Farm-out & Exploration Agreement Knights Landing

EXHIBIT 10.23


FARMOUT AND EXPLORATION AGREEMENT


KNIGHTS LANDING STARKEY SAND DEVELOPMENT PROGRAM


THIS FARMOUT AND EXPLORATION AGREEMENT ("Agreement") is made and entered into as of the Effective Date (February 17, 2004) by and between THE NAHABEDIAN EXPLORATION GROUP, LLC ("NEG") and IVANHOE ENERGY (USA) INC. dba USA IVANHOE ENERGY, INC., in California ("Ivanhoe"), sometimes referred to individually as a "Party" or collectively as the "Parties."


W I T N E S S E T H:


WHEREAS, NEG, claims, without warranty of title of any kind, to be the owner of NEG Leases as set forth on Exhibit "A", attached hereto and incorporated herein by this reference; and holds certain other lands under Lease, as identified in Exhibits "B-1", "B-2" and "B-3"within the AMI formed hereby, which said Exhibit "B-3" lands are specifically excluded from this Agreement,


WHEREAS, NEG has previously drilled and completed a number of gas wells, producing and shut-in, on the NEG Lands, as further described herein, and


WHEREAS, NEG and Ivanhoe desire to construct a gas gathering system, together with surface treatment facilities to connect NEG's existing shut-in wells to the regional Calpine gas sales line, and, in addition, Ivanhoe desires to acquire an interest in said shut-in wells and the gas gathering system, and;


WHEREAS, Ivanhoe desires to earn an interest in the NEG Leases, subject to the conditions hereof and the requirements and obligations to be performed by Ivanhoe as hereinafter contained; and,


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WHEREAS, the Parties desire to further explore and develop the NEG Leases and the associated AMI Lands to the base of the Starkey Sand stratigraphic level (as further described herein) which collectively comprise the Knights Landing Starkey Sand Development Project, for the production of oil and/or gas and other hydrocarbon substances, and:


WHEREAS, Ivanhoe may desire to earn additional rights or interests in the NEG Leases, below the Starkey Sand stratigraphic level; and,


WHEREAS, the Parties will enter into a JOA, designating NEG as Operator.


NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements contained herein, it is understood and agreed by and between the Parties, as follows:


ARTICLE 1


DEFINITIONS


1.1 Actual Drilling Operations - shall be deemed to have been commenced when a derrick, a rig, and machinery capable of drilling to a depth sufficient to test a prospective oil and/or gas horizon have been erected, and when such well has been spudded in and the rotary bit is rotating under power.


1.2 Affiliate - shall mean any company or other entity which (i) controls, (ii) is controlled by or (iii) is under common control with one of the Parties. For the purpose of this definition, control shall mean the ownership, directly or indirectly, of Fifty Percent (50%) or more of the stock or other units of ownership having the right to vote for the election of directors of such company or other entity.


1.3 Area of Mutual Interest or AMI - shall have the meaning given in Article III, 3.1


1.4 Casing Point- that point in time after which time Contract Depth has been reached in a Test Well, logs have been run, and NEG as Operator shall make a recommendation whether to complete said well as a producer, or abandon same as a dry hole: at such


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time, Ivanhoe shall make an election whether or not to join in the completion attempt of the said Test Well.


1.5 Contract Area - shall refer to the lands comprising the NEG Leases and is shown outlined in red on the plat attached hereto and made a part hereof as Exhibit "B-1."


1.6 Contract Depth - shall mean in the Mandatory Test Wells and the Optional Test Wells, Three Thousand Five Hundred Feet (3,500') or a depth sufficient to adequately test the Starkey Equivalent Sands (defined as that interval found in the Hamar Associates "Giusti" 1 well in Section 25, T12N, R2E MDB&M, between the drilled depths of 2200 to 3400 feet; the Base of the Starkey Sands herein defined at 3400 feet. Contract Depth for the Deeper Exploration Well will be total depth of 9500 feet or the Top of Basement, whichever is the shallower.


1.7 Deeper Exploration Well - shall mean the exploration well that may be drilled pursuant to Article IX of this Agreement.


