Recovery Method Mineral Severances

By William M. Laurin

Originally published on November 7, 2018.

Introduction.

This article seeks to challenge an underlying assumption in an Alberta Court of Appeal decision regarding the relative prevalence and operational effect of recovery method mineral severances in Western Canada tenure and operating agreements.

1. The Issue.

The April 5, 2018 dismissal by the Supreme Court of Canada of an application for leave to appeal a decision of the Alberta Court of Appeal serves as useful context for characterizing and analyzing the severance of in situ mineral hydrocarbon resources on the basis of recovery methodology (as distinct from in situ severances based on phase, substance or stratigraphic criteria) and reaching conclusions in respect of:

· Prevalence of Recovery Method Severances in Western Canada. Rather than being viewed as a rarity, Recovery Method Severances are, historically and currently, prevalent throughout Western Canada both legislatively and contractually, and presumably will become more so as the Western Canadian Sedimentary Basin matures, and the commercial need arises to sever conventional from unconventional resources.

· Recovery Method Severances create a co-tenancy with competing Recovery Rights. Severing Primary Recovery rights from Enhanced Recovery rights results in exclusive rights to recover certain in situ hydrocarbon molecules (i.e. on the one hand those molecules that are only recoverable through Primary Recovery, and on the other hand those molecules that are only recoverable through Enhanced Recovery), but in effect results in the creation of competing, non-exclusive rights to recover those molecules that can be recovered through both Primary Recovery and Enhanced Recovery.

· Existence at law of non-exclusive Recovery Rights. Exclusivity is not a necessary component of the right to “win, take and remove” when creating a profit à prendre, and a grant of competing, non-exclusive rights to recover the same in situ hydrocarbon molecules can be effectively utilized as an efficient tool for maximizing ultimate recovery of hydrocarbons from mature basins.

2. General Context.

a. Distinguishing between Primary and Enhanced Recovery.

As the Western Canadian Sedimentary Basin matures as a hydrocarbon province, and global supplies of non-renewable hydrocarbon resources continue to dwindle, unconventional sources of hydrocarbons and the application of “enhanced recovery” have become increasingly important potential sources of supply. Sophisticated technologies and evolving engineering methodologies make previously unknown or uneconomic hydrocarbon sources economic on a continuing basis.

· Primary Recovery. Primary recovery typically refers to the first phase of reservoir recovery and involves only the natural energy of the reservoir to drive recovery.

· Secondary Recovery. Secondary recovery refers to recovery beyond what is supported from existing reservoir energy only and involves the injection of water or gas to provide pressure support to the reservoir.

· Tertiary Recovery. Tertiary recovery typically refers to a separate type of recovery process that involves the injection of special materials or fluids (e.g. steam, solvents, surfactants, etc.) to change the reservoir fluid properties by mechanisms such as dissolving, mixing, or heat transfer.

For these purposes we will refer only to two classes of recovery, namely conventional or primary production methods (“Primary Recovery”), and enhanced oil recovery methods (“Enhanced Recovery”), recognizing that the general objective of Enhanced Recovery methods is to extract a larger portion of the oil located in a reservoir than is possible through Primary Recovery, which relies solely on the reservoir’s natural energy or drive. We note that this is consistent with the definition of “enhanced recovery” found in Alberta’s Oil and Gas Conservation Act[1] (the “AB O&G Conservation Act”):

AB O&G Conservation Act 1(1) In this Act … (r) “enhanced recovery” means the increased recovery from a pool achieved by artificial means or by the application of energy extrinsic to the pool, which artificial means or application includes pressuring, cycling, pressure maintenance or injection to the pool of a substance or form of energy, but does not include the injection in a well of a substance or form of energy for the sole purpose of (i) aiding in the lifting of fluids in the well, or (ii) stimulation of the reservoir at or near the well by mechanical, chemical, thermal or explosive means …

As inherent efficiencies are realized by industry participants focusing capital on the unconventional and Enhanced Recovery opportunities, commercial arrangements seeking to sever conventional hydrocarbon resources and Primary Recovery activities from unconventional hydrocarbon resources and Enhanced Recovery activities are becoming more prevalent. In order to prevent future entitlement and operational disputes great care should be taken in drafting the language used to bring about these in situ mineral severances.

As a broad reminder, in general, the law in Canada with respect to the interpretation of mineral severance language contained in legislation and private agreements is well settled and, simply put, the test to be applied in judicially resolving ownership disputes is what the words mean in the vernacular of “the mining world, the commercial world and landowners at the time when the grant was made”[2]:

The proper approach, says the appellant, is to ascertain the meaning of the word in the mouths of those non-scientific persons who are concerned with its use, such as landowners, business men and engineers, and to be guided by them as to the true construction of the reservation. The vernacular not the scientific meaning is, he maintains, the true one, and in support of this contention he calls attention to the observations of Lord Halsbury in Glasgow Corpn. v. Farie (1888) 13 App. Cas. 657, at 669, 58 LJPC 33, when he says of mines and minerals that in construing the expression it has to be determined what these words mean in the vernacular of the mining world, the commercial world and landowners at the time when the grant is made. This method of interpretation has been repeated and accepted more than once and their Lordships agree that, where it can be ascertained that a particular vernacular meaning is attributed to words under circumstances similar to those in which the expression to be construed is found, the vernacular meaning must prevail over the scientific. But the distinction is not a rigid one to be applied without regard to the circumstances in which the word is used. It was said by Lord Watson in the same case at p. 675: “‘Mines’ and ‘minerals’ are not definite terms: they are susceptible of limitation or expansion, accordingly to the intention with which they are used.” In their Lordships’ view the same observations are true of the meaning of petroleum. It may vary according to the circumstances in which it is used.

