Scientific Research & Experimental Development (SR&ED) - Guidance Document for In-Situ Heavy Oil and Bitumen R&D

Oil and Gas Sector

Prepared by the Heavy Oil Technical Task Force of the Canadian Association of Petroleum Producers (CAPP) and the Canada Customs and Revenue Agency (CCRA)

• OVERVIEW
• INTRODUCTION
• SCOPE
• SR&ED PROJECT REQUIREMENTS
• IN-SITU HEAVY OIL and BITUMEN R&D
  1. New Process Development
  2. Process Modification
  3. Design Improvement
  4. Implementation Practices
  5. Specific Field Applications
• SR&ED PROJECT COMPLETION
• CLAIM SUBSTANTIATION
• SUMMARY AND CONCLUSIONS

---

I. OVERVIEW

This paper describes the elements of an SR&ED project as conducted by the Oil and Gas Industry in the area of in-situ extraction of heavy oil and bitumen. It discusses the definition of an SR&ED project and emphasizes the importance of demonstrating that SR&ED eligibility requirements are met. Claimants must identify the scientific or technological uncertainty and scientific or technological advancement sought and illustrate that a systematic approach was followed in the SR&ED project. This paper attempts to categorize the development processes used in the in-situ extraction of heavy oil and bitumen. Further, it attempts to clarify what constitutes SR&ED in this industry sector from a practical viewpoint and describes some methods by which this kind of R&D work is accomplished.

II. INTRODUCTION

The Oil and Gas industry is composed of small, medium and large explorers, developers and producers. Scientists, technologists and petroleum engineers have the responsibility and the challenge of finding, developing and producing heavy oil and bitumen deposits. One of the challenges, as in any business, is to use technology to do this as economically and/or competitively as possible.

This paper focuses on the definition of SR&ED as described in sub-section 248(1) of the Income Tax Act (Act). As stated in the Act, SR&ED can be (a) basic research, or (b) applied research, or (c) experimental development. It includes work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research, where such work is commensurate with the needs and directly in support of basic research, applied research or experimental development.

This paper will serve as a tool for companies wishing to participate in this incentive program and for the CCRA to understand the R&D practices in this industry sector.

The origins of this document were a series of meetings between CCRA staff and a sub-committee of the Canadian Association of Petroleum Producers (CAPP) held between February and July 1998. This group is referred to in this document as the Heavy Oil Technical Task Force. The document was finalized as a result of a series of meetings between CCRA and CAPP in 2002.

III. SCOPE

Heavy oil and bitumen accumulations that occur near the surface are usually exploited by surface mining of the oil-bearing sands, followed by the extraction of the oil or bitumen from the sands. A considerable amount of research and development has been undertaken and continues to be carried out by the Oilsands sector in the areas of mining, extraction and upgrading of heavy oil and bitumen. However, most of Canada's heavy oil and bitumen reserves occur in formations that are too deep for mining. Therefore, in-situ processes and technologies are needed to efficiently exploit these resources.

Thus, the scope of in-situ Heavy Oil and Bitumen R&D can include but is not limited to such areas as SAGD (Steam Assisted Gravity Drainage), VAPEX (Vapour Extraction), Steam flooding, CSS (Cyclic Steam Stimulation), In-Situ Combustion, and variations to any of these Enhanced Oil Recovery (EOR) processes. Normally up to 5 elements of work may be identified during the application of these and any other EOR processes. These elements are:

1. new process development
2. existing process modification
3. design improvement
4. implementation practices
5. specific field applications in new locations or by other operators.

We recognize that SR&ED and non-SR&ED work can take place in any of these elements. Work within each element that might be eligible for tax credits is discussed in section V.

Statements made in this paper should be read or applied within the overall context of this paper. This paper is intended to provide practical guidance to help the user in the identification of work that may qualify as SR&ED in the area of in-situ Heavy Oil and Bitumen R&D. The overriding document that defines SR&ED in a general context is the Canadian Income Tax Act.

