2020 Oil Sands Tenure Regulation: a summary of changes
By Daisy Dai (Summer Student) with assistance from Alicia Quesnel and Robyn Finley
Alberta's Oil Sands Tenure Regulation (OSTR), enacted under the Mines and Minerals Act (Alberta), provides for the issuance and continuation of primary oil sands leases, as well as the payment of escalating rentals when a continued lease does not meet a minimum level of production. The OSTR currently in force was introduced in 2010 (the 2010 OSTR). Typically, Alberta Energy releases a new version of the regulation every ten years. As a part of this periodic update, a new OSTR will come into force on December 1, 2020 (the 2020 OSTR).
The 2020 OSTR introduces three major changes:
- The removal of MLE (defined below) as a requirement to convert a permit to a primary lease, or to continue a primary lease;
- Permits are no longer issued; and
- The removal of (a) upgrader credits and (b) research, exploration, and development deductions to offset escalating rental payments for continued leases that are non-producing.
This article will outline each of the three major changes and a number of secondary changes.
The 2020 OSTR will apply to all new leases issued on or after December 1, 2020, as well as permits, primary leases, and continued leases issued under the 2010 OSTR and its previous iterations. While the 2020 OSTR will apply to permits and leases going forward after it comes into force, the 2020 OSTR will honour all decisions made by the Minister of Energy (the Minister), including delegated decisions made by Alberta Energy's Royalty and Tenure Division, under the 2010 OSTR before its repeal, regardless of the effective date of such decisions.
1. Removal of MLE requirement and other changes to lease continuation and permit conversion rules
MLE requirement under the 2010 OSTR
Under the 2010 OSTR, lessees or permitees must prove to the Minister that their lease or permit is eligible for continuation by undertaking an evaluation. This evaluation is subject to the standard of Minimum Level of Evaluation (MLE). To meet the MLE standard, licensees or permittees must:
a) gather technical data, including geological, geophysical, engineering and production information—about the oil sands zone or zones included in oil sands agreements;
b) drill evaluation wells on either:
i. each section or part of a section under the lease; or
ii. at least 60% of the sections and providing seismic or electromagnetic data from each undrilled section
for which lease selection or lease continuation is requested;
c) provide the Minister with well data for each evaluation well; and
d) provide the Minister with core data for at least 25% of the evaluation wells.
Lease continuation and permit approval process under the 2020 OSTR
The 2020 OSTR removes the MLE requirement when lessees or permitees apply to convert a permit to a primary lease or to continue a primary lease. The removal of the MLE standard will simplify the application process to convert or continue oil sand leases.
Once the new regulation is in force, lease continuation applications will be governed by section 9 of the 2020 OSTR, and permit conversions will fall under section 7 of the 2020 OSTR.
Subsection 9(3) the 2020 OSTR sets out the general rules for continuation:
- the Minister shall refuse to continue a primary lease if in the application for continuation the lessee has not indicated the sections and parts of sections to which the application pertains;
- a primary lease shall not be continued unless the Minister is satisfied with the configuration of the continued lease or leases and of the sections and parts of sections that may be continued in the location of that lease or those leases;
- if the sections or parts of sections referred to in clause (a) do not corner or are not laterally adjoining, those sections or parts of sections may be issued out of a primary lease only as the location of separate continued leases;
- the lessee shall provide to the Minister all production data in respect of those sections or parts of section included in an application made under subsection (1).
Subsections 9(6) and 9(7) of the 2020 OSTR provide for automatic lease continuations for the drilling spacing unit of a lease on which a located well is producing, and if a producing well or portion of a producing well is producing from one or more leases that are a part of a unit, the leases or portions of leases that are subject to the unit agreement will be automatically continued. No application for continuation is required for these leases or portions of leases.
The Minister will, as under the 2010 OSTR, provide written notice to the lessee designating parts of the lease that are continued and indicate whether the continued lease is producing or non-producing.
Although the MLE requirements no longer form part of the continuation application process, the Minister continues to have the same discretion as under the 2010 OSTR, to send (or withdraw) a notice to a lessee that requires the lessee, within the time specified in the notice, to commence production or recovery or to increase production or recovery, of bitumen or other oil sands from the location of the lease. If the lessee fails to comply with the notice, the Minister can cancel all or a portion of the lease.
