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B-66927, JUL. 30, 1962

B-66927 Jul 30, 1962
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TO THE SECRETARY OF THE NAVY: REFERENCE IS MADE TO LETTER DATED MARCH 27. IN THE ACTING SECRETARY'S LETTER IT IS POINTED OUT BY WAY OF BACKGROUND THAT THE NAVAL PETROLEUM RESERVE NO. 1 CONSISTS OF 46. 554 ACRES ARE OWNED BY THE UNITED STATES AND 8. STANDARD'S LAND IS CHECKERBOARDED THROUGHOUT A PORTION OF THE AREA. THERE ARE NOW 950 PRODUCTIVE OIL WELLS AND 10 GAS WELLS IN THE FIELD. THE OWNERSHIP OF EACH PARTY IN THESE ZONES IS: SHALLOW OIL ZONE. THE RESERVE IS NORMALLY SHUT IN EXCEPT FOR REMEDIAL AND TEST PRODUCTION FROM THE SHALLOW OIL ZONE. THIS PRODUCTION IS NECESSARY PRIMARILY DUE TO WATER ENCROACHMENT ON THE NORTH FLANK OF THE RESERVE AND OIL MIGRATION FROM THE FIELD ON THE SOUTH FLANK.

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B-66927, JUL. 30, 1962

TO THE SECRETARY OF THE NAVY:

REFERENCE IS MADE TO LETTER DATED MARCH 27, 1962, FROM THE ACTING SECRETARY OF THE NAVY REQUESTING A DECISION AS TO THE PROPER INTERPRETATION OF CERTAIN PROVISIONS OF CONTRACT NO. NOD-4219 DATED JUNE 19, 1944, AND THE AMENDATORY AND SUPPLEMENTAL AGREEMENT THERETO, CONTRACT NOD-8477 DATED DECEMBER 22, 1948, BETWEEN THE UNITED STATES AND THE STANDARD OIL COMPANY OF CALIFORNIA RELATING TO THE UNIT OPERATION OF NAVAL PETROLEUM RESERVE NO. 1 (ELK HILLS), CALIFORNIA.

IN THE ACTING SECRETARY'S LETTER IT IS POINTED OUT BY WAY OF BACKGROUND THAT THE NAVAL PETROLEUM RESERVE NO. 1 CONSISTS OF 46,095 ACRES OF WHICH 37,554 ACRES ARE OWNED BY THE UNITED STATES AND 8,541 ACRES BY STANDARD. STANDARD'S LAND IS CHECKERBOARDED THROUGHOUT A PORTION OF THE AREA. THERE ARE NOW 950 PRODUCTIVE OIL WELLS AND 10 GAS WELLS IN THE FIELD. STANDARD HAS OWNERSHIP IN TWO OF THE THREE KNOWN PRODUCTIVE OIL ZONES AND IN THE GAS ZONE. THE OWNERSHIP OF EACH PARTY IN THESE ZONES IS: SHALLOW OIL ZONE, UNITED STATES 70 PERCENT AND STANDARD 30 PERCENT; STEVENS ZONE, UNITED STATES 83.5 PERCENT AND STANDARD 16.5 PERCENT; DRY GAS ZONE, UNITED STATES 77 PERCENT AND STANDARD 23 PERCENT. THE RESERVE IS NORMALLY SHUT IN EXCEPT FOR REMEDIAL AND TEST PRODUCTION FROM THE SHALLOW OIL ZONE. THIS PRODUCTION IS NECESSARY PRIMARILY DUE TO WATER ENCROACHMENT ON THE NORTH FLANK OF THE RESERVE AND OIL MIGRATION FROM THE FIELD ON THE SOUTH FLANK.

ON JUNE 19, 1944, THE SECRETARY OF THE NAVY ENTERED INTO A UNIT PLAN CONTRACT WITH STANDARD UNDER AUTHORITY OF TITLE 10, UNITED STATES CODE, CHAPTER 641. SECTION 7426 OF THAT TITLE SPECIFICALLY SETS FORTH THE NATURE OF THE UNIT PLAN CONTRACT AND ITS LIMITATIONS. IT IS REPORTED BY THE ACTING SECRETARY THAT THE PURPOSE AND POLICY OF THE GOVERNMENT WITH RESPECT TO THE NAVAL PETROLEUM RESERVES IS TO CONSERVE OIL IN THE GROUND FOR USE IN AN EMERGENCY; THAT THE UNIT PLAN CONTRACT CONTAINS RESTRICTIONS ON THE OPERATION OF THE FIELD TO ACHIEVE THIS PURPOSE; AND THAT THE CONTRACT ALSO PROVIDES FOR RATHER COMPLICATED METHODS OF ALLOCATING COSTS, BALANCING RECEIPTS OF PRODUCTION, AND SHARING COSTS CURRENTLY AND ULTIMATELY. SECTION 6 OF THE CONTRACT IS DEVOTED TO THE SUBJECT OF COSTS, PAYMENTS CURRENTLY, AND ULTIMATE SETTLEMENT. IN EFFECT, IT PROVIDES THAT THE COSTS OF EXPLORING, PROSPECTING, DEVELOPING AND OPERATING THE RESERVE SHALL BE BORNE ULTIMATELY BY NAVY AND STANDARD IN ACCORDANCE WITH THEIR RESPECTIVE PERCENTAGE PARTICIPATIONS OF OWNERSHIP IN EACH PRODUCTIVE ZONE. THE CONTRACT PROVIDES FOR THE FOLLOWING COST CLASSIFICATIONS:

