CHAPTER 8 CRUDE OIL, CONDSENSATE, AND NATURAL GAS LIQUIDS MARKETING AGREEMENTS

• Jurisdiction: United States

Oil and Gas Agreements: Midstream and Marketing
(Feb 2011)
CHAPTER 8
CRUDE OIL, CONDSENSATE, AND NATURAL GAS LIQUIDS MARKETING AGREEMENTS
Michael E. Korenblat
Director, Legal Affairs - R&M U.S.A.
Suncor Energy Services Inc.
Denver, Colorado
Tim Kirwin
Senior Manager, Crude Oil Supply & Trading
Suncor Energy Marketing Inc.
Denver, Colorado ¹

MICHAEL KORENBLAT is the Director, Legal Affairs for Suncor Energy's U.S. Refining and Marketing business, where he has worked for the past six years. Mr. Korenblat also serves on the Board of Directors and as the Corporate Secretary for all of Suncor Energy's U.S. subsidiaries. Mr. Korenblat received his B.A. from Pomona College in Claremont, California, and his J.D. from the University of Arizona. Mr. Korenblat spent his junior undergraduate year at Oxford University as a visiting student. Prior to receiving his law degree, Mr. Korenblat was a Fulbright Scholar to New Zealand, where he spent a year and half conducting research relating to the Maori's group rights claims. During this time, he also served as an instructor in the Department of Politics at the University of Auckland. Mr. Korenblat sits on Board of Directors for the Denver Metro Chamber Leadership Foundation, and serves on the Advisory Council for the City of Denver's Mile High Million Initiative, a plan to plant a million trees within the greater Denver area. Mr. Korenblat is admitted to the practice of law in Arizona and Colorado.

I. INTRODUCTION

This paper provides an introduction to marketing agreements for crude oil, condensate, and natural gas liquids from both a commercial and legal perspective. A basic overview of the market players, their varying interests, and factors that influence pricing is included to help provide a general understanding of the crude oil marketplace. An overview of the key industry terms of these marketing agreements is also provided, with a more detailed discussion regarding confirmation procedures and credit, security and related issues.

This paper focuses solely on domestic transactions. Marine and derivative transactions, which form a very important part of this marketplace, are beyond the scope of this paper and are not discussed in any detail. As the marketing agreements covered are purchase and sale agreements, which share many provisions and concepts with purchase and sale agreements generally, the overview of their terms is kept a high level, except for the areas of emphasis noted above.

II. UNDERSTANDING THE MARKETPLACE

A. THE LIQUIDS

While crude oil, condensate, and natural gas liquids are all traded commodities, the markets for crude oil and condensate, on the one hand, and other natural gas liquids, on the other, are distinct.

The reason for this distinction becomes clear by simply examining the definitions and properties of these liquids. Crude oil can be broadly defined as a mixture of unrefined hydrocarbons, with a wide range of properties and characteristics, which can be refined to

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make petroleum products.² Condensate is a mixture of liquid hydrocarbons recovered at the surface, without resorting to processing, that exist initially in a gaseous phase in an underground reservoir.³ Natural gas liquids are liquid hydrocarbon separated or processed from natural gas, and include propane, butane, and natural gasoline.⁴ While condensate constitutes a natural gas liquid, not all natural gas liquids are condensate. Generally, condensate has an API gravity between 50 and 70. Other natural gas liquids have a higher API gravity, from approximately 70 to 120.

Because the API gravity of condensate falls within the range of a light crude oil, it can be run as a feedstock in refineries and can be blended with other types of crude oil. As such, the crude oil market tends to focus more on crude oil and condensate. While provisions specific to natural gas liquids are covered, together with crude oil, in certain industry agreements, many other industry agreements do not. For simplicity, this paper will use the term crude oil to refer to all of these liquids, except where it is necessary to highlight differences between them.

B. THE PLAYERS AND THEIR DIFFERING PERSPECTIVES

There are three main types of players in the crude oil marketplace: (1) producers, who explore for, produce, and sell crude oil, (2) marketers, who purchase and resell crude oil, and (3) end users, the refiners, who purchase and refine crude oil to make petroleum products. Certain oil and gas companies, including integrated companies, wear two or all three of these hats. In order to successfully negotiate crude oil marketing agreements, it is important to understand the different interests of all three types of these players.