1.8 Drillsite Spacing Unit- shall mean a 40 acre area in the shape of a rectangle or square having as its center point the wellbore penetration at the uppermost Starkey Sand in the subsurface, and extending vertically from the surface of the ground to the base of the Starkey Sands.


1.9 NEG Overriding Royalty (ORR) - The NEG Leases and additional Leases within the AMI shall be burdened with an overriding royalty to NEG or its designees, proportionately reduced to the mineral interest leased. The NEG ORR shall be borne in proportion to the working interest owned by the Parties. The NEG ORR shall be as set forth on Exhibit A attached hereto, and shall apply to all new Leases, extensions and renewals of the Leases in the Contract Area and the AMI.


1.10 Effective Date - shall mean the effective date of this Agreement, being the date of its signature by the Parties, viz., 1:00 p.m., Pacific Standard Time, February 17, 2004.


1.11 Mandatory Test Well - shall mean any one of the ten mandatory Test Wells to be drilled pursuant to Article VI of this Agreement.


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1.12 NEG Leases - shall mean those Leases listed on Exhibit "A" attached hereto and made a part hereof and includes only those geographic portions thereof located within the confines of the Contract Area.


1.13 Optional Test Well - shall mean one of the optional test wells drilled pursuant to Article VII of this Agreement.


1.14 Payout - As to all Test Wells drilled hereunder, Payout shall be computed on a well-by-well basis, and shall be that point in time when the value (as hereinafter defined) of the oil, gas, and other hydrocarbons produced, saved, and marketed from a well received by the Parties equals the cost of (a) drilling, testing, completing, fracing, plugging back, reworking, and equipping the well into the tanks or a purchaser's gas sales line; (b) the cost of operating the Test Well up to the date of Payout; (c) severance, production, and/or mineral ad valorem taxes measured by production from the well; (d) royalty to the landowner/Lessor(s) under the Lease(s); (e) NEG ORR, and all other costs chargeable to the drilling and operation of a well under the JOA, including the Accounting Procedure attached thereto. The costs of a Substitute Well, if drilled, shall be included with those costs of the Test Well in determining Payout.


Value shall be determined by the net proceeds (exclusive of taxes based upon income) realized by the Parties from the sale of such production, or the fair market value thereof at the wellhead if not sold but taken by either Party for its own use and not used in operations within the Contract Area. Costs shall be in accordance with the form of Accounting Procedure attached to the JOA attached hereto as Exhibit "C".


With respect to the gas pipeline which will be constructed to the Project Gas Wells, Payout shall mean that point in time at which Ivanhoe has recovered from gas and oil sales from the Project Gas Wells, Ivanhoe's actual cost share (exclusive of any item of Ivanhoe's general and administrative costs) of the construction of the gas gathering system, plus the purchase price for its interests in the Project Gas Wells paid from the collective production stream from all of the Project Gas Wells, net of operating costs, workover costs, ad valorem taxes and other chargeable expenses under the JOA.


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1.15 Project Gas Wells - shall mean the four (4) gas wells within the Contract Area, to wit: Hamar Associates "Mary's Lake" 5-19 (Section 19, 11N/3E), "Armour Road" 1-7 (Section 7, 11N/3E), "MacKert" 1-1 (Section 1, 11N/2E) and "MacKert" 1-31Section 31, 12N/3E).


1.16 Joint Operating Agreement or JOA - shall mean the Joint Operating Agreement referred to in Article VIII, a form of which is attached hereto and made a part hereof as Exhibit " C".


1.17 Jointly Acquired Lease(s) - shall mean Leases acquired by the Parties pursuant to the AMI provisions of this Agreement.


1.18 Lease - shall mean and include any oil, gas, and mineral lease, mineral interest, or any other instrument granting the right to explore for, drill, and take oil, gas, and other minerals.


1.19 Paying Quantities - shall mean production of hydrocarbon substances in quantities sufficient to yield a reasonable return in excess of producing and operating a well over and above all payable royalties, overriding royalties, and payments out of production (other than those created by a party which are not specifically described in this agreement).


1.20 Test Well - shall mean any one of the Initial Test Well, Mandatory Test Wells, Optional Test Wells or Deeper Exploration Well. A Substitute Well for any of the foregoing shall be deemed to be part of the well for which it is a substitute.