The application of the test is a question of fact on a case by case basis having particular regard to the language of each document or legislative enactment, the time and place of execution of the document and the nature of the parties thereto.

b. Recovery vs. Royalty vs. Conservation Definitions.

For context it is helpful to recognize that there are at least three separate categories of hydrocarbon definitions that appear in legislation and relevant tenure and operating agreements:

· Recovery Definitions. There are definitions that pertain to the granting of recovery rights in respect of in situ hydrocarbons (“Recovery Definitions”).

· Conservation Definitions. There are definitions that pertain to the conservation and regulatory aspects of hydrocarbon recovery (“Conservation Definitions”).

· Royalty Definitions. There are definitions that pertain to the calculation of royalties in respect of hydrocarbons that have been produced and reduced to possession (“Royalty Definitions”).

The differences between Recovery Definitions, Conservation Definitions and Royalty Definitions are appropriately illustrated by referencing the distinctions in the definitions of “oil” among the Recovery Definition in the Saskatchewan Petroleum and Natural Gas Regulation[3] (the “SK Tenure Regs”), the Conservation Definition of “oil” contained in The Oil and Gas Conservation Regulation[4], and the Royalty Definition of “oil” contained in The Crown Oil and Gas Royalty Regulation[5] (the “SK Royalty Regs”):

Recovery Definition: “oil”, “crude”, “crude oil” or “petroleum” means crude petroleum oil and all other hydrocarbons, regardless of density, that are produced at a well in liquid form by ordinary production methods and that are not: (i) oil sands products or oil shale products; or (ii) the result of condensation of gas …

Conservation Definition: “oil” means crude petroleum oil and any other hydrocarbon, regardless of density, that is or is capable of being produced from a well in liquid form, but does not include condensate …

Royalty Definition: “oil” means crude petroleum oil and any other hydrocarbon, regardless of density, that is produced through a wellbore or from an EOR project and that is in liquid form when measured or estimated for the purposes of section 85 of The Oil and Gas Conservation Regulations, 2012 …

Similarly the differences among the Recovery Definition of “petroleum” in the Alberta Mines and Minerals Act[6], the Conservation Definition of “oil” in the AB O&G Conservation Act, and the Royalty Definition of “crude oil” in the Alberta Petroleum Royalty Regulation[7]:

Recovery Definition: “petroleum” means the production from any well that, in the opinion of the Minister, initially produces oil either alone or with gas at a gas-oil ratio of less than 1800:1, but does not include any production that may be recovered from any well that, in the opinion of the Minister, initially produces oil with gas at a higher gas-oil ratio.

Conservation Definition: “oil” means condensate, crude oil or synthetic coal liquid or a constituent of raw gas, condensate or crude oil that is recovered in processing, that is liquid at the conditions under which its volume is measured or estimated…

Royalty Definition: “crude oil” means a mixture mainly of pentanes and heavier hydrocarbons (i) that may be contaminated with sulphur compounds, (ii) that is recovered or is recoverable at a well from an underground reservoir, and (iii) that is liquid at the conditions under which its volume is measured or estimated, and includes all other hydrocarbon mixtures so recovered or recoverable except natural gas, field condensate or crude bitumen …

For these purposes we will focus on certain aspects of Recovery Definitions, and in particular on the issues arising out of in situ mineral severances typically contained in those definitions.

c. Severing Mineral Estates.

An appropriately worded grant can convey not just the right to win, take and remove mineral substances, but may extend to the actual strata of the minerals. The capability to enjoy the strata of lands as distinguished from the mere right to take the mineral substances distinguishes interests of a “corporeal” nature (i.e. that which has an objective, material existence) from those of an “incorporeal” nature such as a conventional mineral “lease” or profit à prendre (a conveyance creating such a “corporeal” mineral estate will be referred as a “Stratigraphic Severance”). Historically, Stratigraphic Severances are associated with solid minerals (i.e. “all strata containing coal”) as the strata of solid minerals may be of significant economic and operational value even after the minerals have been exhausted. In the case of coal, for example, the ownership of the strata would enable a coal operator to use the strata for the transport of coal from under adjoining land. A fluid hydrocarbon reservoir may also have economic value after production of the hydrocarbons as a storage or disposal facility, and accordingly, an appropriately worded mineral severance may be construed as creating a corporeal estate in the stratum in which such hydrocarbon substances are contained. Such a mineral severance typically requires the word “strata”, “vein”, “formation” or “reservoir”, as well as a reference to the substances.

In respect of incorporeal estates, once contracting parties or legislatures deviate from granting “all mines and minerals” a severance of the mineral estate occurs. The specific language of the severance is critical in determining which party is entitled to explore for and produce the various hydrocarbon substances underlying the lands. By way of example, a simple grant or reservation of “natural gas” could be interpreted as an in situ severance of all methane and ethane molecules independent of any time, location, temperature or pressure considerations (a “Compound Severance”), as an in situ severance of all hydrocarbon substances that are in gaseous phase at an implied or explicit location and time or set of temperature and pressure conditions (a “Phase Severance”), or an in situ severance of all hydrocarbon substances that reside above the gas-oil interface at an implied location and time or set of temperature and pressure conditions (an “Interface Severance”), (Compound Severances, Phase Severances and Interface Severances can collectively be referred to as “Substance Severances”, to distinguish them generally from Stratigraphic Severances).

d. Recovery Method Severances.

i. Historical Context.

