Oil and Gas Service
Contracts
Andrew R. Thomas
Energy Policy Center
Levin College of Urban Affairs
Cleveland State University
Of counsel - Meyers, Roman
Friedberg & Lewis
Russell O’Rourke
Meyers, Roman Friedberg & Lewis
NBI CLE Seminar
Cleveland and Youngstown
December 2013
Agenda
o I. Introduction
o Service contracting in the oil and gas business
o Trends
o II. Dispute Resolution and Self Help Remedies
o Russell O’Rourke – Meyers, Roman et al
o III. Special Problems in Service Contracts
o Risk Allocation/Indemnification/Insurance
o Subcontracting
o IV. Common Service Contracts
o Well Services
o Drilling
o Seismic
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.
3
The Advent of Form Contracts
o Contracts becoming commonly available
o Trade associations – AIPN, API, AAPG, AAPL, IADC
o Services – Kane’s, Barrow’s
o Establish perceptions of fairness
o Familiarity bias
o 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 work
o Risk of superfluous or inapplicable provisions, creating
confusion
o Risk of contradictory language, failure to read entire
document to ensure internal consistency.
o Tendency to add special provisions at the end.
Economic Potential for the Utica Shale
Development in Ohio
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Age of Complexity in Oil and Gas
Contracts
o Increasingly Risky Operations
o
o
o
o
o
Arctic regions
Tar sands
Deep water
Deep wells, subsalt
Horizontal/unconventional wells
o Increasing outsourcing
o Shift to more complex chains of subcontracting
o More specialization
o Increases problems with managing the contract
Economic Potential for the Utica Shale
Development in Ohio
5
Master Service Agreements
o Trends
o Increasing complexity
o More and longer subcontracting chains
o 70% subcontracts for typical well
o Wilson & Kuszewski study
o More emphasis on social and environmental
performance
o Primary Tool for managing contractor
responsibility:
o The legal contract
o Change order policy
o Result: focus on relationship between operator and
first tier contractor
o But subcontractor problems can become operator
problems
Trends For Service Agreements
o Challenging operating environments
o Increasing complexity
o
o
o
o
Longer contract chains
“knock for knock” (no fault) indemnification
Indemnification pass through provisions
Dispute resolution provisions
o US - still generally resolved in courts
o International – resolved through arbitration
o Local requirements
o Environmental – State by State in U.S.
o Local Hiring/Social Justice
o Tend to avoid for high risk operations
o Not required in US, but desirable
Economic Potential for the Utica Shale
Development in Ohio
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Upstream Opportunities for Ohio Industries
o Pad construction – location liners, limestone, pits,
dikes, roads, etc.
o Water – for drilling and fracturing
o Mud – bentonite and barite clay
o Steel pipe (casing)
o Cement (conventional cements not acceptable)
o Sand – clean, well-sorted 20-40 mesh in particular
o Steel tanks, separators, metering equipment,
production equipment, etc.
o Compressors
o Pipelines
o Treatment facilities for NGL’s, water, and impurity
removal
Economic Potential for the Utica Shale
Development in Ohio
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Mid and Upstream – Gathering lines
Economic Potential for the Utica Shale
Development in Ohio
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Midstream -- Processing Plants
Economic Potential for the Utica Shale
Development in Ohio
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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.
Economic Potential for the Utica Shale
Development in Ohio
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Grace Problem -- continued
o 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.
Economic Potential for the Utica Shale
Development in Ohio
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Grace Problem -- continued
o 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?
Economic Potential for the Utica Shale
Development in Ohio
13
Part II. Dispute Resolution and Self Help
Remedies
o Similar to Construction Industry
o Special rules for upstream oil and gas
o Midstream?
o Russell O’Rourke
o Myers, Roman, Friedberg & Lewis
o Specializes in representation of contractors and
subcontractors involved in the construction industry.
Economic Potential for the Utica Shale
Development in Ohio
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Part III. Special Problems in Service
Contracts.
o Risk Allocation
o Subcontracting
o Who is in control?
Allocation of Risk
Risk Management in a Changed World –
Rapidly rising costs of insurance
Effects of rise of terrorism
Major 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 Insurance
o 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
o
o
o
Property or equipment damage
Personal injury or death
Lost profits
Pollution or environmental problems
Insurance
o Minimum insurance coverage by Contractor:
o
o
o
o
o
o
Worker’s compensation
Commercial general liability
Automobile liability
Excess liability
Vessel/Hull/Protection & Indemnity
Aircraft/Hull/Aircraft Liability
o Insurance Endorsement
o Obtain waiver of subrogation in favor of Company
(can’t recover from Company if Company is at fault).
