Interpreting Offset Well Clauses In Light Of Horizontal Drilling: An Analysis Of Two New Cases

Two decisions addressing offset well obligations pertaining to leased lands in Saskatchewan were recently released: Canadian Natural Resources Limited v Lisafeld Royalties Ltd. and Whitecap Resources Inc. v Canadian Natural Resources Limited. These decisions are significant given their interpretation of offset well clauses in light of horizontal drilling operations that were not contemplated when the lease was entered into.

Canadian Natural Resources Limited v Lisafeld Royalties Ltd. (2019 SKQB 201) (Lisafeld)

Overview

On August 21, 2019, the Saskatchewan Court of Queen's Bench ruled on a dispute regarding Canadian Natural Resources Limited's (CNRL) obligations under a lease that was originally granted in 1949 (the 1949 Lease). It should be noted that given the age of this lease, it employed an earlier version of the offset well clause than in Whitecap Resources (discussed below). Unlike in Whitecap Resources, there was no "drill, drop or pay" obligation; instead, when the offset well obligations arose, the only options available were to drill or to risk termination of the lease for default.

This case dealt with an offset well (the Horizontal Well) that was spud on legal subdivision (LSD) 2 of the leased lands. It was then completed as a horizontal well under LSD's 3 and 4 in the Frobisher zone, which were not part of the leased lands. The Horizontal Well obtained production in 2012 but was shut down and ceased production in 2015.

There are two formations of relevance in this case - the Midale formation and the Frobisher formation. The Midale formation lies above the Frobisher formation. In 1956, a well was drilled under the 1949 Lease into the Midale and Frobisher formations (the 1956 Well). After testing, it was determined that no oil could be produced from this well and it was converted into a water injection well.

What happened?

In 2016, Lisafeld served a notice of default on CNRL stating that it was in breach of the 1949 Lease offset well obligations since it failed to drill a well into the Frobisher formation in response to the production from the offsetting Horizontal Well. Following this notice, CNRL commenced an action against Lisafeld. CNRL sought declaration that there was no breach or default under the 1949 Lease and that the 1949 Lease remained in full force and effect.

The Court's decision

While Justice Chicoine addressed a number of issues in his decision, a few are particularly noteworthy.

Did an offset well obligation arise pursuant to the lease between CNRL and Lisafeld?

In determining that this was a question of contractual interpretation, the Court stated that "the answer lies in the interpretation to be given to the words 'adjoining drilling unit', and more specifically, whether a horizontal well has a different 'drilling unit' than a vertical well."

CNRL argued that based on the position of the Horizontal Well, it was not a well drilled on any drilling unit laterally adjoining the Lisafeld lands...