ROYALTY IMPLICATIONS OF FERC ORDER 636 ON FEDERAL AND INDIAN GAS TRANSPORTATION ALLOWANCES

• Jurisdiction: United States

Federal & Indian Oil & Gas Royalty Valuation and Management II
(Feb 1998)
CHAPTER 6A
ROYALTY IMPLICATIONS OF FERC ORDER 636 ON FEDERAL AND INDIAN GAS TRANSPORTATION ALLOWANCES
Theresa Walsh Bayani
Royalty Valuation Division
Minerals Management Service
Denver, Colorado

Table of Contents

SYNOPSIS

I. Introduction

II. Background

III. FERC Tariffs And Transportation Allowances

IV. Marketing Costs

V. Allowable Costs in Determining Transportation Allowances

VI. Nonallowable Costs in Determining Transportation Allowances

VII. How to Value Over-delivered Volumes under a Cash-out Program

VIII. Conclusion

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I. Introduction

This paper provides a brief background and discussion of the royalty implications of Federal Regulatory Energy Commission (FERC) Order 636 on Federal and Indian gas transportation allowances. Within this content, the paper highlights which cost components or other charges are deductible (related to transportation) and which costs are not deductible (related to marketing). In addition, this paper also addresses how to value over-delivered production under cash-out programs.

II. Background

The Minerals Management Service (MMS) published a set of rules in 30 CFR part 206 governing gas valuation and gas transportation calculation methods to clarify and codify the departmental policy of granting deductions for the reasonable actual costs of transporting gas from a Federal or Indian lease when the gas is sold at a market away from the lease.¹

Since the 1988 rulemaking, FERC regulatory actions significantly affected the gas transportation industry. Before these actions, gas pipeline companies served as the primary merchants in the natural gas industry. During that environment, pipelines:

• Bought gas at the wellhead,

• Transported the gas, and

• Sold the gas at the city gate to local distribution companies (LDC).

In the mid-1980's, FERC began establishing a competitive gas market, allowing shippers access to the pipeline transportation grid. These actions ensured that willing buyers and sellers could negotiate their own sales transactions.

Specifically, starting with the implementation of FERC Order 436, FERC began regulating pipelines as open access transporters and requiring non-discriminatory transportation. This allowed downstream gas users (such as LDC's and industrial users) to buy gas directly from gas merchants in the production area and to ship that gas through interstate pipelines. FERC Order 436 and amendments, plus the elimination of price controls, created a vigorous spot market. Producers and marketers, in competition for the

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sale of gas to end users, began transporting substantial volumes of gas that they own through interstate pipelines.

In the early 1990's, FERC recognized that pipelines still held an advantage over competing sellers of gas. Pipelines held substantial market power and sold gas bundled with a transportation service. FERC remedied the inequities in the gas market by issuing FERC Order 636, effective May 18, 1992.

Among other changes, FERC Order 636 requires unbundling (separation) of sales and transportation services. Because of this requirement, cost components for gas transportation, which were previously lumped together, are now separated. These components may include transmission, storage, gathering, surcharges for FERC Order 636 transition costs, and administrative costs.

After reviewing our current gas transportation regulations,² we determined that these regulations provide general authority to calculate transportation deductions for cost components resulting from implementing FERC Order 636 and previous FERC orders. However, we also determined that lessees and royalty payors needed specific guidance and certainty on which transportation service components are deductible transportation costs from royalty. This guidance is necessary because components previously aggregated and unidentifiable may now be separately identified in contracts, and new costs unique to the FERC Order 636 environment are emerging. Further, some cost components reflect non-deductible costs of marketing rather than transportation.

We issued a proposed rulemaking to clarify for the oil and gas industry which cost components or other charges are deductible (related to transportation) and which costs are not deductible (related to marketing) for Federal and Indian leases.³ With minor changes based on the comments received, the final rulemaking incorporates these concepts and relates primarily to the effects of FERC Order 636 on interstate gas pipelines that FERC regulates. To the extent these same types of changes and issues are relevant for intrastate pipelines, MMS's FERC 636 rule applies equally.

The proposed rule contemplated making changes retroactive to the effective date of FERC Order 636. Based on advice provided by the Department's Office of the Solicitor, we determined that MMS does not have express statutory authority to implement a

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retroactive effective date for this rule. Therefore, MMS made this final rule effective February 1, 1998. However, this rule merely clarifies and codifies long standing MMS policies in terms of the revised FERC vernacular.

In conjunction with the changes to the transportation allowance regulations, we also made certain changes to the gas valuation regulations. When FERC approves tariffs, they generally allow pipelines to include provisions ensuring that pipelines can maintain operational and financial control of their systems. These...