ARTICLE II


EXHIBITS


2.1 Exhibits - The following exhibits, attached hereto, are incorporated herein and made a part hereof for all purposes, to-wit:


Exhibit "A" NEG Leases
Exhibit "B-1" Map showing the Contract Area
Exhibit "B-2" Map showing the AMI


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Exhibit "B-3" Map and list showing NEG Leases excluded from Agreement.
Exhibit "C" JOA Form
Exhibit "D" Geological Requirements
Exhibit "E" Well Program and AFE
Exhibit "F" List of Mandatory Test Wells


ARTICLE III


AREA OF MUTUAL INTEREST


3.1 Area of Mutual Interest (AMI) - NEG and Ivanhoe by execution hereof establish an Area of Mutual Interest covering the Contract Area and additional lands located within the area outlined in red on the plat attached hereto and made a part hereof as Exhibit "B-2". The AMI specifically excludes NEG's currently producing wells, their drillsites and pooled producing units, as set forth on Exhibit "B-3" hereto, except as otherwise provided herein. The AMI shall continue in effect as long as the Parties jointly own Leases within the AMI and shall continue in effect under the JOA until the JOA terminates. The participation interest of each Party in the AMI shall be NEG, Fifty Percent (50%) and Ivanhoe Fifty Percent (50%).


3.2 Acquisition/Option - Should any Party acquire, directly or indirectly, a Lease covering any lands located, fully or partially, within the AMI, and outside the Contract Area, such Party (the "Acquiring Party") shall immediately give written notice thereof to the other Party (the "Non-Acquiring Party"), together with all pertinent details and information, including copies of all instruments of conveyance (including but not limited to, copies of Leases, assignments, subleases, farmouts, and other contracts affecting the Lease acquired), copies of paid drafts or checks and itemized invoices of the actual costs incurred by the Acquiring Party, including any bonus, administrative fees, brokerage, legal and recording costs, and any other direct costs (said actual costs are referred to as "Acquisition Costs"). The Non-Acquiring Party shall have Thirty (30) Days, or Forty-Eight (48) Hours if a rig capable of performing an operation is on location, from receipt of such notice to elect in writing to acquire its proportionate interest in the Lease by paying its proportionate share of the Acquisition Costs and assuming its proportionate share of the Lease obligations. Failure to respond by the deadlines stated herein shall be deemed an election not to participate in the acquisition as described in


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said notice. Failure to pay said proportionate share of Acquisition Costs within Thirty (30) Days following an election to participate shall result in a forfeiture of the Non-Acquiring Party's interest with the same effect as if said Party had initially elected not to participate. If less than all Parties elect to participate in said acquisition, the lands and/or depths covered by any such Lease acquired shall be excluded from the AMI and the Lease acquired shall not be subject to this Agreement. Ivanhoe agrees it shall not acquire any interests within the Contract Area, except by assignment from NEG under this Agreement, until after it has satisfied and fulfilled the earning requirements hereunder.


3.3 Payment/Assignment - If the Non Acquiring Party elects to participate in such Lease acquisition it shall pay to the Acquiring Party its proportionate share of the Acquisition Costs for such interest, within Thirty (30) Days after receipt of an invoice for said costs. Upon receipt of said payment, the Acquiring Party shall execute and deliver to the Non-Acquiring Party an assignment of the interest due the Non-Acquiring Party, pursuant to which the Non-Acquiring Party shall bear and assume its proportionate share of all obligations, covenants, conditions, requirements, and terms associated with the acquisition. The preceding sentence is solely for the benefit of the Parties to this Agreement and does not benefit any third party and shall not apply to any obligations, covenants, conditions, requirements or terms which were known to the Acquiring Party and not disclosed to the Non-Acquiring Party.


3.4 Encumbrances - Any assignment made pursuant to this Article III shall be free and clear of any encumbrances placed on the assigned Lease in favor of or by the Acquiring Party, except for the NEG ORR, but otherwise shall be made without warranty of title, either express or implied, except by, through, and under the Acquiring Party. The assignment shall be made and accepted subject to, and assignee shall expressly assume its proportionate share of all of the obligations of the assignor pertaining to the assigned Lease, including the NEG ORR.


