The
Pennsylvania farm which had been virtually worthless prior to
the discovery of rock oil in 1859, and which sold for $2 million
dollars in 1865 (“Privately Held Subsurface
Hydrocarbons ”), was auctioned for $4.37 in 1878, after the
flow of oil had mysteriously stopped1. The oil and
gas company that literally and figuratively ‘bought the farm’
could not have been pleased.
The Pennsylvania example illustrates
one side of the difficulty associated with fairly structuring
a property transaction when neither party to the transaction knows
the value of the property. Finding oil and gas requires land on
which to explore, technical expertise, a lot of money, and good
luck. The typical oil company has expertise and access to capital,
but cannot afford to maintain a land inventory for exploration
if the land is bought outright at a price determined by what ‘might’
be under it. The other side of the coin is that owners of subsurface
oil and gas are naturally reluctant to sell outright for substantially
less than the value of the hydrocarbons which may be under their
land.
Out of this conundrum has evolved
the oil and gas lease agreement under which almost all oil and
gas industry operations involving drilling and production are
conducted.
A lease agreement typically provides
for an oil company (the lessee) to pay an owner (the lessor) a
sum of money (the bonus consideration) for the exclusive right,
but not the obligation, to conduct exploration and/or development
on the owner-lessor’s lands for an agreed period of time (the
primary term) and to produce any leased substances which may be
found to exist beneath the lands until these substances are depleted.
The oil company’s right to produce is invariably coupled with
an obligation to pay the owner an agreed share of any leased substances
produced and marketed from the lands (the royalty). The owner-lessor
also usually receives rent on an annual basis during the primary
term before production is established (the delay rental).
At
all times, the form of lease agreement under which oil companies
acquire rights to government-owned subsurface oil and gas in Canada
(“Crown lands”) has been prescribed by the appropriate federal
or provincial agency, as owner of the resource. In Alberta for
instance, since 1930, the Alberta Energy Department or its predecessors
(“Alberta Energy”) has determined the form of lease agreement
under which oil companies may lease Crown lands, including the
length of the primary term and the royalty rate. The only ‘negotiabl
e’ term in an Alberta Crown lease is the bonus consideration.
Oil companies seeking to lease available Crown lands in Alberta
bid for these rights by sealed tender at regularly scheduled ‘Crown
sales’ with lease rights going to the oil company submitting the
highest bonus consideration. In response to changing economic
circumstances, Alberta Energy has modified the form of Crown lease
agreement on a number of occasions in an effort to extract maximum
value from the Province's resource asset, while still maintaining
a healthy climate for oil and gas exploration and development.
In other provinces, Crown lease
forms are prescribed and modified in a similar manner - for the
benefit of the citizens of the province that owns the resource.
Similarly,
where petroleum and natural gas is owned by the Canadian Pacific
Railway Company (the “CPR”), the Hudson’s Bay Company (the “HBC”),
or their successor corporations (“Privately Held Subsurface Hydrocarbons”), the form of lease agreement
under which oil companies may acquire rights to explore for and
produce the hydrocarbons owned by these corporations has, at all
times, been dictated by the corporations, and changes to the lease
forms have been for the benefit of the corporations, as owner
of the resource.
Only in the case of petroleum and
natural gas owned by individual freeholders is the form of lease
agreement dictated and modified by someone other than the owner
of the resource. Freehold lease agreements are prescribed by the
oil company seeking to lease the freehold owner’s hydrocarbons.
Sixty years ago, the late Professor
Maurice Merrill, a renowned authority on United States oil and
gas law, described freehold leasing as follows:
“The parties do not, by mutual negotiation, arrive
at an agreement as to terms, the result of which is embodied
in a written instrument whose language is as much that of one
party as of the other. The lessee comes armed with a printed
form, the product of legal and business experience. It is idle
to suggest that the lessor can afford himself any adequate protection
through haggling over terms” 2
Historical
circumstances in Canada place the typical freehold owner in
an even more disadvantageous position.
For
most of the 20th century, hydrocarbon exploration in western
Canada was focussed on oil. Although several significant oil
discoveries were made in western Canada in the early 1900's
(Norman Wells in 1919 and Turner Valley in 1936), attempts to
extend these discoveries into other areas proved to be unsuccessful.
