Canada: Alberta Crude Oil Curtailment: A Q&A. What Operators Need To Know About The Amendments To The Curtailment Rules

On December 3, 2018, the Lieutenant Governor in Council of Alberta, approved Order in Council O.C. 375/2018, enacting the Curtailment Rules commencing January 1, 2019. According to the Government, producers within Alberta currently produce 190,000 more barrels of raw crude oil and crude bitumen per day than the province can export. With nowhere to go, these barrels enter storage at a faster rate than they leave, resulting in an oversupply of crude oil that has, in large part, been responsible for the significant price differential between Western Canadian Select and West Texas Intermediate oil contracts. While many producers in the oil and gas industry support the Curtailment Rules, this support has not been universal. A number of industry participants immediately raised concerns with the Curtailment Rules and as a result, additional amendments to the Curtailment Rules were made before January 2019, the first month in which operators were subject to curtailment.

On December 12, 2018, the Government amended the Curtailment Rules to create an 84% "curtailment floor" that ensures no operator will be required to curtail more than 16% of the combined amount of crude oil and crude bitumen it produced in October 2018. On December 31, 2018, the Government further amended the Curtailment Rules, changing the manner in which the Minister will calculate each operator's baseline production beginning in February 2019. Instead of calculating an operator's baseline production with reference to the "average number of barrels of crude oil and crude bitumen produced per calendar month by the operator for the 6 calendar months during which the operator's production was greatest in the one-year period commencing November 1, 2017", the Minister will now only refer to the greatest number of barrels of crude oil and crude bitumen the operator produced in any calendar month in the same one year period. Due to this simplified baseline production calculation mechanism, the December 31 amendments also repealed the adjustment formulas for operators that started production after May 1, 2018. However, the Curtailment Rules now provide that the baseline production for operators that exceed the 10,000 bbl/day production threshold after October 2018 will be the number of barrels of crude oil and crude bitumen such operators produced during the month in which it first exceeded the threshold.

Finally, the December 31 amendments allow the Minister to amend the combined maximum amount of crude oil and crude bitumen an oil sands operator can produce if the operator: i) operates no more than one oil sands project; and ii) can demonstrate that it cannot both operate the oil sands project safely and comply with a curtailment order. This discretionary amendment of a curtailment order is only available until the end of March 2019.

Curtailment Rules Q&A

While the Curtailment Rules themselves do not initially appear complex, they are complex in their application. Here we address a number of questions and concerns that have been asked by producers in connection with their review and consideration of the Curtailment Rules.

1. Will a freehold lease terminate if an operator shuts-in production to comply with a curtailment order?

Whether a freehold lease can survive shut-in due to curtailment depends on a number of factors arising from the contractual language contained in the lease. Operators will need to closely consider the scope of the habendum clause to determine the circumstances in which the lease will continue or terminate.

Some freehold leases may entitle the lessee, in its discretion, to shut-in production and maintain the underlying lease by paying the lessor a shut-in royalty. Other forms of lease, such as the 1999 CAPL, go one step further and deem the existence of ongoing operations to preserve the lease. Unfortunately, not all freehold leases are as friendly to lessees. Some may only permit wells to be shut-in to manage an intermittent, uneconomical, or unprofitable market. While the curtailment orders rely on the rulemaking provisions in the Oil and Gas Conservation Act and Oil Sands Conservation Act that address waste and improvident disposition it is unclear whether the current state of the market can justify continued reliance on such a shut-in clause. Indeed, the price differential between WTI and WCS prices has narrowed significantly since the Government announced the curtailment regime. Other leases may only permit wells to be shut-in for reasons beyond a lessee's reasonable control. Given that operators can choose how they want to apportion the required curtailment of production across their productive asset base, it is unlikely that a decision to curtail production from one or more wells under a particular lease qualifies as an event beyond their control.

