CHAPTER 7 TRANSPORTATION ON INTERSTATE PIPELINES

• Jurisdiction: United States

Natural Gas Marketing and Transportation
(Sep 1991)
CHAPTER 7
TRANSPORTATION ON INTERSTATE PIPELINES
Judy M. Johnson
VINSON & ELKINS
Houston, Texas

August 1991

The terms of a transportation contract with an interstate pipeline may, in large part, be dictated by the FERC Gas Tariff which that pipeline has on file with the Federal Energy Regulatory Commission (Commission). Nevertheless, there are options which a shipper or potential shipper should explore in the process of contract negotiation. Certain types of certificates being issued to interstate pipelines provide substantially more latitude in negotiations than the blanket certificate issued pursuant to Section 7 of the Natural Gas Act and the regulations promulgated under Section 311 of the Natural Gas Policy Act of 1978. The optional certificate is an example. Moreover, the negotiation forum has shifted to a significant degree to proceedings at the Commission. The specific terms and conditions and the rates to which shippers will be subject when entering into transportation contracts with interstate pipelines are the subject of ofttimes protracted settlement proceedings or litigation at the Commission. Shippers (producers, marketers, and end users) may intervene and participate in these proceedings. These proceedings are, in effect, a part of the contract negotiation process.

I. THE NATURAL GAS ACT — HISTORICAL UNDERPINNINGS

The Natural Gas Act covers three things: sales for resale of natural gas in interstate commerce, transportation of natural gas in interstate commerce, and companies engaging in either or both of these pursuits.¹ Under Section 7 of the Natural Gas Act a company may not engage in transportation or sales for resale of gas in interstate commerce without first obtaining a certificate of public convenience and necessity.² In particular, that Act provides:

No natural-gas company or person which will be a natural-gas company upon completion of any proposed construction or extension shall engage in the transportation or sale of natural gas, subject to the jurisdiction of the Commission or undertake the construction or extension of

[Page 7-2]

any facilities therefor, or acquire or operate any such facilities or extensions thereof, unless there is in force with respect to such natural gas company a certificate of public convenience and necessity issued by the Commission authorizing such acts or operations....

15 U.S.C. § 717f(c) (1988).

The Act further provides:

Except in the cases governed by the provisos contained in subsection (c) of this section, a certificate shall be issued to any qualified applicant therefore, authorized in the whole or any part of the operation, sale, service, construction, extension, or acquisition covered by the application, if it is found that the applicant is able and willing properly to do the acts and to perform the service proposed and to conform to the provisions of the Act and the requirements, rules, and regulations of the Commission thereunder, and that the proposed service, sale, operation, construction, extension, or acquisition, to the extent authorized by the certificate, is or will be required by the present or future public convenience and necessity; otherwise such application shall be denied. The Commission shall have the power to attach to the issuance of the certificate and to the exercise of the rights granted thereunder such reasonable terms and conditions as the public convenience and necessity may require.

15 U.S.C. § 717f(e) (1988).

Historically, under this scheme the applicant controls in the first instance the transaction proposed to be authorized by the Commission. The Natural Gas Act is founded on the voluntary and independent actions of business persons reflected in negotiated contracts.³ Traditionally, these private negotiations culminate in a contract which accompanies an application for certificate of public convenience and necessity when it is filed with the Commission.⁴ Under the Act the Commission has veto power over

[Page 7-3]

contracts and may attach reasonable conditions to any certificate approving them.⁵ While private negotiations are not dispositive of the Natural Gas Act duties of the Commission, "[t]he Commission is not justified...in cavalierly disregarding private contracts."⁶

