Canada: Alberta Court Of Appeal Delivers Landmark Oil And Gas Ruling

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Oil and Gas, September 2011

In a recent decision that will affect thousands of Alberta oil and gas leases, the Alberta Court of Appeal confirmed that the commercial realities of the parties must be considered when interpreting an oil and gas lease. In Omers Energy Inc. v. Alberta (Energy Resources Conservation Board) (Omers Energy), the court interpreted the phrase "capable of producing the leased substances" in a Suspended Wells Clause and found that it requires:

"the demonstrated, present ability of a well on the lands to produce the leased substances in a meaningful quantity within the timeframes contemplated in the lease."

This is the first decision in Canada to interpret the Suspended Wells Clause in a CAPL oil and gas lease. The insertion of the terms "present ability" and "meaningful quantity" may imply a standard higher than otherwise expected.

Background

In a unanimous and carefully reasoned decision, the court dismissed an appeal by Omers Energy Inc. (Omers) from a decision of the Alberta Energy Resources Conservation Board (ERCB) which suspended its oil and gas licences for two gas wells. The suspensions were handed down due to the expiry of the underlying lease.

The lease in question was a CAPL 91 form lease with a primary term of five years. Omers, as lessee, drilled a well prior to the expiry of the primary term. However, the well experienced water difficulties and was shut-in. A period of inactivity then passed which exceeded the maximum 90 days allowed for an absence of production and operations under the Habendum Clause. Subsequent operations on the well were only able to produce a miniscule amount of gas for a few hours. The mineral owner deemed the lease to be expired and entered into a new lease with Montane Resources Ltd. (New Lessee).

Omers, however, sought to extend the term of the lease by relying on the Suspended Wells Clause. That clause would continue the lease, even absent production or operations, as long as there was any shut-in well on the lands "capable of producing the leased substances". Omers obtained two new licences, drilled the initial well to a new formation and spudded a second well on the lands. The New Lessee viewed this as an infringement of its own drilling rights and applied to the ERCB to have the licences suspended.

The central issue on appeal turned on the proper interpretation of the phrase "capable of producing leased substances."

Court of Appeal's Decision

On appeal, Omers argued that the Suspended Wells Clause should be satisfied by "any amount of gas emitted once the valve is opened". Omers also contended that "it was not necessary for the well to be ready and able to produce gas on a sustained basis provided the well could be put into condition to produce this amount". The New Lessee asserted that the phrase should be interpreted to mean "that when a well is turned on it will produce a meaningful quantity of gas, on a sustained basis, in its existing state and configuration."

In its decision, the court adopted an approach to the interpretation of oil and gas leases that gives effect to the plain and ordinary meaning of the contract while also having regard to the commercial realities of the parties. In particular, the court agreed with the ERCB's analysis that to be "capable of producing the leased substances" two factors must be satisfied – the well must be:

  • capable of producing; and
  • capable of "producing the resource in a meaningful quantity".

Capable of Producing

In order to satisfy the first requirement, the well must have the ability to produce gas in the required quantity in its existing configuration and state of completion "when the tap is turned on". The necessary operation to correct water loading therefore prevented the well in question from being "capable".

The court compared this construction to its interpretation of "producible" in Bearspaw Petroleum Ltd. v. Encana Corp. (Bearspaw). In that case, the lease would continue as long as "leased substances ... are producible from the leased area". The court noted that "producible" is commonly used to refer to "producible reserves", and found that "producible" did not require the leased substances to be capable of immediate production. The court further distinguished Bearspaw by noting that in Bearspaw, unlike the case at hand, it was acknowledged that the well was "ready and able to produce gas at the tap".

Meaningful Quantities

In respect of the second requirement, the court recognized the economic objective of the parties to an oil and gas lease to profit from development of the resource – an objective which would be defeated if the lease could continue indefinitely through a well incapable of producing a meaningful quantity of oil or gas. The court thus interpreted the word "meaningful" in the sense that the quantity is sufficient to provide a reasonable expectation of profits. Conrad, J. noted that it was easy in this case to see the substances were not produced in a meaningful quantity given the mere "puff" of gas that would result if the tap were opened. However, she predicted future litigation would deal more precisely with what would constitute a meaningful quantity and suggested that a future tribunal might ask:

"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?"

Conclusion

In closing, the court upheld the ERCB's conclusion that the Omers well had not produced a meaningful quantity of gas since the well was shut-in and the well did not have the present ability to produce without additional operations. As such, the lease had expired according to its terms, Omers could not maintain its well licences, and the appeal was dismissed. Therefore, the test for whether a well is "capable of producing the leased substances" is whether the well is capable of immediate production of meaningful quantities of the leased substances. However, the court left the precise definition of "meaningful quantities" open for future debate.

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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