Exhibit 10.37


 


A.A.P.L. FORM 610-1982


 


MODEL FORM OPERATING AGREEMENT


 


[SEAL]


 


Exhibit III


 


to


 


Iatan North Participation Agreement


 


dated


 


June 22, 1987


 


OPERATING AGREEMENT


 


DATED


 


June 22, 1987. 


 


OPERATOR
D. L. RAY, INC.


 


CONTRACT AREA  The Northwest Quarter (NW/4) of Section 43 and 70 acres out of
Section 42 lying South of the Texas Pacific Railway, Blk. 29, and the
Southeast Quarter (SE/4) of Section 37 and the Northeast Quarter (NE/4), the East Half (E/2) of the Northwest Quarter (NW/4) and the Southeast Quarter (SE/4) of the Northwest Quarter (NW/4) of the Northwest Quarter
(NW/4) of Section 48, Block 30, T-1-N, T & P Rv, Co. Survey.


 


COUNTIES
OF  Mitchell and Howard STATE OF Texas


 


COPYRIGHT 1982 – ALL
RIGHTS RESERVED 

AMERICAN ASSOCIATION OF PETROLEUM

LANDMEN, 2408 CONTINENTAL, LIFE BUILDING, 

FORT WORTH, TEXAS, 76102, APPROVED FORM. 

A.A.P.L. NO. 610 · 1982 REVISED


 

















 


A.A.P.L. FORM 610- MODEL
FORM OPERATING AGREEMENT 1982


 


TABLE OF CONTENTS


 


	
  Article

  	
   

  	
  Title

  	
   

  	
  Page

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  I.

  	
   

  	
  DEFINITIONS

  	
   

  	
  1

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  II.

  	
   

  	
  EXHIBITS

  	
   

  	
  1

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  III.

  	
   

  	
  INTERESTS OF PARTIES

  	
   

  	
  2

  
	
   

  	
   

  	
  B.    INTERESTS OF PARTIES IN COSTS AND PRODUCTION

  	
   

  	
  2

  
	
   

  	
   

  	
  D.    SUBSEQUENTLY CREATED INTERESTS

  	
   

  	
  2

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  IV.

  	
   

  	
  TITLES

  	
   

  	
  2

  
	
   

  	
   

  	
  A.    TITLE EXAMINATION

  	
   

  	
  2-3

  
	
   

  	
   

  	
  B.    LOSS OF TITLE

  	
   

  	
  3

  
	
   

  	
   

  	
  All losses

  	
   

  	
  3

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  V.

  	
   

  	
  OPERATOR

  	
   

  	
  4

  
	
   

  	
   

  	
  A.    DESIGNATION AND RESPONSIBILITIES OF OPERATOR

  	
   

  	
  4

  
	
   

  	
   

  	
  B.    RESIGNATION OR REMOVAL OF
  OPERATOR AND SELECTION OF SUCCESSOR

  	
   

  	
  4

  
	
   

  	
   

  	
  1.  Resignation
  or Removal of Operator

  	
   

  	
  4

  
	
   

  	
   

  	
  2.  Selection of Successor Operator

  	
   

  	
  4

  
	
   

  	
   

  	
  C.    EMPLOYEES

  	
   

  	
  4

  
	
   

  	
   

  	
  D.    DRILLING CONTRACTS

  	
   

  	
  4

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  VI.

  	
   

  	
  DRILLING AND DEVELOPMENT

  	
   

  	
  4

  
	
   

  	
   

  	
  A.    INITIAL WELL

  	
   

  	
  4-5

  
	
   

  	
   

  	
  B.    SUBSEQUENT OPERATIONS

  	
   

  	
  5

  
	
   

  	
   

  	
  1.  Proposed
  Operations

  	
   

  	
  5

  
	
   

  	
   

  	
  2.  Operations by Less than All
  Parties

  	
   

  	
  5-6-7

  
	
   

  	
   

  	
  3.  Stand-By
  Time

  	
   

  	
  7

  
	
   

  	
   

  	
  4.  Sidetracking

  	
   

  	
  7

  
	
   

  	
   

  	
  C.    TAKING PRODUCTION IN KIND

  	
   

  	
  7

  
	
   

  	
   

  	
  D.    ACCESS TO CONTRACT AREA AND INFORMATION

  	
   

  	
  8

  
	
   

  	
   

  	
  E.     ABANDONMENT OF WELLS

  	
   

  	
  8

  
	
   

  	
   

  	
  1.  Abandonment of Dry Holes

  	
   

  	
  8

  
	
   

  	
   

  	
  2.  Abandonment
  of Wells that have Produced

  	
   

  	
  8-9

  
	
   

  	
   

  	
  3.  Abandonment
  of Non-Consent Operations

  	
   

  	
  9

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  VII.

  	
   

  	
  EXPENDITURES AND LIABILITY OF PARTIES

  	
   

  	
  9

  
	
   

  	
   

  	
  A.    LIABILITY OF PARTIES

  	
   

  	
  9

  
	
   

  	
   

  	
  B.    LIENS AND PAYMENT DEFAULTS

  	
   

  	
  9

  
	
   

  	
   

  	
  C.    PAYMENTS AND ACCOUNTING

  	
   

  	
  9

  
	
   

  	
   

  	
  D.    LIMITATION OF EXPENDITURES

  	
   

  	
  9-10

  
	
   

  	
   

  	
  1.  Drill or
  Deepen

  	
   

  	
  9-10

  
	
   

  	
   

  	
  2.  Rework or Plug Back

  	
   

  	
  10

  
	
   

  	
   

  	
  3.  Other
  Operations

  	
   

  	
  10

  
	
   

  	
   

  	
  E.     RENTALS, SHUT IN WELL PAYMENTS AND MINIMUM ROYALTIES

  	
   

  	
  10

  
	
   

  	
   

  	
  F.     TAXES

  	
   

  	
  10

  
	
   

  	
   

  	
  G.    INSURANCE

  	
   

  	
  11

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  VIII.

  	
   

  	
  ACQUISITION, MAINTENANCE OR TRANSFER OF INTEREST

  	
   

  	
  11

  
	
   

  	
   

  	
  A.    SURRENDER OF LEASES

  	
   

  	
  11

  
	
   

  	
   

  	
  B.    RENEWAL OR EXTENSION OF LEASES

  	
   

  	
  11

  
	
   

  	
   

  	
  C.    ACREAGE OR CASH CONTRIBUTIONS

  	
   

  	
  11-12

  
	
   

  	
   

  	
  D.    MAINTENANCE OF UNIFORM INTEREST

  	
   

  	
  12

  
	
   

  	
   

  	
  E.     WAIVER OF RIGHTS TO PARTITION

  	
   

  	
  12

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  IX.

  	
   

  	
  INTERNAL REVENUE CODE ELECTION

  	
   

  	
  12

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  X.

  	
   

  	
  CLAIMS AND LAWSUITS

  	
   

  	
  13

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  XI.

  	
   

  	
  FORCE MAJEURE

  	
   

  	
  13

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  XII.

  	
   

  	
  NOTICES

  	
   

  	
  13

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  XIII.

  	
   

  	
  TERM OF AGREEMENT

  	
   

  	
  13

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  XIV.

  	
   

  	
  COMPLIANCE WITH LAWS AND REGULATIONS

  	
   

  	
  14

  
	
   

  	
   

  	
  A.    LAWS, REGULATIONS AND ORDERS

  	
   

  	
  14

  
	
   

  	
   

  	
  B.    GOVERNING LAW

  	
   

  	
  14

  
	
   

  	
   

  	
  C.    REGULATORY AGENCIES

  	
   

  	
  14

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  XV.

  	
   

  	
  OTHER PROVISIONS

  	
   

  	
  14

  
	
   

  	
   

  	
   

  	
   

  	
   

  
	
  XVI.

  	
   

  	
  MISCELLANEOUS

  	
   

  	
  15

  



 

















 


A.A.P.L. FORM 610- MODEL
FORM OPERATING AGREEMENT 1982


 


OPERATING AGREEMENT


 


THIS
AGREEMENT, entered into by and between D. L. RAY, INC.  hereinafter designated and
referred to as “Operator”, and the signatory
party or parties other than Operator, sometimes hereinafter referred to
individually herein as “Non-Operator”,
and collectively as “Non-Operators”.


 


WITNESSETH:


 


WHEREAS, the
parties to this agreement are owners of oil and gas leases and/or oil and gas
interests in the land identified in Exhibit “A”, and the parties hereto
have reached an agreement to explore and develop these leases and/or oil and gas interests for the production of
oil and gas to the extent and as
hereinafter provided.


 


 NOW, THEREFORE, it
is agreed as follows:


 


ARTICLE I.


DEFINITIONS


 


As used in
this agreement, the following
words and terms shall have the meanings here ascribed to them:


 


A.  The term “oil and gas” shall mean oil,
gas, casinghead gas, gas condensate, and
all other liquid or gaseous hydrocarbons and other marketable substances
produced therewith, unless an intent to limit the inclusiveness of this term is
specifically stated. 


 


 B.  The
terms “oil and gas lease”, “lease” and “leasehold” shall mean the oil and gas leases covering tracts of land
lying within the Contract Area which are owned by the parties to this
agreement.


 


 C.  The
term “oil and gas interests” shall mean unleased fee and mineral interests in tracts of land lying within the Contract Area which
are owned by parties to this
agreement.


 


 D.  The term “Contract Area” shall mean
all of the lands, oil and gas leasehold interests and oil and gas interests intended to be  developed and operated for oil and gas purposes under this agreement. Such lands, oil
and gas leasehold interests and oil and gas interests are described in Exhibit “A”.


 


 E.  The term “drilling unit” shall mean
the area fixed for the drilling
of one well by order or rule of any state or federal body having authority. If a
drilling unit is not fixed by any such rule or order, a drilling unit shall be the drilling unit as established by
the pattern of drilling in the Contract Area or as fixed by express agreement
of the Drilling Parties.


 


 F.  The
term “drillsite” shall mean the
oil and gas lease or interest on which a proposed well is to be
located. 


 


G.  The terms “Drilling Party” and
“Consenting Party” shall mean a party who agrees to join in and pay its share of the cost of
any operation conducted under the provisions of this agreement.


 


 H.  The
terms “Non-Drilling Party” and “Non-Consenting Party” shall mean a party who
elects not to participate in a proposed operation.


 


Unless the context otherwise clearly indicates, words
used in the singular include the plural, the plural includes the singular, and the neuter gender
includes the masculine and the feminine.


 


ARTICLE II.


EXHIBITS


 


 The following
exhibits, as indicated below and attached
hereto, are incorporated in and made a part
hereof:


 


	
  x

  	
  A.

  	
  Exhibit “A”,
  shall include the following information:

  
	
   

  	
   

  	
   

  
	
   

  	
   

  	
  (1) Identification of lands subject to this
  agreement,

  
	
   

  	
   

  	
  (2) Restrictions, if any, as to depths,
  formations, or substances,

  
	
   

  	
   

  	
  (3) Percentages or fractional interests of
  parties to this agreement,

  
	
   

  	
   

  	
  (4) Oil and gas leases and/or oil and gas
  interests subject to this agreement,

  
	
   

  	
   

  	
  (5) Addresses of parties for notice purposes.

  
	
   

  	
   

  	
   

  
	
  o

  	
  B.

  	
  Exhibit “B”,
  Form of Lease.

  
	
  x

  	
  C.

  	
  Exhibit “C”,
  Accounting Procedure.

  
	
  x

  	
  D.

  	
  Exhibit “D”,
  Insurance.

  
	
  o

  	
  E.

  	
  Exhibit “E”,
  Gas Balancing Agreement.

  
	
  o

  	
  F.

  	
  Exhibit “F”,
  Non-Discrimination and Certification of Non-Segregated Facilities.

  
	
  x

  	
  G.

  	
  Exhibit “G”,
  Tax Partnership.

  



 


 If any provision of
any exhibit, except Exhibits “E” and “G”,
is inconsistent with any provision contained in the body of this agreement, the
provisions in the body of this agreement shall prevail.


 


1

















 


ARTICLE III.


INTERESTS OF PARTIES


 


B.    Interests of Parties in Costs and Production:


 


 Unless changed by
other provisions, all costs and liabilities incurred in operations under this agreement shall be borne and paid,
and all equipment and materials acquired in operations on the Contract Area
shall be owned, by the parties as their interests are set forth in Exhibit “A”.
In the same manner, the parties shall also own all production of oil and gas from
the Contract Area subject to the payment of [ILLEGIBLE] all burdening their
respective interest and shall indemnify and hold the other parties
harmless from any and all claims and demands for the payment of such royalties.


 


 Nothing contained in
this Article III.B, shall be deemed an assignment
or
cross-assignment of interests covered hereby.


 


D.    Subsequently Created Interests:


 


If any party should hereafter create an overriding royalty,
production payment or other burden payable out of production attributable to its
working interest
hereunder
(any such interest being
hereinafter referred to as “subsequently created interest” and the party out of
whose working interest the subsequently created interest is derived being hereinafter referred to as “burdened party”), and:


 


1.     If the burdened party is
required under this agreement to assign or relinquish
to any other
party, or parties, all or a portion of its working interest and/or the production
attributable thereto, said other party, or parties, shall receive said assignment and/or production free and clear of
said subsequently created interest and the burdened party shall indemnify and save said other party, or parties, harmless
from any and all claims and demands for payment asserted by owners of the subsequently created interest; and,


 


2.     If the burdened party fails
to pay,
when due, its share of expenses chargeable hereunder, all provisions of
Article VII.B shall be enforceable against the subsequently created interest in the same manner as they are enforceable against
the working interest of the burdened party.


 


ARTICLE
IV.


