Omers Energy Inc. sought leave to appeal AER (formerly known as the “ERCB”) Decision 2009-037 to the Alberta Court of Appeal and, in December of 2009, was granted leave to appeal on the single issue of whether the AER (formerly known as the “ERCB”) erred in its interpretation of the phrase “capable of producing the leased substances”. In December of 2010, following numerous delays resulting from Omers’ objections, FHOA’s member was granted the right to intervene in the appeal. FHOA supported the association’s member’s appeal.
The written arguments presented to the Court of Appeal by Omers and Montane were similar to those which these firms presented at the AER (formerly known as the “ERCB”) hearing. The FHOA member’s factum focussed on the mutual benefit aspect of freehold leases, the importance of clarifying the extent of production necessary to satisfy the AER's (formerly known as the “ERCB”) ‘meaningful’ volume test, and the settled American case law which equates ‘capable of production’ with ‘capable of production in paying quantities’. The FHOA member was the only participant in the hearing to raise American jurisprudence or the fundamental principles underlying a freehold lease.
The Appeal Court hearing was held on May 11, 2011. The hearing room was filled to overflowing with FHOA members.
On September 7, 2011, the Appeal Court released what has been described by energy company lawyers as a ‘landmark’1 ruling which “may impact thousands of oil and gas leases in Alberta and has significant implications for industry”2.
In dismissing Omers’ appeal the Court stated: “The lease is a contract through which the lessor and the lessee agreed to develop the leased substances for mutual benefit”3 and forcefully denounced the concept of freehold leases being continued for speculative purposes:
“an interpretation suggesting a lessor would agree to tie up its land to a lessee beyond the primary term for speculative purposes only is unreasonable.” 4
“It strains common sense to think a lessor would agree to tie up its land past the primary term, and perhaps indefinitely, for a lessee's speculative purposes only and for a well that lacks commercial viability” 5
“It was never intended that the shut-in well clause could allow a lessee to hold a property for purely speculative purposes."6
The Court agreed with the AER's (formerly known as the “ERCB”) “conclusion that “capable” means that a well could produce in its existing state and configuration, without requiring further operations to produce”7.
After reviewing the American case law submitted by FHOA’s member supporting the position that “produce” and “produce in paying quantities” means substantially the same thing, the Court agreed with the AER (formerly known as the “ERCB”) “that the words “in paying quantities” should not be implied” in the lease8. The Court ruled that the AER (formerly known as the “ERCB”) was correct in finding that to continue a CAPL 91 lease under the suspended wells clause the well had to be “capable of producing the resource in a meaningful quantity”9
However, the Court saw no “significant difference between "meaningful" quantity and "paying" quantity ...”10 and stated:
“The tests set out in Clifton relating to marginal wells may prove helpful guides in developing Canadian jurisprudence on this issue. As noted in paragraphs 63-64, some questions a tribunal might ask are: Would a reasonably prudent operator, for the purpose of making a profit and not merely for speculation, continue to operate a well in the manner that it does? Or put simply, "Is there is a reasonable expectation of profitable returns from the well?”” (emphasis added).
What this mean for freehold owners can perhaps best be summed up by quoting from an article in the November, 2011, Negotiator (the magazine of the Canadian Association of Petroleum Landmen):
“At the end of the day, the OMERS decision means that the lease validity bar has been raised significantly for all CAPL leases. Any CAPL lease that has gaps in production of greater than 90 consecutive days is at risk. The safe haven of the shut-in clause is no more.
Once you [the lessee] need to rely on the shut-in clause, you must be able to prove to the AER (formerly known as the “ERCB”) (or a Court) that the well was capable of "meaningful" production during all such gaps in production and that your actions were of a nature that respected the intention of the contract to be of mutual benefit to both parties with meaningful steps taken during the period of nonproduction to provide the lessor with the ability to make a profit. If not, your lease is toast.11”
Most Calgary legal firms that have energy companies as clients have now provided these companies with advice regarding the Omers decision. Typically, energy companies are being advised to review all of their freehold leases (both CAPL and other leases) to identify those which contain the ‘capable of producing leased substances’ wording and to then review the production history of wells deemed to be holding the leases beyond the leases’ primary term. In situations where the well holding the lease has been shut-in for more than 90 days at any time after the expiry of the primary term, energy companies are being advised to assess whether the well would meet the Omers test and, if it would not, to either drop the lease or renegotiate it.
FHOA advises freehold owners whose leases are being continued with shut-in or suspended wells to review their lease agreements. If your lease contains the ‘capable of producing leased substances’ wording found in CAPL 88, CAPL 91 and some earlier leases or, in the case of CAPL 99, the ‘capable of production of the Leased Substances” wording, you may wish to review the production history of the shut-in or suspended well (FHOA can provide this information – see ‘Technical Service Reports’).
Clearly, wells which have been shut-in or suspended without a production test would not meet the ‘capable’ test set forth in Omers and wells which either have a production test demonstrating very low productivity or have been shut-in or suspended after the expiry of the primary term due to marginal productivity issues which have not been addressed within 90 days would not meet the ‘meaningful’ quantities test set forth in Omers.
In situations where either the ‘capable’ or ‘meaningful’ tests in Omers have not been met, FHOA recommends writing to the energy company-lessee asking the lessee to either remove their caveat from your title or provide you with information which would indicate that the well in question is ‘capable of producing the leased substances’. Where the energy company-lessee does not respond or the response is not satisfactory you may wish to write to the AER's (formerly known as the “ERCB”) Compliance Department seeking a review of the well license under Section 39 or 40 of the Energy Resources Conservation Act.
1. Alberta Court of Appeal Delivers Landmark Oil and Gas Ruling, Blakes, Cassels and Graydon LLP, Sept. 21, 2011
2. Canada: Omers Energy Inc. v. Alberta – (Alberta Energy Regulator (formerly known as the “Energy Resources Conservation Board”)), Borden Ladner Gervais LLP, Oct.18, 2011
3. Omers Energy Inc. v. Alberta (Alberta Energy Regulator (formerly known as the “Energy Resources Conservation Board”))  Alta C.A., A.J. No. 954, Par 3 http://www2.albertacourts.ab.ca/jdb/2003-/ca/civil/2011/2011abca0251.pdf,
4. Ibid, Par 92
5. Ibid, Par 95
7. Ibid, Par 81
8. Ibid, Par 76
9. Ibid, Par 80
10. Ibid, Par 95
11. Game Changer, The Negotiator, November, 2011, p. 3, http://www.landman.ca/publications/Negotiator/2011/nov/nov11_layout.pdf