CHAPTER 9 CANADIAN ACQUISITION ISSUES

• Jurisdiction: United States

Oil and Gas Acquisitions
(Nov 1995)
CHAPTER 9
CANADIAN ACQUISITION ISSUES
Mark R. Smith ^*
John A. Brussa ^**
Burnett, Duckworth & Palmer
Calgary, Alberta

The Western Canada Sedimentary Basin, one of the six principal sedimentary basins of Canada, hosts almost all of the oil and gas production in Canada. It covers a small portion of northeastern British Columbia, a portion of the Northwest Territories, all of the Province of Alberta, the south half of the Province of Saskatchewan and stretches into the southwest of the Province of Manitoba. Although there is production throughout the Western Canada Sedimentary Basin, the bulk of production comes from Alberta.¹ As a result, Canadian law respecting oil and gas has developed primarily in the Province of Alberta.

Oil and gas has been discovered in various quantities in other parts of Canada, with discoveries of oil being found in the Province of Ontario as early as 1859. While none of these discoveries have been in amounts significant compared to the reserves in the Western Canada Sedimentary Basin, there are a few companies still active in exploration and development in Ontario. In the last twenty years, there has also been exploration in the northern frontier of Canada in the Beaufort Sea, the northern Arctic islands and off Atlantic Canada. In particular, and development programs have been conducted off the provinces of Newfoundland (Hibernia), expected to be brought on stream in late 1997, and Nova Scotia (Sable Island), which is in the initial planning stages. These multi-billion dollar offshore developments are being pursued by consortiums of major oil and gas companies in Canada. Due to their complexity and the amount of capital required to develop these projects, many of the agreements and applicable regulations require innovative industry and government involvement, resulting in unique arrangements for

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each project. However, these projects can generally be stated to draw on Alberta industry approaches.

The oil and gas industry is relatively new in Canada. While natural gas was found in Alberta as early as 1884, significant exploratory activity did not occur in Alberta until after the discovery of the Leduc² oilfield in 1947. Because the Canadian oil industry developed much later than in the United States, and as a result of a heavy dominance of American based oil companies, primarily the majors, Canadian oil and gas law and practices drew heavily from the United States. As was observed by the Alberta Court of Appeal³ :

Canadian courts have consistently accepted help in the use and interpretation of terms in the oil and gas business from the courts of the United States because of their much wider experience in problems arising from the development of oil and gas fields and the production of these substances...

Until the early 1980's, the major oil companies of the United States, and to a lesser extent, Europe, dominated the industry. There has been a growing diversification of the oil and gas industry since that time. In an effort to increase Canadian ownership in oil and gas operations, the federal government created PetroCanada which grew through the purchase of various Canadian branches of foreign oil and gas companies.⁴ Another factor in diversifying the ownership of oil and gas reserves has been the "rationalization" by many of the majors of their reserves in Canada resulting in a large number of property sales. These sales have resulted in a significant diversification of control of the oil and gas reserves to medium and smaller sized oil companies.⁵

Many of the properties being sold had significant development potential which the majors, for various reasons, were not pursuing. This, together with the large influx of capital into the Canadian oil and gas industry in 1993,⁶ created heavy demand for the properties being sold by the majors. These historical factors have had a significant effect on the oil and gas acquisition practices in Canada which today generally favour the vendor. Consequently, the purchaser receives little comfort from the vendor in respect of title to properties and must rely on its own

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investigation of the properties being purchased.⁷ Diversification of the reserves out of the hands of the majors has resulted in opportunities for entry level, junior and intermediate Canadian and American oil companies to acquire and develop Canadian reserves. There are a number of general legal factors to be taken into account when acquiring oil and gas properties in Canada, from ownership and regulatory questions to tax considerations.

PART A — NON-TAX CONSIDERATIONS

OWNERSHIP

There are basically three types of ownership of mines and minerals being (1) Her Majesty the Queen (the "Crown") on behalf of Canada or of an individual province, (2) freehold (owned privately, but occasionally, especially in Saskatchewan, by the government) and (3) Indian. Most of the mineral rights in the Western Canada Sedimentary Basin are held by the Crown in right of the provinces in which the lands are located. The level of freehold ownership increases as you move east into Saskatchewan and Manitoba.

