BEFORE THE CORPORATION COMMISSION OF THE STATE OF OKLAHOMA BAYS EXPLORATION, INC.

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1 BEFORE THE CORPORATION COMMISSION OF THE STATE OF OKLAHOMA APPLICANT: BAYS EXPLORATION, INC. RELIEF SOUGHT: POOLING LEGAL DESCRIPTION: SE/4 SECTION 7, TOWNSHIP 6 NORTH, RANGE 4 WEST, MCCLAIN COUNTY, OKLAHOMA CAUSE CD NO ILE I MAR cm 2012 I CLERK'S OFFICE - OKC REPORT OF THE ADMINISTRATIVE LAW JU1tPATION COMMISSION OF OKLAHOMA This Cause came on for hearing before Susan R. Osburn, Administrative Law Judge for the Corporation Commission of the State of Oklahoma, on the 8th day of February, 2012, at 8:30 a.m. in the Commission's Courtroom, Jim Thorpe Building, Oklahoma City, Oklahoma, pursuant to notice given as required by law and the rules of the Commission for the purpose of taking testimony and reporting to the Commission. CASE SUMMARY: CD is the application of Bays Exploration, Inc. seeking pooling authority for the SE/4 of Section 17, T6N, R4W, McClain County, Oklahoma for the Prue, Hart, Skinner, Red Fork, Mississippi Lime, Misener- Hunton, Viola, Bromide Dense, First Bromide, Second Bromide, McLish, Joins Osborne and Arbuckle common sources of supply which were all spaced on a 160 acre basis by Orders and The issue in this cause, as first stated, was the impact of this pooling application for a vertical well on parties who did not participate in the vertical well but would want to participate when later horizontal development occurred. Protestant questioned whether upon nonparticipation they would be entitled to participate in later horizontal wells or whether their interest would be pooled in the formation as vertically spaced. During the course of the hearing it turned out that fair market value also became an issue, with the landman for applicant recommending a certain cash bonus amount and royalty based on his search of transactions in the area and a separate recommendation based on a statement by the attorney for protestant. No witnesses were presented for the protestant and both sides stated their reasons for recommending fair market value in the cause. As to the issue about vertical development and later horizontal development and the impact of nonparticipation in the initial vertical well, both attorneys indicated there was no case law regarding this issue and applicant's attorney argued that such an issue was premature in this cause.

2 1. That the undisputed issues of operator, costs, timeframes and deeming provisions be established under the order as Bays' witness recommended. 2. That fair market value be establisehd as $150 an acre and a 3/16th total royalty or no cash and a 1/5th total royalty. 3. That the pooling order to issue be determined to be a unit pooling without distinction between vertical develpoment and possible later horizontal development. HEARING DATE(S): February 8, 2012 APPEARANCES: David E. Pepper, attorney, appeared on behalf of applicant, Bays Exploration, Inc. ("Bays") Gregory L. Mahaffey, attorney, appeared on behalf of Newfield Exploration Mid-Continent, Inc. FINDINGS AND SUMMARY OF EVIDENCE 1. CD is the application of Bays requesting that the Commission pool the interests and adjudicate the rights and equities of oil and gas owners in the Prue, Hart, Skinner, Red Fork, Mississippi Lime, Misener- Hunton, Viola, Bromide Dense, First Bromide, Second Bromide, McLish, Joins, Osborne and Arbuckle common sources of supply underlying the SE/4 of Section 7, T6N, R4W, McClain County, Oklahoma. That heretofore by Order Nos and this Commission established the SE/4 of Section 7-6N-4W, McClain County, Oklahoma as a 160 acre drilling and spacing unit for Page 2

3 CD Bays the production of hydrocarbons from the aforementioned common sources of supply. 2. The Commission has jurisdiction over the subject matter and notice has been given in all respects as required by law and the rules of the Commission. 3. The following numbered exhibit was accepted into evidence: #1. An AFE provided by Bays for the Peters #1-7 well. 4. That prior to testimony being taken Mr. Pepper advised that the application was being dismissed as to the Joins and the Arbuckle common sources of supply. 5. A. That Scott Rice, a broker and owner of Jabez Land and Minerals, appeared on behalf of applicant and stated that he had done land work for applicant in this cause. Applicant owns the right to drill to drill in this unit, owning 120 acres of the 160 acre unit; the only other party owning an interest in this unit at the time the application was filed was Energy Lease Account, LLC. That Hal Smith, working on behalf of that company, leased 40 acres in the unit. When Bays mailed the proposal letter to Hal Smith on October 4, 2012 they were advised that the interest had been assigned to Newfield. Thereafter a proposal letter was sent to Newfield on November 22, 2012 and since that time there had been numerous discussions between the attorneys representing Newfield and Bays and no agreement could be reached regarding development of this unit. He explained this would be a vertical well and that the options afforded the respondent would be participation or a fair market value which he believed would be $150 an acre and a 3/16th total royalty. He explained that a $150 and 3/16th was the highest values that he had found which had been paid in the nine unit area. He explained that Newfield had also taken a lease for a 1/5t h royalty in the second quarter of 2011 but he didn't know how much bonus was paid with that so he was recommending additionally as fair market value a no cash and a 1/5 th option. He recommended the order provide the respondent have 20 days from the date of the order within which to make an election, 25 days from the date of the order within which to pay their participation monies if they elected to Page 3

