Joint Operating Agreements: Risk Control for the Non-Operator

Joint Operating Agreements: Risk Control for the Non-Operator

by Eduardo G. Pereira

Hardcover(2nd Edition)

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Product Details

ISBN-13: 9781787421240
Publisher: Globe Law And Business
Publication date: 06/15/2018
Edition description: 2nd Edition
Pages: 250
Product dimensions: 6.24(w) x 9.58(h) x 0.79(d)

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CHAPTER 1

Introduction

1.1 Scope

(a) Objective

The joint operating agreement (JOA) is one of the most important documents in oil and gas transactions and projects. JOAs regulate the rights and duties of the parties to an unincorporated joint venture (JV) aimed at the exploration and exploitation of oil and gas. Most of the duties under a JOA rest with the operator – that is, the party responsible for the administration of the day-to-day activities of the JV. Consequently, JOA models and studies commonly focus on the operator's perspective. However, such ventures are not the exclusive preserve of the operator: non-operators also make a vital contribution to the success of joint operations.

Non-operators might retain, individually, a smaller participating interest in the JV, as they might have fewer financial and technical resources than the operator, though this is not always the case. This creates an environment where little attention is given to the perspective of the non-operators. Their situation is akin to that of minority shareholders, who similarly have less say than majority shareholders in the conduct of a company's operations. However, they still have shares in the company, along with their own views on how the company should be run. Thus, it is necessary to understand the needs and perspectives of non-operators in order to establish an efficient, reasonable and fair agreement. If the perspectives of non-operators are ignored, it is extremely difficult to create a balanced instrument. Consequently, critical problems may arise and potentially jeopardise the existence of the consortium, as the cooperation of all its participants is crucial to success. Moreover, the JOA is usually in force for the whole duration of the petroleum title, which can last for 30 years or more. A provision which appears to be favourable to one party in the early stages might, later in the life of the JOA, turn out to be less so. The JOA should thus offer reasonable terms for all contracting parties, from the beginning until the end of the agreement.

This book may be of particular value to mature provinces such as the UK and Norway, as the major oil companies tend to withdraw their investments (especially in smaller projects) from such areas and reinvest in jurisdictions where larger projects promise greater rewards. These companies are in turn being replaced by small or medium-sized independent companies, commonly with less experience and lacking the robust financial resources required to operate in exploration and production (E&P) projects. In other words, the traditional context, in which a JOA is based on a strong, dominant operator, is radically changing. Some JVs are composed of several parties in a more equal position. Many oil and gas regions have already reached maturity, so this trend is set to continue – even if new technology extends the life of current fields. This new scenario requires better-balanced agreements to govern joint operations. It is thus more crucial than ever to understand the perspectives and views of non-operators, as these will assume even greater significance in future JOAs, where the parties are in a more equal position.

The aim of this book is to analyse the most widely used JOA standard model forms from various jurisdictions, in particular the following:

• The Association of International Petroleum Negotiators (AIPN) model (the International model);

• The Oil & Gas UK (OGUK) model (the British model);

• The American Association of Professional Landmen (AAPL) model (the American model);

• The Canadian Association of Petroleum Landmen (CAPL) model (the Canadian model);

• The Rocky Mountain Mineral Law Foundation (RMMLF) model (the old American model);

• The Greenlandic model (issued by the Greenlandic government);

• The Norwegian model (issued by the Norwegian government); and

• The Australian Mineral and Petroleum Law Association (AMPLA) model (the Australian model).

The aim is to arrive at an understanding of how each of these models treats and positions non-operators and their major concerns.

Finally, it is crucial to establish a distinction between these different perspectives and views as outlined and any misalignment of interests that might occur in a JOA. While the different views often relate to the roles of the parties, they do not signify a misalignment of interests. Misalignment of interests is a potential scenario that is likely to lead to an exclusive operation (ie, sole risk or non-consent clauses) as the parties might disagree on the potential value of certain areas, one party might lack the funds to proceed with a given project or there might be other corporate reasons for a difference of views as to whether to proceed. Thus, different views and perspectives of non-operators will always exist, from the moment a JV is established until it ends. It is these different views that are fully analysed in the following chapters.

