Unitization - A Mathematical Formula to calculate Redeterminations
Authors: Derman Andrew B. , Derman Peter B. 
Published: December 2007

As the oil and gas industry matures, we will continue to witness a marked increase in the number of unitizations. In many units, notably units created outside the United States, a mechanism exists to allow the parties to readjust their individual economic returns to the extent that it is later substantiated that their individual equity interest or ownership of the reservoir, on a percentage basis, increases or decreases. This mechanism to readjust the individual equity interests is called redetermination.

The upstream sector now struggling with how best to handle equity redeterminations. Unitization equity redeterminations have historically caused nightmares for those working in the upstream sector. The concept is not the problem; the process is. The typical equity redetermination process is ambiguous and contentious, often resulting in arbitration and/or litigation.

Equity redetermination, also known as Participating Interest redeterminations serve a valid and legitimate purpose. They allow the parties owning interests in multiple areas to efficiently develop areas or blocks prior to fully understanding the subsurface and the quality and quantity of oil and gas reserves on separate areas or blocks. As information is acquired and the subsurface is better understood, the equities or Participating Interests of the parties can be adjusted.

Two basic problems have developed in effectuating the operation of redetermination provisions and, as the issues in redeterminations tend to involve significant value, these problems have precipitated costly arbitration and litigation. First, the parties have argued over the technical interpretation of the subsurface. The second problem involves how to adjust the equities or Participating Interests after it has been technically proven that the original determination was incorrect. Most unitization agreements do not contain a redetermination mathematical formula to allow the parties to simply transfer value from those who overpaid to those who underpaid. This failing has caused controversy and has further cast a pall over the concept of redetermination.

The process of adjusting or redeterminating equity or Participating Interests has precipitated an adverse reaction among many in the oil and gas industry, spawning burdensome and expensive arbitrations and lawsuits. The authors contend that the concept of redetermination is sound but that the contractual redetermination processes incorporated in most unitization agreements are primitive and ambiguous.

The authors have developed a mathematical formula that could be incorporated into unitization agreements that would easily allow the parties to adjust value to address redetermined equities or Participating Interests. Such a formula must consider all economic and fiscal aspects to return the parties to the economic position they would have been in had redetermined equities or Participating Interests existed originally.

The mathematical formula described in this article is based on the Nigerian offshore model. In the narrative accompanying it, we note how the formula could be adjusted to account for differences in economic and fiscal regimes. The concepts underpinning this formula can be applied elsewhere to address other economic and fiscal regimes.

Beyond the mathematical formula, the authors have proposed certain "rules of engagement" for structuring and administering unitization and redetermination concepts (provisions) to discourage controversy and its resulting implications - delay, lost project value, expert determinations, arbitration and overall inefficient operations.