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In 1926, the board of directors of the Canadian Pacific Railway Company (the “CPR”) was concerned with whether the form of petroleum lease it was prescribing on split title lands exposed the railway company to any potential legal liability (see “1920's - The Turner Valley Controversy"). The CPR’s general counsel apparently recognized no problem in the CPR demanding a royalty on something it didn’t own (see “Curle Legal Opinion”). The unknown author of the December 7, 1926 Memorandum of Law in the CPR files at the Glenbow Museum was more cautious. The author was particularly concerned because the form of petroleum lease prescribed by the CPR seemed to contemplate appropriation or theft of the natural gas owner’s gas by the CPR’s petroleum lessee (see “1920's - The Turner Valley Controversy”).

Although the highest court of appeal in the Commonwealth ruled in the 1953 Borys v. CPR and Imperial Oil Limited decision that the CPR’s reservation of petroleum did not include natural gas which was a separate substance (see “1950 – 1953: Borys v. CPR and Imperial Oil”), the CPR continued to prescribe petroleum lease agreements in which the petroleum lessee was required to pay the railway company a royalty on all natural gas produced and marketed from wells on split title lands. These petroleum leases addressed the issue of the railway company’s potential liability in demanding a royalty on something it didn’t own – the petroleum lessee was required to indemnify the CPR for any costs the railway company incurred in defending any legal action that might be brought by the freehold owner of natural gas, and for any and all damages that a court might award against the CPR (see “Post-Borys CPR Petroleum Lease”).

In some instances, EnCana Corporation (the successor to PanCanadian Petroleum Limited as successor to the CPR’s petroleum and natural gas rights), continues to enforce the terms of these petroleum leases today. In other instances, petroleum lease amending agreements were entered between the CPR and its petroleum lessee during the 1960’s. Under the terms of these amending agreements, the CPR waived its contractual right to a royalty on dry gas, but continued to require the petroleum lessee to pay it royalties on all other hydrocarbons produced and marketed from split title lands, including all condensate and natural gas liquids (see “CPR Petroleum Lease Addendum”). EnCana continues to enforce these amended petroleum leases.

In Borys, the Privy Council ruled that the CPR and Imperial Oil Limited had the right to work their petroleum irrespective of damage to, or waste of, Mr. Borys’ gas, provided their operations were conducted in compliance with the regulations of the Alberta Energy Regulator (formerly known as the “Energy Resources Conservation Board”) or its predecessors (the “Board”). But the Privy Council did not rule that the petroleum lessee or the CPR had the right to appropriate or steal Mr. Borys’ natural gas. The Privy Council also did not rule that the CPR and its successors own all of the hydrocarbons produced from a well on split title lands, or that they own all hydrocarbons except dry gas. EnCana acknowledged this in 1998 (see “1990's - The Ownership Trial”).

Why would any company have entered into a petroleum lease agreement with the CPR which not only obligated the company to pay royalties to the CPR and its successors on hydrocarbons not owned by the railway company, but also required the company to pay any legal costs incurred by, or damages awarded against, the CPR or its successors if the true owner of the hydrocarbons objected? Perhaps the answer lies in the different circumstances that existed when these leases were executed. During the 1950’s and 1960’s, petroleum was the focus of oil and gas industry activity. Much of the gas produced in conjunction with oil was flared. Even if gas could be sold, the price received was in the range of 5 -10 cents per thousand cubic feet (Mcf). Perhaps some companies were so anxious to acquire interests in the railway company’s petroleum that they were prepared to accept whatever petroleum lease terms the CPR demanded.

Whatever the reason, the impact of the CPR’s post-Borys form of petroleum lease has been both subtle and profound.

According to the Privy Council, in Borys the Appellate Division of the Alberta Supreme Court decided that ownership of hydrocarbons produced from wells on split title land was to be determined based on “the condition of the substance as it emerges from time to time from the reservoir”1. The Privy Council ruled that the Appellate Division decision was “right in all respects”2.