Oil
exploration in the United States during the same time period
was much more successful. In 1901, a well drilled on a salt
dome structure at Spindletop, along the Texas Gulf coast, blew
in at 100,000 barrels of oil per day. Lands within the Spindletop
field (or Swindletop as it came to be known by freeholders)
changed hands for up to $900,000 per acre. Subsequent drilling
on other salt dome structures in Texas and Louisiana resulted
in further significant discoveries. In 1905, an even larger
discovery was made near Tulsa, Oklahoma, on a different type
of geological feature. By the late 1940's, most of the oil reserves
in the lower 48 states had been discovered and the current framework
of the U.S. domestic oil and gas industry had largely been established
- a number of major corporations controlled the production in
the principal producing states of California, Louisiana, Oklahoma
and Texas.
The
oil and gas potential of the western Canadian sedimentary basin
only became apparent in 1947, when Imperial Oil Limited discovered
a giant field in a subsurface reef of Devonian age at Leduc,
Alberta. The magnitude of the Leduc discovery and the fact that
the location of ancient subsurface reefs similar to Leduc could
be predicted using seismic technology attracted the attention
of major oil companies with established United States production.
Over the following decade, the majority of exploration in western
Canada was conducted by these ‘majors’, or their Canadian subsidiaries.
Freehold
ownership of subsurface oil and gas is the rule rather than
the exception in the original 48 states of the American union
("Privately Held Subsurface Hydrocarbons”).
Because of this, and because the American legal system is ‘friendlier’
than the Canadian system to individuals who sue corporations
(“The Role of the Courts”), thousands
of cases involving freehold lease agreements had been heard
in the courts of the United States by the 1940's. One of the
most significant of these cases was heard by the Oklahoma Supreme
Court in 19163, and involved a freehold lease agreement
in which an oil company had committed to drill a well by a certain
date “or” make a delay rental payment in order to continue the
lease. The lease also contained a clause allowing the oil company
to surrender the lease at any time upon the payment of one dollar.
The court found that, since the lease was voidable, at any time,
at the option of the oil company, it was also voidable at the
option of the freehold owner-lessor. To circumvent this court
decision, a form of lease agreement known as the ‘Producer’s
88' was subsequently adopted by most oil companies operating
in the United States. In the Producer’s 88, the word “unless”
is substituted for the word “or” - if the oil company-lessee
does not drill a well by a certain date (usually one year from
the date of lease execution) the lease terminates “unless” the
oil company makes a delay rental payment. This wording change
prevents the freeholder from terminating his or her lease agreement
at will, and gives the oil company-lessee the option of either
paying delay rentals to continue the lease or allowing the lease
to terminate. Over the years, most of the major American oil
companies developed their own particular form of Producer’s
88 in response to their own experiences in the courts of the
United States.
When
American-based major oil companies became active in western
Canada following the Leduc discovery, it was natural for these
companies to use the ‘unless’ form of freehold lease agreement
which they had developed south of the border in their dealings
with Canadian freehold owners. Many of the independent Canadian
producers that became active in western Canada after Leduc also
adopted ‘unless’ forms of freehold lease agreements based on
the Producer’s 88. In consequence, although many different forms
of freehold lease were entered into by Canadian freehold owners
in the quarter century after the Leduc discovery, the great
majority were ‘unless’ leases.
The
‘unless’ form of freehold lease agreement came before the Canadian
courts on a number of occasions in the quarter century following
Leduc. In most instances, the Canadian courts applied the legal
principle of contra proferentum (any ambiguity in an agreement
is to be construed against the party that drafted the agreement)
and strictly interpreted this form of lease against the oil
company-lessee, without regard for surrounding circumstances.
The courts found that ‘unless’ rental payments were made on
time and ‘unless’ the company could provide proof of timely
payment, an ‘unless’ form of lease automatically terminated
on its own terms. As a result, much to the consternation of
the oil and gas industry, a number of valuable leases were terminated
in situations where the involved companies had purportedly lost
receipts or made administrative errors. Predictably, this ‘judicial
battering’ resulted in changes to freehold lease agreements
as lawyers for various oil companies attempted to ‘bullet-proof’
their company’s particular freehold lease form.