Designation as producing or non-producing
Except for the automatic lease continuation provisions found in subsections 9(6) and 9(7) of the 2020 OSTR, and in the absence of a specific notice from the Minister, there is no requirement or rule that the lease or any portion of the lease be producing. The 2020 OSTR has maintained the Minister's discretion to designate a continued lease as producing or non-producing and establish a minimum level of production. For a lease to be designated as producing, it must meet the minimum level of production, including the duration of production, set by the Minister. The lessee of a continued lease that has been designated as non-producing may apply to the Minister to change that lease's designation, if the lease is producing.
Changes to production allocation
The 2020 OSTR makes additional changes to the production allocation rules. First, the 2020 OSTR removes the 2010 OSTR's method of allocating production equally between a well borehole that intersects multiple agreements. Second, the 2020 OSTR makes a distinction between Crown and non-Crown lands for wells with a borehole that intersects multiple agreements. Third, the 2020 OSTR adds a provision that allocates production for wells located on drilling spacing units and subject to one or more agreements.
Accordingly, the Minister will allocate production for:
- a crude bitumen producing well borehole that intersects two or more oil sands agreements on Crown-owned oil sands;
- a crude bitumen producing well borehole that intersects one or more oil sands agreements on non-Crown-owned oil sands;
- a well located on a drilling spacing unit that is subject to two or more oil sands agreements on Crown lands; and
- a well located on drilling spacing unit subject to one or more oil sands agreements on non-Crown lands.
The Minister will do so in a manner that best approximates the recovery from each oil sands agreement, based on any available technical information, including those submitted by a lessee or permittee.
As we transition from the 2010 OSTR to the 2020 OSTR, applications made under the 2010 OSTR to change a lease's designation to producing or non-producing that have not been approved by November 30, 2020 will be treated as applications received under the 2020 OSTR.
The 2020 OSTR's new rules relating to lease continuation and permit conversion will take effect on December 1, 2020. An application for continuation made under the 2010 OSTR that has not been decided by the Minister on or before November 30, 2020 will be governed under the 2020 OSTR. Agreements expiring before December 1, 2020 will continue to be subject to the 2010 OSTR.
2. Permits no longer issued
Effective November 30, 2020, Alberta Energy will no longer issue permits under the 2020 OSTR. Alberta Energy indicated that this change is a consequence of the removal of the MLE requirement. Existing permits, however, will continue to be honoured, and a permit holder may still apply to convert a permit to a primary lease. The process for applying to convert a permit to a primary lease is the same in the 2020 OSTR as in the 2010 OSTR. To apply, the permit holder must indicate the sections of the permit to be converted and the converted sections must adjoin or corner each other. The resulting primary lease will have a 15-year term starting from the date of the permit's expiration.
3. Changes to available relief regarding escalating rentals
Escalating rental payment trigger remains in place; deduction rules changed
Pursuant to section 11 of the 2020 OSTR, the designation of a continued lease as non-producing triggers escalating rental payments. This has not changed from the 2010 OSTR.
However, the 2020 OSTR has made a key change relating to escalating rental payment deductions—it removes the lessee’s ability to claim research, exploration, and development costs to offset their escalating rental payments. The award of upgrader credits for upgrading crude bitumen produced from leased lands has also been removed. While the removal of the deduction and upgrader credit awards have considerably simplified the escalating rental calculation process, any such research, exploration, development, or upgrading efforts are no longer subsidized and the lessees will be subject to the full escalating rental payment amount.
Along with the removal of escalating rental deductions and upgrader credits, the 2020 OSTR eliminates the 2010 OSTR's definitions of "arm's length transaction" which prevented non-arm's length expenditures, such as transfer of proprietary research or proprietary technology (including research publications and licensed research or technologies), from qualifying as deductibles.
