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Behind the scenes: Lexin Resources, the chaos and its clash with regulators

 

Alberta Energy Threatens to Confiscate Individually-Owned Property

AN URGENT OPEN LETTER TO PREMIER RACHEL NOTLEY FROM THE FREEHOLD OWNERS ASSOCIATION (“FHOA”)

Madam Premier, please stop the bureaucrats in Alberta Energy from further exploitation of citizens including vulnerable seniors!  

Our forefathers, this Province’s pioneer settlers, broke the land under harsh circumstances and earned the right to any oil and gas beneath their homesteads.  Now, more than a century later, Alberta Energy bureaucrats are threatening to expropriate without compensation the property rights which we have inherited.  Why?  According to the bureaucrats “We’re just doing our jobs” and enforcing the regulations. 

Your government was elected on a platform of social justice and fairness.  When senior Alberta civil servants recognize that enforcing a regulation is creating an injustice, their job is to take steps to change the regulation, not just express sympathy to the exploited while they blithely sip their lattes and admire their bloated pay checks.

We own approximately 4% of the oil and gas rights in Alberta.  There are an estimated 75,000 of us.  The vast majority of us are ordinary citizens with no training or experience in the complexities of oil and gas exploration and development.  As laymen, we find ourselves at a tremendous disadvantage in our dealings with the technically sophisticated energy companies that lease our property and sometimes drill and produce oil or gas and pay us a small royalty on production. 

Alberta Energy taxes the production from our property. Taxpayers rightfully expect something in return for the taxes they pay.  Since the turn of the millennia, the Alberta Government has collected an estimated $357 million in freehold mineral tax from our properties.  Alberta Energy provides us with no services or assistance whatsoever in return for this tax.  Queries to Alberta Energy or to the Alberta Energy Regulator from individual owners of oil and gas rights are re-directed to FHOA – a volunteer not-for-profit association.  The only thing we receive from Alberta Energy is an annual invoice advising of the amount of freehold mineral tax payable.   That is not fair! 

Before it was elected, the NDP recognized that it was not fair and pledged to support the allocation of a small portion of the freehold mineral tax collected annually by Alberta Energy to FHOA to support the association’s efforts to provide information and education to individual owners of oil and gas rights.  Sadly, this pre-election pledge has not been honoured.

Ongoing low oil and gas prices have impacted all Albertans.  Production royalties on the oil and gas rights owned collectively by the people of Alberta and by those owned by individuals have been drastically reduced.  Although the oil and gas industry is suffering, most oil and gas companies have continued to honour the lease agreements under which they produce.  However, some foreign-controlled companies that have leased our individually-owned oil and gas rights have stopped paying royalties completely even though they continue to produce from our properties.  They have also apparently stopped paying their share of freehold mineral tax on production from our oil and gas rights to Alberta Energy.

Good governments protect the property rights of their citizens.  Having paid Alberta Energy millions in taxes on production from our property, we would expect the Government to help us to rectify the situation.  Not so!

Some individual owners of Alberta freehold oil and gas rights are senior citizens who rely on modest royalties from their oil and gas rights to supplement their Canada Pension Plan and Old Age Security benefits. 

How would you feel Madam Premier if you were one of those vulnerable seniors and the oil and gas company that held your lease had decided to stop paying you royalties, but continued to produce your oil or gas?  And what if you then received a letter from Alberta Energy stating that the company had not paid the freehold mineral tax which was due on April 25, 2016 and that you are required to pay both your share, and the company’s share of this tax together with interest calculated from the due date, or your mineral rights would be forfeited to the Government.  Madam Premier that is exactly what is happening!  Do you think that it is fair or that it in any way could be construed as social justice? 

The final default notices can be served at the pleasure of the Government which speaks to the urgency requiring you to address the potential of this grievous act immediately. 

And this is just the most recent blatant example of Alberta Energy’s exploitive relationship with the individual owners of oil and gas rights in this Province.

FHOA urged its membership to support the NDP in the last election because of your social justice platform.  We commend your Government for the positive steps taken in many areas to date.  Can we count on you to address these matters and create an environment in which citizens can rely on your Government to protect their property rights, not exploit them?

                                                                                On behalf of Alberta oil and gas rights owners,                                                                                                                                                                                        Else Pedersen, President, Freehold Owners Association

                                                                               

 

Freehold Owners Association
208, 1235 17th Ave SW, Calgary, Alberta T2T0C2
Telephone: 403-245-4438 Email: This email address is being protected from spambots. You need JavaScript enabled to view it.


Alberta Royalty Review

FHOA’s Alberta Members,

Dave Mowat, the Chief Executive Officer of ATB Financial, has taken on the role of chairing Alberta's royalty review.  He recently announced the panel members and published the Review Framework that he will be working on. You can find all that information at letstalkroyalties.ca.  

