Analyzing Oil and Gas Farmout Agreements

FARMOUT AGREEMENT
(Providing for a Single Well Producer to Earn an Assignment)

FARMOR:

FARMEE:

NAME OF AREA/PROSPECT:

This Farmout Agreement (“the Agreement”) shall be effective as of the date it is executed by Farmee as provided in Section 8.

1. EXHIBITS.

The following exhibits, if checked, are attached and shall be considered part of this Agreement:

Exhibit A: General Terms and Conditions which shall apply to this Agreement unless they are in conflict with the terms and conditions provided in the body of this Agreement.

Exhibit B-1: Description of lands covered by this Agreement ("Farmout Lands").

Exhibit B-2: Lease Schedule describing oil and gas leases subject to this Agreement.

Exhibit C: Accounting Procedures, used in calculating payout of the Earning Well provided in Section 2.

Exhibit D: Tax Partnership Agreement.

Exhibit E: Operating Agreement.

Exhibit F: Geological Requirements.

Exhibit G: (Other Exhibits)

2. EARNING WELL.

2.1 Well Specifications. Farmee shall drill a well, (the "Earning Well"), strictly in compliance with the following specifications:

(a) Location:

(b) Spudding Deadline:

(c) Required Depth:

(d) Completion/Plugging Deadline:

2.2 Earned Assignment. As soon as practicable after Farmor is satisfied that Farmee has complied with all of its obligations under this Agreement with regard to the completion of the Earning Well as a producer of oil and/or gas in paying quantities, including the specifications provided in Section 2.1, Farmor shall deliver to Farmee the following (check one or both assignments):

A drill site acreage assignment as described in Section 2.3.

An additional acreage assignment as described in Section 2.4.

2.3 Drill Site Acreage Assignment. If a drill site acreage assignment is earned, that assignment shall cover

all      an undivided of Farmor's rights, title, and interests in the Farmout Lands, subject to the reserved overriding royalty interest described in Section 3., and subject to the following area and/or depth limitations (check appropriate limitations):

Area Limited to the "drilling unit" for the well as defined in Paragraph 3.2 of Exhibit A; or,

Limited to the following area:

Depth Limited to the interval between the surface of the ground and 100 feet below the stratigraphic equivalent of the total depth drilled in the Earning Well; or,

Limited to the following interval:

2.4 Additional Acreage Assignment. If an additional acreage assignment is earned, that assignment shall cover

all      an undivided of Farmor's rights, title, and interests in the Farmout Lands not covered by the drill site acreage assignment provided for in Section 2.3., subject to the following area and/or depth limitations (check appropriate limitations):

Area No area limitation.

Limited to the following area:

Depth Limited to the interval between the surface of the ground and 100 feet below the stratigraphic equivalent of the total depth drilled in the Earning Well; or,

Limited to the following interval:

3. RESERVED OVERRIDING ROYALTY INTEREST.

3.1 Reservation. If the Drill Site Acreage Assignment is made by Farmor under the terms of this Agreement, Farmor shall reserve an overriding royalty interest in production from the Earning Well equal to (check appropriate alternative):

of production if the Earning Well is an oil well, and of production if the Earning Well is a gas well, reduced in proportion to the assigned interest; or,

the amount by which of production, reduced in proportion to the assigned interest, exceeds the sum of all royalties, overriding royalties and other payments out of production which burden the assigned interest at the time the Drill Site Acreage Assignment is made.

3.2 Conversion. Check appropriate alternative.

Upon "payout" of the Earning Well, as defined in Paragraph 4.3 of Exhibit A, Farmor's reserved overriding royalty interest shall be convertible, at Farmor's election, to an undivided working interest equal to of the working interest covered by the Drill Site Acreage Assignment; or,

Farmor's reserved overriding royalty interest shall not be convertible to a working interest upon payout of the Earning Well.

4. OPERATING AGREEMENT.

If an Operating Agreement is attached as Exhibit E to this Farmout Agreement, it shall be executed at the same time this Agreement is executed and shall become effective if and when Farmor and Farmee become co-owners of working interest in any of the Farmout Lands. The Operating Agreement shall govern all operations on jointly-owned Farmout Lands, but shall be subject to this Agreement. If there is any conflict between the Operating Agreement and this Agreement, this Agreement shall be the governing Agreement.

