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In early 2009, a three-day hearing was held before the Energy Resources Conservation Board (the “AER (formerly known as the “ERCB”)”) at the request of Montane Resources Ltd. to determine whether a CAPL 91 lease held by Omers Energy Inc. was a valid and subsisting lease for the purpose of the AER's (formerly known as the “ERCB”) issuance of well licenses. The central question before the AER (formerly known as the “ERCB”) was whether a well drilled and shut in by Omers on mineral rights owned by one of FHOA’s members was “capable of producing the leased substances” such that the token suspended well payments which had been made by Omers could continue the lease. The Freehold Owners Association sought intervener status and the AER (formerly known as the “ERCB”) granted FHOA the right to fully participate in the hearing on behalf of its member and in its own right.

During the hearing, Omers took the position that the phrase ‘capable of producing the leased substances’ should be literally interpreted to mean that any amount of production, no matter how small, so long as it was measurable, was sufficient to continue its CAPL 91 lease. Montane submitted that the phrase meant that the well must be capable of producing a meaningful quantity of gas on a sustained basis when it was turned on in its existing state and configuration. FHOA submitted that Omers’ interpretation would allow CAPL 91 leases to be continued indefinitely for speculative purposes without profitable production and that this was contrary to the fundamental purpose of a freehold lease - to develop the mineral rights for the mutual benefit of the parties to the lease agreement. FHOA also submitted that lease continuation for speculative purposes did not support the economic, orderly and efficient development of the resource as was required under Section 4(c) of the Oil and Gas Conservation Act and was not in keeping with commercial considerations. FHOA urged the AER (formerly known as the “ERCB”) to adopt the meaning of the word ‘producing’ followed in American jurisdictions – ‘produced in paying quantities’ - and cited the ‘paying quantities’ test set forth by the Texas Supreme Court in Clifton v. Koontz: whether in all the relevant circumstances, a reasonably prudent operator, for the purposes of making a profit and not merely for speculation, would continue to operate the well1.

In its May, 2009 decision (See AER (formerly known as the “ERCB”) Decision 2009-037), the AER (formerly known as the “ERCB”) stated that “the lease established a contractual arrangement to facilitate production of the resource from the lands, with a resulting benefit for both the lessor and lessee.” With respect to the phrase ‘capable of producing the leased substances’, the AER (formerly known as the “ERCB”) made two critical rulings.

Firstly, the AER (formerly known as the “ERCB”) ruled:

The Board has concluded that the phrase “producing the leased substances” would not be satisfied by a minuscule or insignificant amount of production. It is the Board’s view that there must at least be some material, as in a meaningful, volume of production possible for the lessee to rely on the suspended well clause to extend the lease. An interpretation that would permit a very low or even nonexistent threshold would provide little or no incentive for a lessee to undertake operations to enhance the recovery of leased substances. It would also result in only a nominal return to the lessor for an indeterminate length of time without any obligation on the lessee to rectify the situation. Such an interpretation is, in the Board’s view, contrary to the intention of the parties as expressed throughout the lease as a whole.

Secondly, the AER (formerly known as the “ERCB”) ruled that the word ‘capable’ meant that:

the well must have that ability in its existing configuration and state of completion. ... if any work were required for the well to attain or maintain the ability to produce the lease substances, in particular work falling within the definition of “operations” under the lease, the well would not be capable of producing the leased substances within the meaning of the suspended wells clause.

The AER (formerly known as the “ERCB”) concluded that Omers did not hold a valid and subsisting lease for the purposes of a well license.

Following the release of AER (formerly known as the “ERCB”) Decision 2009-037, a number of lawyers who acted for energy companies openly criticized the decision in print and in talks given to industry associations and legal groups. These lawyers were concerned with the AER's (formerly known as the “ERCB”) finding that it was “evident from the lease that the parties’ intentions were to strike an agreement that would provide a benefit for both sides.” As one commentator put it: “The Board thinks it is unfair for a lease to continue absent meaningful production as "lt would also result in only a nominal return to the lessor for an indeterminate length of time”. The lease never promises a specific return for the lessor. Never ever. It kind of says the opposite.” The commentator was particularly concerned that the AER (formerly known as the “ERCB”), and not the courts, would become the preferred route for challenging “thousands (if not tens of thousands) of leases2.

Was the AER (formerly known as the “ERCB”) listening to the criticism?

Section 28 of the Energy Resources Conservation Act provides that the AER (formerly known as the “ERCB”) may award costs to a person, group or association who, in the opinion of the AER (formerly known as the “ERCB”), has an interest in land that may be directly and adversely affected by a decision of the AER (formerly known as the “ERCB”) (a ‘local intervener’). FHOA applied to the AER (formerly known as the “ERCB”) for local intervener costs on the basis that the FHOA member who the Association had represented was a landowner whose rights could have been directly and adversely impacted had the AER (formerly known as the “ERCB”) ruled that the Omers lease was valid for well license purposes. Omers opposed FHOA’s application. The ERCB denied the cost application on the basis that it was only the FHOA member’s contractual rights which were impacted by the AER (formerly known as the “ERCB”) decision. The Montane toplease provided for a higher royalty than the pre-existing Omers lease and it is settled law that a royalty interest is an interest in land. In FHOA’s view the FHOA member’s interest in land had clearly been in issue before the AER (formerly known as the “ERCB”) and FHOA considered the AER (formerly known as the “ERCB”) ruling to be an error of law. FHOA applied to the Court of Appeal for leave to appeal the AER (formerly known as the “ERCB”) cost ruling. The Court of Appeal denied leave to appeal on the basis that the AER's (formerly known as the “ERCB”) “determination on whether a person or group is a “local intervener” is discretionary3.

Following the release of the AER's (formerly known as the “ERCB”) ‘capable of producing’ ruling, Omers sought leave to appeal the ruling to the Alberta Court of Appeal.


End Notes:

1. Clifton v. Koontz [1959] Tex. Sup. Ct., 325 SW 2d 684
2. ‘Was it Meaningful for You’, The Negotiator, December 2009, p. 13, http://www.landman.ca/publications/Negotiator/2009/dec/dec09_layout.pdf
3. Freehold Petroleum and Natural Gas Owners Association v. Alberta Energy Regulator (formerly known as the “Energy Resources Conservation Board”) [2010] Alta. C.A., A.J. 205, Par. 10

Freehold Petroleum & Natural Gas Owners Association

"Freehold Owners Association"

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