Location of the Well

If a farmor’s purpose in entering into the farmout agreement is to save its lease, it may be willing to let the farmee drill at a location of its choice.165 If, however, the farmor’s purpose is to obtain geologic information or to satisfy an express or implied covenant of a lease, the farmor may designate the location precisely. Moncrief v. Martin Oil Service, Inc.166 illustrates the importance of clearly designating the location of the well if a specific location is important to the parties. In Moncrief Martin farmed out to Moncrief in a farmout agreement that provided that “the interest earned by operator [Moncrief] hereunder shall be in consideration for the drilling of the well on lands belonging only to Martin.”167 The agreement also contained a proportionate reduction clause that provided that the interest earned by Moncrief in the Martin acreage would be reduced to the proportion that the amount of the Martin acreage within the participating area for the test well bore to the total acreage within the participating area. After Martin and Moncrief executed the agreement, Martin agreed to amend it so that “if our acreage on the first Test Well does not earn your Company its full interest under the Agreement, . . . the drilling of subsequent tests can earn the interest agreed to.”168 Moncrief then drilled several wells, spending between $13 and $14 million dollars in the process. Martin refused to assign the interest that Moncrief claimed he had earned because the additional wells drilled were not located “on lands belonging only to Martin.”169 The trial court found in favor of Moncrief, the farmee, because the amending letter did not specifically embrace the requirement of the initial contract.170 The appellate court upheld this position on the ground that the agreement did not require positively that subsequent tests be located on Martin’s acreage, so that the trial court’s decision was not plain error.171

165. An example of a clause permitting the farmee to select the location of the earning well follows: “Farmee’s Choice: Farmee shall have the right, but not the obligation, to commence on or before ____, operations for the drilling of well (the “Initial Earning Well”) at a location of Farmee’s choice on the ____ of Section ____, Township ____, Range ____, ____ . . . .” The discretion given the farmee will be illusory if the tract identified is small. 166. 658 F.2d 768 (10th Cir. 1981). 167. Id. at 769–71. 168. Id. at 771. 169. Id at 773. 170. Id at 770. 171. Id.

Even when the farmor and the farmee can agree that the location of the well is an essential part of their agreement, they may encounter practical problems in formulating the designation. Exact locations are hard for the farmee to satisfy and will lead to dispute. A mathematically determinable point (e.g., “the center of the SE/4 of the NW/4”) may be difficult to locate when it comes time to spud the drilling rig. A general location (e.g., “within 330 feet of the center of the NW/4” or “in the NW/4”) will generally be adequate to protect the interests of both parties. The farmee must satisfy itself, however, that it can meet lease restrictions and conservation agency rules by drilling in the general area identified.

Farmout agreements often provide for the initial well’s location “at a legal location of farmee’s choice.”172 This language is appropriate where the farmor’s purpose is to extend the farmed-out lease. If the geological information obtained from drilling is important to the farmor, however, this language may not accomplish the farmor’s goals, particularly if the tract is large. Geological information from a well drilled near the edge of the tract may not be as valuable as that from its center. A risk likewise arises that describing the location as “a legal location of the farmee’s choice” will permit the farmee to earn its interest by obtaining an exception tract drilling permit173 to drill close to the edge of the farmed-out acreage near a producing well outside the farmout area.174

In farmout agreements as in other contracts, a drafter should never use the phrase “at a mutually agreeable location.” If the parties cannot subsequently agree upon a location, the courts will probably hold the farmout agreement to be an unenforceable agreement to agree.175

172. See T. FAY, supra note 3, at 7.

173. State oil and gas conservation agencies generally issue exception tract drilling permits either to protect correlative rights, when strict adherence to the rules would result in drainage, or to prevent waste when strict adherence would result in oil or gas never being produced. E. KUNTZ, J. LOWE, O. ANDERSON & E. SMITH, supra note 5, at 79. Whether either rationale would justify issuance of a permit in the circumstance described is problematic.

174. T. FAY, supra note 3, at 6. Fay suggests the language used should read “at a legal location as required under the spacing requirements in effect at the time of the execution of the farmout agreement.” Id. at 7.

175. Cf. the discussion of Getty OH Co. v. Blevco Energy, Inc., supra notes 78–80; see also Klein & Burke, supra note 3, at 494. For a discussion of the Statute of Frauds, see supra