(b) Unbalanced provisions, imbalance of power

Ideally, a JOA should contain balanced provisions which reflect the concerns of all parties involved – operator and non-operators. It should also allow for the participation of all parties, as they all share ownership of the JV. However, this is not usually the case – current JOAs tend to be biased towards the wishes of the operator. Further, the success of oil and gas operations clearly depends on the contribution of all parties (as such operations often involve extraordinarily high expenditure over lengthy timeframes). The question is this: why are JOAs so often unbalanced? The answer lies in the context and history of oil and gas operations.

The operator's position of strength has its origins in the first JOA established back in 1956 (ie, AAPL JOA Form 1956), and still prevails today – it is considered the 'traditional' approach. This fact is recognised by the great majority of academics and professionals involved in oil and gas operations. The oil and gas industry has always assumed a need for a dominant operator who could control the consortium and set the pace of operations. The unbalanced relationships that resulted did not encourage a high degree of non-operator participation.

Why, then, was it thought necessary to give one party so much authority? Commentators offer three possible theories. The first is based on the fact that the operator has a number of performance and compliance responsibilities for which it should be compensated. The second is based on the formation of the consortium, the theory being that the leader requires a higher degree of benefit to encourage it to create the JV and take a leadership position. The third theory is the one most widely accepted by commentators, and is related to the level of commitment of the operator. Oil and gas operations involve significant risks and costs, which demand a high level of commitment from the operator if the JV is to succeed. At the same time, the operator's greater level of commitment reduces the risk that it will try to make more profit or recover any losses when negotiating the JOA, which it might seek to do if it were a smaller participant.

In addition, there is a general perception that the operator should have the largest participating interest in the consortium, which in turn demands a higher degree of control over the decision-making process.

The first and second theories are likely to be raised by the operator during the negotiation phase to support its arguments in favour of more control and a higher percentage interest from the JV, as Terence Daintith explains:

Usually, but by no means invariably, the operator will be the party holding the largest percentage interest or one of its affiliated companies. Reasons for this include a perception of the non-operators that the operator should hold a substantial interest as evidence of its commitment to the project and the fact that operators themselves are usually not keen to take on the burdens of operatorship if they have only a minor share of equity. Furthermore bidding groups are usually organized by an operator who makes it clear from the start that it requires a major interest.

However, the third reason for the operator's dominant position in terms of control and participating interest, which is founded on economic reasoning, is the most persuasive. Ernest Smith and Kenneth Mildwaters explain this theory as follows:

The operator under an international JOA is usually the party with the largest interest in the concession. A party with a less substantial interest may be hesitant to commit scarce personnel and technical resources to the management of the host government agreement, and the other participants may doubt that party's commitment to the project or fear that its motivation arises from a desire to profit from the position, rather than from the success of the operations.

The operator is usually the participant with the largest interest. The rationale behind this is that the participant with the largest interest will incur the greatest expenditure and greater commitment will be generated in matters of co-ordination and conduct of the operations. It is hoped that a prudent and economic management and conduct will result.

The government might also play an important role in determining the higher participating interest of the operator, as in some cases the applicable legal regime will require that the operator retain a minimum percentage of interest for the whole duration of the JOA, subject to its removal if such obligation is not complied with.

It can be seen that both non-operators and host governments sometimes fear that an operator with a smaller interest might not dedicate the necessary effort and commitment to the operations; the operator is therefore likely to be the party with the greatest interest and the strongest position in the JV.

It could also be argued that it is in the nature of business that the party in the better negotiating position gets the most benefits. In general terms this may be true, but in an oil and gas context the scenario will be slightly different. Firstly, the operator will not wish to shoulder all the risks and costs of operations by itself, as they could be extremely high – it will want to have co-venturers to share the risks and costs. Secondly, the non-operators are not only part of the JV, but also jointly liable for the operations conducted by the operator in relation to third parties and the host government. Thirdly, oil and gas companies usually have their assets spread across different investments, so normally no party can realistically conduct all operations alone. Thus, it is extremely important that all parties, including the operator, maintain a certain equilibrium in terms of roles within the consortium, as in the end this will benefit all of them.

Failure to establish a balanced agreement may cause problems later on. Firstly, there may be uncertainty, as any non-operator could seek court protection or relief against unfair provisions of the JOA (eg, under the Unfair Contract Terms Act 1977 in the UK), though such protection is not easy to obtain in practice. Secondly, it might lead to the withdrawal of non-operators on the grounds that they are unable to control the operations, yet remain liable for their consequences. If this happens, the operator has to find another co-venturer and negotiate another JOA, possibly while involved in litigation or arbitration with its previous co-venturers. Unbalanced JOAs, therefore, can cause serious damage to the consortium and indeed to the operator itself.

