January 30, 2013 Articles

Recent Changes to the Louisiana Risk-Fee Statute: Selected Issues

The Louisiana legislature recently amended the drilling statute to include several key changes.

By Dana E. Dupre and Sara E. Mouledoux – January 30, 2013

In Louisiana, the commissioner of conservation has the statutory authority to combine or “pool” mineral interests to create a drilling unit—the maximum area of land or deposit of minerals that may be efficiently and economically drained by one well. By default, all the “owners” in the unit, defined as persons with the right to drill, produce, and appropriate production in the unit, share the proceeds of the unit well based upon their pro-rata ownership share of the minerals within the unit. The commissioner also has the authority to designate a unit operator or “drilling owner,” who has the exclusive right to drill a unit well and sell unit production. When there is no contractual relationship between a “drilling” owner and a “non-drilling” owner in a drilling unit formed by the commissioner, the provisions contained in the Risk Fee Statute (La. R.S. § 30:10) allocate the risk and expense of drilling certain unit wells.

Under the Risk Fee Statute, a drilling owner has the option to send a notice offering other owners in the unit the opportunity to participate in drilling a unit well. The non-drilling owners are sent an estimate of the total cost of the proposed well (an “authorization for expenditure” or “AFE”) and given the opportunity to pay their pro-rata share of the costs. When a non-drilling owner receives such a notice and elects not to participate or is deemed to be a non-participant in the drilling of the unit well, the drilling owner may recoup the costs to be borne by the non-drilling owner from the non-drilling owner’s share of unit production, plus a risk fee of 200 percent (or in some cases, 100 percent) of the drilling owner’s allocated share of the cost of drilling, testing, and completing the unit well.

The Risk Fee Statute thus provides a mechanism to compensate the drilling owner for advancing the non-drilling owner’s share of the costs of a successful well. Given its oil and gas history and the development of recent shale plays, Louisiana is a legislative leader in this area, and many states watch changes to Louisiana’s Risk Fee Statute with interest, especially in light of the growing development of shale plays throughout the country.

On June 6, 2012, the Louisiana legislature amended the Risk Fee Statute to include the following key changes:

  • making alternate unit wells and cross-unit wells subject to the statute
  • requiring the notice contain a detailed AFE and estimate of a non-drilling owner’s percentage interest in the unit
  • requiring that the notice be sent before “the actual spudding” of a well
  • allowing delivery of notice and response by registered mail or other form of guaranteed delivery and notification method
  • requiring a participating party to pay drilling costs within 60 days of spudding the well
  • requiring a drilling owner to pay to a non-participating party (even during recovery of the risk fee) a portion of the proceeds of production sufficient to cover any lease royalties or overriding royalties owed by the non-participating owner for that production, with some limitations
  • providing for damages and attorney fees against a drilling owner in the event the drilling owner fails to pay non-participants the required royalty and overriding burdens

Because the legislature did not provide a specific effective date for the amendment, the default effective date was August 1, 2012. It is unclear, however, whether these changes will apply retroactively. The amendment does not expressly provide for retroactive application, and the changes are substantive—as opposed to procedural or interpretive—and may affect vested rights; thus, it should arguably apply only to wells drilled after August 1, 2012.

What Wells Are Eligible?
The Risk Fee Statute applies to unit wells or substitute unit wells (which replace original unit wells), alternate wells (where more than one unit well is needed for efficient production), and cross-unit wells (when a unit well drains more than one unit) in commissioner-formed units. Whereas previously there was some question as to whether the statute applied to certain wells, the amendment expressly makes alternate wells and cross-unit wells eligible.

Who May Use the Risk Fee Statute?
Under the statute, an “owner” may offer other “owners” the option to elect to participate in the cost, risk, and expense of drilling a unit well. The term “owner” is broadly defined as “the person, including operators and producers acting on behalf of the person, who has or had the right to drill into and to produce from a pool and to appropriate the production either for himself or for others.”

Importantly, the statute only affects third parties with whom the drilling owner has no contractual relationship or other cost-sharing agreement in place, and it cannot modify or change the rights and obligations under any contract between or among owners. Additionally, the risk-fee penalty provisions (described herein) do not apply to any owner not subject to an oil, gas, and mineral lease.

What Is Considered Effective Notice?
To trigger the Risk Fee Statute, the drilling owner must send notice, by registered mail, return receipt requested, or some “other form of guaranteed delivery and notification method” to all other owners in the unit of the drilling or the intent to drill and give each owner an opportunity to elect to participate in the risk and expense of the well. Thus, the amendment expanded delivery options to presumably allow delivery by private carriers such as FedEx or UPS, but expressly prohibits notice by “electronic communication or mail.”

