FUNDAMENTALS OF GEOTHERMAL LEASING Presented By Jerry R. Fish (503) 294-9620 [email protected] Christopher M. Heaps (503) 294-9864 [email protected] S TOEL.

FUNDAMENTALS OF FUNDAMENTALS OF GEOTHERMAL LEASINGGEOTHERMAL LEASING

Presented By

Jerry R. Fish(503) [email protected]

Christopher M. Heaps(503) [email protected]

STOEL RIVES LLPMarch 27, 2009

Oil & Gas vs. Geothermal Leasing

• Target geology: broad oil and gas traps in sedimentary rocks vs. geothermal heat concentrated along narrow fault zones or hot spots.

• Ownership: oil & gas are always “minerals” – geothermal resources treated differently by state law.

Oil & Gas vs. Geothermal Leasing

• Injection: fluids are sometimes injected for secondary recovery of oil and gas; but reinjection of geothermal fluids is always required for geothermal reservoir recharge.

• Water: after drilling, negligible water needs for oil and gas vs. substantial cooling and makeup water needs for geothermal.

Oil & Gas vs. Geothermal Leasing

• Limited surface structures for oil and gas production vs. a significant plant for geothermal electricity.

• Both oil and gas and geothermal production can go on for many years – though geothermal production will likely last much longer.

Industry Forms?

• Oil and Gas has the “Producers’ 88”– But it’s usually a company form– Many oil and gas leases are heavily

negotiated– Federal and state leases look very different

than private leases

• There is no standard for private geothermal leases – examples found in SEC filings.

Title Due Diligence

• Are you negotiating a lease with the right person?

• Consult the state laws on ownership (are geothermal resources private property?).

• Review the deeds to the property in question (are surface and minerals severed?).

• Many developers want title opinions -- no title insurance for minerals.

OwnershipIn a severed estate, are rights

to geothermal resources held by the surface owner or the owner of the mineral estate?– These questions are resolved

under state property law.– Geothermal resources are

minerals in some states, surface rights in some states, water rights sometimes, and not defined in others.

– Deed language often determines ownership, with the intent of the parties controlling.

Ownership - CaliforniaGeothermal Kinetics, Inc. case:

In California, geothermal resources belong to the mineral estate.

“Magma No. 1” well (1955)

1951 Deed: conveyed “all minerals in, on or under” the property.

The Geysers

Ownership - Nevada

Nevada Revised Statutes Section 534A.050:

Ownership of geothermal resources.  The owner of real property owns the rights to the underlying geothermal resources unless they have been reserved by or conveyed to another person.

Ownership - Washington

Revised Code of Washington Section 78.60.040:

Geothermal resources deemed sui generis.Notwithstanding any other provision of law, geothermal resources are found and hereby determined to be sui generis, being neither a mineral resource nor a water resource and as such are hereby declared to be the private property of the holder of the title to the surface land above the resource.

Ownership - Oregon

Oregon Revised Statutes Section 522.035:

Ownership rights to geothermal resources shall be in the owner of the surface property underlain by the geothermal resources unless such rights have been otherwise reserved or conveyed. However, nothing in this section shall divest the people or the state of any rights, title or interest they may have in geothermal resources.

Ownership - Colorado

Colorado Revised Statutes 37-90.5-104:

(1) Where a geothermal resource is found in association with geothermal fluid which is tributary groundwater, such geothermal resource is declared to be a public resource to which usufructuary rights only may be established according to the procedures of this article. No correlative property right to such a geothermal resource in place is recognized as an incident of ownership of an estate in land.

Ownership - Colorado

Colorado Revised Statutes 37-90.5-104:

(2) The property right to a hot dry rock resource is an incident of the ownership of the overlying surface, unless severed, reserved, or transferred with the subsurface estate expressly.(4) Nothing in this section shall be deemed to derogate the rights of a landowner to nontributary groundwater.