Regulations governing the disposal of petroleum and natural gas rights that were the property of the Dominion Crown in Manitoba, Alberta, Saskatchewan, the North-West Territories and the Yukon Territory were established by Privy Council Order №414 dated March 11, 1910 (the “1910 Regulations”). These were the first regulations for the leasing of petroleum and natural gas rights and were entitled “Regulations for the disposal of Petroleum and Natural Gas Rights the property of the Crown, in Manitoba, Saskatchewan, Alberta, the North West Territories, the Yukon Territory and within the tract containing three and one-half (3½) million acres of land acquired by the Dominion Government from the Province of British Columbia and referred to in Sub-section (b) of Section 3 of the Dominion Lands Act”. These remained essentially unchanged until in 1921 representations were made to the Department of the Interior that under certain lands, oil shales occurred capable of commercial development by a process differing entirely from the “normal boring operations” contemplated under the 1910 Regulations. The recitals to Order in Council №857 dated March 21, 1921 (copy included as Attachment №1 hereto) include the following:

AND WHEREAS these regulations contemplate that the petroleum and natural gas conveyed under the lease shall be recovered in a free state by boring operations, but representations have been made to the Department of the Interior that there are upon certain lands affected by the regulations oil shales capable of commercial development, by a process differing entirely from that contemplated under these regulations;

AND WHEREAS in view of the wide disparity which exists between the respective methods of recovery, it would appear that separate leases covering the same area might be issued comprising the petroleum and natural gas rights conveyed under the provisions of the regulations, and the oil shale rights, since the establishment and operation of the oil shale industry involves a very large initial expenditure, not likely to be incurred by lessees engaged in the discovery of oil or natural gas by the usual process of boring …

We see that, even as far back as 1921, the advent of new technologies, and the recovery economics of implementing those new technologies (i.e. other than the usual process of boring), necessitated the introduction of an in situ severance of hydrocarbons on the basis of recovery methodology (a “Recovery Method Severance”).

ii. Saskatchewan Legislative Recovery Method Severances.

The SK Tenure Regs apply to all “oil” that is the property of the Crown in right of Saskatchewan, with that term incorporating a Recovery Method Severance through the use of the phrases “produced at a well” (i.e. not, for example, through oil sands mining operations) and “by ordinary production methods” (i.e. not, for example, through unconventional production methods) as follows:

SK Tenure Regs: 3(k) In these regulations the expression … “oil”, “crude”, “crude oil” or “petroleum” means crude petroleum oil and all other hydrocarbons, regardless of density, that are produced at a well in liquid form by ordinary production methods and that are not: (i) oil sands products or oil shale products; or (ii) the result of condensation of gas …

By its nature, the use of the phrase “ordinary production methods” introduces significant ambiguity into the definition as there is an implied temporal and “familiarity” aspect to it. In other words, if the term includes as “ordinary” all methods currently in use or currently contemplated to extract hydrocarbons, including standard enhanced oil recovery projects, heavy oil production techniques and bitumen recovery, then no ambiguity exists as only “extraordinary production methods” (eg. perhaps microbial enhanced oil recovery[8]) would be excluded. The inference to be drawn, however, is that those hydrocarbons produced from a well in liquid form by “extraordinary” production methods are much broader and perhaps align more closely with the commonly understood definitions of “unconventional oil”[9] including the International Energy Agency[10]:

Conventional oil is a category of oil that includes crude oil and natural gas liquids and condensate liquids, which are extracted from natural gas production. Crude oil production in 2011 stood at approximately 70 million barrels per day. Unconventional oil consists of a wider variety of liquid sources including oil sands, extra heavy oil, gas to liquids and other liquids. In general conventional oil is easier and cheaper to produce than unconventional oil. However, the categories “conventional” and “unconventional” do not remain fixed, and over time, as economic and technological conditions evolve, resources hitherto considered unconventional can migrate into the conventional category.

The reference to “ordinary production methods” may, in fact, be a reflection of the differential royalty treatment given to “heavy oil” and “EOR oil” under related Saskatchewan legislation. Section 56.2 of SK Tenure Regs provides that, for the purposes of the “enhanced oil recovery” sections of the Regulations (being sections 56.1 through 56.9) the Minister may, on application by the lessee, designate an area to be a “heavy oil area”. In order to be designated a “heavy oil area” the area must, inter alia, contain one or more “oil, oil sands or oil shale deposits” that in the opinion of the Minister are not economically recoverable through primary recovery methods, and are suited to the application of enhanced recovery methods. It is important to recognize from the outset that an application to designate a “heavy oil area” is submitted by the lessee of a conventional petroleum and natural gas disposition and accordingly such “heavy oil” must therefore be included in the substances granted by the Crown lease by the term “oil”. The term “primary recovery method” used in section 56.2 of the SK Tenure Regs is clearly not equivalent to the term “ordinary production methods” used in the definition of “oil” but is, by inference, distinct from the term “enhanced recovery methods”. We also note that section 56.1 of the SK Tenure Regs defines “primary recovery methods” to include horizontal well technology. Subsection 56.1(b) of SK Tenure Regs adopts by reference the definition of “EOR oil” contained in the SK Royalty Regs, which include the following definitions relevant to heavy oil:

“EOR oil” means: (i) the quantity of non-heavy oil determined by multiplying the total amount of non-heavy oil produced within an EOR project on or after January 1, 1994 by the EOR factor applicable to that project; (ii) all heavy oil produced within an EOR project on or after January 1, 1994; or (iii) any oil that is approved by the Minister from time to time as EOR oil for the purposes of these regulations.

