JurisdictionUnited States
Oil and Gas Operations in Federal and Coastal Waters
(May 1989)


Edward B. Poitevent, II
Jones, Walker, Waechter, Poitevent, Carrere & Denegre
New Orleans, Louisiana


Passage by Congress of the National Gas Policy Act of 19781 ("NGPA") profoundly and dramatically altered the landscape of the natural gas industry from wellhead to burner tip. Its singular importance in revolutionizing the industry cannot be overlooked by anyone with an interest in natural gas. It stands as one of the three great "regulatory milestones" in the history of natural gas regulation.2 However, revolutions, like our own and the French Revolution (whose 200th anniversary is being celebrated this July 14), often produce wholly unexpected results as the consequence of the unleashing of previously restrained forces.3 Correspondingly, although the NGPA has had many of the profoundly dramatic effects envisioned on the fateful day on which President Carter signed the bill into law, probably no one at that time fully understood all of the long-term consequences the NGPA would create once the pent-up market forces it was meant to unleash were fully accomplished. Indeed, the process continues today, more than eleven years later, through the debate in Congress on full price decontrol.4

The highly symbolic — but substantively unimportant — fall of the Bastille on July 14, 1789, was a clear moment when, for French society, the symbolic walls of the restraints holding that society together began to crumble. In the case of natural gas markets, the impediments (or "walls") separating the creation of a national gas market began to crumble on November 9, 1978, by virtue of Section 311 of the NGPA, among other

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things.5 However, like all revolutions — the French included — wholly unanticipated and original changes have taken place in the natural gas industry since these walls were torn down in an attempt to implement the revolution begun on November 9, 1978. Although in the case of the natural gas industry nothing quite so grisly as the spectacle of guillotining an entire caste occurred,6 nevertheless, the occurrence of such things as (i) the elimination of minimum bills per Order No. 380; (ii) the institution of "self-implementing" open access transportation; (iii) the "good faith negotiation" rule of Order No. 451; (iv) the abandonment provisions of Order No. 490; (v) the pro rata allocation of capacity of offshore pipelines; and (vi) the brokering of pipeline capacity have all helped to radically change the natural gas industry in ways which were most likely wholly unintended by Congress —and the industry — in 1978.

The NGPA was clearly a compromise which resulted from the problems of gas supply shortages facing the interstate natural gas market in the mid-1970's. Its pricing provisions were designed to stimulate supply based on the assumption that oil prices would increase in the future at an ever-growing rate. Its transportation provisions, on the other hand, were intended to abolish the barriers between the intrastate and interstate natural gas markets and allow a more free flow of gas from the intrastate into the interstate market.7

Shortly after the NGPA's passage, its assumptions about world oil prices were shown to be incorrect. Cheap oil invaded the industrial market, and at about the same time, the United States experienced a recession. Concurrently, conservation of gas increased in response to the shortages of the 1970's and the producer price

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increases stimulated in large measure by the NGPA.8 At that point, with an increasing supply and a decreasing demand, a surplus of gas — the dreaded "gas bubble" — developed, causing distortions in both pipeline marketing and purchasing practices which to this day are still not resolved.

The distortions created by the conveyance of these events is not new, and since 1978 the natural gas industry has been in a continuing state of transition, exacerbated over the last several years by the developing framework of regulation under the NGPA. In addition to creating other problems for all segments of the natural gas industry, however, the surplus of gas created by these forces clearly also worsened at least one problem which already existed in 1978, that is, the problem of gas imbalances.9 Furthermore, since projections through 1990 indicate only a modest 3% increase in gas consumption, the "gas bubble" will most likely not be significantly reduced in the future and will therefore continue to be a problem for many producers of natural gas.10

One of the principal market reactions to the NGPA-induced "gas bubble" was the creation the long-term and spot markets for natural gas, a process greatly hastened by the partial deregulation of wellhead prices under the NGPA on January 1, 1985. Deregulation of specific categories of NGPA-price controlled gas along with the continued regulation of older, low-priced gas in an oversupplied market clearly set the stage for deregulated gas prices to fall, thus allowing purchasers to selectively choose which gas they would purchase.

Quite obviously, producers are interested in selling gas. Therefore, where there is no long-term market, producers often sell into the spot market. However, producer sales into this alternative market are not wholly without liability for them. On the one hand,

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sales into different markets benefit all parties — working interest owners and royalty owners — but they also create certain problems involving gas balancing which have either heretofore been overlooked or not dealt with properly. Furthermore, although an additional outlet for sales of gas may immediately seem to create a condition which mitigates or eliminates gas imbalances, just the opposite effect may be created. The existence of multiple purchasers for wellhead gas creates an additional probability that imbalances will in fact exist, since in many cases small independents may have a difficult time obtaining a market or releases of previously dedicated gas than will the larger producers. Accordingly, the spot market, while seemingly the answer to the erasure of gas imbalances, may also create additional imbalances based on, among other things, purchasing practices and pricing differentials at the wellhead. This, in turn, leads to perplexing problems for accounting between working interest owners and to royalty owners.

The problem of gas imbalances has also been created (or worsened) either by the failure of many parties to enter into properly negotiated gas balancing agreements or by the fact that historically little attention has been paid to gas balancing agreements. Although this may reflect the low historic value of gas prior to 1978, it also reflects the ability of parties heretofore to negotiate informal agreements by which their interests were brought into balance when imbalances occurred. The dramatic run-up in prices for natural gas experienced since the passage of the NGPA has, however, focused all eyes on the importance of natural gas to the energy needs of the United States, as well as on the bottom line of the companies producing it. This has, therefore, more sharply focused interest on the development of a more formal approach to gas imbalances and, hence, gas balancing agreements, among other things. At the same time, numerous developments have occurred in laws and regulations which have had an impact on the subject. Unfortunately, then, the natural gas industry is presently confronted with increasing instances of imbalances with no formal or clear mechanism for resolution of the problem. It is the intent of this paper to focus on the state of the question of gas imbalances and to suggest certain avenues to resolve various problems, both between the marketing parties and the royalty owners, which may exist. Ideally, in the discussion and resolution of this subject, none of us, unlike Louis XVI, will lose his head.

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A. The Problem of Gas Balancing.

Gas balancing issues most often arise when one mineral lessee sells gas attributable to his interest, while at the same time another co-owner is not selling gas attributable to his interest, or when different prices apply to the same co-owned stream of gas. In these circumstances, when the selling party sells more than his pro rata share of production, he is said to be "overproduced", while the non-selling party is said to be "underproduced". The parties are also said to be "in balance" when each party has sold his pro rata share of production and, conversely, are said to be "out of balance" when one party has sold more than his pro rata share of production.

B. Causes of Gas Imbalances.

Gas imbalances are caused by many things. Principal among them are split stream sales, the failure of gas markets and different purchasing arrangements that arose as a result of deregulation of the pipeline industry after January 1, 1985, the effective date for deregulation of most gas prices, and the creation of a spot market for gas.

Split stream sales of gas at the wellhead often cause gas imbalances. Split stream sales occur when co-owners of a mineral lease sell gas to different purchasers. In such circumstances, disproportionate sales may take place, leaving the parties out of balance.

The failure of the gas markets has also caused gas imbalances. During the late 1970's and early 1980's, when industry analysts forecast increasing prices and demand for natural gas, pipeline-purchasers generally contracted for all the gas they believed they could market. At that time, mineral lessees had a ready market for the production attributable to their interests. In the mid-1980's, however, with the collapse of the price and demand for gas, pipeline purchasers began to reduce their purchases of gas. In many cases, pipelines only

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purchased gas from parties with whom...

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