TITLES


 


A.    Title Examination:


 


 Title examination shall be made on the
drillsite of any proposed well prior to commencement of drilling operations or, if
the Drilling Parties so request, title examination shall be made on the leases and/or oil and gas
interests included, or planned to-be included, in
the drilling unit around such well. The opinion will include the ownership of the working interest, minerals, royalty,
overriding royalty and production payments under the applicable leases. At the time a well is
proposed, each party contributing leases and/or oil and gas interests to the drillsite, or to
be included in such drilling unit, shall furnish to Operator all abstracts (including federal lease status reports),
title opinions, title papers and curative material in
its possession free of charge. All such information not in the possession of or
made available to Operator by the parties, but necessary for the examination of the title,
shall
be obtained by Operator. Operator shall cause title to be examined by attorneys on its staff or by outside attorneys. Copies of all title opinions shall be furnished to each party hereto. The cost
incurred by Operator in this title program shall be borne as follows:


 


o    Option No. 1: Costs incurred by Operator in procuring abstracts and title examination (including
preliminary, supplemental, shut-in gas royalty opinions and division order title
opinions) shall be a part of the
administrative overhead as provided in Exhibit “C”, and shall not be a direct charge, whether performed by
Operator’s staff attorneys or by outside attorneys.


 


2

















 


ARTICLE IV 


continued


 


x   Option No. 2: Costs incurred by
Operator in procuring abstracts and fees paid outside attorneys for title
examination (including preliminary, supplemental, shut-in gas royalty opinions and
division order title opinions) shall be borne by the Drilling Parties in the proportion that the interest of each Drilling Party bears to the total
interest of all Drilling Parties as such interests
appear in Exhibit “A”. Operator shall make no charge for services rendered by its staff attorneys or
other personnel
in the performance
of the above functions.


 


 Each party shall be
responsible for securing curative matter and pooling amendments
or agreements
required in connection with leases or oil and gas interests contributed by such party. Operator shall be responsible for the preparation and recording of pooling designations
or declarations as well as the conduct of hearings before governmental agencies for the securing of spacing
or pooling orders. This shall not prevent any party from appearing on its own behalf at any such hearing.


 


 No well shall be drilled on the Contract Area until after (1) the title to the
drillsite or drilling unit has been examined as above provided, and
(2) the title has been approved by the examining attorney or title has been accepted by all of the parties who have elected to participate in the drilling of the well.


 


B.    Loss of Title:


 


3. All Losses: All losses incurred, and
failure of title shall
be joint
losses and shall be borne by all parties in proportion to their
interests. There shall be no readjustment of interests in the remaining portion
of the Contract Area.


 


3














 


ARTICLE V.


OPERATOR


 


A.    Designation and Responsibilities of Operator:


 


D. L. RAY, INC, shall be the Operator of
the Contract Area, and shall conduct and direct and have full control of all
operations on the Contract Area as permitted and required by, and within the
limits of this agreement. It shall conduct all such operations in a good and workmanlike
manner, but it shall have no liability as Operator to the other parties for losses sustained or liabilities incurred, except such as may result from
gross negligence or willful misconduct.


 


B.    Resignation or Removal of Operator
and Selection of Successor:


 


1. Resignation or Removal of Operator: Operator may resign
at any time by giving written notice thereof to Non-Operators. If Operator
terminates its legal existence, or is no longer capable of serving as Operator, Operator
shall be deemed to have resigned without any action by Non-Operators, except the selection
of a
successor. Operator may be removed if it fails or refuses to carry out its
duties hereunder, or becomes insolvent, bankrupt or is placed in receivership,
by the affirmative vote of two (2) or more Non-Operators owning a majority
interest based on ownership as shown on Exhibit “A” remaining after
excluding the voting interest of
Operator. Such resignation or removal shall not become effective until 7:00 o’clock A.M. on the
first day of the calendar month following the expiration of ninety (90) days
after the giving of notice of
resignation by Operator or action by the Non-Operators to remove Operator,
unless a successor Operator has been selected and assumes the duties of Operator at an
earlier date. Operator, after effective date of resignation or removal, shall be bound by
the terms hereof as a Non-Operator. A change of a corporate name or structure of Operator or transfer of Operator’s interest to
any single subsidiary, parent or successor corporation shall not be the basis for removal of Operator.


 


2. Selection of Successor
Operator: Upon
the resignation or removal of Operator, a successor Operator shall be selected by
the parties. The successor Operator shall be selected from the parties owning an interest
in the Contract Area at the time such successor Operator is selected. The successor Operator shall be
selected by the affirmative vote of two
(2) or more parties owning
a majority interest based on ownership as shown on Exhibit “A”; provided,
however, if an Operator which has been removed fails to vote or votes only to succeed
itself, the successor Operator shall be selected by the affirmative vote of two
(2) or more parties owning a majority interest based on ownership as shown
on Exhibit “A” remaining after excluding the voting
interest of the Operator that was removed.


 


C.    Employees:


 


The number of employees used by Operator in
conducting operations hereunder, their selection, and the hours of labor and the compensation for services performed shall be determined by Operator, and all such
employees shall be the employees of Operator.


 


D.    Drilling Contracts:


 


All wells drilled on the Contract Area shall be drilled on a competitive contract
basis
at the usual rates prevailing in the area.
If it so desires, Operator may employ its own tools and equipment in the
drilling of wells, but its charges therefor shall not exceed the prevailing rates in the area and the rate of such charges shall be agreed upon by the parties in writing before drilling operations
are commenced, and such work shall be performed by Operator under the same
terms and conditions as are customary and usual in the area in contracts of independent
contractors who are doing work of a similar
nature.


 


ARTICLE
VI.


DRILLING
AND DEVELOPMENT


 


A.    On or before one hundred eighty (180) days
from the date of Acquisition of the properties subject to this agreement by the
parties hereto from G. F. Ray, Jr. etal, Operator shall commence the
drilling and completion of the necessary production and injection wells and all
other activities reasonably necessary to the full implementation of a
waterflood program thereon in accordance with the terms and provisions of the
Participation Agreement between Operator and Non-Operator with respect to the
oil and gas lands within the Contract Area. Each party agrees to pay, upon the
call of Operator therefor, his, her or its proportionate share of such costs. 


 


All
operation on the Contract Area by the parties hereto subsequent to the completion of
the installation
of said waterflood project on the Contract Area shall be subject to the provisions of Article VI B, which follows this
provision.


 


4

















 


ARTICLE VI


continued


 


B.    Subsequent Operations: The provisions of this
Article VI B shall not become effective until completion of the waterflood
program under Article VI A. 


 


1. Proposed Operations: Should any
party hereto desire to drill any well on the Contract Area other than the well provided for in Article VI.A., or to rework, deepen or plug
back a dry hole drilled at the joint expense of all parties or a
well jointly owned by all the parties and not then producing in paying
quantities, the party desiring to drill, rework, deepen or plug back such a
well shall give the other parties written notice of the proposed operation,
specifying the work to be performed, the location, proposed
depth, objective formation and the estimated cost of the operation. The parties
receiving such a notice shall have thirty (30) days after receipt of the notice within which
to notify the party wishing to do the work whether they elect to participate in
the cost of the proposed operation. If a drilling rig is on location, notice of a proposal to rework, plug back or drill deeper
may be given by telephone and the response period
shall be limited to forty-eight (48) hours, exclusive of Saturday, Sunday and
legal holidays. Failure of a party receiving such notice to reply within the
period above fixed shall constitute an election by that party not to
participate in the cost of the proposed operation.
Any notice or  response given by
telephone shall be promptly confirmed in writing.


 


If all parties elect to participate in such a
proposed operation, Operator shall, within ninety (90) days after expiration of
the notice period of thirty (30) days (or as promptly as possible after the
expiration of the forty-eight (48) hour period when a drilling rig is on
location, as the case may be), actually commence the
proposed operation and complete it with due diligence at the risk and  expense of all parties hereto; provided, however, said commencement date
may be extended upon written notice of same by Operator to the other parties, for a period of up to thirty (30) additional days if, in the sole opinion
of Operator, such additional time is reasonably necessary to obtain permits
from governmental authorities, surface rights (including rights-of-way) or
appropriate drilling equipment, or to complete title examination or curative
matter required for title approval or acceptance. Notwithstanding the force
majeure provisions of Article XI, if the actual operation has
not been commenced within the time provided (including any extension thereof as
specifically permitted herein) and if any party hereto still desires to conduct
said operation, written notice proposing same must be resubmitted
to the other parties in accor-dance
with the provisions hereof as if no prior proposal had been made.


 


2. Operations by Less than All Parties:
If any party receiving such notice as provided in Article VI.B.I. or VII.D.I.
(Option No. 2) elects not to participate in the proposed operation, then,
in order to be entitled to the benefits of this Article, the
party or parties giving the notice and such other parties as shall elect to
participate in the operation shall, within ninety (90) days after the
expiration of the notice period of thirty (30) days (or as promptly as
possible after the expiration of the forty-eight (48) hour period when a
drilling rig is on location, as the case may be) actually commence the proposed operation and complete it with due diligence. Operator shall
perform all work for the account of the Consenting Parties; provided,
however, if no drilling rig or other equipment is on location, and if Operator
is  a Non-Consenting Party, the Consenting Parties shall
either: (a) request Operator to perform the work required by such proposed
Operation for the account of the Consenting Parties, or (b) designate one
(1) of the Consenting Parties as Operator to perform such work. Consenting
Parties, when conducting operations on the Contract Area pursuant to this
Article V1.B.2., shall comply with all terms and conditions of this agreement.



 


If less than all parties approve
any proposed operation, the proposing party, immediately after the expiration of the applicable notice period, shall advise the Consenting
Parties of the total interest of the parties approving such
operation and its recommendation as to whether the Consenting Parties should
proceed with the operation as proposed. Each Consenting Party, within
forty-eight (48) hours (exclusive of Saturday, Sunday and legal holidays) after receipt of such notice, shall advise the proposing party of its desire to
(a) limit participation to such party’s interest as shown on
Exhibit “A” or (b) carry its proportionate part of Non-Consenting
Parties’ interests, and failure to advise the proposing party shall be deemed an election under (a). In the event a drilling rig is on
location, the time permitted
for such a response shall not exceed a total of
forty-eight (48) hours (inclusive of Saturday, Sunday and legal holidays). The proposing party, at its election, may withdraw such
proposal if there is insufficient participation and shall promptly notify all
parties of such decision. 


 


The entire cost and risk of conducting such
operations shall be borne by the Consenting Parties in the proportions they
have elected to bear same under the terms of the preceding paragraph.
Consenting Parties shall keep the leasehold estates involved in such
operations
free and clear of all liens and encumbrances of every kind created by or
arising from
the
operations of the Consenting Parties. If such an operation results in a dry hole, the Consenting
Parties shall plug and abandon the well and restore the surface location at their sole cost, risk and expense. If any well drilled,
reworked, deepened or plugged back under the provisions of this Article result in a
producer
of oil and/or gas in paying quantities, the Consenting Parties shall complete
and equip the well to produce at their sole cost and risk,


 


5

















 


ARTICLE VI 

continued


 


and the well shall then be turned over to Operator and shall
be operated by it at the expense and for the account of the Consenting Parties. Upon commencement of operations for the drilling, reworking, deepening or plugging
back of any such well by Consenting Parties in accordance with the provisions of this Article, each Non-Consenting Party shall be deemed to
have relinquished to Consenting Parties, and the Consenting Parties shall own and be entitled
to receive, in proportion to their respective interests all of such Non-Consenting Party’s interest in the well and
share of production therefrom until the proceeds of the sale of such share, calculated at the well, or market value thereof if such share is not sold, (after
deducting production taxes, excise taxes,
royalty, overriding royalty and other interests not excepted by Article III.D. payable out of or
measured by the production from such well accruing with respect to such interest until it reverts) shall equal the total of the following:


 


(a) 100% of each such Non-Consenting
Party’s share of the cost of any newly acquired surface equipment beyond the
wellhead connections (including, but not limited to, stock tanks, separators, treaters, pumping equipment and
piping), plus 100% of each such Non-Consenting Party’s share of the cost of operation of the well
commencing with first production and continuing until each such Non-Consenting Party’s
relinquished interest shall revert to it under
other provisions of this Article, it being agreed that each Non-Consenting
Party’s share of such costs and equipment will be that interest which would
have been chargeable to such Non-Consenting Party had it participated in the
well from the beginning of the operations; and


 


(b) 400 % of that portion of
the costs and expenses of
drilling, reworking, deepening, plugging back, testing and completing, after deducting any
cash contributions received under Article VIII.C.,
and 400% of that portion of
the cost of newly acquired equip ment in the well (to and including the wellhead connections), which
would have been chargeable to
such Non-Consenting Party if it
had participated therein. 


 


An election not to
participate in the drilling or the deepening of a well shall be deemed an election not to participate in any re-working or plugging back operation proposed in such a well, or portion thereof, to which the
initial Non-Consent election applied that is conducted at any time prior to full recovery by the Consenting Parties of the
Non-Consenting Party’s recoupment account. Any such reworking or plugging back operation
conducted during the recoupment period shall be deemed part of the cost of
operation of said well and there shall be added to the sums to be recouped by
the Consenting Parties one hundred percent (100%) of that portion of the costs of the reworking or plugging back operation
which would have been chargeable
to such Non-Consenting Party had it participated therein. If such a reworking
or plugging back operation is proposed during such recoupment period, the provisions of this Article VI.B.
shall be applicable as between said Consenting Parties in said well.


 


During the period  of time Consenting Parties are entitled to receive
Non-Consenting Party’s share of production, or the proceeds therefrom,
Consenting Parties shall be responsible for the payment of all production,
severance, excise, gathering and other taxes, and all royalty, overriding royalty and other burdens
applicable to Non-Consenting Party’s share of production not
excepted by Article III.D.


 


In the case of any reworking, plugging back or deeper drilling operation, the Consenting Parties shall be
permitted to use, free of cost, all casing, tubing and other equipment in the
well, but the ownership of all such equipment shall remain unchanged; and upon
abandonment of a well after such reworking, plugging back or deeper drilling,
the Consenting Parties shall account for all such equipment to the owners thereof, with each party
receiving its proportionate part in kind or in value, less cost of salvage.


