Curtailment Rules Come Into Force for Production of Crude Oil and Crude Bitumen in Alberta

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[co-author: Emerson Frostad - Articling Student]

The government of Alberta has ordered and approved rules for curtailment of the production of crude oil and crude bitumen in Alberta. These rules took effect in January 2019. Following an announcement by Premier Rachel Notley on December 2, 2018, Order in Council 375/2018 was issued on December 3. Amendments were made on December 12 and 18, and January 30, 2019, by Orders in Council 434/18, 438/18 and 34/19 and are consolidated as Alberta Regulation 214/2018 (the "Curtailment Rules").

The Curtailment Rules currently provide that they are repealed effective December 31, 2019. The Curtailment Rules were the provincial government’s response to a historically high differential between the price of the West Texas Intermediate and Western Canada Select grades of oil, which is regarded as being caused by constraints on access of Alberta oil to export markets, and among other things had resulted in high volumes of crude in storage. The initial stated intention was to reduce production by 325,000 barrels of crude oil and crude bitumen per day, or about 8.7 percent of provincial production. The provincial government announced on January 30, that aggregate provincial production for March would be set at 3.63 million barrels per day, an increase of 75,000 barrels per day from February 2019, due to storage volumes being drawn down.

The Curtailment Rules

The stated intent of the Curtailment Rules is to: (a) effect conservation and prevent wasteful operations; (b) prevent improvident disposition; and (c) ensure the prudent and economic development in the public interest of the crude bitumen and crude oil resources of Alberta. The Curtailment Rules supersede any approvals, directives or orders issued by the Alberta Energy Regulator (AER), and any agreements or approvals under the Mines and Minerals Act, RSA 2000, c M-17, that allow crude oil or crude bitumen production at a greater rate than is permitted under a curtailment order. 

Effective in January 2019, the Curtailment Rules grant the Minster of Energy the authority to fix the combined provincial production of crude oil and crude bitumen in Alberta for a calendar month, which as mentioned above will be 3.56 million barrels per day in February and 3.63 million barrels per day in March. The Minister may also, by monthly order, allocate that combined provincial allocation to individual operators, in accordance with the formulae in the Schedule to the Curtailment Rules. These formulae are discussed below. Operators are not permitted to produce more than their allotment under a curtailment order. Infractions are subject to administrative penalties under the Responsible Energy Development Act, SA 2012, c R-17.3, as well as additional penalties under the Oil Sands Conservation Act, RSA 2000, c O-7, and the Oil and Gas Conservation Act, RSA 2000, c O-6.

The Curtailment Rules import the definition of "operator" from the Oil Sands Conservation Act in respect of crude bitumen, and define the operator as the "licensee" or "approval holder" as those terms are defined from the Oil and Gas Conservation Act in respect of crude oil. All operators and their production are therefore caught by the definition, regardless of whether the rights to extract from the underlying mineral estate are derived from Crown or freehold mineral leases. The volume restrictions are implemented at the operator level, meaning that it is in effect assumed for these purposes that the operator produces and controls 100 percent of the production from the well or oil sands project.

One of the amendments, which was in effect only for January 2019, meant that no operator would have its January production curtailed to a volume less than 84 percent of its October 2018 production. This curtailment floor provided operators with some certainty as to what their minimum production allotment will be in 2019. A second change, which is in effect for the months of January through March 2019, allows the Minister to amend an operator’s curtailment order to increase the operator’s allocation to an amount sufficient for the safe operation of an oil sands project if that project is the only such project operated by the operator and the project cannot be operated safely on the volume allocated under the original ministerial order applicable to that operator.

The Formulae

The Schedule contains the formulae for determining an operator's baseline production and adjusted baseline production, and for calculating the percentage that the combined provincial production allocation is of the aggregate of all operators’ adjusted baseline production for the month in question.

Each operator’s baseline production will be equal to the highest combined crude oil and crude bitumen production volume it achieved during any calendar month in the 12-month period starting with November 2017. Its adjusted baseline production will be equal to that volume minus 310,000 barrels.

