FHOA, Past Present and Future

WRITTEN BY
DAVID SPEIRS &
DENNIS EISNER

THE FREEHOLD PETROLEUM & NATURAL GAS OWNERS ASSOCIATION (FHOA) WAS INCORPORATED   UNDER   THE   CANADA   CORPORATIONS ACT ON OCTOBER  16, 1998 as a not-for-profit organization to provide education and information to individuals who own subsurface petroleum or natural gas in Canada (“freeholders”), research issues of concern to freeholders and act as their common voice in respect of matters that impact their ownership rights.
The issues that affect ownership derive primarily from decisions made by either government, regulatory agencies or the courts.  Many other issues arise due to the provisions of freehold leases, the lack of clarity in these agreements and freeholders’ inability to understand the complexities.

When FHOA was first established, the issue of the day was the distinction between petroleum, owned by the successor corporations to the Canadian Pacific Railway Company, and natural gas, owned by individual freeholders as the successors or assigns of western Canada’s pioneer settlers on ‘split title’ mineral rights. This issue was ultimately decided by the Supreme Court in 2004. The association raised funds from its membership to intervene before the high court and, although FHOA’s intervention was unsuccessful, there is now certainty as to the legal ownership of the hydrocarbons produced from wells on the approximately 2.5 million acres of petroleum/natural gas split title mineral rights in southern Alberta.

FHOA was more successful in the coal bed methane ownership dispute. This dispute also pitted individual freeholders whose forefathers had purchased homestead lands from the CPR at the turn of the last century against the corporate successors to the railway company. In the early 1900’s the CPR had retained the rights to coal in land sales to settlers and the CPR’s successors claimed that their ownership of coal included CBM.  FHOA successfully intervened before the Alberta regulator in 2007. The regulator ruled that CBM is a form of gas that should be gaseous under initial in situ conditions and should not be part of the coal. The Alberta Government ultimately put an end to ongoing litigation by amending the Mines and Minerals Act in 2010 to declare that CBM is, and always has been, natural gas.

FHOA also successfully intervened before the Alberta regulator in 2009 in a hearing to determine the meaning of the phrase ‘capable of producing the leased substances’ in a CAPL 91 freehold lease and before the Alberta Court of Appeal in 2011 in the appeal of the regulator’s ruling. In OMERS, the Appeal Court upheld the regulator’s ruling that to continue a CAPL 91 lease with a suspended well, the well must capable of producing a meaningful quantity of the leased substances in its current configuration.

Although contentious ownership issues and some of the more problematic lease interpretation issues have now been resolved, FHOA and its membership must now address a far graver issue – the viability of conventional exploration and development on freehold mineral rights in Alberta –  an issue which impacts not just freeholders.

The 5% Crown royalty for new wells on Crown lands until payout of drilling and completion costs in the new Crown royalty regime should have the effect of driving down Alberta well costs, and making the province more competitive with other oil and gas producing jurisdictions. FHOA commends the Royalty Review Panel for recommending this approach. However, there are unintended consequences.

Most existing freehold leases provide for a fixed royalty of somewhere between 12.5% and 20% and most freeholders are accustomed to leasing for fixed royalties in this range.  The combination of freehold royalties of this magnitude and Alberta freehold mineral tax (“FMT”) creates a situation in which the financial burden during the critical pre-payout period for an operator of a good well (500 Mcf/d or 50 bopd) on freehold land is roughly four times as great as it would be for the same well on Crown land with current oil and gas prices.

This unbalanced Crown/freehold playing field can only result in technically superior opportunities on freehold land remaining unleased, while industry operators concentrate on less prospective Crown opportunities, driving up Crown prices and skewing industry economics.

Freehold mineral owners must adjust their royalty expectations to current economic realities.  However, there are other issues that the Alberta Government could, and should, address:

1. align the royalty review conclusions with FMT such that for a well on freehold lands, FMT is waived or reduced during the “payout period” for a like well on Crown. This benefit both the freeholder and the producer.
2. follow Saskatchewan’s lead by having FMT collected on a monthly basis from the well operator with the lessor’s share deducted on a monthly basis from the freeholder’s royalty. Under Alberta’s current system, FMT is levied against each freehold title owner in a productive spacing unit. However, FMT is paid by the ‘designated payor’ who typically, but not necessarily, is the lessee.  In February of each year, Alberta Energy publishes default oil and gas product prices for the prior year, and on March 25 sends invoices to the designated payor and the freeholder for production during the prior year.  The designated payor pays FMT by April 25, then invoices its working interest partners for their share and deducts the lessor’s royalty share from future royalties.  Even during good times, this cumbersome system creates an unnecessary economic burden on industry operators. During difficult times such as we are currently experiencing this ‘delayed payment’ FMT system creates chaos. The designated payor, or their working interest partners, who were going concerns in the prior year may become insolvent by April of the following year.  If the designated payor can’t, or won’t pay FMT, the freeholder must pay his own share plus the designated payor’s or risk having the mineral rights appropriated by the Crown.  Designated payors also run the risk of being unable to collect from working interest partners who have become insolvent.  A major revision to legislation governing Alberta FMT to align the system with that used in Saskatchewan would benefit industry, freeholders, and Alberta.

When dealing with the freehold lease there are many issues that cause concern. Notwithstanding the fact that CAPL lease agreements have evolved to more fairly balance the rights of the lessor and the lessee, industry tends to ignore the newer documents and land agents typically use the 1991 CAPL lease form which does not contain the more balanced 1999 or 2014 provisions.  The Canadian Bar Association advocates plain language drafting, yet very few freeholders and many land agents understand the convoluted language in the CAPL 91 lease form.

Some of the issues we counsel FHOA members about when they ask advice on signing the lease agreements are:

• deep rights reversion, similar to Crown leases – if a freeholder’s deep rights have not been evaluated during the primary term, they should not be continued;
• although the OMERS decision has caused some companies to address their freehold well and lease portfolio relative to suspended wells, more companies and freeholders need to ensure they understand the implications of OMERS on their leases at and after the end of the primary term;
• deductions continue to be a major source of conflict in the relationship between freehold lessors and lessees and creating a less complex way of calculating deductions is in all party’s best interest; and
• dealing with a professional landman.

Companies may utilize the services of land agents to acquire freehold leases on their behalf. As with anything, one bad apple spoils the whole bunch, and the actions of an undereducated landman is not something that benefits the industry nor the freehold owner community.  In FHOA’s view, one way to address this issue is to have freeholders refuse to deal with the land agent assigned to the file unless the agent has a P.  Land or equivalent designation.  The CAPL ethics and professionalism requirements are quite stringent and enforceable against the individual should there be an issue.  With the recent decline in professional members of the CAPL, this is an area where FHOA can, and will, support CAPL in its efforts to advocate value in having a professional designation.

Working with CAPL to resolve issues was the intent of establishing a liaison position in 2015.  Although we will likely be on opposite sides on many issues, we can hopefully work together to compromise.  Industry can review practices to establish and build relationships.  For example, when negotiating lease terms, it should be widespread practice to leave a copy of the lease with the freeholder so they can read it and be informed prior to signing the lease.  Corporate lessors require information on drilling, completion, testing and production (as reported to the Crown) in their leases, so updating the practice to include all freeholders should not be a burden.

In these troubled times, FHOA considers it essential to work with reputable industry organizations such as the CAPL to enhance the economics of conventional exploration and development. The FHOA website (www.fhoa.ca) is a very valuable resource for freeholders and industry alike, and to ensure we can continue to provide the service, we encourage CAPL members to join FHOA and assist us in our efforts.

 

Published: The Negotiator, June 2017

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