 


Within sixty (60) days after the completion of
any operation under this Article, the party conducting the operations for the Consenting Parties shall furnish each
Non-Consenting Party with an inventory of the equipment in and connected to the
well, and an itemized statement of the cost of drilling, deepening, plugging
back, testing, completing, and equipping the well for production; or, at its option,
the operating party, in lieu of an itemized statement of such costs of
operation, may submit a detailed statement of monthly billing. Each month
thereafter, during the time the Consenting Parties are being reimbursed as
provided above, the party conducting the operations for the Consenting Parties shall furnish the Non-Consenting Parties with an itemized statement of all costs
and liabilities incurred in the operation of the well, together with a
statement of the quantity of oil and gas produced from it and the amount of proceeds realized from the sale of the well’s  working interest production during the preceding month. In determining the quantity of oil and gas produced
during any month, Consenting
Parties shall use industry accepted methods such as, but not limited to,
metering or periodic well
tests. Any amount realized from the sale or other disposition of
equipment newly acquired in connection with any such operation which would have
been owned by a Non-Consenting Party had it participated therein shall be
credited against the total unreturned costs of the work done and of the equipment purchased in
determining when the interest of such Non-Consenting Party shall
reverse to it as  above provided; and if there is a credit
balance it shall be paid to such Non-Consenting Party. 


 


6

















 


ARTICLE VI 


continued


 


If and when the
Consenting Parties recover from a Non-Consenting Party’s relinquished interest the amounts provided for
above, the relinquished interests of such Non-Consenting Party shall automatically revert to it, and, from and after such reversion, such Non-Consenting Party
shall own the same
interest in such well, the material and equipment in or pertaining thereto, and the production therefrom as such
Non-Consenting Party would have been entitled to had it participated in the drilling,
reworking, deepening or plugging back of said well. Thereafter, such Non-Consenting
Party shall be charged with and shall pay its proportionate
part of the further costs of the operation of said well in accordance
with the terms
of this agreement and the Accounting Procedure attached hereto.


 


Notwithstanding
the provisions of this Article VI.B.2., it is agreed that without the mutual
consent of all parties, no wells shall be completed in or produced from a
source of supply from which a well located elsewhere on the Contract Area is producing, unless
such well conforms to the then existing well spacing pattern for such
source of supply.


 


The provisions
of this Article shall have no application whatsoever to the installation of the waterflood project
described in Article VI.A. except as to the reworking, deepening
and plugging back of any such well after completion of the waterflood project
it shall thereafter prove to be a dry hole or, if initially completed for production, ceases to
produce in paying quantities.


 


3.     Stand-By Time: When after completion of the waterflood project described in
Paragraph VI A above a well which has been drilled or deepened
has reached its authorized depth and all tests have been
completed, and the results thereof
furnished to the parties, stand-by
costs incurred pending response to a
party’s notice proposing a
reworking, deepening, plugging back or completing operation in such a well shall
be charged and borne as part of the drilling or deepening operation just completed. Stand-by costs
subsequent to all parties responding, or expiration of the response time permitted, whichever first occurs, and
prior to agreement as to the participating interests of all Consenting Parties
pursuant to the terms of the second
grammatical paragraph of Article VI.B.2, shall be charged to and borne as
part of the
proposed operation, but if the proposal is subsequently withdrawn because of
insufficient participation, such stand-by costs shall be allocated
between the Consenting Parties in the proportion each Consenting Party’s
interest as shown on Exhibit “A” bears to the total interest as shown on
Exhibit “A” of all Consenting Parties.


 


4      Sidetracking: Except as hereinafter provided,
those provisions of this agreement applicable to a “deepening” operation shall
also be applicable to any proposal to directionally control and intentionally
deviate a well from vertical so as to change the bottom hole location (herein called “sidetracking”), unless done to
straighten the hole or to drill around junk in the hole or because of other
mechanical difficulties. Any party having the right to participate in a proposed
sidetracking operation that does not own an interest in the affected well bore at the time of the notice
shall, upon electing to participate, tender to the well bore owners its
proportionate share (equal to its interest
in the sidetracking operation) of the value of that portion of the existing
well bore to be utilized as follows:


 


(a) If
the proposal is for sidetracking an existing dry hole, reimbursement shall be
on the basis of the actual costs incurred in the initial drilling of
the well down to the depth at which the sidetracking operation is initiated.


 


(b) If
the proposal is for sidetracking a well which has previously
produced, reimbursement shall be on the basis of the well’s salvable materials and
equipment down to the depth at which
the sidetracking operation is initiated, determined in accordance with the provisions of Exhibit “C’’, less the
estimated cost of salvaging and the estimated cost of plugging and abandoning.


 


In the event
that notice for a sidetracking operation is given while the
drilling rig to be utilized is on location, the response period shall be
limited to forty-eight (48) hours, exclusive of Saturday, Sunday and legal
holidays; provided, however, any party may request and receive up to eight
(8) additional days after expiration of the forty eight (48) hours within which to
respond by paying for all stand-by time incurred during such extended response
period. If more than one party elects to take such additional time to respond
to the notice, stand-by costs shall be
allocated between the parties taking additional time to respond on a
day-to-day basis in the proportion each electing party’s interest as shown on
Exhibit “A” bears to the total interest as shown on Exhibit “A” of all
the electing parties. In all other instances the response period to a proposal for sidetracking shall be limited
to thirty (30) days.


 


C.    TAKING PRODUCTION IN KIND:


 


Each party
shall take in kind or separately dispose of its proportionate share of all oil
and gas produced from the Contract Area, exclusive of production which
may be used
in development and producing operations and in preparing and creating oil and
gas for marketing purposes and production unavoidably cost. Any extra
expenditure incurred in the taking in kind or separate disposition by any party
of its proportionate share of the production
shall be borne by such party. Any party taking its share of production in kind shall be


 


7

















 


ARTICLE VI


continued


 


required to pay for only its
proportionate share of such part of Operator’s surface facilities which it
uses.


 


Each party shall execute such division orders and contracts as may be necessary for the sale of its
interest in production from the Contract Area, and, except as provided in Article VII.B., shall be
entitled to receive payment directly from the purchaser thereof for
its share of all production.


 


In the event
any party shall fail to make the arrangements necessary to take in kind or
separately dispose of its proportionate share of the oil and
gas produced from the Contract Area, Operator shall have the right, subject to
the revocation at will by the party owning it, but not the obligation, to
purchase such oil and gas or sell it to others at any time and from time to
time, for the account of the non-taking
party at the best price
obtainable in the area for such production. Any such purchase or sale by
Operator shall be subject always to the right of the owner of the production to
exercise at any time its right to take in kind, or separately dispose of, its share of all
oil and gas not previously delivered to a
purchaser. Any purchase or sale by Operator of any other party’s share of oil and gas shall be only
for such reasonable periods of time as are consistent with the minimum needs of
the industry under the particular circumstances, but in no event for a period
in excess of one (1) year. Notwithstanding the foregoing, Operator shall
not make a sale, including one into interstate commerce, of any other party’s
share of gas production without first giving such other party thirty (30) days
notice of such intended sale.


 


D.    Access to
Contract Area and Information:


 


Each party
shall have access to
the Contract Area at all
reasonable times, at its sole cost and risk to inspect or observe operations.
and shall have access at reasonable times to information pertaining to the
development or operation thereof, including Operator’s books and records
relating thereto. Operator, upon request, shall furnish each of the other parties with copies of all forms or reports
filed with governmental agencies, daily drilling reports, well logs, tank
tables, daily gauge and run tickets and reports of stock on hand at the first
of each month, and shall make available samples
of any cures or cuttings taken from any well drilled on the Contract Area. The
cost of gathering and furnishing information to Non-Operator, other than that
specified above,
shall be charged to the Non-Operator that requests the information.


 


E.     Abandonment
of Wells:


 


1. Abandonment
of Dry Holes: Except for the wells drilled under Article VI A above and/for
any well drilled or deepened pursuant to Article VI.B.2., any well which has been drilled or deepened under the terms of this agreement and is
proposed to be completed as a dry hole shall not be plugged and abandoned
without the consent of all parties. Should Operator, after diligent effort, be
unable to contact any party, or should any party fail to reply within forty-eight (48) hours (exclusive of
Saturday, Sunday and legal holidays) after receipt of notice of the proposal to
plug and abandon such well, such party shall be deemed to have consented to the
proposed abandonment. All such wells shall be plugged and abandoned in accordance with
applicable regulations and at the cost, risk and expense of the parties who
participated in the cost of drilling or deepening such well. Any party who
objects to plugging and abandoning such well shall have the right to take over
the well and conduct further operations in search of oil
and/or gas subject to the provisions of Article VI.B.


 


2. Abandonment
of Wells that have Produced: Except/for the wells drilled under
Article VI A or for any well in which a Non-Consent operation has been conducted hereunder for
which the Consenting Parties have not been fully reimbursed as herein provided,
any well which has been completed
as a
producer shall not be plugged and abandoned without the consent of all parties.
If all parties consent to such
abandonment, the well shall be
plugged and abandoned in
accordance with applicable regulations and at the cost, risk and expense of all
the parties hereto. If, within thirty (30) days after receipt of notice of the
proposed abandonment of any well, all parties do not agree to the abandonment of such well,
those wishing to continue its operation from the interval(s) of the
formation(s) then open to production shall render to each of the other
parties its proportionate share of the value of the well’s salvable material
and equipment, determined in accordance with the provisions of
Exhibit “C”, less the estimated cost of salvaging and the estimated cost of plugging and abandoning. Each
abandoning party shall assign the non-abandoning parties, without warranty,
express or implied, as to title or as to quantity, or fitness for use of the
equipment and material, all of its interest in the well and related equipment, together with its interest in
the leasehold estate as to, but only as to, the interval or intervals of the
formation or formations then open to production. If the interest of the
abandoning party is or includes an oil and gas interest, such party shall
execute and deliver to the non-abandoning party or parties an oil and gas
lease, limited to the interval or intervals of the formation or formations then
open to production, for a term of one (1) year and so long thereafter as oil and/or gas is produced from the
interval or intervals of the formation or formations covered thereby, such
lease to be on the form attached as Exhibit


 


8

















 


ARTICLE VI


continued


 


“B”. The assignments or leases so limited
shall encompass the “drilling unit” upon which the well is located. The
payments by, and the assignments or leases to, the assignees shall be in a ratio based upon the relationship of their respective
percentage of participation in the Contract Area to the aggregate of the
percentages of participation in the Contract Area of all assignees. There shall be no readjustment of interests in the remaining portion of the Contract Area.


 


Thereafter, abandoning parties
shall have no further responsibility, liability, or interest in the operation of or production from the
well in the interval or intervals then open other than the royalties retained in any lease made under the terms of
this Article. Upon request, Operator shall continue to operate the assigned well
for the account of the non/abandoning parties at the rates and charges contemplated
by this agreement, plus any additional cost and charges which may arise as the
result of the separate ownership of the assigned well. Upon proposed
abandonment of the producing interval(s) assigned or leased, the assignor or lessor
shall then have the option to repurchase its prior interest in the well (using
the same valuation formula) and participate in further operations therein
subject to the provisions hereof.


 


3. Abandonment of Non-Consent
Operations: The provisions of Article VIE.1. or VI.E.2. above shall be
applicable as between Consenting Parties in the event of the
proposed abandonment of any well excepted from said Articles; provided, however, no well shall be permanently plugged and abandoned unless and until all
parties having the right to conduct
further operations therein have been notified of the proposed abandonment and afforded the opportunity to
elect to take
over the
well in accordance with the
provisions of this Article VI.E.


 


ARTICLE
VII.


EXPENDITURES AND LIABILITY OF PARTIES


 


A.    Liability
of Parties:


 


The liability
of the parties shall be several, not joint or collective. Each
party shall be responsible only for its obligations, and shall be liable
only for its
proportionate share of the costs of
developing and operating the Contract Area. Accordingly, the liens
granted among the parties in Article VIII.B. are given to secure only the
debts of each
severally. It is not the intention of the parties
to create, nor
shall this agreement be construed as creating a mining or other
partnership or association, or to render
the parties liable as partners.


 


B.    Liens
and Payment Defaults:


 


Each Non-Operator grants to
Operator a lien upon its oil and
gas rights in the Contract
Area, and a security interest in
its share of oil and/or gas when
extracted and its interest in all equipment, to secure payment of its share of
expense, together with interest thereon at the rate provided in Exhibit “C”. To the extent that Operator has a
security interest under the Uniform Commercial Code of the state, Operator
shall be entitled to exercise the rights and remedies of a secured party under
the Code. The bringing of a suit and the obtaining of judgment by Operator for the secured indebtedness shall not be deemed an election of remedies or
otherwise affect the lien rights or security interest as
security for the payment thereof. In addition, upon default by any Non-Operator in the payment
of its share of expense. Operator shall have the right, without prejudice to other rights or remedies, to collect from the purchaser the proceeds from the sale of
such Non-Operator’s share of oil and/or
gas until the amount owed by such Non-Operator, plus interest,
has been paid. Each purchaser shall be entitled to rely upon Operator’s written
statement concerning the amount of any default. Operator grants a like lien and security interest to the Non-Operators to secure payment of
Operator’s proportionate share of expense.


 


If any party fails or
is unable to pay its share of expense within sixty (60) days after rendition of a statement therefor by
Operator, the non-defaulting parties, including Operator, shall, upon request by Operator,
pay the unpaid amount in the proportion that the interest of each such party
bears to the interest of all such parties. Each party so paying its share of
the unpaid amount shall, to obtain reimbursement
thereof, be subrogated to the security rights described in the foregoing
paragraph.


 


C.    Payments
and Accounting:


 


Except as
herein otherwise specifically provided, Operator shall promptly pay and
discharge expenses incurred in the development and operation of the Contract
Area pursuant to this agreement and shall charge each of the parties hereto
with their respective proportionate shares upon the expense basis provided in
Exhibit “C”. Operator
shall keep an accurate record of the joint account hereunder, showing
expenses incurred and charges and credits made and received.


