Whereas pooling agreements combine ownership interests within a single spacing unit on the basis of acreage contributed to the spacing unit, unitization agreements combine interests in one or more pools (the “unitized zone”) within an area comprising multiple spacing units (the “unit area”) based on an agreed formula. In the vast majority of units, the formula is based on the involved energy companies’ (the ‘unit working interest owners’) estimate of the recoverable reserves of unitized substances at the time of unitization. Future unit production is allocated to each parcel of land or tract within the unit area based on a ‘tract factor’ equal to the estimated reserves beneath the particular tract divided by the total estimated reserves within the unit area as determined by the working interest owners at the time of unitization.
In Alberta, the Alberta Energy Regulator (formerly known as the “Energy Resources Conservation Board”) (the “AER (formerly known as the “ERCB”)”) approved all unit agreements in the Province prior to the early 1960’s. In 1962, a model form of unit agreement was approved at the annual conference of the Provincial Mines Ministers. The ‘Mines Ministers’ Model’ form of unit agreement has been revised several times since 1962. In addition, in 1992 the board of directors of the Petroleum Joint Venture Association (the “PJVA”) and Alberta Energy approved a PJVA Model unit agreement. Currently Alberta Energy requires unit agreements to be in the PJVA 2003 form. In Saskatchewan, the Crown requires the use of a modified 1972 Mines Ministers’ Model form.
Whereas oil and gas legislation in the prairie provinces provides for forced or compulsory pooling, only in Manitoba and Saskatchewan does the legislation provide for forced unitization. Forced unitization provisions were included in the Alberta Oil and Gas Conservation Act in 1957 but these provisions were never enacted.
Pooling provides benefits to both the freehold owner-lessor and the energy company-lessee in more or less equal measures. The benefits of unitization are much more skewed toward the energy company-lessee.
The vast majority of the approximately 750 units in Alberta were negotiated prior to the introduction of the 1992 or 2003 PJVA Model forms of unit agreements. These early forms of unit agreement typically contain a clause whereby the interests of each owner-lessor (‘royalty owner’) and each working interest owner in the unitized substances within the unit area are unitized as if the unitized zone was included in a single lease executed by all of the royalty owners in favour of all of the working interest owners. The form of unit agreement used in creating the approximately 241 active units in Saskatchewan contains a similar clause. As a result, production from any well in these unit is deemed to be production from each freehold owner-lessor’s mineral rights. This means that all of the working interest owners’ leases need not be drilled in order to continue them.
These pre-PJVA unit agreements also contain a clause whereby each of the freehold owner-lessors ratifies his or her lease. Although it is arguable whether such a clause is effective in situations where the freehold owner-lessor is unaware that his or her lease is not binding, the clause presents an additional impediment to any freehold owner who has the temerity to legally challenge his or her lease’s validity.
Any uncertainty as to whether an energy company-lessee can deduct the operating and capital costs associated with the facilities used in producing, gathering and marketing leased substances under a freehold lease are eliminated because most pre-PJVA unit agreements contain a clause providing for the unit working interest owners to deduct these costs, including a reasonable rate of return on invested capital.
The PJVA model forms of unit agreement accomplish the intent of the earlier forms with more convoluted and binding legalese. For instance, under earlier forms of unit agreement many forms of freehold lease which were continued by unit production arguably expired on their own terms if all unit production ceased for a 90 day period. The PJVA model form of unit agreement continues all unitized leases until the unit agreement is terminated and the life of the unit agreement may be continued until 90 days after all unit wells have been abandoned. As there are no regulatory provisions in Alberta pursuant to which an operator can be forced to abandon a shut-in well, a PJVA model form of unit agreement may be continued indefinitely.
After unitization, competition between the various energy company-lessees holding leases of the unitized zone within the unit area is eliminated. A unit operator is appointed and the unit operator develops the unitized zone within the unit area on behalf of the unit working interest owners in a more cost effective manner. Within a unit area there are no off-target regulatory restrictions and consequently the unit operator can minimize the number of wells necessary to drain the unitized zone by drilling and producing wells in the most technically advantageous locations.
Similarly, by eliminating competition between the working interest owners within the unit area the unit operator can achieve significant cost savings for the unit working interest owners in the design and construction of gathering and processing facilities.
The benefits of unitization for a freehold owner-lessor are essentially limited to risk reduction – the risk that a well on the freehold mineral owner’s mineral rights will develop production problems and have to be abandoned eliminating his or her royalty stream is significantly greater that the risk that all of the unitized wells will develop problems and be abandoned.
Unfortunately this benefit to the freehold owner-lessor is often negated by the manner in which the tract participations in a unit agreement are negotiated. Donald Trump and his ‘apprentices’ could learn from this negotiation process.
Technical experts seldom agree on the recoverable reserves within even the simplest subsurface oil or gas pool. In unit negotiations, technical disagreements are exacerbated by the fact that it is the task of each of the experts to maximize his or her company’s participation in the unit. Frequently, reserve ‘trade-offs’ occur. One technical expert may solicit support from other experts for an optimistic interpretation of the recoverable reserves beneath his company’s tracts in return for his support of their optimistic interpretation of the reserves beneath their companies’ tracts. Alternatively, the experts may decide it is in their mutual best interest to interpret another company’s reserves pessimistically. If what is ‘traded around’ by the unit working interest owners during unit negotiations are the reserves beneath Crown lands, the process may ‘even out’ and have no negative implications for the Crown or freehold owners. If however, reserves beneath a freeholder’s lands are traded off, the consequences to the freehold owner may be extreme.
According to Alberta Energy, the department’s role in unitization is not the approval or rejection of a unit agreement but the negotiation of the Crown’s royalty share. However, “The Department also has an obligation to all companies and individuals whose rights will be affected by the unit, to ensure that the unit will not have a detrimental effect on those rights.”1
FHOA is aware of a number of situations in which a unit has had an extremely detrimental effect on the rights of individual freehold owners. Alberta Energy has been made aware of some of these situations but has taken no action to fulfill its purported obligation.
The ‘Pooling and Unitization’ clause in all CAPL freehold leases provides the energy company-lessee with the unfettered right to unitize without the consent of the freehold owner-lessor. In most pre-CAPL freehold leases no such right existed. Unitization under most pre-CAPL leases represented one of the few occasions when a freehold owner-lessor had any real bargaining power with an energy company-lessee.
A knowledgeable technical professional could potentially help a freeholder avoid entering into a unit agreement in which the tract participation assigned to the freeholder’s mineral rights was unfair. Such an expert might also be able to negotiate such things as a deep rights reversion clause in an existing lease as part of unitization.
According to the late John B. Ballem, Q.C., an energy company-lessee that includes its freehold owner-lessor’s mineral rights in a unit agreement without the freehold owner’s informed consent pursuant to a CAPL lease owes a fiduciary duty to the freeholder in respect of the allocation of tract participations2. In FHOA’s view, proving to the satisfaction of a court that an energy company-lessee breached its fiduciary duty in respect of the tract participation allocated to a freehold owner-lessor would be virtually impossible. In consequence, FHOA recommends that freeholders amend the unitization provisions in CAPL leases (see “CAPL 99" Suggested Modifications, "CAPL 91" Suggested Modifications).
If you have a pre-CAPL lease agreement and you are approached to approve a unitization agreement, FHOA recommends that you seek the advice of competent technical and legal professionals.
1. The Crown as a Royalty Owner, Miles, J., Manager Crown Equity, in Pooling and Unitization in the Petroleum Industry, Insight Press, Toronto, 1995
2. The Oil and Gas Lease in Canada, Ballem J.B., 3d  University of Toronto Press, p. 227