(A) ORDINARY PRODUCTION COSTS, SECTION 6 (B) (1), WHICH ARE PAID CURRENTLY BY NAVY AND STANDARD IN PROPORTION TO THE PERCENTAGE OF PRODUCTION RECEIVED CURRENTLY BY EACH FROM EACH ZONE.

(B) READINESS MAINTENANCE COSTS, SECTION 6 (B) (1) (VI), WHICH ARE PAID CURRENTLY IN PROPORTION TO PERCENTAGE PARTICIPATIONS, OR OWNERSHIPS OF OIL IN EACH ZONE.

(C) READINESS DEVELOPMENT COSTS, SECTION 6 (B) (1) (IV) WHICH ARE PAID 100 PERCENT CURRENTLY BY NAVY IN ALL ZONES SUBJECT TO ULTIMATE SHARING WITH STANDARD IN PROPORTION TO PERCENTAGE PARTICIPATION, OF OWNERSHIP OF OIL IN EACH ZONE.

(D) EXPLORATORY COSTS, SECTION 6 (B) (1) (II) (III), MAY BE SHARED CURRENTLY, OR MAY BE BORNE BY THE PARTY WHICH SPONSORS THE EXPLORATION, SUBJECT TO SHARING ULTIMATELY IN THE EVENT THE WELL PROVES TO BE PRODUCTIVE.

SECTION 2 (A) (3) OF THE CONTRACT PROVIDES FOR AN ENGINEERING COMMITTEE AND SECTION 3 (B) PROVIDES FOR AN OPERATING COMMITTEE. THE ENGINEERING COMMITTEE WHICH IS COMPOSED OF SIX MEMBERS, THREE EACH REPRESENTING NAVY AND STANDARD, IS CHARGED WITH CERTAIN SPECIFIC ENGINEERING AND GEOLOGICAL DUTIES RELATING TO THE FIELD. ALL EXPLORATION, PROSPECTING, DEVELOPMENT, AND PRODUCING OPERATIONS ON THE RESERVE ARE CARRIED ON UNDER THE SUPERVISION AND DIRECTION OF THE OPERATING COMMITTEE, WHICH IS COMPOSED OF TWO MEMBERS, ONE EACH REPRESENTING NAVY AND STANDARD, WHO ARE ALSO MEMBERS OF THE ENGINEERING COMMITTEE.

RECITAL (6) OF THE UNIT PLAN CONTRACT PROVIDES THAT:

"/6) THE FOLLOWING CONSIDERATIONS HAVE LED NAVY AND STANDARD TO CONCLUDE THAT THE MOST DESIRABLE AND EFFECTIVE MEANS OF PROTECTING THE RESERVE AND OF ASSURING THE MAXIMUM ULTIMATE RECOVERY OF OIL, GAS, NATURAL GASOLINE AND ASSOCIATED HYDROCARBONS FROM THE RESERVE IS TO DEVELOP AND OPERATE ALL LANDS IN THE RESERVE AS A UNIT: "

THEN FOLLOW SUBPARAGRAPHS (A), (B), (C) AND (D). SUBPARAGRAPH (D) PROVIDES:

"/D) THE UNIT PLAN OF DEVELOPMENT AND OPERATION AS SET OUT HERE WILL:

"/VI) RESULT IN SECURING THE MAXIMUM ULTIMATE RECOVERY OF OIL, GAS, NATURAL GASOLINE AND ASSOCIATED HYDROCARBONS FROM THE RESERVE.'

SECTION 3 (B) (4) OF THE UNIT PLAN CONTRACT PROVIDES THAT SUBJECT TO THE OTHER PROVISIONS OF THE CONTRACT, THE OPERATING COMMITTEE "SHALL PERFORM THE FOLLOWING FUNCTIONS:

"/4) REQUIRE THE USE OF SOUND OIL FIELD ENGINEERING PRACTICES DESIGNED TO ACHIEVE THE MAXIMUM ECONOMIC RECOVERY OF OIL FROM THE RESERVE.'

