La. R.S. 30:10 otherwise known as Louisiana’s “Risk-Fee Statute” continues to present questions and concerns to oil and gas well operators and non-operators. Recently, an operator contacted one of our attorneys to clarify the risk charges imposed on unit wells and substitute unit wells versus those of alternate unit wells and to clarify differences between an alternate unit well and a substitute unit well. Also, a seasoned oil and gas landman recently asked me about the 2012 revision, specifically who is generally responsible for paying a non-participant’s royalty and overriding royalty. Though I will reserve comment on the fairness of the revision, the prevailing disdain felt by many industry folks is apparent. This article is a follow-up of a paper that Dana Dupre and Cynthia Nicholson of our firm wrote in 2013 for the National Association of Division Order Analysts and explains the basic purpose and application of the Risk-Fee Statute. It also clarifies and expounds on particular parts of the statute and a few related rules that our clients should be sure to know.

The purpose of the Risk-Fee Statute is to allocate the risk and expense of drilling certain wells. In Louisiana, the Commissioner of Conservation has statutory authority to combine, pool or “unitize” mineral rights by creating units comprised of the maximum area of land or deposit of minerals that may be efficiently and economically drained by one well. All persons with the right to drill, produce and appropriate production in the unit are considered “owners” in the unit and have the right to share the production proceeds of the unit well based on their pro-rata ownership share of the mineral rights in the unit. The Commissioner also has authority to designate a unit operator (the “drilling owner” or operator) with exclusive rights to drill the unit well and sell its production. In this context, then, there is often times no contractual relationship between the operator/drilling owner and a non-drilling owner/non-operator in a drilling unit. The Risk-Fee Statute provides a mechanism to compensate the operator for advancing costs, including those owed by non-operators with whom the operator holds no contractual relationship, in the event of a successful well.

Under the Risk-Fee Statute, the operator has the option to send to other owners in the unit a statutory notice offering the opportunity to participate in the risk and expense of drilling the unit well by advancing their pro rata share of the total anticipated cost of the proposed well. Under the statute, the notice must contain:

1. An authorization for expenditure form (AFE) that includes a detailed estimate of the cost of drilling, testing, completing and equipping the proposed well. The AFE must be dated within 120 days of date when the notice is mailed.
2. The proposed location of the unit well.
3. The proposed objective depth of the unit well.
4. An estimate of ownership as a percentage of expected unit size or approximate percentage of well participation.
5. If the proposed well is being drilled at the time of the notice, then a copy of all available logs, core analysis, production data and well test data from the well that has not been made public.

The Risk-Fee Statute does not apply to any owner who elects to participate and pay its pro-rata share of the unit costs. However, when an owner/non-operator elects not to participate or is deemed to be a non-participant in the drilling of the unit well (such as from not timely paying its share of the AFE costs), the Risk-Fee Statute affords the operator the right to recoup from such non-operator’s share of unit production (i) such non-operator’s share of the costs for drilling, testing, completing, equipping and operating the well and of a supervision charge and (ii) a risk-fee calculated at either 100% or 200% (depending on the type of well) times that non-operator’s allocated share of the costs for drilling, testing and completing the well.

(1)        To what wells and how does the Risk-Fee Statute apply?

Since the 2012 revision, it is clear that the Risk-Fee Statute applies to unit wells, substitute unit wells, alternate unit wells and cross-unit wells. A substitute unit well is a unit well that replaces the original unit well. An alternate unit well is an additional well drilled to provide for efficient production in the unit. Finally, a cross-unit well is a well that drains more than one unit. These unit wells are treated differently under the Risk-Fee Statute. Specifically, the risk charge for a unit well, substitute unit well or cross unit well that will serve as either the unit well or a substitute unit well is 200%. But the risk charge for an alternate unit well or cross unit well that will serve as an alternate unit well for the unit is only 100%.

Louisiana statutes and jurisprudence provide little guidance on exactly how to compute these unit costs (except that La. R.S. 30:111 provides that non-participating parties/non-operators “shall not be liable or obligated to pay to the operator or producer for materials furnished or used in the drilling, completion, and production of any oil, gas, or mineral well drilled on said unit a sum in excess of the prevailing market price of such materials”). If parties cannot agree on what are proper unit well costs, the Risk-Fee Statute authorizes the Commissioner of Conservation to “determine” the proper costs after notice to all interested parties and a public hearing. Unfortunately, because these decisions are generally unreported, it is difficult to assess exactly what types of expenses may be recoverable under the Risk-Fee Statute. Practically, then, a general rule for recouping expenses/costs from non-participating parties may be as simple as (1) the expenses must be reasonable and (2) they must be incurred in connection with drilling, testing, completing, equipping and/or operating the unit well.

