Tracey Stock Articles
Well World - April 14th, 2008
Categories: Business Practises, Land A&D, Oil & Gas
Author: Tracey Stock
A colleague just dropped by with a puzzled and panicked look on their face. In their hand was a list of instructions passed to them by corporate pooh-bahs who had decided to divest the organization of all its properties that were producing in the bottom 25th quartile. Undoubtedly the pooh-bahs were very proud of their strategic brilliance. Unfortunately, corporate moves are not just about strategy. It’s also crucial that any strategy fit with tactical logistics and in this case the pooh-bahs weren’t thinking about the tactics of implementing their grand scheme. We sat down together and studied the well list.
The first instruction asked for the preparation of a schedule for these lousy, non-performing wells that cross-referenced lands and agreements. Okay. The first well is a shut-in oil well. It appears to have been shut-in since 1975 and the company appears to be its operator. Obviously, it’s a terrible performer. It sits on the southwest quarter of a full section Crown lease that was issued in 1975. Curious. This lease is well past its primary term. It’s continuing indefinitely under Section 15. A very old, shut-in, non-producing well might not be holding this lease. A land analyst will suspect that there are other wells on the land and, yes, there are three producing oil wells. All four wells are tied in to a nearby battery. So, to implement the pooh-bah’s scheme we will have to schedule the SW/4 of this Crown lease for sale and relate the shut-in well to it. Weird. Who would want to buy 1 of 4 wells that are tied into a common battery? How will this work? What are we really trying to sell? Where’s the value?
Oh, we also have to consider whether there’s an operating agreement governing this land; and, not surprisingly, we find that there is one. It’s a joint operating agreement (JOA) from 1975. The company is in it with 4 partners and the JOA includes the 1974 CAPL operating procedure with Clause 2401(b). This means it has a 20-day right of first refusal (ROFR). So, after finding a potential buyer for this property, the company will need to issue the ROFR to its partners. To find that buyer, the company will need to market the opportunity to pick-up just a wellbore or pickup a portion of the Crown lease with a shut-in oil well that cannot be produced with existing infrastructure. Oh, the company also has no certainty that it will be able to transfer operatorship of the well and lands to the buyer. That will depend on how the partners respond to the notice of change of operator that the company will need to issue. Of course, once the lease portion is carved out of the original lease and standing on its own with only a shut-in oil well to support it, the Crown will notice the lack of production and can be expected to issue a Section 18 notice that will give the buyer one year to produce from the land or lose the lease and be left holding abandonment liability for the well. Hot deal—maybe not.
My colleague and I looked at the plan in more detail. We noticed that the pooh-bahs had apparently organized the wells into sale packages based on annual cash flow. Yikes. Here was a list that saw “packages†with wells that were hundreds of miles apart—even in different provinces—all lumped together just because they all had similar annual cash flow. So, you could buy the Alberta shut-in oil well I was just talking about along with a similar one near Estevan, Saskatchewan. My colleague then said that the pooh-bahs forbid the sale of any pipe that was connected to wells being kept. So, we could be left trying to sell half a pipeline—just the end connected to our poor producing well. How do we do that? This was just going from bad to worse.
Surprising as it may seem, the acquisition and divestiture design process does not revolve around wells alone—with the exception of wellbore-only transactions. The assets being traded in oil and gas A&D include a comprehensive package of lands, agreements, and infrastructure—not just wells. From an A&D closing perspective, the wells just go along for the ride as the land title, rights, and agreements are transferred. Except for wellbore-only deals, a well-centric divestiture scheme is probably a bust from the get-go. Wells and production data are certainly critical in driving the economics of a deal. But, to let the sale of low revenue wells drive the structure of a transaction is to let the tail wag the dog. It is fraught with legal and tactical problems, logistical tangles, high transaction costs, and in many cases simply cannot be done. The design of an effective divestiture plan that optimizes value for poor performing wells will need to be built around coherent packages that receive input not only from accounting, but also land, operations, and marketing.
