Generally, oil and gas production facilities have accounted for volume losses under the concept of “Fuel, Flare & Losses.” In a recent case, the Louisiana Fourth Circuit Court of Appeal held that processors must also account for gas volume diverted to gas lift operations.
In Red Willow Offshore, LLC v. Palm Energy Offshore, LLC, the Fourth Circuit found that a processing facility operator breached its Production Processing Agreement (“PPA”) with working interest owners by diverting without allocation the working interest owners’ production stream of natural gas to the operator’s own gas lift oil wells, and affirmed a trial court’s judgment awarding the working interest owners $1.16 million in damages for diversion of more than ten million cubic feet of gas.
Red Willow Offshore, LLC and Medco Energi US, LLC (collectively, “Red Willow”) were co-working interest owners of a natural gas well without the facilities to produce the well. Red Willow contracted a PPA with Palm Energy Offshore, LLC (“Palm”), the owner of a production processing facility and operator of its own wells, for transportation of Red Willow’s production stream to the Palm facility for commingling, processing, and preparation for sale. The PPA was silent as to the use of the Red Willow production stream as lift gas and made no mention of lift gas in the allocation provision, but required Palm to allocate to Red Willow its proportion of the metered volume of gas that exited the Palm facility for sale. However, before the Red Willow production stream reached the sales line, Palm diverted more than twenty percent of the gas to use as lift gas in its own low pressure oil wells. The gas lift operations often resulted in negative production; as one of Palm’s experts testified, “less came out than went in.”
Palm did not account for the diversion, did not compensate Red Willow for gas lost to the gas lift operations, and did not charge its own wells for use of the lift gas. Both the trial court and the Fourth Circuit determined that Palm’s unauthorized and unallocated use of Red Willow’s production stream was a breach of the PPA.
The Fourth Circuit found that the PPA required Palm to perform only processing services, and that it did not allow Palm to use Red Willow’s gas for the operational function of gas lift. The court found further that the allocation method set forth in the PPA accounted for volume losses due to fuel use, flaring, and shrinkage (often called a “Fuel, Flare & Losses” provision) but did not address adjustment for lift gas. The measurement provision did, however, expressly reference and adopt an American Petroleum Institute manual that requires that equitable allocation include adjustment for “fuel gas, gas lift, flare gas, and the like.” The court also considered state regulations and industry standards. Statewide Order No. 29-D-1, which adopted the API manual, requires an operator to provide reasonably accurate measurement and allow the owner to recover his just and equitable share of production. And the Gas Accounting Manual of the Council of Petroleum and Accountants Societies provides guidance on industry standards on gas accounting, and requires that a lease that uses lift gas from an outside source should be charged based on the price paid to the supplier.
The court found that “[u]ndoubtedly, these provisions require an operator to account for and properly allocate to its producers the value of the gas it uses as lift gas.”