Canada: Drilling An Offset Well – Is It A Title Preserving Well ?

Copyright 2008, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on on Energy -Oil & Gas - March 2008

The recent Alberta Court of Appeal case, Amethyst Petroleums Ltd. v. Primrose Drilling Ventures Ltd., involved a dispute over the right to oil and gas on lands jointly leased by the respondents, Amethyst Petroleums Ltd. and Hill Oil (1993) Limited, and the appellant Primrose Drilling Ventures Ltd. The lands were owned by Bearspaw Petroleum Ltd. (Bearspaw), and Primrose was the operator. Amethyst, Hill Oil and Primrose had previously drilled the 14-8 well on the lands. The right to oil and gas in this instance depended on whether a particular well was considered a "title preserving well" under the governing operating procedure, the 1990 CAPL Operating Procedure (the Operating Procedure). If the 2-8 well was a title preserving well, Primrose would be entitled to the respondents' working interest in the 2-8 well. If it wasn't, then Amethyst and Hill Oil would retain their interest upon payment of certain costs and penalties.

Pursuant to clause 1007 of the Operating Procedure, a party who has elected not to participate in the drilling of a well may retain its interest in the well by paying certain costs and penalties unless the well is a so-called "title preserving well".

Clause 1010 applies to title preserving wells and includes the following provisions:"(a)...(iv) "title preserving well" means a well which is drilled, completed or re-completed hereunder, whether the failure to conduct such operation would result in the forfeiture of all or a portion of the joint lands contained in a title document ...(b) Notwithstanding Clauses 903, 1007 and 1008, a non-participating party with respect to a title preserving well shall forfeit: (i) upon completion of such operation, one hundred percent (100%) of its working interest in such well ... to the participating parties in the title preserving well ..."

Pursuant to the offset well clause contained in the subject lease, the lessees had six months to commence or cause to be commenced the drilling of an offset well following the date upon which commercial production is obtained from a well located on laterally adjoining lands. Pursuant to the default clause contained in the lease, upon receipt by the lessees of written notice from the lessor of a default, the lessees would have 30 days to remedy such default or the lease would terminate.

On September 18, 1997, Bearspaw issued a default notice to Amethyst, copied to Primrose, as the 14-5 well on neighbouring lands was draining the detrital formation. The notice demanded that the lessees drill an offset well in accordance with the offset well provision contained in the subject lease. The default notice was later withdrawn by Bearspaw for various reasons, including Primrose's argument that the default notice was invalid. Following the issuance of this default notice, Primrose conducted geological investigations in respect of the lands and found that considerable potential existed.

Several months following the issuance of the default notice, Bearspaw issued a subsequent default notice to both Amethyst and Primrose, which included a proposal whereby, in the event that Amethyst elected not to offset the 14-5 well, Amethyst would retain the 14-8 wellbore and the rights to the current producing interval, but would return the remainder of section 8 to Bearspaw. The offer was open for acceptance for 30 days, after which time the lease would become null and void and Bearspaw would seek to terminate the lease as a whole and take over the 14-8 well.

Two days following the receipt of this notice, Primrose issued an independent operations notice to the respondents stating that, as the offset notice required a well to be drilled, this was a title preserving well, and that failure to participate in the operation would result in forfeiture of each non-participating party's interests pursuant to Article 1010 of the Operating Procedure.

Primrose subsequently proceeded to drill the offset well at 2-8 and asserted that Amethyst and Hill Oil had forfeited their interests in the well as they did not participate and as it was a title preserving well.

The trial court found that the well was not a "title preserving well" as the default notice did not specify that failure to drill the offset well would result in the "forfeiture of all or a portion of the joint lands contained in the title document" as required by Clause 1010. The lessees could have surrendered certain formations as opposed to surrendering the entire lease. Secondly, the trial court held that, where a well is drilled for economic reasons rather than to preserve an interest in land, such well is not a "title preserving well". The trial court found that Amethyst and Hill Oil did not forfeit their interests in the well.

The Court of Appeal noted that the standard required to overturn the trial court is a palpable and overriding error. Contrary to finding an error, the Court of Appeal agreed with the trial judge that the only reason Primrose had changed its attitude towards the default notices was because the Primrose geologist expected promising production from both the detrital and glauconite formations. The Court of Appeal noted that in order to be a true offset well, production in the offset well must be restricted to the formation that is being produced by the well which invoked the offset obligation – in this case, the detrital zone.

Finally, the Court of Appeal reiterated the trial court's findings that the lessees had another option available other than termination of the lease. The appeal was dismissed and the respondents were entitled to retain their interest in the oil and gas in the 2-8 well.

In order for the drilling of an offset well to be considered a title preserving operation, the failure to drill such well must result in no other outcome other than forfeiture of land contained in the title document.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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