Accounting for Oil and Gas Revenues Without an Operating Agreement

January 10, 2023

Written By Grant Stapon, Laura Gill and Daphne Wang

In IFP Technologies (Canada) Inc v EnCana Midstream and Marketing, 2022 ABKB 807, the Court considered for the first time how to perform an accounting of profits from an oil and gas working interest between tenants in common where there is no operating agreement in place between the owners. The case has a long history and involved accounting for the profits earned by numerous operators over a twenty two-year period.

Factual Background

In October 1998, IFP Technologies (Canada) Inc. (IFP), entered into an Asset Exchange Agreement (AEA) with PanCanadian Resources (PCR) where IFP received 20 percent of PCR's working interest in the petroleum and natural gas rights of Eyehill Creek. At the time, IFP and PCR believed that primary production was likely finished at Eyehill Creek and the parties expected to jointly pursue a steam-assisted gravity drainage (SAGD) project. The parties' operating agreement for a possible SAGD project specifically excluded IFP from receiving profits or paying costs associated with primary production from the lands.

Several years after signing the AEA, the economics of a SAGD project looked poor. In May 2001, PCR agreed to sell its interest to The Wiser Oil Company (Wiser) in exchange for Wiser undertaking certain necessary abandonments at the field. Wiser decided to pursue primary rather than thermal production, including for the purposes of continuing several of the leases at Eyehill Creek. IFP refused to consent to PCR's disposition to Wiser and in 2003, filed a statement of claim against PCR and Wiser and their successors (the Defendants). IFP's main claim focused on an alleged loss of opportunity to pursue the SAGD project, and IFP sought in the alternative an accounting of profits that Wiser and its successors realized from primary production in Eyehill Creek.

The trial took place in 2011 for 34 days. In 2014, Chief Justice Wittmann (as he was then) issued his decision dismissing IFP's claim in its entirety. IFP appealed. In 2017, the Court of Appeal issued its decision agreeing with the Court below that IFP was not entitled to damages for its loss of opportunity claim because the SAGD project would not have proceeded due to the economics at the time. However, the majority of the Court of Appeal held that IFP was entitled to an accounting of its 20 percent proportionate share of net revenue realized arising from primary production at Eyehill Creek based on the language in the AEA and the parties' "reasonable expectations". The Court remitted the accounting of those profits back to trial. 

By that time, Wiser and its successor operators had undertaken extensive primary production and operated the field on the belief that the lands were wholly their own.

In June 2022, the parties went back for a two-week accounting trial. There was a lack of case law on many issues and no operating agreement between the parties to guide how an accounting should be performed. According to IFP's expert, IFP was entitled to $61,781,624 including compound interest from field operations since 2001. The Defendants' expert testified that IFP was in a debit position of $2,471,955 having regard to expected future abandonment liabilities.

On December 2, 2022, the Court issued its decision largely accepting the arguments advanced by the Defendants and finding in their favour. The Defendants could make all of their deductions on a field basis and were entitled to estimate operating and capital expenses not necessarily captured in the operators' internal electronic accounting records provided that there was a reasonable certainty that an expense was incurred and to do so would be consistent with industry standards, with the exception of (1) a $2 million deduction for early abandonment costs incurred by Wiser to earn its interest, and (2) a deduction of certain royalty payments made to PCR.

The Court agreed with the Defendants that IFP's future abandonment liabilities must be included in the accounting and that IFP was not entitled to compound interest. Given the large amount of time and expert fees spent in the 2011 trial on IFP's unsuccessful loss of opportunity claim, the Defendants are also entitled to two-thirds of their 2011 trial costs.

Key Takeaways

In rare circumstances where a party has a working interest in oil and gas assets without an operating agreement in place, this case suggests the following accounting principles will likely apply:

• The Court will generally rely on industry accepted accounting principles.
• To calculate net revenue realized, the Court will take the overall gross revenue minus all reasonable and necessary costs and expenses. If there has been a material passage of time, such as in this case, Courts can use cost estimates provided that there is reasonable certainty that the expenses were in fact incurred. This approach is in line with the Supreme Court's recent comments in Nova Chemicals Corp v Dow Chemical Co, 2022 SCC 43 that an accounting should not constitute punishment and requires disgorgement of profits only.
• While there is no Canadian case law directly on point, an accounting is based on the entire enterprise or field rather than on a well-by-well basis where the enterprise has been operated as a field.
• A non-consenting working interest owner's estimated future abandonment costs can be taken in account against a present accounting of net revenue realized from its interest in the lands.

The case is currently under appeal. If you have any questions about the decision, please contact Grant Stapon, KC, Laura Gill, or Daphne Wang.

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