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Most existing freehold lease agreements contain a shut-in or suspended well clause which purports to allow the energy company-lessee to continue the lease beyond the primary term of the lease by making payments of $1 per acre per year in situations where a well has been drilled and shut-in. At the time the suspended well clause was introduced: oil was the focus of industry exploration and development; markets for natural gas were very limited; and a $1 per acre per year payment was meaningful to both the freeholder who received the money and the oil company-lessee who made the payment. If an energy company-lessee had drilled a well during the primary term of the lease and had found gas, but was unable to produce the gas due to a lack of market, it seemed fair and reasonable for an annual payment of this magnitude to secure the energy company-lessee’s interest in the gas it had discovered until a market developed (see “Understanding Freehold Leases" - "The Shut-in Well Clause").

Today, gas marketing facilities exist in virtually every area of Alberta in which freehold mineral rights are found. Only in areas of Saskatchewan and Manitoba where very little gas has been discovered is there an absence of gas marketing facilities. Despite this, many gas wells on freehold lands remain shut-in. Some of these gas wells have been shut-in for decades. In the last 50 years, inflation has ravaged the value of the dollar. A payment of $1 per acre per year is no longer material to the freehold owner-lessors who receive these payments. From an energy company-lessee’s standpoint, the cost to acquire mineral rights for exploration and development has escalated dramatically while the $1 per acre per year cost to hold freehold mineral rights under the shut-in clause has remained unchanged. In most cases, the reason gas wells on freehold land remain shut-in has nothing whatsoever to do with lack of marketing infrastructure and everything to do with energy company-lessees holding freehold mineral rights for speculative purposes with token payments.

In most pre-CAPL leases, it is the third proviso of the lease agreement in combination with the shut-in wells clause which is relied upon by the energy company-lessee to continue the lease with a shut-in well. Canadian courts initially dealt fairly harshly with energy company-lessees attempts to continue their freehold leases under these provisions , . Many different wordings of the third proviso and of the shut-in wells or suspended wells clause may now be found in existing pre-CAPL leases as a result of energy company lawyers’ attempts to more fully protect their clients.

Since 1988, the vast majority of freehold lease agreements entered into in Canada have been either CAPL 1988 or CAPL 1991 leases. These lease forms (and the CAPL 99 lease form) were structured to remove the uncertainty associated with lease continuation with shut-in wells. All that is required to continue a CAPL 88 or 91 lease with a token $1 per acre per year payment is that there be a well on the freeholder’s lands, or lands pooled or unitized therewith, which is shut-in and which is “capable of producing the leased substances”.

Although the courts in the United States have generally found that the term ‘production’ means ‘production in paying quantities’ , the late John B. Ballem, Q.C., author of The Oil and Gas Lease in Canada, was of the opinion that no Canadian court would uphold that position . Presumably in reliance on Mr. Ballem’s opinion, many Canadian energy company-lessees have historically taken the position that the wording in CAPL 88, 91 and 99 leases provides them with the authority to continue a freehold lease with a well capable of producing the leased substance in any quantity, no matter how insignificant. In 2011, Mr. Ballem was proven wrong when the Court of Appeal of Alberta upheld an AER (formerly known as the “ERCB”) ruling which found that to continue a CAPL 91 lease under the Suspended Wells clause the well must be capable of ‘meaningful’ production in its existing configuration and current state of completion (see “The Capable of Producing Issue’”).

Ironically, in 2008 the same court, in a split decision, had overturned a trial court ruling and found that what the finder of fact had ruled was essentially a dry hole was sufficient to continue a pre-CAPL lease under the third proviso of the habendum and the shut-in wells clause. 

The CAPL 99 lease form was approved for use by the Canadian Association of Petroleum Landmen in the fall of 2000. Rather than the $1 per acre per annum suspended well payment in CAPL 88 and 91, the CAPL 99 lease provides an annual suspended well payment in an amount equal to the initial per acre bonus consideration divided by the number of years in the primary term of the lease. Perhaps not surprisingly, most energy company-lessees refuse to use CAPL 99.

If your pre-CAPL lease is being continued by a shut-in well, FHOA recommends that you carefully review the provisos in the habendum and the shut-in or suspended well clause in your lease agreement. If the conditions specified for a shut-in well continuing the lease are limited to “a lack of or intermittent market or any cause whatsoever beyond the lessee’s reasonable control”, it may be in your best interest to write to your oil company-lessee asking the company to surrender the lease and remove its caveat from your title. If your oil company-lessee refuses to do so, it may be in your best interest to seek professional advice or contact the Freehold Owners Association.

If your lease is being continued by a shut-in well and you have a CAPL 88, CAPL 91 or CAPL 99 lease agreement, it may be in your best interest to write to your oil company-lessee asking the company to provide information on the production capability of the shut-in well in its current configuration and its plans for bringing the well on production. If you receive an unsatisfactory response, you may wish to seek professional advice or contact FHOA.

 

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End Notes:

1. Shell Oil Co. V. Gunderson S.C.C. [1960] 23 D.L.R. 92d) 81
2. Blair Estate Ltd. v. Altana Exploration Co. Alta. C.A. [1987] 53 Alta L.R. (2d) 419
3. Cases and Materials on Oil and Gas Law, Kuntz, E.O., Lowe J.S., Smith E.E., West Publishing Co., St. Paul, Minn., 2d, 1993, p. 204
4. The Oil and Gas Lease in Canada, Ballem J.B., [1999] 3 d., University of Toronto Press, p. 132
5. Kensington Energy Ltd. v. B & G Energy Ltd. Alta C.A. [2008] A.J No. 440

Freehold Petroleum & Natural Gas Owners Association

"Freehold Owners Association"

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