An Overview of Oil and Gas Contracts
Oil and gas contracts are the lifeblood of the energy sector. Whether you are looking for an agreement to extract, refine, sell, or purchase oil, there are many types of contracts available. You could have an agreement in place for operating, management, joint operating, farmout, or even a contract that outlines a farm-in. There are contracts for gas processing , but also agreements for selling produced gas, which might be covered under a sales agreement (also called a purchase and sale agreement). Other contracts include transportation agreements that might also be called a pipeline transportation agreement. Again, these are only a few examples of the types of contracts commonly used by different parties in the oil and gas industry.
Oil and Gas Contract Types
The world of oil and gas is underpinned by a complex web of various types of contracts that cascade down from the very top – the leasing of mineral rights – through to contracting customers for the sale of the oil and gas at the other end. These include: Lease agreements – these are entered into between a landholder and oil and gas company to allow that company the right to explore, extract and produce hydrocarbons from the land. Joint venture agreements – can be between companies who share an interest in a well, to share the responsibility and cost of drilling. They can also be entered into between land holders and oil companies sharing profit or revenue from oil fields. Production sharing agreements ("PSAs") – further upstream from royalty agreements, PSAs have much in common with joint venture agreements but here the object is the production of oil rather than exploration. A PSA enables the contracting parties (usually one or multiple oil companies and the host government) to share in the production of oil and gas. The host country receives a pre-agreed level of production, while the oil companies receive the remainder of the oil produced, minus expenses and government royalties. Joint operating agreements ("JOAs") – these are contractual agreements for the management of operations on a joint oil and gas venture. The agreement establishes the framework for decision-making in every phase of joint operation and provides for liability for costs and expenses and sharing of production profits. In the UK, JOAs are usually subject to the international Association of Drilling Contractors (IADC) model JOA. This does not mean that all JOA will so far as possible be based on the IADC model, for example in Dubai the Dubai International Financial Market – the world’s third largest financial exchange – recently released a new model form of JOA. The Latham and Watkins UNITED STATES PPP & Infrastructure Projects Guide June 2015 edition provides details on how the UAE oil and gas sector is regulated. Supply contracts – these arise within the oil and gas industry in order to extract oil from the ground and then transport it to point of sale.
Significant Oil and Gas Contract Clauses
The following is a brief description of the most commonly found oil and gas terms and conditions, and their significance.
- (1) Terms and Conditions: Terms and conditions are the background and standard commercial provisions contained in an oil and gas contract. The language often varies slightly from supplier to supplier, but many elements remain constant. These standard terms and conditions can include: scope of supply, place of delivery (FOB or CIF), invoicing, and title and risk of loss. Although the title and risk of loss provision will vary based on Incoterms, the typical provision requires that title passes to the purchaser when the goods have been delivered to the transport carrier by the supplier. It is common for the supplier to state that the risk of loss remains with the supplier until a particular event occurs, such as delivery to the vessel.
- (2) Delivery Schedule: A delivery schedule sets forth the volume and specification of the supply, the delivery/installation date(s), the price, and the means and method of shipment. It is important to have sellers confirm their delivery schedules, no matter how small the order. Delays in shipment or delivery may result in subsequent contractual obligations or liabilities, which could include a breach of other contracts or running afoul of U.S. sanctions or shipping restrictions.
- (3) Pricing: Pricing provisions typically list the prices for delivered quantities, as well as the payment terms (i.e., at sight, cash in advance, etc.). Pricing is extremely important, because small variances in price could yield large differences in overall value when calculating liquidated damages arising out of early termination. A price adjustment clause typically denotes factors that may trigger a price adjustment. Price fluctuation clauses are also important, as they help purchasers keep track of the market prices and adjust accordingly.
- (4) Force Majeure: Not all force majeure clauses are created the same. Certain clauses only excuse performance for "force majeure events," while others also excuse performance for non-performance or delays caused by non-force majeure events. Further, some clauses require the parties to attempt to find a substitute product or material within a given amount of time. Additionally, the parties may wish to include language that discusses allocation of force majeure events as between multiple contractual obligations.
- (5) Dispute Resolution: Standard contracts generally contain robust contractual dispute resolution provisions. Fundamental procedural and substantive dispute resolution concerns include: governing law, location of the dispute, statutory versus common law, arbitration, mediation, litigation, etc. For example, insurers may want to consider whether to arbitrate disputes concerning liability, as compared to those concerning damages, or whether new, foreign laws may apply to subsequent litigation.