IV. SR&ED PROJECT REQUIREMENTS

The Income Tax Act (subsection 248(1)) defines SR&ED as:

"systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is

(a) "basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or

(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,

and, in applying this definition in respect of a taxpayer, includes

(d) work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where the work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b) or (c) that is undertaken in Canada by or on behalf of the taxpayer,

but does not include work with respect to

(e) market research or sales promotion,

(f) quality control or routine testing of materials, devices, products or processes,

(g) research in the social sciences or the humanities,

(h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas,

(i) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,

(j) style changes, or

(k) routine data collection."

The elements defined in Section III would generally fall into applied research and experimental development (categories (b) & (c) above). But, it is important to point out that the purpose of the systematic investigation for these two categories is different. For applied research, thepurposeis an advancement of scientific knowledge, for experimental development, it is a technological advancement.

Although some in-situ heavy oil and bitumen R&D may be classified as basic and applied research, the overwhelming majority of the research done in this area is experimental development. Based on the definition of SR&ED in the Act, the following principles have been identified as key considerations in the recognition of experimental development:

• Experimental development is the attempt to achieve technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements.
• In experimental development, the objective is the achievement of technological advancement, whereas in basic and applied research the objective is the advancement of scientific knowledge. In either case, there is no requirement that the attempt be successful.
• Experimental development follows a systematic investigation or search by experiment or analysis in a field of technology.
• Experimental development is typically carried out in a commercial setting.
• The technological advancement can be either embodied in the new or improved materials, devices, products or processes, or represented by the technological know-how gained.
• An attempt to resolve technological uncertainty is an attempt to achieve technological advancement.
• The technological advancement sought must be identified within the business context of the claimant.
• Work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research is included as experimental development if it is "directly in support" of and "commensurate with the needs" of the experimental development being undertaken.

To qualify as SR&ED, the claimant must demonstrate that the work meets the SR&ED eligibility requirements outlined above. Additional details on the principles outlined above can be found in the document "Recognizing Experimental Development".

V. IN-SITU HEAVY OIL and BITUMEN R&D

A brief explanation of the different platforms that may be used for conducting R&D in the oil and gas industry is as follows:

a) Laboratory or bench-scale: These experiments are usually devised to explore theoretical ideas or concepts for a new EOR process and they are often conducted in a laboratory environment employing standard laboratory equipment and apparatus.

b) Field pilots are non-commercial plants in which process parameters or methodologies are systematically investigated. They are often built for developing or for evaluating a new EOR process. Field pilots are mostly involved in elements 1,2, & 3 below (see comments below in respect of the size of the plant).

c) Feasibility or demonstration plants are built to exploit a known process in a new scenario, either in a new reservoir, or by an operator who has not used this process before. "Known" in this context means a process that is in the public domain. These plants are mostly involved in elements 2,3,4 & 5 listed below.

d) Commercial plants are built to exploit a proven process to produce oil from a reservoir. R&D in these plants would generally be involved with elements 4 & 5, but may include 1,2 & 3.

The approach adopted by the Heavy Oil Task Force, was to develop a general framework of what work in the area of in-situ heavy oil and bitumen R&D is SR&ED. The framework also attempts to identify the type of work that could be eligible for Investment Tax Credit (ITC).

Elements of the framework considered are:

1. New process development (e.g. VAPEX, SAGP (Steam And Gas Push), Toe-to-Heel Combustion, and other relatively new EOR processes)
   
   
2. Existing process modifications (e.g. COSH (Combustion Override Split production Horizontal well), SWSAGD (Single Well Steam Assisted Gravity Drainage), ESAGD (Enhanced Steam Assisted Gravity Drainage), new sand control methodologies, or process modifications to deal with challenges posed by reservoirs with top gas and bottom water, abnormal permeabilities, reservoir thickness and depths, etc.)
   