Most of the lands which now form Alberta, Saskatchewan and part of Manitoba were originally granted in 1670 by King Charles II of England to a company of British traders known as The Governor and Company of Adventurers of England Trading into Hudson's Bay, also known as the Hudson's Bay Company. The Hudson's Bay Company surrendered these lands in 1869 to the Crown in right of Canada. In connection with the surrender, the Hudson's Bay Company was granted certain lands throughout the southern portion of the surrendered lands, which grant included the minerals rights. The Crown in right of Canada also granted to certain railroads and others certain lands which until the late 1800s included mineral rights. To make Alberta, Saskatchewan and Manitoba equal with other provinces which had retained minerals rights when joining Canada, the Crown in right of Canada transferred to the Crown in right of these provinces in 1930 all mines and minerals, including royalties, other than under Indian reserves, national parks and certain other specified lands of the Crown in right of Canada. In result, approximately 80% of the mines and mineral rights in Alberta are held by the Crown in right of the Province of Alberta with less than 10% being freehold estates held by companies and individuals. Less than 1% of Alberta lands are Indian reserves and the balance being national parks.

The system of survey used in Alberta is the Alberta township system. The system consists of quadrilateral townships each consisting of 36 sections as nearly one mile square as the convergence of meridians shall permit. Each township shall consist of six rows of six sections. They are numbered sequentially from 1 through 36 commencing in the SE corner, alternating between east to west and west to east moving northward until reaching section 36 in the northeast corner. The lines bounding townships on the east and west sides are meridians and on the north and south sides are chords to parallels of latitude. The townships are numbered in regular order northerly from the 49th parallel and lie in ranges numbered westward of the 4th.

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5th and 6th meridians. Townships range from 1 which is based on the 49th parallel northward to the 126th township bordering on the North West Territories. There are between 23 and 30 townships between meridians, reducing to the north. Sections are 640 acres and are broken down into quarter sections each consisting of 160 acres. Each section is also divided into 16 quarter sections called legal subdivisions, each consisting of 40 acres, more or less numbered sequentially in the same manner as sections.⁸

In British Columbia, the township system is used in the Peace River block but outside of the Peace River block, the national topographic system is used. British Columbia is broken down into approximately four sheets 82, 92, 93 and 94 which is broken down into map unit subdivisions (A through P).⁹ Each map unit subdivision is divided into 16 further subdivisions referred to as map sheets which are further broken down into twelve blocks (A through I).¹⁰ Each block is broken down into 100 units with each unit being broken down into four subunits (A through D).¹¹ A unit is roughly comparable in size to a quarter section in the township system.

In Western Canada, licenses must be obtained to drill wells. In order to drill an oil well, the applicant must have leased (or own) a quarter section down to the depth to which the applicant intends to drill. This area is referred to as a drilling spacing unit. The spacing unit required to drill a gas well is one section. Normally only one well can be drilled in a spacing unit.¹² To the extent that an applicant does not control an entire spacing unit, he can voluntarily pool the lands necessary to create a spacing unit failing which he can apply to the appropriate regulatory body to have forced pooling ordered.

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Crown Lands

Alberta Crown

The Mines and Minerals Act,¹³ and the regulations promulgated thereunder, governs the leasing of mineral rights.¹⁴ The Petroleum and Natural Gas Agreement Regulations ¹⁵ set up a scheme of licences and leases. Petroleum and natural gas licences, for a term between two and five years, grant the right to explore for and recover petroleum and natural gas substances owned by the Crown within an area of between 29 and 36 sections. Licenses and leases are acquired through a public bidding process. On drilling a well on the lands subject to a license, the licensee is entitled to apply for a lease of petroleum rights for a number of sections which is calculated based on the depth of the earning well and depends on the area in Alberta in which the well is located. Petroleum and natural gas leases, petroleum leases or natural gas leases, may...