Ownership – Private Surface; Federal Minerals

See United States v. Union Oil Co. of California, 549 F.2d 1271, 1272 (9th Cir.1977) (holding that "the mineral reservation in patents issued under the Stock-Raising Homestead Act of 1916 reserved to the United States geothermal resources underlying the patented lands")

Ownership – Private Surface; Federal Minerals

• The Geothermal Steam Act, 30 U.S.C. § 1020(b): Geothermal resources in lands the surface of which has passed from Federal ownership but in which the minerals have been reserved to the United States shall not be developed or produced except under geothermal leases made pursuant to this chapter.

Key Lease Provisions

• Grant of Rights• Bonus & Rent• Royalty• Term• Surrender/Pugh

Clause• Express/Implied

Covenants• Water Rights

• Unitization/Contraction• Surface Impacts• Fee, Easements• Information• Indemnity & Insurance• Taxes• Default & Remedies

Grant of Rights• Exclusive rights to explore for, extract, and

produce geothermal resources.• Non-Exclusive rights to:

– construct and maintain necessary roads, wells, pipelines, plants, electrical and communization transmission lines, and all associated facilities.

– use water needed for operations.– cross-utilize with adjacent lands.– access property to exercise rights.– maintain and/or obtain easements after lease term.

Grant of Rights

• Lessor and its other lessees will not unreasonably interfere with geothermal operations.

• Specify areas, if any, where the geothermal lessee will not unreasonably interfere with other surface uses.

• “No surface occupancy” clause can be negotiated for small areas only.

Grant of RightsNo Surface Occupancy

Except as provided in this section, Lessee shall not have the right to enter onto the surface of the Property or to place any wells, plants, or other structures on the surfaces of the Property for the purpose of conducting activities under this Lease. Lessee shall have the right to enter onto the surface of the Property for the purpose of conducting inspections or environmental surveys of the Property or for the purpose of facilitating surface operations on adjacent lands. All wells drilled into or through the Property shall enter the property at or greater than 200’ below the surface of the Property.

Bonus and Rent

• Signing Bonus – Federal leases have bonus bidding. Private leases sometimes have a negotiated bonus payable at signing in addition to first year’s rent.

• Annual Rental – Be clear whether “unless” or “or” rental clause (oil and gas case law). – $2 to $3 per acre in federal leases; sometimes

higher in private leases– Clarify whether rental stops when production begins

Royalty

Federal geothermal royalty is a reference:• Lessee pays 1.75% of gross proceeds during the first

10 years of production and 3.5% thereafter from commercial sales of electricity by lessee or its affiliate.

• “Gross proceeds” means “the total monies and other consideration accruing to a geothermal lessee for the sale of electricity…” 30 CFR § 206.351.

• “Affiliate” means a person under common control with the lessee. Affiliation is conclusively presumed if two persons share 50 percent or more of ownership interests. Id.

Royalty

• Minimum royalty vs. production royalty (recoupable?)

• Pay percentage to lessor for– Electricity sales (at Plant)– Geothermal resource sales (steam, hot water)– Extractable mineral sales– Direct use (fee-based)

Key Royalty Negotiating Points• Gross vs. Net

– Transmission to point of sale deducted?– Taxes deducted?– Contract penalties deducted? (e.g. delay

commencing production)

• What payments are counted?– Capacity payments?– Damages for early termination?– Environmental Attributes?

Royalty

• Environmental Attributes– State Renewable Portfolio Standards have

created significant value in Renewable Energy Certificates (“RECs”).

– Many states allow REC trading, e.g., Oregon, Washington, Nevada. Does a Lessee pay royalty on separately-sold REC proceeds?

– Where RECs must be sold with electricity (e.g., California), can REC price be deducted from royalty proceeds?

– Western Climate Initiative carbon offset credits?

Royalty

• Arm’s length Sales vs. Affiliate Transactions

– Lessee may be challenged if it sells to an affiliate that resells for a higher price.

