CHAPTER 5 CURRENT GAS MARKETING ROYALTY ISSUES—INDUSTRY PERSPECTIVE
| Jurisdiction | United States |
(Jan 1992)
CURRENT GAS MARKETING ROYALTY ISSUES—INDUSTRY PERSPECTIVE
ARCO Oil and Gas Company
Dallas, Texas
ROCKY MOUNTAIN MINERAL LAW FOUNDATION
SPECIAL INSTITUTE ON FEDERAL AND INDIAN
ROYALTY VALUATION AND MANAGEMENT
I. THE EFFECT OF THE UNBUNDLING OF PIPELINE SERVICES ON THE ABILITY TO DETERMINE THE GROSS PROCEEDS ACCRUING TO THE LEASE FOR PURPOSE OF ROYALTY VALUATION
The last half of the 1980's and the first two years of the 1990's have brought about profound changes in the way producers market their gas. All of the changes, in one way or another, result from sagging demand and shrinking markets coupled with changes made to the regulatory apparatus. Falling demand led to the creation of huge take-or-pay obligations on the part of many pipeline companies, triggered the exercising of numerous market-out clauses and, in some cases, outright abrogation of contracts. At the same time that some gas was locked into contractual rates that were considerably above market, other gas was locked into below market pricing by virtue of regulations stemming from the Natural Gas Policy Act and predecessor decisions and rulings.
FERC Order 436, issued in 1985, permitted interstate pipelines to become open access transporters of gas. This meant producers could ship gas to distant customers, and their market was no longer confined to a few pipeline purchasers. In 1986, FERC issued Order 451 which permitted producers and pipeline purchasers to enter into "good faith negotiations" to increase the price received for certain old low priced gas. Typically an attempt was made by the pipeline purchaser to seek agreement from the producer to simultaneously drop the price of high priced gas. If the two parties could not agree on a price, the gas could be "abandoned" in a regulatory sense which permitted the producer to sell the gas to others. FERC Order 490 further enhanced the producer's ability to market its gas to others than pipeline purchasers.
As these events unfolded, the spot market for gas grew rapidly and became a potent force. Major gas trading centers emerged. Producers added staff and developed sophisticated and costly marketing organizations that actively sought out all types of potential customers for their gas. Often these new customers were unwilling or unable to buy the gas at the wellhead and arrange transportation to their facilities. This caused
[Page 5-2]
producers to have to arrange the transportation and act as shipper of the gas. This in turn required the producers to again add costly staff and to become expert in the art of gas shipment. In the process, markets moved away from the wellhead.
Sales are typically made now at various points along the pipeline system, or at the city gate, or at the inlet to the customer's facility. Increasingly such sales are unsourced — the sales contract does not reference the lease or field from which the gas originated. Gas from many sources is often aggregated and may be sold to a multitude of customers at various points along the transportation system, and may involve moving the gas through multiple transportation systems. Sales became increasingly short term, with the customer base in constant state of change, although we are now beginning to see a reversal of this trend. Pipeline/producer inventory imbalances are commonplace and may result in imposition of monetary penalties if allowed to long go unreconciled. In addition, we have seen the emergence of the gas futures market and the institution of gas exchanges. As off-season prices dropped to new lows, there has been an increase in the amount of gas stored off-lease for later sale. All of these factors impact the producer's ability to determine the gross proceeds attributable to the gas from a particular lease.
[Page 5-3]
II. ACCOUNTING FOR PRODUCER MOVEMENTS OF NATURAL GAS
The advent of producers acting as shippers of gas in mainline transmission systems required the development of a new accounting protocol to keep track of the gas. A joint task force was formed, composed of representatives from the Interstate Natural Gas Association of America (INGAA), the Council of Petroleum Accountants Societies (COPAS), the American Petroleum Institute (API), and the American Gas Association (A.G.A.), to develop the new accounting protocol. The work of this group was summarized in COPAS Bulletin No. 28, which is titled Joint Task Force Guidelines on Natural Gas Administrative Issues, and was issued in April 1990.
The basic concepts on which the task force relied are threefold:
1. Confirmed nominations and physical flow were adopted as the basic vehicles for gas allocations. Confirmed nominations means that there has been agreement between the parties as to the volume of gas to flow daily from source to market.
2. Prior agreement should be in place as to the allocation methodology that will be employed when confirmed nominations and actual measured volumes differ.
3. Timely communication must exist between the parties as to confirmed nominations, allocations, and volume imbalances.
The operator is key to the process. COPAS Bulletin 28 recommends that the operator at custody transfer points should serve as facilitators in the nomination, confirmation, and allocation process. When the operator performs this role, and when co-owners diligently work through the operator, it is to everyone's advantage. Most imbalance problems result from a breakdown in this process.
To accurately determine gross proceeds from the sale of the gas, as required under the regulations, it is necessary to track the gas from the lease to the customer. The lease may be in the Gulf of Mexico and the customer may be in Baltimore or Brooklyn, or the lease may be in the San Juan basin and the customer in California. This can be done with a fair degree of precision when each sales contract is sourced to a particular producing lease, or all the gas available for sale came from a particular producing lease. The process begins to
[Page 5-4]
break down when sales are unsourced and or multiple producing leases are involved.
Accounting for the movement of gas based on confirmed nominations and physical flows does not necessarily assure that it is always possible to relate each sale to the point of production. The objective is to track the ownership of various "packages" of gas through various transportation facilities to the ultimate customers so that they can be invoiced, and to assure that gas is neither lost nor overlooked. As the customer based and the number of transportation options multiplied, and as the number of sourced sales declined, it became apparent that a pooling concept for sales would be necessary. Thus, the concept of "market pools" or "market pots" came into being.
A COPAS Subcommittee presented the "market pot" concept to MMS for consideration, and at the April 20, 1988 COPAS meeting in Banff, Don Sant of MMS endorsed the concept. A copy of the material actually presented by Mr. Sant in Banff is attached as Attachment I to this paper.
A major company presented a more complicated set of facts to MMS at about the same time, and sought a formal valuation determination. In the application, the company noted that it had encountered complications in tracing production from many different sources, delivered under different transportation agreements and sold to many purchasers. To value the production for royalty purposes in such instances, the company proposed to use "market pots," or a weighted average price for the untraceable production. Similarly, it proposed the use of "transportation pots," or a weighted average cost of all transportation up to the point of sale, where the exact costs for transportation are untraceable. MMS agreed with these concepts and approved the use of "market pots" and "transportation pots" where the gas cannot be contractually or physically traced to the point of production.
Later in the Institute, MMS will describe and illustrate their current thinking in this regard. The audience will be well served to pay close attention to that material as I believe you will find their methodology to involve certain intracacies not typically found in...
To continue reading
Request your trial