During the last couple of years the Energy Resources Conservation Board of Alberta has been called upon to rule on the validity of freehold oil and natural gas leases, and has asserted its jurisdiction to do so, striking down two leases. Prior to 2008, the validity of leases had only been contested in the courts. The emergence of the ERCB as an alternative forum for litigating exactly the same issues is an interesting development which has some important implications from a procedural and potentially a substantive point of view.

Over the past 50 years, the freehold oil and gas lease has provided a fertile ground for court challenges. A great deal is potentially at stake. In some cases, leases covering millions of dollars worth of reserves have been struck down. A fascinating body of law has developed, focussing on the habendum and several key clauses of the lease, including the shut-in clause, the default clause and the offset drilling clause.

ERCB Decision 2008-047, Desoto Resources Limited

In mid-2008 the Alberta Energy Resources Conservation Board (ERCB or the Board) made what to many was a surprising move by suspending a well licence previously issued by the Board itself on the ground that the licence-holder no longer held a valid lease: ERCB Decision 2008-047, Desoto Resources Limited (June 18, 2008). Desoto claimed to have the necessary working interests by virtue of some 1970’s-vintage leases granted by PanCanadian Petroleum Limited. An issue concerning the validity of Desoto’s leases led to an action being commenced in the Court of Queen’s Bench between Desoto and PanCanadian’s successor, EnCana Corporation. While the litigation was ongoing EnCana wrote a letter to the Board requesting a review of the well licence on the ground that Desoto was not entitled to the licence because it did not hold a valid lease.

The Board held a hearing and later issued a Decision which reads much like a court ruling, reciting the important evidence which had been adduced before it including the key provisions of the leases. After considering the jurisprudence, the Board decided that the leases had in fact terminated and that a well Desoto had drilled under the authority of its licence should be shut in.

The leases in question had been granted in 1975 for primary terms of three and five years “and so long thereafter as any of the leased substances is being produced or is capable of production in paying quantities from a well or wells on the said lands”. Prior to the drilling of Desoto’s successful well, the last well on the lands had stopped producing in 1985.

The central issue was whether the suspended well had remained “capable of production in paying quantities” up to the time Desoto drilled its own well. After reviewing the case law, the Board held that for a well to be capable of production in paying quantities, it had to be able to begin flowing if it was “turned on” without equipment being added or repairs made. In this case, there was no evidence that the old well could produce in this sense. The leases had therefore long since terminated.

Desoto applied for leave to appeal to the Court of Appeal, apparently concentrating on the argument that the ERCB had no jurisdiction to rule on the validity of the lease. Madam Justice McFadyen ruled that there was no merit to this argument, and so dismissed the application: Desoto Resources Limited v. Energy Resources Conservation Board, 2008 ABCA 349 (Oct. 9, 2008).

ERCB Decision 2009-037, OMERS Energy Inc.

After the Board made the ruling that it did in the Desoto case – and its jurisdiction to do so had been upheld by a judge of the Court of Appeal in chambers – it is not surprising that interested parties started to invite the Board to shut in other wells held under doubtful leases. A second case, ERCB Decision 2008-037, OMERS Energy Inc. (Decision 2009-027) arose in a similar fashion – that is, a letter being written to the ERCB arguing that the lessee’s well licence was invalid. A difference this time was that the challenge was brought not by the lessor but by a toplessee (a company which takes a new lease, to come into effect upon the original lease being struck down).

The leases in this case were also for a five-year term. Another similarity to the Desoto case is that the lessee, OMERS, relied upon a shut-in well as continuing the leases beyond their primary term. However, the focus of attention in this case was the leases’ shut-in clause, which provided that the leases would continue in force after the expiration of the primary term if there was a well on the lands which was ”capable of producing the leased substances”. The Board decided that, for a suspended well to be capable of producing the leased substances, it had to have the ability in its existing configuration and state of completion to produce leased substances in some meaningful or material amount. A miniscule amount would not suffice.

Prior to being shut in, the well in question had experienced a high water level in the wellbore. OMERS believed that a poor cementing job was responsible for this problem and had attempted two operations to address the problem. The Board considered that “it is not clear that after [the date it was shut in, the well] was capable of producing without remedial operations”. The Board therefore held that the leases had terminated and were not saved by the shut-in clause.

In this case, an application for leave to appeal was successful: OMERS Energy Inc. v. Energy Resources Conservation Board, 2009 ABCA 273 (August 11, 2009). Madam Justice Paperny granted leave only on the question of whether the Board had erred in its interpretation of the phrase ”capable of producing the leased substances”.

Potential Implications of this Development

It seems that the Board was right in holding that it does have jurisdiction to rule on the validity of leases, as it does on other questions of law which arise incidentally to the Board’s statutory authority. To be entitled to hold a well licence, a person must satisfy the Board that it is “a working interest participant and is entitled to the right to produce” oil or gas from the well: Oil and Gas Conservation Act, s. 16.

However, the Board’s new practice of exercising this jurisdiction over this specific type of issue raises some interesting issues and potential concerns. Among these are the following:

  • The Courts continue to have an unquestionable jurisdiction over exactly the same issue of lease validity. This raises the possibility that there could be two competing sets of proceedings, a possibility which in turn could give rise to some possible conundrums. For example, will a ruling by the ERCB be treated as conclusive (as res judicata) if one of the parties – following an adverse decision by the ERCB – insists on continuing to litigate the issue in court?
  • What weight will ERCB decisions be given by the courts in future decisions? Does it matter that the Board is not a court of law? The decisions in both Desoto and OMERS appear on their face to be soundly reasoned (although the OMERS decision has generated controversy and is under appeal). In both cases, the Board undoubtedly benefited from the fact that some of the Board members sitting on those cases were lawyers (one of the three members sitting on the Desoto case and two of the three in the OMERS case). Arguably, the Board is better equipped than a court would be to address some of the technical issues concerned with (e.g.) the reasons a well was shut in or has remained shut in.
  • Are any concerns raised by the fact that the parties to an ERCB hearing do not have the benefit (or burden) of all of the procedures inherent in a court action, such as the ability to compel documentary production or the right to conduct examinations for discovery? Are these procedural differences likely to lead to different results in some types of cases?
  • To the extent that the task of challenging a lease may be easier (in the sense of being more cost-effective and more expeditious) in a proceeding before the ERCB, is the option to challenge leases in this manner likely to encourage such challenges by lessors or the practice of topleasing?
  • We shall see if it proves easier to persuade the Board to shut in a well on an interim basis than it is to obtain an interim injunction or another type of order from a court having a similar effect. The differences in practice might have the potential to strengthen the hand of lessors.
  • Will the Board’s public interest mandate have an impact on its decision-making in these cases? In a civil lawsuit, the court is only interested in doing justice between the parties. In the OMERS case, the Board gave standing to a lobby group, the Freeholders Petroleum & Natural Gas Owners Association, which was allowed to make arguments in support of the position of the toplessee. This raises possible issues of fairness.
  • Some potentially troublesome issues could arise if the Board were asked to rule on the validity of a Crown lease. While the Board is not an arm of the provincial Crown, there could be an apprehension that it was not a completely impartial body in any contest between the Department of Energy and an oil company Crown lessee.

For these and other reasons, future rulings by the Board on the validity of leases will be watched with great interest.

A cautionary note is that the ERCB does not have unlimited jurisdiction to rule on the validity of oil and gas leases. There must be a connection between that issue and a matter falling under the Board’s jurisdiction, such as whether the holder of a well licence has title to the relevant working interests.