CHAPTER 7 EMERGING BUSINESS AND LEGAL ASPECTS OF THE CONTEMPORARY NATURAL GAS PROCESSING INDUSTRY

• Jurisdiction: United States

Oil and Gas Agreements: The Production and Marketing Phase
(May 2005)
CHAPTER 7
EMERGING BUSINESS AND LEGAL ASPECTS OF THE CONTEMPORARY NATURAL GAS PROCESSING INDUSTRY
Jeffrey Strausser
Director of Marketing, EOG Resources, Inc.
Adjunct Professor of Law, South Texas College of Law
Houston, Texas
JEFFREY STRAUSSER

Jeff Strausser is the Director of Marketing for EOG Resources, Inc. and an Adjunct Professor at the South Texas College of Law where he teaches Oil and Gas Law I and Oil and Gas Law II.

He is the author of the textbook, Fundamentals of Texas Oil and Gas Law. He has also authored Painless American Government and Painless Writing, both published by Barrons Educational Series for middle school students.

Jeff is active in the Houston Bar Association's program to help at-risk students. He tutors seventh and eighth graders in algebra.

CONTENTS

I. INTRODUCTION

II. THE DYNAMICS OF PROCESSING NATURAL GAS

III. A COMMERCIAL OVERVIEW OF THE NATURAL GAS PROCESSING MARKET

A. Determining Commercial Viability

B. Economic Questions

IV. STRUCTURING A MODERN GAS PROCESSING CONTRACT

A. Recital Language

B. Representations and Warranties of the Processor and Producer

C. Definitions

D. Delivery and Processing of Gas

E. Election to Suspend Processing

F. Right of the Producer to Suspend Processing

G. Quality

H. Measurement and Testing

I. Plant Products and Residue Gas

J. Plant Fuel, Compressor Fuel, and Shrinkage

K. Processing Fee

L. Warranty of Title

M. Term

N. Statements and Payment

O. Liability of the Parties

P. Force Majeure

Q. Regulation

R. Taxes

S. Assignment

T. Notices and Statements

V. CONCLUSION

It is better to know some of the questions than all of the answers.
-- James Thurber

I. INTRODUCTION

At the market's current high prices for natural gas and natural gas liquids, the decision for a producer to process its hydrocarbon stream is of significant financial consequence. Consequently, understanding and properly negotiating the associated gas processing contract has taken on an elevated importance. The purpose of this article is to first explain the dynamics of processing natural gas and the issues it creates for producer and processor and then to discuss model contract language that addresses these issues. The discussion will emphasize the producer's viewpoint because, typically, the producer is at a disadvantage to the processor in understanding the processing dynamics and the structure and details of the natural gas processing contract.

II. THE DYNAMICS OF PROCESSING NATURAL GAS¹

Let us first examine the dynamics of the natural gas processing ² so that we can understand the framework upon which the commercial and legal issues rest and how we should incorporate these dynamics into the natural gas processing contract.

Processing natural gas in plant facilities involves separating, isolating, and removing heavier hydrocarbon compounds ³ FN3 from the production stream. ⁴ FN4 These hydrocarbons have economic value, but paradoxically, these valuable hydrocarbons ⁵ FN5 may render gas non-merchantable if they are present in too high concentrations. ⁶ FN6 As such, some form of gas processing (i.e. conditioning) may be necessary. Thus, the decision to process the wellstream can be one to enhance value or simply one to render the production stream merchantable.

The processing of the natural gas hydrocarbon stream and processing in the gas plant involves two basic sequential operations, extraction and fractionation. The first operation involves the extraction of the natural gas liquids from the hydrocarbon stream. This extraction of the heavier hydrocarbon components is accomplished in gas processing facilities by taking advantage of the physical properties of the hydrocarbons themselves. The extraction sequence begins with separating the commingled gas and liquids by passing them through a vessel large enough for them to decelerate and have time to separate. Separation can also occur by increasing the pressure or reducing the temperature in the vessels such that the entrained liquid hydrocarbons will condense and separate from the gaseous portion of the hydrocarbon stream. Thus, the liquid extraction process may be as simple as drying the gas by passing it through a fixed bed of desiccant material, or it may be as complex as complete liquefaction by cooling the total well stream to extremely low temperatures. The two most important extraction processes are absorption process ⁷ FN7 and the cryogenic expander process. ⁸ FN8 Together, these processes account for over 90 percent of total natural gas liquids production.

