CHAPTER 6 CURRENT GAS MARKETING ROYALTY ISSUES MINERALS MANAGEMENT SERVICE PERSPECTIVE
| Jurisdiction | United States |
(Jan 1992)
CURRENT GAS MARKETING ROYALTY ISSUES MINERALS MANAGEMENT SERVICE PERSPECTIVE
Minerals Management Service
Denver, Colorado
TABLE OF CONTENTS
I. INTRODUCTION
II. BACKGROUND
A. The Changing Gas Market During the 1980's
B. The Federal and Indian Royalty Implications of the Changing Gas Market Prior to March 1, 1988
III. TRADITIONAL LONG-TERM SALES
A. The Valuation of Unprocessed Gas, Residue Gas, or Gas Plant Products Sold Under an Arm's-Length Contract On or After March 1, 1988
B. The Valuation of Unprocessed Gas, Residue Gas, or Gas Plant Products Not Sold Pursuant to an Arm's-Length Contract On or After March 1, 1988
1. General Requirements
2. Unprocessed Gas
3. Processed Gas
IV. SPOT MARKET SALES
V. POOL PRICING
VI. BUY/SELL AND EXCHANGE AGREEMENTS
VII. GAS FUTURES CONTRACT TRADING
A. Gas Futures Contracts in the New York Mercantile Exchange
B. The MMS' Policy Regarding the Various Trading Scenarios for Royalty Purposes
VIII. GAS STORAGE
IX. MODIFICATION TO THE REPORTING REQUIREMENTS
X. MARKETABLE CONDITION
XI. CONCLUSION
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I. INTRODUCTION
This paper will provide a brief background and discussion of the natural gas market during the 1980's, including special marketing programs and the Federal Energy Regulatory Commission (FERC) Order Nos. 94, 436, 451, and 500. Within this context, it will highlight the Federal and Indian royalty implications introduced by the changing gas market. Specific royalty valuation issues will be addressed in the areas of traditional and spot market sales, end user sales, futures trading, and storage.
This paper also provides four examples illustrating how a lessee should value gas for royalty purposes under the current gas valuation regulations (on or after March 1, 1988) for the following situations: pool pricing; gas futures contract trading; buy/sell and exchanges; and stored gas.1
II. BACKGROUND
A. The Changing Gas Market During the 1980's
The natural gas industry in the United States has experienced radical changes during the 1980's in both the market structure and the regulatory environment. These changes can be traced back to industry's acknowledgement that traditional long-term contracts provided no buffer zones for near term market adjustments. In the market environment that developed under the influence of the Natural Gas Policy Act (NGPA) of 1978, natural gas prices rose and increased exploration resulted in the discovery of additional domestic reserves.
However, in the early 1980's, gas prices began what was to become a precipitous fall owing to many factors, including more favorably priced competing fuels and the development of a natural gas deliverability surplus. In order to deal with this changing market, producers and pipelines entered into an era of special marketing programs which included industrial sales programs, market retention programs, and contract carriage programs. These special marketing programs were all designed to retain those customers of the pipeline company that had alternate fuel capabilities by offering lower prices for the gas. Special marketing programs were arrangements under which producers generally agreed to accept a lower price per unit volume of gas in exchange for higher takes—the result was a net increase in the producer's cash flow.2
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Due to the claimed discriminatory nature of the special marketing programs, FERC issued Order No. 436 in the Federal Register at 50 F.R. 42408 (October 18, 1985).3 In FERC Order No. 436, the Commission fundamentally altered the way in which it regulates natural gas pipelines in light of regulatory and economic developments in the natural gas industry that began with Congress' enactment of the NGPA of 1978. This order effectively forced pipelines to become nondiscriminatory carriers of gas, and ultimately resulted in pipelines assuming the primary role of transporter rather than than multiple roles of buyer, transporter, and reseller. The FERC Order No. 436 allowed interstate pipelines to become open access transporters for gas bought directly from producers by all classes of customers. On June 23, 1987, the United States Court of Appeals for the District of Columbia Court issued its opinion in Associated Gas Distributors v. FERC, 824 F.2d 981 (D.C. Cir. 1987) generally upholding the substance of FERC Order No. 436. However, due to the interrelationship of the rule's provisions, the Court vacated FERC Order No. 436 and remanded the matter for further proceedings. In FERC Order No. 436, the Court was extremely critical of the Commission's failure to recognize the relationship between FERC Order No. 436 and pipeline take-or-pay liabilities as well as FERC's failure to address the take-or-pay question while establishing a regulatory program under Order No. 436 which exacerbates the pipelines' problems.