5. DELAY RENTALS.

Until a lease(s) included in the Farmout Lands is assigned in whole or in part to Farmee, Farmor shall be responsible for paying any and all delay rentals required to maintain the lease(s) in effect, and within 30 days after receipt of an invoice from Farmor, Farmee shall reimburse Farmor for of the delay rentals paid by Farmor. If Farmee fails to pay Farmor the balance of any unpaid delay rental invoice shall bear interest monthly at the rate of per annum, or the maximum contract rate permitted by the applicable usury laws in the state in which the Farmout Lands are located, whichever is the lesser, plus attorney's fees, court costs, and any other costs in connection with the collection of the unpaid balance. After the lease(s) has been assigned in whole or in part to Farmee, the responsibility for making future delay rental payments shall belong to

Farmor     Farmee

subject to reimbursement by the other party upon receipt of an invoice as described above. The party responsible for paying rentals shall not be liable to the other party for any loss resulting from a good faith effort to make any payment.

6. NOTICES AND WELL INFORMATION.

6.1 General. All well data, information, and notices to be given to Farmor or Farmee as provided in this Agreement shall be given as follows:

Farmor:    Farmee:

Farmor or Farmee may change their address at any time by furnishing a written notice of change of address to the other party.

7. AGREEMENTS AFFECTING FARMOUT LANDS.

7.1 Farmee Bound. Except as may be otherwise provided in this Agreement, Farmee shall be bound by any agreement which affects the Farmout Lands at the time of assignment to Farmee. Farmor shall not be liable for its good faith failure to disclose the existence or effect of any such agreement to Farmee, either in this Agreement or otherwise.

7.2 Other Agreements. Subject to the disclaimer of liability contained in Section 7.1, Farmor believes, in good faith, that as of the date of this Agreement the only other agreements affecting any interest to be assigned to Farmee under the terms of this Agreement is the oil and gas lease(s) described in Exhibit B, and the following agreements:

8. EXECUTION.

Duplicate originals of this Agreement are being executed. This Agreement shall be null and void, at Farmor's option, if one of the duplicate originals of this Agreement is not executed by Farmee and returned to Farmor within days after the date shown below Farmor's signature.

EXHIBIT A
TO FARMOUT AGREEMENT
GENERAL TERMS AND CONDITIONS

TABLE OF CONTENTS

Paragraph            Page

1. Title and Access to Farmout Lands

  1.1 Title Information

  1.2 Access by Farmee and Farmor

2. Conduct of Operations

  2.1 Cost and Risk

  2.2 Performance Standards

  2.3 Federal Contract Requirements

  2.4 Lease Obligations

  2.5 Well Information

  2.6 Confidentiality

  2.7 Substitute Wells

  2.8 Takeover by Farmor

  2.9 Additional Wells After Earning Well

3. Earned Assignment

  3.1 Scope of Assignment

  3.2 Drilling Unit

  3.3 Default by Farmee

4. Reserved Overriding Royalty Interest

  4.1 Calculation and Payment

  4.2 Monthly Statements

  4.3 Conversion of Overriding Royalty Interest

  4.4 Audits

5. Liability and Insurance

  5.1 Relationship of Parties

  5.2 Farmee's Indemnity

  5.3 Required Insurance Coverage

  5.4 Proof of Coverage

6. Option to Purchase or Process Production

  6.1 Oil Production

  6.2 Gas Production

  6.3 Gas Processing

7. Assignments, Encumbrances and Restrictions

8. Reassignment Rights of Farmor

  8.1 Termination or Cancellation of Leases

  8.2 Abandonment of Wells

9. Renewals and Extensions

10. Term of Farmout Agreement

11. Miscellaneous

  11.1 Taxes

  11.2 Income Tax Provisions

  11.3 Payments by Farmor

  11.4 Division of Proceeds

  11.5 Furnishing Data

GENERAL TERMS AND CONDITIONS

1. Titles and Access to Farmout Lands.

1.1 Title Information. On written request by Farmee, Farmor shall make available to Farmee copies of all title opinions, abstracts of title, and other title information in Farmor's possession with respect to the Farmout Lands. Providing such items shall not be construed as a warranty or representation by Farmor of title or ownership. Any curative work or additional title examination required by Farmee shall be conducted by Farmee at its sole cost and risk. On request, Farmee shall provide Farmor with a copy of all curative work, title information, and title opinions resulting from any additional title examinations conducted by Farmee.

1.2 Access by Farmee and Farmor. To the extent Farmor can authorize it, Farmee and its contractors and subcontractors shall be entitled to exercise all of Farmor's rights of ingress and egress pertaining to the Farmout Lands for the purpose of conducting operations. Farmor shall advise Farmee of any unusual limitations or restrictions on ingress or egress, known to Farmor, and Farmee and its contractors and subcontractors shall comply with such limitations or restrictions. During Farmee's operations Farmor and Farmor's representatives shall have access at all times to the well-site, including the derrick floor, for the purpose of observation. All information requested by Farmor concerning operations shall be promptly furnished by Farmee.

