On December 2, the Government of Alberta announced mandatory reductions to oil and bitumen production in an attempt to narrow the price differential received for Alberta oil and bitumen compared to North American benchmark prices. This temporary cut to production will commence in January 2019, with an initial decrease of 325,000 barrels per day (b/d) (approximately 8.7% of Alberta’s current production). The curtailment will be applied at the operator level, with several dozen operators to be issued curtailment orders to reduce their production.
The Curtailment Rules provide that the minister of energy may “fix the combined amount of crude oil and bitumen that may be produced by each operator.” The first 10,000 b/d of an operator’s production are exempt from curtailment and operators with less than 10,000 b/d of production of crude oil and bitumen will not be subject to a curtailment order.
Implementation is left in the hands of industry. Two or more operators that are issued curtailment orders may apply to have the maximum amounts set out in such orders merged or redistributed among themselves. Additionally, the Rules contemplate allocation agreements between persons carrying on business in a partnership or a joint venture whereby they may allocate production among themselves to meet an applicable curtailment order. The Rules, however, do not provide guidance about the provisions that such allocation agreements should include.
Producers with less than 10,000 b/d were intended to be exempt from the mandatory curtailment. However, it is not apparent this objective will be achieved. There may be situations where a smaller, non-operating producer’s lands are jointly owned and operated by an operator who is subject to a curtailment order. In this situation, the Rules do not prohibit the operator from curtailing production from the jointly owned lands and consequently impacting a smaller producer who was intended to be exempt. The Alberta Energy Regulator (AER) is to establish a panel to hear concerns about the curtailment. However, no further clarity on how disputes will be resolved has been provided.
The Rules also do not include any guidelines for an operator to determine how to satisfy a curtailment order. Operators required to curtail production have discretion on how to achieve their required reduction. While a logical curtailment solution for an operator may be to shut in its most uneconomic production, the legal and operational impacts of doing so must also be considered.
What are some of the legal issues an operator must consider when determining how to implement a mandatory curtailment of its production?
Obligations of an Operator of Jointly Owned Assets
An operator’s discretion in choosing which production to shut in is not absolute. An operator must be cautious and ensure it does not breach a legal or equitable duty owed to its joint venture partners, including potential fiduciary and duty of good faith obligations.
The precise nature of an operator’s legal and equitable duties to its partners is not fully settled in the oil and gas context and depends on the circumstances of each contractual relationship. However, an operator may be legally vulnerable if it curtails production in a manner that adversely affects its joint venture partners, even though the operator is in compliance with a curtailment order in doing so.
Availability of Force Majeure
Force majeure can suspend a party’s contractual obligations when it is prevented from performing its obligations for reasons outside of its control. Government action (or inaction), including change in law, is often included as a type of force majeure.
Shutting in production in response to a curtailment order may result in an operator breaching its contractual obligations to third parties.
If the operator were to be issued a curtailment order for specific wells, it could likely claim force majeure for any breach of contract due to the shut-in. However, in the present case, operators have discretion to decide which wells will be shut in. It will be therefore more difficult to prove that “government action” has required the operator to shut in any specific well, which may limit the likelihood of success of claiming force majeure should a breach of contract claim arise from the shut-in.
Maintaining Title to Freehold Lands
Operators will also need to be mindful of the terms of any freehold leases when implementing their reductions as a curtailment order will not necessarily excuse an operator’s lack of production under a freehold lease.
When shutting in wells, the habendum clause (which sets out how the lease is to continue past the primary term) and the shut-in well clause will need to be considered, along with whether there is other production from the lands that may continue the lease if wells are to be shut-in. The shut-in well clause will need to be examined to ensure it may be relied upon in such circumstances and that all of the requirements of the clause are met.
The mandatory curtailment has been viewed positively by a large part of the industry in Alberta, but not universally. With the implementation being left largely in the hands of industry, industry participants will need to work together to achieve the curtailment’s intended purpose with limited disruption. While a curtailment order will require certain operators to take action to curtail production, this may not excuse the operator from continuing to meet its legal obligations to third parties. Affected operators will need to be mindful of avoiding unintended legal consequences when implementing the required curtailment.