Oil and Gas Contracts and Risk Management
When it comes to managing the risks associated with oil and gas operations, statutory authorities provide a useful framework for operators to follow and oil and gas contracts can incorporate broader business terms to address remaining causes of uncertainty. Statutory requirements that are applicable to oil and gas agreements include: With these requirements as a baseline, proper risk management under oil and gas contracts requires careful attention to all aspects of the operation, including relying on the expertise of geologists, geophysicists, and other technical consultants in negotiating and drafting oil and gas leases and related contracts to ensure that the allocation of risks and obligations is fair and reasonable under the circumstances. Negotiating agreements with landowners (i.e. oil and gas leases) presents its own unique set of risks, influenced more by the nature of the parties than the technicalities of the underlying resource . Aside from the risks outlined above, environmental risks should be assessed at every stage of an oil and gas contract. Environmental risks can arise from many sources, and the primary challenge is to allocate those risks among the parties in a fair and reasonable way. While the above-listed statutory requirements help mitigate certain environmental risks, their impact is limited to state-owned land and surface-level environmental concerns. The following industry standard clauses are commonly found in oil and gas contracts and can play a critical role in how environmental risks are addressed: A lot of thought goes into negotiating oil and gas leases and related contracts because they have long-term financial implications and affect the way companies manage their operations. Oil and gas contracts are critically important when it comes to managing financial and environmental risks.
Oil and Gas Contracts and Litigation
The legal challenges that sometimes arise in connection with oil and gas, are broad and varied. Disputes may arise over whether there has been a breach of contract, or of a fiduciary duty, or the interpretation of a leasehold term or right.
Almost universally, the disputed issues require careful examination and construction of the written agreements. A thorough review is necessary to understand the obligations of both parties, with appropriate attention paid to the key terms of the agreement. One of the most basic tasks, that is generally problematic, if not performed in advance, is to determine the applicable land. The existence of outstanding rights of first refusal, rights of pitting, leasehold depth limitations and a whole host of other contractual provisions are all points of potential contention.
A classic dispute arises over the nature and extent of the obligations of a lessee to conduct operations on a lease. The oil and gas lessee generally has an obligation to maintain the lease in force by the payment of delay rentals, the conduct of drilling operations in accordance with manifest intent to discover oil and gas, or the production of oil and gas. If the lessee fails to timely commence a drilling operation or drilling rig is not actually spudded on or before the anniversary date, the lease will terminate unless the lessee commences a new drilling year on or before the anniversary date. The lessee may be able to avoid termination only when the delay in commencing new drilling or production efforts is due to factors beyond the lessee’s control. Failure of the lessee to drill wells on a leasehold prospect, after such prospect has been pooled with one or more other leased properties, may also constitute a breach of the pooling agreement, resulting in the unintended termination of the pooled leases by the operator of the pooled unit.
Disputes may also arise over the division of the oil and gas lease bonus paid upon leasing of land by the lessee. A dispute may arise when more than one person claims ownership of the interest to be divided under the terms of the oil and gas lease. The analysis of the transmittal of the interest, either by will or intestacy, may be necessary in order to determine the proper recipients of the lease bonus.
The question of the proper allocation of production payments often gives rise to an action, usually under the auspices of the Department of Justice, frequently against the lesser.
The dispute almost always involves a complex layered history of prior contracts, assignments, amendments and Operating Agreements that arguably give rise to a governmental claim of some type. It is essential for the recipient of any letter from a governmental authority seeking reimbursement to protect its interest at an early stage in the process. Responding to such a communication will, invariably, require a thorough investigation of the contract explicit rights and obligations, as well as an evaluation of corollary and ancillary agreements that also detail the rights and obligations of the parties.
The experience of an expert oil and gas attorney is invaluable to brokers, operators and landmen in determining what is a reasonable resolution or response to a request or demand.
Emerging Trends in Oil and Gas Contracts
The oil and gas industry is at the forefront of a seismic shift towards embracing technological innovations and a trend towards sustainability. These changes will usher in a new era in oil and gas contracts, with increased environmental regulation and more transparency becoming the norm.
Technological advances are driving change; from fracking fluid spacers and centralizers with highly engineered capabilities to highly digitized contracts. The rise in prevalence of artificial intelligence in the industry – including tools that can perform document review and legal research – will continue . These tools will naturally lend themselves to negotiation and execution, centralizing oil and gas contracts into secure servers. In terms of the format, both new contracts and newly digitized existing contracts will begin trending towards options that are more easily consumable by mobile devices.
Emerging renewable energy technologies are gaining a foothold in the market, expanding fast enough to outpace the recently developed regulatory and contractual frameworks. Field services are struggling to maintain profitability in a challenging market, while contracts become a greater proportion of the cost of service. These trends and others will affect how the oil and gas contracts of the future take form.
