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Joshi Technologies International, Inc. v. Chi Operating, Inc.

United States District Court, D. New Mexico

July 1, 2019

JOSHI TECHNOLOGIES INTERNATIONAL, INC., Plaintiff/Counterdefendant,
v.
CHI ENERGY, INC., Defendan/Counterclaimant.

          MEMORANDUM OPINION AND ORDER

         This matter comes before the Court upon Special Master S. Tim Smith, P.E.'s “Evaluation of Certain Working and Leasehold Interests and Accounting of Certain Revenue Streams” (Report), filed September 28, 2018. (Doc. 105). On January 14, 2019, Joshi Technologies International, Inc. (Joshi) filed objections to the Report, and on January 28, 2019, Chi Energy, Inc. (Chi) filed a response to those objections. (Docs. 118 and 121). Having considered the Report, the objections, and the response to the objections, the Court overrules the objections and adopts the Report. A. Special Master's Report Pursuant to the Order of Reference (Doc. 97), the Special Master prepared a Report in which he opined that:

1. The fair market value of Joshi's pre-September 2012 working interest ownership applied to the leasehold interests and wellbores (excluding the Zircon wells and undeveloped leasehold associated with the Zircon wells) as of September 1, 2012 is estimated to be $39, 826.
2. The fair market value of Joshi's pre-September 2012 working interest ownership applied to the wellbores only (excluding the Zircon wells) as of September 1, 2012 is estimated to be $794.
3. The fair market value of Joshi's pre-September 2012 working interest ownership applied to the relevant Zircon wellbores (only) is estimated to be $38, 945 as of September 1, 2012. The term “relevant Zircon wells” are deemed in this analysis to be those that had at least been spudded by September 1, 2012.
4. The fair market value of Joshi's pre-September 2012 working interest ownership applied to the Zircon “leasehold” … as of September 1, 2012 is estimated to be $6, 683.
5. The value of Joshi's pre-September 2012 working interest ownership applied to the “deep rights” in the wells as of September 1, 2019 is nominal. No. value has been assigned to “deep rights” in my analysis.
6. The cumulative gross revenues and expenses calculable for Joshi's pre-September 2012 working and net revenue interests in the non-Zircon wells during the period from September 1, 2012 through March 1, 2018 are determinable, as needed, if additional data is acquired from Chi.
7. The cumulative gross revenues attributable to Joshi's pre-September 2012 revenue interest ownership applied to the Zircon wells during the period from September 1, 2012 through March 1, 2018 are provided by accounting month in tabular form in Appendix 1. The gross revenues are net of production taxes, excess royalty and marketing costs, but not operating or capital costs.
8. The cumulative gross expenses (operating expenses and capital costs) attributable to Joshi's pre-September 2012 working interest ownership applied to the Zircon wells during the period from September 1, 2012 through March 1, 2018 are provided by-month in tabular form in Appendix 2.

(Doc. 105) at 4 (citations and footnotes omitted).

         1. Pre-September 2012 Fair Market Value (FMV) of Wellbores-Only[1]

         The Special Master observed that the purchase and sale agreements (collectively, the PSA documents), i.e., the September 10, 2012, agreement letter (Doc. 5-1) and the September 17, 2012, Assignment and Bill of Sale (Doc. 5-2), “do not specifically speak to the concept of a wellbore-only assignment.” (Doc. 105) at 2. Consequently, the Special Master concluded that “under a hypothetical scenario that the transaction involved a wellbore-only assignment, there is no contractual guidance on what a wellbore-only assignment means.” Id. The Special Master, therefore, utilized Joshi's definition of “wellbore-only.” Id. at 2. Under that definition, “‘wellbore-only' means current producing zone only….” Id.

         To calculate the pre-September 2012 FMV of wellbores-only, the Special Master first determined what type of reserve to attribute to the wellbores, either a Proved Developed Producing (PDP) reserve or a Proved Undeveloped (PUD) reserve. Id. at 12-13. A proved reserve “mean[s] there is a high confidence in the estimate of the volumes to be recovered….” Id. at 9. A developed producing reserve means the reserve is “expected to be recovered from completion intervals that are open and producing at the time of the estimate.” Id. at 10. An undeveloped reserve has “quantities expected to be recovered through future investments.” Id.

         Second, the Special Master converted cash flows to present values, as of September 1, 2012, by applying a 20% present value discount rate (PV20). Id. at 13. The Special Master explained that the PV20 “is typical of discounts rates used by evaluators to calculate purchase price for assets or well packages similar to the one involved in this matter.” Id.

         Third, the Special Master “used a 90% reserves risk multiplier to adjust the discounted cash flows for uncertainty associated with the forecasts applicable to PDP Reserves.” Id. at 13. The Special Master explained that “[t]he 90% factor is called a Reserves Adjustment Factor (‘RAF'), and the 90% value (equal to a 10% reduction) is within the low end of the typical range used to value PDP reserves.” Id. The Special Master applied a 50% RAF to adjust the FMV of Zircon 1 State Well No. 1H, which had a PUD reserve attributed to it. Id. at 14.

         Finally, the Special Master applied “a 75% factor to adjust the cash flow for the fact that the Joshi interests are small, non-controlling interests.” Id. The Special Master explained that “[s]mall, non-operated interests in a true ...


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