CHAPTER 8 OIL MARKETING AND TRANSPORTATION AGREEMENTS
| Jurisdiction | United States |
(May 2005)
OIL MARKETING AND TRANSPORTATION AGREEMENTS
Marathon Oil Company
Houston, Texas
Daniel F. Reimer holds a B.S. degree in civil engineering from Valparaiso University. He joined Marathon in 1980 as a Pipeline Engineer and has served in a variety of technical, commercial and operational positions. Dan became Manager, Crude Oil Marketing & Transportation in January 1993, and he has been actively involved in royalty policy matters since that time.
Dan received the MMS Corporate Leadership Award in April 2002 for providing assistance to MMS in implementing the crude oil RIK pilots and Small Refiner Program.
He is acting Chairman of the Royalty Strategy Task Force, an intra-agency focus group consisting of representatives from API, DPC, IPAA and USOGA. Dan is also a member of the Royalty Policy Committee representing USOGA.
I. Introduction
Oil marketing agreements come in a variety of shapes and sizes depending on the degree of sophistication that an owner chooses to employ in the disposition of its oil. The Agreements incorporate standard industry practices to provide expediency in execution, and they promote the use of commercially reasonable standards to resolve disputes. Industry practices are governed by regulations like the Texas Common Purchaser Act (CPA) and the Interstate Commerce Act (ICA) which mandate non-discriminatory treatment of customers. The fact that there is no Standards Board to provide oversight for oil marketing agreements is evidence that industry has done a pretty good job over time of regulating itself and adhering to a relatively high code of conduct. This paper will review the various types of agreements that are utilized by Exploration & Production companies as they market their oil production.
II. Marketing Options: To Receive Payment In-Value or Take Production In-Kind?
Owners typically have the option of receiving their production in-value or taking their production in-kind. When a royalty owner (or an over-riding royalty interest owner) chooses to receive its production payment in-value, the royalty owner's interest will be marketed by the working interest owner or operator that controls said interest, and the royalty owner will receive a cash remittance. When a royalty owner or a working interest owner takes its production in-kind, the taking owner will assume title to their oil entitlement within the production facility, and the taking owner will be responsible for disposing the oil.
The basic form of in-value disposition for a royalty owner is a Division Order sale. A Division Order specifies the decimal interest that the royalty owner has in a property, and provides the royalty owner's mailing address for correspondence and the remittance address for cash payments. There are differences in opinion as to whether disposition under a Division Order constitutes a sale by the royalty owner, or whether the Division Order serves as an authorization to allow the controlling working interest owner to "market on behalf of" the royalty owner. This paper will not engage in that debate.
In-value dispositions between working interest owners in a multi-owner lease (or a multi-owner well) are addressed by a Joint Operating Agreement (JOA). The JOA gives the operator the right, but not the obligation, to dispose of a working interest owner's oil entitlement when that working interest owner does not take their oil entitlement in-kind. The non-taking owner's share of lease or well operating costs are normally deducted from the disposition proceeds.
Owners that take their oil production in-kind have the option of disposing of their oil at the lease, or repositioning the oil and disposing of it away from the lease. Repositioning can occur as a tariff movement or as a contract movement. When a tariff movement occurs, the owner retains title to the oil and physically ships the oil via pipeline, truck or barge under a published tariff. Contract movements require the owner to render title of the delivered oil to a contract carrier (or to the counter party of an exchange) and the owner receives a like quantity of oil at a mutually agreed upon location (the "barrel-back" location).
III. Oil Exchange Agreements
There are basically three types of oil exchange agreements:
(a) Barter Exchange -- to barter means to trade by using goods or services without using money. Under a barter exchange, no value is placed on the barrel of oil that is delivered by the owner and no value is placed on the like quantity of oil that the owner receives. The intent of barter exchanges is for deliveries and receipts to match, and a differential is negotiated based on the location, quality and/or timing differences between the owner's deliveries and the owner's receipts. The differential serves as a net difference in the agreed upon value of the owner's delivered barrel and the owner's received barrel, and the net value is typically invoiced and paid based on the barrel-back quantity.
(b) Buy/Sell Exchange -- a buy/sell exchange is similar to a barter exchange except that a value is placed on each barrel of oil that is exchanged, and each party invoices the other party for the total value of the oil delivered by that party.
(c) Matching Buy/Sell Exchange -- a matching buy/sell exchange stipulates that the intent of both parties is to deliver equal volumes during the term of the contract. A final balancing provision will specify how volume imbalances will be handled after the contract expires or is terminated.
Barter exchanges were prevalent until the 1980's when the price of crude oil began to fluctuate significantly from month to month. Price risk became an issue when equal volumes were not delivered and received during the same month because the volume imbalance that was created by the unequal deliveries had to be made up in a subsequent month, and there was no adjustment for the change in market price between the different delivery months. Higher prices also increased credit exposure, and the degree of exposure was difficult to calculate for a given delivery month because there was no value attributed to the owners contracted deliveries for that month. Buy/Sell agreements gained prominence in the 1980's because placing a value on each delivery reduced price risk associated with unequal deliveries and facilitated credit exposure calculations. Because the intent of most Buy/Sell transactions was for like quantities to be delivered by each party, industry acquiesced to the term "Matching Buy/Sell" as a means of making it clear that the parties intend to deliver like quantities.
IV. Elements of an Oil Transaction
The most common types of oil transactions are outright sales, outright purchases and exchanges. The terms and conditions for all three types of transactions are essentially the same, although exchange agreements contain additional provisions for netting of receipt and delivery invoices, and provisions for settling unequal deliveries (or imbalances). The standard terms and conditions that apply to oil marketing agreements are as follows:
(a) Contract Type: Most oil transactions fall into the categories of Outright Sales, Outright Purchases, Barters, Buy/Sells or Matching Buy/Sells.
(b) Contract Numbers: Each counter party will assign their own contract number consistent with their internal contract management system.
(c) Confirmation: Contains the names of the company representatives, the names of the legal entities that are...
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