Oil and Gas Service Contracts

Oil and Gas Service Contracts

Andrew R. ThomasEnergy Policy CenterLevin College of Urban AffairsCleveland State UniversityOf counsel - Meyers, Roman Friedberg & Lewis

Russell O’RourkeMeyers, Roman Friedberg & Lewis

NBI CLE SeminarCleveland and YoungstownDecember 2013

Agendao I. Introduction

o Service contracting in the oil and gas businesso Trends

o II. Dispute Resolution and Self Help Remedieso Russell O’Rourke – Meyers, Roman et al

o III. Special Problems in Service Contractso Risk Allocation/Indemnification/Insuranceo Subcontracting

o IV. Common Service Contractso Well Serviceso Drillingo Seismic

3

Part I. Introduction Contract Types Common to Industry

o Granting Instruments – grants rights to explore for and produce hydrocarbons

o Transfer of Mineral Rights – purchase and sale, assignments, farm outs

o Joint Ventures – confidentiality, exploration, area of mutual interest, and joint operating agreements

o Service Agreements – contracts for mixture of goods and services usually between producer and technology company.

o Hydrocarbon sales agreements – natural gas agreements tend to be complex.

Economic Potential for the Utica Shale Development in Ohio

4

The Advent of Form Contractso Contracts becoming commonly available

o Trade associations – AIPN, API, AAPG, AAPL, IADC

o Services – Kane’s, Barrow’so Establish perceptions of fairness

o Familiarity biaso Need to know perspective of drafters

o Bias of trade association – IADC drilling contract, Bath lease form, etc.

o Risk -- parties may execute without reading it.

o Can create instead of save worko Risk of superfluous or inapplicable provisions,

creating confusiono Risk of contradictory language, failure to read

entire document to ensure internal consistency.o Tendency to add special provisions at the

end.


5

Age of Complexity in Oil and Gas Contractso Increasingly Risky Operations

o Arctic regionso Tar sands o Deep watero Deep wells, subsalto Horizontal/unconventional wells

o Increasing outsourcingo Shift to more complex chains of

subcontractingo More specializationo Increases problems with managing the

contract

Master Service Agreementso Trends

o Increasing complexityo More and longer subcontracting chains

o 70% subcontracts for typical wello Wilson & Kuszewski study

o More emphasis on social and environmental performance

o Primary Tool for managing contractor responsibility:o The legal contracto Change order policyo Result: focus on relationship between

operator and first tier contractoro But subcontractor problems can become

operator problems


7

Trends For Service Agreementso Challenging operating environmentso Increasing complexity

o Longer contract chainso “knock for knock” (no fault) indemnificationo Indemnification pass through provisionso Dispute resolution provisions

o US - still generally resolved in courtso International – resolved through arbitration

o Local requirementso Environmental – State by State in U.S.o Local Hiring/Social Justice

o Tend to avoid for high risk operationso Not required in US, but desirable


8

Upstream Opportunities for Ohio Industrieso Pad construction – location liners, limestone, pits,

dikes, roads, etc.o Water – for drilling and fracturingo Mud – bentonite and barite clayo Steel pipe (casing)o Cement (conventional cements not acceptable)o Sand – clean, well-sorted 20-40 mesh in particularo Steel tanks, separators, metering equipment,

production equipment, etc.o Compressorso Pipelineso Treatment facilities for NGL’s, water, and impurity

removal


9

Mid and Upstream – Gathering lines


10

Midstream -- Processing Plants


11

Example Service Contract Problem

o Grace Drilling Company enters into a contract to drill onshore prospect for Able Oil Company.

o Grace knows Able is underfinanced, so it prepares a contract that requires payment of day rate one day in advance, or Grace can terminate contract. o However Grace must give written notice of

termination.o Grace drills to 500 feet short of

prospective reservoir when Able stops paying. Grace goes into standby mode pending Able’s next payment.


12

Grace Problem -- continuedo Able spends next five days frantically

trying to raise the money, but cannot. With another drilling job waiting, Grace finally gives up and moves offsite.o But Grace fails to give written notice.

o Able raises the money on sixth day, but Grace has moved to another drill site. Able cannot pay to redrill, and loses the lease.

o Able sues Grace for breach of contract, alleging it was not given written notice of termination.


