The Association of International Petroleum Negotiators (AIPN) has a definition of crude oil which is wide enough to include condensates, natural gas liquids and other forms of liquid hydrocarbons. Increasingly, economic and political pressures require the parties to extract as much value as possible from their hydrocarbon reserves, which will likely involve finding a way to produce and market associated natural gas.
This, in turn, will mean that the joint venture will produce not only crude oil but condensates and liquid hydrocarbons, often in the form of one or more liquid petroleum gases such as pentane or butane. Each such product is ultimately going to have its own production train and delivery point, and its own mechanism for transportation and marketing. The condition of the disposition of oil must confirm that the parties’ rights to a pro-rata entitlement of each such product; in reality, the parties are likely to agree to a separate lifting agreement for each such product, setting out an appropriate mechanism for forecasting, nominating and lifting entitlements in each case. There is little point in trying to manage the scheduling of lifting of different products under one common lifting agreement.
There is a practical reason for aligning the conditions of the disposition of crude and natural gas more closely. Most hydrocarbon reservoirs are capable of producing crude oil and natural gas in the association. In fact, crude oil and natural gas production must be managed as part of the single coordinated production strategy in order to manage the decline of reservoir pressure effectively. Furthermore, the global natural gas market has evolved considerably, with the expansion of natural gas pipeline networks, liquefied natural gas liquefaction and re-gasification plants, gas to liquids technology, and other mechanisms of transporting and monetizing natural gas. It is becoming more and more likely that the economic potential of the hydrocarbon reservoir will lie partly in its associated natural gas, as well as its crude oil.
Regardless of the economic value of associated natural gas, its presence in the reservoir sustains the pressure which enables crude oil to be extracted. Unless the natural gas is re-injected into the reservoir, it must be produced, and disposed of; since the 1980s, the option of flaring associated natural gas has been steadily eliminated in order to reduce emissions and enhance energy efficiency. Furthermore, any associated natural gas which is produced and delivered to the natural gas delivery point for lifting by the joint venture parties must be lifted immediately by them; failure to do so may oblige the operator to curtail production both of associated natural gas and crude oil, with significant impact on the parties’ revenues. Natural gas storage is unlikely to be available, and few production facilities are designed to enable natural gas to be recycled back into the reservoir once the gas has been processed and ready for delivery at the delivery point.
Therefore, the joint venture’s strategy for lifting associated natural gas must be absolutely consistent with and complementary to their crude oil lifting strategy. A number of Joint Operating Agreement (JOA) drafting consequences flows from this. The discussion on the disposition of crude oil must make the point that it would be prudent for Parties to agree at least the principles of a crude oil lifting agreement at the time of their investment decision. The features of the disposition of natural gas should provide for the parties to agree with principles of a natural gas balancing agreement prior to their investment decision in respect of a non-associated gas reservoir. If the parties are contemplating developing a reservoir with associated natural gas, it would be doubly prudent for them to agree to lifting principles in relation to crude oil and balancing principles in relation to associated natural gas prior to that investment decision in a coordinated manner. In the context of associated natural gas, there is little point agreeing to the principles for the natural gas balancing agreement at the time of the investment decision whilst leaving the crude oil lifting agreement until six months prior to the first production (Fowler 2018).
The interdependency of associated natural gas and crude oil is also relevant to the choices the parties may make in managing any undertaking of natural gas. The parties will be keen to disincentivize undertaking of natural gas because it is likely to have an immediate negative impact on the operator’s ability to continue production of crude oil. Ironically, associated natural gas may be less valuable, and subject to higher transportation and marketing costs, making it all the less attractive to lift and all the more important that undertaking is minimized.
The subsoil legislation of certain jurisdictions may require the parties to make associated natural gas exclusively available to the state; it does not form part of cost hydrocarbons or profit hydrocarbons and the joint venture parties have no entitlement in respect of it. In such cases, the drafting of the principle of the disposition of production is simpler, enabling crude oil and natural gas lifting to be treated separately under different lifting. However, such cases also pose a significant crude oil production risk for the joint venture parties; any failure by the state to lift associated natural gas may impact almost immediately on the operator’s ability to produce crude oil. It will be in the joint venture parties’ interests to ensure that the state also benefits substantially from its entitlement to crude oil and is aligned with the joint venture parties in taking associated natural gas reliably.
The disposition of the production component of any joint operating agreement must contain more alternatives to choose from than any other article in the agreement. The lifting agreement could also be a pandora’s box of choices. This reflects the difficulty in guessing correctly how to provide for hydrocarbon lifting at the stage of negotiating a JOA. Only in rare cases will it be obvious which choices to make at the outset of the joint venture. Optimistically, it goes some way in encouraging drafters to be realistic in the amount of detail they can expect to agree at the outset of any JOA with respect to lifting procedures, and at the same time cautions drafters against blithely assuming that it is enough to incorporate the lifting agreement by reference, and hope for the best.
A good ‘rule of thumb’ is to negotiate and agree with lifting principles both the crude oil and natural gas as part of the package of agreements that underpin the operating committee decision to develop a discovery, backed up with a commitment to agree fully termed lifting agreements by first oil, starting to negotiate eighteen months before. Even then, parties should be ready to pick their way through the countless issues that will be within the principles of the agreement.