SUBMISSION TO THE ALBERTA ROYALTY REVIEW PANEL FREEHOLD PETROLEUM & NATURAL GAS OWNERS ASSOCIATION

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1 SUBMISSION TO THE ALBERTA ROYALTY REVIEW PANEL FREEHOLD PETROLEUM & NATURAL GAS OWNERS ASSOCIATION The Freehold Petroleum & Natural Gas Owners Association ( FHOA ) represents individuals or family corporations who collectively own natural gas or petroleum and natural gas rights beneath approximately six million acres in Alberta. Issue 1: The Impact of Alberta Crown Royalty Credits and Holidays on Freehold Historically, freehold mineral owners have leased their mineral rights under lease agreements drafted by industry operators which provide for fixed royalty rates. In the past few decades, these royalty rates have typically been in the range of 15% to 18%. The Alberta Crown s royalty regime includes the: Natural Gas Deep Drilling Program ( NGDDP ) which provides royalty credits for new gas wells on Crown lands with true vertical depths of more than 2,000 meters with credits of from $625 to $3,750 per meter depending on depth drilled below 2,000 meters; New Well Royalty Rate ( NWRR ) which provides for a 5% Crown royalty for the first 12 months of production for any new well drilled on Crown lands; Coalbed Methane NWRR which provides for a 5% Crown royalty for the first 36 months or 750 Mmcf of coalbed methane production; Shale Gas NWRR which provides for a 5% Crown royalty for the first 36 months of shale gas production with no production cap; Horizontal Oil NWRR which provides for a 5% Crown royalty for from 18 to 48 months with volume caps of 7,949 m 3 to 15,899 m 3 depending on well vertical depth; and Horizontal Gas NWRR which provides for a 5% Crown royalty for 18 months or 500 Mmcf of production. The introduction of these Crown royalty credits and holidays significantly tilted the Crown/freehold playing field in favour of the Alberta Crown. The collapse in oil and natural gas prices has exacerbated the tilt. The map of 9 sections of Crown and freehold mineral rights in the Lochend area on the next page illustrates the issue. Wells drilled through the Cardium formation with 2-mile horizontal legs through Crown lands several miles to the south have had initial flow in the bopd range. In early 2014 with oil trading for more than $100/bbl, three 2-mile horizontal wells were licensed to be drilled from a surface location in lsd 3 of section W5M through section 34 (Crown) to bottom hole locations in section W5M (mostly freehold). Freehold owners in section 27 had negotiated fixed 20% royalty rates in November, 2012 leases with a 3-year primary term. When the 100/ W5M well was spudded in August of 2015, one of the freehold owners

2 contacted the well operator and asked why she had not been approached to sign a production allocation unit agreement. She was advised that the company s drilling program had been changed, that the well would bottom hole in section 34 and that the company s freehold leases in section 27 would be allowed to expire. Had the well operator completed its drilling program as originally intended and established Cardium oil production comparable to the 2-mile laterals to the south, the portion of the productive wellbore on the freehold in section 27 would have been subject

3 to a 20% lessor royalty together with Alberta freehold mineral tax which initially would have been equivalent to an additional royalty of at least 5%. The Cardium in this area lies at a vertical depth of about 2,400 meters so the measured depth of a 1-mile horizontal lateral would be approximately 3,900 meters as compared to about 5,800 meters for a 2-mile lateral. For these measured depths, the 5% Crown royalty would apply for 36 months and 12,718 m 3 of production or 48 months and 15,899 m 3 of production. Fixed freehold lessor royalties in combination with freehold mineral tax results in an economic burden on industry operators developing Cardium light oil in this area which is anywhere from 4 to 5 times greater than the burden on Crown lands. Even in situations such as section 27 with expiring freehold leases, a licensed well and sunk surface costs, industry operators cannot economically justify extending an existing horizontal well bore onto freehold lands given current and projected future oil prices. To compound the problem faced by the freehold owners of section 27, the same industry operator has recently drilled another horizontal Cardium oil well with a bottom hole location in lsd 16 of section 22, immediately offsetting section 27 to the south. The freehold owners in section 27 are now faced with drainage issues. Similar drainage of freehold mineral rights by wells drilled on Crown lands in direct response to Alberta Government policies exist throughout southern Alberta. The most blatant example is in the coalbed methane ( CBM ) fairway between Edmonton and Calgary on either side of the QE highway where Crown and freehold mineral rights are checkerboarded. The map on the next page shows a typical township of checkerboarded Crown and freehold mineral rights in the Joffre area. On the 18 and ¼ sections of Crown lands, 73 wells producing CBM have been completed. These wells have produced a combined cumulative total of 15.8 billion cubic feet ( Bcf ) of natural gas. On the 17 and ¾ sections of freehold, 20 wells producing CBM have been completed. These wells have produced a combined cumulative total of 3.7 Bcf of natural gas. It is apparent from the distribution of wells and the cumulative gas production from each well that there is no material difference in the quality of the coal reservoirs beneath freehold land and Crown land in this township. The well locations and their produced volumes also make it obvious that drainage of the freehold mineral rights by wells on Crown land has occurred and is continuing. FHOA has advised those of its members who face drainage issues to consider amending their existing leases or executing new leases so as to provide for new wells to have royalty holidays comparable to those granted by the Crown. However, this does not address the freehold mineral tax issue on freehold.

4 When the Saskatchewan Government introduced Crown royalty holiday incentives, it partially mitigated the tilting of the Crown/freehold playing field by providing that Saskatchewan production tax on freehold lands (equivalent to Alberta s freehold mineral tax) for new wells on freehold would be reduced to zero for the time periods and volumes of production corresponding to the volumes and time periods for identical wells on Saskatchewan Crown land (see Saskatchewan Information Circulars PR-IC03, PR-

5 IC04 and PR-IC05). In Manitoba freehold oil and gas production tax (freehold mineral tax) is waived in a similar manner for new wells on freehold lands. FHOA submits that encouraging industry activity on freehold lands in Alberta is just as important for the Provincial economy as encouraging activity on Crown lands. Furthermore, a more equitable development of crown/ freehold minerals could reduce the Province s carbon footprint through a more orderly and efficient development of oil and gas resources. In FHOA s opinion, it is long past time for the Alberta Government to follow the example set by Saskatchewan and Manitoba so as to mitigate the tilting of the Alberta Crown/freehold playing field resulting from Crown royalty credits and holidays for new wells on Crown land.