As an example, assume the following. Operator drills a unit well. Non-operator holds mineral leases covering 25% of the lands within the unit. Operator sends Non-operator the requisite notice to trigger the Risk-Fee Statute. Non-operator receives the notice but elects not to participate. Operator incurs total well costs of $650,000 – consisting of $300,000 in drilling costs, $50,000 in testing costs, $150,000 in completion costs, $50,000 in equipping costs, $50,000 in operating costs and $50,000 in supervision charges. In this example, Operator is entitled to recover from the unit well’s production allocable to Non-operator the total sum of $412,500 (plus additional amounts, further discussed in item (2) below, for royalties and overriding royalties burdening Non-operator’s leases).

(i)         Drilling costs $300,000 x 25%                        =  $75,000

(ii)        Testing costs $50,000 x 25%                          =  $12,500

(iii)       Completion costs $150,000 x 25%                 =  $37,500

(iv)       Equipping costs $50,000 x 25%                     =  $12,500

(v)        Operating costs $50,000 x 25%                      =  $12,500

(vi)       Supervision charges $50,000 x 25%               =  $12,500

(vii)      Risk-fee (items (i)-(iii) above x 2)                   = $250,000

                                                                                      $412,500

(2)        Is the operator really responsible for a non-operator’s royalty and overriding royalty burdens?

Yes. Under the current version of Louisiana’s Risk-Fee Statute, during the recovery of (i) actual reasonable expenditures, (ii) the charge for supervision and (iii) the risk charge, the operator/drilling owner is required to give each non-participating owner/non-operator “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 reflected of record at the time of the well proposal.” Additionally, during this recovery period, the drilling owner is also responsible for the lesser of (i) the non-participating owner’s total percentage of actual relevant overriding royalty burdens 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 within the unit and the non-participating owner’s actual leasehold royalty burdens reflected of record at the time of the well proposal.

Although there is no privity of contract between the drilling owner/operator and the non-participating owner/non-operator’s royalty and overriding royalty interest holders, the statute specifically provides these burden holders with special direct rights of action against the drilling owner/operator, including for statutory penalties under Louisiana Mineral Code articles 137-140. However, under the statute, such rights are triggered only upon written notice to both the drilling owner/operator and the non-participating owner/non-operator. The important thing for operators to remember is that they will be insulated from liability upon sufficient proof that royalties and overriding royalties were paid to the non-participating owner/ non-operator. Additionally, and perhaps more importantly, if the drilling owner/operator fails to pay the burdens and the non-operator makes such payment, the operator/drilling owner may be subject to damages up to double the amount of the royalties due plus interest and attorney fees if, within 30 days after written notice from the non-participating owner/non-operator, the operator has neither paid nor responded with a reasonable cause for non-payment.

(3)        What about unleased owners in the unit?

An operator may recover certain well costs from an unleased owner out of the unleased owner’s share of production proceeds until payout is achieved. But the Risk-Fee Statute is express that, unlike for non-operating mineral lessees who elect to be or are otherwise deemed non-participating parties and thus must bear a risk charge (of 100% or 200%, as applicable), no risk charge of any kind applies to unleased owners.

It is important to know that under certain circumstances as provided in La. R.S. 30:103.1-103.2, an operator may forfeit the right to recoup from the unleased owner any “costs of the drilling operations of the well.” While forfeiture of recovery of drilling costs is a harsh punishment, this forfeiture applies only if each of the following events occurs:

1. The unleased owner sends the operator by certified mail a written request for reports on unit well production and cost information and encloses his name and address; AND
2. the operator fails to provide a sworn, detailed, itemized report on a timely basis, as required under Section 103.1; AND
3. the unleased owner sends the operator by certified mail a further notice calling attention to the operator’s failure to comply with Section 103.1; AND
4. the operator fails or refuses to provide the appropriate reports within thirty (30) days after its receipt of the second notice calling attention to its failure to comply with Section 103.1.

If all of these events occur, then the forfeiture penalty will apply and the operator cannot force the unleased owner to contribute his pro rata share of the costs of the drilling operations of the unit well. Nonetheless, because the forfeiture under Section 103.2 applies only to “the costs of the drilling operations of the well” and because the Risk-Fee Statute distinguishes between drilling costs on the one hand and costs for testing, completing, equipping or operating a well on the other hand, it is arguable (but not yet definitively determined by courts) that the operator may nonetheless retain out of an unleased owner’s share of production such unleased owner’s share of costs for testing, completing, equipping and operating the well.

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These rules and the Risk-Fee Statute continue to spur inquiries and concerns from both unit well operators and non-participating owners alike. In the event you have any specific questions about notice procedures and/or rights or obligations associated with the risks, costs and fees related to a unit well in Louisiana, please contact a Gordon Arata Montgomery Barnett attorney. We are here to help.