   
3. Design improvement (may include the development of new technologies to accomplish specific tasks e.g. new well completion design, new water re-use process or new pump design)
   
   
4. Implementation practices (include developing new start-up procedures for EOR processes, tests designed to evaluate effects of varying steam ratios, varying lengths of lateral extensions to horizontal wells, operating data collection, logging, numerical simulation, and work done to determine the applicable lateral or areal extent of a proposed EOR scheme)
   
   
5. Specific field applications in new locations or by other operators (includes feasibility tests as well as pilots designed to resolve specific technological questions).

(1) New Process Development

New process development often requires the development and subsequent field-testing of a new, comprehensive heavy oil process or a theoretical concept for a particular application with the purpose of achieving a technological advancement.

In new process development, some laboratory or "bench-scale" controlled work would be carried out prior to the field pilot work. However, for the field pilot work to qualify, field operational parameters and methodologies as well as the applicable scientific and engineering principles would not yet have been proven.

The scale of the field pilot can vary; however, such facilities are usually sized purely for experimental purposes (see comments below in respect of the size of the plant). Under these circumstances, costs related to equipment, wells and operations could qualify for SR&ED tax credits.

(2) Existing Process Modification

Modification of an existing process can occur in a field pilot, feasibility plant or commercial plant, in the following two scenarios:

(a) Planned from commencement of the SR&ED project.

This work involves modifications to existing, proven technological processes for experimental development of new or improved processes where the scientific and engineering principles have not been proven. Such modifications could include enhancements to currently available processes, such as the development of an operating practice for SWSAGD, ESAGD, COSH, developing methodologies for dealing with challenges posed by such problems as top gas and bottom water, abnormal permeabilities, thickness of reservoir and depth to production. When such work is associated with a systematic investigation or search by means of experiment or analysis to modify the existing process, it could be SR&ED.

(b) Arising from technical uncertainties encountered in a plant.

If, in the course of operating a plant, a technological problem requiring a process or methods enhancement is encountered, projects carried out to implement and test the process modification could qualify as SR&ED provided they meet SR&ED eligibility requirements as described above.

Equipment modifications and new wells that are put in for the purpose of completing the testing of the process modification necessary for the SR&ED could also be eligible.

However, for example, implementing the basic SAGD process in accordance with the principles established from the UTF (Underground Test Facility) tests, with no intent to conduct SR&ED, would not be eligible.

(3) Design Improvement

When design improvement work is commensurate with the need to resolve technological questions such as those raised in elements 1 and 2, the work could be eligible.

As part of the work associated with a field pilot or a feasibility study, or commercial operation, specific projects could be carried out with a view to achieving a technological advancement in a defined area of engineering or science.

The onus is on the claimant to demonstrate how the claimed work meets the definition of SR&ED. For Design Improvement type of work, it may be preferable to claim the work in the form of distinct SR&ED Projects (or modules) within the overall R&D program, which may not, in its totality, qualify as SR&ED. Such "modules" would have the following characteristics:

• Each module would have a specific technological advancement objective; and
• The work carried out would be documented and the costs associated with the work would be identified. As an example, work carried out within the context of a feasibility test for the purpose of developing a new horizontal well completion method could be considered a process development module, which could potentially meet the eligibility requirements for SR&ED.

(4) Implementation Practices

The oil and gas industry has over the years developed standard procedures for implementing field development projects. Therefore, these project implementation practices would on their own not be considered to be SR&ED. However, when such work is carried out to resolve a technological uncertainty in a distinct or semi-independent phase of the field pilot, feasibility or commercial plant, the work done would have to be captured as a module (as defined above) and any incremental work carried out to address the technological question could qualify as SR&ED.

Work related to the gathering of geophysical and geological data could qualify if it is performed to monitor the behaviour of the EOR process being developed. For example, 4-D reflection seismology used to monitor the development of the vapour chamber in a SAGD pilot could be eligible.

Modeling and simulation activities carried out in Canada in support of work undertaken under elements 1 to 4 above, where such work is deemed to be part of the SR&ED envelope, would qualify. For example building a numerical model to simulate a VAPEX process where the model supports a field pilot test is eligible work. Model development and simulation would also qualify as SR&ED in their own right where such work can be shown to meet the eligibility requirements.