In
1973, when the first edition of “The Oil and Gas Lease in Canada”4
was published by Mr. John B. Ballem, Q.C., there were “as many
varieties of lease forms as there were oil companies”5
in western Canada . In his book, Mr. Ballem, who is now recognized
as Canada’s “dean of the energy bar”6, proposed a
model form of freehold lease which would: “remove the hazards
to the lessee, improve the position of the lessor, and generally
provide a framework within which the minerals could be developed
in a reasonable and equitable fashion”7. In the 2nd
edition of his book, published in 1985, Mr. Ballem acknowledged
that further changes to freehold lease forms had occurred which
were “designed to improve the lot of the lessee and to enhance
the security of his tenure, to the disadvantage of the lessor
in some instances”, and re-iterated his call for a “‘standard’
oil and gas lease which would adequately protect the position
of the oil company while at the same time treating the mineral
owner fairly”8. In response to Mr. Ballem’s suggestion,
a joint committee of the Canadian Association of Petroleum Landmen
(the “CAPL”) and the Natural Resources Section of the Canadian
Bar Association was formed. In 1988, this joint committee released
a standard form of freehold lease agreement for use in Canada
known as CAPL 88. Three years later, a revised standard freehold
lease form known as CAPL 91 was released by the joint committee.
The most recent CAPL standard lease form, known as CAPL 99,
was released in November of 2000. According to Mr. Ballem, 95%
of the freehold leases currently being negotiated in western
Canada now follow the CAPL form9.
Since
1988, Canadian freeholders have typically been confronted, not
with an oil company landman armed with a printed form which
is the product of that particular company’s legal and business
experience, but by a land agent, acting on behalf of an unidentified
oil company, armed with a printed form which is the product
of the collective business experience of the CAPL and the collective
legal experience of the Canadian Bar.
The
landmen who comprise the CAPL and the lawyers who comprise the
Natural Resources Section of the Canadian Bar Association have
been eminently successful in achieving Mr. Ballem’s first goal
of protecting the position of the oil company-lessee. According
to Mr. Ballem: “When it comes to termination, the CAPL lease
is pretty well bullet proof”.10 In other words, no
matter what an oil company-lessee does, it is impossible for
a freehold owner-lessor to terminate a CAPL lease agreement,
through the courts or otherwise, without the oil company-lessee’s
consent. In FHOA’s view, this is not just unfair, it is offensive.
And offensive lease forms are just the start of the problems
faced by Canadian freehold owners (“Conflicts
Between Oil Company-Lessees and Lessors”, “The
Oil Company-Lessee / Freehold Owner-Lessor Relationship”,
“The Role of Regulatory Authorities”
and “The Role of the Courts”).
Back
to Top
End Notes:
- Accumulation, Ownership, and Conservation of Oil and Gas,
in Oil and Gas Law, Cases and Materials, 2d, 1993, West Publishing
Co., St. Paul, Minnesota, p. 18
- The Law Relating to Covenants Implied in Oil and Gas Leases,
Merrill, M.H., 2d., 1940, Thomas Law Book Co., St. Louis,
Mo., p 468
- Brown v. Wilson, 1916, 58 Okla. 392, 160
P 94
- The Oil and Gas Lease in Canada, Ballem J.B., 1973, University
of Toronto Press, Toronto
- Ballem’s Legal Text a Classic, Calgary Herald Business
Section, Oct. 28, 1999
- Mr. N. Schultz, Vice President and General Counsel for
the Canadian Association of Petroleum Producers, as quoted
in the Calgary Herald Business Section, Note 4 supra
- Supra Note 2, Preface
- The Oil and Gas Lease in Canada, 2d, Ballem J.B., 1985,
University of Toronto Press, Toronto, Preface
- The Oil and Gas Lease in Canada, Ballem J.B., 3d, 1999,
University of Toronto Press, Toronto, p. 4
- Some Issues Surrounding the “Conventional” Oil and Gas
Lease, Ballem, J.B., in Working with the Oil and Gas Lease,
1998, Insight Press, Toronto, p. 315Some Issues Surrounding
the “Conventional” Oil and Gas Lease, Ballem, J.B., in Working
with the Oil and Gas Lease, 1998
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