If the condition of the substance as it emerges from time to time from the reservoir determines ownership, then any hydrocarbons that emerge from the reservoir and are recovered in liquid phase at the bottom of a well bore on split title lands are petroleum and are owned by the CPR and its successors. As petroleum moves to surface in the production process, the pressure confining it drops and gas dissolved in the petroleum emerges from solution in the well bore and is produced at surface in gaseous phase. This gas is known as ‘solution gas’ and, pursuant to the Privy Council decision in Borys belongs to the petroleum owner in split title situations.

But gas that breaks out of liquid solution in petroleum as a result of pressure decline in a producing well bore is not the only type of gas produced from oil wells. If an oil pool is at saturation pressure prior to human disturbance, then free gas will exist in the oil pool in the form of a gas cap. Similarly, if an oil pool has no initial gas cap but the pressure in the pool falls below saturation pressure as the result of production-induced reservoir pressure decline, then gas in solution in the petroleum will evolve from petroleum and form free gas within the pool. In a legal article dealing with the split title problem published in 1991in the Alberta Law Review4, the term ‘evolved gas’ was coined for gas that evolves from petroleum in a pool to distinguish this gas from the solution gas that breaks out of solution in a well bore. Terms such as ‘evolved gas’ or ‘solution gas’ may be used in other contexts. These terms were not used by the Borys courts. Instead, the only types of gas referred to by the Borys courts were ‘gas in solution’ in petroleum and ‘free gas’ – terminology that cannot be misinterpreted by a reasonable person.

If the condition of the substance as it emerges from time to time from the reservoir determines ownership, then any hydrocarbons that emerge from the reservoir and are recovered in gaseous phase at the bottom of a well bore on split title lands are owned by the individual freehold owner of natural gas (ie the owner of all mines and minerals except coal and petroleum or coal, petroleum and valuable stone).

The hydrocarbons that emerge from a reservoir in gaseous phase and are recovered at the bottom of a well bore are also subject to phase changes as they move up the well bore to surface. As a result of the drop in temperature between the bottom of the well bore and the surface, hydrocarbon liquids may condense from the recovered gas in the well bore and may be produced at surface in liquid phase. If measurable quantities of liquid hydrocarbons are produced, the liquid is known as ‘condensate’ and the recovered gas is referred to as ‘wet gas’. Likewise, when gas produced at surface is processed in a gas plant, the temperature is further reduced and liquid hydrocarbons known as ‘natural gas liquids’ are recovered. The natural gas which remains after recovery of natural gas liquids at a gas plant is known as ‘residue gas’.

If the condition of the substance as it emerges from time to time from the reservoir determines ownership, then on split title lands the natural gas owner owns all of the condensate produced from wells and all natural gas liquids recovered at gas plants except those natural gas liquids recovered from solution gas.

Prior to drilling a well, it cannot be known with certainty whether the well will encounter oil, gas, both or neither. As a consequence, before drilling on split title lands, most oil companies lease the rights to both petroleum and natural gas. Natural gas lease agreements typically require the oil company-lessee to pay the freehold owner-lessor a royalty on all leased substances produced and marketed. Leased substances are typically defined to be those hydrocarbons owned by the individual freeholder.

An oil company that has leased natural gas from an individual freehold owner and petroleum from the CPR under the form of petroleum lease set forth above is faced with a dilemma if it produces and markets hydrocarbons from the split title lands.

If the condition of the substance as it emerges from time to time from the reservoir determines ownership, then the oil company is obligated to pay royalties to both the individual freehold owner of natural gas and to the CPR or its successors on all free gas that emerges from the reservoir and is recovered in gaseous phase at the bottom of a well bore together with any condensate or natural gas liquids contained therein (or on all free gas except dry gas if the petroleum lease has been amended).

Most wells are not economic to operate if double royalties are paid.

On the one hand is a powerful corporation fully capable of enforcing its contractual rights. These rights include the right to terminate the petroleum lease under the default clause and acquire the energy company-lessee’s well and surface facilities, if the energy company does not fulfill its royalty payment obligations (see “Post-Borys CPR Petroleum Lease”).

On the other hand is an individual freehold owner of natural gas. The freeholder has a right to a royalty on all hydrocarbons owned by him that are produced and marketed by the oil company, but has no right to terminate the natural gas lease if proper royalties are not paid nor take over the energy-company-lessee’s well and surface facilities (see “Understanding Freehold Leases – Default Clause”).