2. Conduct of Operations.

2.1 Cost and Risk. All operations conducted by Farmee shall be at Farmee's sole cost and risk, and subject to the indemnity provisions of paragraph 5.2 below.

2.2 Performance Standards. All of Farmee's operations shall be conducted in a diligent and workmanlike manner, and in accordance with all applicable federal, state and local laws, regulations, and orders. Whether or not the Earning Well must be completed as a producer of oil and/or gas in order to earn an assignment, Farmee shall use its best efforts, in accordance with good oil and gas practice, to complete the well as a producer of oil and/or gas in paying quantities. Farmee shall conduct such coring, logging, testing, fracing, and acidizing operations as Farmor may reasonably request or as a prudent operator would conduct under the same or similar circumstances. If the well cannot reasonably be completed as a producer of oil and/or gas, Farmee shall promptly plug the well and perform all necessary surface restoration work. Time is of the essence in Farmee's performance of all undertakings provided for in the Agreement.

2.3 Federal Contract Requirements. If applicable, Farmee agrees to comply with the requirements of all applicable Executive Orders governing Federal contractors, as well as all related rules, regulations and orders, and any amendments or additions of or to those rules and orders. Farmee additionally agrees to supply Farmor all certificates required pursuant to any applicable rules, regulations, and orders.

2.4 Lease Obligations. Except as otherwise provided in the body of the Farmout Agreement, Farmee shall at its sole cost, risk, and expense comply with all of the express and implied covenants and other obligations of the oil and gas leases covering the Farmout Lands, including the payment of royalties, shut-in royalties, and delay rentals, and the cost of any renewals or extensions of the leases.

2.5 Well Information. During Farmee's operations, Farmee shall promptly furnish Farmor the following information pertaining to the Earning Well and any other well drilled by Farmee:

(a) Written notice of the exact time and date on which the well is spudded.

(b) A daily drilling report showing all formations encountered and the depths at which those formations were encountered during the immediately preceding day, and the well operations conducted during the immediately preceding day.

(c) Written reports on all cuttings and cores taken in the well, along with representative samples of the cuttings and cores, if requested by Farmor.

(d) Reasonable advance notice of any production tests, pressure tests, cores, and logs to be run in the well so that Farmor may witness the operations. Written report of such operations, when they are completed, shall be furnished to Farmor.

(e) Copies of all reports and other forms filed with any federal, state, or local governmental authority concerning the well.

(f) A complete copy of the driller's log and a complete copy of all electrical logs, on a scale of not less than 2 inches per 100 feet, from the bottom of the surface casing to the total depth of the well.

(g) Copies of all fluid analyses and other reports or information obtained with respect to the well.

(h) Any other information specifically required by Farmor as part of this Farmout Agreement.

2.6 Confidentiality. Without Farmor's prior written consent, Farmee shall not divulge information obtained from Farmee's operations under the terms of this Agreement to any party other than Farmor, any party owning an interest in the well, and the appropriate governmental authority.

2.7 Substitute Wells. If Farmee has failed to earn an assignment under the terms of this Agreement, either (i) because the original Earning Well failed to reach the required depth as a result of mechanical problems or impenetrable strata or other conditions in the hole which make further drilling impracticable, under generally accepted oil field practices; or (ii) because the original Earning Well was drilled to the required depth but it is not capable of producing in paying quantities, Farmee shall have the option, but not the obligation, to drill one or more substitute wells subject to the following provisions:

(a) Farmee shall give Farmor written notice describing the status of the well and stating whether or not Farmee elects to drill a substitute well. This notice shall be given while the drilling rig or completion unit is on the well, or within 10 days after its release. Failure to timely make such an election shall be deemed to be an election by Farmee not to drill a substitute well.

(b) If Farmee elects to drill a substitute well, Farmor shall advise Farmee within 10 days after receipt of Farmee's notice, or within 72 hours if the rig is on location, to either plug the original well or turn it over to Farmor as provided in paragraph 2.8 below, and to proceed with the substitute well as provided in paragraph 2.7(d) below.

(c) If Farmee elects not to drill a substitute well, or if Farmee has waived its right to do so as provided in paragraph 2.7(a) above, Farmor shall advise Farmee within 10 days after receipt of Farmee's notice, or within 72 hours if the rig is on location, whether or not Farmor elects to take over the well as provided in paragraph 2.8 below. If Farmor elects not to take over the well or fails to make an election, Farmee shall promptly plug and abandon the well and restore the surface. In either event, Farmee shall have no right to drill a substitute well in order to earn an assignment.

