593 TEPCO, L.L.C. v. Reef Exploration, L.P., 485 S.W.3d 557 (Tex. App.—Houston [14th Dist.] 2016, no pet.)

Tuesday, December 6th, 2016

Richard F. Brown

The following is not a legal opinion. You should consult your attorney if the case may be of significance to you.

TEPCO, L.L.C. v. Reef Exploration, L.P., 485 S.W.3d 557 (Tex. App.—Houston [14th Dist.] 2016, no pet.). (Subsequent operations under JOA) held that the Wellbore Charges for reworking a well for completion in a more shallow area were subject to a recoupment calculation for non-participating parties, because the reworking was a Subsequent Operation and was specifically included in the recoupment clause of the Joint Operating Agreement (JOA). All parties were subject to a joint operating agreement (“JOA”). Some parties wanted to drill a deep well and some did not, but it was anticipated that the wellbore of the potential deep well might be taken over for a completion in a known shallow zone. A JOA to test the deeper zones was executed (“Deep JOA”) making the original JOA the “Shallow JOA.” The Deep JOA had a clause requiring participants in a shallow completion to reimburse the deep well participants for part of the drilling costs (“Wellbore Charge”), if the wellbore was taken over to be used in the shallow completion. The Deep JOA provided that any shallow well participants “shall reimburse the owners of the rights below 14,600′ who participated in drilling the well for a proportionate share of said drilling costs.” The attempt at a deep well was a dry hole. It was eventually agreed that the Wellbore Charge was $6,000,000. A successful shallow well was completed, and the parties who participated in the deep well dry hole were paid the Wellbore Charge.

Some of the parties did not participate in the shallow well completion (“Non-Consenting Parties”). Article VI.B.2 of the Shallow JOA included a 600% cost recoupment factor (non-consent penalty) for Non-Consenting Parties which applied to “that portion of the costs and expenses of drilling, reworking, deepening, plugging back, testing and completing . . . and . . . that portion of the cost of newly acquired equipment in the well . . ., which would have been chargeable to such Non-Consenting Party if it had participated therein.” The operator under the Shallow JOA included the $6,000,000 Wellbore Charge in the charges subject to the 600% non-consent penalty for the Non-Consenting Parties. The key issue was whether under the Shallow JOA and the Deep JOA the 600% non-consent penalty should be applied to the $6,000,000 Wellbore Charge for purposes of determining payout.

The issue was apparently fought out in the trial court on the question of whether or not the Wellbore Charge was a “drilling” cost, but it was also admitted that the shallow well completion was a subsequent operation under the Shallow JOA. On appeal, the Non-Consenting Parties challenged the trial court’s ruling that was based on language in the Deep JOA and the characterization of the Wellbore Charge as a “drilling” cost. However, the court’s opinion and analysis assumed without deciding that the Wellbore Charge was not a drilling cost and focused solely on the language in the Shallow JOA. It defines a “Subsequent Operation” in Article VI.B. as either (1) the drilling of a well on the contract area other than the well provided in VI.A. of the Shallow JOA, or (2) the reworking, deepening, or plugging back of a dry hole drilled at the joint expense of all parties and not then producing or capable of producing in paying quantities. If the completion did not involve “drilling” a well, but the operation was proposed under Article VI.B, then it must have been the reworking of a well. Additionally, the notice of proposed operations included the Wellbore Charge, and the Wellbore Charge should be included in calculating payout.

The case is narrow in that it is a contract construction case involving the construction of two separate JOAs. However, in construing the very common Subsequent Operations clause, the opinion broadly concludes that doing something in an existing wellbore that is not “drilling” must be “reworking” the well, although arguably the operation was a completion. The opinion does not discuss whether the deep dry hole was “drilled at the joint expense of all parties” as required by Article VI.B.2.