CHAPTER 8 NATURAL GAS PROCESSING AGREEMENTS

• Jurisdiction: United States

Natural Gas Marketing II
(Apr 1988)
CHAPTER 8
NATURAL GAS PROCESSING AGREEMENTS¹
Judith M. Matlock
Thomas W. Whittington & Associates, P.C.
Denver, Colorado

TABLE OF CONTENTS

SYNOPSIS

Page

INTRODUCTION

I. OVERVIEW OF NATURAL GAS PROCESSING

II. HISTORICAL PERSPECTIVE

III. NEGOTIATION CONSIDERATIONS

A. Exchange of Natural Gas and Plant Services

B. Additional Economic Factors

1. Shrinkage and Plant Fuel Costs

2. Other Charges to Producers

3. Capacity of the Plant

4. Start-up Expenses

5. Outside Risks

C. Cash Flow Analysis

IV. SETTLEMENT CALCULATIONS AND ALLOCATIONS

A. Converting Data to Standard Bases and Common Units

B. Basic Calculations

1. Total Production—Gallons of Liquids Produced

2. Sales of Liquids

3. Residue Gas Deliveries

4. Shrinkage

a. Calculating the MMBTU Content of Products Produced

b. Calculating Shrinkage on the Basis of Inlet and Outlet Meters

5. Fuel

C. Allocations Between Multiple Inlet Sources, Single Residue Purchaser

1. Allocating Total Production

2. Allocating Total Sales

3. Allocating Residue Gas Deliveries

4. Allocating Shrinkage

5. Allocating Fuel

a. Plant Fuel

b. Inlet Compression Fuel

c. Residue Compression Fuel

d. Allocating Purchased Fuel

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D. Additional Allocation Complexities

1. Outside Fractionation

2. Multiple Residue Gas Purchasers

3. Multiple Liquids Purchasers

4. Sales of Commingled Residue Gas or Liquids to a Common Purchaser

5. Sweet and Sour Gas Processing

6. Multiple Streams Behind the Plant Inlet

E. Calculation and Allocation Provisions Under Three Types of Natural Gas Processing Agreements

1. Fixed Fee Agreements

2. Percentage Agreements

3. Net Profits Agreements

F. Drafting the Accounting Procedure

1. Drafting metering, measuring and sampling/analysis provisions

2. Drafting calculation/allocation provisions

V. DRAFTING OTHER CONTRACT PROVISIONS

A. Payment Provision

B. Settlement Reports

VI. USE OF PERSONAL COMPUTERS AND SPREADSHEETS

VII. RENEGOTIATION

VIII. CONCLUSION

Exhibits

A Sample Net Profits Gas Processing Agreement (8-53 -

B Sample Accounting Procedure (8-73 -

C Schematic Diagram

Supplement (8-85 -

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This paper is a supplement to the paper presented by Mr. Watson regarding fundamentals of gas marketing contracts. Natural gas processing agreements contain many provisions in common with other gas marketing contracts and those provisions will generally not be discussed in this paper. However, the negotiation of natural gas processing agreements and the calculations and allocations required by such agreements distinguish natural gas processing agreements from other types of gas marketing contracts. This paper will discuss these unique aspects of natural gas processing agreements in detail.

For purposes of this paper, the term "natural gas" is used to mean "hydrocarbons which at atmospheric conditions of temperature and pressure are in a gaseous phase."² Additionally, for purposes of this paper, the phrase "natural gas processing agreements" includes all agreements which involve the processing of natural gas for the removal of liquid hydrocarbon products contained therein.

One method of categorizing natural gas processing agreements is by the type of compensation to be received by the processor of the natural gas. Based upon this method of categorization, natural gas processing agreements may be divided into the following types (among others):

(1) Fixed fee agreements which provide that the processor receives a fixed fee for processing the natural gas, which fee is expressed in terms of ¢/Mcf of inlet gas or ¢/gallon of product produced, and the owner of the natural gas retains title to the residue gas and all of the products produced from the processing of the natural gas. The processor may also receive other compensation such as a gathering fee, compression fees (inlet and outlet), or a fractionation fee.

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(2) Percentage agreements which provide that the processor and the owner of the natural gas share the products produced from the processing (and possibly also share the residue gas remaining after processing) in fixed percentages.