1. PRODUCERS

The primary interests of producers are securing the highest netback and securing access to markets. The latter is crucial, as producers must avoid being shut-in and want to ensure that their crude flows. The ability of a purchaser to ratably and reliably move a producer's crude oil can influence pricing and other terms. On the other hand, a producer with limited or no access to certain markets may be motivated to take certain actions to secure or improve access to those markets, such as supporting the construction of a pipeline or other infrastructure - whether on its own or through an arrangement with another player.

2. MIDDLEMEN - THE MARKETERS

Marketers' primary interest is in securing a margin, and they can look to achieve that end in a number of ways, including by: (a) purchasing and reselling crude oil in the same market, (b) purchasing, transporting, and reselling crude oil in other markets, (c) purchasing and blending multiple types of crude oil to create more premium types of

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crude oil for resale, (d) purchasing, storing, and reselling crude oil on a speculative basis, (e) providing services to producers, such as transportation or price protection through contracts involving hedging arrangements, and (f) many other activities. In addition, Marketers have an inherent pecuniary interest in understanding and developing logistics solutions, as well as understanding the demands of end users in the marketplace.

3. END USERS - THE REFINERS - FOCUS ON CRUDE OIL QUALITY

Refiners' interests differ from producers and marketers. While all refiners are driven by crude oil price, they are also keenly focused on crude oil quality. That is, the specific types of crude oil that they purchase and refine.

Types of crude oil are differentiated by crude quality, and generally upon two factors - API gravity and sulfur content. "Light" crude oils typically have an API gravity of 40 or higher, while "Heavy" crude oils typically have an API gravity below the low 20s. "Sweet" crude oils typically have less than .5% sulfur, while "sour" crude oils typically have greater than .5%.

Producers and marketers often focus primarily upon these two quality characteristics. Refiners, however, are concerned with many more aspects of the quality of crude oil, including: (a) the yields from the crude oil across the distillation curve, (b) total acid number (TAN) (as some refineries cannot run crudes with high TAN, while others that can may prefer crudes with high TAN as they are generally cheaper), (c) metal content, (d) cetane in distillates, (e) particulates, and (f) asphalt content. All of these particular quality characteristics are important to refiners as they want to make the most profitable products that they can from the crudes they refine from the particular units at their refinery. No two refineries are identical. They all have different capabilities and limitations, and need multiple types of crudes to achieve their desired production yields. Furthermore, once a refiner elects to purchase a particular type of crude from a supplier, ratable delivery and consistency in quality are very important - particularly for a longer term deals.

As the refiner is the end-user, it is obviously important to understand the refiner's perspective and concerns. The failure to appreciate this perspective can create disconnections in the market. For example, a producer or marketer that attempts to blend crudes at both ends of the API gravity spectrum to create a more premium type of crude may achieve similar API gravity and sulfur characteristics, but the blend may not produce the same yields as the crude oil that it was modeled after, creating an unhappy customer.

One of the most important take-aways from this section is that the type of crude oil matters. Parties need to ensure that the quality of the crude oil bargained for is mutually understood, and specified and protected in their marketing agreements.

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C. PRICING CONSIDERATIONS

For domestic transactions, the price of crude oil is usually based on the monthly average West Texas Intermediate or Brent crude oil price, as applicable, plus or minus a differential.

The direction and amount of the differential is dependent upon a number of factors, including the type of the crude oil, and transportation costs and any associated fees or charges. In addition, whether you are a purchaser or seller, pricing is often influenced by an understanding of both parties' alternatives. This can be more transparent in liquid markets, and more difficult to discern where there are limited transportation options or other logistical constraints. Further, as stated earlier, factors specific to particular counterparty, such as being reliable, financially creditworthy, or able to provide other services, may add value that ultimately can influence price.

III. TYPES AND FORMS OF CRUDE OIL MARKETING AGREEMENTS

A. TYPES OF AGREEMENTS.

There are two main categories of agreements utilized in connection with crude oil marketing: (1) domestic agreements, and (2) marine agreements. As stated in the introduction, this paper is focused on domestic agreements, and does not cover...