It has been generally accepted that acquiring wellbore-only interests as a Non-Operator is considered a relatively low-risk investment. In fact, many groups view such acquisitions as an entry point due to the perceived lower barrier to entrance and lack of operational concerns in the acquisition process. Acquiring wellbore-only interests requires the Non-Operator to navigate certain legal and financial considerations. In particular, it is crucial that the Non-Operator perform thorough due diligence and understand the defect mechanisms and the protections offered by the seller’s representations and warranties under the Purchase and Sale Agreement (“PSA”), as doing so will enable the Non-Operator to mitigate the risks and maximize the value derived from their wellbore interest.

As a quick recap, when a Non-Operator purchases a wellbore, they acquire only the rights to future production out of that single wellbore. If that well is plugged and abandoned, the Non-Operator’s interest ends. There is no transfer of mineral interest and no right granted to participate in drilling future wells. This is the simplest type and form of this transaction.

The due diligence process ensures that the buyer fully understands the value and limitations of the asset, identifies any potential liabilities, and verifies the accuracy of the seller’s representations. Here, the buyer should analyze the historical production data of the Operator and the area to assess the well’s performance, decline rates, and future production potential. The buyer should also examine the reservoir’s geological characteristics, such as the reservoir’s pressure, porosity, permeability, and fluid properties, all of which impact the well’s productivity and longevity. This will involve careful attention to historical permits and other information available to the relevant regulatory authority.

 Moreover, the Non-Operator should consider certain operational and financial questions: What is the condition of the proposed wellbore?  Is the proposed wellbore to be operated by an experienced, credible, and financially dependable Operator? What are the anticipated operating costs and revenues and is there a Joint Operating Agreement (“JOA”) in place covering the proposed wellbore? What are the economic risks and areas of potential exposure? Have certain costs been already paid by the Operator and will those be excluded from operating expenses due and owing under the JOA? As always, past performance is not a sure indication of future results, and an Operator’s reputation will be a key determination.

Once due diligence is complete, the Non-Operator can move to the PSA, which should include detailed defect mechanisms to protect the buyer’s interests. These mechanisms are crucial, as the buyer is entitled only to production from or attributable to the acquired well’s wellbore, with all interests outside of the wellbore and deeper depths being excluded.

 The PSA should define title defects and outline the process for identifying and remedying such defects. This may include a title defect threshold, timelines for reporting defects, and options for the seller to cure defects or adjust the purchase price. Provisions should also be in place for operational defects, such as issues related to the physical condition of the wellbore or equipment failures, and the PSA should outline the buyer’s rights if significant operational defects are discovered or the well is not ultimately drilled or completed, including substitute wellbores or the ability to unwind the transaction. Additionally, the PSA should address production allocation defects, ensuring that the production from the wellbore is accurately allocated to the buyer and not improperly attributed to other interest holders or wells.

Finally, the Non-Operator will want to carefully peruse any Joint Operating Agreement (“JOA”) to sort through their relative rights and obligations with respect to the Operator for activities on the acquired wellbore. In order to better understand the specifics of their ownership as a matter of law, it’s essential to request any and all past title ownership reports, opinions, lease files, and other documentation.

Of course, there are countless more elements to consider during due diligence and during the drafting and negotiation of the underlying PSA. RR&A has attorneys with decades of experience advising Non-Operators, Operators, and numerous other actors in the oil and gas industry. Contact and engage RR&A at the earliest stages of your next acquisition to help evaluate associated legal and regulatory issues and better understand your legal needs at each phase of due diligence.