4 participate and 35 days from the date of the order within which Bays would have to pay any bonuses due. Since Newfield took a lease at a 1/5 th royalty he did not think they could deliver the 13/1 6ths NRI required to elect the $150 and a 3/16th so he believed Newfield could elect either to participate or take the no cash and 1/5th. He recommended that if Newfield failed to elect timely or if they elected to participate and then failed to pay their costs timely that they be deemed to have elected the no cash and 1/5 th royalty since their interests were burdened. He recommended that Bays be designated operator and he agreed that the escrow language should be included in this order. He recommended that the order provide for subsequent operations be limited to parties who have participated in the initial well, that any working interest owners could propose a subsequent well by certified mail with information about the cost, the location, etc. for the subsequent well. That any party receiving the subsequent well proposal would then have 20 days within which to elect to participate or to take the no cash and 1/5th and that they would have 25 days from the receipt of the proposal within which to pay any costs if they elected to participate. He recommended that the operator have 180 days within which to commence operations under the order and that they have 180 days from proposal of a subsequent well within which to commence any subsequent well or the proposal would lapse. B. On cross the witness explained that the Peters Trust lease had been about to expire in the SE/4 and they re-leased that around the time of the Newfield lease in the second quarter of He said there were other Bays leases in Section 7 which had been taken several years ago and as they became available they were all re-leased at $150 an acre and a 3/16th total royalty and some of those were taken since the Peters Trust lease. That Bays owns a total of almost 200 acres in Section 7 with some of those taken in the fourth quarter of 2011 after the Peters Trust lease and they were all at $150 an acre and 3/16th for three years. There was a Continental lease covering 20 acres in the section and it was a 3/16th lease but he couldn't get information about the bonus value, that he contacted Continental and their landman said it was their policy not to tell the bonus amount they paid; he also contacted the mineral owner who said he did not want to discuss the money amount that he received for that lease. As to the Newfield lease he said he contacted Fleischaker who leased to Newfield and he was told that they did not want to say what bonus they had been paid for their lease. That he had not Page 4

5 contacted Hal Smith at Energy Lease Account LLC about that lease, nor had he talked with anyone at Newfield about the lease. When asked if he thought that Beverly Brown or Dave Corel at Newfield would not tell him about the lease he said he had no reason to believe that they would or wouldn't, that he just didn't talk to them. He was asked if Ms. Brown had sent an which stated they had paid $600 an acre and a 1/5th if he thought that might be fair market value and he said if he had received that he would think Newfield overpaid because Bays had been taking leases since the second quarter of 2011 for $150 an acre and 3/16th. It was noted to the witness that he couldn't give a date or a name of a single lessor involved in a transaction for that amount during that timeframe and he noted he could get that information. At this time Mr. Pepper objected noting that he had been informed by Mr. Mahaffey that fair market value was not an issue. Upon inquiry by the Court Mr. Mahaffey said he thought it was an issue now and he felt the burden was on Bays to prove fair market value and that he did not have a burden to bring a witness. At this point the witness said that if he could have a few minutes he thought he could pull that information up. He was asked if he would also check if their leases mandated renewal times and the witness said they did not renew their leases, that they obtained new leases at the values he is recommending today. That he didn't have any evidence the Fleischaker/Newfield 40 acre transaction in the second quarter of 2011 was not an arms-length transaction, nor did he have any information to indicate that Hal Smith was trying to overpay values for that lease. It was noted to the witness that Newfield owns about 60 acres in the offsets and he was asked what he knew about that and he said he had looked at leases in the offset and had talked with land owners. He could not state specifically what land owners he had contacted, since he had not known fair market value was an issue and did not bring that type information with him. He had checked contiguous units including the SW/4 of Section 8, the NW/4 of Section 17 and the N/2 of Section 18 in his analysis and transactions there were standard with values Bays had paid and values he was recommending today. C. After a short break for the witness to pull up some of his records the witness was redirected by Mr. Pepper and said that the Fleischaker lease was dated May 10, 2011, that the Bays lease from the Peters Trust for 120 acres was dated June 24, 2011; there were other leases since Page 5