Delineation and other existing wells would not generally qualify unless they are converted and used as observation wells for the purpose of collecting data as part of an SR&ED project.

(5) Specific Field Applications in new Locations or by other Operators

(a) General Guidelines for Eligibility Considerations

The eligibility of any work in this category does not depend on whether the company is the first to implement a selected EOR scheme in a given location, or on the number of pilots or feasibility plants that have been implemented either by the same claimant or by other operators. In determining eligibility, the following elements need to be taken into consideration:

• The claimant needs to demonstrate familiarity with the state of knowledge that is in the public domain at the time the field pilot or feasibility plant is initiated. The claimant is not expected to be aware of proprietary information of companies who may have implemented similar EOR schemes. However, the claimant is expected to be aware of published literature on the current state of the technology such as public information available through EUB and AEUB reports, conference proceedings and journal publications. The claimant must also consider the body of knowledge gained through its development activities and any expertise acquired "in-house" when determining project eligibility.
• The technological advancement objective, the concept underlying the field pilot or feasibility or demonstration plant and the experimentation strategy should be stated clearly in the supporting documentation.
• Work such as tests and experiments carried out should be well documented, as well as data interpretation and conclusions derived from the work.

(b) Size of Plants

As defined earlier in this section V (and discussed in sub-sections (1) & (2)) field pilots are non-commercial plants built to systematically investigate or develop new process parameters or methodologies. Feasibility or demonstration plants are built to exploit a known process in a new scenario, either in a new reservoir, or by an operator who has not used this process before. Such feasibility or demonstration plants are generally run for the purpose of evaluating a selected EOR process or for determining the economics of implementing an EOR process in a target reservoir. Such demonstration tests ordinarily would not involve SR&ED. However, depending on the state of the science or technology associated with the EOR process, the feasibility test could involve a significant degree of experimentation to resolve technological uncertainties.

There are two limiting conditions on the sizing of field pilots and feasibility plants in actual practice:

• The scale of the plant is such that all surface facilities are sized purely for experimental purposes, or
• All, or a portion, of the plant surface facilities are scaled to commercial size (this would appear to indicate a high degree of certainty and predictability in the EOR process).

In between the two extremes noted above, there might be a number of reasons a claimant may elect to use commercial-sized surface facilities for its pilot or feasibility trials. For example, from a cost management point of view, some components may be over-built simply because the incremental cost is relatively small, or the SR&ED plan contemplates increasing or extending the number of wells for various stages of the experimentation. Note that the CCRA does not insist on the construction of a small plant if a larger one is more cost effective. The onus is on the claimant to justify the size of the plant relative to the technological uncertainty to be resolved, and to ensure that any capital expenditures claimed meet the provisions of the Act.

(c) Duration of the Project

A research and development project should have a time frame within which some result is expected to be obtained, or a set of milestones reached from which a decision can be made on whether the work should be continued. However, the claimant must file a claim each fiscal year. Thus, the claimant needs to demonstrate on a year-to-year basis what outstanding scientific/ technological uncertainties are being addressed in the year of interest, and how that ties in to the overall technological advancement objective identified at the start of the project.

Cases where the focus of the research effort is dramatically altered as a result of new insights gained from work completed may require that the original SR&ED project be terminated and a new one initiated to deal specifically with the problem that has been newly identified.

(d) Unsuccessful or Prematurely Terminated Projects

The results of the experimentation involving a conclusion that the hypothesis was not correct constitute advancement in science or technology.

Case where the plant is prematurely shut down:

Ideally, a field pilot, or feasibility plant, designed for the collection of scientific data would continue to operate until the end of the "experiment". The reality is that businesses are responsible to operate in a cost efficient manner. As a result, there are times when plants must be shut in, for example due to funding cut-backs during a period of sustained low oil prices. If a field pilot, or feasibility plant is shut in (or suspended), the progress to the point of shut-in must be evaluated. The project could still qualify as SR&ED subject to it meeting the eligibility requirements.

