CHAPTER 9 GAS CONTRACTS MANAGEMENT ISSUES An Overview for Producers
| Jurisdiction | United States |
(Apr 1988)
GAS CONTRACTS MANAGEMENT ISSUES An Overview for Producers
Sun Exploration and Production Company
Dallas, Texas
Effective management of gas contracts demands identification of the many issues which relate to the marketing of natural gas in the current environment. These issues surface in several aspects of the producer's business. Thus, the scope of the producer's effort in managing its gas contracts, and the underlying transactions, must extend across its entire organization. The satisfactory resolution of these issues through negotiation of appropriate contract provisions, as well as the successful implementation of the negotiated terms are equally critical to the effective resolution of gas contracts management issues.
I. IDENTIFICATION OF CONTRACTUAL ISSUES RELATING TO GAS CONTRACTS MANAGEMENT.
Consideration of several gas supply-related and gas price-related issues can lead to additional gas marketing opportunities for the producer. Availability of supply for market can be impacted by contractual and regulatory factors, as well as physical and operational factors. Contractual and regulatory factors impact the producer's pricing responsibilities also.
Not surprisingly, the producer of natural gas has numerous contractual rights and obligations relating to the supply and the price of gas, and certain of these rights and obligations are significant in the management of the producer's gas contracts. The producer's obligations and rights under exploration and production contracts, as well as under gas marketing contracts (sales
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contracts and transportation contracts), must be carefully considered on an ongoing basis.
A. Gas Marketing Contracts.
Certainly gas contracts management involves effective structuring, negotiating and drafting of gas marketing contracts. However, the key issues and current trends in negotiating and drafting wellhead sales agreements, direct sales agreements and transportation agreements are discussed in other papers presented at this Institute.1 This gas marketing contracts discussion will focus on monitoring these contracts to identify potential opportunities and problems.
1. Sales Contracts.
As to the producer's gas supply which is under contract already, several provisions of the contract determine when and what amount of supply may be available for marketing. Information which must be accessible in order to make this determination includes the existence of a surplus contract, as well as a base contract, the duration of the contract(s), the quantity obligation (if any), the existence of "reopeners" allowing for volume adjustments during the term of the contract, and the opportunity for full or partial release of volumes from the contract (e.g., meet-or-release clauses, take-or-release clauses, etc.).
The quantity of gas to be sold may be set forth in terms of a specific quantity for a given period (for example, daily, monthly, etc.) or in terms of
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the well's capacity to produce. The more flexible quantity provisions in use today may set forth the quantity to be sold on a best efforts basis or on a best efforts basis up to a specified level.2 Alternatively, the quantity may be explicitly interruptible or the volumes to be delivered and purchased may be determined by the parties each month on a no-obligation basis.3 Minimum and maximum quantities may be specified in the contract.4 Or, the contract may feature a "reopener" provision allowing periodic reevaluation and modification of the quantity subject to the contract. Take-or-release clauses and meet-or-release clauses are common in contemporary contracts. Under the take-or-release clause, the buyer must purchase a minimum quantity over the specified time period. If the minimum quantity is not purchased, the contract may be terminated at seller's option. The meet-or-release clause gives seller the option to terminate the contract if purchaser does not meet a competing purchase offer. It is clear that these types of provisions can present opportunities
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or problems for the producer. Thus, effective gas contracts management requires ready access to this information.
Ready access to information about the producer's older, more traditional contracts is important also. For example, the producer must continue to monitor performance under any take-or-pay clauses in existing contracts. Likewise, traditional renegotiation and redetermination provisions must be monitored in order to avoid missing opportunities. Careful monitoring will aid the producer in enforcing its contracts and may provide additional leverage in settlements and other negotiations with purchasers.
2. Transportation Contracts.
The producer's transportation arrangements must be closely monitored also. As a shipper under a transportation contract, the producer may have unintentionally accumulated an inventory in the transporting pipeline as a result of the producer's deliveries in excess of the quantities bought by its purchaser. This supply is certainly available to be marketed and should be marketed as soon as possible to avoid pipeline balancing penalties and charges.
In the event the amount of gas taken by the purchaser does not match the amount of gas delivered by the seller, the transporter may assess a balancing penalty. Thus, whether the producer is the shipper or whether the producer is selling to the shipper, the producer must analyze the pertinent pipeline transportation tariffs and negotiate into the sales contract the responsibility for any balancing penalties. In addition, the producer should include in its sales and transportation contracts the process by which the seller, transporter and buyer will control the volumes delivered and received. The producer's contracts should describe a control process which requires the parties to coordinate on a regular, perhaps daily, basis to avoid the imposition of these penalties. If this type of provision is not a part of and cannot be added to
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the contract(s), the producer should establish communication between the appropriate representatives of each party to ensure proper coordination.
B. Exploration and Production Contracts.
Additionally, gas contracts management entails familiarity with and active involvement in contracts other than gas sales contracts and gas transportation contracts. Most exploration and production contracts contain provisions which affect the price and supply of the producer's gas and, therefore, may present gas marketing opportunities and possible gas marketing problems.
1. Oil and Gas Lease.
An oil and gas lease, for example, may contain a provision allowing the royalty owner to take its royalty in kind. Although lease clauses providing for in-kind royalty on crude oil are more common, in-kind gas royalty provisions are not uncommon. Also, the lease may give the lessor a call on the production, a right of first refusal on the production, or an option to purchase the production.5 Clearly these provisions have a direct bearing on the supply which is available to be marketed by the producer-lessee. Moreover, the call and option to purchase provisions can directly impact the price of the gas and the right of first refusal can indirectly determine the price. Price issues rather than supply issues are of concern under the customary gas royalty provision which requires payment of funds to the royalty owner.6
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These clauses typically contain specific notice requirements and time deadlines. The rights under the clause may or may not be optional and the rights may be ongoing or they may be subject to a one-time election. These clauses may present marketing opportunities or marketing problems. In either case, it is imperative that these potential opportunities or problems be recognized by the producer in the management of its gas contracts. Moreover, correct analysis of the provision(s) and proper administration are key to capturing the opportunities and avoiding, or at least minimizing, any problems.
The producer's obligation under the implied marketing covenant of the oil and gas lease is very important in the management of gas contracts also.7 At increasing intervals, the producer is required to negotiate or renegotiate the terms of the gas contracts.8 Where the producer's interests coincide with its lessor's interests, the producer's marketing activities will be considered to be in accordance with the implied marketing covenant if the activities are those which would be carried on by a reasonably prudent operator under the same or similar circumstances. However, a more stringent standard may apply if the
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interests of the producer and its lessor are not aligned.9 Thus, a producer must consider the interests of the lessor, in addition to its own interests, as it conducts its gas contracting activities. Given the various alternatives which may be available to the producer for marketing natural gas, it may be difficult to determine which course(s) of action will satisfy the implied marketing covenant.10 It is advisable for the producer to take an objective look at the proposed contract's price, term, takes, and other provisions to insure these provisions will appear reasonable to a third party. Additionally, the interests of the lessor should be considered in connection with settlement of take-or-pay claims. The implied covenant to market may be triggered where the settlement payment is received in part for the producer's tradeoff of
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favorable pricing provisions.11 Clearly, the gas marketing organization's contracting activities must consider the producer's obligations under the oil and gas lease to reduce the producer's exposure for damages under the implied covenant to market gas.
2. Other Exploration and Production Agreements.
Other agreements pertaining to the producer's exploration and production...
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