In responding to a curtailment order, an operator may be able to declare force majeure and suspend production from one or more wells without being in default of the lease or causing the lease to automatically terminate. While government action (and any necessary operational response) is widely understood to be a force majeure event, its availability will depend entirely on the construction of the clause. In The Oil and Gas Lease in Canada, John Ballem provides the following example of a force majeure clause that would apply to save a lease in the face of a curtailment order:

...The Lessee need not perform any requirement hereunder, the performance of which would violate any reasonable conservation and / or curtailment program or plan of orderly development to which the Lessee may voluntarily or by order of any governmental agency subscribe or observe.

Barring a force majeure clause as explicit as this, the discretion that an operator has in the implementation of a mandatory curtailment order may again bring an operator's decision to shut-in production from particular wells outside of the scope of contractual protection. Finally, the curtailment regime presents a range of options to impacted operators. While curtailment orders are mandatory, they do not necessarily oblige operators to shut-in production from a particular well. Where a termination event flows from an option rather than an obligation, Canadian courts have adopted a narrow approach to the identification of a force majeure event.

The question of whether a freehold lease will terminate if an operator shuts-in production to comply with a curtailment order depends on the nature of the habendum, the discretion afforded under the shut-in clause, and scope of the force majeure clause. Answers to this question will therefore vary with each lease.

2. Are there obligations under Joint Operating Agreements relating to the curtailment of jointly operated wells and oil sands mines?

While curtailment orders are issued at the operator level, compliance with an order may have the effect of reducing the production volumes of non-operator Working Interest Participants (WIPs). For example, if an operator has a 60% working interest in production from a well or oil sands mine, reducing the operator's production levels also reduces the production volumes that correspond to the 40% working interests of the WIPs. This may result in disputes among the owners of jointly operated oil wells and oil sands mines.

In most cases, operators of jointly owned assets do not owe fiduciary obligations to their WIPs, but the precise scope of their obligations can vary with the circumstances and is not readily discernable. While the industry standard CAPL joint operating procedures (CAPL JOAs) do not impose a duty on operators to produce, the extent to which operators owe their WIPs any other duties (specifically a duty of care) is a question of fact that must be addressed on a case-by-case basis. A question that WIPs may ask is whether it is good oilfield practice to curtail production in a way that negatively impacts their interests, particularly if the operator's decision was motivated by its own financial interests. While operators must ensure they remain compliant with all applicable laws, the interaction between the mandatory nature of a curtailment order, the Government's apparent preference to target marginal production, and the granting of operator discretion under the Curtailment Rules further complicates an analysis of an operator's obligations to WIPs.

Although s. 6 of the Curtailment Rules only refers to operators "compris[ing] two or more persons carrying on business as a joint venture or partnership", neither joint ventures nor partnerships can hold licenses or approvals and, therefore, cannot be "operators" as that term is defined in the Curtailment Rules. A purposive interpretation suggests that this section can be read more broadly to denote projects that involve multiple persons. Accordingly, the purpose of this section may have been to allow operators and WIPs of jointly owned assets to, in their discretion, enter agreements "respecting the allocation of the combined production of crude oil and crude bitumen among themselves". Such an agreement would unseat the presumption that all WIP is curtailed on a pro rata basis and ensure that such production is not impacted by an operator reducing a well's production volumes. Unfortunately, the actual wording of the section is ambiguous and its precise legal effect is not clear.

In any event, and notwithstanding the effect of s. 6, the curtailment regime will likely lead to disputes among operators and WIPs over the operator's right to curtail production in its discretion. Some privately negotiated contracts governing joint operations may provide for mandated curtailment, but the industry standard CAPL JOAs do not include such contractual solutions. However, operators may be able to claim force majeure to protect themselves, but the availability of force majeure relief will depend on the precise wording of the for majeure provision.

3. How does curtailment impact take-or-pay midstream and oil field service contracts?

As with any contractual agreement between private parties, the precise terms of the contract will determine the consequences of curtailment and which remedies, if any, are available. It may be possible for a party whose production has been curtailed to claim force majeure, or it may be that the curtailed party has no choice but to incur a payment obligation—particularly in light of the discretion operators exercise over the allocation of curtailment and the effect of optionality on force majeure noted above. Importantly, if an operator's decision to curtail production impacts a WIP's ability to meet its contractual obligations, such WIP will likely have a stronger force majeure claim. The decision to curtail was beyond its reasonable control.

