In this period of depressed oil and gas prices, many companies are considering refracturing and/or reworking older wells to gain production at lower costs than from drilling new wells. Refracking allows companies to extract more hydrocarbons from already existing wells by recompleting the well. Nowadays, companies have better technology and are more efficient in their completion techniques and thus are able to capture additional hydrocarbons from existing well bores. For example, instead of spending around ten million dollars to drill and complete a new well in the Haynesville shale in Northwest Louisiana, a company can usually refrac an existing well for around two million dollars. Along with the cost savings, the results also look promising. According to Comstock Resources 2015 first quarter earnings call:
We [Comstock] began the year by executing our first refrac of a Haynesville shale well during the first quarter of 2015. Following the refrac, the Pace 33 #1 well in DeSoto Parish, Louisiana, had an initial production rate of 4 million cubic feet per day, which was an eight-fold increase from its 0.5 million per day production rate before the refrac. We’re currently producing this well at a stable rate of 3.5 million cubic feet per day.
This example is just one of many where refrac operations on existing wells in shale plays have been profitable. However, refracs also pose risks, including the total loss of a well bore resulting in both additional costs and no production.
Despite these risks and as the technology continues to improve, refrac operations are likely to become even more common in shale plays. Thus, it is helpful to review common contractual provisions that may address or affect refrac operations.
Companies operating under joint operating agreements and those looking to acquire interests in properties burdened by such agreements should be mindful of how such agreements may affect refrac operations. Many standard form joint operating agreements do not specifically address the refrac of a well already producing in paying quantities. Thus, the question arises whether a party is allowed to undertake refrac operations without all parties’ consent for wells that are producing in paying quantities. Moreover, if a party does not consent, can that party be treated as a non-consenting party and thus be subject to the non-consent penalties under the terms of most joint operating agreements. At present, there does not yet appear to be a Louisiana case decided on these questions, and the jurisprudence from neighboring Texas is unsettled.
I. Interpretation of the JOA
Consider the AAPL Form 610-1982 Model Form Operating Agreement (which we refer to below as the “JOA”). While there are other model AAPL Forms, such as the AAPL Form 610 1989H JOA Model Form, the 1982 Form is still the most common in use today. Of course, every joint operating agreement can be different due to negotiations and changes made by the signatories to each. But the pertinent provisions of the model JOA are as follows:
Article VI.B.1. provides, in pertinent part:
- Proposed Operations: Should any party hereto desire to drill any well on the Contract Area, or to rework, deepen or plug back a dry hole drilled at the joint expense of all parties or a well jointly owned by all the parties and not then producing in paying quantities, the party desiring to drill, rework, deepen or plug back such a well shall give the other parties written notice of the proposed operation, specifying the work to be performed, the location, proposed depth, objective formation and the estimated cost of the operation.
Article VI.B.2. provides, in pertinent part:
- Operations by Less than All Parties: If any party receiving such notice as provided in Article VI.B.I … elects not to participate in the proposed operation, then, in order to be entitled to the benefits of this Article, the party or parties giving the notice and such other parties as shall elect to participate in the operation shall, within ninety (90) days after the expiration of the notice period of thirty (30) days (or as promptly as possible after the expiration of the twenty-four (24) hour period when a drilling rig is on location, as the case may be) actually commence the proposed operation and complete it with due diligence. Operator shall perform all work for the account of the Consenting Parties; provided, however, if no drilling rig or other equipment is on location, and if Operator is a Non-Consenting party, the Consenting Parties shall either: (a) request Operator to perform the work required by such proposed operation for the account of the Consenting Parties, or (b) designate one (1) of the Consenting Parties as Operator to perform such work. Consenting Parties, when conducting operations on the Contract Area pursuant to this Article VI.B.2., shall comply with all terms and conditions of this agreement.
Article VI.B.2. also sets forth the non-consent penalty and provides in part “this Article shall have no application whatsoever to the drilling of the initial well described in Article VI.A. except … as to the reworking, deepening and plugging back of such initial well after it has been drilled to the depth specified in Article VI.A. if it …, if initially completed for production, ceases to produce in paying quantities.”
Article VII.D.2. in relevant part provides:
- Rework or Plug Back: Without the consent of all parties, no well shall be reworked or plugged back, except a well reworked or plugged back pursuant to the provisions of Article VI.B.2. of this agreement. Consent to the reworking or plugging back of a well shall include all necessary expenditures in conducting such operations and completing and equipping of said well, including necessary tankage and/or surface facilities.
At first glance, it appears that under Articles VI.B.1. and VI.B.2. of the JOA, the operator has no authority to propose a refrac of a well that is producing in paying quantities. With regard to reworking operations, “Proposed Operations” as defined in Article VI.B.1. of the JOA include only reworks, deepening and/or plugging back of wells “not then producing in paying quantities.” Thus, under the plain language of Article VI of the JOA, reworking a well producing in paying quantities would not fall under the category of an operation that can be proposed under these provisions. However, other JOA provisions, namely, in Article VII.D.2., coupled with several Texas Court of Appeals decisions interpreting similar language in a 1982 Model Form Operating Agreement, suggest that the JOA may indeed contemplate, and allow for, the refrac of a commercially productive well.