THE OPERATING COMMITTEE DIRECTS AND SUPERVISES THE UNIT OPERATIONS THROUGH "MINUTES" JOINTLY ISSUED. GENERALLY, THESE MINUTES STATE THE PURPOSE OF THE WORK TO BE ACCOMPLISHED AND THE TYPE OF COST INVOLVED IN ACCORDANCE WITH THE UNIT PLAN CONTRACT.

JUST WHAT CONSTITUTES "MAXIMUM ECONOMIC RECOVERY" UNDER THE TERMS OF THE UNIT PLAN CONTRACT IS NOT DEFINED THEREIN. IN NAVY'S VIEW, THIS EXPRESSION RELATES TO THE MANNER WITH WHICH THE OPERATOR PERFORMS ITS FUNCTIONS, IN THAT IT SHALL CONDUCT ALL OPERATIONS ON THE RESERVE WITHOUT WASTE OF OIL OR GAS, AND NOT AT EXCESSIVE COST. STANDARD HAS TENDERED THE OPINION THAT MAXIMUM ECONOMIC RECOVERY MEANS "PAY OUT," OF RETURN OF INVESTMENT WITH PROFIT. IN THIS RESPECT, THE ACTING SECRETARY POINTS OUT THAT BOTH THE STATUTE (10 U.S.C. 7426 (C) ( AND THE UNIT PLAN CONTRACT WOULD APPEAR NOT TO GUARANTEE TO STANDARD A CURRENT PROFIT AT ALL TIMES FROM OPERATION OF THE RESERVE. SECTION 5 (F) OF THAT CONTRACT GUARANTEES ONLY A SUFFICIENT QUANTITY OF CURRENT PRODUCTION TO STANDARD TO COVER "/1) STANDARD'S SHARE OF CURRENT EXPENSES OF PROTECTING, CONSERVING, TESTING, AND MAINTAINING THE RESERVE IN GOOD OIL-FIELD CONDITION, AND (2) THE REAL AND PERSONAL TAXES LEVIED OR ASSESSED AGAINST STANDARD'S LANDS AND EQUIPMENT AND/OR ITS RIGHTS AND INTERESTS UNDER THIS CONTRACT.' THE ACTING SECRETARY STATES THAT THE QUESTIONS AT ISSUE DO NOT INCLUDE WHETHER STANDARD IS RECEIVING THIS AMOUNT OF GUARANTEED PRODUCTION, BUT WHETHER, IN EFFECT, STANDARD MAY DECLINE TO PARTICIPATE IN AN OPERATION FOR THE REASON THAT IT MAY NOT BE PROFITABLE.

SECTION 4 OF THE UNIT PLAN CONTRACT PROVIDES FOR CONTROL BY NAVY OVER THE RATE OF EXPLORATION, PROSPECTING AND DEVELOPMENT ON AND THE QUANTITY AND RATE OF PRODUCTION FROM THE RESERVE. SECTION 5 (D) PROVIDED THAT STANDARD BE PERMITTED TO RECEIVE FROM PRODUCTION UP TO 15,000 BARRELS OF OIL PER DAY UNTIL IT HAD RECEIVED A TOTAL OF 25,000,000 BARRELS FROM THE SHALLOW OIL ZONE. BY SECTION 6 OF THE AMENDATORY AND SUPPLEMENTAL AGREEMENT, STANDARD WAS PERMITTED TO CONTINUE RECEIVING PRODUCTION FROM THE SHALLOW OIL ZONE FOR A LITTLE OVER 18 MONTHS AFTER ITS RECEIPTS REACHED THE 25,000,000 BARREL LIMIT. BY THE END OF THE EXTENDED TIME, STANDARD HAD RECEIVED A TOTAL OF OVER 28,200,000 BARRELS, ALL OF WHICH WAS CHARGED AGAINST STANDARD'S SHARE OF RESERVES. IT IS REPORTED THAT THIS PRIVILEGE OF STANDARD'S TO RECEIVE PRODUCTION IN EXCESS OF ITS NORMAL SHARE DURING THE ,PRIMARY PERIOD" WAS A CONSIDERATION TO STANDARD FOR ENTERING INTO THE UNIT PLAN CONTRACT AND FOR GIVING NAVY CONTROL OVER EXPLORATION, PROSPECTING, AND DEVELOPMENT ON AND THE QUANTITY AND RATE OF PRODUCTION FROM ALL LANDS COMMITTED TO THE UNIT OPERATION.

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