While the adoption of unbalanced JOAs within the traditional matrix may be understandable, albeit risky, it will become less appropriate for future operations as more oil and gas regions reach maturity. Mature regions are less attractive to major or large companies, as most of the reserves have already been produced, leaving only small or medium-sized fields to be explored. In this scenario, large companies tend to migrate towards new regions where reserves remain untapped. As they exit mature provinces they are replaced by mainly small and medium-sized companies, and the whole paradigm of the JOA changes radically. The operator is no longer in a dominant but an equal position compared with the non-operators. An unbalanced JOA is no longer tenable, and a more equitable agreement is negotiated that reflects the views and concerns of all parties.

That said, the parties' respective bargaining power remains unequal in these non-mature areas, and the de facto dominant party is always likely to seek the best outcome for itself. This lack of equality can prove problematic when the smaller party seeks to include optional provisions in a model form. Optional provisions will not be implemented unless they are beneficial to the stronger party. Therefore, the current standard forms do not provide truly balanced terms, as it is unlikely that under current operations the parties will achieve such balance by themselves.

The extent of such an imbalance is clearly seen in the roles of the parties in the consortium. Although the agreement refers to 'joint operations', the reality is that one party will conduct the operations, while the others will mainly contribute financially. However, all parties are jointly liable for the costs and liabilities of all operations performed under the petroleum title (except under limited circumstances related to gross negligence or wilful misconduct). In other words, the costs and liabilities are shared, but the conduct of the operations is not. For non-operators, this can be a critical concern – they are in the same position as passengers in public transport, sharing the cost of the transport but unable to determine the route or the final destination (unless they can effectively control the operating committee). In an oil and gas operation, this lack of control might have severe consequences, as will be discussed in the following chapters.

(c) Conclusion

In the traditional framework of oil and gas operations, one party is granted extensive rights and powers in order to secure the performance of operations. Historically, it was considered necessary to put the operator in such a strong position, but this view is changing. It is no longer desirable for the operator that the contract place a heavy burden on non-operators, as courts might provide reliefs for the smaller participating interest, for example by the establishment of fiduciary duties, modification of the restriction of liabilities or allowance of extra time to pay cash calls. However, such protection is not easy to obtain in practice and the extent of any interference will vary between jurisdictions, particularly in civil law countries.

Clearly, good faith and balance are essential to maintain a consortium in good health in the longer term. On the other hand, if an unfair agreement is established, the courts might modify the contract in order to resolve or adjust the imbalance.

The inclusion of balanced terms helps to avoid uncertainties and can even be positive for the operator, which might enjoy greater cooperation from the non-operators. Best practice thus indicates that an efficient consortium should allow a high degree of participation by all parties, as experience and expertise can be shared towards a common goal.

Another reason to provide balance is the marketability of the agreement. As previously mentioned, the JOA will be of long duration, in some cases over 30 years. During this period, the parties might change their priorities and are likely to assign a part or even their entire share of the consortium to a third party. Without a balanced agreement, third parties might be reluctant to engage with such a consortium, unless in the operator role.

The current operator-focused JOAs do not take into account the risks involved for non-operators. Elizabeth Pennington recognises this when she states that "some of the standard provisions would appear to favour the large incumbents rather than the smaller independent players and potential new entrants." If the JOA does not establish a measure of balance, it is difficult to expect any significant participation by non-operators.

That said, the Canadian Association of Petroleum Landmen (CAPL) recognises at least the principle of balanced provisions in order to achieve a reasonable agreement for all parties: "We believe that the 2007 CAPL Operating Procedure offers significant benefits to operators, non-operators, large and small companies." In another document, the CAPL mentions the drivers behind the latest revision of its model form:

Opportunities identified by Industry's experiences with the document.

Evolving business needs.

The challenge was to meet the needs of today and to anticipate the needs of tomorrow in a way in which industry uses the product.

(Continues…)



Excerpted from "Joint Operating Agreements"
by .
Copyright © 2018 Globe Law and Business Ltd.
Excerpted by permission of Globe Law and Business Ltd.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents

Acknowledgements, 5,
Introduction to the first edition, 7,
Glossary, 9,
Chapter 1: Introduction, 11,
Chapter 2: The relationship between the JOA parties, 37,
Chapter 3: Non-operators' concerns, 57,
Chapter 4: Conclusion, 185,
About the author, 201,
Index, 203,

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