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Check List
o Types of Risk
o
o
o
o
Personal injury
Property or equipment damage
Pollution
Third parties
o Rules of Law – Public Policy
o Governing law
o Available resources/strategies
o
o
o
o
Contractual allocation of risk
Insurance
Assumption
Management
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Damages
o Direct
o Foreseeable, readily predictable.
o Liquidated
o Provided for by contract – where damages are
difficult to prove
o Intended to replace actual damages
o Indirect/Consequential
o Attenuated, unforeseen
o But cannot be speculative – must be proven.
o Punitive
o Provided by statute – designed to promote or
discourage behavior.
o Separate from Civil or Criminal penalties.
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Consequential Damages
o Types
o
o
o
o
Impacts of delay/time of essence
Lost profits
Lost leasehold/reserves
Lost opportunity
o Waivers
o Must be clear
o Sophistication of parties
o Boldface, italics, all caps – not boilerplate
o “clear and unequivocal” -- maritime
o “magic words” – Louisiana, TX
o Problem of purchase orders
o Public policy issues
o Gross negligence/intentional tort
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Considerations for Risk Transfer
o Fair – not equal – distribution of risk
o Should be in proportion to the rewards
o No duplication of insurance coverage
o Minimal potential for lapses of insurance
coverage
o Minimal potential for disputes.
o Allocate risks to be insurable.
o Affordable
o Available
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Difficult Negotiation Problems
o 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.
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Indemnity
o 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
24
Forms of Indemnity
o 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 based
o Indemnification is based on nature of activity.
o Requires some disclaimer of fault.
o Control based
o Based on “care, custody & control”
o Requires fault disclaimer to distinguish.
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Indemnity Form Problems
o Fault based indemnity
o Complex fact finding, time intensive
o Uncertain outcome
o Difficult to allocate fault
o Control based indemnity
o Designed to reduce expensive litigation
o Insurance may be easier to get
o In practice – if amount at stake is large, it will not
reduce litigation
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Indemnity Relationships
o 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 example
o Unbalanced
o One party via contract assumes relatively more risk
for a particular circumstance.
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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
Goal of Knock for Knock Provisions
o 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.
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Problems with Knock for Knock Provision
o Anti-indemnity Statutes – personal injury
o Jurisdiction – choice of law provisions
o 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 Acts
o Re-introduces concept of fault
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Role of Subcontractors
o 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
indemnity
o Group usually includes:
o Officers, directors, employees
o May include joint venturers, co-owners, non-operators.
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Pass Through Provisions
o 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
Macondo – lessons on k for k
33
Background facts
o April 20, 2010 explosion on Deepwater Horizon
rig in Gulf of Mexico
o BP hired the rig
o Owned and operated by TransOcean
o Water depth – 1500 meters
o 11/121 workers killed
o 4.9 mm bbls spilled in Gulf before July 15 cap
put in place
o Parties: BP, Anadarko, TransOcean, MOEX,
Halliburton, Cameron International
Economic Potential for the Utica Shale
Development in Ohio
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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 BP
o 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
35
Public Policy Issues for the Courts
o 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 provision
o Fraud
o Louisiana – can invalidate K for K provision
36
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.
37
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.
38
Part IV. Common Service Agreements
o Drilling Contracts
o Well Services
o Seismic Agreements
Drilling Contracts
o API forms
o Drafted by producers
o IADC forms
o Favorable to drillers
o Advantages
o Readily accepted by drillers
o Can get done quickly or if rigs scarce
o Not especially unfair to producers
Drilling Contracts
o Drilling contracts often determine the
commercial success of a venture.
o Especially true offshore or in shale development
o Two types of drilling contracts
o Turnkey
o
o
o
o
o
Driller gets set price
Driller takes some or all risk for mechanical failure
Popular with small producers – no cost overruns
But operator cannot escape responsibility
Less common for risky operations
o Daywork
o Paid a “day rate” for operations
o Producer at risk for mechanical problems of other
delays, such as weather
Turnkey contracts
o Producer concerns:
o Price – tend to be very expensive
o If not – better look at track record of driller
o Problem of underbidding by underfinanced driller
o really intend to take no risk
o 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 Contracts
o 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 concerns
o 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
o
o
o
Day Rate
Control
Indemnification/allocation of risk
Consequential damages/limitations in liability
Day Rate
o This will be area of most negotiations
o Controlled by market conditions
o 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 Liability
o 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 & Responsibilities
o 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?
Representatives
o 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?
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Liabilities & Indemnifications
o 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 risk
o 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.
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Liabilities
o Company must retrieve NORM contaminated
downhole equipment.
o Company liable for injury due to handling
contaminated equipment regardless of fault.
o Consequential damages
o Neither party entitled to
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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.
Other Areas of Interest
o 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?
Economic Potential for the Utica Shale
Development in Ohio
54
CSU Energy Policy Center
Andrew R. Thomas
a.r.thomas99@csuohio.edu
Thank you!