13

Grace Problem -- continuedo Able seeks, as damages, the cost of the

well ($1 mm) plus the value of the lost reservoir, which it values at $10 mm. o Should Grace have any liability?

o Constructive notice? o Should damages be limited to cost of new

well?o Are lost reserves speculative?

o What if there is a waiver of consequential damages provision?

o If no waiver, should damages be limited to drill costs plus the cost of a new lease?

o What should be results?


14

Part II. Dispute Resolution and Self Help Remedieso Similar to Construction Industry

o Special rules for upstream oil and gaso Midstream?

o Russell O’Rourkeo Myers, Roman, Friedberg & Lewiso Specializes in representation of contractors

and subcontractors involved in the construction industry.

Part III. Special Problems in Service Contracts.o Risk Allocationo Subcontractingo Who is in control?

Allocation of Risk

Risk Management in a Changed World –Rapidly rising costs of insurance

Effects of rise of terrorismMajor events – Capsized PetroBras platform in 2001 consumed 80%of oil and gas casualty insurance

that year.

Insurers hate risk that cannot be quantified!

Importance of Insuranceo Project Financiers require insurance

o Failure to carry insurance usually a default scenario.

o Underinsured project will carry high interest rates on loan.

o Service Contracting is a high risk activity – risk exposure can be very large:o Property or equipment damageo Personal injury or deatho Lost profitso Pollution or environmental problems

18

Insuranceo Minimum insurance coverage by

Contractor:o Worker’s compensationo Commercial general liabilityo Automobile liabilityo Excess liabilityo Vessel/Hull/Protection & Indemnityo Aircraft/Hull/Aircraft Liability

o Insurance Endorsemento Obtain waiver of subrogation in favor of

Company (can’t recover from Company if Company is at fault).

19

Check Listo Types of Risk

o Personal injuryo Property or equipment damageo Pollutiono Third parties

o Rules of Law – Public Policyo Governing law

o Available resources/strategieso Contractual allocation of risko Insuranceo Assumptiono Management

20

Damageso Direct

o Foreseeable, readily predictable.o Liquidated

o Provided for by contract – where damages are difficult to prove

o Intended to replace actual damageso Indirect/Consequential

o Attenuated, unforeseeno But cannot be speculative – must be proven.

o Punitiveo Provided by statute – designed to promote or

discourage behavior.o Separate from Civil or Criminal penalties.

21

Consequential Damageso Types

o Impacts of delay/time of essenceo Lost profitso Lost leasehold/reserveso Lost opportunity

o Waivers o Must be clear

o Sophistication of partieso Boldface, italics, all caps – not boilerplate

o “clear and unequivocal” -- maritimeo “magic words” – Louisiana, TX

o Problem of purchase orderso Public policy issues

o Gross negligence/intentional tort

22

Considerations for Risk Transfero Fair – not equal – distribution of risk

o Should be in proportion to the rewardso No duplication of insurance coverageo Minimal potential for lapses of insurance

coverageo Minimal potential for disputes.o Allocate risks to be insurable.

o Affordableo Available

23

Difficult Negotiation Problemso Allocation of Risk that is difficult to insure

is point of contention.o Biggest issue: pollution

o Treatment of allocation of risk provision as mere “boilerplate” – o Language tends to be over-inclusive and

tortured.o As a result, dismissed by negotiators as

“legalese” and not substantive.

24

Indemnityo One party to the contract promises to

protect the other from some specified event that may occur in the course of contract performance.

o Often will be regardless of the negligence of the either party.

o Usually does not include gross negligence or willful misconduct.o Courts will impose own sense of justice if

unclear

25

Forms of Indemnityo Promise based – usually unnecessary

o E.g. promise to indemnify other party in the event their equipment is not returned.

o Fault based –o Also not legally needed – works by operation

of law. o Cannot be completely avoided.

o Activity basedo Indemnification is based on nature of activity.o Requires some disclaimer of fault.

o Control basedo Based on “care, custody & control”o Requires fault disclaimer to distinguish.

26

Indemnity Form Problemso Fault based indemnity

o Complex fact finding, time intensiveo Uncertain outcomeo Difficult to allocate fault

o Control based indemnityo Designed to reduce expensive litigationo Insurance may be easier to geto In practice – if amount at stake is large, it will

not reduce litigation

27

Indemnity Relationshipso Unilateral

o One party assumes particular risks for certain property or persons

o “cram down”o Reciprocal

o Each party indemnifies the other for a particular risk

o “knock for knock” is exampleo Unbalanced

o One party via contract assumes relatively more risk for a particular circumstance.