6 CD Bays that time and they represented 15 to 20 tracts which were leased May 31st to October 30th of 2011 and all were at $150 an acre and a 3/16th royalty. D. On further cross by Mr. Mahaffey he said the other 60 acres of Newfield leases were 3/16th royalty leases taken from June 2010 to August 21, 2011 and that was during a time when Bays was also leasing. When asked the number of leases that those 15 to 20 tracts would represent he said he would have had to check tract by tract and didn't have that information; that this acreage represented leases taken after the Newfield lease and represent less than 75 acres total. That the Peters Trust lease was June 24th of Asked if he was aware of about 80 acres of leasing that had occurred from June 11th to October 31st taken by other parties and he said he would accept that from the attorney; that perhaps it had been in one of his reports but he doesn't have that in the courtroom so he cannot testify about it. He agreed he had determined his fair market value recommendation without contacting Newfield or their broker about the Fleischaker lease. E. On further direct he said that in fact as to the Newfield lease he did contact the land owner but could get no information. F. On further cross he was asked, other than Continental what other land owners that Newfield leased had he contacted and he said he had contacted various land owners but didn't have that information in the courtroom since he hadn't known fair market value was an issue. When asked what basis he had for saying the $600 an acre that Newfield had paid was too much to represent fair market value he said that during that time he was still leasing at a $150 an acre and a 3/16th royalty and if there were leases being taken at $600 an acre and 1/5th royalty then he wouldn't have been able to obtain leases for the values he was paying. When asked what land owners he had ever leased that was on the ground, he said the Peters Trust owns interests and they are in the area and he felt like the values they were willing to accept would be reflective of fair market value; it was a lease which occurred after the Fleischaker lease and was for a $150 an acre and 3/16th. That he was aware of other leases taken at a 3/16th royalty during the time he was leasing but he couldn't state the money amounts. Page 6

7 6. A. Joe Bays, an owner of the applicant company, appeared on behalf of applicant. He stated Bays operated over a 100 wells in the area until 2010 and then sold some; they currently operate 32 wells in the Grady-McClain County area. Both he and his engineer prepare AFEs for area development; he knows about costs and operations and was qualified to testify regarding such matters. He opined the Exhibit 1 AFE reflected current costs to drill a well today. The Exhibit 1 AFE had been furnished to Newfield; it was admitted into the record. He requested Bays be designated operator, that they were bonded to operate in Oklahoma; that Newfield is not objecting to Bays as operator. Bays has been prospecting for the named formations for some time and these are legitimate prospects especially the Bromides, McLish, Hunton and Mississippi. That the Hunton is the immediate secondary target while the Bromide is the primary target of their development. He explained that Bays operates a number of wells in the general area and through the Golden Trend which produce from the zones named here and in fact they operate two adjacent producing Bromide wells with each having the Sycamore/ Mississippi and the Hunton behind pipe. He requested they have 180 days under the order to commence the well. B. On cross the witness said he had no experience with drilling horizontal Woodford wells. That type of development had not been in this area yet, but he acknowledged that it would be prospective to develop horizontal Woodford wells. He was familiar with the custom in horizontal development of having the Mississippi zone above and the Hunton zone below the Woodford, as part of a package in drilling in case the wellbore gets out of zone, that they are studying this in the Woodford and the Eagleford Shale, as well as the Bakken Shale. He had heard the fair market value questions asked of his contracted landman. When asked if the Commission adopted Bays' recommendations if Bays would have any objection if Newfield chose not to participate in this vertical well but retained their rights in the Mississippi and Hunton for any later horizontal drilling Bays might do in the section, to which Mr. Pepper objected noting that it was calling for a legal conclusion and also that this was never discussed on direct examination, so it was outside the scope of questioning on cross. Mr. Mahaffey responded that he wasn't asking for a legal conclusion, he was asking if they would object to such provision and he noted in fact that it was brought up by Mr. Bays when he mentioned that the Hunton was their secondary objective. The AIJ sustained the objection Page 7

