPATION)

EACH FORMATION HAS DIFFERENT WORKING INTEREST OWNERSHIP

HAROLD EHRLICH NON-CONSENT - $$$ PENALTY

OTHER NON-CONSENTS - ACREAGE FORFEITURE PENALTY

FORFEITED ACREAGE INCONSISTENT WITH PARTICIPATING AREAS

Market Value Royalty Clauses In Leases

SPRATT AND OKIE FEE LEASES - 1964 - MARKET VALUE ROYALTY CLAUSES

PROCEEDS - “PAY LESSOR AS A ROYALTY FOR ALL SUCH GAS OR OIL SO PRODUCED AND SAVED AN AMOUNT EQUAL TO ONE-EIGHTH OF THE GROSS SALES PROCEEDS REALIZED BY LESSEE FROM THE SALE OF SUCH PRODUCTS”

MARKET VALUE - “PAY TO THE ROYALTY OWNER OR OWNERS MONTHLY THE REASONABLE MARKET VALUE OF ALL ROYALTY GAS OR OIL PRODUCED AND MARKETED”

Market Value Royalty Clauses In Leases

LARGE FEDERAL UNIT

NUMEROUS WORKING INTEREST OWNERS

GAS PURCHASE CONTRACTS OR SPOT SALES

REGULATED GAS PRICES FOR DIFFERENT FORMATIONS

WORKING INTEREST OWNERS SELLING OR STORING

WHAT IS THE “MARKET VALUE”?

Split Stream Gas SalesLEASE A - FEE

WI OWNER A

LEASE B - FEE

WI OWNER B

LEASE C - FEDERAL

WI OWNER C

LEASE D - FEDERAL

WI OWNER D

LEASE E- FEDERAL

WI OWNER E

LEASE F - FEDERAL

WI OWNER FLEASE G - FEDERAL

WI OWNER G

LEASE H - FEDERAL

WI OWNER H

LEASE I - FEDERAL

WI OWNER I

WI OWNER A SELLING GAS AT $3.00/MCF UNDER A LONG TERM CONTRACT

WI OWNER B STORING GAS PURSUANT TO GAS BALANCING AGREEMENT

WI OWNER C SELLING GAS AT $2.50/MCF UNDER A LONG TERM CONTRACT

WI OWNERS D - F SELLING GAS ON SPOT MARKET, CURRENT MONTH $3.50/MCF

WI OWNERS G - I STORING GAS PURSUANT TO GAS BALANCING AGREEMENT

Split Stream Gas SalesLEASE A - FEE

WI OWNER A

LEASE B - FEE

WI OWNER B

LEASE C - FEDERAL

WI OWNER C

LEASE D - FEDERAL

WI OWNER D

LEASE E- FEDERAL

WI OWNER E

LEASE F - FEDERAL

WI OWNER FLEASE G - FEDERAL

WI OWNER G

LEASE H - FEDERAL

WI OWNER H

LEASE I - FEDERAL

WI OWNER I

ISSUES:

WHO PAYS LESSOR OF LEASE A? WHAT VOLUME? WHAT PRICE?

DOES LESSOR OF LEASE B GET PAID? IF SO, WHO PAYS? VOLUME? PRICE?

DOES UNITED STATES GET PAID ITS SHARE OF ALL PRODUCTION? PRICE?

Green River Bend Unit

Lincoln and Sublette Counties, Wyoming

Size: Approximately 15,000 Acres

Operator: EOG RESOURCES, INC.

TOWN OF LA BARGE WITHIN UNIT

ISSUE - UNLEASED STREETS

ISSUE - SEPARATE LEASES OF TOWN LOTS - ALL ONE TRACT

ISSUE - ACREAGE OF LOTS ADJACENT TO RIVER

Green River Bend Unit

FORMATIONS ALMY

MESAVERDEBAXTER FRONTIER BEAR RIVER (MUDDY)

Lease Q has an Entirety Clause

Participating Area – Tracts A, B, C

Unit production allocated to Tract D paid to MI Owner W (1/3) and MI Owners X, Y, and Z (2/3) even though X, Y, and Z own MI outside of the Unit.

Leases with Entirety ClausesTRACT A TRACT B

TRACT C TRACT DLease Q – MI Owner W

OUTSIDE UNITLEASE Q – MI OWNERS X, Y, Z

Entirety Clause: If the leased premises shall hereafter be owned in severalty, the premises, nevertheless shall be developed and treated as an entirety and shall be divided among and paid to such separate owners in the proportion that the acreage owned by each separate owner bears to the entire leased acreage.

Participating Area – Tracts A, B, C. D - Lands shaded in Green are pooled

UNIT PRODUCTION ALLOCATED TO TRACT D FROM WELL ON TRACT A, B OR C, LEASE Q ROYALTY PAID TO MI OWNER W

UNIT PRODUCTION ALLOCATED TO TRACT D FROM WELL ON TRACT D, LEASE Q ROYALTY PAID TO MI OWNER W AND EXCESS ROYALTY IN AN AMOUNT OF 50% OF LEASE R ROYALTY PAID TO MI OWNER X

Pooled Area Partially within UnitTRACT A TRACT B

TRACT C TRACT DFee Lease Q – MI Owner W

OUTSIDE UNITFEE LEASE R – MI OWNER X

POOLED AREA PRODUCTION FROM WELL OUTSIDE UNIT, 50% OF PRODUCTION ALLOCATED TO TRACT D TREATED AS UNIT PRODUCTION, ALLOCATED TO TRACTS A, B, C AND D, AND ROYALTY IN AN AMOUNT OF 50% OF LEASE R ROYALTY PAID TO MI OWNER X

Participating Area – Tracts A, B, C. D - Lands shaded in Orange are communitized

Communitized Area Partially within Unit

PER BLM MANUEL:

COMMUNITIZATION AGREEMENT (“CA”) ENTIRELY OR PARTIALLY OVERLAPPED BY A PARTICIPATING AREA

ALL OVERLAPPED CA LANDS COMMITTED TO UNIT AGREEMENT OR SOME OVERLAPPED LANDS NOT COMMITTED TO UNIT AGREEMENT

LOCATION OF CA WELL MAKES NO DIFFERENCE

ASSUME LEASE S COMMITTED TO UNIT

TRACT A TRACT B

TRACT C TRACT D -Federal Lease S

OUTSIDE UNIT -Federal Lease T

Participating Area – Tracts A, B, C. D - Lands shaded in Orange are communitized

Communitized Area Partially within Unit

CA PRODUCTION ALLOCATED TO TRACT D FROM WELL ON CA, ROYALTY ON 50% OF CA PRODUCTION ALLOCATED TO TRACTS A, B, C AND D (USA GETS 1/4 UNDER LEASE S) AND ROYALTY ON 50% OF PRODUCTION PAID TO USA UNDER LEASE T

UNIT PRODUCTION ALLOCATED TO TRACT D FROM WELL ON TRACT A, B OR C, APPARENTLY USA GETS ROYALTY ON 1/4 OF UNIT PRODUCTION ALLOCATED TO TRACT D UNDER LEASE S AND USA GETS NO SHARE OF THAT ROYALTY UNDER LEASE T

TRACT A TRACT B

TRACT C TRACT D -Federal Lease S

OUTSIDE UNIT -Federal Lease T

A Note on Hydraulic Fracturing

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