Omers Energy Inc. v. Alberta (Energy Resources Conservation Board)

In the Court of Appeal of AlbertaCitation: Omers Energy Inc. v. Alberta (Energy Resources Conservation Board), 2011 ABCA251Date: 20110907Docket: 0901-0153-ACRegistry: CalgaryBetween:Omers Energy Inc. (“Omers”)Appellant (Applicant)- and -Energy Resources Conservation Board (“Board”) and Montane Resources Ltd.- and -Eva CymbalukRespondent (Respondent)IntervenerThe Court:_______________________________________________________The Honourable Madam Justice Carole ConradThe Honourable Mr. Justice Ronald BergerThe Honourable Mr. Justice J.D. Bruce McDonald_______________________________________________________Reasons for Judgment Reserved ofThe Honourable Madam Justice ConradConcurred in by The Honourable Mr. Justice BergerConcurred in by The Honourable Mr. Justice McDonaldAppeal from the Decision 2009-037thFiled on the 12 day of May, 2009

_______________________________________________________Reasons for Judgment Reserved ofThe Honourable Madam Justice Conrad_______________________________________________________I. Introduction[1] The appellant, Omers Energy Inc. (Omers), appeals a decision of the Energy ResourcesConservation Board (the Board) suspending two gas well licences because the underlying lease hadexpired. Omers had sought to rely on the Suspended Wells Clause in the lease to extend its term.That clause continues a lease as though operations were being conducted, provided the well was“capable of producing the leased substances”. The Board found, however, that the words “capableof producing the leased substances” meant being capable of producing the leased substances in“meaningful quantities” in its present state and configuration, a test that Omers did not meet.II. Issue[2] Leave to appeal was granted on the sole issue of whether the Board erred in its interpretationof the phrase “capable of producing the leased substances”.III. Decision[3] The appeal is dismissed. The Board did not err in finding that the phrase “capable ofproducing the leased substances” means the “demonstrated, present ability of a well on the lands toproduce the leased substances in a meaningful quantity within the time frames contemplated in thelease.” (Board Decision 2009-037 at 9, hereafter Board Decision) The lease is a contract throughwhich the lessor and lessee agreed to develop the leased substances for mutual benefit. This purposewould be defeated if the lease were interpreted in a manner that allowed it to continue almostindefinitely at a time when a drilled well is incapable of producing a meaningful quantity of oil orgas in its present state and operations are not being conducted to make it produce. Requiring a“meaningful” volumetric quantity was sufficient to determine this case. Considering each lease andits surrounding circumstances will allow this test to develop in a contextual setting.IV. Background[4] On February 8, 2001, Dennis John Cymbaluk and Heritage Freehold Specialists & Co.entered into a freehold Petroleum and Natural Gas Lease (Cymbaluk Lease). They used the CAPL91 Alberta Form lease – a form commonly used in the industry and one which has been andcontinues to be amended. The Cymbaluk Lease granted the lessee 100 per cent of the freeholdmineral owner’s interest in the northwest quarter of Section 4-54-14 W4M for a primary term of fiveyears, and thereafter as provided, in exchange for a royalty. A caveat was registered at the AlbertaLand Titles to protect this interest. After a succession of transfers, Omers eventually became thelessee.

Page: 4that a very low, or even nonexistent threshold, would offer little or no incentive for a lessee toundertake and maintain operations to recover leased substances. Moreover, it could result in onlya nominal return to the lessor for an indeterminate length of time without any obligation on thelessee to rectify the situation. Such an interpretation was, in the Board’s view, contrary to theintention of the parties as expressed throughout the lease as a whole.[19] The Board held, therefore, that “capable of producing the leased substances” required morethan a minuscule amount of production. Rather, it found that the volume of production needed tobe material or meaningful before the lessee could rely on the Suspended Wells Clause to extend thelease (Board Decision 9). Furthermore, the Board concluded that “capable of producing” referredto the well in its present state. It rejected the idea that a well could be “capable of producing theleased substances” and at the same time be in need of an operation to address a situation such aswater loading (Board Decision 13). The Board found that this type of remedial requirement fellwithin the definition of “operations” under Clause 1(g) of the Cymbaluk Lease, and that a well couldnot be both capable of production and in need of operations of that type at the same time.[20] The Board concluded:“[C]apable of producing the leased substances” is to be interpreted to meanthe demonstrated, present ability of a well on the lands to produce the leasedsubstances in a meaningful quantity within the timeframes contemplated inthe lease. The Board emphasizes that what is “material” or “meaningful”depends on the relevant factors in each individual case. In this case, the termsof the Cymbaluk lease coupled with the evidence of the well’s capability toproduce, as set out below, are determinative of the issues in this proceeding.(Board Decision 9)[21] Finally, the Board turned to whether the 100/05-4 Well met this test. After reviewing theevidence on the well’s capabilities, the Board concluded that the well had not produced a meaningfulquantity of gas since March 28, 2006 when the wellbore filled with water. Nor had the well beencapable, since that date, of emitting gas without further operations to clear the water out of thewellbore – with the result that it did not have the present ability to produce. The Board concluded,therefore, that the well was not capable of producing the leased substances.[22] Although the lease had been preserved by clean out operations on May 9, 2006, the welldepleted in 13 seconds and no further operations were conducted until November 9, 2006 – a periodof more than 90 days without operations being conducted. As a result, the Board concluded the leasehad not been extended by further operations and had expired on May 10, 2006, the day after the lastoperations had been conducted. As the lease had expired, the Board upheld the suspension of the twowell licences.

Page: 5VI. The Intervener[23] Although the FHOA participated in the Board hearing, it is neither a party, nor an intervener,in this appeal. Eva Cymbaluk, however, was granted leave to intervene.VII. Standard of Review[24] Omers submits the issue before the court is a legal one as it involves the interpretation of aspecific term in the lease. Omers says, further, that the decision does not call upon the Board’sspecialized expertise, nor its policy-making function, with the result that the standard of review iscorrectness. Omers relies, in part, on this court’s decision in Alberta Energy Co v GoodwellPetroleum Corp, 2003 ABCA 277, 339 AR 201, where the court held that the interpretation of welllicences did not engage the Board’s technical expertise because it involved, by necessity, theinterpretation and application of statute and case law. The intervener agrees with Omers’submission. Montane, on the other hand, submits the interpretation of “capable of producing theleased substances” is ultimately a matter of mixed fact and law falling within the Board’s expertise,thus inviting a standard of reasonableness.[25] The Board takes a third view. It submits there are two discrete issues of law involved in theappeal, each of which has a different standard of review. The first issue of law is whether the Boardadopted the correct legal principles of interpretation in determining the meaning of “capable ofproducing the leased substances”. The Board submits this is not a matter within its specialized areaof expertise with the result that the standard of review for this question is correctness. The Boardgoes on to argue, however, that the application of those interpretive principles to attribute meaningto the phrase “capable of producing the leased substances” is a second principle of law that fallswithin the Board’s expertise. Therefore, the Board says the standard of review with respect to thelease’s interpretation, as well as to its ultimate finding on the facts, is reasonableness.[26] The starting point for any analysis of the standard of review is the Supreme Court ofCanada’s decision in Dunsmuir v New Brunswick, 2008 SCC 9, [2008] 1 SCR 190. In Dunsmuir,the court described a two-step process for determining the standard of review. The court held at para62:In summary, the process of judicial review involves two steps. First, courtsascertain whether the jurisprudence has already determined in a satisfactorymanner the degree of deference to be accorded with regard to a particularcategory of question. Second, where the first inquiry proves unfruitful, courtsmust proceed to an analysis of the factors making it possible to identify theproper standard of review.[27] The Supreme Court affirmed that if the standard of review could not be determined by areview of the existing jurisprudence, it was necessary to examine such matters as the existence ofa privative clause, the nature of the administrative decision-maker, the nature of the statutoryscheme and whether the issue raised is one of law or fact.

Page: 6[28] I am satisfied that the standard of review, applicable to the Board in this case, was effectivelydetermined by this court in Goodwell. In Goodwell, the Energy and Utilities Board (the Board’spredecessor) was asked to interpret and apply certain oil sands leases, granted by the government,to determine if the lessee of an oil sands lease was entitled to produce gas-cap gas incidental tobitumen recovery. As in the present case, the appellants had a statutory right of appeal on questionsof law or jurisdiction, and the issue on appeal was a matter of law. Fruman JA discussed the issueof the Board’s expertise at paras 24-26:In considering this factor, the reviewing court is not to focus on theadministrative board’s general expertise, but must examine the board’sexpertise on the particular issue in question, and compare it to the court’sexpertise: Barrie, supra, at 219.The Board is a specialized tribunal that administers a comprehensive set oflegislation regulating the energy industry in Alberta: Coalition of CitizensImpacted by the Caroline Shell Plant v. Alberta Energy and Utilities Board(1996), 187 A.R. 205 at 209 (C.A.). It has considerable technical expertisein addressing issues concerning hydrocarbon exploration, development,production and conservation, and balancing competing policy interestsamong industry participants, government and the public. The Board’sinterpretation of a well license that engages these areas of expertise might beaccorded considerable deference by the courts.However, the Board’s well license interpretation in this case did not employthat technical expertise, but involved a legal determination of the right toextract resources. In order to delineate the scope of the AEC’s rights underthe well licenses, the Board had to interpret the oil sands leases, which wouldhave required an examination of the relevant energy statutes and applicablecase law. The well licenses would been contravened if, based on thisanalysis, AEC’s leased right to recover bitumen did not include the right toproduce initial gas-cap gas incidental to bitumen recovery. The court’sexpertise in determining legal issues, which involves analyzing and applyingcase law and interpreting contracts and statutes, is superior to the Board’s.See Barrie, at 218-219.[29] The situation is similar here. The Board was asked to determine whether a valid lease existedto support the licence. To do so, the Board was required to properly interpret an oil and gas leaseto determine the circumstances under which a lease could be maintained once the well was shut-in.This, in turn, required an interpretation of the phrase “capable of producing the leased substances”– the interpretation challenged in this appeal. Although the Board’s expertise may be relevant tofactual underpinnings of any interpretation adopted, it holds no special expertise in the interpretationof this phrase within this lease. Rather, the courts have superior expertise in determining legal issueswhich involve analyzing and applying case law, and interpreting contracts and statutes, and I am

Page: 7satisfied that correctness is the proper standard for the interpretation of meaning to be attributed to“capable of producing the leased substances” in the Cymbaluk Lease.[30] Accordingly, I find that correctness is the proper standard of review. The interpretive issuehere involves the application of general principles of contract interpretation that does not engage theBoard’s specialized expertise. Furthermore, we were advised by the parties during the hearing thelease being interpreted is a standard form lease that is in broad use throughout the industry. Thecourt noted in Goodwell, in discussing the criteria dealing with the “nature of the question” at para31:While questions of law “may be granted a wide degree of deference whereother factors suggest the legislature so intended,” no such legislative intentis evident in this case: Barrie at para. 18. In addition, questions of lawgenerally attract less deference when the decision will be of generalimportance or precedential value: Chieu v. Canada (Minister of Citizenshipand Immigration), [2002] 1 S.C.R. 84 at 100. The questions raised on appealin this case are questions of law or jurisdiction that will be relied on byindustry participants in the future in defining competing rights betweenbitumen and natural gas lessees. These considerations favour a lessdeferential standard of review.[31] Finally, I reject the Board’s argument that two standards of review apply to the Board’sinterpretation of the lease. When interpreting the lease there is no useful distinction betweenchoosing the proper interpretive rules, and giving meaning to the words. In either case, the Boardmust come to the correct conclusion.[32] In summary, I am satisfied that the standard of review applicable to the interpretation of thephrase “capable of producing the leased substances” found in this lease, is correctness.VIII. AnalysisA. Relevant Principles of Contractual Interpretation[33] An oil and gas lease is a contract. A tribunal, interpreting such a contract, must search forthe intention of the parties by examining the specific words used with regard to the whole contractand the demonstrated intention of the parties: Kensington Energy Ltd v B & G Energy Ltd, 2008ABCA 151 at paras 13-15, 432 AR 141. Individual words or phrases may achieve a clear meaningwhen the entire document is read: BG Checo International Ltd v British Columbia Hydro and PowerAuthority, [1993] 1 SCR 12 at 23-24, 99 DLR (4th) 577. Where the words of the contract areunambiguous, the court should not deviate from its clear terms unless the contract is absurd, or hasan effect clearly contrary to the intention of the parties: Scott v Wawanesa Mutual Insurance Co,[1989] 1 SCR 1445 at 1467, 59 DLR (4th) 660; Suncor Inc v Norcen International Ltd (1988), 89AR 200. Where the words of the contract are ambiguous, extrinsic evidence can be relied upon asan interpretive aid. It is from the whole of the document coupled with the surrounding circumstancesthat the general intention of the party or parties is to be ascertained: Suncor.

Page: 8[34] The search for the parties’ intentions is conducted on an objective basis. What the partiesbelieve their rights to be is not important, but what a reasonable person would infer them to be fromthe words used: ATCO Electric Ltd v Alberta (Energy and Utilities Board), 2004 ABCA 215, 361AR 1. In ATCO, at para 77, Fraser CJA adopted the language of Lord Hoffman in Jumbo King Ltdv Faithful Properties Ltd, [1999] HKCFAR 279:The construction of a document is not a game with words. It is an attempt todiscover what a reasonable person would have understood the parties tomean. And this involves having regard, not merely to the individual wordsthey have used, but to the agreement as a whole, the factual and legalbackground against which it was concluded and the practical objectiveswhich it was intended to achieve.[35] Similarly, in Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd, [2004] HCA 52, (2004), 79 ALJR129 the principle of objectivity by which the rights and liabilities of the parties are to be determinedwas described at para 40 as follows:It is not the subjective beliefs or understandings of the parties about theirrights and liabilities that govern their contractual relations. What matters iswhat each party by words and conduct would have led a reasonable personin the position of the other party to believe. References to the commonintention of the parties to a contract are to be understood as referring to whata reasonable person would understand by the language in which the partieshave expressed their agreement. The meaning of the terms of a contractualdocument is to be determined by what a reasonable person would haveunderstood them to mean. That, normally, requires consideration not only ofthe text, but also of the surrounding circumstances known to the parties, andthe purpose and object of the transaction.[36] Finally, while the goals, objectives, and practices of parties throughout the oil and gasindustry are similar, each lease must be interpreted on its own. Case law while often helpful, is notdefinitive.B. The Relevant Terms of the Cymbaluk Lease[37] As the phrase “capable of producing the leased substances” must be interpreted in the contextof the lease as a whole it is necessary to review the relevant terms of the lease. I start with theHabendum Clause which sets the primary term of a lease, and deals with how the lease can be madeto continue past its primary term. The Habendum Clause reads:TO HAVE AND ENJOY the same for the term of FIVE (5) years (hereincalled the “primary term”) commencing on the date hereof [February 8,2001] and continuing so long thereafter as operations (as hereinafter defined)are conducted upon the said lands, the pooled lands or the unitized lands,

Page: 9with no cessation, in the case of each cessation of operations, of more than90 consecutive days.[38] The “operations,” which can extend the lease, are defined in Clause 1(g):“operations” means any of the following:(i) drilling, testing, completing, reworking, recompleting, deepening,plugging back or repairing a well or equipment on or in the said landsor injecting substances by means of a well, in search for or in anendeavor to obtain, maintain or increase production of any leasedsubstance from the said lands, the pooled lands or the unitized lands;(ii) the production of any leased substance;(iii) the recovery of an injected substance; or(iv) any acts for or incidental to any of the foregoing;[39] When read together, these clauses provide that at the end of the primary term the lease willonly be extended if the lessee is conducting operations, as defined, without a cessation of more than90 days. Thus, while the lessee has five years to commence operations, once the five-year periodends the lease will expire unless a lessee is producing, recovering injected substances, drilling, orconducting other specific enumerated activities, without a cessation of more than 90 days.[40] Despite the stringent nature of these clauses, the lease provides relief to the lessee in certaincircumstances. The Force Majeure Clause, for example, provides relief from the need to conductcontinuing operations when certain circumstances arise that are beyond the lessee’s control. Clause16 reads:16. FORCE MAJEURE(a)(b)If operations are interrupted or suspended or cannot be commenced asa result of force majeure, this Lease shall not terminate during any suchperiod of interruption, suspension or inability to commence causedthereby or for 30 days thereafter.If the Lessee is unable, in whole or in part, by force majeure to carryout its obligations hereunder, other than any obligation to makepayment of any monies due hereunder, then the obligations of theLessee, so far as they are affected by such force majeure, shall besuspended during the continuance of any inability so caused; and thecause of the force majeure so far as possible shall be remedied with allreasonable dispatch.

Page: 10(c)Nothing herein shall require the settlement of strikes, lockouts or otherlabour disturbances except in the sole discretion of the Lessee.[41] Force majeure is defined in Clause 1 as follows:(c) “force majeure”means any cause beyond the Lessee’s reasonable controland, without limitation, includes an act of God, strike, lockout, or otherindustrial disturbance, act of any public enemy, war, blockade, riot, lightning,fire, storm, flood, explosion, unusually severe weather conditions,government restraints, including road bans, but shall not include lack offinances; (Emphasis added)[42] The Force Majeure Clause protects the loss of the lessee’s investment in the lease for definedreasons beyond the lessee’s reasonable control. The fact that “lack of finances” is excluded as acause of force majeure supports the clear inference that the parties intended the resource to bedeveloped without regard to lack of finances.[43] Similarly, Clause 3 of the lease – the Suspended Wells Clause – gives the lessee furtherflexibility. It reads:3. SUSPENDED WELLSIf, at the expiration of the primary term or at any time or times thereafter,there is any well on the said lands, the pooled lands, or the unitized lands,capable of producing the leased substances or any of them, and all suchwells are shut-in or suspended, this Lease shall, nevertheless, continue inforce as though operations were being conducted on the said lands, for solong as all the said wells are shut-in or suspended and so long thereafter asoperations are conducted upon the said lands, the pooled lands or the unitizedlands, with no cessation, in the case of each cessation of operations, of morethan 90 consecutive days. If no royalties are otherwise payable hereunderduring a lease year after the primary term within which such shut-in periodor periods occur and during such lease year no other operations areconducted on the said lands, the pooled lands, or the unitized lands then theLessee shall pay to the Lessor an amount equal toONE HUNDRED SIXTY AND 00/100 DOLLARS ($160.00) within 90 daysafter the expiry of such lease year (herein called the “suspended wellpayment”). (Emphasis added)[44] Clause 3 provides that when a well that is “capable of producing the leased substances” isshut-in or suspended the lease continues as though operations were being conducted. By deemingthat operations are continuing when the shut-in or a suspended well is capable of producing theleased substances, the clause protects a lessee against the loss of its investment. As the Board noted,

Page: 11the “lease also recognizes the practicalities of the oil and gas industry, which at times may presentan environment in which it is not reasonable or even possible for the lessee to produce the well.”(Board Decision 8). As examples of such contingencies, the Board cited the inability to moveproduct to market, or unfavourable market conditions that make it prudent not to sell.[45] These provisions, read together, demonstrate the general intention of both parties to discoverand exploit available resources quickly and efficiently so that both parties can profit – the lessorthrough a royalty, and the lessee through the sale of the resource. The Force Majeure Clause and theSuspended Wells Clause are designed to afford the lessee some flexibility so that it does not losethe benefit of the lease through a catastrophe beyond its control, or temporary market ortransportation conditions that make it unfeasible to produce.[46] Unlike some Canadian oil and gas leases, the Cymbaluk Lease does not (apart from the ForceMajeure Clause) describe when shut-in may occur. The Suspended Wells Clause deals only with theconsequences of a suspended or shut-in well that is “capable of producing the leased substances”.There may be many valid reasons to shut-in a well. For example, there may be no market for gasduring certain months, or quota may have been reached. Although the Board seemed to accept thata well capable of production would be shut-in for a valid reason – seemingly a reasonableassumption having regard to the terms of the lease and the desirability of capturing gas while captureis possible – none of the parties to this appeal challenged the right to shut-in a well for any reasonwhatsoever. As the issue of entitlement to shut-in is not directly engaged in this appeal, I leave toanother day the question of whether the language of this lease, viewed objectively, demonstrates acommon intention that a well, even one “capable of producing”, can only be shut-in for prudentreasons.[47] I turn now to the interpretation of the phrase “capable of producing the leased substances”found in the Suspended Wells Clause.C. The meaning of the phrase “capable of producing the leased substances”1. Position of the parties[48] Omers argues that the interpretation of a freehold mineral lease requires “strict attention tothe actual wording of a particular lease itself and a determinatively literalistic application of thatlanguage.” At para 40 of its factum, Omers says:Having regard to the legal principles set out above, OMERS submits that asuspended well is “capable of producing” for the purposes of the OMERS Leasewhenever it has the ability to achieve any production flow whatsoever. That is theplain and obvious meaning of the phrase “capable of producing the leasedsubstances”. OMERS further submits that a suspended well certainly has thatcapability whenever there is pressure from the leased substances at the outlet valueof that well. OMERS further submits that a suspended well has that capability even

Page: 12whenever steps can be taken to address that well’s conditions or the reservoirsconditions to achieve any production flow whatsoever.”[49] Furthermore, Omers takes issue with the Board’s test of “meaningful quantities” because itsays the phrase “meaningful” is elusive; it also strongly opposes reading in the words “producingin commercial or paying quantities” when the parties have chosen not to put these words in the lease.[50] Montane says that “capable of producing” means capable of producing on a sustained basisquantities that are sufficiently meaningful to provide an incentive to produce. Montane argues thatthe fact that there is positive pressure at the casing head of the well annulus is not sufficient torender a well capable of producing leased substances. Montane points out that in May andNovember 2006, Omers had attempted to get gas to flow on a sustained basis without success, andto suggest that such a well is “producing” within the meaning of the Omers lease is absurd. Montanesubmits that the shut-in clause provides only that the lease will continue when the well is capableof producing, or where operations are being conducted, language that would not be necessary if“capable of producing the leased substances” covered wells that needed to undergo operations inorder to obtain or maintain production.[51] The intervener argues that the phrase “capable of producing the leased substances” shouldbe read as “capable of producing the leased substances in paying quantities” (emphasis added). Shenotes that the extent of the production necessary to satisfy the Board’s interpretation received littleelaboration except for the Board’s assertion that the relevant factors in each individual case willgovern. The intervener submits that in the absence of governing case law in Canada, reference tothe American authorities is appropriate. In relying on such authorities, the intervener takes the viewthat “there is no comprehensible motivation for entering an oil and gas lease outside of the potentialfor economic gain.”2. The “paying quantities” argument[52] I propose, first, to deal with Cymbaluk’s argument that “capable of producing” meansproducing in “paying quantities”. Cymbaluk argues that the objective of this lease is the commondesire to profit from the development of the resource, and that this provides a rationale to supportthe term “capable of production in paying quantities”. Without such wording, or a comparableproviso, a lessor would have no incentive to grant a lease that could tie up property forever withoutany realistic hope of profit. Accordingly, she submits we should interpret the clauses consistent withpractical reality – namely, that the lessor would not have agreed to extend the term of the leaseabsent production in paying quantities. Cymbaluk relies upon American authority to support herargument and submits that in rejecting this test the Board misunderstood the distinction between“paying quantities” and “commercial quantities”. At para 26 of her factum, Cymbaluk states:The fundamental theory of the petroleum and gas lease is that the parties shouldbe entitled to reap the benefits of their respective investments. If a well canproduce in paying quantities, then presumably the lessee will only suspend or shutin the well for valid business reasons. However, once a well cannot produce in

Page: 13paying quantities, then the lessee must undertake some form of operations withinthe 90 days to try to get a producing well or the lease will expire. This allows forthe economic, orderly, and efficient development of the resources without allowinga lessor to simply hold onto a property in perpetuity for purely speculative reasons.[53] The other parties rejected this position before the Board and on appeal. Omers, in particular,argues that the wording of the shut-in clause does not require any commercial or volumetricamounts. Moreover, Omers refers us to various Canadian leases filed by the FHOA, where theparties have used express words to set out such requirements, including phrases such as “payingquantities”, “commercial quantities”, and “commercial production” and notes that the CymbalukLease contains no such language.[54] Omers also refers us to John Bishop Ballem, The Oil and Gas Lease in Canada, 4th ed.(Toronto: University of Toronto Press, 2008) at 109 and 154, for the principle that in freeholdmineral disputes it is necessary to pay “ strict attention to the actual wording of the particular leaseitself and a determinedly literalistic application of that language”. Ballem also suggests at 154 thatthe American interpretation of the word “produced” as meaning “produced in paying quantities” isunlikely to be adopted in Canada:In view of the approach taken by the Canadian courts on other aspects of the lease,it must be considered highly unlikely that the words would be expanded to includeany economic or volume conditions. If an operator is prepared to physicallyproduce a well, regardless of profit or loss, it is submitted that a Canadian courtwould hold that the “are produced” test has been met.[55] But Ballem was not addressing the specific issue involved here and does not refer to anyauthorities to support this broad proposition. Moreover, Ballem’s statement seems to refer to asituation where a well is capable of sustained production (profitable or not) which is not this case.[56] In this case, the words “in paying quantities” do not appear in the Cymbaluk Lease. Nor havethe parties referred us to any Canadian authority reading those words into the relevant terms of alease. To assess the merit of Cymbaluk’s argument, therefore, it is instructive to examine theAmerican case law. I recognize that any reliance on American law should not contradict conceptsadopted by Canadian courts (Scurry Rainbow Oil Ltd v Galloway Estate (1993), 138 AR 321 at para27, [1993] AJ No 227), and that Canadian courts are generally reluctant to apply American case law(Ballem 109). It is also important to remember that in each case the court’s interpretation turns onthe provisions of the specific lease being reviewed. Nonetheless, because of the lack of Canadianjurisprudence on point, and as the issues arising in this appeal have been dealt with in severalAmerican jurisdictions, a brief review of the American approach is helpful.[57] Gypsy Oil Co v Marsh, 248 P (Okla Sup Ct 1926), is an early decision interpreting the term“produced”. In Gypsy, the Habendum Clause provided that the lease continued for 3 years and “aslong thereafter as oil or gas or either of them is produced ....”.The Oklahoma court found that thepurpose of a lessor, executing a lease, is to have the oil and gas in the leased premises produced and

Page: 14marketed so that royalties may be received, while the lessee’s purpose is to discover and produceoil and gas for profit. The court went on to say at 333:These are material elements to be considered in the interpretation of the contract,and, if consideration is given these elements, it must be held that the word“produce”, when used in this connection, means something more than merediscovery of a trace of oil or gas, or the discovery thereof in quantities so small asto render the operation of a well unprofitable. Such a well would be no benefit toeither party.[58] The court found that “produce” and “produce in paying quantities” mean substantially thesame thing. The court stated further at 334:It has been generally held that “paying quantities”, when used in this connection,means paying quantities to the lessee. If a well pays a profit, even small, overoperating expenses, it produces in paying quantities, though it may never repay itscosts, and the enterprise as a whole may prove unprofitable. Ordinarily the phraseis to be construed with reference to the operator, and by his judgment whenexercised in good faith. (Lowther Oil Co. v. Miller – Sibley Oil Co. 53 W.Va, 44S.E. 433.)[59] It is noteworthy that the common intention to profit played an important role in the court’sdecision to interpret “produce” as being synonymous with “produce in paying quantities”.[60] Similar reasoning appears in Garcia v King, 164 SW 2d 509 (Tex Sup Ct 1942), where therelevant provisions of the lease allowed for continuation past the primary term for “so longthereafter as oil, gas, or other minerals is produced from the said land”. At the end of the 10-yearprimary term, the lease was only producing, on average, about 24 barrels of oil per month. This levelof production failed to produce a profit over and above the cost of operating and marketingexpenses. The court held, at 511, that “the very purpose of the land owner in executing the lease isto have the oil and gas on the leased premises produced and marketed so that he may receive hisroyalty therefrom, and the purpose of the lessee is to discover and produce oil and gas in suchquantities as will yield him a profit.” The court reasoned that the word “produce” meant more thanmere discovery, or production in small quantities. It went on to equate “production” with“production in paying quantities”.[61] The court, at 512-13, reiterated the need to consider the parties’ objectives in entering intothe lease when interpreting its language:The objective of the contract was to secure development of the property for themutual benefit of the parties. It was contemplated that this would be done duringthe primary period of the contract. So far as the lessees were concerned, the objectin providing for the continuation of the lease for an indefinite time after theexpiration of the primary period was to allow the lessees to reap the full fruits of

Page: 15the investments made by them in developing the property. Obviously, if the leasecould no longer be operated at a profit, there were no fruits for them to reap. Thelessor should not be required to suffer a continuation of the lease after theexpiration of the primary period merely for speculation purposes on the part of thelessees.[62] This interpretation of production was with respect to the continuation of a lease past itsprimary term. The court found that, viewed objectively, the parties would not have intendedanything short of a meaningful, profitable, or paying quantity when they entered into the lease.[63] One of the difficulties with the “paying quantities” test, however, arises when productionswings between being profitable and non-profitable. That issue was addressed in Lillie M Cliftonv R W Koontz, 325 SW 2d 684 (Tex Sup Ct 1959), where a well had been producing at a profit forseveral years but there had also been several months where the well operated at a loss. The lessorchallenged the lease as failing to produce continuously in paying quantities.[64] The court adopted the Garcia definition of “production in paying quantities”. It held that theterm “paying quantities” includes the ability to market the product at a profit. Income derived fromthe production must be in excess of actual marketing and operating costs. The court considered thewell marginal due to the periods of loss and sought a reasonable basis for testing the expectation ofprofitable returns from such a marginal well.[65] The court held that in the case of a marginal well, production in paying quantities isdetermined by whether, in all the relevant circumstances, a reasonably prudent operator, for thepurposes of making a profit and not merely for speculation, would continue to operate a well in themanner in which the well in question was operated. The court went on to state at para 9:In determining paying quantities, in accordance with the above standard, the trialcourt necessarily must take into consideration all matters which would influencea reasonable and prudent operator. Some of the factors are: depletion of thereservoir and the price for which the lessee is able to sell his produce, the relativeprofitableness of other wells in the area, the operating and marketing cost of thelease, his net profit, the lease provisions, a reasonable period of time under thecircumstances, and whether or not the lessee is holding the lease merely forspeculative purposes.[66] At para 10, dealing with the determination of whether production was in paying quantities,the court said, “Whether there is a reasonable basis for the expectation of profitable returns from thewell is the test...”.[67] This test is appealing. It recognizes that a profitable well today may operate at a losstomorrow. If “in paying quantities” means that at any given moment a well must produce, or becapable of producing, in paying quantities, then “capable of producing in paying quantities” couldrequire a moment by moment analysis of the well to ensure no breach of the Clause 3 requirement

Page: 16occurred. Indeed, if a well were producing at less than paying quantities for more than 90 days, andoperations as required by a particular lease have not occurred within the required time limit, thelease could be lost notwithstanding that production at greater than paying quantities had occurredand were readily foreseeable as occurring again. As the court noted, a short period of losses couldforce the respondents to immediately commence, or re-work, drilling operations to hold the lease.[68] In Clifton, the court found that any temporary slowing down or cessation of production wasjustifiable. Assessing the various factors set out above, the court found that the gas well was deemedto have continually produced in paying quantities, yielding an overall return in excess of operatingand marketing costs.[69] The Clifton interpretation of “in paying quantities”, and the suggested tests, minimize Omersand Montane’s argument that production in paying quantities would result in day-by-day, momentby-momentaccounting to determine the status of a marginal well and also relieves against the casewhere a well, although at certain times was not capable of producing in paying quantities, hadoverall profitability.[70] In addition, the following comments by the court, in Clifton at 433-34 are apt:We believe that the phrase “capable of production in paying quantities” means awell that will produce in paying quantities if the well is turned “on”, and it beginsflowing, without additional equipment or repair. Conversely, a well would not becapable of producing in paying quantities if the well switch were turned “on”, andthe well did not flow, because of mechanical problems or because the well needsrods, tubing, or pumping equipment.[71] Finally, in Hydrocarbon Management v Tracker Exploration, [1993] 861 SW 2d 427 (TexCt App), the shut-in royalty clause did not save the lease from expiry. The well was not producingin paying quantities before the shut-in, and it could not have done so immediately after. To save thelease, the court held that the well had to be able to produce in paying quantities once it was turnedon and immediately before it was turned off.[72] These cases were put before the Board in the argument below by the FHOA. The Boardrefused to read “paying quantities” into the lease. It stated:The Board agrees with OMERS and Montane that it should not, in thesecircumstances, infer or imply that production in commercial amounts orpaying amounts is needed to satisfy the requirement that the well be“capable of producing the leased substances.” That is not the wording usedby the parties, nor is it an interpretation that is so well established in theindustry or under Canadian law that the Board can reasonably infer it to bewhat the parties intended. (Board Decision 8)

Page: 17[73] Cymbaluk argues that the Board erred in that decision because it misunderstood, or failedto distinguish, the difference between “commercial quantities” and “paying quantities” and thatmisunderstanding influenced its decision to reject the “paying quantity” definition. This argumentis based on the following statement from the Board:The Board notes that in paragraph 8 of the Cymbaluk lease, dealing with offsetwells, the lease does use the phrase “If commercial production is obtained.” TheBoard must use caution not to import that standard to another provision of thelease unless it is satisfied that the parties themselves intended the phrase to havethat meaning. (Board Decision 8) (Emphasis added)[74] Cymbaluk submits that commercial production is different from production in payingquantities in that commercial production provides a return to an investor on his original investment,whereas paying quantities is generally understood to mean any profit over costs of operation andmarketing. In the present lease, commercial production is defined and relates to output that wouldcommercially and economically justify the drilling of a well. She argues that the Board’s failure tounderstand this distinction impacted its decision.[75] In my view, the main point the Board was making is that where parties spell out a specificquantitative measurement in one term of an agreement, a tribunal should be slow to assume theparties intended a specific quantitative measurement in another term where none was included. Evenif the Board’s comment suggests a misunderstanding of the meaning of “in paying quantities”,which in my view is highly unlikely considering its experience, I am not satisfied that the commentmaterially affected its decision. It is necessary to look at the totality of the Board’s reasons forrejecting “paying quantities” terminology. The Board agreed with Omers and Montane that it shouldnot infer or imply that production in “commercial amounts” or “paying amounts” is needed to satisfythe requirement that the well be “capable of producing the leased substances”. But then the Boardwent on to say, “That is not the wording used by the parties, nor is it an interpretation that is so wellestablished in the industry or under Canadian law that the Board can reasonably infer it to be whatthe parties intended.” (Board Decision 8). I am satisfied that even if the Board made an error byequating the two quantitative measurements, it was not a material error and the decision would bethe same.[76] In any event, I arrive at the same conclusion. Words should not be read into a contract unlessthe court is satisfied that the parties intended to contract subject to those words. Other terms of thelease contain quantitative definitions. The parties did not choose to include “in paying quantities”in Clause 3 of the Cymbaluk Lease. I agree with the Board that the words “in paying quantities”should not be implied: see Freyberg v Fletcher Challenge Oil and Gas Inc, 2005 ABCA 46, 363 AR35.[77] By making this finding, however, I do not wish to be seen as rejecting the general rationaleupon which the term “paying quantities” is based. I agree with the American authorities, and theBoard, that the purpose and goal of parties entering into such a lease is to develop the resource forthe purpose of making a profit. That purpose provides the rationale for concluding that where

Page: 18production extends the primary term of a lease, the parties would have anticipated production atsomething more than trivial or minuscule production. Certainly they would not have anticipated thata lessee could hold a lease by shutting in a well that was not capable of producing a meaningfulamount, even if not every moment would have been in paying quantities. In my view, although theBoard was not prepared to read the words “in paying quantities” into the contract, it adopted therationale underlying the American cases and was proper in doing so.3. Did the Board chose the correct test?[78] What then is the proper interpretation of Clause 3 of the Cymbaluk Lease and did the Boarderr in its interpretation of “capable of producing the leased substances”? An interpretation whichdefeats the purpose of the parties in entering an agreement should be discarded in favour of aninterpretation which promotes that purpose and a sensible commercial result: Bearspaw PetroleumLtd v Encana Corporation, 2011 ABCA 7, 39 Alta LR (5th) 302; Mannai Investment Co Ltd v EagleStar Life Assurance Co Ltd, [1997] 3 All ER 352 (HL), cited in Nickel Developments Ltd v CanadaSafeway Ltd, 2001 MBCA 79, 156 Man R (2d) 170 at para 34.[79] The Board conducted a cogent analysis of the Suspended Wells Clause within the contextof the entire lease, and in particular in relation to the Habendum Clause. It found that the SuspendedWells Clause mirrors the Habendum Clause, and that for the Suspended Wells Clause to apply toextend the lease, there must be either a shut-in well on the lands that is capable of producing, or ifthe well is not capable of production, operations, as defined in 1(g), must commence with nocessation of more than 90 consecutive days between successive operations. As well, the Board notedthat to extend the lease under the Habendum and Suspended Wells Clauses the lessee mustundertake operations if a producing well is no longer producing the leased substances or if asuspended or shut-in well is no longer capable of producing the leased substances (Board Decision8).[80] When dealing with the interpretation of “capable of producing the leased substances”, theBoard correctly found two factors must be satisfied. First, the well had to be capable of producingand, second, it had to be capable of producing the resource in a meaningful quantity. The Boardfound that to satisfy the “capable” requirement, the well must have the ability to produce in itsexisting configuration and state of completion. Applying that concept to the present case, the Boardrejected Omers’ argument that because well head pressures showed the existence of gas in thewellbore, the well was capable of producing the leased substance and all that was needed was aroutine water clean out operation. The Board correctly found that a well could not be capable ofproducing the leased substances and at the same time in need of an operation to address the waterloading to do so. Rather, the lease calls upon the lessee to address the water loading situation if itis required to produce the leased substances in meaningful amounts. With respect to the 100/05-4Well, the Board looked at the history of the well and concluded that it was not capable of producingthe leased substances and at the same time be in need of an operation to address the water loadingsituation to do so.

Page: 19[81] I agree with the Board’s conclusion that “capable” means that a well could produce in itsexisting state and configuration, without requiring further operations to produce, and in particular,of the kind listed in Clause 1(g) of the Cymbaluk Lease. To hold otherwise would defeat therequirements of the 90-day provision of the Habendum Clause and Clause 3. To suggest that a wellthat is not in working order, and upon which operations have not been conducted for more than 90consecutive days, satisfies the definition of “capable” in the term “capable of producing the leasedsubstances,” would make the 90-day time line stipulated in the Habendum Clause of the leasesuperfluous. In short, the well must be ready and able to produce gas (in the required quantity) whenthe tap is turned on.[82] Omers refers to the memorandum of judgment from this court in Bearspaw in support of itsposition that the well need not be able to produce immediately to be “capable of producing”. InBearspaw, the lessee had drilled three wells that were ready and able to produce gas at the tap whenthe 10-year primary term of the lease expired. All that was missing to market the gas was a pipeline.The Habendum Clause in the lease allowed the lease to continue for as long as “leased substances... are producible from the leased area.” The issue that arose in the ensuing litigation, therefore, wasthe meaning of “producible”.[83] The argument was that it was necessary for the well to be tied into a pipeline for the gas tobe producible. The trial judge rejected that argument and the Court of Appeal upheld that judgment,noting at paras 16 and 17:The word “producible” does appear to be commonly used as part of the phrase“producible reserves”, which has been interpreted to mean capable of beingproduced from a wellbore or reservoir: see Wheeler v. R., [1997] 2 C.T.C. 2960 atpara. 32; Sawtooth Industrial Resources Inc., Re, [2007] A.W.L.D. 1163, 2005CarswellAlta 2209 at paras. 40-48 (Alta. E.U.B.). This meaning is consistent withthat given to “producible” by the trial judge.Therefore, the plain and ordinary meaning of the word “producible” and pastrelevant applications of the term each support the trial judge’s conclusion thatthe lease continued because “producible” means something less than capable ofimmediate production, with no more to be done than turning on a valve.[84] In my view, this case is distinguishable. In Bearspaw, the well was acknowledged to becapable of producing, in that it was ready and able to produce gas at the tap. The issue of whetherthe well was capable of producing gas and in what quantities was not engaged, whereas that is thevery issue in this appeal.[85] In Bearspaw, the issue was whether a lessee was obligated to build a pipeline so that gascould be transported to market. The court in Bearspaw was not dealing with a well that requiredfurther operations to attain any sustained production, nor was it dealing with whether the clause“capable of production” required a volumetric amount of production. There was no issue of whetherthe well itself, in its present configuration, could produce leased substances, nor if there were leased

Page: 20substances to produce. The issue assumed both the ability to produce when the tap was turned onand gas in the reservoir worthy of production.[86] The court in Bearspaw was also dealing with a habendum clause that employed the word“producible” rather than the usual “produced or producing”. The court noted the importance ofdifferences in lease language at paras 29-30 when distinguishing Freyberg , as well as the differencebetween a well that is shut-in at the lessee’s choice:Freyberg involved the interpretation of a habendum clause which provided that theterm of the lease depended upon the leased substances being “produced” ratherthan “producible”. The case also arose from different facts, including a well thatwas tied into a pipeline but “shut-in”, and lessors who had chosen not to produceand market the gas by “shutting off” the well.We do not interpret Freyberg as suggesting that a lease cannot define its term onthe basis of anything short of immediate and continual production, but rather thateach lease must be interpreted strictly on its own terms. The policy concernsoutlined in Freyberg do not preclude parties to a lease from choosing its durationon a basis other than that of immediate production, which is what occurred herethrough the use of the word “producible” rather than “produced”.[87] If anything, the finding in Bearspaw that the wells were ready and able to produce when thetap was turned on supports the Board’s finding that a well must be capable of producing in itsexisting configuration without requiring further operations that continue a lease.[88] It follows that Omers must lose this appeal unless the minimal amount of gas that flowedfrom the tap here, described by Montane as a “puff” of gas, constitutes, in itself, production. Thismeans asking whether “capable of producing the leased substances” requires a particular volumeof gas. What did the parties intend by the term “producing”?[89] The Board found there must be a meaningful quantity of gas to satisfy the phrase “producingthe leased substances”. It stated at 9 of its decision:[T]here must be at least some material, as in a meaningful, volume of productionpossible for the lessee to rely on the suspended well clause to extend the lease. Aninterpretation that would permit a very low or even nonexistent threshold wouldprovide little or no incentive for a lessee to undertake operations to enhance therecovery of leased substances. It would also result in only a nominal return to thelessor for an indeterminate length of time without any obligation on the lessee torectify the situation. Such an interpretation is, in the Board’s view, contrary to theintention of the parties as expressed throughout the lease as a whole.[90] Summing up the interpretation of the phrase “capable of producing the leased substances”in the Suspended Wells Clause, the Board stated that the phrase:

Page: 21....is to be interpreted to mean the demonstrated, present ability of a well on thelands to produce the leased substances in a meaningful quantity within thetimeframes contemplated in the lease. The Board emphasizes that what is“material” or “meaningful” depends on the relevant factors in each individual case.(Board Decision 9)[91] To determine the parties’ intent relating to the quantitative volumetric requirement, theBoard reviewed the entire lease. With respect to the financial rewards for the lessor, the Board notedthat the initial lease payment of $5,000, and the further rental fee of $640, were nominal rewardsand that the primary benefit to the lessor under the lease was the royalty on production. In the eventof a shut-in well, where no operations are conducted during a lease year, the suspended wellpayment is only $160. Considering that payment as compared to a royalty, the Board stated:This indicates to the Board that the parties would not have intended that the leasewould continue for an extended period past the primary term in circumstanceswhere the lessor received only the suspended wells payment because the lesseecould not obtain production in meaningful quantities from the well. That could,however, be the result if the phrase “capable of producing the leased substances”were interpreted to mean a well capable of producing any minuscule orinsignificant amount. As FHOA indicated, that interpretation would allow a lesseeto continue the lease almost indefinitely without any real sharing of the benefits ofthe lease with the lessor. It is an interpretation that is contrary to the commonintentions of the parties to the lease as expressed in the sharing of rights andresponsibilities under the lease for mutual benefit. (Board Decision 9)[92] These, and other comments throughout its decision, suggest that the Board intended that“meaningful” would reach levels associated with profitability or commercial viability. Viewedobjectively, an owner would not tie up property indefinitely for a quantity of production that wouldnever pay – which is a result that could flow from Omers’ interpretation. Moreover, the HabendumClause and its 90-day clause would be meaningless once the primary term has passed, unless thelease requires the lessee to be diligent about performing required operations. Moreover, aninterpretation suggesting a lessor would agree to tie up its land to a lessee beyond the primary termfor speculative purposes only is unreasonable.[93] Omers argues that the Board’s interpretation does not reflect the commercial context thatincludes serious risk and expense on the part of the lessee. In exchange for this risk and expense,the lessee expects that if it encounters hydrocarbons, its right to produce them will be maintained.But this argument only addresses the commercial interests of the lessee. To be sure, the risk andexpense to the lessee are significant. That risk and expectation are managed, however, by theHabendum Clause and the Suspended Wells Clause in the following ways:1. If the well is producing at the end of the primary term, the lease will not expire;

Page: 222. If the lessee is conducting operations related to repair or maintenance at the end ofthe primary term, the lease will not expire;3. If a well is capable of producing but is shut-in (for instance, market conditions),the lease will not expire; and4. If the shut-in well is not capable of producing but the lessee is conductingoperations on the well, the lease will not expire.[94] In my view, the parties intended that to continue the lease past the primary term, the wellmust be capable of producing a volumetric quantity that would encourage both production andoperations to maximize that production. The lessee is granted a substantial primary term where ithas great discretion as to timing of its operations. But if it seeks to hold the lease past the primaryterm, there are conditions. The various lease provisions were intended to balance the parties’ rightsby ensuring that the interests of the lessee are protected, while at the same time ensuring that theterm of the lease cannot be extended indefinitely when there is no reasonable expectation of a returnto profitability in the near future.[95] Given the rationale which the Board employed to support its choice of “meaningful”, I donot see a significant difference between “meaningful” quantity and “paying” quantity – although incertain circumstances the latter may provide more latitude than the former. While I am not preparedto interpret the Suspended Wells Clause as requiring production in “paying quantities”, I note thatthe reasoning behind the concept of “paying quantities” in the American authorities, and that usedby the Board for choosing “material” and “meaningful”, are very similar. That rationale seeks tosupport the common objective of the parties to benefit by profit from development of the resource.It strains common sense to think a lessor would agree to tie up its land past the primary term, andperhaps indefinitely, for a lessee’s speculative purposes only and for a well that lacks commercialviability: see Freyberg at para 50. By using the term “meaningful” the direction of the Boardappears to be much the same as that of the American courts in choosing “paying quantities”. Beforea lessee can take advantage of the Habendum Clause and the Suspended Wells Clause to extend ormaintain the lease beyond the primary term, there must be a meaningful amount of resource capableof production. It was never intended that the shut-in well clause could allow a lessee to hold aproperty for purely speculative purposes. There must be some commercial viability to the well.Moreover, if the well requires operations of the type defined in the lease to be capable of producingthat meaningful quantity, those operations, must be conducted as required by the lease.[96] In cases where the production is clearly profitable, quantification, and how it is arrived at,will not be an issue. Certainly in this case, the volume was not meaningful by any application of thatword, as indicated by the short time gas flowed after the two clean outs. As cases move forwardthrough the Board and the courts, the volumetric test will undoubtedly be refined within the contextof the specific cases. The tests set out in Clifton relating to marginal wells may prove helpful guidesin developing Canadian jurisprudence on this issue. As noted in paragraphs 63-64, some questionsa tribunal might ask are: Would a reasonably prudent operator, for the purpose of making a profit

Page: 23and not merely for speculation, continue to operate a well in the manner that it does? Or put simply,“Is there is a reasonable expectation of profitable returns from the well?” .[97] In conclusion, the Board did not err in applying a quantitative requirement. Its test of“meaningful”, as opposed to something more definitive in terms of quantity, would not have affectedits decision having regard to its fact findings. In my view, the Board used the word “meaningful”in the sense that the quantity was sufficient to provide a reasonable expectation of profits, and it didnot err in doing so.[98] The Board’s interpretation is correct. It gives effect to the plain and ordinary meaning of thecontract as a whole and with regard to the commercial realities at the time the parties entered theagreement.[99] The appeal is dismissed.IX. ConclusionAppeal heard on May 11, 2011Reasons filed at Calgary, Albertathis 7th day of September, 2011Conrad J.A.I concur:I concur:“authorized to sign”Berger J.A.McDonald J.A.

Page: 24Appearances:T.M. Bewsfor the AppellantD. Burns and G.D. Perkinsfor the Respondent Energy Resources Conservation BoardB.J. Rothfor the Respondent Montane Resources Ltd.W.T. Osvathfor the Intervener Eva Cymbaluk