CHAPTER 6 END USER AGREEMENTS

• Jurisdiction: United States

Natural Gas Marketing
(May 1987)
CHAPTER 6
END USER AGREEMENTS
Edward J. Grenier, Jr.
Sutherland, Asbill & Brennan
Washington, D.C.

I. Background

One the first principles of marketing, which everyone learns in Marketing 101, is know your markets. Now that end users of gas have become major markets of gas, independent of their traditional pipeline and distribution company suppliers, producers and other would-be sellers of gas need to focus upon the true needs and interests of the end users. Who are they? Everyone knows about the large industrial consumers of gas — chemical plants, fertilizer plants, major glass manufacturing facilities, the primary metals industry. These are well known, energy intensive users. However, many other manufacturers are greatly interested in the potential savings available through direct purchase of natural gas, even though their operations are not energy- or gas-intensive. Examples are the automotive, textile, and various metal heat treating industries.

Just a few short years ago, conventional wisdom suggested that only large manufacturing operations would be candidates for direct, self-help purchase of gas. With the 18-month "gas bubble" now becoming a seven or eight-year "gas sausage", smaller users have come to realize that there is a lot of potential wealth hiding in their natural gas pipes. Now the end user market has expanded to include smaller manufacturing facilities and larger commercial-type operations, such as universities, hospitals, schools, prisons, apartment complexes and similar institutions. We have even seen interest among business users, whose usage at each location may be very small, even tiny, but whose aggregate usage is reasonably respectable.

Producers and other would-be marketers of gas to end users should also be aware of two distinct sub-markets, each with very different characteristics. One consists of uses which have no alternate fuel, such as process and feedstock industrial uses. The other sub-market consists of uses with alternate fuels, typically large or even relatively small boiler fuel uses. In the latter market are both industrial and commercial users, such as hospitals, universities, etc. The sub-market with alternative fuel will be much more likely to play the price game and be satisfied with very short term spot arrangements. Those without alternate fuel tend to be more interested in longer term, more firm arrangements. Of course neither of these tendencies is absolute. The boiler fuel user will certainly be interested in a longer term arrangement (one or two years) with absolute or at least reasonable price certainty if he believes that, over that period, spot prices might to tend to rise. On the other hand, the process or feedstock user will be interested in some short term spot arrangements at exceptionally attractive prices if they have adequate backup supplies.

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Traditionally, most end users did not negotiate individual contracts for their natural gas supplies. They simply signed standard service agreements with local gas distribution companies, embodying standard tariff terms and conditions. Some larger users, however, did negotiate individual agreements with interstate and intrastate pipelines.

In the mid-1970's, users began to negotiate individual gas purchase contracts with producers or marketers, pursuant to the old FPC's Order 533 program. That early self-help program was limited to the replacement of curtailed high priority (process and feedstock) volumes. Given the generally tight supply situation in the mid-1970's when the Order 533 program started, the sales agreements between the producers and the end users greatly resembled those between producers and pipelines, particularly with respect to key items such as take-or-pay. Producers frequently dedicated the production from a well or group of wells, or from specified acreage — again, in a manner very similar to their agreements with pipelines. Of course, the fact that the price for this gas was not regulated gave producers a real incentive to turn to the end user market, since, in such a time of shortage, they could command premium prices.

With the oil price shock in 1979 and the perceived need to displace imported oil with domestic natural gas, the Secretary of Energy and the FERC initiated the oil displacement program (implemented through the Commission's Order 30). Again, contracting practices between producers and end-users greatly resembled those between producers and pipelines. Here, too, producers could command premium prices, above those for system supply, but below the skyrocketing oil prices.

We all know what happened as we moved into the 1980's. At some point in 1982 or early 1983 interstate pipeline system supplies lost their competitive edge over oil, and pipeline sales began to drop significantly. In the end, market forces will always prevail. The natural gas market in the 1980's has proven to be no exception. Despite initial foot dragging, the FERC eventually adopted a series of regulations accommodating to an ever increasing degree the emerging natural gas spot market. Of course, this effort has culminated in the Commission's Order 436, which, after one and a half years is still going through the very slow and painful implementation process.

It now seems abundantly clear that emergence of a strong spot market featuring competitively priced gas was...