We, the citizens of Alberta, collectively own the oil and gas beneath our province and the amount of money which the Alberta Government collects in royalties on production from Crown oil and gas rights clearly impacts every one of us.  Setting Alberta Crown royalties too high discourages oil and gas investment and causes industry operators to seek opportunities in other lower royalty jurisdictions; setting Crown royalties too low deprives us of our fair share of our non-renewable resources, leads to more multi-million dollar salaries for industry executives and exacerbates the widening wealth gap in Alberta society.    

As owners of freehold mineral rights in Alberta we are impacted by Crown royalties to an even greater extent than other Albertans.  

For many years Crown royalty rates were higher than the fixed 12 ½% royalties in the freehold leases our forefathers had signed.  To level the Crown/freehold playing field and to discourage industry operators from drilling on freehold in preference to Crown mineral rights, the Government of Alberta introduced a tax on production from freehold mineral rights.  Freehold mineral tax is still with us and on a high productivity well this tax can equate to a 6.9% incremental royalty payable by the producer and the freehold owner to the Government.   What is no longer with us is the level Crown/freehold playing field.  

The Alberta Government’s current royalty regime provides for Crown royalty holidays.  The royalty for all new wells in Alberta on Crown lands is 5% and, in many instances, that 5% royalty applies for the first three years of production.  The majority of the oil and gas recoverable from a well is typically produced in the first three years of production.  

Most of us now have freehold leases with fixed royalty rates of between 15% and 19% or expect to negotiate royalty rates in that range in any new leases of our mineral rights.  The combination of these fixed freehold royalty rates and freehold mineral tax results in the financial burden for the operator of a successful new well on freehold being anywhere from three to five times greater than the same well on Crown lands.  Is it any wonder that industry activity on freehold lands in Alberta has virtually disappeared and many of us can look across our fence lines and see wells on Crown lands draining our resources?

In FHOA’s view, Mr. Mowat and his panel are highly competent, knowledgeable and fair minded individuals.  The panel’s objective is to present the Government with recommendations for a royalty regime which provides optimal returns to all Albertans and encourages industry investment in responsible development.  The panel recognizes the difficulties that current oil and gas prices create for individual Albertans, the Alberta Government and the energy industry and the need for public support of whatever recommendations are presented and adopted by the Government.  

Over the next two months the panel will be asking a series of questions and providing updates to Albertans on what they are hearing. They are eager to have as many Albertans as possible be a part of the whole process.

This is your opportunity to have your voice heard.  

There are changes which could be made to provide a fairer Crown/freehold playing field. 

If you don’t think you know enough to provide a suggestion or an opinion, ask a question of the panel.  You can share your personal thoughts at letstalkroyalties.ca. The panel wants to hear from you now and throughout the course of the review.  

FHOA reiterates Mr. Mowat’s suggestion to let your friends and family know that this Royalty Review Panel is open for their input, too.  You can also follow the panel on Twitter and join the review’s Facebook page, if that interests you.

Else Pedersen,
President
(signed)

Gas Proration Proposals

Due to ongoing low gas prices, gas proration proposals may become more widespread, raising some serious concerns about the risks for freehold mineral owners surrounded by Crown rights. Else Pedersen, FHOA President, has circulated a letter (click here to download) to all FHOA members regarding the matter, and FHOA intends to express it's concern to Alberta Energy and the AER.

Estate Planning for Freehold Mineral Owners

The mineral rights in western Canada which are now owned by individual freehold owners were originally acquired more than a century ago by the western Canada’s pioneer settlers (see “About Freehold Mineral Rights” – “About 'Owning' Petroleum & Natural Gas”). Most of these mineral rights have now been passed down through three or more generations. Parents tend to treat their children equally in their wills and, in result, in many instances the number of individuals on title is growing exponentially. Freehold mineral title fractionation is a growing crisis. A multitude of owners on title impacts the economics of development for an energy company and title fractionation may ultimately destroy the value of freehold mineral rights.

Many freehold owners do not realize that the mineral rights they own are not capital property. Freehold mineral rights are Canadian Resource Property and passing mineral rights from one generation to the next gives rise to a deemed disposition with the older generation effectively being taxed on the difference between what was paid for the mineral rights and their fair market value on the date of the disposition (ie. the entire amount comes into income; not 50% of this amount as in the case of a capital gain).