Where force majeure impacts a curtailed party's ability to deliver a fixed quantity of a specified product, it may have a common law obligation to apportion its remaining supply in a fair and equitable or commercially reasonable manner among its buyers. If this is the case (the requirement will vary with the terms of the relevant contract and surrounding commercial circumstances), failure to comply with this requirement may preclude the curtailed party from claiming force majeure.

4. What are the penalties for failure to comply with curtailment?

If an operator subject to a curtailment order fails to comply with a curtailment order, the Regulator can assess administrative penalties of up to $5,000 per day. While the quantum of the penalty is small, administrative penalties are treated as judgments of the Court of Queen's Bench. This means that the Regulator can make use of civil enforcement remedies to ensure payment, including the possibility of imprisonment for contempt.

Because the Curtailment Rules are enacted pursuant to the rulemaking powers contained in the OGCA and the OSCA the Regulator has additional tools to address non-compliance. If an operator fails to comply with a curtailment order, it may also be liable for a penalty of up to $50,000 for an individual and $500,000 for a corporation. The Regulator can also make declarations that have the effect of limiting an operator's or working interest participant's participation in the oil and gas industry, including barring license transfers and halting production.

5. Are there any Competition Act concerns that arise in connection with arrangements made between producers to allocate or consolidate production?

The Curtailment Rules allow: i) two or more persons involved in a joint venture or partnership to enter into an agreement to allocate the combined production of crude oil and crude bitumen among themselves to comply with the curtailment order; and ii) two or more operators, both of whom are subject to curtailment orders, to apply to the Minister for an order permitting consolidation of the maximum amounts, or to apply to the Minister for an order amending the curtailment order to redistribute the amounts fixed under the curtailment orders among those making the request.

While authorized by the Curtailment Rules, such arrangements are not mandated by the Curtailment Rules. As a result, such arrangements could technically be construed as arrangements between competitors to "fix, maintain, control, prevent, lessen or eliminate the production or supply of a product" contrary to the criminal conspiracy provisions of s. 45 of the Competition Act, although prosecution under s. 45 of the Competition Act would be highly unlikely.

According to the Competition Bureau's Competitor Collaboration Guidelines, prosecution under s. 45 is reserved for the "most egregious forms of cartel agreements", which these arrangements are clearly not. There are, in addition, two possible defences producers can look to. The first, found in s. 45(4) of the Competition Act, is colloquially called the "joint venture defense" as it exempts from prosecution arrangements that are "ancillary to a broader arrangement" (such as a joint operating agreement) that includes the same parties and is "directly related to, and reasonably necessary for giving effect to, the objective of the broader agreement." Outside of the joint venture context, arrangements between operators to consolidate or re-distribute their maximum amounts can likely rely on the second defense, found in s. 45(7), known as the "Regulated Conduct Defence" (RCD). There is little case law in this area; however, the Competition Bureau has prepared a "Regulated Conduct" bulletin in which they note that the Bureau will always consider whether the RCD applies to conduct that may be regulated by provincial law. It will do so by focusing on the question of whether a validly enacted provincial law authorizes (expressly or impliedly) or requires the impugned conduct. The fact that consolidation and redistribution arrangements between operators are not permitted unless an order has been issued by the Minister, should give Alberta producers a high level of comfort that they are unlikely to be prosecuted criminally under the Competition Act for arrangements they make among themselves pursuant to the Curtailment Rules.

6. Will curtailment negatively impact an operator's LLR and LMR?

Directives 006 and 011 calculate a licensee's LLR with reference to a 36-month trailing industry average netback and the licensee's previous 12 months of production. As a result, any negative impact that the curtailment regime has on an operator's LLR will be softened by these trailing, partially aggregated, figures. Moreover, to the extent that a licensee's LLR constitutes a component of its LMR, the impact of curtailment on LMR and the ability of operators to buy or sell assets may be even less. As an aside, the authors note that the Government's announcement and implementation of the Curtailment Rules appears to have narrowed the price differential between WCS and WTI benchmark prices. If this trend continues, it is possible that the curtailment regime, through the industry average netback calculation, will increase the LLRs and thus the LMRs of affected Alberta licensees.

