CHAPTER 2 FUNDAMENTALS OF GAS MARKETING CONTRACTS
| Jurisdiction | United States |
(Apr 1988)
FUNDAMENTALS OF GAS MARKETING CONTRACTS
Holme Roberts & Owen
Denver, Colorado
I. INTRODUCTION
A. Scope.The scope of this paper is to identify the basic provisions that should be considered in negotiating, drafting or reviewing natural gas marketing contracts. Included are contracts for the purchase and sale of gas; processing agreements; and gathering, transportation and exchange agreements. Gas brokerage agreements are also discussed briefly. The primary format for identifying the basic provisions of all these contracts is a review of the wellhead purchase contract. The other contracts are commented upon primarily by identifying additional or different provisions involved.
B. Issue Identification. It is not the purpose of this paper to "solve" the questions or issues raised, or even to propose sample language. Many issues are identified only by questions. Many of the issues identified and discussed have commonly adopted solutions and those solutions are presented as such. While some of the approaches or options suggested are new, most of the choices for provisions discussed in this paper have been used in gas contracts before, and many have been incorporated at one time or another in "form" contracts.
C. UCC Application. This paper also briefly discusses the application of the Uniform Commercial Code ("UCC") to gas sales agreements. The UCC can provide "missing" terms in a sales contract and has rules for the modification and interpretation of sales contracts which can have a material impact.
D. Special Contract Mystique. One of the purposes of addressing the fundamentals of gas marketing contracts is to dispel the idea that a natural gas contract is too specialized to be analyzed and negotiated like a normal contract.
Many of the contract forms offered by purchasers, processors and transporters have developed over a long period of time; they are forms with a history. In some cases that is a history of being crafted to solve common problems; in other cases, it is merely a history of bits and pieces of language being deposited on the prior form.
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Specialization may be a legitimate concern where specific text is necessary to a regulatory requirement. An example would be the incentive ceiling price for "tight sands" gas under Section 107 of the Natural Gas Policy Act of 1978. Gas does not qualify for that price ceiling unless the contract contains a specialized pricing provision that a "generalist" would be unlikely to include.1 While including "magic" language may reflect specialization, repeating, paraphrasing or incorporating regulations is usually unnecessary and often ambiguous and may be an attempt to disguise significant economic allocations.
Despite the historical development of many contract forms and the impact of regulation, a contract dealing with natural gas is still just a contract and subject to the same kinds of analysis as any other contract.
The journalist's six questions — who, what, when, where, why and how — provide a useful guide for considering a gas marketing contract, or any other contract. The constant reminder that basic questions need to be answered is excellent discipline. Answering the journalist's questions for a wellhead gas purchase contract would not necessarily result in a complete contract, but it would come remarkably close. Answering the right list of questions results in a complete gas purchase contract. Focusing immediately upon adjustments to a complex form may merely perpetuate a failure to address one or more basic issues. The following sections are as basic to a gas contract as the journalist's questions are to a newspaper story.
II. COMMITMENT
The most fundamental question a gas sale contract must address is what gas is to be purchased and sold. What gas is committed to the contract?
A. Reserve Commitment. The most common form of commitment is all of the gas produced from a described leasehold interest. If the contract allows the purchaser to buy less than all of the gas which the producer is capable of delivering, this form of commitment means that the committed leasehold interest will produce no more than the purchaser purchases.
For precision, the leasehold description used in a gas contract should conform to the same standards used in a real property document. However, in many contracts, the land
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covered may be only outlined on a map or the land description incorporated or implied from a reference to the leases involved. Sometimes it is specified that the commitment is only of gas produced from a particular strata or from above or below a depth or stratigraphic equivalent.
The more precise the leasehold description used in a contract, the less likely any disputes over the scope of the commitment. The practical importance of the precision of the description of the committed interest depends upon other provisions of the contract. Does the extent of the commitment affect the obligation of either party? Is the term short enough to make arguments about commitment best solved by termination?
The "all gas produced" concept is sometimes used by reference to wells identified only by name. This is offensive to an oil and gas conveyancer because a well is only a hole in the ground. Committing wells by name leaves several questions unanswered. Does the contract cover a second well drilled on the same spacing unit? Does the contract cover a new completion in the same well? Does the contract cover a substitute well?
B. Warranty Commitment. One of the common features of the reserve commitment is that the producer makes no promise about the amount of gas which the committed reserves will be capable of delivering. A warranty commitment is the opposite. With a pure warranty commitment, the producer promises to deliver a fixed amount of gas at the delivery point, with no comment at all on the source of the gas.
A well drafted warranty commitment should answer several questions. Does the producer have the right to sell gas from the same general source to a third party? Can the seller tender gas produced from anywhere? Can the seller tender gas which has been purchased for resale?
Precision issues raised by a warranty commitment include knowing exactly how much gas is to be purchased and sold at any particular time. Is the quantity clearly stated? Is it clear whether the purchaser is required to buy the stated quantity? Is the purchaser allowed any flexibility in purchase amounts? If the purchaser buys less than the stated quantity for some period of time, does it have a right or duty to purchase more later to adjust? Over what period of time is the promise to purchase or sell applicable? For example, does a promise to deliver "an annual quantity equal to 1,000 MMBtus per day" create only a single aggregate obligation for the year or an obligation on each day?
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A precise warranty obligation would specify the quantity required to be purchased and sold for each period of time for which there is any obligation and might even specify how deliveries are to be scheduled during the day.
C. Less Than All. There is no requirement that the commitment under a gas contract be all of something. Recent difficulties in performing existing contracts and finding new markets have led producers and buyers to be more flexible in the kinds of contract commitment they consider, both for new contracts and in proposals to modify old ones. The partial releases being offered by many pipelines as part of a contract renegotiation program are conversions of the contract to cover less than all of the gas produced from the committed interest. Although the concept of such a partial commitment is far more flexible than the "all gas produced" form, it is also more difficult to describe with precision.
If the producer is to be allowed to sell to other buyers all of the gas the original purchaser does not want, the first problem is quantifying the amount of gas which the original purchaser does not want. When the second purchaser is an affiliate of the original purchaser, the problem of determining which purchaser is taking gas at any particular time is usually ignored in the contracts. Where the producer contemplates selling to unrelated purchasers from a partially committed source of supply, the parties should be concerned with knowing how much gas the first purchaser's "call" covers during any particular production period. The first purchaser may be concerned with insuring that its "call" is definite enough to be enforced. The producer will find the remaining gas more valuable to potential second purchasers if the partial commitment is either specifically quantified or the first purchaser must announce its purchase decision well in advance.
D. No Commitment. Although the question of what gas is covered by a contract is probably the most basic question the contract addresses, there is no reason that the answer cannot be that there is no gas committed under the contract. Without a commitment the document called a contract is just as a pre-agreed "format" for sales which may take place. Such a form is often used in connection with an auction or nomination program where no gas is under contract until a price offered by the buyer or seller is accepted by the other.
E. Reservations. Where the form of commitment is all gas to be produced from a leasehold interest or well, it is common for the contract to contain several reservations by the producer from the general commitment.
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1. Right to operate. The most common reservation is the right to make all operating decisions. Absent that reservation, a purchaser with the right to "all gas produced" might claim it is entitled to have the wells operated differently than the producer would choose. With a pure warranty commitment such a reservation makes little sense because the producer has already promised to deliver a specified...
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