An Introduction To Joint Operating Agreements – Part 2

Non Operators

refinery_1The non operators are active investors who, through the Op-com, exercise overall control and supervise the joint operations of the parties. The major right of non operators is to uplift pro rata their share of any production arising out of the joint venture operations. It must be noted however, that in certain types of JOAs there is no provision for an Op-com and therefore, there is less control over the operator. This type of JOA is more commonly used in the United States. The Op-com is responsible for the management of the joint venture and is constituted by representatives of the parties to the JOA. It appoints area specific sub committees to deal with the major technical matters in more detail. The Op-com’s authority encompasses all major policy decisions involving the joint venture but the operator may however be authorised to act without agreement or consultation in certain cases where there is an emergency.

In practice the non operators exercise control over the joint venture operations through the Op-com’s control of the approval of work programmes which outline the scope of work the joint venture plans to undertake and the budgets which estimate how much the work will cost. In addition the AFE or authorization for expenditure by the operator which requires the Op-com’s approval and the provision for specific requirements regarding contracting and the use of specified accounting procedures by the operator greatly increases the influence of the non operators over the development of joint operations.

Voting on the Op-com is weighted with each representative casting a voting interest equal to the percentage interest in the JOA held by the member he represents. However, these voting rights will be affected by a ‘pass mark’ laid down in the JOA. The pass mark refers to the percentage interest share of votes which must be achieved before a binding decision can be made by the Op-com. The decision over what the pass mark should be is controversial as a low pass mark gives the larger interest holder more influence and a higher pass mark can give the smaller interest holders more control. Usually the final decision on what the pass mark will depend on the negotiation skills and contractual strengths of the parties to the JOA. Furthermore, it is possible to have different pass marks for different types of decisions being made depending on the relative importance of the activities in question. That being said, certain major decisions like relinquishment of the license will be specified as requiring unanimity in the JOA.

Furthermore, in the event where the parties cannot agree on a fundamental decision of policy as to whether to undertake an activity, sole risk and non-consent clauses play an important role in allowing a party autonomy in pursuing or sitting out that activity respectively. A sole risk activity is one which has failed to meet the pass mark required but which the defeated members still wish to go ahead. A non consent activity on the other hand is one which succeeds in meeting the pass mark but where the outvoted minority still elect not to participate in the particular activity. Where a sole risk project or activity is elected to proceed, the sole risk members will bear the entire costs of the operation and will be entitled to any production that should result from the sole risk project. Furthermore the JOA will provide that such activities will be managed by an Op-com composed of only the sole risk members.

Apart from the non operators Op-com’s supervisory role; the major duty they have is to pay pro rata for all expenditure authorised by the Op-com and to contribute pro rata towards any liabilities incurred by the joint operations. Each JOA is constructed on the premise that the burden of financing operations should be shared; as a result all members of a JOA are to provide funds when they are requested under a ‘cash call’. Any failure to comply with this may result in default, and the removal of the defaulting party. The procedure is usually specifically provided for in the JOA through forfeiture clauses. This clause invokes a forfeiture of a defaulting party’s interest in its share of the joint venture if it does not respond to a default notice issued by the operator in the event that payment has not been made after a cash call.

Reasons Why Oil Companies Enter Into Such Agreements

The search for oil has always been fraught with high cost and involved risks, but these costs and challenges facing oil companies have intensified over the years, as discoveries have moved further offshore, into deeper reservoirs and to places that involve much higher risks. The new ultra-deep offshore fields that lie beneath oceans impose even higher costs. This is because as the rigs work in deeper water, they use more steel, new technology and are operated by highly trained and expensive specialists. Apart from high costs of exploration, some of the risks oil companies face include the likelihood of geological risks such as dry holes and technical risks  such as low pressure within a well or challenging geology when trying to access reserves.

In addition, there are more physical risks involved in such oil and gas projects; for instance, the Deep Water Horizon incident involving BP in the Gulf of Mexico. Also, difficult weather, especially hurricanes and tropical storms, can also create a challenging environment and offer potential risks for oil companies. In 2005, Hurricane Katrina delivered an integrated energy shock, by simultaneously disrupting flows of oil, natural gas, and electric power in the Gulf of Mexico. Exploration is also fraught with political risks that could lead to contractual uncertainty and affect investment projects. The UK, Russia, Venezuela and Algeria have all raised their take from oil in the last few years, either by imposing higher taxes or renegotiating contracts while some developing countries have sought to overhaul the terms of contracts entirely. Thus, the use of JOA’s effectively allow IOC’s to share these risks and the costs of capital intensive exploration, development and production activities.

They also facilitate economies of scale and allow for the elimination of duplication of facilities, equipment and personnel. In addition, they allow for the sharing of production advantages in the form of access to technology, supply chain optimization and increased access to resources. Furthermore the choice of a JOA gives the parties the ability to share liability in accordance with each party’s interest share and also allows for added tax incentives when compared to other vehicles such as partnerships and incorporated companies. Finally, the JOA also creates flexibility, as oil companies are able to establish and manage portfolios of assets across the globe, thereby allowing for the minimisation of risks and maximisation of returns.

 

*Noma Garrick is a lawyer and consultant with extensive experience in oil and gas and energy related matters. 

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