As more gas was sold directly to end users, less of the throughput was owned by the pipeline company. For gas sold on the spot market, the pipeline company's only responsibility was the receipt and redelivery of the gas. In these instances, the purchaser was usually unaware of and had little concern for the source of the production. As the gas surplus condition endured during 1985, the take-or-pay issue began to attract more attention as a major problem.
The FERC also issued Order No. 451 in the Federal Register at 51 F.R. 22168 (June 18, 1986) modifying the price structure of old natural gas pursuant to its authority under sections 104(b)(2) and 106(c) of the NGPA of 1978 and adopting regulations governing implementation of the revised price structure. This rule also established a "good faith negotiation procedure" with which producers must comply before collecting a higher price under an existing contract, absent voluntary renegotiation of the contract. The negotiation rule grants producers abandonment if the producer seeks a higher price for its old gas, is unable to agree with the purchaser on a suitable price, and finds another purchaser. In addition, the rule provided blanket transportation certificates to interstate pipelines which formerly purchased gas released under the good faith negotiation rule in order to facilitate marketing of that gas to a new purchaser. If the tentative new purchaser is not a firm sales customer of the existing purchaser and the existing purchaser is not an
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open-access transporter under FERC Order No. 436, firm sales customers of the existing purchaser have a right of first refusal.
In recognition of the expanding spot market and the need to address pipeline difficulties relating to take-or-pay liabilities, FERC issued FERC Order No. 500 in the Federal Register at 52 F.R. 30334 (August 14, 1987).4 This order replaced Order No. 436—retaining most of the key features of Order No. 436, but modifying provisions such as: (1) Producers must offer to credit gas transported by pipeline against pipeline's take-or-pay liability, and (2) pipelines may seek to recover take-or-pay buyout/buydown costs associated with past liability. The FERC Order No. 500 allows a pipeline to receive a credit against a take-or-pay obligation if it transports nonpipeline-owned gas.
In addition to establishing maximum lawful prices, the NGPA provided a separate mechanism for dealing with production-related costs. Section 110 of the NGPA gave FERC the authority to permit any first seller to collect amounts in excess of a maximum lawful price, within certain statutory constraints. Effective December 1, 1978, as part of the general interim rules implementing the NGPA, FERC issued regulations for section 110. After receiving and considering comments, FERC, on July 25, 1980, amended the Interim Regulations in FERC Order No. 94, Regulations Implementing section 110 of the Natural Gas Policy Act of 1978.5
Section 110 of the NGPA of 1978 and related rulemaking including FERC Order No. 94 provide that a price for the first sale of natural gas shall not be considered to exceed the maximum lawful price if such first-sales price exceeds the maximum lawful price to the extent necessary to recover certain production-related costs and taxes. Section 110 and its implementing regulation allow producers to pass on to purchasers certain production-related costs incurred by the producers, such as compression, dehydration, and treatment.
Litigation related to the FERC extensive rulemaking for implementation of section 110 culminated with the decision of the United States Court of Appeals for the Fifth Circuit in Texas Eastern Transmission Corporation, et al. v. FERC, 769 F.2d 1053 (5th Circuit 1985), cert. denied, 106 S. Ct. 196, (1986). The court affirmed FERC's authority under section 110 of the NGPA and related regulations to provide that a price for the first sale of natural gas shall not be considered to exceed the maximum lawful price if such first-sale price
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exceeds the maximum lawful price to the extent necessary to recover production-related costs.
The Natural Gas Wellhead Decontrol Act of 19896 (Decontrol Act) takes the final step in the wellhead decontrol of natural gas by removing those price and nonprice controls that remain in place following the partial wellhead decontrol implemented under the NGPA of 1978. Following full decontrol (January 1, 1993), it is anticipated that all gas will be priced on its value as a commodity as determined by the marketplace and that the price will be established on a short-term basis. As industry takes actions under the Decontrol Act and moves toward a more competitive natural gas market, it is understood by Congress that the legislation will cause some low-cost gas newly deregulated to move up in price, countered by higher priced gas to move down in price.
B. The Federal and Indian Royalty Implications Introduced by the Changing Gas...
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