(d) Any substitute well drilled by Farmee shall be spudded within 30 days after Farmee's election to drill it, at a mutually acceptable location, and the well shall be drilled, tested, and completed or plugged and abandoned in accordance with all of the requirements specified for the original Earning Well, and with the same consequences. The substitute well shall be considered as the Earning Well for all purposes of this Agreement.

2.8 Takeover by Farmor. If Farmor elects to take over a well, the effective date of the takeover shall be 72 hours after the date of Farmor's election to do so or when Farmor takes actual custody of the well, whichever is earlier. If Farmor elects to takeover a well it shall own Farmee's interest in the well and the related equipment, along with any and all interest Farmee owns (or has a right to earn under other contracts or agreements) in the drilling unit for the well taken over, excluding any other producing wells and related equipment in the drilling unit, and excluding any depth intervals or formations which would not have been earned under this Agreement. As soon as practicable after Farmor takes over the well, Farmee shall make an assignment to Farmor, as may be necessary to evidence the foregoing, at which time Farmor shall reimburse Farmee for the estimated salvage value of Farmee's salvable equipment in and on the well, less estimated salvage costs. Farmee shall have no further rights or obligations under this Agreement, except Farmee shall be liable for all actions which occurred prior to the effective date of the takeover.

2.9 Additional Wells After Earning Well. For the purpose of this paragraph, the term "Earned Acreage" means that portion of the Farmout Lands, if any, in which Farmee has earned all of Farmor's interest, subject to an overriding royalty interest retained by Farmor in production from the Earning Well. The term "Additional Well" means each additional well Farmee drills or participates in drilling on Earned Acreage or on the Earning Well's drilling unit after completion of the Earning Well. As to each such Additional Well the following provisions shall apply:

(a) If Farmor's overriding royalty interest in the Earning Well is not convertible at payout to a working interest as described in paragraph 4.3 below, or if the overriding royalty interest was convertible but Farmor elected at payout not to convert, that overriding royalty interest shall apply, without conversion rights, to the Additional Well in the same manner as that interest applies to the Earning Well.

(b) If Farmor's overriding royalty interest in the Earning Well is convertible to a working interest as described in paragraph 4.3 below, but the Earning Well has not yet reached payout, Farmee shall notify Farmor in writing of its intention to drill or participate in drilling the Additional Well at least 60 days before such drilling commences. Within 45 days after receipt of such notice, Farmor shall advise Farmee in writing of Farmor's election either: (i) to have its overriding royalty interest, with conversion rights at payout, apply to the Additional Well in the same manner (but with separate payout accounts) as the interest applies to the Earning Well; or, (ii) to participate as a working interest owner in the Additional Well from the commencement of operations.

Farmor's election and the resulting consequences (including the calculation of payout) shall apply separately to each Additional Well. If Farmor elects to participate in the Additional Well as a working interest owner, Farmee shall promptly reassign to Farmor all of the interest Farmor would otherwise have been entitled to receive upon payout of the Earning Well, except: (i) Farmee's interest in the Earning Well itself and all equipment attributable to that well; (ii) Farmee's interest in any previously drilled Additional Well (and equipment attributable to that well) in which Farmor elected an overriding royalty with conversion rights, but which has not yet reached payout; and, (iii) Farmee's interests in any previously drilled Additional Well (and related equipment) in which Farmor elected an overriding royalty with conversion rights, and which has reached payout, but Farmor has not converted its overriding royalty interest to a working interest. Reassignments by Farmee shall be free and clear of all royalties, overriding royalties, and other payments out of production, and all claims, liabilities, and other encumbrances except those in existence as of the effective date of this Agreement. If Farmor elects to participate in the Additional Well as a working interest owner, as between Farmor and Farmee, all operations shall be governed by the Operating Agreement provided for in the body of this Agreement.

3. Earned Assignment.

3.1 Scope of Assignment. Any assignment of interest earned by Farmee shall be subject to all of the provisions of the Agreement and all its Exhibits, whether or not any of the provisions are recited in the assignment. Farmor shall retain all rights and interests not expressly assigned to Farmee. Farmor expressly retains the right to use all or any part of the assigned Farmout Lands to explore, develop, and operate the Farmout Lands and other lands not assigned to Farmee. The assignments shall be without warranty of title, express or implied, but the assigned interest shall be free and clear of all royalties, overriding royalties and other such payments out of production, except those in existence as of the effective date of the Agreement, and any overriding royalty to be reserved by Farmor.

