CHAPTER 11 TAKE OR PAY PROVISIONS IN PRODUCER GAS SALES CONTRACTS
| Jurisdiction | United States |
(May 1983)
TAKE OR PAY PROVISIONS IN PRODUCER GAS SALES CONTRACTS
Holme Roberts & Owen
Denver, Colorado
I. INTRODUCTION
A. Perspective. Objective legal analysis of gas contract questions is hampered by the relatively stable division of concerned parties into two groups: producers and pipelines. A victory by one pipeline in contract negotiation or interpretation is normally a victory for all pipelines. To date, producers also have considered a victory on gas contract negotiation or interpretation by any producer to be a victory for all producers. As a result, questions of contract interpretation have generally elicited automatic divisions of opinion: producers in one camp and pipelines in the other. The personal result for this author is that representing producers has imprinted a single perspective about gas contracts which no attempt at objectivity may be able to overcome.
Striving for objective analysis of take or pay provisions in gas contracts is also hampered by the lack of relevant reported cases. Computer assisted research has disclosed only three cases in which interpretation of a take or pay provision in a gas contract was the reported issue, and none of the three merits discussion.
Having considered objectivity and found its attainment unlikely, this paper will be presented from the producer's perspective.
B. Coverage. Current concerns over take or pay provisions include the contractual provisions themselves and the external conditions in which they will be negotiated or interpreted. Under present conditions, interpreting existing contracts is more likely to involve sophisticated issues than negotiating new contracts. Concern in negotiations for a new contract over some of the provisions discussed below might be greeted with unrestrained laughter, but the issues are still relevant in interpreting or enforcing some existing contracts.
The discussion of external conditions relevant to take or pay provisions below is not an attempt to portray or predict market conditions in detail or to predict future regulation. That task is impossible. However, summarizing current conditions and considering future regulation may assist producers in setting reasonable objectives and understanding and reacting to pipeline actions.
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C. Take or Pay Objectives. A producer normally signs a gas contract to convert an oil and gas success, the development of commercial gas reserves, into an economic success, the receipt of revenue. For many producers, cash flow is a concern and a take or pay provision is sought to guaranty cash flow. Take or pay provisions are also sought to maximize the present value of reserves covered by the contract. Under some circumstances, deferring gas production could increase its present value, but few producers believe it will happen. Thus, a producer's objectives for a take or pay provision are to insure cash flow and to maximize present value of the reserves.
A pipeline, on the other hand, has absolutely no self-interest in a take or pay provision. The pipeline's objective in signing a gas purchase contract is to secure commitment of the producer's reserves. Pipeline facilities, by virtue of their durability and expense and by virtue of pipeline regulation, must be in service for relatively long periods of time. The pipeline needs the commitment of sufficient reserves to keep the facilities in service for those long periods of time. However, once reserves have been committed, the pipeline's objective is flexibility: The right to purchase gas when it needs gas and to not purchase gas when it does not need gas. To the pipeline, a take or pay provision is an evil best avoided and endured only when necessary to secure the commitment of needed reserves.
Pipelines have a tool which can make it easier to secure commitments without surrendering flexibility. The tool is ambiguity. Gas contracts usually are clear and simple in provisions for the pipeline's benefit, such as the reserve commitment. However, provisions, such as take or pay, which favor the producer are another matter. The take or pay provision may appear consistent with the producer's objectives if read quickly, but, if read more carefully, may be found to be difficult to enforce or nonexistent. The role of a producer's counsel in negotiating a take or pay provision, and probably the entire gas contract, is to seek a clear expression of the pipeline's obligations. In disputing or litigating a take or pay provision, the role of the producer's counsel is to deflect the pipeline's attempt to sow confusion.
D. Contract Fragments. The fragments of contract language scattered in the text below are inserted as illustrations of the aspects of take or pay provisions discussed. Some are copied from pipeline forms; some are modified from pipeline forms; and some are inventions of the author's fancy. The samples so shown are not necessarily recommended for producers.
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II. BASIC TERMS
A. General. A take or pay provision is a promise to pay for a certain amount of gas during a given period, whether taken or not. For some reason, it is normally expressed as a promise to take, immediately followed by a statement of what happens when the promise is broken.
"Buyer agrees to purchase and receive from Seller each day a quantity of gas equal to the daily contract quantity. If during any contract year buyer does not purchase and receive a quantity of gas equal to the daily contract quantity for each day during such year then Buyer will...."
B. Quantity Determination. In order to have an enforceable take or pay provision, it is necessary to identify the quantity the pipeline has promised to take.
1. Deliverability. Reference to the capacity of a well to produce, the well's "deliverability", is a common way to express the take or pay quantity. In many contracts the "daily contract quantity", or an equivalent phrase, is defined as a percentage of the amount which the well is capable of delivering during a twenty-four hour period.
The capacity of the well to deliver is affected by many variables potentially under the control of the pipeline, all of which should be addressed in the contract. The most obvious of these variables is the pressure in the pipeline at the point of delivery. The right to sell 95 percent of the well's deliverability is of little value if the pipeline can control deliveries with line pressure. The producer should always seek a specific ceiling on the pressure which the pipeline can maintain at the point of delivery and, generally, as low as possible.
"The term 'daily contract quantity' as used in this agreement shall mean 70 percent of the daily maximum quantity of gas deliverable by Seller hereunder during the last twenty-four hours of seventy-two hours of continuous delivery at the existing pressure in Buyer's facilities at the delivery point or 300 psig, whichever is lower."
Even if maximum pressure is specified, it is probably wise to have an additional provision that the deliverability
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of a well will be determined at its "unrestricted flow" to insure that no other artificial limitations are placed on the well's capacity to deliver.
Rather than treating improperly high pressures or restrictions on a well's flow as contract breaches which could be litigated, the producer will benefit from a provision requiring adjustment of the deliverability measured under improper conditions to that which would have been measured under contract conditions.
In addition to stating the conditions under which the well's deliverability will be determined, the contract should also state the mechanics of the determination. Typically, the determination is commenced by testing. The pipeline usually conducts the test, but the contract should require notice to the producer of the test and an opportunity for the producer to observe. The appropriate method for measuring deliverability does not appear to be a legal issue, but insuring that the method is adequately specified in the contract may be.
After the testing is completed, some calculation is necessary to convert the test data to a deliverability figure. The pipeline usually makes these calculations. Having the pipeline make the calculations should not be a problem if it is obligated to supply the test data and its calculations to the producer for review, and if the contract does not state that deliverability is whatever the pipeline declares it to be. Even if the contract states that the deliverability of a well is whatever the pipeline determines it to be, there should be recourse for a bad faith determination. However, a bad faith determination is different than an incorrect determination and bad faith may be hard to prove.
Assuming a contract which outlines in adequate detail the mechanism for testing and calculating the deliverability of each well, there is the possibility that the pipeline and the producer will disagree about the results. Many gas contracts refer such a dispute to arbitration. If a gas contract proposal with deliverabilitybased take or pay does not require arbitration of deliverability disputes, the producer should be concerned. How realistic is suing over the deliverability determination if that determination is being made monthly, quarterly or even annually? Arbitrating deliverability seems to the producer's benefit, regardless of the producer's preference about arbitration in general. In addition, the producer
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should seek speedy arbitration, with the determination of deliverability resulting from the arbitration being effective from the same date that the pipeline's determination was due to the producer. If the pipeline's proposal remains in effect, or if there is no deliverability in effect, until the arbitration decision is final and no retroactive adjustment is made, the pipeline will have received benefits from its low determination, even if it...
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