3.5 Merger - The provisions of this Article III shall not be applicable to acquisitions of leases resulting from mergers, consolidations or reorganizations involving all or substantially all of the properties or assets of the Party.


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3.6 NEG Leases - NEG has acquired certain oil and gas Leases within the AMI and these are identified on Exhibit "A." The lands covered by the NEG Leases together comprise the Contract Area.


3.7 Prospect Fee- Ivanhoe shall pay to NEG the sum of One Hundred Twenty-Five Thousand Dollars ($125,000) as a Prospect Generation Fee, which shall be inclusive of all land costs incurred with respect to the Contract Area to January 1, 2004. The entire Prospect Generation Fee shall be paid to NEG upon execution hereof.


3.8 Performance Requirement- Notwithstanding any other provision herein, neither Party may propose the drilling of a well on the AMI Lands outside of the Contract Area until such time as Ivanhoe has completed the Mandatory Well Drilling Program as described in Article VI hereof.


ARTICLE IV


CONSTRUCTION OF THE GAS GATHERING SYSTEM


4.1 Existing Shut-in Gas Wells- NEG has previously drilled, completed and tested the Project Gas Wells that are currently shut-in without hook-up to a gas sales outlet. NEG has obtained permits and rights-of ways for the construction of a gas sales line system, together with surface treatment facilities and meters, to connect said wells to the Calpine gas gathering system. The Estimated Cost of the new gas line and facilities is Six Hundred Thousand Dollars ($600,000). Ivanhoe hereby agrees to fund the construction of said system, up to a maximum cost of Six Hundred Thousand ($600,000). Any costs in excess of Six Hundred Thousand Dollars ($600,000) shall be borne by Ivanhoe as to 50% and NEG as to 50%. Upon execution hereof, Ivanhoe shall pay to NEG the sum of Three Hundred Thousand Dollars ($300,000) as a first installment towards its cost share of the system. NEG shall provide copies of its bids for such construction and copies of the contracts signed for the performance of such work. NEG shall then promptly begin purchase of materials and contract the construction thereof. From time to time, NEG shall Invoice Ivanhoe for the remaining funds necessary to complete construction and testing of the system, and Ivanhoe shall, within Ten (10) Business Days from receipt of said invoices, pay said sums to NEG. Ivanhoe's costs shall be limited to actual costs incurred by NEG; NEG shall receive no cost compensation for its services related to the


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construction thereof, and NEG shall provide Ivanhoe with suitable accounting, including copies of third party invoices, to verify said costs.


4.2 Recoupment of Costs- Upon completion of the gas gathering system and commencement of gas sales from the Project Gas Wells, Ivanhoe shall be entitled to receive from gas sales revenues an amount equal to Sixty-Five Percent (65%) of the net working interest revenue (defined as that revenue remaining after deduction of landowner's and overriding royalties totaling Twenty-Five Percent (25%), operating costs, workover and redrill costs, and provision for severance, production and/or ad valorem taxes) from each of said wells, until Ivanhoe shall have received reimbursement of its full costs incurred in Article 4.1 above, plus One Million Dollars ($1,000,000) as recoupment of Ivanhoe's purchase price for a working interest in the Project Gas Wells as set forth in Article 5.1 below, but in no case shall Ivanhoe's recoupment prior to Payout be greater than One Million Six Hundred Thousand Dollars ($1,600,000). Ivanhoe shall bear Sixty-Five Percent (65%) of operating costs, recompletion,and workover costs prior to Payout. Upon Payout, Ivanhoe shall be assigned a Fifty Percent (50%) working interest in and to each of the Project Gas Wells that are, at that time, still capable of production, together with their Drillsite Spacing Units, limited in depth to the base of the Starkey Sands, as herein defined. Ivanhoe shall additionally be assigned at that time a Fifty Percent (50%) ownership interest in and to the new gas pipeline system and facilities which are connected to the Project Gas Wells. Ivanhoe's interests shall be subject to the terms and conditions of the JOA, attached hereto as Exhibit"C".