 


Operator, at its election,
shall have the right from time to time to demand and receive from the other parties payment in advance of their
respective shares of the estimated amount of the expense to be incurred in operations
hereunder during the next succeeding month, which right may be exercised only
by submission to each such party of an itemized statement of such estimated
expense, together with a invoice for its share thereof. Each such statement and
invoice for the payment in advance of estimated expense shall be submitted on
or before the 20th day of the next preceding month. Each party shall pay to
Operator its proportionate
share of such estimate within fifteen (15) days after such estimate and invoice is received. If any
party fails to pay its share of said estimate within said time, the amount due
shall bear interest as provided in Exhibit “C’’ until paid.
Proper adjustment shall be made monthly between
advances and actual expense to the end that each party shall bear and pay its proportionate
share of actual expenses incurred, and no more.


 


D.    Limitation of Expenditures:


 


1. Drill or Deepen: Without the consent of all parties,
no well shall be drilled or deepened, except any well drilled or deepened
pursuant to the provisions of Article VI.B.2. of this agreement. Consent
to the drilling or deepening shall include:


 


9














 


ARTICLE VII

continued


 


x           Option No. 1: All necessary
expenditures for the drilling or deepening, testing, completing and equipping
of the well, including necessary tankage and/or surface facilities.


 


o            Option No. 2: All necessary
expenditures for the drilling or deepening and testing of the well. When such
well has reached its authorized depth, and all tests have been completed,
and the results thereof furnished to the parties, Operator shall give immediate
notice to the Non-Operators who have the right to participate in the completion
costs. The parties receiving such notice shall have forty eight (48) hours
(exclusive of Saturday, Sunday
and legal holidays) in which to elect to participate in the setting of casing
and the completion attempt. Such election,
when made, shall include consent to all necessary expenditures for the
completing and equipping of such well, including
necessary tankage and/or surface facilities. Failure of any party
receiving such notice to reply within the period above fixed shall constitute
an election by that party not to participate in the cost of the completion
attempt. If one or more, but less than all of the parties, elect to set pipe and to attempt a completion,
the provisions of Article VI.B.2. hereof (the phrase “reworking, deepening
or plugging back” as contained in Article VI.B.2. shall be deemed to
include “completing”) shall apply to the operations thereafter conducted by
less than all parties.


 


2. Rework or Plug Back: Without the
consent of all parties, no well shall be reworked or plugged back except a well
reworked or plugged back pursuant to the provisions of Article VI.B.2. of
this agreement. Consent to the reworking or plugging back of a well shall
include all necessary expenditures in conducting such operations and completing
and equipping of said well, including necessary
tankage and/or
surface facilities.


 


3. Other Operations: Without the consent of all
parties. Operator shall not undertake any single project reasonably estimated to require an expenditure in excess of Fifty Thousand
Dollars ($ 50,000.00) except in connection with a well, the
drilling, reworking, deepening,
completing, recompleting, or plugging back of which has been previously authorized by
or pursuant to this agreement; provided, however, that, in case of explosion, fire,
flood or other sudden emergency, whether of the same or different nature.
Operator may take such steps and incur such expenses as in its opinion are
required to deal with the emergency
to safeguard life and
property but Operator, as promptly as possible, shall report the emergency to
the other parties. If Operator prepares an authority for expenditure (AFE) for its own use, Operator shall furnish any
Non-Operator so requesting an information copy thereof for any single project
costing in excess of Twenty-five Thousand Dollars ($ 25, 000 00)
but less than the amount first
set forth above in this paragraph.


 


E.             Rentals, Shut-in Well
Payments and Minimum Royalties:


 


Rentals,
shut-in well payments and minimum royalties which may be required under the
terms of any lease shall be paid by the party or parties who subjected such
lease to this agreement at its or their expense. In the event two or more
parties own and have contributed interests in the same lease to this agreement,
such parties may designate one of such parties to make said payments for and on
behalf of all such parties. Any party may request,
and shall be entitled to receive, proper
evidenced of all such payments. In
the event of failure to make proper payment of any rental, shut-in well payment
or minimum royalty through mistake or oversight where such payment is required to continue the lease in
force, any loss which results from such non-payment shall be borne in accordance with the
provisions of Article IV.B.2.


 


Operator shall
notify Non-Operator of the anticipated completion of a shut-in gas well, or the
shutting in or return to production of a producing gas well, at least five
(5) days (excluding Saturday, Sunday and legal
holidays), or at the earliest opportunity permitted by circumstances, prior to
taking such action, but assumes no liability for failure to do so. In the event of
failure by Operator to so notify Non-Operator, the loss of any lease
contributed hereto by Non-Operator for failure to make timely payments of any
shut-in well payment shall be borne jointly by the parties hereto under the provisions
of Article IV.B.3.


 


F.             Taxes:


 


Beginning with
the first calendar year after the effective date hereof, Operator shall render
for ad valorem taxation all
property subject to this agreement which by law should be rendered for such taxes, and it shall pay all such taxes
assessed thereon before they
become delinquent. Prior to the rendition date, each Non-Operator shall furnish
Operator information as to burdens (to include,
but not be limited to, royalties, overriding royalties and production
payments) on leases and oil and gas interests contributed by such Non-Operator. If
the assessed valuation of any leasehold estate is reduced by reason of its
being subject to outstanding excess royalties. over-riding royalties or
production payments, the reduction in ad valorem taxes resulting therefrom
shall inure to the
benefit of the owner or owners of such leasehold estate, and Operator
shall adjust the
charge to such owner or owners so as to reflect the benefit of such
reduction. If the
ad valorem taxes are based in whole or in part upon separate valuations
of each party’s working interest, then notwithstanding anything to the contrary
herein, charges to the joint account shall be made and paid by the parties hereto in accordance with
the tax value generated by each party’s working interest. Operator shall bill
the other parties for their proportionate shares of all tax payments in the manner provided
in Exhibit “C”.


 


If Operator
considers any tax assessment improper, Operator may, at its discretion, protest
within the time and manner prescribed by law, and prosecute the protest to a final
determination, unless all parties agree to abandon the protest prior to final
determination. During the pendency of administrative or judicial proceedings,
Operator may elect to pay, under protest, all such taxes and any interest and penalty. When any
such protested assessment shall have been finally determined, Operator shall
pay the tax for the joint account, together with any interest and penalty accrued, and
the total cost shall then be assessed against the parties, and be paid by them, as provided
in Exhibit “C”.


 


Each party
shall pay or cause to be paid all production, severance, excise, gathering and
other taxes imposed
upon or with respect to the production or handling of such party’s share
of oil
and/or gas produced under the terms of this agreement


 


10

















 


ARTICLE VII 


continued


 


G.            Insurance:


 


At all times while
operations are conducted hereunder, Operator shall comply with the workmen’s
compensation law of the state where the operations are being conducted;
provided, however, that Operator may be a self-insurer for liability under said
compensation laws in which event the only charge that shall be made to the
joint account shall be as provided in Exhibit “C”. Operator shall also carry or provide insurance for the benefit
of the joint account of the parties as outlined in Exhibit “D”, attached to
and made a part hereof. Operator shall
require all contractors engaged in work on or for the Contract Area to
comply with the workmen’s compensation law of the state where the operations
are being conducted and to maintain such other insurance as Operator may
require.


 


In the event
automobile public liability insurance is specified in said Exhibit “D”, or
subsequently receives the approval of the parties, no direct charge shall be made by
Operator for premiums paid for such insurance for Operator’s automotive equipment.


 


ARTICLE VIII.


ACQUISITION, MAINTENANCE OR TRANSFER OF INTEREST


 


A.            Surrender of Leases:


 


The leases
covered by this agreement, insofar as they embrace acreage in the
Contract Area, shall not be surrendered in whole or in part unless all parties
consent thereto.


 


However,
should any party desire to surrender its interest in any lease or in any
portion thereof, and the other parties do not agree or consent thereto, the party
desiring to surrender shall assign, without express or implied warranty of
title, all of its interest in such lease, or portion thereof, and any well,
material and equipment which may be located thereon and any rights in
production thereafter secured, to
the parties not consenting to
such surrender. If the interest of the assigning party is or includes an oil and gas interest, the assigning party
shall execute and
deliver to the party or
parties not consenting to such surrender an oil and gas lease covering such oil and gas
interest for a term of one (1) year and so long thereafter as oil and/or gas is produced from the land covered thereby, such lease to be
on the form attached hereto as Exhibit “B”. Upon such assignment or lease, the
assigning party shall be relieved from all obligations thereafter accruing, but
not theretofore accrued, with respect to the interest assigned or leased and
the operation of any well attributable thereto, and the assigning party shall
have no further interest in the assigned or leased premises and its equipment and production
other than the royalties retained in any lease made under the terms of this
Article. The party assignee or lessee shall pay to the party assignor or lessor
the reasonable salvage value of the latter’s interest in any wells and
equipment attributable to the assigned
or leased acreage. The value of all material shall be determined in
accordance with the
provisions of Exhibit “C”, less the estimated cost of salvaging and the
estimated cost of plugging and abandoning. If the assignment or lease is in
favor of more than one party, the interest shall be shared by such parties in
the proportions that the interest of each bears to the total interest of all
such parties. 


 


Any
assignment, lease or surrender made under this provision shall not reduce or
change the assignor’s, lessor’s or surrendering party’s interest as it was
immediately before the assignment, lease or surrender in the balance
of the Contract Area; and the acreage
assigned, leased or surrendered, and subsequent
operations thereon, shall not thereafter be subject to the terms and provisions of this agreement.


 


B.            Renewal or Extension
of Leases:


 


If any party
secures a renewal of any oil and gas lease subject to
this agreement, all other parties shall
be notified
promptly, and shall have the right for a period of thirty (30) days following
receipt of such notice in which to elect to participate in the ownership of the
renewal lease, insofar as such lease affects lands within the Contract Area, by
paying to the
party who acquired it their several proper proportionate shares of the acquisition
cost allocated to that part of such lease within the Contract Area, which shall
be in proportion to the interests held at that time by the limits in the Contract Area.


 


If some, but
less than all, of the parties elect to participate in the purchase
of a renewal lease, it shall be owned by the parties who elect to participate
therein, in a ratio based upon the relationship of their
respective percentage of participation in the Contract Area to the aggregate of
the percentages of participation in the Contract Area of all parties
participating in the purchase of such renewal lease. Any renewal lease in which
less than all parties elect to participate shall not be subject to this
agreement.


 


Each party who
participates in the purchase of a renewal lease shall be given an assignment of
its proportionate interest therein by the acquiring party.


 


The provisions
of this Article shall apply to renewal leases whether they are for the entire interest covered by the expiring lease or cover only a portion of its area or an interest therein. Any
renewal lease taken before the expiration of its predecessor lease, or taken or
contracted for within six (6) months after the expiration of the existing
lease shall be subject to this provision; but any lease taken or contracted for
more than six (6) months after the expiration of an existing lease shall not be
deemed a renewal
lease and shall not be subject to the provisions
of this agreement.


 


The
provisions in this Article shall also be applicable to extensions
of oil and gas leases.


 


C.            Acreage or Cash
Contributions:


 


While this
agreement is in force, if any party contracts for a contribution of cash
towards the drilling of a well or any other
operation on the Contract Area, such contribution shall be paid to the party
who conducted the drilling or other operation and shall be applied by it against the cost of such drilling or other
operation. If the
contribution be in the form of acreage, the party to whom the
contribution is made shall promptly tender an assignment of the acreage,
without warranty of title, to the Drilling Parties in the proportions


 


11

















 


ARTICLE VIII

continued


 


said Drilling Parties shared the cost
of drilling the well. Such acreage shall become a separate Contract
Area and, to
the extent possible, be governed by
provisions identical to this agreement. Each party shall promptly notify
all other parties of any acreage or cash contributions
it may obtain in support of any
well or any other operation on the Contract Area. The above provisions shall also
be applicable to optional rights to earn acreage outside
the Contract Area which are in
support of a well drilled inside the Contract Area.


 


If any party contracts for any
consideration relating to disposition of such party’s share of substances produced hereunder, such
consideration shall not be deemed a contribution as contemplated
in this Article VIII.C.


 


D.            Maintenance of Uniform Interest:


 


For the
purpose of maintaining uniformity of ownership in the oil and gas leasehold interests covered by this agreement, no party shall sell,
encumber, transfer or make other disposition of its interest in the leases embraced within the Contract
Area and in wells, equipment and
production unless such disposition covers
either:


 


1. the entire
interest of the party in all leases and equipment and production;
or


 


2. an equal
undivided interest in all leases and equipment and production in the Contract
Area.


 


Every such
sale, encumbrance, transfer or other disposition made by any party shall be
made expressly subject to this agreement and shall be made without prejudice to the right of
the other parties. 


 


If, at any
time the interest of any party is divided among and owned by four or more
co-owners, Operator, at its discretion, may require such co-owners to appoint a
single trustee or agent with full authority to receive notices, approve expenditures,
receive billings for and approve and pay
such party’s share of the
joint expenses, and to deal generally with, and with power to bind, the
co-owners of such party’s interest within the scope of the operations embraced
in this agreement; however, all such co-owners shall have the right to enter
into and execute all contracts or agreements
for the disposition of their respective shares of the oil and gas produced from the Contract Area and they shall have the right to receive, separately, payment of the sale proceeds thereof.


 


E.             Waiver of Rights to
Partition:


 


If permitted
by the laws of the state or states in which the property covered hereby is
located, each party hereto owning an undivided interest in the Contract Area
waives any and all rights it may have to partition and have set aside to it in separately
its undivided interest therein. 


 


F.             Preferential Right to
Purchase:


 


12

















 


ARTICLE IX.


INTERNAL
REVENUE CODE ELECTION


 


ARTICLE X.


CLAIMS AND LAWSUITS


 


Operator may
sent any single uninsured third party damage claim or suit arising from operations hereunder if the
expenditure does not exceed Fifty Thousand
Dollars ($50,000.00) and if the
payment is in complete settlement of such claim or suit. If the amount
required for settlement exceeds the above amount, the
parties hereto shall assume and take over the further handling of the
claim or suit, unless such authority is delegated to Operator. All costs and expenses of handling, settling, or
otherwise discharging such claim or suit shall be at the joint expense of the parties
participating in the operation from which the claim or suit arises. If a claim
is made against any party or if any party is sued on account of any matter arising
from operations hereunder over which such individual has no control because of the rights
given Operator by this agreement, such party shall immediately notify all other
parties, and the claim or suit shall be treated as any other claim or suit
involving operations hereunder.