In addition, the 2020 OSTR moves the due date of escalating rentals ahead by 30 days. It requires lessees whose lease term year begins on or after December 1, 2020 to make escalating rental payment on the first day of each term year. This differs from 2010 OSTR’s payment date of 30 days after a term year’s last day.
Introduction of forward-looking escalating rental rates
The 2020 OSTR modifies the escalating rental payment calculation scheme for a continued lease that is currently designated as non-producing, and has also been designated as non-producing in the past. Whereas the escalating rental payment rate for such leases is equivalent to the rate per hectare that was being paid for the last non-producing period, the new scheme levies the escalating rental rate amount that would be payable for the following year.
Operationally, the forward-looking escalating rental rates for continued leases under the 2020 OSTR are calculated before a previous non-producing designation becomes effective. If:
- the lessee was in the first term year of a three-term year period, the lessee will have to pay an escalating rental amount as if the second year of the three-term year period had begun;
- the lessee was in the second term year of a three-term year period, the lessee will have to pay an escalating rental amount as if the third year of the three-term year period had begun; or
- the lessee that was in the second term year of a three-term year period, the lessee will have to pay an escalating rental amount as if the first year of the next three-term year period had begun.
Further, escalating rentals due on or after December 1, 2020 under the 2010 OSTR are due by December 31, 2020. The lessee will not be able to claim deductions or upgrader credits for escalating rentals due on or after December 1, 2020.
As a result of the changes to the province's oil sands tenure regulations, a lessee may have an obligation to make escalating rental payments under both the 2010 OSTR and 2020 OSTR. In this scenario, the escalating rental payment under the 2020 OSTR will be based on the same rate for the same term year of the 3-term year period as the 2010 OSTR.
4. Other changes: withdrawal of Crown from unit agreements
The 2020 OSTR now also provides for the Crown's ability to withdraw from a unit agreement. If no unit operations (meaning activities or operations that produce, develop, or exploit oil sands products or solution gas) have been conducted for at least 12 months, the Crown may give notice of its intention to withdraw from the unit agreement three months after the date of the notice.
A unit operator is entitled to dispute the Crown’s notice. The application to dispute a notice of Crown withdrawal must:
a) be made before the three-month period following the date and notice, and
b) provide evidence that unit operations either
i. had not ceased before the date of the notice,
ii. have restarted since the date of the notice and are continuing in good faith, or
iii. were suspended pursuant to force majeure provisions under the unit agreement on the date of the notice.
A unit operator can bring an application to extend the three-month notice period, before or after it expires, if the Minister considers the extension warranted. If no application is made or if the Minister rejects the application based on insufficient evidence, the Minister may make a declaration to withdraw from the unit agreement and the Crown will cease to be a party to the unit agreement on the date specified in the declaration. The declaration to withdraw will also be published in The Alberta Gazette.
5. Also removed: rules governing leases subject to development plan, transfer of a lease location, and transfer of sections of a continued lease
The 2020 OSTR removes several provisions relating to primary leases and deemed primary lease continuation subject to development plans. As a result, rules that require a lessee whose lease is subject to a development plan to meet milestones in the development plan or MLE requirements when the said lease is transferred will no longer apply.
Further, the transfer of oil sands lease locations is not permitted under the 2020 OSTR. Previously, a partial lease location resulting from a location transfer would have been deemed as a primary lease. The transfer would have triggered the MLE requirement. If the transferee were to fail to provide proof of MLE, the Minister would have cancelled the partial lease.
Lastly, the transfer of sections of a continued lease in the 2010 OSTR is also removed. Due to this change, lessees holding two or more continued leases will not be able to swap sections of their leases with one another when 2020 OSTR comes into force.
For the industry, the release of the 2020 OSTR has mixed implications. While the elimination of the MLE requirements simplifies a lessee's application process to convert a permit or continue a lease, the removal of research, exploration, development, and upgrader credit deduction rids of all escalating rental reliefs available to a lessee and subjects the lessee to the full escalating rental payment.
Alberta Energy has released an information letter to address a number of frequently asked questions relating to the operational and application of the 2020 OSTR available here.
Further guidelines with respect to 2020 OSTR will be published in early December 2020. We will continue to update this bulletin as additional information becomes available.