ARTICLE V


PURCHASE OF INTEREST IN FOUR SHUT-IN GAS WELLS


5.1 Ivanhoe shall, upon execution hereof, pay to NEG, in addition to other payments required hereunder, the sum of One Million Dollars ($1,000,000) to purchase a Fifty Percent (50%) working interest in and to each of the four Project Gas Wells described in Section 4.1 above, together with their respective Drillsite Spacing Units. Said interest shall bear its proportionate share of landowners and overriding royalties totaling Twenty-Five Percent (25%), including the NEG ORR Said interest shall be subject to the terms and conditions of the JOA, attached hereto as Exhibit "C". Notwithstanding the foregoing, prior to Payout, Ivanhoe shall be entitled to receive Sixty-Five Percent (65%) of


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the net working interest proceeds from oil and gas sales from the Project Gas Wells, as set forth in Section 4.2 above.


ARTICLE VI


MANDATORY TEN TEST WELL DRILLING PROGRAM


6.1 Initial Test Well - On or before May 1, 2004, and subject to rig availability and weather conditions, the securing of all requisite permits and any necessary consents of third Parties, NEG, as Operator, shall commence or cause to be commenced, Actual Drilling Operations (as herein defined), of a well ("Initial Test Well") at a legal location, such location shall be mutually agreed upon by the Parties hereto. The Initial Test Well shall be drilled to the Contract Depth. Such Initial Test Well shall be drilled at the Parties' joint cost, risk, and expense as set forth herein with due diligence and in a good, continuous, and workmanlike manner. At such time as the Initial Test Well shall have reached Contract Depth and all logs, surveys, and other tests have been run and made, the Parties shall complete the well as a producer of hydrocarbons or plug and abandon same as a dry hole. The initial cost sharing of the Parties shall be as follows:


To Casing Point (or through abandonment, including site restoration,) if dry:


Ivanhoe One Hundred Percent (100%)


After Casing Point:


Ivanhoe One Hundred Percent (100%)


Prior to commencement of Actual Drilling Operations on the Initial Test Well, Ivanhoe shall pay to NEG One Hundred Percent (100%) of the estimated costs of drilling the Initial Test Well to Casing Point, as set forth on the Well Program and AFE, attached hereto and made a part hereof, as Exhibit "E".


At Casing Point on the Initial Test Well, NEG shall advise Ivanhoe of its decision to complete the well as a potential producer, either in the Starkey Sands as defined, or in a shallower stratigraphic interval, or abandon same as a dry hole. NEG shall prepare and submit to Ivanhoe for such purpose a completion program and AFE for the proposed


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operations. Ivanhoe shall, within forty-eight (48) hours, advise NEG in writing of its intent to join in or not to join in the completion of said well. If, at Casing Point, Ivanhoe does not elect to join in a completion attempt proposed by NEG, or fails to timely respond to NEG's completion recommendation, then Ivanhoe shall have no interest or rights in the Initial Test Well, and its Drillsite Spacing Unit, and NEG may then elect to complete the well at its sole cost and risk. In the event NEG elects to complete the well, the Drillsite Spacing Unit and all production therefrom shall be owned solely by NEG and Ivanhoe shall have no further interest or rights thereto, and NEG shall be responsible for future plugging and abandonment of such well. If Ivanhoe shall make a positive completion election at Casing Point, it shall promptly pay to NEG One Hundred Percent (100%) of the estimated completion AFE costs. Ivanhoe shall further bear One Hundred Percent (100%) of the cost of tying said well into a gas sales line, including surface facilities.