A drilling owner must send notice to all owners of record as of the date of notice, meaning that the drilling owner has the obligation to perform at least some title work before spudding the well. The notice must contain:

  • an AFE that shall include a detailed estimate of the cost of drilling, testing, completing, and equipping the proposed well, and that should be dated within 120 days of the date of mailing of the notice;
  • the proposed location of the well;
  • the proposed objective depth of the well;
  • an estimate of ownership as a percentage of expected unit size or approximate percentage of well participation; and
  • if the well is being drilled or is drilled at the time of notice, all logs, core analysis, production data, and test data from the well that has not been made public.

The notice must be sent “prior to the actual spudding” of a well if the unit is in place on the spud date and within 60 days of the “date of the order” creating the unit if the unit is created during or after drilling. Likewise, if the unit is revised to include an additional tract or tracts after drilling, then the notice is required to be sent within 60 days of the “date of the order” revising the unit. If drilling of the proposed well is not commenced within 90 days after receipt of the initial notice, supplemental notice is required, meaning a drilling owner must again comply with the full notice requirements under the statute.

There is some question as to whether a drilling owner can send notice before the commissioner has formally designated the well as a unit, substitute, or alternate well. Based on Jones Energy Co., LLC v. Chesapeake Louisiana, L.P., F. Supp.2d ___, 2012 WL 1981931 (W.D. La. June 1, 2012), which held that the Risk Fee Statute is to be liberally construed in favor of the drilling owner, it seems likely that a court could find substantial compliance with the notice requirements sufficient under the statute.

What Must an Owner Do to Participate?
An owner electing to participate in a unit well must notify the drilling owner in writing, by registered mail, return receipt requested, or some “other form of guaranteed delivery and notification method” within 30 days of its receipt of notice. Failure to give timely written response shall be deemed an election not to participate.

What Are a Participating Owner’s Obligations for Well Costs?
An owner who chooses to participate is obligated to pay its share of drilling costs, as determined by the AFE, within 60 days of the spudding of the well. Likewise, any “subsequent drilling, completion and operating expenses” have to be paid within 60 days of receipt of detailed invoices, to avoid being deemed a non-participating owner.

What Is the Penalty for Non-Participation?
If a non-drilling owner elects not to participate or is deemed a non-participant, he or she is subject to a risk-fee penalty. The risk charge for a unit well, a substitute unit well,or a cross-unit well that will act as the unit well or the substitute well for the unit is 200 percent of an owner’s allocated share of the cost of drilling, testing, and completing the well, exclusive of amounts the drilling owner remits to the nonparticipating owner for the benefit of the nonparticipating owner’s royalty and overriding royalty owner (explained in more detail below). The risk charge for an alternate unit well or cross-unit well that will act as an alternate unit well for the unit is 100 percent of an owner’s allocated share of the cost of drilling, testing, and completing such well, exclusive of amounts the drilling owner remits to the nonparticipating owner for the benefit of the nonparticipating owner’s royalty and overriding royalty owner. These charges supplement the right of the drilling party to recoup 100 percent of drilling, testing, completing, equipping, and operating costs.

Example calculation:

Assume (a) a drilling owner drills a unit well in the unit; (b) the owner of a mineral lease with 50 percent unit participation receives due notice under the statute but elects not to participate; and (c) the drilling owner incurs total well costs of $525,000, broken down as follows: drilling costs of $200,000; testing costs of $50,000; completing costs of $150,000; equipping costs of $50,000; supervision charge of $50,000; and operating costs (until all of such costs had been recovered out of production) equaling $25,000.

In the above example, the drilling owner would be entitled to recover production allocable to the non-participating owner in the sum of $662,500 as broken down below:

Costs to non-participating owner:

  • i. Drilling costs: $200,000 × 50%           = $100,000
  • ii. Testing costs: $50,000 × 50%             = $ 25,000
  • iii. Completing costs: $150,000 × 50%    = $ 75,000
  • iv. Equipping costs: $50,000 × 50%        = $ 25,000
  • v. Supervision charge: $50,000 × 50%    = $ 25,000
  • vi. Operating costs: $25,000 × 50%         = $ 12,500
  • vii. Risk charge                                          = $ 400,000

                                               ((total of i, ii, and iii above × 2) = $400,000)                                                                                                           $662,500

Note: The risk charge is 200 percent of the tract’s allocated share of the cost of drilling, testing, and completing the well.

