Replies to This Discussion

Permalink Reply by Skip Peel - Mineral Consultant on December 20, 2008 at 2:31

KB. I am unsure of the "level of disclosure" that lessors would demand and lessees would be willing to provide. I hope to get some feedback. If the terms appeared favorable in the opinion of the lessor, I doubt they would demand "full disclosure. I'll let some of the more experienced O&G members tackle what level of disclosure an operator might be willing to accept.

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Permalink Reply by Skip Peel - Mineral Consultant on December 20, 2008 at 14:30

cc: to KB.

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Permalink Reply by Dion Warr, CPL on December 17, 2008 at 11:12

Skip:

I concur with your assessment. Sorry Jim, we're on opposite sides of this one. With the amount of production at stake, I could very well see 'investors' working this angle on just the terms outlined by Skip (ORI equal to 25% minus the lease burdens), even if the cash in the flip is relatively minimal. This is common in that sort of business; non-O/G speculators love the quick in & out with the shot of long residual income, then peddling those rights to pay for the operations and the ability to hold some of the fruits for the principals; I think it is may be equally foolish to discount the possibility. As the main companies were already set up to be in a 75% NRI position in the non-HBP areas, the main players will buy these leases at those terms in a heartbeat rather than carry UMI burden APO if they can help it. Sprinkling a few acres here and there across several units mitigates the risk of getting stuck with more than a few leases that cannot be flipped, or are not developed before the primary term expires.

While I agree with Jim's comments that intermediaries certainly will accumulate leasehold on behalf of a client prior to assigning the rights to said client, and that there will be niches for companies to become minority consenting WI owners or partners in wells, the 'blow and go' pace of this play is ripe for small well-funded speculative interests with a little research, knowledge, and horse sense to come in behind the wake of the big boys and stake some positions in many of these units.

From a strictly industry POV, analysts would point to the first "stupid tax" on the O&G players in this play was the hype-based runup in lease bonus, which strains the E&P budgets in any circumstances. The next "stupid tax" likely to be paid will be the additional leases required to cover the 'holes' left in the wake of 'bad leases' previously taken from the wrong owner(s), and possibly having to deal with the opportunists (aka speculators, 'block busters', etc.) that filled said holes before the company(ies) realized that the holes existed, on the premise of just securing a payday.

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Permalink Reply by Bruce on December 20, 2008 at 8:55

Jim, I just have to say my hat's off to you. I have never seen a better written analysis of what could be. You have laid out what I think many have thought but have not been able to put into words like you have. I hope everyone gets a chance to read this, it is definitely worthwhile, thanks.

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Permalink Reply by Skip Peel - Mineral Consultant on December 20, 2008 at 9:44

Bruce, my hat's off also. Questions for Jim. Would 5 or 6 units be the minimum leasehold to effectively support your model? Or, is it the optimal example? Could the model work with fewer units? How contiguous would the units need to be? I think we should call this new paradigm, "The McClure-Krow Model". Of course, we would actually use Jim's real name, so maybe, "M&M".

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Permalink Reply by Skip Peel - Mineral Consultant on December 20, 2008 at 13:47

Jim. The 5 or 6 unit model would sound optimal but a real challenge to aggregate. Your opinion of the economic dynamics leads me to speculate that the efficiencies might be attainable for the right operator on a somewhat smaller leasehold. If 3 to 4 units would maintain the efficiencies and the profit potential, I think that the state of the play and the current leasehold situation would afford multiple opportunities to employ your business model. I would follow this with your contact information but Haynesville would probably take away all my GHS Christmas presents. LOL. Jim, you are one of the main reasons that I joined the site. And I would like to express my gratitude for all that you have contributed. Thank you.

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Permalink Reply by Dion Warr, CPL on December 22, 2008 at 9:12

Bruce (and Skip):

Sorry, but I have to respectably disagree with Jim, and the current "Jim love-fest".

For those l/o's that sign with Oil and Gas "Investors", as Jim calls them, the trouble could just be starting, depending on with whom said lessor signs an OGML. While there are certain groups and companies in the business that make a substantial living playing the O&G game as active WI participants that never drill or operate a well, there are a certain amount of 'entities', call them speculators, block busters, whatever, (particularly in boom times like the one we've just witnessed) that have rolled the dice in the initial play, and failed to cash in on their recently acquired lease(s) by peddling it to the highest bidder, that are going to be AFE'd on these wells when they are drilled.

