Marginal Fields: What happens to the operator when an OML is revoked?

Marginal Oil fields

Word is out that the Federal Government of Nigeria is set to commence a new bid round for the allocation of marginal fields. Thinking about marginal fields, essentially a small area of a wider OML carved out for use by a third party who is brought onto the field under the terms of a farm-out agreement, an interesting topic of discussion is

“What happens to the operator of a marginal field when the OML (oil mining license) relating to the field is revoked by the government”

As ever with legal issues, an inquiry that presents itself as entirely straightforward at first turned out to be rather more “knotty” under closer scrutiny.

First, some important background: Generally, an OML is granted to a lessee to cover a large area of land (or continental shelf, i.e. sea) which has been found, after some prospecting, to contain reservoirs of oil (and sometimes gas) in commercial quantities. The OML entitles its holder to mine such oil/gas reservoirs as are found on the field. However, the oil is unlikely to be evenly distributed across the entire area of land covered by an OML. The commercially viable quantities of oil may be concentrated in a few specific areas of the field while other areas have substantially less or no oil at all. These areas are likely to be ignored by large upstream oil companies who, unremarkably, prefer to concentrate their considerable capital in the areas likely to provide the most bang for each buck. With this in mind, it makes sense to ‘farm out’ areas known as ‘marginal fields’ i.e. those parts of the OML which contain some level of oil (or gas) reserves but have not, for a sustained period of time, been mined by the OML holder.

In Nigeria, areas designated as marginal fields generally have a few common characteristics: (i) they have been unproduced for a period of at least 10 years,
(ii) they have been ignored by the OML holder for at least 3 years for economic or operational reasons (for example, poor infrastructure in the area or low reserves), and/or (iii) they have high gas and low oil reserves.

 

An area of the field may be farmed out as a marginal field in one of two ways:
(x) by the holder of the OML entering, of his own volition, into a farm-out agreement with a third party who will operate the marginal field; or
(y) under certain circumstances, after the President awards the marginal field to the winner of a competitive bid process in relation to the field. Importantly, in both cases, the marginal field operator and the OML holder will enter into a farm-out agreement which governs the commercial terms upon which the farmee (i.e. the marginal field operator) is able to enter upon and mine the marginal field.

 

With this basic understanding of the context we can now consider the question posed at the top of the piece in proper detail. That question, once more, is what would be the fate of a marginal field operator where the holder of the OML over the wider field has its rights revoked? The question is particularly interesting if it is assumed that the operator came onto the field through option (y) above, i.e. it entered a competitive process after an announcement was made for a bid round, was successful with its bid and subsequently received a letter of award from the President in relation to the field, after which a farm-out agreement is entered into between the OML holder and the marginal field operator. The answer to this seemingly simple question lies, logically enough, in a further question “what constitutes the rights of the operator, is it the letter of award or the farm-out agreement?”. As is often the case, two divergent camps quickly emerged with competing answers.

 

The ‘Letter of Award’ camp argue that since the marginal field is ‘allocated’ to the successful bidder by the letter of award, it is this letter of allocation which grants title over the marginal field. In support of their position, proponents point to the fact that the awardee of a marginal field is required to pay a Signature Bonus within 90 days from the date of the award, failing which, the allocation of the field shall be revoked. One might also point to the fact that the OML holder is given no choice but to negotiate the farm-out agreement with the party selected after the bid round to argue that the winner’s rights are derived from the regulatory (bid) process as opposed to the commercial agreement with the OML holder. This argument is only, it seems, bolstered further when one also takes into account the fact that in the case of non-agreement between the parties, the DPR may step in to determine the commercial terms on behalf of both parties. If this argument is correct, the revocation of the OML holder’s rights has no bearing on the operator at all and the operator can simply continue to mine its marginal field irrespective of any shenanigans at the level of its pseudo-landlord, the OML holder. This is because the operator’s rights, under this view, are derived from the letter of award and exist independently of the OML. This is clearly the best case for the operator, but is it the correct one?

 

The ‘Farm-Out agreement’ camp thinks not. This camp argues that the Letter of Award merely indicates to the holder of the OML the person with which it should enter into a farm-out agreement and neither confers rights nor title on the marginal field awardee. In support, they marshal as evidence the fact that the relevant guidelines state that an awardee holds no rights or title in the marginal field until a farm-out agreement is executed with the OML holder. This clearly undermines the view that the letter of award confers rights of ownership on the awardee, a view further damaged by the actual terms of the farm-out agreement which typically contain an express conferment of rights by the OML holder in favour of the marginal field operator. The picture for the operator only darkens when one also considers the fact that the farm-out agreement will, usually, also require periodic payment of royalties to the OML holder (which looks a lot like payment of rent by a tenant to its landlord). Yet more evidence that the farm-out camp’s position is correct may be found in the Petroleum Act which describes the farm-out agreement as conferring exploration and production rights on the marginal field operator during the validity of the OML. That the right of the marginal field operator depends on the continued existence of the rights of the OML holder spells doom for the former in the context of a revocation of the OML, much as a tenant whose landlord has his property expropriated by the government should consider herself to be in a decidedly sticky situation.

 

Ultimately, it will be left to the courts to decide which view is the correct one, although it is clear that a marginal field operator faced with such circumstances will be under a large degree of uncertainty. In situations such as this it is important for advisors to adopt an entirely proactive approach to safeguard the interests of the operator. It may be wise, for example, for the marginal field operator to engage the Department of Petroleum Resources (the oil sector regulator) for confirmation and assurance of its continued rights in respect of the marginal field or, indeed, to seek to turn a potential negative into a positive and position itself as ideally placed to take over operation (and reap the benefits) of the wider OML.

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