“heavy oil” means: (i) all oil that is produced within the townships north of Township 21 in Ranges 5 through 29, West of the Third Meridian, except oil produced from the Viking zone or from any other zone deposited more recently than the Viking zone; or (ii) any other oil approved by the Minister as heavy oil for the purposes of these regulations.

“non-heavy oil” means all oil produced in Saskatchewan that is not heavy oil.

“oil” means crude petroleum oil and any other hydrocarbon, regardless of density, that is produced through a wellbore and that is in liquid form when measured or estimated for the purposes of section 99 of The Oil and Gas Conservation Regulations, 1985.

iii. Alberta Legislative Recovery Method Severances.

Similar to the current definition of “oil” in Saskatchewan, the original definition of “oil sands” introduced in Alberta in 1978 included the phrase “recoverable through a well by conventional methods”[11] :

“oil sands” means (i) sands and other rock materials containing crude bitumen, (ii) the crude bitumen contained in those sands and other rock materials, and (iii) any other mineral substances in association with that crude bitumen or those sands and other rock materials, but does not include petroleum or natural gas that in its naturally occurring state is recoverable through a well by conventional methods.

That definition was, however, relatively short lived and quickly moved towards an area/zone based conservation authority declaration model under the Alberta Mines and Minerals Act[12] (the “AB M&M Act”) and the Alberta Oil Sands Conservation Act[13] (the “AB OS Conservation Act”):

AB M&M Act: 1(1) In this Act … “oil sands” means (i) sands and other rock materials containing crude bitumen, (ii) the crude bitumen contained in those sands and other rock materials, and (iii) any other mineral substances, other than natural gas, in association with that crude bitumen or the sands and other rock materials referred to in subclauses (i) and (ii), and includes a hydrocarbon substance declared to be oil sands under section 7(2) of the Oil Sands Conservation Act …

AB OS Conservation Act: 7(2) The Regulator may by order, with respect to a zone within a specified area set out in the order, declare any hydrocarbon substance, except natural gas and coal, to be oil sands if the Regulator is satisfied (a) that the zone adjoins or is in reasonable proximity to an oil sands deposit, and (b) that to do so would be in the interests of the orderly, efficient or economic development of (i) the hydrocarbon substance, or (ii) the oil sands in the oil sands deposit referred to in clause (a).

AB OS Conservation Act: 1(1)(r.01) In this Act … “Regulator” means the Alberta Energy Regulator …

iv. British Columbia Legislative Recovery Method Severances.

Pursuant to subsection 50(2) of the British Columbia Petroleum and Natural Gas Act[14] (the “BC P&NG Act”) the holder of a petroleum and natural gas lease has the exclusive right to produce the “petroleum” from the location of the lease, where that term is defined with reference to a Recovery Method Severance using the term “through a well by ordinary production methods”:

1 In this Act … “petroleum” means crude petroleum and all other hydrocarbons, regardless of gravity, that are or can be recovered in liquid form from a pool through a well by ordinary production methods or that are or can be recovered from oil sand or oil shale …

The phrase “hydrocarbons that are recovered in liquid form through a well by ordinary production methods” presupposes the following additional categories: hydrocarbons that are recovered other than through a well, hydrocarbons that are recovered in liquid form through a well by extraordinary production methods, and hydrocarbons that are recovered in gaseous form through a well by either ordinary or extraordinary production methods. As in the case of the Saskatchewan legislation, the difficulty arises in determining whether techniques such as water injection, horizontal drilling, hydraulic fracturing and SAGD are “ordinary production methods”. British Columbia’s Coalbed Gas Act[15] provides another current example of a recovery method severance in its definition of “coalbed gas” through its reference to “through a wellbore”:

“coalbed gas” means all substances (a) that can be recovered to the surface through a wellbore from subsurface coal deposits and any reservoirs in communication with the coal deposits, and (b) the volume of which, if measured at the surface immediately following that recovery, would be measured as a gas …

v. Federal Legislative Recovery Method Severances.

Pursuant to the Federal Real Property and Federal Immovables Act[16] the Governor in Council may, on the recommendation of the Treasury Board, in accordance with any terms and subject to any conditions and restrictions that the Governor in Council considers advisable, authorize the sale, lease or other disposition of any federal real property including mines and minerals. Section 3 of the Public Lands Oil and Gas Regulations[17] governs the granting of “oil” and “gas” leases with the relevant definitions are as follows:

Federal Public Lands Oil and Gas Regulations: 2. In these Regulations … “oil” means crude petroleum oil and all other hydrocarbons, regardless of gravity, that are produced at a well in liquid form by customary production methods …

The ambiguity that presents itself in the Saskatchewan and British Columbia legislation with the use of the phrase “ordinary production methods” is similarly included in the Federal Crown regime but with the introduction of the phrase “customary production methods”. There is little in the Federal legislation that sheds light on what constitutes “customary production methods”. The Indian Oil and Gas Act[18], another Federal enactment which grants the Governor in Council the authority to make regulations respecting the granting of leases, permits and licences for the exploitation of oil and gas in Indian lands, does not reference production methods but nonetheless retains the reference to “from a well”:

Indian Oil and Gas Act: 2 In this Act … “oil” means crude oil and all other hydrocarbons, regardless of gravity, that are or can be produced from a well in liquid form including crude bitumen but excluding condensate.

