Let's Talk About Royalties: The Continued Uncertainty Surrounding The Creation And Legal Status Of The Overriding Royalty

1. INTRODUCTION

   Since the Leduc No. 1 oil well was drilled in 1947, the petroleum and natural gas industry has grown to become a cornerstone of the Alberta economy and a major industry for the Canadian economy. The oil and gas industry is active in 12 of 13 Canadian provinces and territories,1 and Canada is the fifth-largest producer of natural gas and the sixth-largest producer of crude oil globally. 2

   Royalties are central to the financing, development, and operation of oil and gas projects and other mineable resources in Canada. Traditionally, royalties allowed resource owners to participate in and reap the benefit of production from their properties, and also to raise funds to finance exploration and production activities. In Alberta alone, royalty revenues from natural gas, conventional oil, and oil sands production were over $500 million, $700 million, and $1.4 billion, respectively, for 2016-2017. In 2013-2014, these revenues were even higher, totalling $1.1, $2.5, and $5.2 billion, respectively. 3 Given the significant value associated with these royalties, ensuring the viability of such interests is paramount to industry participants. In response to this need, the industry developed a practice whereby parties would attempt to create royalties that would "run with the land" 4 with the intention that the resulting royalty survives for so long as the underlying interest from which it was granted survives, binding successors in interest to the underlying leasehold or freehold estate. The benefit of this designation is clear: a royalty that runs with the land can provide its owner with certainty as to their rights and interest, regardless of what happens to the original grantor. In fact, it was this very industry practice that led to the Supreme Court of Canada's groundbreaking decision in Bank of Montreal v. Dynex Resources Ltd., which recognized that mineral lessees could carve out real property interests in the form of royalties. 5 Dynex was revolutionary in recognizing a new property right and changing the common law.

   Almost two decades after Dynex, there are now public and private companies with oil and gas royalties as the principal or sole focus of their business. For example, PrairieSky Royalty Ltd. (PrairieSky) and Freehold Royalties Ltd. (Freehold Royalties) are two public companies that focus primarily on obtaining royalty interests and payments. PrairieSky's 2017 royalty revenues alone topped $265 million, 6 and, as of 1 August 2018, it had a market capitalization of $5.8 billion. 7 Similarly, Freehold Royalties's 2017 royalty revenues reached $133 million, 8 and its market capitalization is $1.4 billion. 9 In recent years, royalty interests that are interests in land have been created by working interest owners and then sold to third parties for values of up to $250 million. 10 These examples clearly illustrate the magnitude and importance of royalties in the oil and gas industry and the need for commercial certainty in dealing with these valuable interests.

   Despite guidance from the Supreme Court of Canada and the obvious commercial...