8 noting if the parties had a private agreement regarding the issues Mr. Mahaffey brought up that would be fine, but this distinction was not part of a typical pooling order. 7. A. At this time Mr. Mahaffey made a statement for the record noting that Newfield had no witnesses insofar as recommendations for fair market value. That it was Newfield's position that $600 an acre and a 1/5th royalty would be fair market value and if the Commission did not adopt that value that they should require the Bays landman to make contact with the broker who took the lease on behalf of Newfield or with Newfield. Mr. Mahaffey believed as part of due diligence the landman should have contacted either of those parties not just the land owners who gave the lease. Newfield's real concern was that they had purchased leases out here for horizontal development and they would ask the Commission to make a finding that if any of the common sources of supply are subsequently spaced on a horizontal basis, especially the Mississippi Lime and the Misener-Hunton, that Newfield's failure to participate in this vertical well would not deprive them of their rights to participate in or to drill a horizontal well for those formations. Mr. Mahaffey acknowledged that this was probably a legal issue which has not been decided at this point. He noted that the rule says to the extent a horizontal unit is established that it will supersede any nondeveloped vertical spacing and would co-exist with vertical spacing. Here Bays could drill in a unit that has everything pooled down to the McLish and under the Amoco case if Bays completes in any one of those formations they will perpetuate the pooling as to all formations. In that event they could complete in the Bromide and not have productive Mississippi Lime, Misener or Hunton and then Newfield, if a nonparticipant would be concerned that they may have relinquished their rights in those formations. Newfield bought their interest here for horizontal development and not for vertical development and they do not want to be forced to participate in a vertical well in order to protect their rights in future horizontal development. Therefore they would ask the Commission make the finding as he had previously requested to protect rights for which they had paid $600 an acre and a 1/5th. B. In response Mr. Pepper noted that the issue of such a finding was not before the Commission today, that before the Commission today is a pooling application for a vertical well, that the Supreme Court has Page 8

9 not made a determination on any rights that might be retained for horizontal development after vertical development has occurred in a unit. As to the issue of fair market value being $600 and a 1/5th total royalty he said all that was in the record was Mr. Mahaffey's statement, that Newfield could have had a witness come and testify under oath regarding any transactions that they may have been involved in, but they didn't. As to the Fleischaker lease which Newfield took, the Bays' witness indicated that he had contacted Fleischaker and they did not want to reveal the bonus they had received. That the only evidence presented regarding that transaction amount was Mr. Mahaffey's statement about the amount that was paid while he held a cell phone up to the witness which supposedly showed an to that effect. There's no witness presented to support Mr. Mahaffey's statement and no evidence regarding fair market value that contradicts Bays' witness' testimony. record 8. The ALl took the cause under advisement and closed the RECOMMENDATIONS AND CONCLUSIONS After taking into consideration all the facts, circumstances, evidence and testimony presented in this cause it is the recommendation of the ALJ that the Commission issue an order pooling the Prue, Hart, Skinner, Red Fork, Mississippi Lime, Misener-Hunton, Viola, Bromide Dense, First Bromide, Second Bromide, McLish and Osborne common sources of supply in the SE/4 of Section 7-T6N-R4W, McClain County, Oklahoma. As to the undisputed issues including operator, timeframes, deeming, and well cost that the order include the terms as recommended by applicant. As to the disputed issue regarding fair market value the record includes Bays' landman's testimony under oath regarding his investigation for and recommendation of fair market value for this pooling. On the other hand Newfield presented no witness and the record contains only a statement by Newfield's attorney about fair market value as related to him from a landman at Newfield. It was Newfield's position that contacting Fleischaker, who leased to Newfield, was not sufficient investigation of fair market value and that the Commission should continue the hearing and send Bays' landman out to inquire of Newfield or of Newfield's broker about the transaction. The ALl notes that more often the more sophisticated industry parties, including brokers, companies, operators or Page 9

10 owners of extensive mineral interests, will not reveal transaction amounts. Newfield was one of the parties involved in the Fleischaker transaction in question and had received a Bays' proposal letter so if they wanted to dispute values they had notice and opportunity to appear. It was not even apparent that fair market value was an issue until Newfield's attorney began cross examination of Bays' landman. In reliance upon the testimony taken under oath from the Bays' witness it is the recommendation of the ALJ that fair market value be established as a $150 an acre and a 3/16th royalty or no cash and a 1/5th total royalty. As to the issue of whether nonparticipation under a pooling order for a vertical development would deprive a party of future participation in horizontal develpment, both sides indicated this is an issue that has not been addressed by the Supreme Court. It is the opinion of the ALJ that until the Supreme Court revisits the unit pooling issue and makes a distinction between pooling for vertical development and pooling for horizontal development that the Amoco Production Company v. Corporation Commission, 751 P.2d 2003 (Okl.App. 1986) would apply. Therefore, it is the opinion of the ALJ that this order would be a unit pooling for all named formations without any distinction of vertical versus horizontal development. RESPECTFULLY submitted this 8th day of March, SO :ac 364~ R. t14~ Susan R. Osburn Administrative Law Judge xc: David E. Pepper Gregory L. Mahaffey Office of General Counsel Michael L. Decker, OAP Director Oil Law Records Court Clerk - 1 Commission Files Page 10