Indian Oil and Gas Regulations: 2 In these Regulations … “crude bitumen” means a naturally occurring viscous mixture, consisting mainly of hydrocarbons heavier than pentane, that in its natural viscous state is not recoverable through a well in commercial quantity.

vi. Contractual Recovery Method Severances.

As evidence of the prevalence of Recovery Method Severances in common industry contracts we point to the Alberta Court of Appeal decision in Prism Petroleum Ltd. v. Omega Hydrocarbons Ltd.[19], which was an entitlement dispute over “recovered” evolved gas (recalling that in Borys v. Canadian Pacific Railway no well had yet been drilled). The question came down to the interpretation of the phrase “recovered in liquid form … through a well” and the issue was reduced to whether the plain words of the definition contemplated entitlement determination at the surface or at reservoir conditions. Prism Petroleum and the rest of the plaintiffs were holders of participating interests in the West Provost Viking Gas Unit (the “Gas Unit”) which came into effect on or about February 1964. The Gas Unit Agreement dedicated to the Gas Unit the interests of each royalty owner and each working interest owner in and to the “Unitized Substances” as defined in the Gas Unit Agreement. The Gas Unit Agreement created a Recovery Method Severance with the following definition:

“Oil” means crude oil and all other hydrocarbons regardless of gravity that are or can be recovered in liquid form from the Unitized Zone through a well by ordinary crude oil production methods …

3. The Decisions.

On August 5, 2014 the Alberta Court of Queen’s Bench released its decision in IFP Technologies (Canada) v Encana Midstream and Marketing[20] (the “QB Decision”). Mr. Justice Ron Stevens heard the trial between January 31 and March 14, 2011, and oral argument on June 29 and 30, 2011, however the Decision was written by Chief Justice Neil Wittman as Mr. Justice Stevens passed away on Tuesday, May 13, 2014. Subsequently on May 26, 2017 the Alberta Court of Appeal released its decision in IFP Technologies (Canada) v Encana Midstream and Marketing[21] (the “CA Decision”). The Honourable Chief Justice Catherine Fraser and the Honourable Madam Justice Patricia Rowbotham joined in the majority decision (the “CA Majority”), while a dissent was penned by the Honourable Mr. Justice Jack Watson (the QB Decision and the CA Decision are collectively referred to as the “Decisions”). On April 5, 2018 the Supreme Court of Canada dismissed the application for leave to appeal the CA Decision[22].

4. Factual Background.

In the late 1980s and early 1990s, CS Resources Limited (“CS Resources”) was a pioneer in the exploitation of heavy oil using horizontal wells. During this time, it had a business relationship with l’Institut Français du Pétrole (“IFP France”), a French entity with a wide range of technological expertise relating to petroleum research and development. In February 1988, Société Nationale ELF Aquitaine Production (“SNEAP”), IFP France and CS Resources entered into a Technology Licensing Agreement (the “Technology Agreement”) pursuant to which SNEAP and IFP France granted CS Resources a licence over certain expertise and technical information relating to the drilling, placement and completion of horizontal wells for the enhanced production of oil & gas (the “Technology”) in return for a 3% gross overriding royalty on all lands held or acquired by CS Resources in respect of which the Technology was used. In April 1990, SNEAP assigned its rights under the Technology Agreement to IFP France. In March 1993, IFP France assigned those rights to the plaintiff, IFP Technologies (Canada) Inc. (“IFP Canada”). In July 1997, PanCanadian Resources (“PCR”) acquired CS Resources, and in October of 2005 PCR was dissolved and its assets and liabilities were assigned to, inter alia, the defendant Encana Corporation (“Encana”).

In January of 1998 PCR identified the Eyehill Creek property as an attractive potential candidate for development using steam-assisted gravity drainage (“SAGD[23]). In April of 1998 PCR suggested Eyehill Creek as a property in which IFP Canada might be granted a working interest as part of the consideration for terminating the 3% gross overriding royalty it received under the Technology Agreement. In July of 1998 PCR and IFP Canada executed a Memorandum of Understanding (the “MOU”) to redefine their relationship following the termination of the Technology Agreement. The MOU stated that it was the mutual intent of IFP Canada and PCR to optimize the development of the Eyehill Creek lands through the implementation of the technology development program including the application of thermal or other enhanced recovery technologies. The MOU proposed to grant IFP Canada “a 20% working interest in Eyehill Creek, whether such development and production is of a primary, assisted or enhanced nature.”

On October 26, 1998, PCR and IFP Canada entered into an Asset Exchange Agreement (the “Exchange Agreement”) in which IFP Canada gave up its 3% overriding royalty from the Technology Agreement in exchange for working interests in Eyehill Creek and the Pelican Lake property, and a royalty in one of the formations at Pelican Lake. Appended to and incorporated into the Exchange Agreement as schedules were several collateral agreements including the Eyehill Creek Joint Operating Agreement (the “JOA”), which incorporated a modified version of the CAPL 1990 CAPL Operating Procedure (the “1990 Operating Procedure”) and the CAPL 1993 Assignment Procedure (the “Assignment Procedure”).