The Minister may make “curtailment orders” only in respect of operators who have “adjusted baseline production” in excess of zero barrels, meaning, in other words, operators whose “baseline production” is in excess of 310,000 barrels. It is thought that because of this 310,000 barrel per month benchmark, only about 25 Alberta operators (the "Curtailed Operators") will be directly subject to curtailment orders. The Curtailment Rules also allow the Minister to curtail an operator who did not meet the 10,000 barrel per day threshold before November 2018, if the operator achieves that daily level over the course of a calendar month after October 2018.

The aggregate provincial production allocation is then distributed to the Curtailed Operators pro rata according to a formula that adds the 310,000 barrel benchmark volume back to their adjusted baseline production for the purpose of the allocation, and multiplies that volume by the percentage referred to above. This of course has the effect of allocating the province-wide curtailment percentage across only the Curtailed Operators.

Consequences, Intended and Otherwise

A Curtailed Operator could have a production allocation after curtailment that is higher than the volume of crude that it is capable of producing if, for example, it sold producing assets at some time after November 2017 and did not replace that production in Alberta or at all. The Curtailment Rules permit two or more operators to consolidate their respective allocations month by month and redistribute the allocations among themselves as they see fit. This has reputedly created a market for unutilized monthly allocations.

Since the Curtailment Rules apply to production from both Crown leases and freehold leases, issues may arise under freehold leases that could expire in the absence of continuous production. The province changed the Curtailment Rules on January 30, 2019, to allow the Minister to amend a Curtailed Operator’s curtailment order for subsequent months to increase the production allocation of that operator to a volume sufficient to retain its mineral rights if the Curtailed Operator can demonstrate to the Minister’s satisfaction that at least 80 percent of its production is freehold production and that its production allocation would otherwise be insufficient to allow it to produce the volume contractually required to retain its freehold mineral rights. Curtailed Operators will have to manage their curtailments carefully if they produce a large proportion of their crude oil from freehold leases. The provisions of freehold leases vary, such that shutting in freehold wells because of curtailment orders may not result in lease expiries, for example, because of force majeure clauses. Of course, the result in each case is dependent on the terms of the particular lease.

The Curtailment Rules were also amended on January 30, 2019, to allow the Minister to increase a Curtailed Operator’s allocation to mitigate a long-term loss of crude bitumen production if the Curtailed Operator can demonstrate to the Minister’s satisfaction that it operates an in situ oil sands project using steam injection that accounts for at least 80 percent of its forecast 2019 production, that the 2019 volume forecast is at least 125 percent of its 2018 forecast for that project, that steam injection at the project had started in 2018 prior to December 3, and that compliance with the existing curtailment order would result in the long-term loss of crude bitumen production.

Most of the wells and projects operated by Curtailed Operators are owned jointly with other working interest partners, so those co-owners will see their production curtailed as well in some fashion, which may give rise to disputes between working interest owners regarding how an operator has allocated its curtailment across the operator’s portfolio. How these disputes should be resolved will largely on the terms of the relevant contract(s), such as the force majeure provision and, if there is one, a provision that deals with legally mandated production cuts. The CAPL operating procedures in use in Alberta do not contain the latter type of provision. Operators of assets governed by CAPL operating procedures do not, for the most part, owe fiduciary duties to their working interest partners.

The Curtailment Rules contain a provision that applies to allow an operator who is comprised of two or more persons carrying on business as joint venture or partnership to agree as to how the production from the joint venture or partnership will be allocated to each participating party for the purposes of complying with a curtailment order. However, since well licences can be held only by corporations and individuals, and are typically held by one of the working interest owners, e.g., the operator named in the operating agreement, it is not clear what this rule was intended to accomplish nor what its effect will be.

Curtailment may have an impact on the liability management ratings of Curtailed Operators under the AER’s rules relating to well licence transfers (e.g., where assets are being sold), since the formula for calculating the rating is based in part on trailing historical production revenue, although the effect will be mitigated because the calculation takes into account a rolling average of 36 trailing months, whereas the Curtailment Rules are currently intended to be in effect for only 12 months.

The Curtailment Rules could also affect producers who have contracts that require them to deliver minimum volumes of oil to purchasers or that contain take-or-pay or similar obligations to service providers. Again, the consequences will depend on the provisions of the applicable contracts.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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