There are ways to reduce title fractionation and in so doing minimize what can be the very significant income tax consequences of passing mineral rights from one generation to the next. FHOA urges all freehold owners to review the section of this web site dealing with estate planning for freehold owners (see “Estate Planning for Freeholders”)

Levelling the Crown – Freehold Playing Field

Due to recent reductions in Crown royalties and other provincial government incentives encouraging industry to drill on Crown lands, most energy companies in western Canada are focussing their efforts on Crown mineral rights and largely ignoring freehold. This is particularly the case in Alberta (see "Newsletters" - September 30, 2010).

In late 2007, the Alberta Government followed the recommendations of the ‘Our Fair Share’ report and increased the royalty rates charged on production from Crown lands. Western Canadian natural gas prices peaked at more than $10 per Mcf (thousand cubic feet) in early 2008 and then declined precipitously. Lower gas prices and higher Alberta Crown royalties resulted in drastically lower cash flows for energy companies operating in Alberta. In response, many energy companies moved, or threatened to move, their operations to other jurisdictions such as Saskatchewan which had better prospects for oil and a royalty regime much more favourable to producers. Energy industry activity in Alberta fell dramatically. In the spring of 2010 the Alberta Government responded by reducing Crown royalty rates across the board and introducing incentives for new horizontal gas wells, horizontal oil wells and coal bed methane (CBM) wells on Crown lands. These incentives effectively reduced the Crown royalty rate to 5% for periods of from one to three years. Saskatchewan then countered with a reduction in Crown royalties on certain wells to 2.5%.

What is essentially a competition between western Canadian provincial governments to attract limited industry drilling dollars is having a profound impact on freehold owners whose properties are natural gas prone. Southern Alberta, where most freehold mineral rights in Alberta are located, is primarily gas prone. Would an Alberta CBM developer prefer to drill wells on freehold land under a fixed 17% royalty lease or on Crown where production is subject to a 5% royalty for the first three years and a relatively low sliding scale Crown royalty tied to price and production volumes thereafter? The answer is self-evident. Similar Crown/freehold royalty disparities exist for horizontal oil wells in both Alberta and Saskatchewan. In the case of oil however, with oil prices in excess of $100 per barrel, development of oil prone freehold properties is attractive to the industry irrespective of the Crown/freehold royalty discrepancy.

By the second quarter of 2012, spot natural gas prices in Alberta had fallen below $1.60 per Mcf. With these prices, freeholders who own mineral rights in areas disposed to natural gas production who are not being drained may consider leaving their gas in the ground rather than trying to deal with land agents intent on negotiating freehold lease agreements with royalties comparable to those in current Crown leases. However, freeholders whose mineral rights are being drained may wish to consider sliding scale royalties and royalty incentives to encourage development of their mineral rights while there is still something left to develop. The 2012 version of the FHOA Lease is structured with a sliding scale royalty tied to price and production volumes. The FHOA Lease also provides a checkbox for purposes of granting a period of reduced royalties should the freeholder consider this necessary to cause development and thereby mitigate drainage (see “Freehold Friendly (FHOA) Lease”).

Target Areas in Alberta

One of the fundamental obligations of oil and gas regulatory authorities is to protect correlative rights - to provide each owner with the opportunity to recover the owner’s share of a common subsurface resource. Regulatory authorities typically use a combination of spacing units and target areas to fulfil this obligation. Well spacing is essentially a reservoir engineering tool that uses rock, fluid and producing properties to determine the area that a well can economically drain. Historically in western Canada, the normal spacing unit has been a full section (640 acres or 256 hectares) for gas wells. In Alberta the normal spacing unit has been a quarter section (160 acres or 64 hectares) for oil wells. In Saskatchewan and Manitoba the normal oil spacing has historically been one legal subdivision or lsd (40 acres or 16 hectares). These different normal spacing unit sizes reflect the fact that, all other things being equal, gas moves much more easily than does oil through any particular subsurface reservoir. Whereas spacing units define the number of wells that may be drilled within a particular pool, target areas define where within the spacing unit a well may be drilled without regulatory restrictions on the rate of production from the well.

Most producing wells have a circular drainage area that expands as production occurs over time. A target area in the center of a spacing unit with regulatory penalties which restrict production volumes based on how far a particular producing well is located outside the Central Targettarget area therefore protects correlative rights and provides each owner of petroleum or natural within a common source of supply with an opportunity to recover the owner’s share of the resource.

The graphic to the right shows the Alberta regulators central target areas for gas wells as these central target areas expanded during the period subsequent to 1941 and prior to 2006. These expanding target areas did not impact correlative rights. For instance, if a gas well draining a one section area was drilled and brought on production from an on-target location between legal subdivision 2 and 3 in the north section as per the illustration to the left below, the well would drain across the fence line to the south. However the owner of the section to the south could drill a well on his side of the fence the same distance back from the fence line as per the illustration to the right below. The owners of both sections therefore had an equal opportunity to recover their share of the resource.