Who Pays Non-Participant’s Royalty Burdens During Recovery Period? 
Under the previous version of the statute, a non-participant was at all times solely responsible for its lessors’ royalties and any overriding royalties carved out of its working interest; a drilling owner had no responsibility for these burdens.

With the amendment, drilling owners are now required to give non-participants “that portion of production due to the lessor royalty owner under the terms of the contract or agreement creating the royalty between the royalty owner and the non-participating owner’s reflected of record at the time of the well proposal” during the recovery period. The statute defines the recovery period as the time period for “the recovery of the actual reasonable expenditures incurred in drilling, testing, completing, equipping, and operating the well, the charge for supervision, and the risk charge . . .”

With respect to overriding royalties, a drilling owner must now provide to the non-participant during the recovery period (again, for the benefit of the overriding royalty holder), the lesser of:

(I) the non-participating owner’s total percentage of actual overriding royalty burdens associated with the existing lease or leases which cover each tract attributed to the non-participating owner reflected of record at the time of the well proposal; or (II) the difference between the weighted average percentage of the total actual royalty and overriding royalty burdens of the drilling owner’s leasehold interest within the unit and the non-participating owner’s actual leasehold royalty burdens reflected of record at the time of the well proposal.

Importantly, the overriding royalty calculation in II above incorporates only the “non-participating owner’s actual leasehold royalty burdens,” not his or her cumulative royalty and overriding royalty burdens. Note also, that if the overriding royalties attributable to a non-participant exceeds the lesser of the two calculation options noted in the statute, the non-participant is responsible for that remainder override.

What Types of Production Data Must a Drilling Owner Provide?
A drilling owner must also provide non-participants all of the information required under La. Rev. Stat. § 31:212.31 including:

  • lease identification number, if any, or reference to appropriate agreement with identification of the well or unit from which production is attributed;
  • month and year of sales or purchases included in the payment;
  • total barrels of crude oil or MCF of gas purchased;
  • owner’s final realizable price per barrel or MCF;
  • total amount of severance and other production taxes, with the exception of windfall profit tax;
  • net value of total sales from the property after taxes are deducted;
  • interest owner’s interest, expressed as a decimal fraction, in production from the check stub;
  • interest owner’s share of the total value of sales prior to any tax deductions; and
  • interest owner’s share of the sales value less his or her share of the production and severance taxes, as applicable.

What Rights Does a Royalty Owner Have Against a Drilling Owner?
There is no contractual privity between the non-participating owner’s royalty and overriding royalty holders and the drilling owner; however, the amendment specifically provides these burden holders with special direct rights of action against the drilling owner. Specifically, royalty and overriding royalty owners may now seek remedies under Louisiana Mineral Code Articles 133–44 (La. R.S. §§ 31:133–44) relating to termination of mineral leases and Articles 212.21–23 (La. R.S. §§ 31: 212.21–23) relating to royalty payments. Such rights are triggered only upon written notice to both the non-participating owner and drilling owner, and a drilling owner will be insulated from liability upon sufficient proof that royalties and overriding royalties were paid to the non-participating owner.

Notwithstanding these new rights of action, the non-participating owner remains directly responsible to its royalty and overriding royalty holders, and such holders may still seek recovery from the non-participating owner. It is unclear how this new procedure will apply in practice or be interpreted by the courts.

What Rights Does a Non-Participant Have Against a Drilling Owner for Nonpayment?
The amendment added a new provision permitting a non-participant a cause of action against a drilling owner for non-payment of royalty and overriding royalty burdens. In the event (i) the drilling owner fails to pay the burdens and (ii) the non-participant makes such payment and (iii) after written notice, the drilling owner either has not paid within 30 days after receipt of notice or responded with reasonable cause for nonpayment, the drilling owner will be subject to damages double the amount of royalties due, interest, and reasonable attorney fees.

What Is the Relationship Between a Drilling Owner and an Owner Not Notified? 
A risk charge may not be assessed against an “un-notified owner,” but the drilling owner can still recover from production the un-notified owner’s allocated share of actual reasonable expenditures incurred in the drilling, testing, completing, equipping, and operating the well. A drilling owner cannot, however, avoid payment of an un-notified owner’s royalty burdens by foregoing the risk-fee charge. The amendment requires that the “participating owner” (and uses this term instead of the term “drilling owner”) pay the un-notified owner “the proceeds attributable to his royalty and overriding royalty burdens as described in this Section.”

Keywords: energy litigation, exploration and production, mineral receivership, drilling, shale

Dana E. Dupre is an associate in the New Orleans, Louisiana, office of Gordon, Arata, McCollam, Duplantis & Eagan, LLC, and Sara E. Mouledoux is a member in the firm's Houston, Texas, office.

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