In March of 2001 PCR entered into a letter agreement (the “Letter Agreement”) with The Wiser Oil Company of Canada (“Wiser”) granting Wiser the right to earn PCR’s working interests in Eyehill Creek in exchange for Wiser assuming responsibility for the 222 pre-existing primary production wells on the lands, including abandoning or reclaiming wells, re-working or placing shut-in wells on production, or converting wells to injector wells. On April 19, 2001, pursuant to Clause 2401B of the 1990 Operating Procedure, PCR sent IFP Canada a right of first refusal notice in respect of the Letter Agreement (the “ROFR Notice”). On May 9, 2001 IFP Canada waived its rights under the ROFR Notice but refused to consent to the disposition to Wiser on the basis that Wiser had no technical capability or intent to pursue thermal or other enhanced recovery methods (the “Refusal to Consent”). On May 18, 2001, despite IFP Canada’s Refusal to Consent, PCR and Wiser entered into a formal Abandonment, Reclamation and Option Agreement (the “Earning Agreement”), and PCR notified IFP Canada of the Earning Agreement by letter dated July 18, 2001. On June 13, 2002 IFP Canada wrote to PCR claiming the Earning Agreement with Wiser was in breach of the JOA since IFP Canada had withheld its consent to the transaction. Canadian Forest Oil Ltd. (“Canadian Forest”) subsequently acquired Wiser’s interests under the Earning Agreement in November of 2004. None of the operations of Wiser or Canadian Forest in respect of Eyehill Creek has been in the nature of thermal or other enhanced recovery; both using only primary production methods.

There are, in our view, two key issues of interest in the Decisions. The first key issue, which is addressed in a separate article, is an analysis of the basis upon which a counterparty under a 1990 Operating Procedure, and similarly worded provisions, may reasonably withhold its consent to a transaction. The second key issue, which is addressed in this article, is the nature of IFP Canada’s working interest in the Eyehill Creek property, and in particular the severance of in situ hydrocarbon resources on the basis of recovery methodology as distinct from phase, substance or stratigraphic criteria. As discussed below, the MOU set out the intention that IFP Canada’s 20% working interest would relate to “all development and production, whether primary, assisted or enhanced” (i.e. Primary Recovery and Enhanced Recovery), while the JOA relates only to “thermal and other enhanced recovery” (i.e. Enhanced Recovery only).

IFP Canada took the position that the Exchange Agreement conveyed to it an undivided 20% working interest in all oil and gas underlying the Eyehill Creek property whether produced through Primary Recovery or Enhanced Recovery, while Encana insisted that IFP Canada’s interest was limited to an undivided 20% interest in oil and gas produced only through Enhanced Recovery methods only.

5. Conclusions of the Court.

The QB Decision held that IFP Canada’s 20% working interest was limited to Enhanced Recovery only, largely on the basis that the Exchange Agreement did not define what was meant by “working interest”, and the JOA set out that the parties’ respective working interests related to Enhanced Recovery operations only. It followed from this finding that IFP Canada’s working interest in Eyehill Creek was limited to Enhanced Recovery methods only, and that IFP Canada had no entitlement to any of the proceeds of Primary Recovery. It also followed that, since IFP Canada had no entitlement to the proceeds of Primary Recovery, it was unreasonable for IFP Canada to object to PCR’s Earning Agreement with Wiser, as Wiser was proposing to do no more than PCR was already entitled to do under the JOA. As neither the Exchange Agreement or the JOA imposed any obligations on PCR to initiate Enhanced Recovery operations at Eyehill Creek, or to refrain from Primary Recovery operations, PCR’s transfer to Wiser pursuant to the Earning Agreement did not change the status quo, and accordingly IFP Canada acted unreasonably in withholding its consent to the assignment by PCR to Wiser.

The CA Majority took a contrary view, concluding that pursuant to the Exchange Agreement PCR agreed to transfer, and did transfer, to IFP Canada 20% of PCR’s working interest in all the assets held by PCR in Eyehill Creek, including Primary Recovery and Enhanced Recovery, and that the JOA did not reduce or limit IFP Canada’s working interest. If followed that IFP Canada was entitled to an accounting for 20% of the net revenue realized by Wiser through the Primary Recovery at Eyehill Creek. It also followed that the QB Decision erred in finding that IFP Canada acted unreasonably in withholding its consent to the farmout to Wiser. The CA Decision found that IFP Canada’s withholding of consent was reasonable in the circumstances, and accordingly PCR breached the JOA by proceeding as it did.

6. Discussion & Analysis.

a. Prevalence of Recovery Method Severances.

While we are prepared to accept the CA Decision’s conclusion that PCR agreed to transfer, and did transfer, to IFP Canada 20% of PCR’s working interest in all the assets held by PCR in Eyehill Creek, including those subject to both Enhanced Recovery and Primary Recovery, and accordingly that IFP Canada was entitled to an accounting for 20% of the net revenue realized by Wiser through Primary Recovery, we firmly disagree with what appears to be one of the key rationales underlying the CA Decision; namely that a Recovery Method Severance is a rare and unworkable situation. As has been demonstrated above, in fact the opposite is the case; Recovery Method Severances are common place in Western Canada and have been so for nearly 100 years.

CA Decision Paragraph 101: While a working interest may be limited to a specific zone or mineral, a “working interest” in minerals does not contemplate the right to profit from resource extraction being limited to, or dependent upon, a specific method of extraction. Accordingly, where contracting parties limit recovery of minerals conveyed to a particular method of extraction only, the party receiving that truncated right would not receive a true “working interest” in the minerals.