7. Will curtailment have any impact on market activity in Alberta?

It is clear that the Curtailment Rules have injected a degree of uncertainty into the Alberta energy market. Given that curtailment has only just taken effect, we have yet to see what its impacts will be and how industry participants will respond. To the extent that this uncertainty could have a chilling effect on the A&D or M&A market, it will likely arise from the fact that: i) the Government continues to amend the Curtailment Rules; ii) curtailment orders are determined on a monthly basis and may vary over time; and iii) the impact that each asset or corporate sale will have on the parties to the transfer.

If two or more operators to whom curtailment orders apply transfer assets amongst themselves, s. 7 of the Curtailment Rules appears to provide a mechanism through which they can apply to the Minister to reallocate any curtailment amounts on a monthly basis. Precisely how the Regulator's license transfer approval process will interfere with or delay this curtailment reallocation process remains uncertain, but the current processing timelines for license transfers presents a number of practical challenges and unanswered questions. That said, it is possible that the Minister will reallocate maximum production notwithstanding the fact that the Regulator has not yet approved the license transfer. From the Minister's perspective, there is no change to the aggregate volume of curtailed production, only a reallocation of those volumes between operators. In addition, we expect that the requesting operators will likely be larger producers with LMRs substantially above the 2.0 regulatory threshold, thereby posing a lesser degree of risk to the regulatory regime.

It is less clear how the Curtailment Rules will respond to a transfer of production involving a vendor-operator producing above the 10,000 bbl/day threshold (and therefore subject to a curtailment order) and a buyer-operator producing below the 10,000 bbl/day threshold (and therefore not subject to a curtailment order). While the buyer's baseline production, adjusted baseline production, and maximum amount of production will change upon the transfer of the assets, the Curtailment Rules do not provide a means to recalculate the baseline production of the vendor. Due to the time parameters set out in the baseline production calculation mechanism, a transfer in these circumstances will increase the province-wide aggregate adjusted baseline production because there is no mechanism to reflect the corresponding decrease to the vendor's production numbers. Section 7 of the Curtailment Rules does not address this situation as there is no mechanism to reallocate the "maximum amounts fixed under [a] curtailment order" in a manner that complies with the scheme of the Curtailment Rules.

Despite the lack of clear legislative direction, companies are free to negotiate commercial solutions to these uncertainties. Any such solutions may have the effect of dispelling the residual uncertainty highlighted above.

8. Do the Curtailment Rules violate any free trade agreements?

The North America Free Trade Agreement (NAFTA) is a trade agreement to which Canada, the United States, and Mexico are all party. It will remain the governing trade agreement until the relevant governments ratify a new agreement. Accordingly, and despite the recent negotiation of a new trade deal—the United States-Mexico-Canada Agreement (USMCA)—the initial question to consider here is whether curtailment violates NAFTA.

Curtailment was designed to address the fact that, due to a lack of export infrastructure, Canadian producers were selling oil to American purchasers at a deep discount. Had Canada simply blocked the export of oil to American buyers purchasing at depressed prices, it would have run afoul of Article 605—a proportionality clause within NAFTA—which prevents Canada from implementing policies that limit exports to the United States and Mexico relative to the total supply produced in Canada. But the Curtailment Rules apply to production at the wellhead. To the extent that a consistent proportion of the crude oil and crude bitumen Canada produces remains available to Mexico and the United States, the curtailment regime does not violate NAFTA. Reducing supply in a consistent proportion as outlined in Schedule 1 of the Rules simply reduces the required offering on an undifferentiated basis and, as a result, the aggregate volume of crude oil and crude bitumen that Canada sells into the market.

Under the USMCA, a curtailment regime as presently crafted may not be necessary as the proportionality clause has been removed. The United States ceded Article 605 in the USMCA negotiations, likely as a result of bolstered energy security in the United States since 1994, when NAFTA was introduced. The fact that the United States now exports both oil and natural gas to Canada and Mexico when it did not in 1994 may explain why the United States was willing to forego a proportionality clause in the USMCA.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions