IFP Technologies (Canada) Inc v EnCana Midstream and Marketing, 2022 ABKB 807
Opinion
Court of King’s Bench of Alberta Citation: IFP Technologies (Canada) Inc v EnCana Midstream and Marketing, 2022 ABKB 807 Date: 20221202 Docket: 0301 03520 Registry: Calgary Between: IFP Technologies (Canada) Inc. Plaintiff - and - EnCana Midstream and Marketing, PanCanadian Resources, EnCana Corporation, EnCana Oil & Gas Developments Ltd., Canadian Forest Oil Ltd., and The Wiser Oil Company Defendants _______________________________________________________ Reasons for Decision of the Honourable Justice C. S. Anderson _______________________________________________________ I.
Introduction [ 1 ] This is the latest iteration in the protracted litigation between IFP Technologies (Canada) Inc (“IFP”) and the various defendants. As discussed below, the task of this court at this point is to determine the amount payable to IFP pursuant to an accounting. II.
Facts [ 2 ] The contractual relationship arose in October 1998, when IFP entered into an Asset Exchange Agreement (“AEA”) under which it exchanged a gross overriding royalty on a number of wells (valued at $14.8 million) for 20% of the working interest of PanCanadian Resources (“PCR”) in the petroleum and natural gas rights in a property known as Eyehill Creek. [ 3 ] Earlier, in January 1998, PCR believed that a number of sections in Eyehill Creek were an attractive candidate for recovery of heavy oil using an enhanced thermal recovery process known as steam-assisted gravity drainage (“SAGD”).
PCR believed that primary production was finished at Eyehill Creek and that the field should be considered abandoned if production was limited to primary production only. At the time, PCR already had drilled 222 wells at Eyehill Creek, most of which were shut in because they were no longer economically viable. [ 4 ] IFP had a level of technological expertise and innovation and both PCR and IFP intended to pursue a SAGD project at Eyehill Creek.
[ 5 ] Shortly after the parties entered into the AEA, a number of circumstances changed, including that heavy oil prices fell, and gas prices rose. The economics of a SAGD project at Eyehill Creek began to look poor. [ 6 ] By December 2000, PCR had entered into talks to farmout its 80% working interest in Eyehill Creek to The Wiser Oil Company (“Wiser”), which a month earlier had acquired a lease of part of the lands in Eyehill Creek. In March 2001, PCR and Wiser executed a letter agreement setting out the terms under which Wiser would earn PCR’s working interest in Eyehill Creek.
PCR and Wiser entered into an Interim Operations Agreement dated March 31, 2001 (“Interim Agreement”) and an Abandonment Reclamation and Option Agreement dated May 18, 2001 (“ARO”). Wiser planned to reactivate some existing wells and drill new ones using primary production methods. IFP refused to consent to PCR’s disposition, believing that Wiser’s primary production would negatively affect any potential SAGD recovery. [ 7 ] Having been unsuccessful in its attempts to resolve the issue, IFP filed a statement of claim in 2003, alleging breach of contract by the defendants.
IFP alleged that PCR’s farmout to Wiser of its working interest in the Eyehill Creek reservoir, without IFP’s consent, made it impossible for IFP to realize upon its minority interest. More specifically, IFP alleged that the primary production carried out by Wiser had permanently and negatively impacted the thermal development potential of the reservoir. It sought damages for the loss of opportunity to pursue thermal and other enhanced recovery.
In the alternative, IFP sought an accounting of the profits, Wiser and its successors realized from primary production in the Eyehill Creek reservoir. [ 8 ] PCR took the position that the contract gave IFP an undivided 20% working interest in oil and gas at Eyehill Creek arising from thermal or enhanced recovery methods only. [ 9 ] Justice Stevens heard the six-week trial in 2011 but died before issuing his decision. In 2014, then Chief Justice Wittmann took over the case and issued written reasons ( 2014 ABQB 470 ).
He accepted PCR’s position and concluded that IFP’s 20% working interest was limited to thermal and other enhanced recovery operations only. He then concluded that IFP had been unreasonable in objecting to the disposition of PCR’s working interest to Wiser. He found that Wiser was novated into the agreements and that the joint operating agreement continued to bind Wiser and IFP. [ 10 ] With respect to damages, Wittmann CJ concluded that IFP had failed to prove that primary development of the reservoir had destroyed it for development through thermal and other enhanced recovery.
In any event, he found IFP’s modelling was so flawed that it was impossible to assess damages with any degree of accuracy. Further, he discounted any damages by 100% to reflect the “chance of non-occurrence”, since IFP had failed to establish that the purported thermal production opportunity ever would have been realized. [ 11 ] IFP successfully appealed.
The Court of Appeal found that that IFP owned an undivided 20% working interest as a tenant in common in all the oil and gas leases and other assets held by PCR in Eyehill Creek ( 2017 ABCA 157 ). [ 12 ] The Court of Appeal concluded that IFP acted reasonably in refusing to consent to PCR’s disposition to Wiser; consequently, Wiser was not novated into the joint operating agreement. The majority held that IFP was entitled to an accounting for its proportionate share of all net revenue from primary production at Eyehill Creek on both existing and new wells. III.
Issues [ 13 ] In addition to the issue of the 2011 trial costs, the Court of Appeal remitted two issues to this court for determination, at paragraphs 217 and 218 of its decision: …two issues remain unresolved which this Court is not in a position to settle. The first relates to the effect of the contractual limitation on liability contained in
Article 7.9 of the AEA. The Trial Judge found that any damages award would have been limited, in any event, to $16,000,000 based on this Article. However, he did not consider the potential application of this limitation, if any, in the context of IFP’s continued ownership of a working interest in the Eyehill Creek Assets. Consequently, whether that
Article limits in some way IFP’s ownership interests or its ability to require Wiser to account to IFP for IFP’s proportionate share of the net proceeds of primary production to date remains an open issue. In other words, does the $16,000,000 limitation apply to restrict either IFP’s ownership interest or the amount of net revenue it is entitled to receive from primary production to date at Eyehill Creek? We received no argument on this point. The second issue relates to how to calculate the net revenue.
In addition to the obvious, there is a question of whether and to what extent, if any, IFP should be responsible for abandonment costs of existing infrastructure. To take a few examples only, there may be wells that were not reactivated at all and have now been formally abandoned. Whether IFP is responsible for what would otherwise be its proportionate share of those costs remains another open issue. Also, there might be certain abandonment costs that were already required to be paid when existing wells were reactivated.
In other words, those costs might have been baked in, with or without reactivating them for primary production. Again, is IFP responsible for those costs or only the incremental costs of abandoning the wells associated with their reactivation for primary production? And is it, in any event, open to IFP to opt in to existing wells on an individual basis? Again, we heard no argument on these or related points dealing with how to determine the “net revenue” realized from primary production at Eyehill Creek. IV. Analysis [ 14 ] As detailed below, these two “global” issues raise a number of sub-issues.
Some of these already have been settled by the parties, some provide a framework for the accounting, and some are specific to the accounting itself. I have considered in this decision the oral arguments of the parties, as well as their written arguments (including the schedules). A. Expert Evidence
[15] Before I turn to the various issues arising in this case, I consider it necessary to make some general comments about theexpert accounting evidence presented. [16] At the 2011 trial, IFP provided expert accounting evidence from Mr. Barry Parker. In this proceeding, IFP’s expert, Mr. MarkPelzer, a chartered professional accountant, was qualified to give expert opinion evidence in calculating net revenue from the productionof oil and gas assets. Mr. Pelzer provided several reports. [17] On behalf of the defendants, I heard from Mr.
Kody Carroll, who is a member of the Executive Board of the Petroleum JointVenture Association and a member of the Petroleum Accountants Society of Canada. Mr. Carroll was qualified to give expert opinionevidence in Canadian joint venture accounting procedures and in practices and principles in the oil and gas industry for purposes ofcalculating net revenue realized from oil and gas assets. Mr.
Carroll produced a primary report dated September 28, 2021, on thecalculation of damages owed to IFP at Eyehill Creek, a rebuttal report dated March 7, 2022, and a surrebuttal report dated March 29,2022. [18] I also heard from Ms. Katrina LaRocque, who is a certified engineering technologist and a petroleum accountant accredited bythe Council of Petroleum Accountants Societies. There are fewer than 300 accredited petroleum accountants in the world. Ms.
LaRocquewas qualified to give expert evidence in the application of generally accepted accounting practices in calculating net revenue realizedfrom the production of oil and gas assets. [19] After hearing Mr. Pelzer’s evidence, I was left with some significant concerns. First, the methodology in his reports wasinconsistent. At times, he refused to apply standard industry practices and standard terms on the grounds that the parties had not enteredinto any agreement. However, he relied upon those same practices and terms to calculate other items, such as an interest rate.
Similarly,as I will discuss later in these Reasons, he was inconsistent in his approach to accounting for costs. [20] Further, and importantly, several material inconsistencies and errors in Mr. Pelzer’s reports were raised during cross-examination. In his primary report, Mr. Pelzer calculated processing fees of $6,355,355.24. He testified that these were actual processingcharges. In his second supplemental report, however, Mr. Pelzer reduced the processing fees to $435,044.12, a difference of almost $6Million to IFP’s credit.
On the stand, he was unable to explain this discrepancy and agreed that “it would be very difficult” for thedefendants’ experts to understand the discrepancy. Given an opportunity to look into it, Mr. Pelzer later testified that there was an errorin the spreadsheet and that the correct number is “extremely close to $6,355,000”. [21] Mr. Pelzer indicated that his supplemental report covered the period up to July 2001 and that he had “made no other changesto the opinion expressed in [his] primary report”.
Under cross-examination, he acknowledged that he had corrected what he called atranspositional error of $4 million from his primary report that had been identified by the defendants. When questioned why he did notdisclose this change, Mr. Pelzer stated, “I never said there was no changes. What it reads here is that I have made no other changes to theopinion”. When pressed further, he testified that he didn’t think it was necessary to identify the change or correction because he haddiscussed it with the defendants. [22] In his primary report, Mr.
Pelzer stated that well JVSA0382 reported revenue of $4,729,666.68 whereas in his supplementalreport the revenue was recorded as $2,395,503.33. On the stand, he conceded that one or the other was wrong. [23] In another instance, Mr. Pelzer’s primary report identified a well as being abandoned with no revenue as of October 2001. Inhis second supplemental report, he continued to show the well as abandoned, but reported revenue from it of $1,839,000.
He was unableto explain this discrepancy but stated that he believed “the first report had an incorrect number associated with it.” Later, he suggestedthat one of the reports is “off by a row”. He acknowledged that there were inaccuracies that were unexplained in his reports. [24] In his supplemental report (to July 2021), Mr. Pelzer set out IFP’s proportionate share of net revenue realized from EyehillCreek at not less than $19,000,627. In his second supplemental report (to April 2022), he updated this figure to $21,000,684. Mr.
Pelzerwould not acknowledge that the field had been shut in during this period but acknowledged there had been very little production. Whenasked how the amount owing to IFP could increase by $2 million when there had been no or little production, Mr. Pelzer answered thatthere had been filter errors. Ultimately, he acknowledged that his second supplemental report was incorrect. [25] Moreover, I had concerns with the manner in which Mr. Pelzer testified. In my view, Mr. Pelzer did not present as anobjective, independent witness. During cross-examination, he was at times combative, non-responsive and defensive.
At one point, I hadto direct him to answer a question. This is not in keeping with the standard for expert witnesses articulated by the Supreme Court ofCanada in R v Mohan, (SCC), [1994] 2 SCR 9 and White Burgess Langille Inman v Abbott and Haliburton Co, 2015SCC 23. In White Burgess, the Supreme Court indicated that an expert’s impartiality goes to both the admissibility and weight of hisevidence; the court stated this at paragraph 10: In my view, expert witnesses have a duty to the court to give fair, objective and non-partisan opinion evidence.
They must be aware ofthis duty and be able and willing to carry it out. If they do not meet this threshold requirement, their evidence should not be admitted.Once this threshold is met, however, concerns about an expert witness’ independence or impartiality should be considered as part of theoverall weighing of the costs and benefits of admitting the evidence. … [26] While I am not prepared to reject all of Mr.
Pelzer’s evidence outright, I have given most of his evidence little, if any, weight.My concerns with his evidence are relevant to my findings on the various issues in respect of this accounting, as will be seen below. [27] By contrast, Mr. Carroll was a very impressive expert witness. His reports were organized, clear and thorough and he wasprofessional, forthright, and helpful in his testimony. It was clear that he very much enjoyed his task of explaining basic concepts of oiland gas accounting to the court and counsel. Mr.
Carroll has taught classes on this subject and his proficiency in doing so came acrossclearly. His demeanour did not change whether he was testifying in chief or under cross examination. He acknowledged when his reportwas unclear or incorrect and he explained his answers and report in an unbiased manner. It was clear that, as he stated twice, he had “noskin in this game”.
In addition, his reports were structured such that I can still rely upon them whether I rule in or out certain expenses.All of this, in my view, is consistent with the proper role of an expert witness, as articulated by the Supreme Court of Canada in R v
Howard, (SCC), [1989] 1 SCR 1337 at paragraph 19: “Experts assist the trier of fact in reaching a conclusion byapplying a particular scientific skill not shared by the judge or the jury to a set of facts and then by expressing an opinion as to whatconclusions may be drawn as a result.” [28] Ms. LaRocque, too, was an extremely impressive witness. The defendants retained her because Mr. Carroll and Mr. Pelzergave such divergent opinions. Ms. LaRocque did not “crunch all the numbers” as Mr. Carroll and Mr. Pelzer had, but rather gave opinionevidence on industry standards and the overall methodology used by Mr.
Pelzer. [29] I am satisfied that Ms. LaRocque’s testimony did not unduly lengthy this trial in any material manner. Given the widediscrepancy between the other two experts, it was helpful and appropriate for me to receive Ms. LaRocque’s evidence and provided someassurance about oil and gas accounting and a “check” on the other accounting experts; see, for example, Simms Sigal & Co Ltd v CostcoWholesale Canada Ltd, 2017 QCCS 5058 at paragraphs 382-383 and A.A. v C.A.G., 1996 Q.J. 672. [30] I am satisfied that the steps that Ms.
LaRocque took in preparing her opinion, demonstrated an independence from both expertwitnesses. Ms. LaRocque did not contact Mr. Carroll prior to rendering her opinion. With those findings on the expert accountingevidence as background, I turn now to the issues. B. Settled Issues 1. Net Revenue Realized versus Net Revenue [31] The parties agree that net revenue realized has a specific meaning to the accounting profession. It is a term of art.
Net revenueis not the same as net revenue realized. [32] In its decision, the Court of Appeal, at paragraph 218, held that one of the issues remitted back to this court was “how tocalculate net revenue”.
Then, again, at paragraph 222 of its decision, the Court of Appeal stated that, “the outstanding issues relating tothe disputed cap on liability and calculation of net revenue of primary production at Eyehill Creek are remitted to the Queen’s Bench fordetermination.” (My emphasis in both.) As a result, IFP initially took the position that it was entitled to an accounting of net revenue,which IFP asserted does not include any capital costs. [33] I note that at other times in its decision, the Court of Appeal referred to “net revenue realized”.
At paragraph 90, the Court ofAppeal held that “IFP is entitled to an accounting for 20% of the net revenue realized by Wiser through primary production at EyehillCreek”. At paragraph 216, they held that “IFP is entitled to an accounting for its proportionate share of all net revenue realized to datefrom primary production at Eyehill Creek on both existing and new wells” and at paragraph 221 that “IFP is entitled to an accounting forits proportionate share of the net revenue realized from primary production at Eyehill Creek.” (My emphasis in all.) [34] Ms.
LaRocque testified that net revenue is not a term she recognizes. [35] Mr. Pelzer testified that “net revenue” is often understood as “net income” which is “gross income” less expenses. “Netincome” does not include capital costs, Mr. Pelzer testified. Therefore, in his primary report (at paragraph 66), Mr. Pelzer stated that “nocapital costs have been included in [his]
summary.” In his surrebuttal report, Mr. Pelzer stated that capital costs do not form part of thecalculation of net revenue even though in the normal course, a joint venture partner would be expected to contribute its proportionateshare of capital costs associated with production. Under cross-examination, Mr. Pelzer confirmed that he did not include capital costs inconnection with drilling, completion or equipping. [36] IFP now agrees that I am to make my findings on “net revenue realized” from primary production at Eyehill Creek. In hissecond supplemental report, Mr. Pelzer took into account some capital costs.
IFP stressed, however, that Mr. Pelzer’s earlier reports didnot take into account capital costs because of IFP’s understanding of the Court of Appeal’s direction. 2. Commencement Date of Accounting [37] The second now-settled issue is the commencement date of the accounting ordered by the Court of Appeal. The Court ofAppeal held, at paragraph 216, that IFP was entitled to an accounting for its proportionate share of all net revenue realized to date fromprimary production at Eyehill Creek on both existing and new wells.
Primary production at Eyehill Creek took place prior to 1998, whenthe AEA was signed, and prior to Wiser’s involvement in 2001. There was therefore an issue as to when the accounting shouldcommence. [38] The Court of Appeal also stated, at paragraph 90, that IFP is entitled to an accounting for 20% of the net revenue realized byWiser through primary production at Eyehill Creek. [39] The defendants submit that, in its pleadings, IFP claimed an accounting only from Wiser. Wiser only became involved inEyehill Creek in 2001. IFP concedes that the accounting period ought to commence in 2001. Indeed, Mr.
Pelzer used 2001 as thecommencement date in his reports. [40] In accordance with the parties’ agreement, I am to calculate net revenue realized from 2001 onward. Some of the calculations(those that include items from 1998) will have to be adjusted to commence from 2001. C. Preliminary Issues 1. Disclosure
[ 41 ] An allegation that was omnipresent throughout IFP’s case was that the defendants withheld or failed to disclose information and records in their possession. [ 42 ] Although not specifically argued before me, I assume the issue of disclosure is relevant to IFP’s position for two reasons. First, the alleged non-disclosure provides an explanation for the number of Mr. Pelzer’s reports and for certain omissions therein. Second, the defendants relied on estimates instead of reviewing their records, which allegedly prevented IFP from challenging the defendants’ numbers and accounts. [ 43 ] Mr.
Carroll testified that he was responsible for providing Mr. Pelzer with the information or data requested. I accept that there was a significant amount of data and information to compile. The production of Eyehill Creek dates back more than 20 years. There were approximately 4500 record boxes and 500,000 rows of computer data across various periods and accounting systems. [ 44 ] Mr. Carroll testified that the boxes were not labelled well. Mr. Pelzer initially requested documents for tens of thousands of transactions and Mr.
Carroll stated that he would “still be there trying to pull those records for everything they asked for initially”. Mr. Carroll pulled approximately 50 boxes from off-site storage. These filled up an entire office and it took him and another employee over a day to find 50 documents from those boxes. Mr. Pelzer asked for documents relating to transactions valued between $53 and $500,000. Mr. Carroll questioned the materiality of some of the documents but ultimately pulled what was asked. [ 45 ] Mr. Carroll testified that when he and Mr.
Pelzer were preparing their reports, he hoped they could work together on a best- efforts basis in good faith. He stated that where the requests seemed excessive, he asked for more reasonableness. [ 46 ] Both parties relied upon data from the Joint Account Data Extract (“JADE”), a listing of all transactions made to a cost center or authorization for expenditure for any given period and entered into an accounting system. Mr. Carroll testified: I wanted to make sure that I provided Mr.
Pelzer with a reasonable number of documents that could be used to efficiently satisfy any questions that he had on the JADE that he had in front of him. So, our time going through boxes took over 14 hours to pull about 50 documents from these unorganized boxes and I got no further requests for other supporting documents after that. [ 47 ] Mr. Carroll also testified that on December 4, 2020, he sent a letter to Mr.
Pelzer indicating that the defendants had fulfilled the requirements for information discussed at their meeting and that he received no response to this letter or objection to the assumption contained therein. [ 48 ] I accept Mr. Carroll’s evidence and find that neither the defendants nor Mr. Carroll deliberately failed to disclose any information or attempted to frustrate Mr. Pelzer’s efforts to prepare his reports and provide his opinion. As discussed above, Mr. Carroll conducted himself throughout these proceedings in a professional and responsible manner. The suggestion that he intentionally hindered Mr.
Pelzer’s task is inconsistent with my findings about his professionalism and conduct during this trial. 2. Methodology [ 49 ] There was considerable disagreement between the parties as to the appropriate approach to this accounting. The parties’ arguments and my findings in this respect help to provide a framework for the necessary calculations. IFP asserts that it is entitled to an accounting not an assessment of damages, that is entitled to a share in the profitable wells only, and that it is entitled to compound pre- judgment interest at 2% plus prime per annum.
I will deal with each of these issues separately below. a. Accounting vs Assessment of Damages [ 50 ] In its brief, IFP stressed the difference between an accounting and an assessment of damages. It cites Eli Lilly and Co v Apotex Inc , 2014 FC 1254 and Nova Chemicals Corporation v Dow Chemicals Company , 2020 FCA 141 for these principles: 5. An accounting is fundamentally different from an assessment of damages. 5.1. In an assessment of damages, the focus is on the profit the plaintiff would have earned, but for the defendant’s conduct. 5.2.
In an accounting, there is no hypothetical analysis: the focus is on the profit actually earned by the defendant. 6. Unlike the case in a damages assessment, the Court must avoid the “hypothetical ‘but for’ world” in an accounting. 6.1. The focus in an accounting is on the profit actually earned by the defendant in the “real world”, determined from actual revenues and actual costs. 6.2.
The Court must avoid the “but for” world because it is “irrelevant” what the parties could, would or should have done in a hypothetical world where the defendant had behaved differently. [ 51 ] IFP asserts that the defendants must prove (rather than estimate) any expenses they seek to deduct and that in the absence of a joint venture agreement, the defendants cannot rely upon estimates calculated in accordance with Canadian Association of Petroleum Landmen (CAPL) or Petroleum Accountants Society of Canada (“PASC”) accounting procedures [ 52 ] I note however, that both sides sought to rely upon CAPL terms: Mr.
Pelzer stated that he did so. Ms. LaRocque testified that CAPL terms retroactively reflect standard industry practice. [ 53 ] Very recently, the Supreme Court of Canada allowed the appeal from the Federal Court’s decision in Nova ( 2022 SCC 43 ). While that decision was closely focused on the patent infringement context and I appreciate that the parties have not had the benefit of making submissions on it, I take guidance from the Supreme Court’s comments at paragraph 48:
But deterrence should not be conflated with punishment. An infringer can be liable for patent infringement even if they had noknowledge of the patent or genuinely believed that the patent was invalid (Schmeiser, at paragraph 49). An accounting of profits shouldtherefore discourage infringement but do no more.
This requires disgorging only the profits causally attributable to the invention.Requiring infringers to disgorge anything more would constitute punishment and risk chilling public innovation and competition.Disgorging anything less would reduce the incentive to invent (Merck, at paragraph. 42; ADIR, at paragraph 39). [Emphasis in original.] [54] This, in my view, provides some answer to IFP’s objection to the use of estimates. The evidence before me suggests thatestimates are employed in accounting procedures, where there is reasonable certainty that the expenses were in fact incurred.
Further, Ialso heard evidence that where an operation is wholly owned, often certain expenses, even though incurred, are not recorded. [55] I find that to hold the defendants to a more exacting standard by refusing deductions for expenses where there is reasonablecertainty that they were incurred but where precise documentary evidence is not available, would amount to punishment that goes beyondthe boundaries articulated by the Supreme Court of Canada for an accounting of profits. [56] Moreover, I am satisfied on the evidence before me that many of the expenses at issue were in fact incurred, notwithstandingthat they were not documented.
To deny those expenses would be tantamount to ordering disgorgement of revenues rather than profits.This would be essentially an award of harsh damages, as discussed by the Court of Appeal in Stewart Estate v TAQA North Ltd, 2015ABCA 357. While there was considerable disagreement among the panel in that case, the fact remains that what the Court of Appealordered in this case was an accounting of profits, which contemplates deduction of reasonable and necessary expenses. b.
Tenancy in Common vs Joint Venture [57] IFP asserts that its relationship with PCR was not a joint venture; rather, it contends that it is a tenant in common of EyehillCreek. Therefore, IFP asserts that Mr. Carroll’s joint venture accounting approach was improper.
As will be seen later in these Reasons,this distinction between tenancy in common and joint venture is significant because it informs IFP’s position that it is entitled to anaccounting based on profitable wells only. [58] IFP argues that, while parties to a joint venture can modify their default property law rights by agreement, there is no suchagreement in this case.
Therefore, IFP argues that the common law principles of tenancy in common apply, including that each tenant incommon owns an undivided interest in the whole property and each can do as they wish unless the common property is being destroyed.One tenant in common has no control over another’s use of the property. [59] In reality, the parties’ property interest here, is the right to participate or share in what is a highly regulated industry.
Ms.LaRocque testified that, if one tenants, here IFP, wanted to drill its own wells, the Alberta Energy Regulator, would very likely disallowit as it would result in what she called a competitive drainage situation.
Instead, the regulator would likely force a pooling arrangementwhereby the tenant would be required to adhere to the terms and conditions of existing well owners. [60] Nonetheless, under a common law regime, IFP cites Zawick v Zawick, (SCC), [1956] SCR 347 at paragraph34, for the proposition that tenants in common are free to make improvements on the land and incur expenses unilaterally without anyexpectation of reimbursement.
However, where the other tenant in common seeks an accounting, it will be deemed to have adopted andsanctioned those expenses that increased the value of its interest in common property. [61] It is noteworthy that in Zawick, the issue before the Supreme Court was not the non-active co-tenant seeking an accounting, asargued by IFP. Rather, the Supreme Court was addressing the remedy available to the active co-tenant, who made repairs orimprovements to a property. The court held that that tenant was not entitled to a lien or charge against the land but was instead limited toan equitable right to an accounting. c.
Well-by-well vs Field Accounting [62] Pursuant to the common law principles of tenants in common, IFP maintains that the defendants cannot look to it forcontribution to the expenses arising from non-profitable wells because such wells do not constitute improvements to the land and provideno benefit to IFP as a co-tenant.
Accordingly, IFP seeks an accounting of its 20% share of the net revenue realized from the profitablewells only. [63] IFP cites Peel Regional Municipality v Canada, (SCC), [1992] 3 SCR 762 at paragraphs 42 to 46 for theproposition that benefits, and burdens cannot be imposed on another against its will and a party cannot recover a benefit forced onanother unless the benefit is “incontrovertible” such that the recipient would not have refused the benefit even if it had been given achoice.
IFP’s position is that, since it had no say in which wells were drilled and what expenses were incurred, it should be allowed toaccept only the profitable wells.
I note that the facts in Peel arose out of a claim for unjust enrichment and are not particularly helpful indetermining the issue before me, whether an accounting should be based on only select wells of IFP’s choosing or whether theaccounting should be based on the entire field operation or scheme as a whole. [64] For their part, the defendants argue that IFP should not be entitled to “pick and choose” which wells it wants to participate in,particularly on a retrospective basis. [65] Both parties referred to American case law in support of their positions.
IFP cited Neeley v Intercity Mgmt Corp 732 SW 2d644 in which the court found that, in the absence of a joint operating agreement, a co-tenant was not entitled to reimbursement forunsuccessful operations. Similarly, in Burnham v Hardy Oil Co. 147 SW 330 (1912), the court held that expenses connected withnonproducing wells were not chargeable to other co-tenants. [66] IFP also cites Cabot Oil & Gas Corp v Healey LP
(2013) WL 1282007, although I do not find that case to be of much
assistance here. The Texas Court of Appeals declined to address the trial judge’s denial of expenses from a dry hole, because regardless of the benefit to the land, the operator had failed to put forward evidence that the expenses for unprofitable wells were reasonable and necessary. [ 67 ] The defendants cite Prize Energy Resources LP v Cliff Hoskins (2011), 345 SW 3d 537 .
At paragraph 20, the Texas Court held that “as a general rule oil and gas wells are characterized as improvements to real property; as such, equitable principles apply and dictate that a person who in good faith makes improvements upon property owned by another is entitled to compensation therefore.” The court in Prize Energy cited Moody et al v Wagner et al (1933), 23 P2d 633, where the Supreme Court of Oklahoma held that the costs of drilling an unprofitable well, when that well is part of the general scheme of development, may be reasonable and necessary costs of development. [ 68 ] In Moody , the plaintiff argued that as he had never agreed to drilling any wells, he could not be held responsible for the cost of dry holes because those expenses did not inure to his benefit.
Citing Connette v Wright 154 La 1081, where the court found that the drilling operations on the whole property must be considered a single enterprise, the Moody court held that drilling an unprofitable well was part of the hazard of production and of the entire scheme of development of the lease as a whole. As such, the expenses for the unprofitable well were proper and legitimate charges. [ 69 ] IFP points out that in Prize Energy , there was expert evidence before the court that the three unprofitable wells provided a benefit – even though they were unprofitable, they developed the reservoirs.
IFP argues that there is no such evidence before me and that the defendants have failed to establish that the nonprofitable wells constituted an improvement. The evidence before this court, however, amply demonstrates that Eyehill Creek was a significant operation with leases covering several sections of land, 247 wells, 194 pipeline segments and 101 facilities.
There is nothing in the evidence before me to suggest that Eyehill Creek was anything other than, in the words of the Connette court, a “single enterprise”. [ 70 ] In considering whether the unprofitable wells added value, it is helpful to bear in mind the nature of IFP’s interest. In some of the cases cited by the parties, the plaintiffs were landowners, and it is reasonable to conclude that drilling an unprofitable well on their land would not add value to that fee simple ownership. Here, what the parties owned was a working interest in oil and gas leases at Eyehill Creek.
In the 2011 trial decision, Wittmann CJ found that PCR had to engage in production to preserve those leases. He referenced a notice from the Alberta Resource Development on May 25, 2000, that a lease had expired and referenced further notices in August 2000, that PCR had one year to provide evidence that the lands in question were capable of producing petroleum. The Court of Appeal in its decision, at paragraphs 32 to 36, referenced production obligations and the lapsing or expiration of Crown leases.
Had PCR failed to develop or plan to develop Eyehill Creek, the leases would have expired and, with them, the parties’ working interest. [ 71 ] As referenced in the 2011 trial decision, Mr. Greg Sinclair, PCR’s senior landman, testified at the 2011 trial: If we didn’t get the lands producing, we were going to have to go out there and abandon and when we abandoned all the wells all the leases would have died and the contracts along with them. [ 72 ] In Martel v Hunt 195 La. 701 (1940), the court found that the plaintiff’s property was practically worthless until it was developed for oil.
Similarly, I find that IFP’s working interest would have been of no value absent exploration, development and production. Exploration, development and production often leads to unprofitable wells, as the court said in Moody , they are a predictable hazard of exploration and development. [ 73 ] The Alberta Court of Appeal acknowledged those hazards in Bank of Montreal v Dynex Petroleum Ltd. 1999 ABCA 363 , aff’d 2002 SCC 7 at paragraph 35 : Oil and gas ventures require huge amounts of capital but only a small fraction are successful.
The oil and gas investor is betting that the many losses will be made up by the small fraction of successes. [ 74 ] In its brief, IFP argues that the defendants’ position creates a “moral hazard problem”. It asserts that to allow one tenant in common to incur expenses unilaterally and then claim reimbursement leaves that tenant free to gamble with the other tenant’s funds. If PCR is entitled to deduct expenses for unprofitable wells, IFP argues that it would get the best of both worlds: PCR would be able to take risks unilaterally and force the captive tenant (IFP) to cover a portion of the losses.
I am satisfied that there is no such problem in this case for two reasons. First, the defendants operated on the assumption that Eyehill Creek was wholly owned so that only their own funds were at risk. Second, even if IFP’s 20% share had been acknowledged by the defendants, they still would have had 80% of the working interest; the lion’s share of any funds expended in drilling operations were their own.
I do not accept that they would have been prepared to “gamble” in those circumstances. [ 75 ] I rely upon the reasoning of the court in Moody : Their works were prosecuted under the impression that the property was their own. Their bona fides , therefore, cannot be doubted.
They cannot be suspected of reckless expenditure, or of wild and extravagant adventures. [ 76 ] Further, I find that there is no evidence before me to suggest that the defendants undertook the exploration and development of Eyehill Creek in a reckless, indiscriminate or haphazard manner. [ 77 ] While IFP correctly asserts that, despite the duty to consult it was not given a say in what wells were drilled. However, it is significant, in my view, the Court of Appeal’s reference (at paragraph 212) to the 2011 trial decision that “at no time... did IFP make any move to stop the primary production”.
There was no evidence “that IFP took any steps to seek a review of any existing order or well license or otherwise oppose the recommissioning of any old wells. Nor is there any evidence on this record that it took any steps to oppose the granting of well licenses for any new wells.” [ 78 ] IFP also points to the Court of Appeal decision and asks this court to answer in the affirmative, the following question posed at paragraph 218:
Is it…open to IFP to opt in to existing wells on an individual basis? [ 79 ] In support, IFP makes much of the comments at paragraphs 162, 165 and 166 of the Court of Appeal’s decision: [162] ... The corollary of this is that IFP was prepared to accept that with respect to existing infrastructure, it would have no interest in that infrastructure unless and until it agreed to pay its 20% share of costs associated therewith. … [165] Under Clause 4(c), IFP would not be required to assume its proportionate share of costs associated with the existing infrastructure unless and until IFP agreed otherwise. [166] …the decision whether to exercise IFP’s participation right under Clause 4(
c) was intended to be IFP’s and IFP’s alone. … Of course, unless IFP agreed to assume responsibility for costs relating to existing infrastructure, it was only fair that IFP would likewise have no interest in and derive no benefit from it or primary production derived therefrom. [ 80 ] In my view, IFP miscasts the Court of Appeal’s comments, which arose in the context of a discussion of abandonment costs in respect of existing infrastructure.
The Court of Appeal made these additional comments at paragraphs 162 and 163: …the surrounding circumstances confirm that, in keeping with what had been understood and agreed between the parties from the time PCR first proposed an asset swap, IFP would not be responsible for any of the abandonment costs associated with the then existing infrastructure , which included 222 wells at Eyehill Creek, most of which had been shut in. PCR recognized that it would be unfair to burden IFP with those costs. … The crucial point is this.
There is not a shred of evidence on this record that following conclusion of the MOU, PCR and IFP ever agreed to vary, much less reverse, the agreement in place from the start – IFP would not be responsible for abandonment costs of existing infrastructure . … [Emphasis added.] [ 81 ] As both the trial judge and the Court of Appeal noted, at the time the parties entered into the AEA, both understood that primary production at Eyehill Creek was at an end.
Accordingly, as the Court of Appeal indicated, it was reasonable for them to agree that IFP would not be responsible for the costs of abandoning wells whose useful life was considered to be at an end.
The parties did not anticipate that circumstances would change, and primary production would resume, at least to any significant extent. [ 82 ] Further, in reference to the question posed by the Court of Appeal at paragraph 218, the Court of Appeal referred to existing wells, not individual or profitable wells. [ 83 ] For the reasons set out above, once IFP sought its proportionate share of net revenue realized from primary production, I find that it must be based on the entire enterprise or field: IFP cannot opt into only the profitable wells.
I find that an accounting of the entire field is the appropriate and equitable (as per Zawick ) approach. [ 84 ] I note that this approach is consistent with the approach taken at the 2011 trial, where Mr. Barry Parker, an expert witness for IFP, did not consider just profitable wells. [ 85 ] I also note the evidence before this court that under a joint venture agreement, typically, a joint venture partner can decline to participate in wells but if so, they must pay a penalty to the operator if the well is successful, usually between 200 to 300% of the costs of drilling that well.
As there was no agreement here, neither Mr. Pelzer nor Mr. Carroll took these penalties into account. [ 86 ] In any event, for the numerous reasons set out earlier, I reject Mr. Pelzer’s evidence as to which wells were profitable. His evidence in this regard was entirely unreliable. At the end of trial, I asked for IFP’s position if I did not accept Mr. Pelzer’s evidence as to which wells were profitable. In response, IFP initially submitted that if I reject Mr.
Pelzer’s evidence, IFP’s alternate position was that IFP’s 20% interest should be calculated based on the overall gross revenue minus the expenses set out in the JADE. When further pressed, IFP changed tack and asserted that the onus is on the defendants to prove which wells were profitable and which were not. [ 87 ] Having concluded that a field accounting is appropriate, I do not need to consider the issue of which individual wells were profitable.
Instead, I will make findings on the net revenue realized from the entire field, by taking the overall gross revenue minus all reasonable and necessary costs and expenses, a calculation which I note is in accordance with IFP’s position during the 2011 trial and IFP’s initial submission to this court during this trial in response to my concern regarding Mr. Pelzer’s evidence. [ 88 ] If I am wrong in my conclusion that the calculation of net revenue realized must include the nonprofitable wells, Mr.
Carroll’s evidence before this court allows for the calculation of IFP’s proportionate share based on profitable wells. d. JADE [ 89 ] The question of appropriate deductions raises two additional issues. First, the defendants assert that for the reasons discussed below, the JADE does not fully account for all reasonable and necessary expenses incurred in production at Eyehill Creek and that these additional expenses should be allowed. As noted above, the paper records documenting production at Eyehill Creek filled some 4500 boxes.
Not all of those records were reviewed, and the parties relied in large part on the JADE. [ 90 ] Mr. Carroll opined that additional expenses and costs not reflected in the JADE would have been incurred in developing Eyehill Creek. He testified that the JADE does not reflect all expenses and costs because the defendants operated under the misunderstanding that they owned the entire field.
He explained that there is a cost associated with entering expenses into the JADE and that oil and gas companies typically do not incur those costs for a wholly owned field because the expenses are not recoverable from a third party or joint partner. By contrast, in a joint venture, companies are more diligent in recording or assigning these costs because they intend to recapture them from their partners. Mr. Carroll testified that even though certain expenses were not set out in the JADE, he was
100% certain they were incurred. [ 91 ] Ms. LaRocque supported this position and opined that the defendants operated as though the property was wholly owned and kept records accordingly. She further testified that, given that this field was considered to be wholly owned, it was very likely that certain expenses such as production engineering, overhead, processing, and costs would not have been recorded. [ 92 ] IFP argues that Mr. Carroll can only assume that the defendants thought the property was wholly owned. It argues that only Mr.
Bethlemet, the CEO of PPR, could speak to whether they operated as if the property was wholly owned, and he did not testify to that effect. The defendants disagree and argue that both the (then) Court of Queen’s Bench and the Court of Appeal found that Wiser and its successors assumed that IFP did not have a working interest in primary production at Eyehill Creek. I agree with the defendants. [ 93 ] Mr. Pelzer testified that to calculate net revenue realized, he took into account only the actual costs reflected in the JADE.
Under cross-examination, however, he agreed that there would have been expenses incurred that were not set out in the JADE. Interestingly, and contrary to his position, Mr. Pelzer, in noting that the JADE was inconsistent or incomplete in accounting for overhead charges, added overhead charges in his accounting, even though they were not set out in the JADE. [ 94 ] The second issue is the related issue of estimates. Both Ms. LaRocque and Mr. Carroll support the use of estimates in an accounting. Ms.
LaRocque testified that the accounting principle of conservatism requires that liabilities or expenses be recognized and recorded if there is reasonable certainty that those expenses or liabilities have been incurred even when the actual amount is not known with absolute certainty. The defendants rely upon International Accounting Standards 8, which states that estimates are an essential part of the preparation of financial statements and their use does not undermine the reliability of a statement. [ 95 ] The defendants submit that it is fair and reasonable to look to industry standard agreements for guidance.
I heard extensive evidence on the use of the CAPL operating procedures and PASC accounting procedures. The defendants argue that the parties’ intention would have been to conduct themselves in accordance with these industry standards. Indeed, IFP and PCR had used the CAPL operating procedures in respect of thermal production at Eyehill Creek and with two other properties. Even Mr.
Pelzer stated in his primary report that where guidance was necessary, he generally used industry accepted standards set out by CAPL or PASC as a measure of what is reasonable. [ 96 ] Despite this, IFP objects to the defendants’ reliance on estimates and submits that unless an expense was recorded in a document or the JADE, it should not be taken into account in calculating net revenue realized.
IFP relies upon the Court of Appeal’s finding in FIC Real Estate Fund Ltd v Phoenix Land Ventures Ltd. 2020 ABCA 325 that the evidentiary burden in an accounting is on the defendant to prove actual rather than hypothetical expenses. [ 97 ] While I do not disagree with that placement of the burden, the defendants have satisfied me, that there were expenses incurred that are not reflected in the JADE and that an estimate of those expenses is appropriate in accounting for net revenue realized. As in FIC Real Estate , I have found that the defendants have not engaged in financial concealment or wrongdoing.
I accept the evidence put before this court by the defendants as to why certain expenses were not recorded. Having heard the evidence of Ms. LaRocque, I am satisfied that reliance on estimates and industry standards does not amount to positing hypothetical expenses. I note that during the 2011 trial, IFP’s expert, Mr. Parker, relied on estimates and referred to industry standards in the absence of formal documentation. [ 98 ] IFP submits that if a defendant is permitted to deduct more than its actual expenses, it effectively will retain a portion of the profits that should be paid to the plaintiff.
The other side of that coin, however, is that if the defendant is not permitted to deduct actual expenses, the plaintiff will receive a portion of the profit that belongs to the defendants. This is particularly so, given that both parties’ experts agree that there would have been expenses incurred that are not accounted for in the JADE. [ 99 ] Finally, IFP cites Husky Oil Operations Limited v Gulf Canada Resources Limited 2008 ABQB 390 at paragraph 74 and argues that the defendants are changing the basis on which they calculate expenses after the fact. In my view, that case is distinguishable.
In Husky Oil , an operating party had been charging the non-operating parties their share of expenses over some period of time. It then changed its method of calculation and demanded payment of a retrospective amount on the basis of unjust enrichment. The court held that it would not be equitable to award this “major financial gain” and found that the operating party had failed to make full disclosure. The facts before me are different. [ 100 ] I have already dealt with the issue of disclosure.
Further, I accept the evidence and explanation as to why certain expenses would not have been included in the JADE for what was thought to be a wholly owned property. I accept the evidence before me that the defendants would have incurred reasonable and necessary expenses but not accounted for them because they believed the property was wholly owned. IFP’s concerns are fair and therefore I will ensure that my decision regarding these additional expenses or adjustments (as per Mr. Carroll’s report) will not give the defendants a major unsubstantiated financial gain (as per Husky Oil ). D.
Accounting [ 101 ] With the above issues as the framework for the accounting, I now turn to calculating net revenue realized. [ 102 ] IFP agrees to those expenses and costs set out in the JADE (other than royalty payments to PCR and Wiser’s abandonment costs incurred to earn its interest). The defendants claim that those royalty payments and Wiser’s abandonment costs should be included as well as the other expenses not set out in the JADE that Mr. Carroll has itemized in the chart at page 15 of Mr. Carroll’s report dated June 2, 2022 (Exhibit 13 in this trial). [ 103 ] In the end, IFP’s position (as per Mr.
Pelzer’s second supplemental report) is that it is entitled to no less than $21,684,759.32 plus interest (for a total of $61,781,642.60) whereas the defendants maintain that when abandonment costs are factored in, IFP is owed nothing and in fact, although there is no claim against IFP, it is in a debit position of $2,471,955. [ 104 ] For context, Mr. Carroll testified that at the time of trial, the field had been completely shut in for about a year. Not including
abandonment costs, at the time of trial, despite being completely shut in, the field is still incurring costs between $25,000 and $50,000 per month. [ 105 ] Ms. LaRocque’s testimony was that Eyehill Creek lost money. She testified that it was not profitable – that in the industry they would call the property, “a dog”. She opined that the property loss more than $79 million. [ 106 ] I start with the chart in Mr. Carroll’s report (Exhibit 13 in this trial, at page 15).
He calculated that the gross revenue (from 1998) was $207,215,873 (oil revenue of $171,401,896, gas revenue of $35,805,756 and condensate revenue of $8221). [ 107 ] IFP submits that the gross revenue from all the wells at Eyehill Creek for the period November 2001 to April 2022 was $205,489,848.49. The defendants submit that any difference could be attributed to the defendants considering an earlier timeframe. [ 108 ] I am tasked with calculating net revenue realized from 2001 and therefore given my preference for Mr.
Carroll’s evidence, I ask that he calculate gross revenue commencing from May 2001. [ 109 ] The defendants maintain that the records reflect capital expenditures of $50,804,721 and operating expenses of $102,825,355 for Eyehill Creek. They submit, however, that there are other expenses not set out in the records that should be taken into account when calculating the net revenue realized from primary production.
The defendants argue that those adjustments total an additional $8,644,376. [ 110 ] To make findings on net revenue realized and to calculate IFP’s 20% interest in same, I must consider two contentious issues: (
a) which expenses/costs the defendants are entitled to deduct beyond that which is set out in the JADE; and (
b) how should abandonment costs be calculated and should future abandonment costs be included in the accounting. 1. Deduction of Expenses a. Hayter 7-21 Facility and Processing Fees/Costs [ 111 ] Eyehill Creek had a processing facility referred to as the Hayter (7-21) facility. The JADE did not set out the cost of constructing this facility but did set out some costs associated with it. For example, there was an AFE in the amount of $506,000 for a compressor. Mr. Pelzer did not take into account any costs for this facility because he was advised that IFP did not want to participate in it. [ 112 ] Mr.
Carroll estimated that the Hayter facility cost approximately $855,000. IFP objects to including these costs in an accounting and argues that it is likely that this facility was one of the existing production facilities at the time the ARO was entered into that Wiser acquired for nominal value in exchange for assuming the abandonment costs. [ 113 ] I will address the accounting of Wiser’s abandonment costs later in these reasons.
Suffice to say that if IFP is not liable for a portion of Wiser’s abandonment costs or the consideration that Wiser paid for its interest in Eyehill Creek (for which IFP argues Wiser acquired the Hayter facility) then IFP will not have contributed to the costs of the Hayter facility. [ 114 ] The Court of Appeal decision at paragraphs 165 and 166 also provides a response to IFP’s position: [165] Under Clause 4(c), IFP would not be required to assume its proportionate share of costs associated with the existing infrastructure unless and until IFP agreed otherwise.
That included costs associated with the existing primary production facilities (and their phasing out). However, IFP was given the right, at its option, to opt in to the existing infrastructure in which event IFP would be entitled, under the JOA, to the full benefits of primary production flowing from its proportionate interest. [166] That this was to be at IFP’s option is clear from Clause 4(c). It provides that “Unless specifically agreed to in writing, IFP will have no interest and will bear no cost” for primary production. Notably, Clause 4 does not require the agreement of both parties.
Thus, the decision whether to exercise IFP’s participation right under Clause 4(
c) was intended to be IFP’s and IFP’s alone. And understandably so. After all, this Clause was intended to protect IFP, not benefit PCR. Therefore, whether to exercise the option to participate in the phasing out of primary production in existing infrastructure was at IFP’s option, not PCR’s. Of course, unless IFP agreed to assume responsibility for costs relating to existing infrastructure, it was only fair that IFP would likewise have no interest in and derive no benefit from it or primary production derived therefrom. (My emphasis) It is this, and only this, which the last sentence in Clause 4(
c) seeks to convey. [ 115 ] As such, I accept the evidence that once IFP was seeking a benefit from the processing facility, it either had to assume responsibility for ownership and costs of the facility or pay third-party costs for processing. I accept the evidence of Ms. LaRocque that this facility was necessary for production and therefore revenue, for which IFP seeks its proportionate share. [ 116 ] Mr. Carroll calculated that it would be very much to IFP’s advantage to be an owner of the facility rather than paying third- party processing costs.
IFP’s third-party processing fees would have been roughly $18 million. Mr. Carroll calculated the initial construction cost for the Hayter facility, relying upon estimates and materials price catalogues, at $855,066. It thus was very beneficial for IFP to be an owner rather than a third-party user of the Hayter facility. [ 117 ] Ms. LaRocque testified that the Hayter facility would have been complex and quite costly. In her opinion, the costs of the facility would have been significantly higher than Mr. Carroll’s estimate.
She explained that the sand production would require processing and that, because the product was heavy oil, it would require a high temperature, high residence time process. If IFP was an owner of the facility, it would be responsible for its proportionate share of the capital costs, capital additions, licensing and permits, operating costs and abandonment costs. If not, she testified that it would be assessed third-party processing fees using what is known as
the Jumping Pound methodology. IFP’s expert, Mr. Parker testified to that effect during the 2011 trial. Both Ms. LaRocque and Mr. Carroll testified that the user fee for production would be significantly more expensive than the same production as an owner. [ 118 ] Mr. Pelzer did not account for any processing costs or fees because they were not set out in the JADE. I note that Mr. Pelzer had some, albeit limited, evidence as to what was being charged for third-party processing at the Hayter facility. I also note that Mr. Parker in the 2011 trial accounted for the Hayter facility. I reject Mr.
Pelzer’s evidence on this issue. [ 119 ] If IFP did not participate as an owner in the Hayter facility, it would otherwise be charged much more expensive third-party processing fees. Processing costs were necessary. The defendants are not relying upon Ms. LaRocque’s opinion as to the costs of this facility. They ask that I accept Mr. Carroll’s calculations as though IFP was an owner. I accept Mr. Carroll’s calculations as being conservative and his methodology (in having IFP as an owner) as fair and very much to IFP’s benefit.
I am satisfied, to a reasonable certainty, that these expenses would have been incurred. [ 120 ] As a result, Mr. Carroll’s estimate of the Hayter facility costs shall be included in the accounting of IFP’s share of net revenue realized. b. Engineering and Design Calculations [ 121 ] Mr. Carroll testified that because the defendants operated as though the Eyehill Creek property was wholly owned, the JADE did not include costs for engineering and design calculations.
He testified that these costs would have been incurred by the defendants and that these costs are allowed under all model agreements. [ 122 ] In his testimony Mr. Carroll explained the components of engineering and design and explained that even non-PASC agreements typically allow for this charge. He testified that they are calculated on a percentage basis. Mr. Pelzer’s evidence regarding this item was confusing and less helpful. I prefer Mr. Carroll’s evidence regarding this item. [ 123 ] In terms of calculating those costs, Mr.
Carroll testified that standard industry practice under the 1988, 1996, and 2011 PASC Accounting procedures permitted engineering and/or design charges on AFEs to be charged on a percentage of cost basis. He opined that the percentage “commonly, if not universally, applied in the Canadian energy industry” is 1% of base costs, 2% of completions or workovers, 1% for tie-in and equipping, and 1% of facilities. [ 124 ] I am satisfied that Mr. Carroll’s calculations reflect the standard of the industry.
Although I acknowledge that the parties did not have an agreement, there is nothing before me to suggest that the parties would not have agreed to these standard industry practices. They did in the past. His evidence has satisfied me, to a reasonable certainty, that these engineering and design costs would have been incurred. [ 125 ] I accept Mr. Carroll’s evidence and calculations (spanning from May 2001 to July 2021) and ask the parties to confirm this amount of $598,276 (and not $601,810). Upon confirmation, I find that these costs should be included in an accounting of IFP’s share of net revenue realized. c.
Production Engineering [ 126 ] Mr. Carroll testified that there were virtually no charges in the JADE for production engineering. He testified (adamantly) that Eyehill Creek could not have produced revenue without these costs; that production engineering is a defined term and chargeable in all model agreements in the 1996 and 2011 PASC accounting procedures. A 20 page bulletin in the 2011 accounting procedures is dedicated to accounting for production engineering. [ 127 ] Under cross-examination, Mr. Pelzer gave confusing evidence about production engineering being included as professional services.
I give his testimony no weight in this area. [ 128 ] Ms. LaRocque objected to Mr. Pelzer’s evidence that production engineering would apply only if there was an issue with the wells and opined that he misunderstood the type of production at Eyehill Creek. She testified that CHOPS (Cold Heavy Oil Production with Sand) presents significant challenges. Equipment tends to wear out prematurely; and the reservoir can have productivity issues because of sand bridges. As a result, the level of production engineering and geophysical intervention necessary would be much higher than in a conventional oil and gas property.
Ms. LaRocque testified that the records reflect a number of workovers undertaken at Eyehill Creek that would involve production engineering. In her experience, production engineering is not billed if the property is wholly owned. [ 129 ] Mr. Carroll also testified that production engineering would have been constantly required at Eyehill Creek. The PASC accounting procedures allow production engineering to be assessed on an as paid actual basis or a percentage assessment basis. Mr. Carroll used the latter and calculated these costs. Mr. Carroll used 2% of base operating costs excluding overhead.
He excluded expenses that would not attract production engineering. [ 130 ] IFP argues that Mr. Carroll simply used an engineer’s salary of $175,000 a year to calculate these costs. That was not his evidence, however. He testified that his calculations had the net effect of being charged on average the equivalent of 1/3 of an engineer’s salary. [ 131 ] I accept Mr. Carroll’s evidence that production engineering was “absolutely required” and I accept these costs were incurred with reasonable certainty. Again, Mr. Carroll’s evidence has satisfied me that his calculations reflect standards in the industry.
Although the parties did not have an agreement, there is nothing before me to suggest that the parties would not have agreed to these terms had had they entered into an agreement. In fact, past practices of the parties support a finding that they would have relied upon PASC operating procedures. [ 132 ] I am satisfied that Mr. Carroll’s calculations are in accordance with PASC operating procedures ($1,045,834 from May 2001).
They are to be included in an accounting of IFP’s share of net revenue realized. d. Overhead Costs [ 133 ] All experts testified about overhead, which is set out in PASC model accounting procedures and allows an operating company to recover indirect administrative costs. Overhead is separated into capital and operating and can be calculated using a percentage, a fixed rate, or a sliding scale. Both Ms. LaRocque and Mr. Carroll testified that they would not expect to see overhead in the JADE for wholly owned properties. It is not disputed that the JADE did not sufficiently or consistently reflect overhead costs.
Mr. Pelzer also noted that overhead was inconsistently charged, typically at $225 per well per month. [ 134 ] Ms. LaRocque testified that overhead costs are general and administrative in nature and cannot be attributed to any particular property or project. She testified that charges for overhead are generally dictated by agreement between the parties and that the most common method is to utilize a percentage of direct operating costs. [ 135 ] In 2011, PASC accounting procedures set out recommended percentages. Mr.
Carroll testified that the older accounting procedures allowed for a higher percentage, so using 2011 procedures was advantageous to IFP. Mr. Carroll undertook considerable work in calculating overhead as is set out in
Schedule 1 of his September 28, 2021, report (Exhibit 12 in this trial) using the percentage rates set out in the 2011 PASC. He testified that there is a capital and operating component to overhead: 10% on operating base costs with some exceptions such as property taxes and utilities and 2% on capital. [ 136 ] In calculating overhead, Mr. Carroll was guided by the principle that there should be no profit nor loss in recovering overhead. He calculated overhead consistent with industry standards.
In his final report (Exhibit 13 in this trial), he opined that an accounting of net revenue realized should include an additional $6,414,230 in overhead, with 20% of that being assigned to IFP. His calculations commenced as of 1998 and therefore need to be adjusted. [ 137 ] Mr. Pelzer did not agree with using a percentage to calculate overhead and testified that percentages are negotiated between the parties. In his second supplemental report, he calculated overhead at $225 per month per producing well for a total of $2,250,225 for overhead costs. [ 138 ] Ms.
LaRocque testified that the $225 per unit rate utilized by Mr. Pelzer is only the overhead cost associated with regulatory reporting. She explained that once a well has been shut in for three months, the regulatory reporting requirements are finished and therefore the per unit rate stops after three months. She testified that she had never seen $225 per unit rate used as the only basis by which to recover overhead, though she has seen it used in conjunction with other overhead recovery mechanism such as a percentage. [ 139 ] Mr.
Carroll testified that it was not industry practice to charge overhead at $225 per well per month. He said overhead was typically charged at a percentage and reiterated that his calculation of overhead at 2% was very fair to IFP. [ 140 ] Although there is no agreement between the parties, I accept Mr. Carroll’s calculation for overhead. I accept that his methodology for calculating overhead is in accordance with the principle of no profit, not loss.
I accept that these costs were incurred with reasonable certainty and therefore should be included in an accounting of IFP’s share of net revenue realized subject to a calculation commencing from May 2001 and my finding regarding Wiser’s abandonment costs. e. Insurance Costs [ 141 ] In his accounting of net revenue realized, Mr. Carroll added additional insurance costs that were not set out in the JADE. He testified that the JADE had insurance costs for some years but not others. Mr. Carroll calculated insurance costs for the missing years at
Schedule 2 of his report. He testified that he was cautious not to extrapolate premiums from the most recent years to be fair to IFP because insurance premiums increased substantially as of 2018. [ 142 ] IFP objects to these additional insurance costs. Mr. Pelzer did not account for any insurance costs other than what was set out in the JADE. However, Mr. Pelzer acknowledged in his testimony that companies never operate oil and gas properties without insurance.
IFP argued that it could have obtained its own insurance, however, IFP did not introduce any evidence of it having obtained its own insurance. [ 143 ] Given IFP’s own expert’s acknowledgement regarding insurance, I accept Mr. Carroll’s position of adding in insurance costs for each year of operation. I take note of the evidence that certain expenses, although incurred with reasonable certainty, would not be accounted for because at the time, the operators assumed they did not have other working interest owners. [ 144 ] I accept Mr. Carroll’s evidence and methodology in calculating insurance costs.