CA Decision Paragraph 102: It takes but a moment of reflection to realize the difficulties a contrary view would entail. It is important to understand these difficulties because they explain and underscore why a true working interest in oil and gas cannot be limited to a specific method of extraction. If a working interest were contingent on the method of extraction, that would mean that where one party had the right to extract oil on certain lands through thermal production and another through primary production, two different parties would then be claiming rights to the same barrels of oil. This makes no sense practically or economically.

b. Competing Recovery Rights.

Consider another extremely commonplace circumstance; where a fee simple owner of all mines and minerals (i.e. of both petroleum and natural gas), enters into separate but concurrently granted “Petroleum Leases” and “Natural Gas Leases”, where the “Leased Substances” granted by the Petroleum Lease are defined as:

“Leased Substances” means petroleum only and all materials and substances, whether liquid, solid or gaseous, and whether hydrocarbons or not, produced in association therewith, including natural gas produced in association with petroleum which gas was in a liquid state in virgin reservoir conditions (“solution gas”), or found in any water contained in any reservoir, but excludes Coal, CBM and valuable stone.

and the “Leased Substances” granted by the Natural Gas Lease are defined as:

“Leased Substances” means natural gas only and all materials and substances, whether liquid, solid or gaseous, and whether hydrocarbons or not, produced in association therewith or found in any water contained in any reservoir, but excludes natural gas produced in association with petroleum which gas was in a liquid state in virgin reservoir conditions (“solution gas”), Coal, CBM and valuable stone.

In each Lease there is a “primary grant” (i.e. petroleum or natural gas) coupled with a “proximal grant” (i.e. all materials and substances, whether liquid, solid or gaseous, and whether hydrocarbons or not, produced in association therewith); however, the proximal grant in fact may comprise hydrocarbon and other substances granted in the competing, concurrently granted tenure. In other words, since extremely common Substance Severances create competing recovery rights for the same substances without significant disputes arising, the question becomes why should competing recovery rights for the same substances under Recovery Method Severances be treated differently.

CA Decision Paragraph [103]: While more oil can be extracted through thermal production, the reality is that both methods involve extracting some of the same barrels of oil. Therefore, were two parties to be given rights to oil in the same property based on the method of extraction, the level of complexity this would necessarily engender, including how to handle competing claims to the same barrels of oil, would all need to be addressed. Many issues would require resolution, beginning with the most obvious. Who gets to extract the oil first — the party using primary production or the one using thermal production? After all, the answer cannot be based on who wins a footrace to the lands. If it were, the party doing primary production would invariably win given the lesser costs that this entails. Moreover, it is unclear how a right limited to receiving proceeds from a certain method of extraction only could possibly qualify as a property right in minerals when there is no “property” to which the right to share in proceeds of production might ever attach.

CA Decision Paragraph [112]: In summary, the Trial Judge erred in law in (1) failing to recognize that “working interest” is a legal term of art with a specific meaning in the oil and gas industry; (2) disregarding in their entirety the clear, compelling substantive provisions in the AEA relating to the 20% of PCR’s working interest that PCR conveyed to IFP; and (3) wrongly relying on a preamble provision in the AEA to trump its substantive textual provisions. This led the Trial Judge into further errors discussed below and in the end, it led him to an interpretation of the Contract that would give IFP not only an interest incompatible with the parties’ objective intentions but one incompatible with the law on working interests in the oil and gas industry.

Professor Nigel Bankes in an ABlawg.ca post dated June 8, 2017[24] agreed with the CA Decision: “I think that the majority is correct to question Chief Justice Wittmann’s characterization of IFP’s interests. In effect, Chief Justice Wittmann created a new form of property interest that purported to be distinguishable from other interests on the basis of the mode of production. I agree with the majority (see especially at paras 101–103) (and see my post on the trial decision) that there would be significant practical difficulties and uncertainties associated with such a view of property.” With respect, we disagree that a Recovery Method Severance creates an interest incompatible with the law on working interests in the oil and gas industry, and would instead take the view that it is in fact extremely commonplace in Western Canada and fundamentally no different than the other subsurface mineral severances.

c. Non-exclusive Recovery Rights.

In an ABlawg.ca post published on August 18, 2014 in respect of the QB Decision, Professor Nigel Bankes[25] offers the following in respect of the “working interest” acquired by IFP Canada pursuant to the Exchange Agreement:

I think that there are two possible interpretations of what IFP acquired. One interpretation (which I will refer to as the property-limited-by-contract interpretation) is that IFP acquired an undivided interest as a tenant in common of the relevant Crown leases and other assets (subject to some contractual limitations on its precise rights in relation to those assets). A second interpretation (which I will refer to as the property interpretation) would hold that IFP acquired something in the nature of a working interest in production from the lands resulting from thermal or other enhanced recovery techniques. There are pros and cons to each of these interpretations … But the best way to respect that intention is to conclude that the property rights of IFP as a tenant in common were limited by the terms of the other contractual arrangements between them, including the key provision in the JOA referred to above … The principal knock against [the second interpretation] is that it fails to respect the dominant conveyancing language of the AEA and as a result delivers an interest which is unrecognizable in terms of property law. It is one thing to have an undivided interest which is confined to a particular formation or formations; or to have an undivided interest in a particular substance; but we create a whole new layer of complexity when we admit of the possibility that ownership of an interest in land varies with the nature of production from those lands.

