> but we cannot simulate Oil/Water systems

I'm saying that we can: Simply set the initial gas saturation to zero and use dry oil and the gas component will never appear anywhere because it gets conserved. (unless of course you have a source term for it, but then it is not a oil/water system anymore.) Of what I've seen in the current code, that's also what's hardcoded. (except that the conservation equation for gas is avoided.)

If your argument rather is that you want to get the bit of additional performance by avoiding the unnecessary conservation equation,  IMO one should use a two-phase simulator which assumes immiscibility from the outset...

> The present code assumes that the derivative of the residuals with respect to "xvar" is non-zero and that's just not true in an Oil/Water system. 

it is if e.g. Sg is used as primarily variable and the density of gas is != 0...