By Michael Piazza, Bracewell & Giuliani Historians will note that, beginning circa 2007, the discovery of emerging resource plays in the continental US was accompanied by advances in oil and gas drilling, improvements in technical analysis, and soaring private equity investment. It will be more difficult for historians to determine whether, and to the extent, invention, necessity, and/or liquidity proved the mother of discovery – and which type of discovery? Land grabs have been a prelude to each play’s success or failure during this period, with landmen and brokers racing one another to buy or lease up acreage against a backdrop of surging and sinking commodity prices, escalating and then stabilizing lifting costs, a proliferation of cash and carry joint ventures and an explosion of foreign investment in domestic oil and gas. Not business as usual. 2013, however, has seen a slowing in land grabs and private equity investment at the same time that many oil and gas companies have amassed substantial acreage positions and private equity funds have raised funds dedicated, in whole or substantial part, to upstream oil and gas development. The acreage must be drilled or lost, and the money must be spent or idle. With respect to still-speculative, early-stage plays, one solution to the stasis is what I call a “harbinger joint venture,” a scalable joint venture that is designed to “prove up” the play rather than delivering an acreage premium to the producer. Whether the private equity fund’s participation is structured as an equity or asset-level investment, each party’s exposure during the exploration phase of a harbinger joint venture is limited such that each party assumes the risk that the play itself will not be de-risked. The fund’s capital commitment is limited to the drilling capital projected to prove up the play, and while the producer does not recoup much (or, in some cases, any) of its acreage acquisition costs, the producer’s capital commitment is limited during the fund’s commitment period (e.g. the fund typically “carries” the producer for all, or a substantial portion, of the producer’s share of drilling costs during the exploration phase). Following the exploration phase, the joint venture is structured so that, in the event of the play’s success, the fund earns into an accretive investment and the producer is positioned to capture greater upside (whether in the form of back-in, buyout, or other rights). One key to such a harbinger joint venture is a properly structured drilling commitment that, once satisfied, provides production results that are a harbinger of success or failure for all or the relevant portion of the play. Under a customary drilling commitment, the producer must drill a certain number of wells in a play within a certain period of time (often 12 or 18 months), irrespective of commodity prices and with limited (and often highly negotiated) extensions for events of force majeure. To properly incentivize the producer, the consequences of a failure to timely satisfy a drilling commitment are typically draconian and could include one or a combination of the following: (i) payment of liquidated damages for each well shy of the drilling commitment that the producer falls as of a particular measurement date, (ii) a right of the private equity fund to demand specific performance of the drilling commitment, (iii) a forfeiture by the producer of carry, back-in, buyout, and/or operatorship rights, (iv) a put right for the fund that is supported by a parent guarantee, or (v) a call right for the fund on the balance of the producer’s acreage (or equity interests) at a steep discount. For the drilling commitment to serve its primary purpose – to prove up the play – the private equity fund and the producer must perform exhaustive technical due diligence prior to closing. The more the drilling commitment is tied to the drilling of specific wells – in some cases, both vertical and horizontal – that meet specific criteria (e.g. involving minimum lateral lengths, obtaining logging and core data from shallower potential pay zones and wells that target a variety of potentially productive formations) across a diverse spread of the acreage position, the more likely the satisfaction of the drilling commitment is to realize value to both the private equity fund and the producer. At the same time, the less flexible the drilling commitment, the more challenging it is for the parties to agree to modifications on the fly, especially if reasonable minds could differ as to preliminary drilling results. That said, the exercise of jointly sculpting a fine-tuned drilling commitment can flush out future disagreements and enable the parties to both anticipate potential modifications that may arise and develop corresponding adjustment mechanisms. A report released by PriceWaterhouseCoopers LLP on Oct. 31, 2013, indicates that private equity investment in the US oil and gas industry increased in the 3Q as compared to 2Q even as, on an industry-wide basis, the number and value of transactions decreased. This report suggests that although many emerging resource plays have not panned out as planned, lessons have been learned and, under appropriately calibrated structures, substantial private equity financing is available to bail out producers with bloated acreage inventories, triggering a new, and perhaps more modest, wave of discovery. This post originally appeared on Bracewell & Giuliani’s Energy Legal Blog.