After oil and gas lease agreements, the Joint Operating Agreement (JOA) is the most common contract used in the industry. JOAs are agreements between two or more entities that spell out who is considered the operator for the exploration and production work and the way revenue is to be split among the members of the JOA among other things.
Joint operating agreements are popular because they provide a way to spread the risk of exploration and drilling. However, they can become complex rather quickly, and everyone involved should perform due diligence before signing. You must understand exactly what the agreement means for you.
Defining a Joint Operating Agreement
A joint operating agreement, typically designated as JOA, is a contract between two or more mineral interests that collaborate on a gas or oil lease to share resources and expertise. The contract governs a joint venture between those who sign the agreement while allowing each company to retain its own identity.
A JOA is not the same as a merger. The signatories remain separate companies that agree to work together according to a set of rules.
- One entity is classified as the operator. The operator has a working investment in the lease and bears the most impact by the terms and conditions of the JOA. The operator is responsible for all E&P activities on the lease.
- All other entities in the agreement are classified as non-operators. They are not responsible for E&P activities but are still associated with the operator. Non-operators include investors, financial institutions, or other entities.
- There are several common joint operating agreements available from various organizations, such as the American Association of Petroleum Landmen 610 (AAPL) and the Association of International Petroleum Negotiators 2002 (AIPN).
- There are many common terms between JOAs that provide guidance in the various business activities and interests of those brought together by the agreement. Terms include “duration of the agreement,” “parties participating interest,” “scope of work,” “designated operator,” and “dispute resolution.”
The operator has control of all operations as established by the JOA. The non-operators retain only indirect control of operations. They may vote on future operations, elect whether or not to consent to an operation, and have some inspection rights.
The most commonly used JOA is Form 610, mentioned above, which is curated and published by the AAPL. Other JOAs are available but may be designed for specific situations.
Using Joint Operating Agreements
Ownership of the oil and gas property may be shared by multiple owners. The owners execute oil and gas leases among multiple lessees. The lessees now own the leasehold estate in “undivided fractional shares.” The lessees may then assign undivided fractional shares of their leases to third parties. Suddenly, multiple companies and individuals are involved with a single oil or gas estate.
As you can see, it gets complicated fast. Without a contract stating how everything will be administered and how revenue is shared, the risk grows for each non-contracted partner. This type of arrangement has been termed the co-tenant problem.
- There is no agreement about the rights and obligations co-tenants owe each other in their exploration and development activities.
- In Texas, for example, any co-tenant may develop and produce minerals without the consent of other co-tenants.
- The risk is borne by the operating co-tenant alone, but there is no clarity around the costs the operator is entitled to recover from the other “non-operating” co-tenants.
- The lease agreements govern the size of each interest share from production but say nothing about operating costs.
Companies use joint operating agreements to legally assign and assess rights and obligations among the assignees of the JOA. The JOA provides a structure for mining operations and revenue sharing. Each entity under the contract also shares the risk of the venture so that no single company or individual bears the entire burden.
The Benefits of a Joint Operating Agreement
As mentioned above, the primary benefit of a JOA is the protection it provides to those under contract. Not only is the liability and risk shared, but the details of operations and profit and revenue sharing are also specified. Each co-tenant in the contract has specific obligations and rights under the contract.
- Form 610 “establishes the contractual basis for multiple leasehold co-tenants to operate a property, jointly share costs and liabilities, and own equipment and production in proportion to their respective percentage of the ownership and burdens.”
- It sets out terms and conditions for the entity classified as the operator to perform operations.
- The contract states how interests of the various parties are calculated.
- It shows how title examination and title issues are handled.
- It may even cover issues related to future acquisitions or dispositions within the contract area.
The rights and obligations of each co-tenant, the operator and the non-operators, are clearly delineated.
Risk Associated with a Joint Operating Agreement
The primary risk of entering into a joint operating agreement occurs when a co-tenant does not fully understand the agreement. An example from the Landman Blog provides an example of what can happen when a co-tenant hasn’t performed due diligence before signing. We invented company names to make it easier to track.
- The oil company PetrolAssets and the oil company GreaseMonkey enter into a JOA.
- PetrolAssets is named operator and GreaseMonkey is classified as a non-operator.
- Each company is assigned 50% working interest minus one-fourth landowner royalty. (Each would then receive about 37.5% after royalties.)
- The JOA also states that the interest of each party in cost and production is 25% and a non-consent penalty is applied at 400%.
After the JOA is signed, GreaseMonkey assigns a third party, RevenueBoom, a royalty interest of 2% out of its share of the interest according to the terms of the JOA. PetrolAssets proposes a new well on the shared lease, but GreaseMonkey decides to non-consent.
Because the third party’s agreement is with GreaseMonkey, PetrolAssets has no obligation to pay RevenueBoom any share of revenues from the new well. In other words, because:
- RevenueBoom did a deal with GreaseMonkey instead of becoming part of the JOA, and
- GreaseMonkey did not consent to the new well,
- PetrolAssets assumes all the risk and claims all the reward for the new well until it has recovered 400% of all the costs and expenses of drilling the new well. (Remember that non-consent penalty?)
- GreaseMonkey, and subsequently RevenueBoom, get nothing until then.
The best practice with any joint operating agreement is to consult an attorney experienced with joint operating agreements and the oil and gas industry. If RevenueBoom had performed the proper due diligence, its attorney could have pointed out the shortcomings of contracting for a share from a single partner in a JOA.
Joint operating agreements make it possible to pool resources and spread risk. They also guide how the joint operation pays out revenue and profits. In the high-dollar and complex world of gas and oil exploration and production, a contract is a crucial element in protecting all concerned. However, each party must perform due diligence with any contract to protect their own interests.