On September 7, 2011, the Alberta Court of Appeal released its judgment, Omers Energy Inc. v. Alberta (Energy Resources Conservation Board) 2011 ABCA 251, with respect to an appeal by Omers Energy Inc. ("Omers") of an Alberta Energy Resources Conservation Board ("ERCB") decision to suspend two well licenses on an oil and gas lease due to a lapse of the lease. The lease contained a suspended wells clause that provided an indefinite extension of the primary term of the lease when a “well that is capable of producing the leased substances is shut-in or suspended".
The Court of Appeal Decision
Omers argued that a suspended well is “capable of producing” for the purposes of the lease whenever the well has the ability to achieve any production flow whatsoever; particularly where there is pressure from the leased substances at the outlet valve of that well or whenever steps can be taken to address the well’s conditions to achieve production flow.
Montane Resources Ltd., which made the original application for suspension of the lease, asserted that the phrase means that the wells must be capable of producing, on a sustained basis, quantities that are sufficiently meaningful to provide an incentive to produce. Likewise, the mineral rights-owner argued that the phrase should be read as capable of producing the leased substance in paying quantities, on the basis that there is no motivation for entering an oil and gas lease outside of the potential for economic gain.
The Court of Appeal affirmed the ERCB’s interpretation of “capable of producing the leased substance” to mean capable of producing a meaningful quantity of the leased substance, in the well’s existing state, without requiring any further operations. Satisfying the requirement of “meaningful” or “material” will depend on the relevant factors in each individual case, but means more than minuscule.
Although not willing to go as far as reading in or implying that “produce” means produce in paying quantities, as is the case in the American jurisprudence, the Court of Appeal expressed its view that the parties intended to extend the primary term of the lease only when the well was capable of producing a volumetric quantity that would maximize profitability.
What does this mean?
Oil and Gas producers should assess the current production ability of their leasehold properties where the primary terms have expired. Leases will continue to protect leaseholders with shut-in wells provided they have a reasonable expectation of a return to profitability. Where that is not the case, current leaseholders may need to approach the mineral rights-owners to negotiate new deals. The resulting competition could increase the overall receipt of royalties for mineral-rights holders and provide more efficient production of oil and gas resources.
This decision may also lead to further litigation regarding the definition of “meaningful” in this context. Active cases will need to further refine the volumetric test, especially among lease agreements with more specific suspended wells clauses. It may also require that parties vary new lease contracts to clarify the meaning of “capable of production” in suspended well clauses.