May a working interest owner in an offshore oil and gas lease avoid paying a share of the cost of decommissioning a platform that the lessee used to produce from the lease?  If you had a Farmout Agreement like the one between predecessors in interest — the PIIs — of Apache Corporation and W&T Offshore, the Fifth Circuit held last week, you surely may.

The PII of W&T held an oil and gas lease covering a block in the Gulf of Mexico.  The PII of Apache wanted to drill one or more wells on the lease.  To accomplish what they both desired, their PIIs entered into a 1979 Farmout Agreement, which gave the farmee (now Apache) the right to earn an assignment of the leasehold interest of the farmor (now W&T) by timely starting a test well and producing from it. 

The contract allowed W&T to keep an 8.33 percent overriding royalty interest in the test well and any later development wells.  But it also granted W&T two options to convert the royalty into a 33.3 percent working interest.

The first option gave W&T a conversion right as to the test well only.  The second one concerned development wells.  Both entitled Apache to recover certain costs for the privilege of conversion.

The problem arose after Hurricane Ivan damaged an offshore platform that Apache had used to produce oil and gas from wells it had drilled in the lease block.  Federal law obliged Apache, as owner of the platform, to bear the expense of decommissioning the platform.  And, since W&T had opted to become a working interest owner under the second option, Apache claimed that W&T had to pay its share of the decommission costs.  W&T disagreed.  Apache sued but lost on summery judgment in the district court.

The Fifth Circuit affirmed.  The panel's ruling focused on the option language in the Farmout Agreement.  The first option sprang to life at "such time as" Apache "recovered out of the proceeds of production from" the test well "the proportionate costs of drilling, testing, completing, equipping and operating the well, including" part of "the platform costs".  The second option arose if, "prior to payout of the first producing well," Apache chose to drill a second (development) well.  It entitled W&T to "elect to participate in the drilling of such well" and provided that, if W&T so elected, W&T "shall convert its overriding royalty to a 33 1/3 percent working interest in said lease . . . and shall be responsible for its proportionate share of platform costs".

The court held that "platform costs" in both options meant the same thing.  Under the first option, the court reasoned, "platform costs" couldn't refer to (future) decommissioning costs:

[I]f the term "platform costs" included the future expenses of decommissioning the Block 151 platform, W&T's election point to convert its royalty interest in the first well would not occur until after Apache had decommissioned the well.  That is, under Apache's construction, decommission costs would not be recoverable until after the platform had been decommissioned, and once the platform had been decommissioned, it would be impossible to recover such expenses out of the proceeds of a well that is no longer operational.  This construction is nonsensical.  It would be pointless for [W&T] to convert its overriding royalty interest into a working interest following the decommissioning of the Block 151 platform.  Where there is no production, there are no royalties, regardless of the percentage.

Apache Corp. v. W&T Offshore, Inc., No. 09-31122, slip op. at 8 (5th Cir. Nov.16, 2010) (applying Louisiana law).  The panel's equating of "platform costs" in the first option with the same term in the second one meant that the latter "includes only fixed, startup costs of constructing a well, not speculative operational expenses, which are outside the scope of costs contemplated by the [option] election-point provisions."  Id. at 9-10 (footnote omitted).