Knock for Knock Provisions

o Mutual or reciprocal indemnity.o Mutual hold harmless provisions.o “Bury your own dead” provisions.

o Both parties agree to indemnify the other against claims for injuries or damages that they or their employees sustained regardless of who was at fault or who was negligent.

o Theory:o Party in control is best able to manage risk,

obtain insurance

29

Goal of Knock for Knock Provisionso Help avoid the cost of litigation that

occurs with comparative negligence claims.o Comparative negligence - court determines

the percentage of negligence that applies to each party. Damages based upon their percentage of negligence.

o Knock for knock creates a simple sharing of the risk where each party agrees to be fully responsible for any damages they sustain or that their employees sustain and not look to the other party.

30

Problems with Knock for Knock Provisiono Anti-indemnity Statutes – personal injury

o Jurisdiction – choice of law provisionso Third party claims

o Subcontractors should be defined as not being a third party

o Reintroduces fault – comparative negligence rules apply.

o Pollution is big risk for third party damage.o Relative risk

o Fair to small service company who does minimal work on the well but suffers property damage or employee injury?

o Gross Negligence/Intentional Actso Re-introduces concept of fault

31

Role of Subcontractorso Not a party to contract – not affected by

knock for knock provisions unless they contractually agree.

o Not normally third parties for purposes of control.

o Can be third party beneficiary to indemnity provision.

o Can be part of “group” benefiting from indemnityo Group usually includes:

o Officers, directors, employeeso May include joint venturers, co-owners, non-

operators.

Pass Through Provisionso Goal of Pass Through:

o Contractor requires subcontractor to provide indemnification language that protects the operator.

o Accordingly, contractor’s duty to indemnify operator “passes through” to the subcontractor.

o Absent express language, indemnity provisions will not be interpreted to pass through.o Intent to pass through indemnity obligation

must be clear.o Problem: sub-contractors could be taking on

huge indemnity obligation with small contract

33

Macondo – lessons on k for k


34

Background factso April 20, 2010 explosion on Deepwater

Horizon rig in Gulf of Mexicoo BP hired the rig

o Owned and operated by TransOceano Water depth – 1500 meterso 11/121 workers killedo 4.9 mm bbls spilled in Gulf before July 15

cap put in placeo Parties: BP, Anadarko, TransOcean,

MOEX, Halliburton, Cameron International

35

Application of K for K in Macondo

o Facts: o Failure of cement barrier in production casing.o Deepwater Horizon owned by Transocean and

rented by BPo Halliburton is cement contractor

o Investigation found that BP, Transocean and Halliburton all had varying degrees of fault.

o Parties had Knock for Knock provisions.o Jurisdiction: Admiralty? Texas?

Louisiana?o Venue: Federal Court -- Louisiana

36

Public Policy Issues for the Courtso Anti-Indemnity rules.

o Only personal injury.o Civil Penalties.

o Louisiana Courts: if purpose of penalty is to deter rather than compensate, then k for k does not apply.

o Criminal Penalties. o K for K does not extend to criminal fines

o Gross Negligence allegations. o Louisiana court held that grossly negligent

party can benefit from K for K provisiono Fraud

o Louisiana – can invalidate K for K provision

37

Public Policy Issues for the Courts

o Breach of Contract?o Courts have been reluctant to overturn K for K

provisions based upon breach of contract. o BP argument: Transocean had breached

its contract in a way to materially increase BP’s risk as an indemnitor – thereby voiding the indemnity.

o Louisiana Court: “possible that a breach of a fundamental, core obligation of the contract could invalidate the indemnity clause” - but declined to rule on it.

38

Future of Knock for Knock

o Unlikely to see industry move away from the K for K provisions.

o May start to see Operators insisting on gross negligence carve outs.

Part IV. Common Service Agreementso Drilling Contractso Well Serviceso Seismic Agreements

Drilling Contracts

o API formso Drafted by producers

o IADC formso Favorable to drillerso Advantages

o Readily accepted by drillers o Can get done quickly or if rigs scarceo Not especially unfair to producers

Drilling Contractso Drilling contracts often determine the

commercial success of a venture.o Especially true offshore or in shale

developmento Two types of drilling contracts

o Turnkeyo Driller gets set priceo Driller takes some or all risk for mechanical

failureo Popular with small producers – no cost overrunso But operator cannot escape responsibilityo Less common for risky operations

o Dayworko Paid a “day rate” for operationso Producer at risk for mechanical problems of

other delays, such as weather

Turnkey contracts

o Producer concerns:o Price – tend to be very expensiveo If not – better look at track record of driller

o Problem of underbidding by underfinanced drillero really intend to take no risko Will come back to renegotiate if problem

o May leave producer with unpaid subcontractors

o Driller concerns:o Want a low risk drilling opportunity.o Want to ensure paid enough to cover costs in

the event of mechanical or other problems.o Want producer to pay up front.