VI. SR&ED PROJECT COMPLETION

When new projects move from the status of experimental development through field pilot testing to commercial production, it is sometimes difficult to determine when studies to resolve technological uncertainty have been completed. The SR&ED project is complete when the technological advancement has been demonstrated to be achieved under appropriate conditions and the associated technological uncertainty has been resolved. In all cases, the onset of commercial use or commercial exploitation would signal the end of the SR&ED project.

It is possible that unexpected technological problems may arise during the start-up phase of commercial production or after commencement of commercial production. In such cases it is sometimes necessary for the company's research personnel to be involved in the resolution of technological problems during the ongoing production phase. This work may be a continuation of the original project, may constitute a new SR&ED project, or may not be SR&ED depending on the nature of the technical problems being resolved. In either case, this aspect should be clearly identified and the associated work clearly delineated.

VII. CLAIM SUBSTANTIATION

The creation and maintenance of project information allows for the timely and expeditious review of SR&ED claims. Supporting information is required to establish the technical content of a SR&ED project. When claiming for SR&ED, it is important that the company maintain records of the scientific or technological goals of the project, the progress of the work, how it has been carried out and the project conclusions. For long-term projects, this information provides a year-to-year record of progress against objectives.

The type of supporting information will vary by project. As well, companies differ in the types of documents they maintain. A general list of types of supporting information can be found in CCRA's document "Guide to Supporting Technical Aspects of a Scientific Research and Experimental Development (SR&ED) Claim".

Examples of supporting information specific to the Heavy Oil and Bitumen industry are provided below. It should be noted that this is not meant to be an exhaustive list of appropriate supporting information. If there is an uncertainty regarding the type of information required to support the claim, the claimant may consult a CCRA Research and Technology Advisor for assistance.

A. Quantifiable and verifiable SR&ED objectives and results, e.g.:

1. R&D plans, documents describing project objectives, descriptions of problems.
2. Memos, reports detailing experimental findings and interpretation of findings.
3. Records of development trials, observations, notebooks, lab notes, test records, data measurements,
4. Engineering drawings, prototypes or pictures, patent applications.
5. Process flow charts.
6. Results of analytical tests and/or statistical analysis, interim progress and final project reports.

B. Costs and/or appropriations required to meet project objectives, e.g.:

1. Scientific and technical staff employed in Canada as distinct from those employed outside Canada.
2. Materials and supplies utilized directly in the SR&ED project.
3. Direct expenditures: water, electricity, travel etc
4. Directly related capital expenditures and explanation of their relationship to the project. (AFEs (Authorizations For Expenditure) and their breakdown into capital and expense elements). In capturing plant (capital) costs, separate schedules should be maintained for the listing of all major equipment by name, specification, usage and actual purchase cost in addition to installation costs.
5. Project allocation records.
6. Outside contractors: location of work, relationship to the project, and to the company, statement of work, contractual agreement, etc.
7. Allocation for external research organizations, their location, and reason for utilization.

VIII. SUMMARY AND CONCLUSIONS

This paper examines the legislative requirements of the SR&ED Program and clarifies experimental development as it pertains to the Heavy Oil and Bitumen sector of the Oil and Gas Industry.

Five elements in a framework of in-situ Heavy-Oil and Bitumen R&D are identified as follows:

• New EOR process development
• Existing process improvement
• Design improvement
• Implementation practices
• Specific field applications

For each element, the paper indicates how R&D work done in Canada may qualify for SR&ED credits.

The paper also discusses equipment or plants, which may be constructed as part of the development of a heavy oil field. These facilities may include a laboratory, a field pilot, a feasibility or demonstration plant and a commercial plant. Circumstances where any or some of these would be considered an integral part of a SR&ED project are outlined. In all cases, it is important to maintain records that clearly state the scope of the equipment or plants, why these are necessary for the R&D, the essential elements or components of the facility and the associated costs. Examples of supporting information that can be used to substantiate the SR&ED claim are also provided.