3.2 Drilling Unit. Whenever an assignment relates to the "drilling unit" for the Earning Well, the term "drilling unit" is deemed to mean the area within the surface boundaries of the drilling unit, spacing unit or proration unit, as the case may be, established or prescribed as of the date of the Agreement by field rules or special order of the appropriate regulatory authority for the objective reservoir to be tested or the reservoir in which the Earning Well is completed, if other than the objective reservoir. In the absence of field rules or special order, the drilling unit shall be 160 acres if the Earning Well is completed as a gas well, and 40 acres if the Earning Well is completed as an oil well, or is not completed as a producer of either oil or gas in paying quantities. However, if the Earning Well is completed as a producer in a reservoir for which a larger unit is subsequently established by field rules or special order within 120 days after completion, the larger unit shall be considered the drilling unit for the Earning Well and any previous assignment earned by Farmee shall be supplemented accordingly. For the purpose of this Farmout Agreement, the meanings of the terms "oil well" and "gas well" shall be as defined by law or by the appropriate regulatory authority. In the absence of such definitions, an oil well shall be a well with an initial gas-oil ratio of less than 100,000 cubic feet per barrel, and a gas well shall be a well with an initial gas-oil ratio of 100,000 cubic feet or more per barrel, based on a 24-hour production test conducted by Farmee, and witnessed by Farmor, under normal producing conditions and using standard lease separator facilities or equivalent testing equipment.

3.3 Default by Farmee. If Farmee fails to spud the Earning Well within the deadline established in this Agreement, this Farmout Agreement shall automatically terminate without notice, effective as of the date of the deadline. If Farmee defaults in the timely and proper performance of any other obligation, Farmor shall have the right to terminate this Agreement by giving notice of termination to Farmee. Upon termination, Farmee shall have no further rights except rights already earned, and, in addition to any other available legal or equitable remedies, Farmor may elect to take over, pursuant to paragraph 2.8 above, any well which has not yet satisfied the earning requirements of this Agreement.

4. Reserved Overriding Royalty Interest.

4.1 Calculation and Payment. Any overriding royalty interest reserved by Farmor in an assignment of interest to Farmee shall be based on the volume of oil, gas, and other minerals produced and saved from the Earning Well, reduced in proportion to the interest assigned. At Farmor's option, exercised by written notice to Farmee, the overriding royalty interest shall be delivered in kind into Farmor's tanks or pipeline as produced, or paid monthly on the basis of the gross value of production during the preceding calendar month. For the purpose of this Farmout Agreement, "gross value" means the gross proceeds actually received by Farmee in an arm's length sale of production, or, in the absence of an arm's length sale, the prevailing market value of the production of the wellhead when produced. The overriding royalty interest shall be in addition to any other royalty, overriding royalty interest, and payment out of production and free and clear of all costs except applicable production or severance taxes and federal excise taxes.

4.2 Monthly Statements. If Farmor is granted the right to convert its overriding royalty interest to a working interest, each overriding royalty interest payment by Farmee shall be accompanied by a statement showing cumulatively, and for the month covered by the statement, the following information in form and substance acceptable to Farmor:

(a) The Farmee's costs, which are the costs incurred by Farmee in drilling, testing, reworking, completing, equipping, and operating the Earning Well as calculated in accordance with the accounting procedures provided for in "Exhibit C" to the Agreement, insofar as those costs are attributable to the interest assigned to Farmee under this Agreement.

(b) The Farmee's revenue, which is the gross value of production as defined in paragraph 4.1 above, less: (i) applicable production or severance taxes and any federal excise taxes; (ii) all royalties, overriding royalties, and other payments out of production which, as of the effective date of this Agreement, burden the interest assigned to Farmee; and, (iii) the overriding royalty interest reserved by Farmor. Where Farmor has taken its overriding royalty interest in kind, the calculation of farmout revenue shall be made as though the overriding royalty interest had been paid on the basis of the gross value of production, as defined above.

4.3 Conversion of Overriding Royalty Interest. If and when the Farmee's revenue equals the Farmee's costs, as shown by Farmee's monthly statements, the Earning Well shall be considered as having achieved "payout" status. If Farmor is granted the right to convert its reserved overriding royalty interest to a working interest, the Farmor may exercise that right by written notice to Farmee within 60 days after receipt of Farmee's written advice to Farmor stating that payout status has been achieved, accompanied by Farmee's monthly statements supporting that advice. Within that 60 day period Farmee shall provide Farmor all pertinent well production history and most recent test data, if any, and Farmor shall have the right to exercise its conversion privilege within 30 days after its receipt of all that data. Upon receipt of Farmor's conversion notice, Farmee shall promptly reassign to Farmor the working interest Farmor is entitled to receive, including an equivalent interest in the Earning Well and the equipment and all subsequent production effective as of 7:00 a.m. of the day following the date of payout. Farmor's overriding royalty shall be deemed to be extinguished. The reassignment of Farmor's working interest shall be without warranty of title, express or implied, free and clear of all royalties, overriding royalties, and other payments out of production, and all claims, liabilities and other encumbrances except those in existence as of the effective date of this Agreement. This conversion of overriding royalty interest option shall apply in like manner to any other well drilled on the Farmout Lands by Farmee in which Farmor has reserved a conversion option.