Day Work Drilling Contractso Producer’s concerns:

o Low day rates.o Low stand by rates.

o Have to pay stand by fees and fishing company fees – can rack up huge costs quickly.

o Control over drilling and completion activities.o Payment of subcontractors.

o Driller’s concernso Ensuring other drilling opportunities are not

lost during stand by time.o Do not want final decision making authority –

producer must have “company man” on site at all times.

Key Issues in Drilling Contract

o Day Rateo Controlo Indemnification/allocation of risko Consequential damages/limitations in

liability

Day Rate

o This will be area of most negotiationso Controlled by market conditionso Producer can best control price with

ongoing relationship, multiple well program.

o Stand by rates also subject to negotiation.

Control Over Operations

o General rule: producer has control over operations in a day work contract.

o Producer has “company man” on site at drilling operations.o Commonly these are drilling field hands with

years of experience, but not engineers.o Company man has little to no authority given

to him by producing company.o Producer will distance itself from control

if problems arise.o Argue that the driller and its subcontractors

are the experts in using their own equipment.o Often unclear what has gone wrong down

hole.

Allocation of Risk Issues

o Goal:o Dovetail insurance protection with indemnity

protection.o Avoid duplication of insurance coverage.o Avoid holes in insurance coverage.

o Minimize problems:o Name indemnified parties as additional

insured.o Require subcontractors to carry insurance.o Require notice of cancellation of policies to be

made to each party.

Limiting Liabilityo Driller will insist on this.

o Do not want to take on $20 million in potential liability for a $250,000 job.

o But Producer wants full recourse if something goes wrong leading to worst case scenarios:o a damaged reservoir or lost lease.

o Usual result: waiver of consequential damage clause.o Needs to be brought to attention of parties.o Will not apply for “gross negligence.”o Some judges say degree of negligence is a

jury issue.

Well Services Form Contract

o Contractor’s Rights & Responsibilitieso Independent Contractor status. Why do

parties want this?o “Neither Company nor Contractor shall have

direction or control of the employees of the other party.”

o “Contractor, as an independent contractor, shall have complete control over the manner and performance of its operations”

o Instruction and Direction. “Company may instruct Contractor from time to time as the results obtained from the work.”o But not the means to how to do the work. Will

this distance Company from control?

50

Representativeso Contractor and Company each have

representative on site.o Authority to settle disputes – unless there

is no authority to settle disputes.o How does this change anything?

51

Liabilities & Indemnificationso Knock for Knock.o Third parties.

o Fault based. How different from operation of law?

o Special risk.o Company pays for fishing, regardless of cause

o “Wild Well” -- Company assumes risko Reservoir -- Company assumes risk of

reservoir damage.o Pollution

o Company liable if from own equipment “regardless of cause. Contractor or its own.

o Spills from material for company use is company liability, for contractor use, contractor liability.

52

Liabilitieso Company must retrieve NORM

contaminated downhole equipment.o Company liable for injury due to handling

contaminated equipment regardless of fault.

o Consequential damageso Neither party entitled to

Seismic Data Acquisition Agreements

o Fewer problems with indemnity/limitations in liability.o But seismic company will limit the warranty on

accuracy of the data, and limit liability.o Exclusivity of license is key point of

negotiation.o “Spec” data will be available to be sold to

other parties. o Contract data will have exclusive license for

producer for a period of time.o Producer needs to have broad rights to use

data – including showing it to contractors and national oil companies.


54

Other Areas of Interesto Who owns the data?

o When is title transferred?o Warranties?

o Workman like acquisition and processing.o No warranty of accuracy!

o Control over data.o No inadvertent disclosure.

o If Company owns, what can it do with it?o Resell it?o Make it publicly available?o Reprocess it?

o Who is responsible for keeping original data?

CSU Energy Policy Center

Andrew R. Thomas [email protected]

Thank you!

mailto:[email protected]

Documents

Oil and Gas Service Contracts