I find that the insurance premiums set out in his evidence from May 2001 should be included in an accounting of IFP’s share of net revenue realized. f. Royalties [ 145 ] The JADE shows that from 1998, Wiser paid Crown royalties in the amount of $10,713,905 and freehold/gross overriding royalties to third parties, including PCR, in the amount of $18,149,633. Mr.
Carroll’s report sets out that for 2012 to 2018, 98.1% of the freehold and gross overriding royalties were paid to Cenovus Energy Inc., Freehold Royalties Partnership and Heritage Royalty Resources Corp/Heritage Royalty Partnership. [ 146 ] IFP disputes having the royalties Wiser paid to PCR in its accounting of net revenue realized. [ 147 ] In respect of the royalties, both parties rely upon the terms of the AEA. PCR asserts that, under the AEA, it transferred to IFP 20% of its working interest (as opposed to ownership interest) in the “PCR Eyehill Creek Petroleum and Natural Gas Rights”, which
Article 1.1(
x) of the AEA defines to mean the interests set out in Exhibit 2 to
Schedule B-4. That
Schedule sets out twenty-four leases,
each of which refers to a lessor and a royalty. PanCanadian Petroleum Limited is the lessor in seven of the leases; the others are the Crown and other third parties. Only one of the seven PanCanadian Petroleum Limited leases sets out the royalty rate (at 20%); in the other six leases, the royalty is “to be negotiated”. [ 148 ] The defendants rely upon
section 2.10 of the AEA: Within a reasonable time following the written request of IFP, PCR and IFP shall negotiate the terms of, and cause to be executed and delivered to the other, freehold petroleum and natural gas leases evidencing IFP’s interest in respect of any and all of the PCR Lands where the interest of PCR in and to such lands is held, directly or indirectly, via fee simple ownership. The terms of such leases shall give due consideration to the unique relationship between PCR and IFP (my emphasis). [ 149 ] The defendants submit that IFP never entered into the leases contemplated under
section 2.10 and therefore PCR retained its royalty interests in Eyehill Creek. [ 150 ] Further, the defendants assert that the JADE reflects that Wiser paid those royalties to PCR. As Wiser had to drill the wells, sell the production, and pay royalties on that production to generate revenue, those royalties should be included in an accounting of net revenue realized. [ 151 ] For its part, IFP asserts that the AEA does not provide for any royalties payable by IFP and that IFP did not agree to pay royalties to PCR.
IFP argues that if PCR intended to impose a royalty against IFP, it must be contractually agreed to, as part of the negotiation prior to entering into the AEA. This is what happened with Wiser: in the ARO, Wiser and PCR, in
section 11, set out the gross overriding royalty Wiser agreed to pay PCR. [ 152 ] IFP argues that the defendants’ position, that it reserved its royalty rights at a rate to be negotiated at a later date, would permit PCR to unilaterally impose royalty terms on IFP at some future date, a result, IFP suggests is “commercially absurd”. [ 153 ] Mr.
Pelzer in his response (Exhibit 6 in this trial) stated that there is no basis to say IFP is liable for a share of the royalty income that Wiser paid to earn its interest and that IFP should not be liable for any share of royalties paid to related entities or non-arm’s length parties. Further, he stated that as IFP had an interest in the same lands as PCR, IFP was entitled to its share of the royalty income. [ 154 ] Ms. LaRocque disagreed with Mr. Pelzer’s opinion. She testified that he “does not recognize the difference between a working interest ownership and a mineral ownership”.
She stated that IFP acquired only a working interest in Eyehill Creek, and that the mineral rights remained with EnCana. Ms. LaRocque explained the difference as follows: Working interests are a lease agreement that grants oil and gas companies the right to explore, drill and produce natural resources from a land. Mineral interest ownership, on the other hand, is a recorded property document outlining the legal owner of natural resources below the surface level.
The working interest ownership of a well can be and usually is, different than the mineral ownership of the well… EnCana owns a large percentage of the freehold mineral rights in Canada through its connection with Canadian Pacific Railway.
Accordingly, EnCana has two interests in Eyehill Creek: a mineral interest and a working interest. [ 155 ] I note that this accords with the Court of Appeal’s decision that IFP’s interest is a 20% undivided interest as a tenant in common of PCR’s working interest in the PCR Eyehill Creek Petroleum and Natural Gas Rights, and PCR Eyehill Creek Miscellaneous Interests, as both terms are defined in the AEA (my emphasis). [ 156 ] The Assets granted to IFP under the AEA were the leases (subject to royalties to be negotiated) and surface rights. The assets are defined as:
a) PCR Eyehill Creek Petroleum and Natural Gas Rights that are set out in the Exhibit 2,
Schedule B-4. Exhibit 2,
Schedule B-4 sets out the Leases and Joint Lands, in which IFP has its interest. Each of the leases sets out a Lessor Royalty, the rate of which is either set out or “to be negotiated”; and,
b) The PCR Eyehill Creek Miscellaneous Interest. The PCR Eyehill Creek Miscellaneous Interest include
i) contracts and agreements relating to PCR Eyehill Creek Petroleum and Natural Gas Rights, ii) fee simple rights to enter upon, use or occupy the surface of any lands (My emphasis) and iii) the records books, documents, licenses, reports and data relating to the PCR Eyehill Creek Petroleum and Natural Gas Rights. [ 157 ] I also agree with the defendants’ position that a working interest does not necessarily include mineral rights. There is nothing before me to support a finding that PCR transferred its mineral rights to IFP, entitling IFP to a share of the mineral rights royalty.
That said, this does not resolve the issue of whether IFP is responsible for a proportionate share of the royalty paid to PCR. [ 158 ] In Dynex , the Court of Appeal characterized a gross overriding royalty as follows: An overriding royalty or a gross overriding royalty is an unencumbered share or fractional interest in the gross production granted to a third party in exchange for performing duties ( e.g . drilling).
Commonly, it is reserved in an assignment, part assignment or sublease of an oil and gas lease, often carved out or reserved by lessees who have a working interest created by a lease. [ 159 ] The Court of Appeal in Dynex referred to (at paragraph 73) characterizing a royalty interest by examining the parties’ intentions as determined from the agreements and the surrounding circumstances: ...it is more appropriate to consider the substance of the transaction (namely, what were the parties actually trying to achieve?) and to regard the words they have used from that perspective. [ 160 ] Therefore, to resolve this issue about the royalties, I must try to determine the parties’ intentions by examining their agreement and the surrounding circumstances.
[ 161 ] I agree with IFP that in contrast to the AEA, both the Interim Agreement and the ARO specifically set out the gross overriding royalty to be paid by Wiser. I agree that if PCR intended to reserve its royalty in the AEA, it could have done so clearly in the AEA, as it did in the Interim Agreement and the ARO. [ 162 ] However, I also agree that the AEA contemplated the parties negotiating a royalty rate for the leases in the future.
The concern, however, is that other than the one lease in which the royalty rate was set out, I do not know whether the rate negotiated between PCR and Wiser (16.667%) would have been the same rate negotiated between PCR and IFP given “the unique relationship between PCR and IFP” as per
section 2.10 of the AEA. [ 163 ] In his report, of September 28, 2021 (Exhibit 12 in this trial), at page 27, Mr. Carroll opined that: It is my position that, had PCP contemplated IFP as a working interest owner in primary, conventional production, then PCP would have imposed royalty encumbrances on IFP similar to how the production was encumbered in PCP’s disposition of the rights to Wiser and successors. [ 164 ] In accordance with
section 2.10 of the AEA, the terms of the lease (including the royalty rate) were to be negotiated between PCR and IFP, not imposed by PCR as Mr. Carroll testified to. Further, the parties contemplated in
Article 2.10 of the AEA that any terms of the leases shall give due consideration to the unique relationship between PCR and IFP. I do not know what terms or rate PCR and IFP would have negotiated, particularly “given their unique relationship”. I do not know whether Wiser had the same unique relationship as IFP. I heard no evidence on this issue. To accept Mr. Carroll’s position that PCR could impose a royalty rate is contrary to
Article 2.10 of the AEA. To assume that IFP would have negotiated the same rate as Wiser requires speculation on my part. I cannot make that finding. [ 165 ] The burden of proof rests with PCR. The defendant
[…]
Loading document…