– Federal geothermal regulations apply to electricity sales “at arm’s length” by the Lessee or its “affiliate,” ignoring any earlier sales for royalty purposes.

Royalty

• Production and Sale by a Utility– Utility may produce at its own geothermal

plant and deliver directly to its customers.– Customers pay electricity rates that include a

return on utility equity in all plants, poles and wires, not just the geothermal facility – bad for royalty purposes.

– Utility with geothermal plant will want to specify an appropriate price or index as the deemed sale price of electricity from the geothermal facilities.

Term

• Primary term– Usually 10 years or longer– Held by payment of annual rental

• Extension term– “…for so long thereafter as producing in

paying quantities.”– Can also be held by continuous drilling– Minimum royalty for wells capable of

producing but not yet producing

Surrender/Pugh Clause

• Lessee has right to surrender all or any part of lease subject to outstanding obligations (e.g., reclamation).

• Pugh Clause: at end of primary term, lands from which there is no production are dropped from lease.

Express vs. Implied Covenants

• Oil and gas case law produced covenants implied in leases:– Diligent development– Diligent marketing– Protection from drainage

• Better to make express covenants and negate implied covenants.

Water Rights

• Availability of water for exploration and production is important for development.

• Lessor may be willing to allow use of ground or surface water appropriated by Lessor. Application to change use of water and place of use is likely required.

• Lessors generally require no impact to their existing water rights/use, Lessees want right to appropriate using new wells.

Water Rights

• State water law may have special provisions for water used in geothermal drilling or production.

• See NRS 534.050(2): waiver of appropriation requirement for exploration.

Unitization/Contraction

• Royalty paid in proportion to acreage in unit or participating area.

• Can be voluntary (per lease terms) or forced in some states (not for federal units).

• Contraction: After specified time, Lessee may be required to release non-productive areas from the unit. Lease should specify how contracted acres may be held.

Surface Impacts

• Operational Standards: workmanlike, industry, all commercially reasonable efforts to prevent waste.

• Compliance with law; exclusive responsibility for obtaining permits and dealing with government – require landowner cooperation

• Bond (lessee prefers only BLM or state bond).

• Reclamation – state law and negotiated terms.

Surface Impacts• Operations

– fencing of operations– road use & maintenance– minimum well, pipeline, and plant distance to

structures– fire protection and suppression– right of inspection

• Damages– repair/replace structures & roads– market value for crops & livestock

Fee, Easements

• Additional rental payments for exclusive surface use for plants, pipelines, wells, lines, and offices.

• May negotiate to buy fee for plant site.

• May negotiate to buy an easement for plant, pipelines and transmission lines.

• Pipelines, roads, transmission lines, etc. may survive the lease for use in connection with adjacent lands.

Indemnity & Insurance

• Indemnity– Mutual between parties, including contractors,

invitees, lessees, officers, employees, etc.– Procedure for handling third-party claims

• Insurance– Commercial general liability, comprehensive

auto, workers comp– Required prior to operations– Lessor named as additional insured

Information

• Applications, permits and operating plans – copies to lessor

• Well logs and cores?

• Drilling reports?

• Exploration and production data?

• Confidentiality provisions

Taxes• Lessee pays all taxes on operations and lease

interest, including improvements, and any fees or charges imposed by government attributable to lessee activities.

• Lessee reimburses lessor for increases in property taxes attributable to lessee activities.

• Lessor responsible for other taxes.

• Lessee may pay Lessor’s tax liens, be subrogated to rights, and deduct from future lease payments.

Default & Remedies

• Distinction between monetary & non-monetary breaches (time for cure)

• Tension between lessor’s desire for fast consequences and lessee’s need for stable leasehold rights– Notice and cure periods – dispute of breach, continuing operations– resolution (mediation, arbitration, or judicial)

Conclusion

• Geothermal leasing is similar in many respects to oil and gas leasing.

• But geothermal law and the nature of the resource is different.

• Have fun!