SPECIAL REPORT 19
DRILL , DROP, C ARRY: WHAT YOU NEED TO KNOW Drill or drop and carry provisions are useful tools for E&P companies that wish to diversify the risks of exploration and to make investment decisions incrementally based on the latest information. Careful drafting, however, is essential to ensure that they are effective. It is difficult for transaction documents to cover all eventualities, but the relevant circumstances in this case were reasonably foreseeable. In frontier markets, it is not unusual for work obligations to be delayed or for the commercial solution in such circumstances to be the transfer of MWO from one period to the subsequent period. To clarify the parties’ intentions, we would suggest that parties entering into a farm-out transaction involving a carry address the following questions when drafting: 1. SHOULD THERE BE AN AGGREGATE MONETARY C AP IN RESPECT OF THE C ARRY AND, IF THE C ARRY REL ATES TO MWO, A C AP FOR MWO IN E ACH PHA SE OF THE EXPLORATION PERIOD? To the extent the carry relates toMWO, this needs to be considered together with the exit provisions in the relevant PSC. 2. SHOULD ANY OF THE NEGATIVE COVENANTS THAT T YPIC ALLY EXIST BET WEEN SIGNING AND COMPLETION OF THE DE AL APPLY DURING THE C ARRY PERIOD? For example, should there be an express provision stating that any proposed variation of theMWO/PSC has to be agreed between the parties and that carry obligations only apply toMWO as set out in the existing PSC? 3. WHAT RIGHTS SHOULD THE BUYER HAVE TO EXIT THE DE AL? This will be a point of negotiation, but as a starting point, the buyer is likely to want at least the same exit rights as provided for in the PSC. If the seller is willing to provide the buyer with additional exit rights, the seller needs to plan for how it will fund any outstanding obligations under the carry (particularlyMWO) if the buyer relinquishes its interest.
4. ARE THE RULES DE ALING WITH HOW THE BUYER’S EXPENDITURE ON THE C ARRY IS ACCOUNTED FOR CLE AR? COULD THERE BE ANY DIS AGREEMENT ABOUT WHETHER AN EXPENSE IS DIRECTLY AT TRIBUTABLE TO THE C ARRY? With respect to a carry of MS, the PSC accounting procedures should adequately classify expenses, but confirmation is necessary. The parties also need to discuss and agree onwhat would happen to the carry if MWO fromone exploration periodwere rolled into the next exploration period. 5. IF A PART Y HA S THE RIGHT TO REQUIRE A RELINQUISHING PART Y TO TRANSFER ITS PARTICIPATING INTEREST, ARE THERE ANY SELF-HELP MECHANISMS THAT WOULD SUPPORT SUCH A TRANSFER IN PRACTICE? For example, is there any security over the relinquishing party’s participating interest that can be exercised to enforce such a right? 6. ARE RIGHTS AND OBLIGATIONS ALIGNED ACROSS THE RELE VANT P SC, SPA AND JOA AND IS THERE PROVISION FOR WHAT HAPPENS IN THE E VENT OF AN INCONSISTENCY? The parties need to ensure in particular that there is an adequate SPA decision-making protocol that feeds into the PSC and JOA decision-making protocols. This case demonstrates the trigger for voting on drill or drop provisions needs careful thought. A trigger linked to the expected date of MWO completion (as indicated in the operator’s progress reports) may in some circumstances be preferable to the date hardwired as the end of the exploration period in the relevant PSC, although if it appeared that theMWOwould not be completed by the relevant deadline, the parties would need to vote on how to approach the government with such news. 7. WHO WILL BE THE OPERATOR AT E ACH STAGE OF THE PSC AND HAVE THE BUYER’S CONTROL OVER EXPENDITURE? While it does not appear to have been an issue in this case, it is also important that the non-operator has adequate access to operational information and data in order tomake informed drill or drop decisions. 8. IF EXPLORATION IS SUCCESSFUL AND COMMER CIAL PRODUCTION ENSUES, SHOULD THE COST OF THE C ARRY BE REPAID TO THE BUYER THROUGH A PREFERENCE ON COST OIL?
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