The oil company has a clear conflict of interest in determining ownership - the more hydrocarbons the freeholder is deemed to own, the more double royalties the oil company must pay.

For instance, if Borys is authority for ownership of hydrocarbons produced from wells on split title lands to be determined based on the phase condition of the hydrocarbons in the reservoir prior to human disturbance, then evolved gas belongs to the CPR and its successors and the company would only be obligated to pay double royalties on any gas cap gas produced and marketed (and the condensate and natural gas liquids contained therein). But, as explained to the Borys courts by the CPR and Imperial’s “array of the world's greatest living scientists”, once production starts from an oil pool with a gas cap, there is an interchange of hydrocarbons between the oil leg and the gas cap and “difficulties of separating ownership” based on the phase condition of the hydrocarbons in the reservoir prior to human disturbance become “physically and practically insurmountable” (see “1950 – 1953: Borys v. CPR and Imperial Oil”). This uncertainty provides an opportunity for the oil company to pay royalties on all gas produced and marketed from an oil well on split title lands to the CPR and its successors and avoid paying royalties to the freehold owner of natural gas under the assumption that all of the gas produced is solution gas or evolved gas. This ‘opportunity’ is ‘enhanced’ by the fact that the typical freeholder has no technical or legal experience in oil and gas matters, relies on his oil company-lessee to properly determine ownership, and cannot afford to enforce his legal rights even if he understood them.

Oil and gas conservation regulations are designed to minimize the production of gas cap gas so as to conserve reservoir energy and improve the ultimate recovery of petroleum. The Board may impose penalties or shut-in an oil well that produces excessive gas cap gas. The Board’s regulations provide further incentive for an oil company to claim that all of the gas produced from an oil well is either solution gas or evolved gas in order to avoid penalties.

To their credit, some oil companies do make double royalty payments. However in the vast majority of split title situations, a single set of royalty payments have been made to the CPR and its successors on all gas produced from oil wells on split title lands.

On a more subtle level, to paraphrase that most infamous of German Chancellors: ‘A big lie told long enough and often enough becomes the truth’5.

Most technical professionals have no interest in the law and have never read the Borys decision. Because several generations of oil and gas industry professionals have come and gone since the Privy Council decision in Borys was handed down, some of today’s technical professionals actually believe that the CPR and its successors own all of the gas produced from an oil well on split title lands.

Is it reasonable to interpret the Borys decision as authority for ownership determination based on the phase condition of the hydrocarbons in the reservoir prior to human disturbance?

All courts strive for certainty in their decisions. Why would the highest court of appeal in the Commonwealth, presented with un-contested evidence that ownership determination on split title lands based on the phase condition of the hydrocarbons in a pool prior to human disturbance would create insurmountable difficulties, ignore the evidence before it? Why would the Privy Council have set forth as a principle of law that ownership of fugacious substances such as gas, petroleum and water is based on recovery of these substances, if the Court meant ownership of hydrocarbons produced from split title lands to be determined based on the phase condition of the hydrocarbons prior to human disturbance? Why would the Court have summarized the Appeal Court ownership decision it upheld as being based on: “the condition of the substance as it emerges from time to time from the reservoir”, if it really meant the condition of the substance prior to human disturbance (see "1950 – 1953: Borys v. CPR and Imperial Oil”)?

In the opinion of the Freehold Owners Association, it is not reasonable to interpret the Borys decision as authority for ownership determination based on the phase condition of the hydrocarbons in the reservoir prior to human disturbance, and this interpretation is merely a convenience for the CPR, its successors, and those companies that have historically paid royalties to the CPR and its successors rather than the rightful owners of the resource

In 1998, an Alberta Court of Queen’s Bench judge disagreed with FHOA (see “1990's - The Ownership Trial”).

 

End Notes:

1. Borys v. CPR and Imperial Oil Limited, J.C.P.C. [1953] 2 D.L.R. 72
2. Ibid, p. 79
3. Pasieka, J.M. and Cameron N.G., Ownership of Evolved Gas in Split Title Situations [1991] 29 Alta L. Rev. 19
4. Hitler, A., Mein Kampf [1930] Vol 1, Chapter 2

Freehold Petroleum & Natural Gas Owners Association

"Freehold Owners Association"

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