4.4 Audits. Upon written notice to Farmee, Farmor may, during normal business hours, audit Farmee's books and records relating to overriding royalty payments and/or the calculation of payout. Such audit rights may be exercised at any time while overriding royalties are payable and for a period of 24 months after payout status has been achieved, despite an earlier termination of this Farmout Agreement.

5. Liability and Insurance.

5.1 Relationship of Parties. In performing its obligations, Farmee shall be an independent contractor and not the agent of Farmor. Nothing in this Agreement shall be construed as creating a partnership or otherwise establishing joint or collective liability. The relationship of the parties for federal and state income tax purposes shall be as set forth in Exhibit D to this Agreement (Tax Partnership Agreement). If no Exhibit D is attached to this Agreement, the relationship of the parties for federal and state income tax purposes shall be as set forth in paragraph 11.2 below, and shall be effective from and after the effective date of this Agreement.

5.2 Farmee's Indemnity. Farmee shall indemnify and hold harmless Farmor and its employees and agents from all claims, demands, losses, and liabilities of every kind and character arising out of Farmee's performance or failure to perform under this Agreement, or the acts of or failure to act by Farmee's employees, agents, contractors and/or subcontractors.

5.3 Required Insurance Coverage. At all times while Farmee has the right to earn an assignment of interest or is conducting operations on the Farmout Lands, Farmee shall maintain, at its sole cost, the following insurance coverage for its operations:

(a) Worker's Compensation Insurance and Employer's Liability Insurance with such limits as are specified by law in the jurisdiction in which the Farmout Lands are located.

(b) Comprehensive General Public Liability Insurance, including Contractual Liability coverage, with a combined single limit of $ for bodily injury and property damage.

(c) Automobile Liability Insurance with the same limits as prescribed above for Comprehensive General Public Liability Insurance.

5.4 Proof of Coverage. Prior to the commencement of operations, Farmee shall furnish Farmor one or more certificates signed by the insurance carrier or carriers showing, to Farmor's satisfaction, that the required insurance coverage is in force and stating that the coverage shall not be canceled or materially altered without at least 10 days advance written notice to Farmor. A cancellation or material alteration, if not accompanied by new insurance coverage satisfactory to Farmor, shall constitute a default by Farmee under paragraph 3.3 above. Each certificate shall also contain a waiver by the insurance carrier of any right to be subrogated to the rights of any claimant against Farmor or Farmor's employees and agents, except that the carrier shall be subrogated to the rights of Farmee against Farmor with respect to any risk expressly assumed by Farmor.

6. Option to Purchase or Process Production.

6.1 Oil Production. Farmor shall have a continuing option to purchase Farmee's share of oil and liquid hydrocarbons produced and saved from the Farmout Lands through standard lease separator facilities, to the extent the production is attributable to the interest assigned to Farmee. The option may be exercised by Farmor at any time and from time to time while production continues, by giving written notice to Farmee not less than 30 days before the date on which Farmor's purchases are to commence. The price paid by Farmor for the production shall be equal to the prevailing wellhead market price then being paid in the same field for production of the same or similar grade and gravity, or if there is no prevailing price being paid in the same field, the prevailing price being paid in the nearest field. Farmor may terminate its purchases by giving written notice to Farmee not less than 30 days before the date of termination.

6.2 Gas Production. Farmor shall have the option to purchase Farmee's share of gas, including casinghead gas, produced and saved from the Farmout Lands through standard lease separator facilities, to the extent the production is attributable to the interest assigned to Farmee. When Farmee's gas becomes available for purchase initially, and at any time thereafter, Farmee shall advise Farmor in writing and Farmor shall have 60 days thereafter to give Farmee written notice of Farmor's election to purchase the gas at the prevailing wellhead market price paid for gas of the same or similar quantity and quality in the same field (or if there is no price then prevailing in the same field, then in the nearest field in which there is a prevailing price) pursuant to comparable purchase contracts entered into on the same or nearest preceding date as the date of Farmor's election to purchase gas.

