During my time as a field landman I never really got the opportunity to see how deals work and how the economics of a deal play out with regards to the party who develops it. In hindsight, that’s unfortunate because it’s some pretty interesting stuff.
I’ve been told that many of the readers of this blog are field landmen, so I thought some background on it might be of some interest to you. Don’t confuse this background information for someone who has stratospheric knowledge about this subject. My exposure to the subject is still woefully inadequate, something I hope to remedy as time goes on.
One of the common methods of taking a promote / carried interest on a play is the “1/3 for 1/4” method. Basically the developer would get three parties to pay 33 1/3% of the total development cost in exchange for a 25% working interest. This will essentially “carry” the developers remaining 25% working interest after 75% has been farmed out. You will often see variations on this to account for the number of partners, such as “1/8 for 1/9”. Most operators will not pay for more than a 15% promote on a deal.
There are many variations on this principle, sometimes the carry is only to ‘casing point’, or other times it might be to the tanks or to the pipeline. These terms all establish what costs the other parties are responsible for paying. If the promoter gets only a carried interest to the casing point, this means that he is responsible for his share of the working interest after drilling. This typically means that the carried interest party is responsible for the costs of completion and all activities thereafter.
Obviously, if interest is carried to the tanks then the carried party is not responsible for for any costs before the production in gathered. In some cases they might responsible for marketing a transportation of the production.
Promotes on Acreage
Some of the more lucrative deals come into play when a developer can afford to acquire a large play, and possibly even prove up some of the acreage (drill productive test wells). Let’s say that Company A has bought leases on wildcat acreage in the Blackacre Project area for $100/acre. For this example let’s assume that the play is 10,000 net mineral acres. The area has good geology and Company A sells a 20% stake in their play to Partner B for $50/net mineral acre. Company A and Partner B don’t operate, so they’ll need to find a partner — let’s call them Operator C. Operator C reviews the data on the acreage and feels like they should drill this area and get some production. So Company A makes a deal with Operator C that goes something like this:
Wildcat Drilling: The process of drilling for oil or natural gas in an unproven area, that has no concrete historic production records and has been unexplored as a site for potential oil and gas output.
Operator C will pay Company A a fee of $100,000 to get into the play, and will agree to drill 3 wells to test for productive acreage. Two of the wells will be vertical and one well will be horizontal. Operator C will receive a 55% working interest in the wellbore of these wells.
After the completion of these commitment wells, Operator C will have the option to purchase a 55% working interest in the entire play for $650/net mineral acre.
So, this will most likely result in one of two possibilities:
The first possibility is that Operator C will exercise their right to purchase a 55% working interest in the Blackacre project area after completion of their commitment wells. In this instance Company A has spent $1mm on bonus payments, and let’s say $200k on lease acquisition costs. In the event that the commitment wells aren’t promising, Operator C may elect to leave the play. In this case Company A has recouped $500k from Partner B, and $100k from Operator C. Covering half of it’s costs. However, this isn’t all they’ve received, they also keep their 80% working interest and have well data to possibly start the process over again with a new operator.
In the event that Operator C elects to purchase the 55% working interest then Company A still has the $500k from Partner B, as well as $6.5mm from Operator C. Now Company A has made this play profitable, and still has a 25% working interest in the production that comes from it.
Now this is obviously only a few simple elements of these types of deals. The operating and participation agreements for these deals aren’t 90+ pages long for no reason. However, this can get you thinking that if you have the right partners (financing, geology, lease acquisition), then with a little luck you can make really profitable things happen.
I’d love to have a conversation about structuring these types of deals, so tell us about your experiences in the comments below!