(3) Net profits agreements which provide that the processor and the owner of the natural gas share the net profits from the sale of the products produced from the processing (and possibly also share the net profits from the sale of the residue gas remaining after processing).³

However, as is discussed in more detail in Section III of this paper, parties negotiating a natural gas processing agreement should not necessarily limit themselves to these types of standard agreements in attempting to arrive at a processing arrangement which best fits the needs of all parties.

This paper does not attempt to discuss every possible natural gas processing arrangement. Rather, it is intended to provide the reader with a background which may be helpful in negotiating, analyzing and drafting natural gas processing agreements regardless of the particular processing arangement which might be involved. It is hoped that the examples, checklists and sample contract provisions included in this paper will be useful in achieving this goal. However, this paper is not intended to be a training manual for the gas accountant.⁴

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Throughout this paper the supplier of the inlet gas stream to a natural gas processing plant is referred to as a "Producer" and the owner or operator of a plant is referred to as a "Processor." However, natural gas producers are not the only suppliers of inlet gas to a gas processing plant. A purchaser of natural gas at the wellhead or at other points upstream of a natural gas processing plant may also be a supplier of inlet gas to a plant. Such a purchaser may purchase the gas subject to a reservation by the seller of the right to remove the liquids. However, where a seller who has reserved such a removal right is not exercising such right, the purchaser may elect to have the natural gas processed for his own account. In the event of such an election, the purchaser and a Processor may enter into a natural gas processing agreement and take the risk of being "upstreamed" (i.e., they may take the risk that the upstream seller of the natural gas will later decide to construct his own natural gas processing plant or make other arrangements to have his gas processed in a third-party facility).

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Section I below provides a brief overview of natural gas processing and certain definitions necessary to an understanding of the topics to be discussed in the other Sections of this paper. Many of the readers will, of course, already be familiar with this background information.

I. OVERVIEW OF NATURAL GAS PROCESSING

Natural gas is a gaseous mixture consisting essentially of the following hydrocarbons of the paraffin series:

Hydrocarbon	Symbol
methane	C1
ethane	C2
propane	C3
iso-butane	i-C4
normal butane	C4
isopentane	i-C5
normal pentane	C5
hexane	C6
heptane	C7
octane	C8
nonane	C9
decane	C10

Methane is the largest constituent of natural gas, followed by ethane, propane, and the other hydrocarbons listed above. Natural gas processing is primarily concerned with removing the lighter hydrocarbons (methane through hexane). The heavier hydrocarbons are often referred to as "heptanes-plus" or "C₇+".

Natural gas processing recovers marketable hydrocarbon products ("liquids" or "products") from natural gas. These products are first removed as a bulk product known as propane-plus (C₃+). The extracted propane-plus bulk product is marketable. However, some natural gas processing plants also have the ability to reduce the propane-plus product into separate products such as propane, butane and natural gasoline through a separation process called fractionation. Some processing plants also remove ethane as a separate product. These separated products can be marketed more profitably than the propane-plus bulk product.

The amount of product recovered from any natural gas stream is dependent on (1) the volume of gas coming into the plant, expressed in terms of cubic feet (cf), 1000 cubic feet (Mcf), or 1,000,000 cubic feet (MMCF), (2) the concentration of recoverable liquid hydrocarbon products in the natural gas

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stream, expressed in terms of gallons per Mcf (GPM),⁵ and (3) the technical efficiency of the processing equipment at the plant which determines the percentage of the recoverable liquid hydrocarbon products which can actually be removed.

The gas remaining after the propane-plus bulk product has been removed is a marketable natural gas, containing primarily methane, which is known as "residue gas" and which is used commercially and domestically as fuel. Residue gas may also be used for lease operations.

Due to the removal of the products, natural gas processing decreases both the volume and gross heating value (measured in British Thermal units or BTUs) of the inlet gas stream. This decrease is known as "shrinkage." Since natural gas today is sold on the basis of its gross heating value, rather than its volume, "shrinkage" in natural gas processing agreements is usually defined in terms of the reduction in gross heating value (BTUs) caused by processing. Such reduction is normally expressed in units of 1,000,000 BTUs (MMBTUs).

Residue gas may be used as fuel for operation of the gas processing plant. In that case, a distinction may be made in the natural gas processing agreement between "residue gas" (which is the gas remaining after removal of liquids) and "residue gas available for sale" (which is the residue gas remaining after fuel usage). The quantity of gas consummed as fuel is usually expressed in MMBTUs.

In some instances, the natural gas being processed will also be treated to remove water (a process known as "dehydration") or to remove impurities such as carbon dioxide...