What is a Production Sharing Agreement? What does it mean?
You walk to your mailbox and find a large envelope from the operator of your units. You open it with excitement! Maybe it’s a division order! Unfortunately, it’s only a long agreement with the heading “Production Sharing Agreement” (PSA). What does this mean for your mineral interest? Are you about to share your production with someone else in another unit? Does this mean you’re getting less of what’s owed to you? If you sign this will the operator will come drill a well on your property? These are all legitimate questions.
As mineral owners ourselves, Revere receives many PSAs, also known as “Allocated Well Agreements”. We also help people who have sold us a portion of their mineral rights when they call and ask what they should do. To understand a production sharing agreement, we have to first understand where drilling technology was and where it is going.
During the first few years that operators drilled horizontal wells, when landowners signed a lease, operators were limited by how far they could efficiently and safely drill horizontally. Normally, all wells drilled within a unit were drilled under the originally formed unit designation. Rarely did operators drill outside originally planned unit configurations. We remember the days when a 3,000-foot lateral was an impressive accomplishment for an operator!
However, as time passed, operators improved their ability to safely drill longer laterals. This is a good thing for several reasons. For starters, operators can do more with less. Drilling a well 2x the lateral distance does not result in the well costing 2x as much. It only increases the well cost by 20% and can allow the operators to recover twice as much. This is essential with oil stuck in the $45 - $60 range.
We can hear you asking “Okay, I get what you’re saying… but what does that really mean for me?”
It means since operators are being forced to stretch their capital further, they will try to find ways to drill more efficiently, regardless of historical drilling unit outlines. This means when they drill longer laterals that pool acreage outside your unit, your division of interest will change.
“But doesn’t that mean that I’m now giving a portion of my production to another unit? How can I trust that the operator is paying me correctly for the portion of the lateral in my unit?” We hear these questions, and you’re not the only one asking. So let’s take them in order:
“Am I giving up production to another mineral right owner?”
Operators are meticulously detailed when allocating each lateral’s unit-by-unit participation factor. You can feel confident an operator is paying you accordingly for how much each lateral participates. For example, let’s say you have a 0.01 DOI in one 5,000’ lateral. If an operator drills a 10,000’ lateral that falls half in your unit and half in another unit, then your DOI would change by (5,000/10,000) = 50%. Your new DOI would be 0.01 * 50% = 0.005. That might seem like a rip-off, but remember that the operator thinks the new 10,000’ lateral will produce 2x as much oil as the 5,000’ lateral, so you really break even.
Rest assured that Revere maps and checks every allocated well to confirm operators doing what they’ve promised. To date, we’ve haven’t found any inconsistencies with any operator – and we work with almost all of them. We are happy to talk to you about any allocation calculations that you have.
“Okay, but why don’t they just continue to drill how they were?”
We get this a lot too. However, we have seen operators land laterals in portions of units that previously would have been untapped due to odd unit configurations. This is good for all mineral owners. Operators are ignoring original unit configurations and instead focusing on getting all the oil out of the ground.
We have also seen operators recently start to work together to drill units that touch each other. This means that wells that previously couldn’t be drilled now can be drilled. It also means that an operator who is running a lower rig count can be carried by a fellow operator, so you potentially may get a well sooner than previously assumed.
We say in the above paragraph that there is only the “potential” they may drill a well sooner. Sadly, one thing you will not find in a PSA is a commitment to when they will come back and drill on your unit. Operators are unwilling to lock themselves into drilling commitments outside of a lease’s continuous drilling clause, which is typically only given to large ranches and contiguous mineral rights holders.
“So why should I sign this if they aren’t going to drill a well on my property anytime soon?
We struggle with this as well because we want the operator to commit to drilling our units sooner rather than later. It’s not always a bad thing that they do not. Certain areas pose certain complexities and operators often go ahead and get all the production sharing agreements ahead of time. This allows them to accurately plan how they will return and drill on your unit and all units in the area. Not signing a PSA will impede an operator’s plans to drill a certain area. This is often why operators start trying to get PSAs in place 1-3 years before they drill the wells.
Revere also wants to note that signing a production sharing agreement doesn’t guarantee an operator will drill longer laterals. Operators are tasked with developing the acreage in the most efficient way possible. Subsurface faults and myriad other issues can cause an operator to not pursue longer laterals. That said, since they plan on developing their resources as efficiently as possible, most likely their interests are completely aligned with yours.
At the end of the day, PSAs aren’t a bad thing. Revere, like every mineral rights owner, hopes that every operator develops acreage efficiently, which translates to us being able to pay you more for your mineral rights. If you have any questions or have an agreement you’d like to discuss, we welcome you to call us. Regardless if you want to sell to us, we will gladly use our years of expertise and staff to help you understand what is in front of you.