Jim paints a wonderful picture in which the hapless major independent O&G company holding a majority position in a unit, when faced with the prospect of dealing with minority WI partners sprinkled into their unit, will just own up to being beaten to the punch and gladly arrange farmouts on gracious terms to the 'investors'.

Generally, if the entity or group has a reasonable presence in the area such that the benefit of cooperation outweighs a 'scorched earth' approach with the ensuing war of attrition, the parties will cooperate with each other (CHK/HK/Encana/Goodrich, and the like), because all of these entities have a deliberate presence, and the funding available to work within a broader development program of developing a field.

As to smaller entities: while I can't say that such farmout arrangements won't happen, I have also seen it done where the owner-operator of the unit treats such WI owners in a hostile manner, and simply sends the letter and the AFE. Some of these groups simply don't have the resources to lease AND pay their share. HZ wells in the HS will AFE at over $11,000 per net mineral acre leased, based upon an $8MM completion.

The company to whom this thread is dedicated is wanting to pay $1,000 per acre for the lease. Now, while all of us would hope that this particular entity got into this business knowing full well that they should maintain appropriate funds or a credit line to be responsible for paying their proportional share of the well cost, how does one know that they did?

Let's examine what happens to the l/o that leases to an small entity that has insufficient capital to fund his share of the work. Fly-By-Night Oil Company buys a few leases in a few CHK-controlled (could be any one of the major players; just an example) units such that it acquires approximately 10 - 20 acres per unit (approx. 1 - 3% WI). Courthouse researchers for CHK indicate the WI held by Fly-by-Night, and CHK quickly comes to the conclusion that Fly-By-Night is a block buster (whether true or not). Ensuing communication b/w CHK and Fly-By-Night elicits an farmout offer from Fly-by-Night, with standard ORI and reversionary WI at payout. CHK rejects the offer, and sends the AFE and election letter, to which Fly-By-Night cannot consent due to lack of funds. Thus going non-consent, Fly-By-Night's WI also becomes subject to risk penalty, amounting to Fly-By-Night being able to come back in at 200% payout.

The well is drilled. Gas starts flowing. Fly-By-Night's lessors clamor for their royalty payments, which Fly-By-Night cannot pay. The lessors file suit, looking for their money.

Can they sue the operator? NO. A lessor must look to his lessee for his royalty. The operator is not responsible for disbursing royalties, even if the non-operating lessor is not paying them.

Can they obtain royalty and damages from lessee? Maybe, to the extent that Fly-By-Night is able to pay, but then, they can always go into Chapter 11, at which point the lessor, as an unsecured creditor, gets to stand in line to collect pennies from any cash flows as they come into the now bankrupt Fly-By-Night.

Can they get the lease dissolved? Maybe, but if Fly-By-Night has taken refuge behind federal bankruptcy protection, has a plan in place, and is paying at least a portion of what would be due, probably not. Many district courts are averse to interfering in a bankruptcy proceeding in this manner, since the assets and liabilities (including producing oil and gas leases) are managed by the higher jurisdiction, namely in the federal bankruptcy court.

Jim invokes the name of C. T. "Tom" Carden, and regales us with Jim's own personal well-monied tales of thousands of acres bought and sold and dealt on his side of Sabine. (Jim likes to name drop). Tom Carden passed away some time ago, but many of the industry O&G folks that he 'rubbed wrong' over the years would hardly call what he was doing 'helping them out', and though I don't know if Jim and his partners helped to develop fields, I would suppose that at least some of the drillers and developers that have run across them have not looked upon their efforts as 'help', either.

Mr. Carden was very shrewd and well-funded, and could (and would) write the checks to fund his share of the load, so companies could not really rid themselves of him simply by treating him shabbily, so they learned to tolerate him. He also did right by his lessors, as best as I recall, so being that he could acquire the leases, manage the assets and the risks, as well as fund the obligations and liabilities thereof, he fits the definition of a responsible investor. Not all do.

Perhaps Jim and his partners should make a counter-offer to linda and her mother. More importantly, can anyone vouch for Kouga? Or Columbia, or whoever they go by this week?

BTW, as far as Jim's last quip about burying the cost in the AFE, that only works on the front end of the deal. The NRI gets affected. When the revenue decreases, that will affect the bottom line, and will begin to influence subsequent deals, and future budgets. In the small scale, it should not matter much; however, if these major O&G players adapt the attitude of 'rolling over' every time some Fly-By-Night pops out of the woodwork wanting to flip a lease or do a farmout, it will do harm to their budgets eventually.

