CHAPTER 7 END-USER CONTRACTS AND TRANSPORTATION AGREEMENTS AND TARIFFS
| Jurisdiction | United States |
(Apr 1988)
END-USER CONTRACTS AND TRANSPORTATION AGREEMENTS AND TARIFFS
Victoria J. Brown
SUTHERLAND, ASBILL & BRENNAN
Washington, D.C.
I. INTRODUCTION
In the past decade, the natural gas industry has changed in dramatic ways. Perhaps the most significant change has been the evolution of the role of the interstate pipeline. In the past, a pipeline served solely as a merchant of gas; today, however, in the post-Order No. 436 era, interstate pipelines now offer expanded transportation programs. Indeed, many major pipelines now transport more gas than they sell.
All transportation on an interstate pipeline is accomplished through a variety of legal acts. In order to transport gas, a pipeline must obtain Commission approval, either under Section 7(c) of the Natural Gas Act ("NGA") or under Section 311 of the Natural Gas Policy Act ("NGPA"). Before such approval can be sought, however, the pipeline must reach agreement with the shipper whose gas the pipeline will transport. The shipper, in addition, must reach agreement with a gas supplier or marketer to buy the gas to be transported.
This paper deals with these two kinds of contractual arrangements: (1) sales agreements between gas suppliers and end users and (2) transportation service agreements between a pipeline and its customers (local distribution companies ("LDCs"),
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end users, producers, brokers, marketers, etc.). The former contracts are the result of negotiations between suppliers and users based on what the market calls for. The latter, on the other hand, are governed to a much greater extent by the provisions contained in the pipeline's tariff, which must be filed with and accepted by the Federal Energy Regulatory Commission ("FERC" or "the Commission").
II. END-USER AGREEMENTS
A. 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
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for direct, self-help purchase of gas. With the 18month "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
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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.
In the past year or so, end users have shown increased interest in entering into longer term contracts. The perception appears to be that the market, which has been favorable to spot gas purchasers, is beginning to change. End users, therefore, want to obtain assured supplies at present prices. In addition, end users increasingly want to gain flexibility in their contracts. As the market restructures, they may want to draw on several supply sources, including the pipeline's system supply.
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.1 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
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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 replace imported oil with domestic natural gas, the Secretary of Energy and the FERC initiated the oil displacement program (implemented through the Commission's Order 302 ). 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
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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 culminated in the Commission's Order 436, which, after two-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 inevitable, given the strong competition with other fuels, particularly No. 6 fuel oil. The spot market of the 1980's thus far has been a product of the significant deliverability surplus that has existed throughout this decade. It is this surplusdriven spot market, along with the increasingly severe worldwide competition encountered by industrial end users in numerous manufacturing fields, that has led to the types of end-user agreements we have today.
Of course, we do not want to fall victim to the straight-line fallacy, namely, simply projecting what we have today indefinitely into the future. (Indeed, it was the straight-line fallacy that led some forecasters to predict $50-100 per barrel oil by 1985.) Therefore, the contractual provisions which seem so popular and necessary today may not appear that way in the future. On the other hand, one must
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presume that experience teaches us something. Even if gas supplies become tight (as they undoubtedly will, at least on a short-term and regional basis), one must assume that gas purchasers will not repeat the mistakes of some interstate pipelines in the late 1970's and early 1980's of buying very high priced, ever-price-escalating gas, with high take-or-pay requirements based on deliverability (with no restraint on the producers' developing additional deliverability through drilling additional wells), and all without market-out clauses. What is likely to emerge, at least among sophisticated buyers, is what we are already beginning to see today, namely, the portfolio approach to purchasing gas, under which different agreements will be arrived at with different suppliers, providing various degrees of supply security, at different prices.
B. Major Issues in End-User Agreements
In many respects, the end-user gas purchaser is like any gas purchaser. He desires to get the best value for his dollar. However, given the increasingly competitive milieu in which many industrial end users, at least, operate, they find it increasingly necessary to seek not only good value, but also flexibility. Of paramount importance to an industrial plant manager is to be the master of his own destiny. He must be able to plan his operations with reasonable certitude. Of course, his goals of competitive and flexible prices, security of supply...
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