Under Bankes’ first interpretation IFP Canada acquired a property interest in all the hydrocarbon molecules, but was limited by contract to benefit only from those molecules brought to surface by Enhanced Recovery. Under Bankes’ latter interpretation, IFP Canada only acquired a property interest in those hydrocarbon molecules brought to surface by Enhanced Recovery; presumably an exclusive right to recover those molecules that are only recoverable through Enhanced Recovery, but in effect a non-exclusive right to recover those molecules that could be recovered through both Primary Recovery and Enhanced Recovery. The question becomes whether creating these two competing estates denigrates the interests granted:

Not only is this complex but it seems to be inconsistent with the royalty-as-interest-in-land cases culminating in Bank of Montreal v Dynex Petroleum Ltd, 2002 SCC 7. If an interest in the proceeds of production cannot give an interest in land how can a party have a tenancy in common (not just any old interest in land, but an undivided interest) in a Crown lease that is contingent on the mode of production of the leased substances?

With respect, we again disagree that this latter interpretation “delivers an interest which is unrecognizable in terms of property law”, and that we create “a whole new layer of complexity when we admit of the possibility that ownership of an interest in land varies with the nature of the production from those lands”. As we feel has been demonstrated above, Recovery Method Severances are, in fact, prevalent throughout Western Canada both legislatively and contractually. In our view, exclusivity is not a necessary component of the right to “win, take and remove” when creating a profit à prendre, and a grant of competing, non-exclusive rights to recover the same molecules should be embraced as an effective tool for maximizing ultimate recovery of hydrocarbons from mature basins.

EnerNEXT is a boutique legal and advisory platform focused on energy, cleantech and sustainability. We have extensive experience in oil & gas, conventional and alternative energy, cleantech, climate change and emissions trading; as well as corporate, commercial, aboriginal and construction law, environmental compliance, liability and risk management and strategic planning. We advise businesses in the energy and technology sectors by employing a unique service delivery model, and a solution-oriented approach. For more information on the substance of this article, please contact either William M. Laurin at william.laurin@enernext.ca or (587) 224–4904 or Morella De Castro at morella.decastro@enernext.ca or (403) 616–9186.

[1] https://www.canlii.org/en/ab/laws/stat/rsa-2000-c-o-6/latest/rsa-2000-c-o-6.html

[2] Borys v CPR, [1953] AC 217, http://www.bailii.org/uk/cases/UKPC/1953/1953_2.html.

[3] https://www.canlii.org/en/sk/laws/regu/sask-reg-8-69/latest/part-1/sask-reg-8-69-part-1.pdf

[4] https://www.canlii.org/en/sk/laws/regu/rrs-c-o-2-reg-6/latest/part-1/rrs-c-o-2-reg-6-part-1.pdf

[5] https://www.canlii.org/en/sk/laws/regu/rrs-c-c-50.2-reg-28/latest/part-1/rrs-c-c-50.2-reg-28-part-1.pdf

[6] https://www.canlii.org/en/ab/laws/stat/rsa-2000-c-m-17/latest/rsa-2000-c-m-17.html

[7] https://www.canlii.org/en/ab/laws/regu/alta-reg-222-2008/latest/alta-reg-222-2008.html

[8] https://en.wikipedia.org/wiki/Microbial_enhanced_oil_recovery

[9] https://en.wikipedia.org/wiki/Unconventional_oil

[10] https://www.iea.org/about/faqs/oil/

[11] The Mines and Minerals Amendment Act, 1978, S.A. 1978, Chapter 23.

[12] https://www.canlii.org/en/ab/laws/stat/rsa-2000-c-m-17/latest/rsa-2000-c-m-17.html

[13] https://www.canlii.org/en/ab/laws/stat/rsa-2000-c-o-7/latest/rsa-2000-c-o-7.html

[14] https://www.canlii.org/en/bc/laws/stat/rsbc-1996-c-361/latest/rsbc-1996-c-361.html

[15] https://www.canlii.org/en/bc/laws/stat/sbc-2003-c-18/latest/sbc-2003-c-18.html

[16] https://www.canlii.org/en/ca/laws/stat/sc-1991-c-50/latest/sc-1991-c-50.html

[17] https://www.canlii.org/en/ca/laws/regu/crc-c-1326/latest/crc-c-1326.html

[18] https://www.canlii.org/en/ca/laws/stat/rsc-1985-c-i-7/latest/rsc-1985-c-i-7.html

[19] https://www.canlii.org/en/ab/abca/doc/1994/1994abca97/1994abca97.pdf

[20] https://www.canlii.org/en/ab/abqb/doc/2014/2014abqb470/2014abqb470.pdf

[21] https://www.canlii.org/en/ab/abca/doc/2017/2017abca157/2017abca157.pdf

[22] https://scc-csc.lexum.com/scc-csc/scc-l-csc-a/en/item/17039/index.do

[23] SAGD is one of several thermal Enhanced Recovery processes designed for heavy oil reservoirs. In a traditional SAGD project, two horizontal wells are drilled one above the other. Steam is injected into the upper well; the steam renders the oil less viscous and the oil flows down towards the lower, producer well.

[24] https://ablawg.ca/wp-content/uploads/2017/06/Blog_NB_IFP_v_Encana.pdf

[25] http://ablawg.ca/wp-content/uploads/2014/08/Blog_NB_IFP_Encana_August2014.pdf