As set forth above, the clear language of Article VI.B.1. and Article VI.B.2., contemplate the rework of a well under those provisions only if the well is “not then producing in paying quantities”. However, Article VII.D.2. appears to provide for the authority required to rework other wells (those not covered by Articles VI.B.1. and VI.B.2.). In sum, the provisions seemingly provide that in the event a party desires to rework a commercially productive well, the requisite authority to perform such operations would entail obtaining the consent of all parties. Moreover, Article VI.B.2., which includes the non-consent penalty provision, provides that said provisions “shall have no application whatsoever” to the rework of an initial well after it has been drilled if initially completed for production and has not ceased production in paying quantities. Thus, assuming the requisite consent to refrac a commercially productive well is obtained, it appears that the penalty provisions would not apply. [But of course the penalty provisions for an operation do not otherwise apply when all parties consent to that operation.]
Additionally, it should be noted that the parties’ past actions may be indicative of their own intent with regard to whether the JOA governs a proposed refrac of a commercially productive well. Thus, if for example the parties have executed a separate agreement outlining their respective rights and obligations with regard to refracs of commercially productive wells, then that agreement may evidence their intent that the JOA not govern this situation, even though Article VII.D.2. arguably governs the issue at hand.
However, the question arises whether under the model JOA, a proposed refrac operation requires unanimous consent if the well in question is producing in paying quantities? Although Louisiana courts have not yet addresses this issue, Texas courts are split on it.
II. Texas Jurisprudence
The court in Texstar North America, Inc. v. Ladd Petroleum Corp., 809 S.W.2d 672 (Tex. App. Corpus Christi 1991) was presented with this issue. The action arose as an alleged breach of a 1982 Model Form Joint Operating Agreement between Texstar North American, Inc. and Ladd Petroleum Corporation. In that case, Texstar and Ladd entered into a JOA whereby Texstar was the operator and Ladd was a non-operator. Thereafter, Texstar submitted a proposal to fracture stimulate a well covered by the JOA in order to “enhance its productive capacity.” However, Ladd would not consent to the fracture procedure. Ladd argued that the well was producing in paying quantities and there existed “several mechanical, economical, technical and geological risks associated with the fracture … that could potentially cause a loss of the well.” Texstar alleged that Ladd’s refusal to consent was in bad faith and violated the duty of mutual cooperation implied in the JOA. Texstar also alleged that a reasonably prudent operator would fracture stimulate the well. Ladd argued that the JOA should control any non-consent rights of a rework procedure.
The Texstar court found the JOA to be “unambiguous” under the terms of the parties’ JOA, no well producing in paying quantities could be reworked or plugged back without the consent of all parties. The court emphasized that Article VII.D.2. provides, in relevant part, that “without the consent of all parties, no well shall be reworked or plugged back, except a well reworked or plugged back pursuant to the provisions of Article VI.B.2 of this agreement.” Article VI.B.2. concerned wells that were not producing in paying quantities. Under Article VI.B.1. of the JOA, any party desiring to drill any well or to rework, deepen or plug back a well not then producing in paying quantities must provide the other parties with written notice of the proposed operation along with the specifics of the work to be performed, including the location of the work, both geographically and geologically, and the estimated costs of the work. The court agreed with Ladd that the proposed refrac would constitute a reworking procedure under the JOA and that the well in question was producing in paying quantities at all times pertinent to the case.
The Texstar court held that Articles VI.B.1. and VII.D.2. expressly controlled the requisites for the well at issue to be reworked under the JOA. Therefore, under these circumstances, the court concluded that Texstar, in accordance with the JOA, needed Ladd’s consent before it could refrac the well in question and that there was no implied covenant that could vary the clear terms of the parties’ JOA. Under the rationale of this ruling, a party must obtain the unanimous consent of all parties to rework/refrac a commercially productive well.
But the court in Cone v. Fagadau Energy Corp., 68 S.W.3d 147 (Tex. App. Eastland 2001, pet’n denied), disagreed with the conclusion in Texstar that the “rework” provision constituted an absolute prohibition against the proposed rework unless all parties consented to the proposal. Noting that the rework provision was contained in the article of the JOA entitled “EXPENDITURES AND LIABILITY OF PARTIES,” the Cone court concluded that the provision would not have prevented the operator in Texstar from reworking the well without every working interest owner’s consent if the operator chose to do so “at the expense of itself and of the consenting working interest owners. The provision would only prevent the operator from trying to charge the non-consenting working interest owner.” Thus, under this ruling, it appears that regardless of whether a party is required to obtain the consent of all parties (as provided in Article VII.D.2. of the JOA), in order to rework a commercially productive well, under Article VI.B.2. of a JOA and under Cone, the non-consent penalties would not apply.
Based on the conflicting Texas decisions discussed above and the absence of Louisiana jurisprudence regarding same, a proposed refrac operation of a commercially productive well may or may not require unanimous consent. As companies get better at identifying candidate wells to refrac and the technology to do so continues to improve, all parties with an interest should be aware of their obligations or lack thereof to participate in any refrac operations on wells covered by a JOA or similar agreement.