6.3 Gas Processing. If Farmor does not elect to purchase Farmee's share of gas under paragraph 6.2 above, Farmor shall nevertheless have a continuing option to process Farmee's share of gas, including casinghead gas, produced and saved through standard lease separator facilities, to the extent the gas is attributable to the interest assigned to Farmee, all in accordance with the following provisions:

(a) Farmor may exercise its option at any time, before or after commencement of gas production, by giving written notice to Farmee not less than 60 days before Farmor's processing is to begin. Any agreement made by Farmee for the sale of its gas shall be made expressly subject to Farmor's processing option, whether or not exercised by Farmor.

(b) If Farmor exercises its processing option, Farmor shall have the right to remove any or all commercially liquefiable hydrocarbons from the gas before or after delivery to Farmee's gas purchaser, and to redeliver the residue gas to Farmee or its gas purchaser at the tailgate of the gas processing plant.

(c) Farmor shall own all liquefiable hydrocarbons removed from the gas in processing and shall bear all of the costs and risks thereof, but Farmor shall reimburse Farmee, or its gas purchaser, for the BTU reduction caused by such processing, using either of the following reimbursement methods, from time to time, at Farmor's sole discretion:

(i) The reimbursement shall be a cash payment equal to the BTU reduction caused by processing, times the net price per BTU which Farmee would have received for the gas under its gas sales contract if no such processing had occurred; or,

(ii) The reimbursement shall be a volume of residue gas having a total BTU content equal to the BTU reduction caused by processing, delivered in kind to Farmee, or its gas purchaser at the tailgate of the plant.

(d) Farmor's processing of gas and any in-kind reimbursement for the processing shall not reduce the BTU content of gas delivered to Farmee or its gas purchaser below 950 BTU's per standard cubic foot, nor shall the pressure of such gas be reduced by more than 50 pounds between the point it is delivered to Farmor for processing and the point it is redelivered to Farmee or its gas purchaser.

7. Assignments, Encumbrances and Restrictions.

This Agreement shall be binding on the respective heirs, successors, and assigns of Farmor and Farmee. Farmor may freely assign or encumber its interest at any time, but Farmee shall not assign or encumber its interest without the prior written consent of Farmor, which consent shall not be unreasonably withheld. Any attempt by Farmee to assign or encumber its interest without Farmor's prior written consent shall constitute a default under paragraph 3.3 above. When an assignment or encumbrance is made, Farmee shall promptly furnish a copy to Farmor. Any rights of reverter and the rights to reassignment retained by Farmor shall be superior to all liens, encumbrances, debts, judgments, claims, overriding royalty interests, and production payment burdens and other obligations created or incurred by Farmee and asserted against any oil and gas lease that is the subject of this Agreement. Any interest in any oil and gas lease included in the Farmout Lands reverting to Farmor or reassigned to Farmor shall be free and clear of all such liens, encumbrances, debts, judgments, claims, overriding royalty interests, and production payment burdens and other obligations. Farmee agrees not to use, for any promotion purposes or for the purpose of selling stock in any organization, and not to advertise in any manner, Farmee's relationship with Farmor arising out of this Agreement.

8. Reassignment Rights of Farmor.

8.1 Termination or Cancellation of Leases. If at any time after an interest in any oil and gas lease is assigned to Farmee, and Farmee elects to surrender its interest in the lease, or allow the lease to expire by its terms, or subjects the lease to possible cancellation for failure to comply with any express or implied covenant, Farmee shall notify Farmor in writing at least 60 days before the intended date of surrender or expiration, or as soon as practicable in the event of possible cancellation, and Farmor shall then have 30 days to notify Farmee in writing of Farmor's election to reacquire such interest. If Farmor elects to reacquire the interest, Farmee shall promptly assign it to Farmor free and clear of all royalties, overriding royalties interests, and other payments out of production and any other lease burden, except those in existence as of the effective date of this Agreement and except those to which Farmor has consented. Upon such assignment, Farmor shall reimburse Farmee for Farmee's share of the estimated salvage value of any salvable equipment in and on any wells covered by the assignment, less estimated salvage costs. Farmor's failure to notify Farmee in writing shall be deemed an election to not reacquire the interest.

8.2 Abandonment of Wells. Farmee shall not plug and abandon any Earning Well or Additional Well drilled without giving Farmor written notice at least 30 days before the intended plugging date. Farmor shall then have 15 days to notify Farmee in writing of Farmor's election to take over the well. Upon giving that notice, Farmor shall own Farmee's interest in the well and the related equipment, along with any and all interest Farmee owns (or has a right to earn under other contracts or agreements) in the drilling unit for the well taken over, excluding any other producing wells and related equipment in the drilling unit, and excluding any depth intervals or formations which would not have been earned under this Agreement. As soon as practicable after that time, Farmee shall make such assignment to Farmor as may be necessary to evidence the foregoing. At that time, Farmor shall reimburse Farmee for the estimated salvage value of Farmee's salvable equipment in and on the well, less estimated salvage costs. Farmee shall have no further rights or obligations under this Agreement, except Farmee shall be liable for all actions which occurred prior to the effective date of the takeover. Farmor's failure to notify Farmee in writing shall be deemed an election by Farmor to not take over the well.