Accordingly, the Act and historical practice under it left substantial room for negotiation of contractual provisions tailored to meet the particular transportation transaction involved and to accommodate the interests of the parties and their allocation of the risks associated with the business transaction. That is not to say that contract negotiations were totally unbridled by regulatory considerations. Over the years, the Commission's regulations and the body of case law construing provisions of the Natural Gas Act and the regulations thereunder provided legal and practical constraints on the negotiation of provisions of contracts. For example, Section 4 of the Act provides that rates, charges and practices filed for jurisdictional services must be just and reasonable. The "just and reasonable" standard has been construed as providing for cost-based rates. Section 5 of the Act specifically forbids provisions of contracts which are unjust, unreasonable, unduly discriminatory, or unduly preferential.⁷ Under the case law, the prohibition against undue preferences and undue discrimination means that similarly situated customers or classes of customers must be dealt with in similar fashion. Differences in treatment are justified only where there are differences in customers or classes of customers.⁸

[Page 7-4]

Another more specific prohibition provision applied during the period of active regulation of producer sales for resale in interstate commerce. Under the Commission regulations certain types of indefinite price escalator clauses were rendered inoperative.

Provided, That in contracts executed on or after April 3, 1961, for the sale or transportation of natural gas subject to the jurisdiction of the Commission, any provision for a change of price other than the following provisions shall be inoperative and of no effect at law; the permissible provisions for a change in price are:

(a) Provisions that change price in order to reimburse the seller for all or any part of the changes in production, severance, or gathering taxes levied upon the seller;

(b) Provisions that change a price to a specific amount at a definite date;

(b-1) Provisions that permit a change in price to the applicable just and reasonable ceiling rate which has been, or which may be, prescribed by the Commission for the quality of the gas involved; and

(c) Provisions that once in five-year contract periods during which there is no provision in a change in price to a specific amount (paragraph (b) of this section), change a price at a definite date by a price-redetermination based upon and not higher than a producer rate or producer rates which are subject to the jurisdiction of the Commission, are not in issue in suspension or certificate proceedings and, are in the area in the price in question: Provided further, That any contract executed on or after April 2, 1962 containing price-changing provisions other than the permissible provisions set forth in the proviso next above shall be rejected.⁹

[Page 7-5]

After the enactment of the Natural Gas Policy Act of 1978 (NGPA),¹⁰ the Commission promulgated regulations which ofttimes required specific contractual language in order to permit a producer to collect a certain NGPA ceiling rate. For example, particular types of clauses or language were needed to collect tight formation prices under Section 107 of the NGPA¹¹ and compression allowances.¹² The Commission governed take-or-pay provisions entered into by pipelines through a policy statement establishing a rebuttable presumption that prepayments based on contracts entered into on and after December 23, 1981 with take-or-pay provisions exceeding 75% of annual deliverability would not receive rate base treatment.¹³

Nevertheless, there was room for negotiation of contractual provisions in transportation contracts. Indeed, prior to enactment of the NGPA, many transportation contracts typically were not included in the Volume 1 of pipeline tariffs for generically applicable services, but in Volume 2 which includes transactions specifically negotiated to fit specific factual circumstances.¹⁴

II. THE INFLUENCE OF THE NATURAL GAS POLICY ACT OF 1978

On November 8, 1978 Congress enacted the NGPA which became effective on November 9, 1978. The NGPA, both because of what the statute specifically says and because of the interpretation of it, has changed the Commission's approach to transportation in interstate commerce. Two critical areas of the statute have led to this change. First, under the NGPA producer wellhead price controls were substantially phased out over a period of time. Second, Section 311 of the NGPA contains provisions permitting interstate pipelines on the one hand and intrastate pipelines on the other to engage in transportation transactions approved by rule or order of the Commission without subjecting intrastate pipelines to control and regulation under the Natural Gas Act. While these provisions were originally designed to increase gas production available to the interstate market and to eliminate the distinctions between the inter- and intrastate markets, the Commission and the courts have construed Section 311 in conjunction with phased wellhead price decontrol as indicating Congressional

[Page 7-6]

intent to foster a nationwide transportation network and competition in the market so that consumers of gas will have the ability to choose among alternative sources of supply and lower gas costs.¹⁵

The Commission's actions which were milestones in this march to increased competition were not many, but were sweeping their application and implications. First, in the Order No. 380 series...