The Lease Continuation Landscape: Is It "Capable of" Clarification? (Omers v. ERCB)

In Omers Energy Inc. v. Alberta (Energy Resources Conservation Board), 2011 ABCA 251, the Alberta Court of Appeal has again interpreted an oil and gas lease to determine whether it was continued past the primary term.

The lease in question in Omers (the “CAPL 91 form”) provided that it could be continued past the primary term so long as “operations” (as specifically defined in the lease) were conducted with no cessation of more than 90 days. Clause 3, being the suspended wells (or shut-in) clause, provided that the lease would not terminate if there was a well on the leased lands that was “capable of producing leased substances”.

The matter came before the Alberta Court of Appeal on an appeal from a decision of the ERCB that the lease had terminated. The lessor had asked the ERCB to cancel the well licence arguing that the precondition to a well licence, being a valid and subsisting lease, was absent. The well upon which Omers was relying to continue the lease had produced only negligible quantities of gas between 2006 – 2009. The evidence, which did not appear to be the subject of controversy before the ERCB, was that in the absence of dealing with an issue related to water loading in the casing, the well was not capable of producing more than what was referred to as “puffs” of gas.

After a full hearing, the ERCB concluded that the negligible production from the well was not sufficient to continue the lease. Omers challenged that ruling in the Alberta Court of Appeal.

Interestingly, prior to dealing with the interpretation of the phrase “capable of producing leased substances”, the Court questioned whether there was any right to shut-in the well in the first place. The shut-in clause in the CAPL 91 form does not contain any pre-conditions to a lessee’s right to shut-in a well, however, it appears clear from the existence of this clause that the parties contemplated this eventuality. The Court declined to decide on this issue and left it for a future case.

A number of American authorities were considered by the Court with respect to whether the phrase “capable of producing leased substances” had a quantitative element. Two interpretations of the phrase were put forward:

1) sustained production of meaningful quantities;

2) production in “paying quantities”.

The Court declined to imply a “paying quantities” element into the shut-in clause and instead adopted the requirement of the well having a present capability of producing leased substances in meaningful quantities. Given that the well had produced only negligible volumes, the Court found that the decision of the ERCB that the lease had terminated was correct and dismissed the Omers' appeal.

There are two critical components to the Court’s interpretation of the phrase “capable of producing leased substances”. The first is the requirement for an immediate (as opposed to future) ability for the well to produce leased substances without the need for any further operations. The well upon which Omers was relying could not meet this requirement as the water loading had to be first dealt with.

The second element was the requirement for production volumes that were “meaningful”. No guidance was offered by the Court as to what tests would be employed to determine whether a volume of produced gas was sufficiently meaningful to continue a lease. The difficulty will arise in cases where there has been production volumes greater than a “puff” but less than commercial volumes.

The Court in Omers referenced an earlier lease continuation decision which it issued in Bearspaw Petroleum Ltd. v. Encana Corp., 2011 ABCA 7. In that case, the subject lease provided for continuation in the secondary term if leased substances were found to be “producible”. The lessee had drilled and completed a well that was held to be capable of producing, however, there was no gathering system in place to get the gas to market. The Court of Appeal in Bearspaw upheld the trial decision to continue the lease. The trial judge had interpreted “producible” as meaning “something less than capable of immediate production with no more to be done than turning on a valve”. [para. 17]

Omers sought to rely on the Bearspaw decision, however, the Court distinguished it for the following reasons:

1) each lease must be construed under its own terms; and

2) the well in Bearspaw, although not tied in and therefore not capable of getting leased substances to market (and thus providing the lessor with a royalty), was theoretically capable of being turned on and producing without further operations.

The decisions in Bearspaw and Omers (issued approximately 6 months apart) are somewhat difficult to reconcile. In neither case was the lessor receiving a royalty for actual production. The lessor in Omers was far closer to being a royalty recipient than the lessor in Bearspaw; in the latter case this lessor had to wait for the decision of the lessee to construct a gathering system.

Moreover, pursuant to the Court’s reasoning in Omers, the lease would arguably have been continued if the lessee had rendered the well capable of production (by conducting an operation to eliminate the water loading), and subsequently shut the well. The shut-in clause in the Omers lease (CAPL 91) contained no pre-conditions (such as lack of market or for reasons consistent with good oilfield practice) to shutting in a well. Such an outcome would seem to frustrate the intention of the parties to the Omers lease as stated by the Court.

In conclusion, we may be no closer to clarity on secondary term lease continuation. The Court suggested as such in Omers by issuing the warning that “[c]ase law, while often helpful, is not definitive”.

This Alert! is intended for general information only. Please feel free to contact us for additional information on this or any other issue:

  • Scott Whitby | Calgary | 403.693.4341 | swhitby@mlt.com
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