When there are farm-outs, farm-ins and non-consents with penalties, it can take more than two years for a well to pay out which means there will be many arguments and litigation concerns in the oil and gas industry on joint venture audit rights that extend past the usual, contractual 24 month limit. Also, most of the costs are in the drilling and completion phases. For both of these reasons, you had best get in and perform an initial joint venture audit / joint interest audit in order to nail down both issues and to assure yourself that any payout calculations have even started by the operator. If they have even started the payout, the documentation will be easily and timely available for the operator to provide to the non-operator so that you can make certain the largest calculations, which will significantly delay the payout, have been performed correctly. You can easily tell in advance if the well is a good producer with a probable successful payout in order to make a decision to protect your interest.
Ask yourself, "What do you do if the old drilling and completion charges and revenues are not available, refused or lost?" As the old saying goes, "An ounce of prevention is worth a pound of cure." Also, an investment can be sold many times which means the documentation is spread with multiple operators.
Payouts are the kicking boy in any industry, because they are controlled and completed by the recipient of the property who is required to give back some portion of the ownership to the entity that initially owned it and farmed out to them in the first place. Therefore, the preparer of the payout has a conflict of interest. Usually, a payout statement is required monthly, yet, in many cases, no statements are received for a farmout. The worst thing one can do is to farm out a coal bed methane project since the operator will continue to spend money indefinitely, significantly improving its value in order to flip it for a future sale at a large profit - yet never allowing it to pay out - resulting only in total expenses indefinitely being much larger than total revenues. The buyer of the investment can do the same thing too. Since we have both helped to author the COPAS bulletin #9 on payouts and have actually have professionally developed payouts for operators, we probably have more experience than most in both preparing and auditing payouts which can be very complicated.
Obviously, there is a risk of revenue being manipulated. For instance, some operators have been caught bypassing the meter so that they can keep 100% of the stolen production. Never sign an agreement that states you lose everything if you go non-consent. Payouts should be on a well by well basis which is easily controlled and never on a lease basis which is a long-term trap.
A disastrous situation we saw is where the operator leased a lower zone to an oil company who had to pay ALL of the costs related to the new wells and carry the operator free of charge. The cost to the investor was over 100 million dollars. The operator kept the best zone which was right above the investor’s zone. With everything paid for by the sucker investor, all the operator will have to do is perforate their 100%-owned, upper zone either: 1) after the wells are dry or uneconomical or 2) while the wells are producing and produce up the back side of the tubing. This also gives the operator the incentive to drill wells that they fully know are not economical so they get their wells drilled totally free.