 


ARTICLE XI.


FORCE MAJEURE


 


If any party
is rendered unable, wholly or in part, by force
majeure to carry out its obligations under this agreement, other than the obligation to make money payments,
that party shall give to all other parties prompt written notice of the force
majeure with reasonably full
particulars concerning it; thereupon, the obligations of the party giving the
notice, so far as they are affected by the force majeure, shall be suspended during,
but no longer than, the continuance of the force majeure. The affected party shall use all reasonable
diligence to remove the force majeure situation as quickly as practicable.


 


The
requirement that any force majeure shall be remedied with all reasonable
dispatch shall not require the settlement of strikes, lockouts, or other labor
difficulty by the party involved, contrary to its wishes; how all such
difficulties shall be handled shall be entirely within the discretion of the party
concerned. 


 


The
term “force majeure”, as here employed, shall mean an act of God,
strike, lockout, or other industrial disturbance, act of the public enemy, war,
blockade, public riot, lightning, fire, storm, flood, explosion, governmental
action, governmental delay, restraint or inaction, unavailability of equipment,
and any other cause, whether of the kind specifically enumerated above or
otherwise, which is not reasonably within the control of the party claiming suspension.


 


ARTICLE XII.


NOTICES


 


All notices
authorized or required between the parties and required by any of the
provisions of this agreement, unless otherwise specifically provided, shall be
given in writing by mail or telegram, postage or charges prepaid, or by telex
or telecopier and addressed to the parties to whom the notice is given at the
addresses listed on Exhibit “A”. The originating notice given under any
provision hereof shall be deemed given only when received by the party to whom
such notice is directed, and the time for such party to give any notice in response thereto shall run from the
date the originating notice is received. The second or any responsive notice shall be deemed given
when deposited in the mail or with the telegraph company, with postage or
charges prepaid, or sent by telex
or telecopier. Each party shall have the right to change its address at any time, and from time to time, by giving
written notice thereof to all other parties.


 


ARTICLE XIII.


TERM OF AGREEMENT


 


This agreement
shall remain in full force and effect as to the oil and gas leases
and/or oil and gas interests subject hereto for the period of time selected
below; provided, however, no party hereto shall ever be construed as having any
right, title or interest in or to any lease or oil and gas interest contributed by any other
party beyond the term of this agreement.


 


x           Option
No. 1: So long as any of the oil and gas leases subject to this agreement remain
or are continued in force as to any part of
the Contract Area, whether by production, extension, renewal or otherwise.


 


o            Option
No. 2: In the event the well described in Article VI.A., or any
subsequent well drilled under any provision of this agreement, results us
production of oil and/or gas in paying quantities, this agreement shall
continue in force so long as any such well or wells produce, or are capable of
production, and for an additional period of      days from
cessation of all production; provided, however, if, prior to the expiration
of such additional period, one or more of the parties hereto are engaged in drilling, reworking,
deepening, plugging back, testing
or attempting to complete a well or wells hereunder, this agreement shall
continue in force until such operations have been completed and if
production results therefrom, this agreement
shall continue in force as provided herein. In the event the well described in
Article VI.A., or any subsequent well drilled hereunder, results in a dry
hole, and no other well is producing, or capable of producing oil and/or gas
from the Contract Area, this agreement shall
terminate unless drilling, deepening, plugging back of reworking
operations are commenced
within        days from the date of
abandonment of said well.


 


It is agreed, however, that
the termination
of this agreement shall not relieve any party hereto from any liability which has
accrued or attached
prior to the date of such termination.


 


13

















 


ARTICLE XIV.


COMPLIANCE WITH LAWS AND REGULATIONS


 


A.            Laws, Regulations and
Orders:


 


This agreement
shall be subject to the conservation laws of the state in which the Contract Area is located, to
the valid rules, regulations, and orders of any duly constituted regulatory
body of said state; and to all other applicable federal, state, and local laws,
ordinances, rules, regulations,
and orders.


 


B.            Governing Law:


 


This agreement
and all matters pertaining hereto, including, but not limited to, matters of
performance, non-performance, breach, remedies, procedures, rights, duties and
interpretation of construction, shall be governed and determined by the law of
the state in which the Contract Area is located 


 


C.            Regulatory Agencies:


 


Nothing herein
contained shall grant, or be construed to grant, Operator the right or
authority to waive or release any rights, privileges, or obligations which
Non-Operators may have under federal or state laws or under rules, regulations
or orders promulgated under such laws in reference to
oil, gas and mineral
operations, including the location, operation, or production of wells, on
tracts offsetting or adjacent to the Contract Area.


 


With respect
to operations hereunder. Non-Operators agree to release Operator
from any and all losses, damages, injuries, claims and causes of action arising
out of, incident to or resulting directly or indirectly from Operator’s
interpretation or application of rules, rulings, regulations or orders of the
Department of Energy or predecessor or successor agencies to the extent such
interpretation or application was made in good faith. Each Non-Operator
further agrees to reimburse Operator for any amounts applicable to such Non-Operator’s
share of production that Operator may be required to refund, rebate or pay as a
result of such an incorrect interpretation or application, together with
interest and penalties thereon owing by Operator as a result of such incorrect
interpretation or application.


 


Non-Operators
authorize Operator to prepare and submit such documents as may be required to
be submitted to the purchaser of any crude oil sold hereunder or to any other
person or entity pursuant to the requirements of the “Crude Oil
Windfall Profit Tax Act of 1980”, as same may be amended from time to time (“Act”),
and any valid regulations or rules which may be issued by the Treasury
Department from time to time pursuant to said Act. Each party hereto agrees to furnish
any and all
certifications or other information which is required to be furnished by said
Act in a timely manner and in sufficient detail to permit compliance with said
Act.


 


 


ARTICLE XV.


OTHER PROVISIONS


 


In the event of any conflict
between the provisions of this agreement and the Participation Agreement between the parties hereto, the terms of the latter shall prevail.


 


Operator may (but shall not be obligated to) prepare and file
any affidavit or other instrument which Operator in its sole discretion
deems necessary to be filed in the appropriate
records to give record notice of this
agreement and the terms hereof including, but not limited to, the liens and security interests created herein.


 


14














 


ARTICLE XVI.


MISCELLANEOUS


 


This agreement
shall be binding upon
and shall inure to the benefit
of the parties hereto and to their respective heirs, devisees, legal representatives, successors and assigns.


 


This
instrument may be executed in any number of counterparts, each of which shall be considered an original for all purposes.


 


IN WITNESS
WHEREOF, this agreement shall be effective as of 22nd
day of June 1987.


 


OPERATOR


 


	
   

  	
   

  	
  D. L.
  RAY, INC.

  
	
   

  	
   

  
	
   

  	
  By:

  	
  /s/ Donald
  L. Ray

  
	
   

  	
   

  	
  Donald L.
  Ray, President

  
	
   

  	
   

  



 


NON-OPERATORS


 


	
  ATTEST:

  	
   

  	
  Enron
  Oil and Gas Company

  
	
   

  	
   

  
	
   

  	
   

  
	
  /s/ J.
  Jeffers Spencer

  	
   

  	
  By:

  	
  /s/ Rex G.
  Howell

  
	
  J. JEFFERS
  SPENCER

  Illegible

  	
   

  	
   

  	
  Rex G.
  Howell

  Executive Vice President

  



 


15

















 


	
  STATE OF

  	
   

  	
  Texas

  	
  )

  
	
   

  	
   

  	
   

  	
  )

  
	
  COUNTY OF

  	
   

  	
  Dallas

  	
  )

  



 


BEFORE ME, the undersigned, a Notary Public in said State, on this day
personally appeared Donald
L. Ray, President of
D. L. RAY. INC., known to me to be the person and
officer whose name is subscribed to
the foregoing instrument, and acknowledged to me that he executed the
same on behalf of said D. L. RAY, INC. for the purpose and consideration
therein expressed.


 


GIVEN UNDER MY HAND AND SEAL OF OFFICE, this 25th day of June, 1987.


 


 


	
   

  	
  Illegible

  
	
   

  	
  Notary
  Public in and for the 

  State of Texas

  
	
   

  	
   

  
	
   

  	
  My
  commission expires:

  
	
   

  	
   

  
	
   

  	
  November 23,
  1989

  



 


 


	
  STATE OF

  	
   

  	
   

  	
  )

  
	
   

  	
   

  	
   

  	
  )

  
	
  COUNTY OF

  	
   

  	
   

  	
  )

  



 


BEFORE ME, the undersigned, a Notary
Public in said State, on this day personally appeared
              ,        of
              , known to me to be the
person and officer whose name is subscribed to the foregoing instrument, and
acknowledged to me that he executed the
same on behalf of said
                      for the purpose and
consideration therein
expressed. 


 


GIVEN UNDER MY HAND AND SEAL OF OFFICE, this           day
of
                ,
19           .


 


	
   

  	
   

  
	
   

  	
  Notary
  Public in and for the 

  State of Texas

  
	
   

  	
   

  
	
   

  	
  My
  commission expires:

  
	
   

  	
   

  
	
   

  	
   

  



 

















 


EXHIBIT “A”


 


In accordance
with the terms and conditions of the Participation Agreement, the Contract Area
shall include all interest acquired by Operator and Non-Operator in and to
certain producing oil and gas mineral properties located in Howard and Mitchell
Counties, Texas. Such properties are more fully described as follows:


 


(1)           The
Northwest Quarter (NW/4) of Section 43 and 70 acres out of Section 42
lying South of the Texas Pacific Railway, Blk. 29, and the Southeast Quarter
(SE/4) of Section 37 and the Northeast Quarter (NE/4), the East Half (E/2)
of the Northwest Quarter (NW/4) of the Southeast Quarter (SE/4) of the
Northwest Quarter (NW/4) of the Northwest Quarter (NW/4) of Section 48,
Block 30, T-1-N, T & P Ry. Co. Survey, Howard and Mitchell Counties, Texas.


 


(2)           TO BE PROVIDED BY OPERATOR WITH A REASONABLE TIME AFTER THE DATE OF
CLOSING


 


(3)           Fractional interest of
parties are those provided by the Participation Agreement.


 


(4)           TO
BE PROVIDED BY OPERATOR WITHIN A REASONABLE
TIME AFTER THE DATE OF CLOSING.


 


(5)           D.
L. Ray Mitchell


1112 North
Floyd Road 


Suite 9


Richardson,
Texas 75080


 


(6)           Enron
Oil and Gas Company 


P. O. Box 1188


Houston, Texas
77251


 

















 


COPAS — 1974


 


Recommended by the 


Council of Petroleum


ILLEGIBLE


 





 


EXHIBIT
“C”


 


Attached
to and made a part of Operating Agreement between

D. L. Ray, Inc., as Operator, and Enron Oil & Gas Co.

as Non-Operator


 


ACCOUNTING PROCEDURE


JOINT OPERATIONS


 


I.
GENERAL PROVISIONS


 


1.             Definitions


 


“Joint
Property” shall mean the real and personal property
subject to the
agreement to which this Accounting Procedure is attached.


 


“Joint
Operations” shall mean all operations necessary or proper for the development,
operation, protection and maintenance of the Joint Property.


 


“Joint
Account” shall mean the account showing the charges paid and credits received
in the conduct of the Joint Operations and which are to be shared by the
Parties.


 


“Operator”
shall mean the party designated to conduct the Joint Operations. 


 


“Non-Operators”
shall mean the parties to this agreement other than the Operator. 


 


“Parties”
shall mean Operator and Non-Operators.


 


“First Level
Supervisors” shall mean those employees whose primary function in Joint
Operations is the direct supervision of other employees and/or contract labor
directly employed on the Joint Property in a field operating capacity.


 


“Technical
Employees” shall mean those employees having special and specific engineering,
geological or other professional skills, and whose primary function in Joint
Operations is the handling of specific operating conditions and problems for
the benefit of the Joint Property.


 


“Personal
Expenses” shall mean travel and other reasonable reimbursable expenses of Operator’s
employees. 


 


“Material”
shall mean personal property, equipment or supplies acquired or held for
use on
the Joint Property.


 


“Controllable
Material” shall mean Material which at the time is so classified in the
Material Classification Manual as most recently recommended by the
Council of Petroleum Accountants Societies of North America.


 


2.             Statement and Billings


 


Operator shall
bill Non-Operators on or before the last day of each month for their proportionate share of the
Joint Account for the preceding month. Such bills will be accompanied by
statements which identify the authority for expenditure, lease or facility, and
all charges and credits, summarized by appropriate classifications of
investment and expense except that
items of Controllable Material and unusual charges and credits shall be
separately identified and fully described in detail.


 


3.             Advances and Payments
by Non-Operators


 


Unless
otherwise provided for in the agreement, the Operator may require the
Non-Operators to advance their share of estimated cash outlay for the
succeeding month’s operation. Operator shall adjust each monthly billing to
reflect advances received from the Non-Operators.


 


Each
Non-Operator shall pay its proportion of all bills within fifteen (15) days
after receipt. If payment is not made within such time, the unpaid balance
shall bear interest monthly at the maximum contract rate permitted by the
applicable usury laws in the state in which the Joint Property is located, plus
attorney’s fees, court costs, and other costs in connection with the collection
of unpaid amounts.


 


4.             Adjustments


 


Payment of any
such bills shall not prejudice the right of any Non-Operator to protest or
question the correctness thereof; provided, however, all bills and statements
rendered to Non-Operators by Operator during any calendar year shall
conclusively be presumed to be true and correct after twenty-four (24) months
following the end of any such calendar year, unless within the said twenty-four
(24) month period a Non-Operator takes written exception thereto and makes
claim on Operator for adjustment. No adjustment favorable to Operator shall be
made unless it is made within the same prescribed period. The provisions of
this paragraph shall not prevent adjustments resulting from a physical
inventory of Controllable Material as provided for in Section V.