6.2 Additional Mandatory Test Wells- Immediately after the Initial Test Well is drilled and completed or abandoned as a dry hole, as the case may be, NEG shall commence or cause to be commenced the drilling, in seriatim, of nine (9) additional Mandatory Test Wells, to test the Starkey Sands at locations mutually agreeable to NEG and Ivanhoe, in the Contract Area. Cost sharing for the nine Mandatory Test Wells shall be the same as the Initial Test Well, including gas sales lines and facilities. The nine (9) Mandatory Test Wells shall be drilled in seriatim, using one (1) string of tools, and Ivanhoe shall make a separate completion election at Casing Point for each of said wells. The rights and obligations of each Party with respect to the completion elections and their interests and cost sharing shall be the same for each of the Mandatory Test Wells as for the Initial Test Well. NEG shall invoice Ivanhoe for its full cost share to Casing Point of each of the Mandatory Test Wells at such time as required under the operative drilling contract and, furthermore, as each Mandatory Test Well reaches Casing Point NEG shall invoice Ivanhoe by AFE for its share of completions costs. Ivanhoe shall promptly pay in full each of said invoices to NEG. Upon reaching Casing Point on each Mandatory Test Well, Ivanhoe shall make a completion election and payment as in the Initial Test Well, based on AFE's prepared by NEG and the rights and obligations of each of Ivanhoe and NEG with respect thereto, shall be the same as for the Initial Test Well as set forth above. It is understood by both Parties that promptly after completion of each AFE, NEG will provide Ivanhoe with an accounting of costs incurred for each Mandatory Test Well as required


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by Exhibit "C" of the JOA and that NEG will either invoice Ivanhoe for costs incurred in excess of the approved AFE amount or refund to Ivanhoe those amounts advanced by Ivanhoe and not spent on the AFE.


6.3 Substitute Test Well - If, because of encountering impenetrable substances or because of other conditions making further drilling impracticable NEG discontinues drilling any Mandatory Test Well before the Contract Depth requirement therefor is satisfied, NEG and Ivanhoe shall mutually agree to drill a Substitute Well, at any legal location selected by NEG and Ivanhoe within the Contract Area, provided the actual drilling of said Substitute Well is commenced no later than Thirty (30) Days after the abandonment of the Mandatory Test Well (or such later date, not to exceed Ninety (90) Days, as NEG, acting with reasonable diligence and prudence is able to secure a rig and all necessary permits and consents). In such case, Ivanhoe shall have the right to participate in the drilling of the Substitute Well, and each said additional Substitute Well, paying the same share of costs and bearing the same risk as in the Mandatory Test Well; provided, however, Ivanhoe shall not be obligated to participate in drilling more than one Substitute Well with respect to any Mandatory Test Well. Such Substitute Well shall be drilled in a manner and to the Contract Depth specified for the Mandatory Test Well. If a Substitute Well is commenced and drilled, as herein provided, and Ivanhoe shall have participated in each said Mandatory Test Well and Substitute Well, then Ivanhoe shall have complied with this Agreement with respect to that well, to the same extent as if the Mandatory Test Well had been commenced and drilled in accordance herewith. Each reference herein to a Test Well shall include any Substitute Well therefor. If the first Substitute Well is discontinued because of encountering impenetrable substance or because of other conditions making further drilling impracticable, NEG and Ivanhoe shall mutually agree to drill a second and subsequent Substitute Well and Ivanhoe shall have the right to participate therein under the same terms and conditions as provided herein. Each reference herein to a Mandatory Test Well shall include any Substitute Well therefor.


6.4 Completion of the Mandatory Test Well Program- Upon completion or abandonment of the tenth (10th) Mandatory Test Well, provided Ivanhoe shall have made all positive elections and payments theretofore required hereunder, Ivanhoe shall be deemed to have earned its interests, as further set forth in Article VIII, in and to each


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Mandatory Test Well drilled and completed as a producer of oil and/or gas in paying quantities, together with its Drillsite Spacing Unit; and shall have earned the right to make an election to participate in the Optional Test Well Program Should Ivanhoe fail, for any reason, to complete its obligations with respect to the Mandatory Test Well Program, it shall not earn any interest in any of the Mandatory Test Wells theretofore drilled, their Drillsite Spacing Units, or the Contract Area and the NEG leaseholds, except that Ivanhoe shall retain its interests in the gas pipeline and four Project Gas Wells and their spacing units as described in Articles 4.1 and 5.1 hereof. In such case, Ivanhoe shall have no further rights to drill within the Contract Area, to participate in the Optional Test Well Program, or to participate in a Deeper Exploration Well. Ivanhoe shall, however, retain its full interests and rights with respect to its other interests within th ...