If Farmor's election to take over results in a diversity of ownership giving rise to a commingling of production with uncommon ownership, in Farmee's storage tanks, Farmor shall be responsible for and shall bear all cost of setting and connecting tanks and pipelines for production from the well taken over by Farmor.

9. Renewals and Extensions.

If any oil and gas lease included in the Farmout Lands is extended or renewed in whole or in part by either party or their agents, during the term of the Agreement, this Agreement shall apply to such extension or renewal to the same extent as it would have applied to the original lease. For this purpose, any new lease covering an interest originally included in the Farmout Lands and acquired within 90 days after the termination of the original lease shall be considered an extension or renewal.

10. Term of Farmout Agreement.

The Farmout Agreement shall be in effect until such time as: (i) Farmee's rights to earn an assignment of interest have expired without Farmee having earned an assignment; (ii) Farmee has earned an assignment of interest and neither Farmee nor Farmor have any further rights or obligations under the Agreement; or, (iii) this Agreement terminates pursuant to paragraph 3.3 above as a consequence of Farmee's default.

11. Miscellaneous.

11.1 Taxes. Farmee shall pay when due all taxes, including, but not limited to, federal excise taxes, and state and local ad valorem, occupation, severance, excise, privilege or regulatory taxes, now or hereafter lawfully assessed against Farmee's interest in the Farmout Lands or the production attributable to Farmee's interest.

11.2 Income Tax Provisions. If this Agreement is or may be construed as creating a partnership for federal or state income tax purposes, then, unless the parties expressly provide for a tax partnership in this Agreement and Exhibit D to this Agreement, Farmee is authorized and directed to execute and file on behalf of all parties an election to be excluded from application of the provisions of Subchapter K, Chapter 1, Subtitle A of the current United States Internal Revenue Code, and any amendments, or to be excluded from application of any comparable provisions of state law. Each party agrees to furnish such additional evidence of that election as may be necessary or proper.

11.3 Payments by Farmor. Farmor shall have the right to pay rentals, royalties, or other payments which may become due under any oil and gas lease included in the Farmout Lands, and Farmee agrees to reimburse Farmor for the full amount of those payments which Farmor is not obligated to bear. Farmee shall pay interest on paid sums effective as of the date of the payment by Farmor at the interest rate provided in the body of this Agreement.

11.4 Division of Proceeds. To make proper division of the proceeds from the sale of oil and gas production from the Farmout Lands, Farmor shall have the right, but not the obligation, to collect such proceeds. After deducting the overriding royalty or working interest to which it is entitled, Farmor shall pay to Farmee its portion of the proceeds thus collected.

11.5 Furnishing Data. Each party has the affirmative duty to timely supply adequate data to the other party when such data is necessary to comply with Federal, State or local reporting requirements.

EXHIBIT B-1
TO FARMOUT AGREEMENT
DESCRIPTION OF FARMOUT LANDS

The Farmout Lands covered by the Farmout Agreement and in which Farmee shall have the right to earn an Assignment under the terms of the Farmout Agreement are described as follows (check appropriate limitations):

Area: All lands covered by the oil and gas leases described on Exhibit B-2.

Limited to the following area:

Depth: All depths.

Limited to the following interval:

EXHIBIT B-2
TO FARMOUT AGREEMENT
LEASE SCHEDULE

Lease No:

County:

State:

Lessor:

Lessee:

Lands Covered:

Recording Information:

Lease No:

County:

State:

Lessor:

Lessee:

Lands Covered:

Recording Information:

Lease No:

County:

State:

Lessor:

Lessee:

Lands Covered:

Recording Information:

EXHIBIT C
TO FARMOUT AGREEMENT
ACCOUNTING PROCEDURES

The Accounting Procedure used in calculating payout of an Earning Well under the Farmout Agreement shall be the same Accounting Procedure attached as Exhibit "C" to the Operating Agreement, which is attached as Exhibit "E" to this Farmout Agreement.

EXHIBIT D
TO FARMOUT AGREEMENT
TAX PARTNERSHIP AGREEMENT

EXHIBIT E
TO FARMOUT AGREEMENT
OPERATING AGREEMENT

EXHIBIT F
TO FARMOUT AGREEMENT
GEOLOGICAL REQUIREMENTS