A recent Alberta decision is the first ruling on whether an Area of Mutual Interest (AMI) obligation (which requires each party to a contract to give the other a chance to participate in any acquisition made within a defined geographic area during a specified period of time) is triggered when one party enters into a voluntary pooling agreement with a third party, thereby acquiring additional interests within the AMI. Mr. Justice Alan MacLeod of the Court of Queen’s Bench held that, in the circumstances of the case, the AMI obligation did not apply to a pooling arrangement which one of the parties had entered into.

Farmout agreements, under which the holder of an oil or gas lease gives another company an opportunity to earn an interest in the lease, usually by drilling a test well or wells, commonly contain an “AMI” (Area of Mutual Interest) clause. The test well results, or other operations, may arouse interest in surrounding lands. The AMI clause provides that if, during some specified period of time, one of the parties to the farmout decides to acquire an interest in any lands within a defined area, it must give the other party an opportunity to participate in the acquisition.

In Hunt Oil Company of Canada, Inc. v. Shell Canada Limited, Shell and Hunt had entered into a Farmout, Participation and Option Agreement, under which Hunt was given the right to earn an interest in one block of lands (Block “A”) by drilling a test well, together with an option to earn in a second block of lands (Block “B”) by drilling a second, option well. The results of the test well suggested that wells drilled on Block “B” would be marginally economic. Hunt unsuccessfully proposed a variation to the Agreement, then allowed the Block “B” option to expire.

Farmout agreements respecting lands in the Western Canadian basin commonly incorporate the 1997 Canadian Association of Petroleum Landmen (CAPL) standard form of Farmout and Royalty Procedure, which includes an AMI provision. The Shell-Hunt Agreement included the CAPL Farmout and Royalty Procedure.

Before Hunt let the option expire, Shell had begun negotiations with a third party, Talisman Energy Inc., to “pool” its interests in Block “B” with Talisman lands which also fell within the AMI. A pooling agreement was concluded after the expiration of Hunt’s option. A joint Shell/Talisman well drilled on the Talisman lands was successful. Hunt’s position was that Shell’s interest in the Talisman lands resulted from an “acquisition” within the meaning of the AMI clause, and that Shell therefore ought to have given Hunt the opportunity to participate in the pooling.

Macleod, J., while recognizing that the pooling agreement with Talisman gave Shell rights within the AMI that it had not previously held, concluded that the AMI clause was not intended to apply to interests acquired in this manner. Poolings are often “regulatory” or “compulsory” in nature. In Alberta at least, Regulations require a party holding only a part of a “drilling spacing unit” to pool its interests with the remaining interests in the spacing unit before it may drill a well. Hunt conceded that the AMI clause in the Farmout, Participation and Option Agreement would not have applied to a compulsory pooling. The pooling between Shell and Talisman was voluntary, in that it was not required by Regulation in order to form a spacing unit, or for any other reason.

The court concluded that even voluntary poolings were not caught by this AMI clause. The clause was silent on whether a pooling arrangement could amount to an “acquisition” within the meaning of the clause. However, the court considered that the objective of the CAPL AMI clause (which – like all AMI clauses – was to negate the parties’ normal right to compete with one another in making certain land acquisitions) was not served by treating pooling agreements as “acquisitions”. From Shell’s point of view, the pooling with Talisman was financially neutral, in that Shell had to give Talisman interests (also falling in the AMI) of equal value to the interests of Talisman which Shell obtained through the pooling.

The judge chose not to base his decision on the point that Shell’s pooling with Talisman was a “non cross-conveyance pooling” (in that it was not structured so as to involve a formal conveyance to Shell of any portion of Talisman’s interests, or vice versa).

In reaching its decision the court rejected expert opinion evidence from an experienced landman called by Hunt to the effect that industry practice was to treat voluntary poolings as acquisitions for purposes of AMI clauses.

Macleod stated that his decision should not be interpreted as meaning that no AMI obligation can ever be triggered by a pooling agreement, and that each case would depend on its facts including (in particular) the way the AMI clause was worded. Nonetheless, in the face of this decision, any one wishing to argue that an acquisition pursuant to a pooling triggers an AMI obligation will clearly be facing an uphill battle.