Central Target  Central Target

Corner target areas for oil were first introduced by the Alberta regulator in 1974. FHOA was not around to object at that time nor was FHOA around to object when, in 1994, the regulator waived off target penalties for the first well in a pool. FHOA did object in 2005 when, in conjunction with an increase in base line well density for most areas of Alberta in which freehold mineral rights exist, corner target areas for natural gas wells were first proposed by the ERCB (see "Correspondence" - October 3, 2005 Letter of Objection). The proposals provided for up to four gas wells per pool per section to be completed in zones above the Mannville formation and for up to two wells per pool per section for wells completed in the Mannville formation. The target area was defined as the entire section except for a 300 meter buffer zone along the south and east fence lines of a section. 

The impact of this proposal on the correlative rights of freeholders was particularly critical in the case of coal bed methane and shallow gas wells which are generally assumed to drain natural gas from a quarter section area. The 4-section illustration below and to the left, show a quarter section drainage area for a well drilled on target in the extreme northeast corner of the section to the southwest. The well clearly drains equally from all four adjacent quarter sections. 

Quarter Section  Quarter Section

The problem for freeholders is shown in the illustration above and to the right. The quarter section drainage area of a well drilled by the owner(s) of the northeast section on target and as close as possible to the first well is shown in purple. Clearly, the 300 meter buffer zone prevents these owners from draining the southwest section to the same extent as the first well on the southwest section is draining the northeast section. These owners have been deprived of the opportunity to recover their share of the CBM resource by virtue of the very regulations which should provide them with this opportunity. 

Neither the corporations that own substantial tracts of freehold mineral rights in Alberta nor the Alberta Government is impacted by this issue because for every situation where a well is draining these entities’ mineral rights, there is a corresponding situation where a well on these entities’ mineral rights is draining other owners. However most individual freeholders own a single tract of mineral rights and regulations which allow wells to be drilled on their fence lines, for whatever reason, gives rise to inequities and calls into question the fairness of the oil and gas regulatory system in Alberta.

In early 2006, the ERCB implemented the proposed corner target areas and increased well densities for gas wells pursuant to Bulletin 2006-24. At the same time, corner target areas for oil and a two-well per quarter section well density for oil wells producing from the Mannville Formation were also implemented. (ERCB Bulletins may be accessed by going to the ERCB website and searching by Bulletin number under ‘Regulations and Directives’ and then ‘Bulletins) 

Subsequent to the release of Bulletin 2006-24, FHOA has met and corresponded with members of the Energy Resources Conservation Board (the “ERCB”) and senior ERCB staff on a number of occasions regarding this issue. 

In November of 2010, the ERCB released Bulletin 2010-39 in which it sought stakeholder input to a proposal to return to central target areas for both gas and oil wells throughout the Province. The proposed standard central target area for gas wells would be anywhere within the section 150 meters back from the fence lines. For oil wells the standard target area would be anywhere within the quarter section 100 meters back from the quarter section borders. FHOA has submitted a letter commending the ERCB for addressing this issue and supporting the proposal (see "Correspondence" - FHOA Submission Bulletin 2010-39). FHOA was pleased with this development however a number of industry operators and associations have opposed the proposal. 

On October 6, 2011, the ERCB released Bulletin 2011-29. Pursuant to this Bulletin the ERCB implemented central target areas for natural gas throughout the Province, except for the area of southern Alberta where most freehold mineral rights are found. In this area corner target areas were retained with 150 meter buffer zones along the south and west section lines. Within this area the ERCB also completely removed well density controls for wells producing CBM and for all wells producing conventional natural gas from formations above the Mannville Group of formations. So instead of allowing four wells to be drilled on a freeholders’ fence lines, the ERCB now allows an infinite number of wells to be drilled for gas from any zone down to the top of the Mannville formation on freeholders’ fence lines. 

According to the ERCB, the proposal contained in Bulletin 2010-39 was not implemented in Bulletin 2011-39 because the energy industry pointed out that to do so would be contrary to the ERCB’s mandate to conserve the Province’s resources. The industry had drilled up much of the CBM fairway between Edmonton and Calgary in a pattern corresponding to the ERCB’s corner target area policy and to subsequently change to central target areas would result in inefficient drainage of the remaining undrilled spacing units prospective for CBM. In other words, rather than correct policies implemented in Bulletin 2006-24 (and in holding approvals issued prior thereto) which contravened its mandate to protect the correlative rights of freehold owners, the ERCB chose to make matters worse.

Freehold Petroleum & Natural Gas Owners Association

"Freehold Owners Association"

208, 1235 17th Ave SW, Calgary, AB T2T 0C2 Telephone: 403-245-4438