 


5.             Audits


 


A.
Non-Operator, upon notice in writing to Operator and all other Non-Operators,
shall have the right to audit Operator’s accounts and records relating to the
Joint Account for any calendar year within the twenty-four (24) month period
following the end of such calendar year; provided, however, the making of an
audit shall not extend the time for the taking of written exception to and the
adjustments of accounts as provided for in Paragraph 4 of this Section I.
Where there are two or more Non-Operators, the Non-Operators shall make every
reasonable effort to conduct joint or simultaneous audits in a manner which
will result in a minimum of inconvenience to the Operator. Operator shall bear
no portion of the Non-Operators’ audit cost incurred under this paragraph
unless agreed to by the Operator.


 


6.             Approval
by Non-Operators


 


Where an
approval or other agreement of the Parties or Non-Operators is expressly
required under other sections of this Accounting Procedure and if the agreement
to which this Accounting Procedure is attached contains no contrary provisions
in regard thereto, Operator shall notify all Non-Operators of the Operator’s
proposal, and the agreement or approval of a majority in interest of the
Non-Operators shall be controlling on all Non-Operators.


 


1

















 


II. DIRECT CHARGES


 


Operator shall charge the Joint
Account with the following items:


 


1.             Rentals and Royalties


 


Lease rentals
and royalties paid by Operator for the Joint Operations.


 


2.             Labor


 


A.   (1)            Salaries
and wages of
Operator’s field employees directly employed on the Joint Property in the conduct of Joint Operations.


 


(2)          Salaries of First Level Supervisors in the field.


 


(3)          Salaries and wages of Technical Employees
directly employed on the Joint Property if such charges are excluded from the
Overhead rates.


 


B.  Operator’s cost of holiday, vacation, sickness
and disability benefits and other customary allowances paid to employees whose
salaries and wages are chargeable to the Joint Account under Paragraph 2A of
this Section II. Such costs under this Paragraph 2B may be charged on a
“when and as paid basis” or by “percentage assessment” on the amount of
salaries and wages chargeable to the Joint Account under Paragraph 2A of this
Section II. If percentage assessment is used, the rate shall be based on
the Operator’s cost experience.


 


C.  Expenditures or contributions made pursuant to
assessments imposed by governmental authority which are applicable to
Operator’s costs chargeable to the Joint Account under Paragraphs 2A and 2B of
this Section II.


 


D.  Personal Expenses of those employees whose
salaries and wages are chargeable to the Joint Account under Paragraph 2A of
this Section II.


 


3.             Employee Benefits


 


Operator’s
current costs of established plans for employees’ group life insurance,
hospitalization, pension, retirement, stock purchase, thrift, bonus, and other
benefit plans of a like nature, applicable to Operator’s labor cost chargeable
to the Joint Account under Paragraphs 2A and 2B of this Section II shall
be Operator’s actual cost not to exceed twenty per cent (20%).


 


4.             Material


 


Material purchased
or furnished by Operator for use on the Joint Property as
provided under Section IV. Only such Material shall be purchased for or
transferred to the Joint Property as may be required
for immediate use and is reasonably practical and consistent with
efficient and economical operations. The accumulation of surplus stocks
shall be avoided.


 


5.             Transportation


 


Transportation
of employees and Material necessary for the Joint Operations but subject to the
following limitations:


 


A.           If Material is moved to
the Joint Property from the Operator’s warehouse or other properties, no charge
shall be made to the Joint Account for a distance greater than the distance
from the nearest reliable supply store, recognized barge terminal, or railway
receiving point where like material is normally available, unless agreed to by
the Parties.


 


B.             If surplus Material
is moved to Operator’s warehouse or other storage point, no charge shall be
made to the Joint Account for a distance greater than the distance to the
nearest reliable supply store, recognized barge terminal, or railway receiving
point unless agreed to by the Parties. No charge shall be made to the Joint
Account for moving Material to other properties belonging to Operator, unless
agreed to by the Parties.


 


C.             In the application of
Subparagraphs A and B above, there shall be no equalization of actual gross
trucking cost of $200 or less excluding accessorial charges.


 


6.             Services


 


The cost of
contract services, equipment and utilities provided by outside sources, except
services excluded by Paragraph 9 of Section II and Paragraph 1. ii of
Section III. The cost of professional consultant services and contract
services of technical personnel directly engaged on the Joint Property if such
charges are excluded from the Overhead rates. The cost of professional
consultant services or contract services of technical personnel not directly
engaged on the Joint Property shall not be charged to the Joint Account unless
previously agreed to by the Parties.


 


7.             Equipment and Facilities
Furnished by Operator


 


A.           Operator shall charge
the Joint Account for use of Operator owned equipment and facilities at rates
commensurate with costs of ownership and operation. Such rates shall include
costs of maintenance, repairs, other operating expense, insurance, taxes,
depreciation, and interest on investment not to exceed eight per cent (8%) per
annum. Such rates shall not exceed average commercial rates currently
prevailing in the immediate area of the Joint Property.


 


B.             In lieu of charges in
Paragraph 7A above, Operator may elect to use average commercial rates
prevailing in the immediate area of the Joint Property less 20%. For automotive
equipment, Operator may elect to use rates published by the Petroleum Motor
Transport Association.


 


8.             Damages and Losses to Joint Property


 


All
costs or expenses necessary for the repair or replacement of Joint
Property made necessary because of damages or losses incurred by fire, flood,
storm, theft, accident, or other cause, except those resulting from Operator’s gross negligence or willful
misconduct. Operator shall furnish Non-Operator written notice of damages or losses incurred
as soon as practicable after a report thereof has been received by Operator.


 


9.             Legal Expense


 


Expense of
handling, investigating and settling litigation or claims, discharging of
liens, payment of judgments and amounts paid for settlement of claims incurred
in or resulting from operations under the agreement or necessary to protect or
recover the Joint Property, except that no charge for services of Operator’s
legal staff or fees or expense of outside attorneys shall be made unless
previously agreed to by the Parties. All other legal expense is considered to
be covered by the overhead provisions of Section III unless otherwise agreed
to by the Parties, except as provided in Section I, Paragraph 3.


 


2














 


10.  Taxes


 


All taxes of
every kind and nature assessed or levied upon or in connection with the Joint
Property, the operation thereof, or the production therefrom, and which taxes
have been paid by the Operator for the benefit of the Parties.


 


11.  Insurance


 


Net premiums
paid for insurance required to be carried for the Joint Operations for the
protection of the Parties. In the event Joint Operations are conducted in a
state in which Operator may act as self-insurer for Workmen’s Compensation
and/or Employers Liability under the respective state’s laws, Operator
may, at its election, include the risk under its self-insurance program and in
that event, Operator shall include a charge at Operator’s cost not to exceed
manual rates.


 


12.  Other Expenditures


 


Any other
expenditure not covered or dealt with in the foregoing provisions of this
Section II, or in Section III, and which is incurred by the Operator
in the necessary and proper conduct of the Joint Operations.


 


III. OVERHEAD


 


1.     Overhead - Drilling and Producing
Operations


 


i.      As compensation for administrative, supervision,
office services and warehousing costs, Operator shall charge drilling and
producing operations on either:


 


(xx) Fixed
Rate Basis, Paragraph 1A, or 


(   )
Percentage Basis, Paragraph 1B.


 


Unless
otherwise agreed to by the Parties, such charge shall be in lieu of costs and
expenses of all offices and salaries or wages plus applicable burdens and
expenses of all personnel, except those directly chargeable under Paragraph 2A,
Section II. The cost and expense of services from outside sources in
connection with matters of taxation, traffic, accounting or matters before or
involving governmental agencies shall be considered as included in the Overhead
rates provided for in the above selected Paragraph of this Section III
unless such cost and expense are agreed to by the Parties as a direct charge to
the Joint Account.


 


ii.     The
salaries, wages and Personal Expenses of Technical Employees and/or the cost of
professional consultant services and contract services of technical personnel
directly employed on the Joint Property shall not (x) be covered by the
Overhead rates.


 


A.    Overhead - Fixed Rate Basis


 


(1)   Operator
shall charge the Joint Account at the following rates per well per month:


 


Drilling Well Rate $2,650.00


Producing Well Rate $400.00


 


(2)   Application
of Overhead - Fixed Rate Basis shall be as follows:


 


(a)   Drilling
Well Rate


 


[1]   Charges
for onshore drilling wells shall begin on the date the well is spudded and
terminate on the date the drilling or completion rig is released, whichever is
later, except that no charge shall be made during suspension of drilling
operations for fifteen (15) or more consecutive days.


 


[2]   Charges
for offshore drilling wells shall begin on the date when drilling or completion
equipment arrives on location and terminate on the date the drilling or
completion equipment moves off location or rig is released, whichever occurs
first, except that no charge shall be made during suspension of drilling
operations for fifteen (15) or more consecutive days


 


[3]   Charges
for wells undergoing any type of workover or recompletion for a period of five
(5) consecutive days or more shall be made at the drilling well rate. Such
charges shall be applied for the period from date workover operations, with
rig, commence through date of rig release, except that no charge shall be made
during suspension of operations for fifteen (15) or more consecutive days.


 


(b)   Producing
Well Rates


 


[1]   An
active well either produced or injected into for any portion of the month shall
be considered as a one-well charge for the entire month.


 


[2]   Each
active completion in a multi-completed well in which production is not
commingled down hole shall be considered as a one-well charge providing each
completion is considered a separate well by the governing regulatory authority.


 


[3]   An
inactive gas well shut in because of overproduction or failure of purchaser to
take the production shall be considered as a one-well charge providing the gas
well is directly connected to a permanent sales outlet.


 


[4]   A
one-well charge may be made for the month in which plugging and abandonment
operations are completed on any well.


 


[5]   All
other inactive wells (including but not limited to inactive wells covered by
unit allowable, lease allowable, transferred allowable, etc.) shall not qualify
for an overhead charge.


 


(3)   The
well rates shall be adjusted as of the first day of April each year
following the effective date of the agreement to which this Accounting
Procedure is attached. The adjustment shall be computed by multiplying the rate
currently in use by the percentage increase or decrease in the average weekly
earnings of Crude Petroleum and Gas Production Workers for the last calendar
year compared to the calendar year preceding as shown by the index of average
weekly earnings of Crude Petroleum and Gas Fields Production Workers as
published by the United States Department of Labor, Bureau of Labor Statistics,
or the equivalent Canadian index as published by Statistics Canada, as
applicable. The adjusted rates shall be the rates currently in use, plus or
minus the computed adjustment.


 


3

















 


B.    Overhead - Percentage Basis


 


(1)   Operator shall charge the Joint Account at the
following rates:


 


(a)   Development


 


                   Percent
(%) of the cost of Development of the Joint Property exclusive of
costs provided under
Paragraph 9 of Section II and all salvage credits.


 


(b)   Operating


 


                               Percent
(%) of the cost of Operating the Joint Property exclusive of costs provided under Paragraphs 1
and 9 of Section II, all salvage credits, the value of injected substances purchased for
secondary recovery and all taxes and assessments which are levied, assessed and
paid upon the mineral interest in and to the Joint Property.


 


(2)   Application of Overhead - Percentage Basis
shall be as follows:


 


For
the purpose of determining charges on a percentage basis under Paragraph 1B of
this Section III, development shall include all costs in connection with
drilling, redrilling, deepening or any remedial operations on any or all wells
involving the use of drilling crew and equipment; also, preliminary
expenditures necessary in preparation for drilling and expenditures incurred in
abandoning when the well is not completed as a producer, and original cost of
construction or installation of fixed assets, the expansion of
fixed assets and any other project clearly discernible as a fixed asset, except Major Construction as defined in Paragraph 2 of this
Section III. All other costs shall be considered as Operating.


 


2.     Overhead - Major Construction


 


To
compensate Operator for overhead costs incurred in the construction and
installation of fixed assets, the expansion of fixed assets, and any other
project clearly discernible as a fixed asset required for the development and
operation of the Joint Property, Operator shall either negotiate a rate prior
to the beginning of construction, or shall charge the Joint Account for
Overhead based on the following rates for any Major Construction
project 


 


B.
3% of total costs up to $1,000,000; plus


 


C.
11/2% of total costs in excess of $1,000,000.


 


Total
cost shall mean the gross cost of any one project. For
the purpose of this paragraph, the component parts of a single project shall
not be treated separately and the cost of drilling and workover wells shall be
excluded.


 


3.     Amendment of Sales


 


The
Overhead rates provided for in this Section III may be amended from time
to time only by mutual agreement between the Parties hereto if, in practice,
the rates are found to be insufficient or
excessive.


 


IV. PRICING OF JOINT ACCOUNT MATERIAL PURCHASES, TRANSFERS
AND DISPOSITIONS


 


Operator is responsible for
Joint Account Material and shall make proper and timely charges and credits for
all material movements affecting the Joint Property. Operator shall provide all
Material for use on the Joint Property; however, at Operator’s option, such
Material may be supplied by the Non-Operator. Operator shall make timely
disposition of idle and/or surplus Material, such disposal being
made either through sale to Operator or Non-Operator, division in kind, or sale
to outsiders. Operator may purchase, but shall be under no obligation to
purchase, interest of Non-Operators in surplus condition A or B Material. The
disposal of surplus Controllable Material not purchased by the Operator shall
be agreed to by the
Parties.


 


1.     Purchases


 


Material
purchased shall be charged at the price paid by Operator after deduction of all
discounts received. In case of Material found to be defective or returned to vendor for any
other reason, credit shall be passed to the Joint Account when adjustment has
been received by the Operator.


 


2.     Transfers and Dispositions


 


Material
furnished to the Joint Property and Material transferred from the Joint Property or
disposed of by the Operator, unless otherwise agreed to by the Parties, shall
be priced on the following bases
exclusive of cash discounts:


 


A.    New
Material (Condition A)


 


(1)   Tubular goods, except line pipe, shall be
priced at the current new price in effect on date of movement on a
maximum carload or barge load weight basis, regardless of quantity transferred,
equalized to the lowest published price
f.o.b. railway receiving point or recognized barge terminal nearest the Joint Property where such
Material is normally available.


