Office of Natural Resources Revenue U.S. Department of the Interior Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Federal and Indian Royalty Payments on Horizontal Wells Presented by Deborah Gibbs Tschudy, Deputy Director RMMLF Special Institute on Horizontal Oil and Gas Development November 8-9, 2012

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Outline of Presentation Introduction Background The Challenge with Horizontal Drilling on Indian Lands Pre-Communitization Agreements on Indian Allotted Leases Future Actions/Steps 2

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Introduction Bottom-line In general, royalty obligations and reporting and payment requirements for Federal and Indian leases are the same whether an operator drills a vertical or a horizontal well Challenge A challenge arises with the distribution of royalties when the horizontal drilling occurs on Indian allotted lands and approval of a communitization agreement or unit participating area lags production and the obligation to pay royalties 3

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity 4 The Roles of Federal Agencies in Horizontal Drilling Bureau of Land Management (BLM) Responsible for onshore leasing and related functions including drilling permits, production verification, diligence, onsite inspections, and enforcement Office of the Special Trustee (OST) for American Indians OST makes royalty payments to Indian mineral owners based on availability of funds from ONRR and directions from BIA Bureau of Indian Affairs (BIA) Responsible for oversight of mineral leases on Indian lands, onsite compliance, appraising resources, and expert advice on drilling permits and other operational matters. BIA also conducts oil and gas lease sales and approves easements on trust lands Office of Natural Resources Revenue (ONRR) Responsible for the collection, accounting, disbursement, and verification of mineral revenues paid on Federal and Indian oil and gas, coal, and other mineral leases onshore and for Federal leases on the OCS

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Reporting and Paying Royalties on Federal and Indian Lands All Federal and Indian production is subject to royalties except production that is unavoidably lost, stored on the lease/agreement, or used on the lease/agreement Because of numerous perforation points and State spacing requirements, horizontal drilling often involves unit or communitization agreements Federal and Indian lessees must report royalties based on a BLM-approved communitization agreement (CA) or unit participating area (PA) allocation percentage CAs and PAs drive collection and distribution of royalties for both vertical and horizontal wells

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Until BLM approves a CA or PA, there is no allocation schedule from which ONRR can distribute royalties If BLM approves a CA or PA after production has occurred and royalties have been paid, lessees have 1 month to make retroactive adjustments without incurring interest Recoupment of overpayments resulting from allocation errors on Indian lands are limited:  No more than 50% recouped per month for allottees  No more than 100% recouped per month for tribes Reporting and Paying Royalties on Federal and Indian Lands

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Lease 1 would receive 100% of royalties until the CA is approved Leases 2-4 are rightfully entitled to 25% of royalties each, but would receive nothing without an allocation schedule Federal Lease 1 Federal Lease 2 Federal Lease 4 Federal Lease 3 Royalty Reporting Pending CA Approval – Well Located in Federal Lease Assume 640 acre spacing with 4 Federal leases; each 160 acres State spacing calls for a Communitization Agreement

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity The Fee lease would receive 100% of royalties until the CA is approved Leases 2-4 are rightfully entitled to 25% of royalties each, but would receive nothing without allocation schedule Fee Lease Federal Lease 2 Federal Lease 4 Federal Lease 3 Royalty Reporting Pending CA Approval – Well Located in Fee Lease Assume 640 acre spacing with 1 Fee lease and 3 Federal leases; each 160 acres State spacing calls for a Communitization Agreement

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Indian lease 1 would receive 100% of royalties until the CA is approved Leases 2-4 are rightfully entitled to 25% of royalties each but would receive nothing without allocation schedule Once the CA is approved, the Indian lessee must reallocate production and royalties, subject to the 50% recoupment limit Indian Lease 1 Indian Lease 2 Indian Lease 4 Indian Lease 3 Royalty Reporting Pending CA Approval – Well Located in Indian Allotted Lease Assume 640 acre spacing with 4 Indian allotted leases; each 160 acres Several individual mineral owners on all 4 leases State spacing calls for a Communitization Agreement

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Communitization Agreement Approval Process Why does the CA approval process take so long? Companies have difficulty getting clear title particularly in areas such as the Bakken where there is a shortage of title attorneys, BLM must verify the leases and ensure that the lands are described correctly, BLM must verify the State spacing and survey, All lessees of record title must sign off on the CA, and Once BLM approves the CA package, BIA must approve and verify that all impacted Indian allottees have been notified of the CA. 11

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Fort Berthold Indian Reservation in North Dakota In 2007, BIA issued 2,879 oil and gas leases in an Indian allotted lease sale on the Fort Berthold Indian Reservation Total bonus bids of over $180 million The Bakken produced 23.1 million barrels and generated $388 million in Indian tribal and allotted royalties from January 2008 through September 2012 Current production is at 37,500 barrels per day with $20 million in royalties each month Proven remaining reserves are 130 million barrels from currently producing wells with estimated future royalties of $3.4 billion from the proven remaining reserves

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Preliminary Communitization Agreements Increase in North Dakota activity resulted in backlog of CA approvals Without CAs, ONRR cannot distribute royalties correctly or timely Preliminary CAs allow allocation schedule so lessees can accurately report royalties and Indian lessors can receive their royalties Pre-CAs mirror final CA allocations BLM Dickinson Office now requires companies to submit a Pre-CA before they can receive ROW or APD

Industry ComplianceAccurate Revenues & DataProfessionalism & Integrity Future Actions/Next Steps Royalty Policy Committee’s Reporting Subcommittee identified misreporting on units and CAs as largest issue BLM and ONRR have developed Unit and CA training ONRR offers in depth royalty and production reporter training both internally and externally ONRR and BLM to issue reporter guidance in conjunction with CA or Unit approval RMMLF Workshop on Unit and Agreement Reporting – April 2-3, 2013, in Houston, TX