The extraction and separation of the liquid hydrocarbons from the gaseous phase hydrocarbons is followed by fractionation of the hydrocarbon liquids into their separate C%ln%lH%l2n±1%l components of ethane, iso-butane, normal butane, iso-propane, normal propane, and natural gasoline. Fractionation of the hydrocarbon liquid stream may occur right at the gas processing plant or it may take place at a central fractionator many miles from the processing plant. In the case of the remote central facility, it may receive mixed streams of natural gas liquids from many plants. Regardless of location, fractionation of the mixed liquid hydrocarbon stream (natural gas liquids "NGL's'D') into separate components is accomplished by controlling the temperature of the stream in the fractionator to take advantage of the difference in boiling points ⁹ FN9 of the desired products. ¹⁰ FN10

III. A COMMERCIAL OVERVIEW OF THE NATURAL GAS PROCESSING MARKET

A. Determining Commercial Viability

Processing will be a viable commercial option for a producer if the anticipated value of the net plant products and net residue gas exceeds the anticipated value of both the hydrocarbon stream when sold, without separation, on an MMBtu basis. For the commercial and legal representatives of the producer to properly determine the economic viability of the proposed transaction, several economic questions must be answered.

B. Economic Questions

Question No. 1: Under the processing mode, what will be the respective recoveries of the various plant products?

Plant products typically mean the liquefiable hydrocarbon components that the processor recovers and removes from the hydrocarbon stream: ethane, propane, iso-butane, normal butane, and natural gasoline. Most contemporary contracts will provide for the liquefiable hydrocarbons to be recovered in the following percentages in the processing mode: ¹¹ FN11

12. As mentioned in Footnote 7, some modern plants using certain processes can recover close to 95 percent of the ethane from the hydrocarbon stream.

Product	Recovered Amount
%w
Ethane	65%%n12%n
Propane	95%
Iso-butane	99%
Normal Butane	99%
Natural Gasoline	100%

Contracts stipulating lower recovery percentages than those listed above should be thoroughly investigated by the producer client. Old and inefficient plants usually cannot obtain these types of recoveries. ¹³ FN13 If this type of plant is involved in the processing, the producer may want to search for other plants in the area. If other plants are not available, the producer should keep the low recoveries in mind and strive to have the processor share the burden of the inefficient plant. ¹⁴ FN14

Question No. 2: How is the processor to be compensated, and in what amount?

Processors are usually compensated by one of two methods. The most common method is for the processor to receive a share of the proceeds from the sale of the recovered plant products. Most gas processing contracts entitle the processor to claim anywhere from 10 to 20 percent of the recovered liquefiable hydrocarbons. ¹⁵ FN15 If the processor's share is more than the aforementioned range, the producer client should question this, and, if possible, explore options with other processors. As always, whatever the outcome of the negotiations, the processor's share of the liquid hydrocarbons must be incorporated into the producer's analysis on the economic viability of processing.

The other, and less common method, to compensate the processor is to stipulate that the processor receives a fee for each MMBtu processed. Under this method, the producer will retain all of the recovered liquefiable hydrocarbons and the proceeds from the sale therefrom, but will pay the processor a predetermined amount for each MMBtu that is handled by the plant. Although this method is not as common as the percentage of net proceeds method, it is still found in contracts and is a reasonable method for compensating a processor who does not want to assume the risk of fluctuating natural gas liquid product prices. The processing fee usually ranges from as low as a few cents per MMBtu, up to $.25 per MMBtu. ¹⁶ FN16

Question No. 3: How is the net sales price of the plant products determined?

Most contracts specify the net sales price of each of the liquefiable hydrocarbon components that the producer and the processor will receive for their share of the plant products. On the other hand, some contracts allow the producer the option to take its share of plant products in-kind and sell them. In the case of the former, the contract should specify a value for each component based on a local sales hub market, ¹⁷ FN17 as published monthly by OPIS, ¹⁸ FN18 less an applicable transportation rate ¹⁹ FN19 for each of the component products, if required. If your producer client is contemplating taking its products in-kind and selling them, it should make sure to understand any charges, such a tank rentals and storage fees, associated with doing so.

Question No. 4: What is the duration of the processing? That is, does the producer have the right to suspend processing if it is in its best economic interest to do so?

Due to the volatility of the relationship between the price of natural gas and the price of liquefiable hydrocarbons that can be recovered from the...