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Energy & the Law

Operator Can’t Recover Drilling Costs For Affiliate’s Expensive Rig

Posted in Contract Disputes, Operating Agreements

Co-author Alexandra Crawley

In Elm Ridge Exploration Co., LLC v. Engle we are reminded of a little-used provision in the 1989 Model Form Operating Agreement. Article VI.D.1 allows the operator to use its own equipment, but his charges may not exceed prevailing rates in the area, and the rates must be agreed to in writing before drilling commences.

Breach of the JOA?

A New Mexico Operator sued the majority working interest owner/non-operator for recovery of well costs. The AFE for the well specified a 24-hour rig.  The majority owner alleged that Operator breached the Operating Agreement by drilling the well with a more expensive daylight rig of Operator’s affiliate, instead of a 24-hour rig. He claimed that the excess cost of the daylight rig should reduce the amount he owed for his share of well costs.  Use of the daylight rig was without the majority owner’s consent. A 24-hour rig would have cost less to operate than the daylight rig.

Operator argued that the BLM drilling permit would have expired had it waited, leading to an even costlier re-permitting process to finish drilling the well and that by not waiting, Operator saved money.

The Testimony

Operator testified that they were lucky to get the rig they did because another rig was not available. However, he also testified that the permits were satisfied when the Operator spudded some time between October and January, and that an Application for Permit to Drill (“APD”) that was extended to November 2008 meant that Operator had until then to spud the well. Nevertheless, he went ahead and spudded the well in August 2008.

In testimony likely to negatively impact his chances for career advancement, Operator’s district superintendent testified that an APD deadline no longer matters once surface pipe has been set to 250 to 300 feet or, at the very least, the well has been spudded by setting a conductor pipe. Possibly seeking another reason to dust off his resume, he then testified that Operator would initially use smaller rigs (like the one used) on deep wells to put pipe down to 250 or 300 feet to “hold [the] wells, or get them where the permits would be good,” and they could come back later, when a larger rig was available, to finish drilling.  The court noted that 24–hour rigs were available by the beginning of 2009.

The Result

The jury found, and the appellate court agreed, that a reasonably prudent operator would have used the less expensive rig and reduced the defendant’s share of costs by the amount attributable to the breach. Operator was not entitled to judgment for the more expensive rig. The permit would not have been jeopardized by waiting for a less expensive rig. Problem for the non-operator:  Operator was entitled to foreclose because other costs the non-operator failed to pay were justified.

Enough About Extravagance 

My wife and I drink “affordable” wine during the week. That way, when we drink good wine on the weekend we appreciate it more. And so it is with music. Today’s musical interlude is not one but two of the most vapid, lame and treacly musical offerings ever. Quaff a little Phantom 309 and Teen Angel and  you will be blown away by just about any tune you will ever hear from this moment forward.  Don’t laugh. Patches is next.