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Permalink Reply by Skip Peel - Mineral Consultant on December 22, 2008 at 9:38

Dion. Thanks for your opinions. Maybe I am missing something here. The thread starts out with Kouga/Columbia but later switches to a hypothetical example. Questions were asked, Jim answered them. Dion, it appears that you think the abstract we were batting around was K/C. It was not. Your admonitions are still valid.

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Permalink Reply by Dion Warr, CPL on December 22, 2008 at 12:28

Skip:

Maybe I'm just dizzy from all the posts and replies thereto. I thought that I was replying to Bruce (followed by you), in support of Jim's reply to my previous post (try saying that three times fast). My apologies to all if my interjection somehow detracts from your discussion (hypothetical, or otherwise).

All that said: saying that there is no block busting if there is no competition is just absurd. Under most definitions (maybe not Jim's), a block buster has no intent to develop his lease directly, the primary interest is to selling said lease for a profit, or a residual or reversionary interest. That doesn't necessarily mean that each and every WI owner must consent to operations (and their cost share) each and every time, lest they be labeled "block buster", but one has to have a certain intent to develop the lease, either by drilling his own well or contributing to the unit. He can contribute by assignment, farmout, or any other manner or trade, but the intent to develop is of primary importance. The block buster generally just wants to be paid for his find. As I said previously in this respect on this thread, to a speculator (block buster), 'Your lease is currency, period.' Whether there is competitive leasing or not, it does not change the intent and the motive(s) behind the acquisition of the lease. If a l/o - m/o determines to lease their rights to a non-operator classed entity, who has no intent of directly contributing to the development of the lease, that l/o or m/o has set themselves up to have the lease bonus be the last consideration that they may ever see.

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Permalink Reply by Dion Warr, CPL on December 22, 2008 at 13:26

KB:

While there is codified provisions for TX owners under the TX Business & Commerce Code (9.319), such that interest owners are held senior to lenders, and granted a security interest in all cash and deposit accounts, there is no such stated security provided to interest owners under LA law that I know of. In fact, I remember seeing quoted case law (on this site, possibly?) that operator must honor his obligation to his contracted party (even the BK non-operator); that is in addition to stated legal opinion as to the "lessor must look to his lessee" issue. I have to look around for that one...

I am unsure as to the logic behind the obvious discrepancy, but if I had to postulate, I would lean upon the idea that mineral rights have a different status (primary as to right to capture) rather than as to a more tangible right in the asset itself, as it is viewed in Texas and other states. I would be interested as to what the 'real' legal thinking is on that, however.

As to the right to terminate, I can only surmise (from the 'non-lawyerly' side) that terminating the lease would directly impact lessee's ability to receive income and/or revenue, and that lease termination would adversely impact lessee's continued ability to become solvent and re-emerge from bankruptcy, hence as long as the BK lessee is attempting to work on a prescribed plan and paying his obligations, it would be difficult to break the lease.

Under most lease forms in LA, the paying of royalty is an obligation in that must be paid, but does not state how, or when. Timely payment or adequate royalty consideration is largely left to determination, and is not a covenant to the lease, although you could certainly supplement the lease language by lease rider to make timely and adequate minimum payment provisions a lease covenant, the non-compliance with which allowing for the termination of the lease.

There is a procedure to demand for back royalty or underpayment of royalty, but the process starts contractually, then must be followed administratively, before the process can begin judicially. This is part and parcel of the Mineral Code. Beyond that, one can only assume that the interplay and inevitable turf battles between the state and federal courts could only serve to complicate and lengthen the process of petitioning to receive one's royalties and/or dissolving the lease.

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Permalink Reply by Snake Stewart on December 22, 2008 at 13:05

Reply by KB, rsp'd maddog 1 hour ago
Can't find what i originally wrote: probably another victim of my shaleside.

Indubitably my dear KB.
Sadly to say, there has been much dismemberment in terms of your avatar! :-(

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Permalink Reply by Grillin' - MmmMmm on December 22, 2008 at 12:44

KB: the penalty you refer to is not a punative penalty, it is a penalty set up in the operating agreement/unit agreement. It compensates for the risk that a company takes on for drilling a well. Prettty standard procedure and I've seen them in contracts for the last 30 years.

If a company can't afford to participate in a well, they shouldn't lease the land. pure and simple.

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