 


(2)   Line Pipe


 


(a)   Movement of less than 30,000 pounds shall be priced at the
current new price, in effect at date of movement, as listed by a reliable
supply store nearest the Joint Property where such Material is normally available.


 


(b)   Movement of 30,000 pounds or more shall be priced
under provisions of tubular goods pricing in Paragraph 2 A (1) of this Section IV.


 


(3)   Other Material shall be priced at the current new
price, in
effect at date of movement, as listed by a reliable supply
store or
f.o.b. railway receiving point nearest the Joint Property where such Material
is normally available.


 


B.    Good Used Material (Condition B)


 


Material
in sound and serviceable condition and suitable for reuse without reconditioning:


 


(1)   Material moved to the Joint Property


 


(a)   At seventy-five percent (75%) of current new price, as
determined by Paragraph 2A of this Section IV. 


 


(2)   Material moved from the Joint Property


 


(a)   At seventy-five percent (75%) of current new price, as determined by Paragraph 2A of
this Section IV, if Material was originally charged to the Joint Account
as new Material, or


 


4

















 


(b)   at sixty-five percent (65%) of current new
price, as determined by Paragraph 2A of this Section IV, if Material was
originally charged to the Joint Account as good used Material at seventy-five
percent (75%) of current new price.


 


The
cost of reconditioning, if any, shall be absorbed by the transferring property.


 


C.    Other Used Material (Condition C and D)


 


(1)   Condition C


 


Material
which is not in sound and serviceable condition and not suitable for its
original function until after reconditioning shall be priced at fifty percent
(50%) of current new price as determined by Paragraph 2A of this
Section IV. The cost of reconditioning shall be charged to the receiving
property, provided Condition C value plus cost of reconditioning does not
exceed Condition B value.


 


(2)   Condition D


 


All
other Material, including junk, shall be
priced at a value commensurate with its use or at prevailing prices.
Material no longer suitable for its original purpose but usable for some other
purpose, shall be priced on a basis comparable with that of items normally used
for such other purpose. Operator may dispose of Condition D Material under
procedures normally utilized by the Operator without prior approval of
Non-Operators.


 


D.    Obsolete Material


 


Material
which is serviceable and usable for its original function but condition and/or
value of such Material is not equivalent to that which would justify a price as provided above may be
specially priced as agreed to by the Parties. Such price should result in the
Joint Account being charged with the value of the service rendered by such
Material.


 


E.    Pricing Conditions


 


(1)   Loading and unloading costs may be charged to the Joint Account at
the rate of fifteen cents (15c) per hundred
weight on all tubular goods movements, in lieu of loading and unloading costs
sustained, when actual hauling cost of such tubular goods are equalized under
provisions of Paragraph 5 of Section II.


 


(2)   Material involving erection costs shall be
charged at applicable
percentage of the current knocked-down price of new Material.


 


3.     Premium Prices


 


Whenever
Material is not readily obtainable at published or listed prices because of
national emergencies, strikes or other unusual causes over which the Operator
has no control, the Operator may charge the Joint Account for the required
Material at the Operator’s actual cost incurred in providing such Material, in
making it suitable for use, and in moving it to the Joint Property; provided
notice in writing is furnished to Non-Operators of the proposed charge prior to billing Non-Operators
for such Material. Each Non-Operator shall have the right, by so electing and
notifying Operator within ten days after receiving notice from Operator, to
furnish in kind all or part of his share
of such Material suitable for use and acceptable to Operator.


 


4.     Warranty of Material
Furnished by Operator


 


Operator
does not warrant the Material furnished. In case of defective Material, credit
shall not be passed to the Joint Account until adjustment has been received by
Operator from the manufacturers or their agents.


 


V. INVENTORIES


 


The Operator shall
maintain detailed records of Controllable Material. 


 


1.     Periodic Inventories, Notice and Representation


 


At
reasonable intervals, Inventories shall be taken by Operator of the Joint
Account Controllable Material. Written notice of intention to take inventory
shall be given by Operator at least thirty (30) days before any inventory is to
begin so that Non-Operators may be represented when any inventory is taken.
Failure of Non-Operators to be represented at an inventory shall bind
Non-Operators to accept the inventory taken by Operator.


 


2.     Reconciliation and Adjustment
of Inventories


 


Reconciliation
of a physical inventory with the Joint Account shall be made, and a list of
overages and shortages shall be furnished to the Non-Operators within six months following the
taking of the inventory. Inventory adjustments shall be made by Operator with
the Joint Account for overages and
shortages, but Operator shall be held accountable only for shortages due to
lack of reasonable diligence.


 


3.     Special Inventories


 


Special
Inventories may be taken whenever there is any sale or change of interest in the Joint Property. It shall be
the duty of the party selling to notify all other Parties as quickly as
possible after the transfer of interest takes place. In such cases, both the
seller and the purchaser shall be governed by such inventory.


 


4.     Expense of Conducting
Periodic Inventories


 


The
expense of conducting periodic Inventories shall not be charged to the Joint
Account unless agreed to by the Parties.


 


5

















 


EXHIBIT “D”


 


INSURANCE PROVISIONS 


OF OPERATING AGREEMENT


 


Operator
shall carry or provide for the benefits of the Joint Account of the parties the
types and amounts of insurance as shown below:


 


(1)        Workers’ Compensation insurance in compliance
with the laws of the states of operation, including Employers’ Liability with a
minimum limit of $25,000 for each employee/accident/ disease.


 


(2)        Comprehensive General Liability insurance
with limits of not less than $500,000 each occurrence and aggregate for Bodily
Injury and $100,000 each occurrence and aggregate for Property Damage.


 


(3)        Automobile Public Liability Bodily Injury
Insurance with limits of not less than $250,000 for the accidental injury or
death of one person and $500,000 for accidental injuries or deaths of more than
one person as a result of one
accident; and Automobile Public Liability Property Damage Insurance with a
limit of not less than $500,000 for damage to or destruction of property as a
result of one accident.


 


The premiums paid or allocated for all such
insurance except Automobile shall be charged as operation expense. No insurance
other than shown above, shall be carried for the benefit of the Joint Account
except by mutual consent of the parties.


 














 


EXHIBIT “G”


 


TO


 


OPERATING AGREEMENT


 


between


 


Enron
Oil & Gas  Company


 


and


 


D.
L. RAY, INC.


 


PROVISIONS CONCERNING TAXATION


 


1.             Relationship of
the Parties. Neither this Exhibit nor the Operating Agreement to which it
is attached (the “Operating Agreement”) is intended to create, nor shall the
same be construed as creating, any mining partnership, partnership or other
partnership relation or joint venture among the - parties thereto (the “Parties”).
Rather, it is the intent and purpose of the Operating Agreement and this
Exhibit to create a relationship which is limited to the development and
the extraction and processing of oil and gas for division in kind or for sale
for the accounts of the several Parties individually, and in which the
liabilities of each of the Parties shall be several and not joint or
collective; provided, however, solely for United States federal and state
income tax reporting purposes as provided in paragraph 2, the relationship
created by this Exhibit and the Operating Agreement shall be considered as
a partnership, but such relationship shall not be a partnership to any other
extent or for any other purpose. Such relationship and the activities
contemplated thereby are referred to in this Exhibit as the “Joint
Operation”.


 


2.             Election in
Respect of Subchapter K. Notwithstanding anything to the contrary in the
Operating Agreement, each party agrees, with respect to all operations
conducted hereunder:


 


(a)           not
to elect to be excluded from the application of Subchapter K of Chapter 1 of
Subtitle A of the Internal Revenue Code of 1954, as amended (the “Code”); and


 


(b)           to join in the execution of any additional documents and elections as may be
required by the Internal Revenue
Service
in order to evidence the foregoing
election.


 

















 


In addition, if the income tax laws of any state in
which the Parties conduct operations
pursuant to the terms of the Operating Agreement contain provisions similar
to those contained in Subchapter K of Chapter 1 of Subtitle A of the Code, each Party agrees not to elect to exclude all or any part of the operations
hereunder from the application of such provisions.


 


3.             Term. The effective date
of the Joint Operation shall be the effective date of the Operating Agreement,
and the Joint Operation shall continue
in full force and effect from and after such date until the earlier of;


 


(a)           such time as the Operating Agreement between the Parties is terminated pursuant
to its terms; or


 


(b)           such time as the tax partnership created
hereby is terminated for federal income tax purposes under section 708 (b)(1)(B) of
the Code;


 


(c)           such time as the Parties mutually agree to
the dissolution and termination of the Joint Operation, or to the election to
be excluded from the application of Subchapter K of Chapter 1 of Subtitle A of the Code; or


 


(d)           the bankruptcy of any Party, which shall
also cause a termination of the Operating Agreement.


 


Upon the occurrence of either of the events set
forth in this paragraph 3, the provisions of paragraph 7 hereof shall be
applicable.


 


4.             Capital Contributions and
Capital Accounts.


 


(a)           The capital contributions of each Party to
the Joint
Operation
shall be: (i) his or its undivided interest in oil and gas properties contributed in kind to the Joint Operation (the “Leases”) and all
property associated with the Leases under
the Operating Agreement, and/or (ii) all amounts paid by or charged to him or it in
connection with the acquisition, exploration, development and operation of the Leases and all other costs paid or charged to him or it pursuant to the
Operating Agreement. The contribution of the Leases and all property associated with the Leases under the Operating Agreement to the Joint Operation shall be
evidenced by each Party’s agreement hereby to hold legal title to his or its undivided interest in such Leases and property as nominee for
the Joint Operation created hereby, subject,
however, to the provisions regarding
reassignment contained in paragraph 7 hereof. The Parties agree that the fair market value of the
properties


 


2

















 


initially contributed by the Parties to the Joint
Operation, and the adjusted tax bases of such properties, are as shown on
Schedule I hereto.


 


(b)           Each Party shall have a capital account
consisting of the amount of cash and the adjusted basis (net of liabilities
assumed by the Joint Operation and liabilities to which contributed property is subject) of properties contributed by such party initially to the Joint Operation, if any, increased
by:


 


(i)            the amount of cash
and the adjusted basis (net
of  liabilities assumed
by the Joint Operation and liabilites to which such contributed property is
subject) of property subsequently contributed by that Party,


 


(ii)           that Party’s share of income and gain for federal income tax purposes, and


 


(iii)          that Party’s share of any basis increase in Joint Operation “Section 38” property pursuant to Section 48 (q) of the Code,


 


and decreased by:


 


(i)            the amount of cash and adjusted tax basis (net of liabilities
assumed by such Party and liabilities to which distributed property is subject) of property distributed to that Party (or in the
case of a distribution to a Party of such Party’s proportionate interest in
depletable oil and gas properties, such Party’s share of the remaining hypothetical adjusted basis (as defined below) in such properties),


 


(ii)           that Party’s share of losses and other items
of deduction for federal income tax purposes, and


 


(iii)          that Party’s share of any basis decrease in
Joint Operation “Section 38” property pursuant to Section 48
(q) of the Code.


 


The term “adjusted basis” as used in this
Exhibit shall mean “adjusted basis” as defined in Section 1011 of the
Code.


 


A Party’s share of any basis reduction or increase
in Joint Operation “Section 38” property pursuant to Section 48
(q) of the Code shall be
determined based upon that Party’s contribution to qualified investment as defined in
Section 46 (c) of the Code.


 


3

















 


Pursuant to Section 613 A (c)(7)(D) of the
Code, each Party shall be allocated his or its proportionate share of the
adjusted basis of each oil or gas property acquired by the Joint Operation.
Except as Section 704 (c) of the Code may otherwise require in
connection with gain allocations, a Party’s “proportionate share” of the
adjusted basis of an oil or gas property shall be such Party’s relative
interest in the capital of the Joint Operation with respect of that property,
which, in turn, shall be determined in accordance with his or its relative
interest either: (i) in the Joint Operation’s capital used to acquire (and
capitalized in the adjusted basis of) such property (if the property is
acquired by the Joint Operation other than by way of contribution by one or
more Parties); or (ii) in the adjusted basis of such property (if the
property is contributed or is considered to be contributed to the Joint
Operation by one or more Parties). The foregoing allocation shall have no
effect on the capital accounts of the Parties.


 


Notwithstanding Section 613 A (c)(7)(D) of
the Code, the Joint Operation shall, solely for capital account purposes,
compute depletion (based upon its hypothetical adjusted basis in the applicable
property as if Section 613 A (c)(7)(D) were not in effect) and make
allocation thereof to the Parties in
the same ratio as the adjusted basis in the applicable property was allocated
to the Parties. Depletion so allocated shall be the higher of cost or
percentage, computed without regard to any limitation to which a Party may be subject pursuant to
Section 613 A of the Code; provided, however, that the aggregate depletion so allocated shall not exceed the adjusted tax
basis of
the applicable
property allocated to the Parties.


 


Gain or loss arising out of the sale or
other disposition of an oil or gas property shall, notwithstanding the
application of Section 613 A (c)(7)(D) of the Code, solely for
capital account purposes, be computed by the Joint Operation by reference to
its hypothetical adjusted basis in the applicable property and the amount realized in respect of such sale or other disposition. Except as Section 704 (c) of the
Code may otherwise require, with respect to gain allocation, the amount of gain so determined shall be allocated to
the Parties in the same ratio as amount realized in excess of the Joint Operation’s hypothetical adjusted basis in the
applicable property was allocated to the Parties. Loss, if any, shall be
allocated to the Parties in the same manner as the adjusted basis of the
applicable property was allocated to the Parties.


 


4

















 


5.             Federal and State
Income Tax Returns and Elections.


 


(a)           The Parties agree that the Party named as
Operator under the Operating Agreement shall prepare and file the necessary federal
and state partnership income tax returns, and the Operator agrees to use his or
its best efforts to prepare properly
and file such partnership income tax returns, including the making of appropriate elections
as described in paragraph 5 (b). In addition, the Operator agrees to submit each year a copy of the final partnership return figures to
the other Parties not later than 30 days before such partnership return must be filed, including extensions.
Each Party agrees to furnish to the Operator all pertinent information relating to the operations conducted under the Operating Agreement and this Exhibit which are necessary for the
Operator to prepare and file such
partnership income tax returns.


 


(b)           The Parties hereby
authorize and direct the Operator to make the following elections on the appropriate returns of the Joint Operation:


 


(i)            To elect, in accordance with Section 263
(c) of the Code and
applicable income tax regulations and comparable provisions of state law, to deduct as an expense all intangible drilling and development
costs with respect to
productive and nonproductive wells.


 


(ii)           To elect, in
accordance with the Code and applicable income tax regulations and comparable
provisions of state law, to deduct such additional costs (other than intangible drilling and development costs) incurred
in connection with the drilling, testing, abandonment, completion or connection of any well which additional costs are not, or
pursuant to an election under the Code and comparable provisions of state law
need not be, capitalized for federal or state income tax purposes.


 


(iii)            To elect the
calendar year as the Joint Operation’s fiscal year;


 


(iv)            To elect the cash method of accounting;


 


(v)           To determine the method to be used in reporting and
computing depreciation and whether to make the elections provided by Sections
179 and 48 (q) of the Code;


 


(vi)            To determine
whether to report gain under the installment
method;


 


5

















 


(vii)           To make, at the request of any Party, the
election referred to in section 754 of the Code, or any similar provision
enacted in lieu thereof. Each Party shall supply to the Operator and the other
Parties the information necessary to give proper effect to any such election.
Should such an election be made, computations with respect to the capital
accounts will continue to be made as if such election had not been made.


 


(viii)          To make all other elections agreed upon by
the Parties that are permitted under the Code.


 


(c)           Each Party agrees to make any required or permitted
elections to enable the Operator to file the returns described in paragraph 5
(a) and to inform the Operator of such elections.


 


(d)           Each Party agrees to furnish to the Operator
such information as it may have which is required for the proper preparation of
tax returns. The Operator shall use its best efforts in preparing and filing
said returns and making appropriate elections, but shall incur no liability to
any other party with respect to such returns and elections. The Operator agrees
to furnish to the Parties information available to the Operator relating to the
calculation of the percentage depletion allowance under the independent
producer and royalty owner exemption in
Section 613 A (c) of the Code if such exemption appears to be
available, and the net income limitation on windfall profit in
Section 4988 (b) of the Code.


 


(e)           The Parties agree that if any one of them makes a sale or assignment of its interest under
this Agreement, such a sale or assignment will be structured so as not to cause
a termination of the Joint Operation under Section 708 (b)(1)(B) of the Code.
without the written consent of all parties and said parties agree that such
consent will not be unreasonably withheld.


 


(f)            Each Party agrees
to furnish the Operator its federal tax identification number at the time of executing the Operating Agreement to which this Agreement is attached as Exhibit “G”. Operator
is designated as the “Tax Matters Partner” as defined in Section 6231
(a)(7) of the Code.


 


6.             Allocations. The Parties agree
that for accounting purposes and for United States federal and state income tax
reporting purposes, the distributive
share of each of the Parties in each item of income, gain, loss, deduction or
credit (including, but not by way of limitation, the classes of items
specifically mentioned below) shall be determined as follows:


 


6














 


(a)          All items  of income, deduction and credit arising from
the sale of oil, gas or other hydrocarbon substances shall be allocated to the
Party entitled to the proceeds realized therefrom;


 


(b)         The production costs shall be allocated as
deductions to each Party in accordance with his or its respective contributions
to such costs;


 


(c)           The exploration costs and intangible drilling
and development costs shall be allocated as deductions to each Party in
accordance with his or its respective contributions to such costs;


 


(d)           Except as otherwise required by
Section 704 (c) of the Code with respect to the property contributed
by a Party to the Joint Operation, the depreciation deductions with respect to
tangible equipment shall be allocated to each Party in accordance with his or
its respective contributions to the adjusted basis of such equipment;


 


(e)           If any depreciation or intangible drilling
and development costs are recaptured as a result of the disposition of any
assets subject to the Operating Agreement and this Exhibit, the character of
the gain allocated under other provisions of this Exhibit shall be
determined and allocated to the Parties in such manner, and in the proportion,
so that to the maximum extent possible those Parties who originally received allocations
of depreciation and intangible drilling and development cost deductions
attributable to the assets disposed of shall be allocated the ordinary income
element of any gain realized and recognized;


 


(f)            The deduction for
depletion with respect to each separate oil and gas property (as defined in
Section 614 of the Code) subject to the Operating Agreement and this
Exhibit shall be computed separately by each Party rather than by the Joint  Operation.
Each Party shall separately keep records of his or its share of the adjusted
basis in each oil and gas property allocated pursuant to paragraph 4 (b) of this Exhibit, adjust such
share of the adjusted basis for any cost or percentage depletion allowable on
such property, and use such
adjusted basis in the computation of his or its gain or loss on the disposition of such
property. Notwithstanding any other provision of the Operating Agreement or any
Exhibit thereto, or any other agreement among the Parties or between any
Party and a third Party (including division orders and gas purchase contracts),
but except as otherwise may be required by Section 704 (c) of the
Code, for purposes of determining gain or loss from


 


7

















 


disposition of any such property the amount realized
therefrom shall be allocated (i) first, to the extent of the Joint
Operation’s remaining hypothetical adjusted basis in the applicable property,
in the ratio in which such adjusted basis was allocated to the Parties pursuant
to paragraph 4 (b), and (ii) then, to the extent of the remaining amount
realized, to the Parties in the ratio in which they are entitled to the
proceeds of such disposition. Upon the request of the Operator, each Party
shall advise the Operator of his or its adjusted basis in each oil and gas
property of the Joint Operation as computed in accordance with the provisions
of this paragraph 6 (f);


 


(g)           Amounts realized, gains and losses from each
sale, abandonment or other disposition of property (other than oil, gas or
other hydrocarbon substances, and other than oil or gas properties) will be
allocated to the Parties to reflect the amounts realized, gains and losses that
would have been includible in their respective income tax returns if such
property were held directly by the Parties for tax purposes without regard to
the Joint Operation. The computations shall take into account each Party’s
share of the proceeds derived from each sale or other disposition of such
property during the year, selling expenses and the Party’s respective
contributions to the unadjusted cost basis of such property, less any allowed
or allowable depreciation, amortization or other deductions which have been
allocated to each Party.


 


(h)           The investment tax credit allowed by
Section 38 of the Code shall be allocated to the Parties in accordance with
their respective contributions to qualified investment as defined in
Section 46 (c) of the Code;


 


(i)            Income resulting
from any dry-hole or bottom-hole monetary contribution obtained from a third
person in connection with the drilling of a well on the oil and gas properties
subject to the Operating Agreement and this Exhibit shall be allocated in
the same manner as the costs of drilling such well are allocated under the
foregoing provisions; and


 


(j)            Windfall Profit Tax
shall not be taken into account as a deduction by the Joint Operation, and
revenues of the Joint Operation (including revenues paid directly to a Party by
a purchaser) shall be “grossed up” by the amount of Windfall Profit Tax
withheld therefrom. The amount withheld or otherwise paid by the Joint
Operation (including amounts withheld from revenues payable directly to a Party by a purchaser, and amounts paid
directly by a Party due to underwithholding) shall be deemed distributed to the
Parties in


 


8

















 


the same manner as the tax is legally borne, and
each Party shall separately claim any deduction resulting from payment of such tax. Each
Party shall be separately responsible for claiming any refund to which such Party is
entitled and for filing returns reflecting any underwithholding. Amounts received as
refunds of Withfall Profit Tax shall be claimed directly as income by the Party
entitled thereto. The Parties agree to file the appropriate election under
section 6232(c)(2) of the Code to be excluded from the application of section
6232(c)(1) of the Code.


 


(k)           All other classes
of costs, expenses and credits not falling within subparagraphs (b), (c), (d),
(e), (f), (g), (h), (i) and (j) of this paragraph 6 shall be
allocated to and accounted for by each Party in accordance with his or its
respective contributions to such costs,
expenses
and credits.


 


7.           Distribution Upon
Dissolution. Upon any actual termination of the Joint Operation pursuant to paragraph 3 hereof, the business of the
Joint Operation
shall be wound-up and concluded, and the assets of the Joint Operation shall be  distributed to the
Parties as discribed below.


 


(a)           Debts of the Joint Operation, other than to
Parties, shall be paid or otherwise provided for; then


 


(b)           Debts owed by the Joint Operation to Parties
shall be paid; then


 


(c)           All remaining assets of the Joint Operation
shall be distributed to the Parties in the following order:


 


(1)           First, all cash on hand representing
unexpended contributions by any Party shall be returned to the contributor.


 


(2)           Second, the capital accounts of the Parties shall be determined
and, if necessary, adjusted. Adjustment of such capital accounts shall not be
necessary under this paragraph 7(c)(2) unless the ratio of the capital
accounts of the Parties is not equal to the ratio of their interests in the
Joint Operation (after payout, if any). If adjustment is necessary, the Operator shall
take the actions specified under this paragraph 7(c)(2) in order to either
(i) cause the capital accounts of all Parties to equal zero, or
(ii) cause the ratio of the Parties’ capital accounts to be equal to the
ratio of their interests in the Joint Operation (after payout, if any). Such actions are
hereafter referred to as “balancing the capital accounts”, and at such time as
either (i) or (ii) is


 


9

















 


achieved, the capital accounts of the Parties shall
be referred to as being “balanced”. The Operator shall select whichever of
(i) or (ii) is most practicable under the circumstances and requires
fever transactions. The manner in which the capital accounts of the
Parties are to be balanced under this paragraph 7(c)(2) shall be determined as
follows:


 


(A)          If all of the Parties consent, selected Joint Operation
property may be sold by the Parties to unrelated third parties. Subject to the
limitations, if any, of Section 704(c) of the Code, gain from any such sales
(represented
by the excess of amount realized over the Joint Operation’s hypothetical
adjusted basis in the applicable property), if any, shall be allocated
disproportionately to the Parties in  the least amount necessary to balance the
capital accounts. Any  remaining gain or loss shall be allocated in
accordance with subparagraph 6(f). Whether or not any properties of the Joint Operation are sold,
remaining oil and gas properties of the Joint Operation shall be valued and
deemed to be sold at their respective fair market values, and the hypothetical gain or loss
therefrom shall be allocated as required in the preceding sentence. Sales or deemed sales
shall
be made or deemed made free and clear of after-payout reversionary interests, but the
existence of such interests shall be taken -into account in determining the Parties interests
in the proceeds
or deemed
proceeds of sale, subject, however, to the requirement that
disproportionate allocations thereof be made under certain circumstances set
forth hereinabove.
If,
after the allocation of gain or loss from the sale or deemed sale of the Joint Operation’s properties, the capital
accounts are not balanced, any cash generated from actual sales shall be distributed among the
Parties in the least amount necessary to balance the capital accounts.


 


(B)           If all the Parties consent, an undivided interest in certain selected Joint Operation
properties shall be distributed to one or more Parties as necessary for the purpose
of balancing capital accounts.


 


(C)           Unless paragraphs 7(c)(2)(A) or 7(c)(2)(B) applies,
an undivided interest in each and every Joint Operation property shall be distributed to one or more Parties as
necessary for the purpose of balancing capital accounts.


 


(D)          Notwithstanding the method of distribution
applied in paragraphs 7(c)(2)(A), (B) or (C), any Party which has a relative
deficit in his or its capital account shall have the option, but not the
obligation, to balance his


 


10

















 


or its capital account by
contributing cash to the Joint Operation.


 


If property of the Joint
Operation is distributed pursuant to paragraph 7(c)(2)(A) for purposes of
the deemed sale described in paragraph 7(c)(2)(A) the fair market value of
properties shall be estimated and agreed upon by the Parties. If the Parties do
not agree as to the fair market value of any property, the Operator shall cause
an independent engineering firm to prepare an evaluation of the fair market
value of such property and such evaluation shall be conclusive.


 


(3)           Third, after the
capital accounts of the Parties have been adjusted, if necessary, pursuant to
paragraph 7(c)(2), all other or remaining properties and interests then held by
the Joint Operation shall be distributed to the Parties in accordance with
their respective interests (after payout, if any) in the Joint Operation.


 


(4)           Notwithstanding
paragraphs 7(c)(2). and 7(c)(3) if drilling or other operations have been
conducted and the cost or expense thereof has been allocated to the Parties in
a ratio (the “Special Ratio”) other than the ratio of their interest in the
Joint Operation, and if, as a result of - such operation, the income resulting
from production from such operation is being allocated at the date of
termination of the Joint Operation to the Parties in the Special Ratio pending
satisfaction of the terms of a payout provision, then the assignments to be
made to the Parties pursuant to paragraphs 7(c)(2) or 7(c)(3) shall
provide that the Parties which participated in such operation shall own the
undivided interest in such well and the production accruing thereto in
accordance with the Special Ratio instead of the ratio they would otherwise
acquire pursuant to paragraphs 7(c)(2) or 7(c)(3), until the terms of such
payout provision have been satisfied; thereafter, such well and the remaining
production therefrom shall be owned as provided in paragraphs 7(c)(2) or
7(c)(3).


 


All assignments made under the
provisions of this paragraph 7 shall be by special warranty. It is understood
and agreed that it shall be the obligation of each Party, as nominee for the Joint
Operation, to make such assignments or payments as are required upon
termination of the Joint Operation in accordance with the foregoing provisions
of this paragraph 7. Assignments of properties shall be made subject to the
liability of each assignee for costs, expenses and liabilities theretofore
incurred or for which commitment had been made by the Operator prior to the
date of termination and such costs, expenses and


 


11

















 


liabilities shall be allocated to
such assignee pursuant to this Exhibit.


 


8.             Application of
this Exhibit. If the terms of this Exhibit conflict with any of the
terms and conditions of the Operating Agreement, then as between the Parties,
the terms of this Exhibit shall control on the point of such conflict.


 


12

















 


SCHEDULE I


 


[Fair Market
Value of the Properties Initially Contributed by the Parties to the Joint Operations and the
Adjusted Tax Basis of such Properties]


 


This Schedule
shall be completed as soon as reasonably possible after the date of the closing
of the transactions contemplated
in the Participation Agreement.