THE INTRIGUE AND IMPLICATIONS OF NATURAL GAS MARKETING AFFILIATES
| Jurisdiction | United States |
(Jan 1992)
THE INTRIGUE AND IMPLICATIONS OF NATURAL GAS MARKETING AFFILIATES
Mobil Exploration & Producing U.S. Inc.
Dallas, Texas
Table of Contents
1 The Evolving Gas Industry
1.1 The Traditional Model
1.2 Regulatory Framework
1.3 Market Distortions and Regulatory Disillusionment
1.4 FERC and The Quiet Revolution
1.4.1 Freer and Easier Access to Transportation
1.4.2 Easier and Freer Sales Authority
1.5 The Direct Sales Era
1.5.1 New Players
1.5.2 New Procedures
2 Rationale for Marketing Affiliates
2.1 Transacting business in many states
2.1.1 Jurisdictional Implications
2.1.2 An Additional Layer of Insulation
2.2 Administrative Benefits
2.3 Qualifying to Conduct Business
2.4 Tax Implications
2.5 Regulatory Implications
2.5.1 State Utility Law
2.5.2 Federal Regulation
2.6 The "Saturn" Mentality
3 Considerations Arising From Marketing Affiliates
3.1 Organization
3.1.1 Supply
3.1.2 Transportation
3.1.3 Sales
3.2 Corporate Documentation
3.3 Inter-affiliate Transfer Options
3.4 Relations with Working Interest
3.5 Severance Tax Implications
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1 The Evolving Gas Industry
Recent changes in the natural gas industry are prompting companies to re-asses the way they do business. This re-assessment, in turn, is inviting companies to re-consider the legal structures employed to maximize marketing opportunities and to minimize associated risks. Producer marketing affiliates represent a relatively new legal structure in the natural gas industry to which companies are now gravitating. This paper explores the reasons for and implications of this new phenomenon.
A fundamental reason why producers are now re-assessing their business practices is because the gas business itself has changed dramatically over the last several years. In understanding how dramatic the change has been, it is helpful to briefly trace the historical context from which direct sales emerged.
1.1 The Traditional Model
Historically, gas producers restricted themselves to exploring, producing and processing activities. Interstate and intrastate pipelines purchased the producers' gas (generally at or near the field), constructed massive transmission systems, and transported the purchased gas to their core markets. These core markets were comprised of local distribution companies, which re-sold the gas to end-users (e.g., residential and industrial customers) or of large end-users themselves (e.g., General Motors, Frito-Lay etc.). Of course there were notable exceptions1 , but the general rule was that there were these three distinct segments of the natural gas industry, each having its own unique and somewhat circumspect role in making gas available to the consuming public.
There were good reasons for producers historically to play a limited role in marketing their gas. The prices at which producers could sell their gas generally were set by law, not necessarily by the market, and therefore there was little incentive to actively compete with pipeline or local distribution companies to establish a direct marketing base. Moreover, there were significant barriers. It was difficult, if not impossible for producers to arrange for contract carriage on a transmission system if the goal was to compete for core market customers. The alternative, to build ones own system, presented similar impediments. Transmission and distribution systems involved outlays of significant financial capital, which made this option practical for only the largest of companies. More importantly, such systems could subject companies to utility-type regulation by federal, state or local governments, which further discouraged producers fearful of subjecting their internal accounts to rate-making
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for only the largest of companies. More importantly, such systems could subject companies to utility-type regulation by federal, state or local governments, which further discouraged producers fearful of subjecting their internal accounts to rate-making processes. These factors tended to limit the adventuresomeness of producers beyond the comfortable parameters of their traditional functions.
Legal structures and instruments employed by producers mirrored the realities of the day. Since pipelines generally came to producers in the field to hook up reserves, there was less concern by producers over the aspects of conducting business in remote areas. Therefore the concern of unnecessarily subjecting ones substantial capital reserves to B&O and franchise taxes of remote states did command the attention it might today. Similarly, the concern over exposing these same assets to claims initiated in remote jurisdictions was not as great as it might be today. The business environment also promoted long-term contract relationships and discouraged the formation of short-term, market driven options. Contract terms were for many years and the provisions mirrored the long-term nature of the relationship.
1.2 Regulatory Framework
These characteristics of the old natural gas industry did not occur by happenstance, but rather were rational responses to the regulatory environment of the time. Central at the time was the New-Deal mentality that enlightened regulation was the best insurance for secure and reasonably priced natural gas supplies to the consuming public. And we should not be too critical of this mentality in retrospect. The thinking was certainly fashionable during the time when the public's faith in free market principles had been severely shaken and when competing economic theories were gaining ground overseas. Also, the transportation and distribution segments of the industry appeared to act like natural monopolies that traditionally had been subject to regulation. Additionally, segments of the industry were themselves seeking a federal solution.2 This mentality resulted in passage
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of the Natural Gas Act of 19383 , which established a comprehensive regulatory scheme for the industry and assigned to the Federal Power Commission the task of achieving the NGA's goals.
The NGA was successful at nourishing the fledgling natural gas industry during its first several decades of existence. Stability created by the regulatory framework is credited with having fostered the explosive growth of the interstate pipeline system between the years 1938 and 1958.4 During most of this early period, however, the FPC had applied NGA regulation primarily to interstate pipeline company activities in transporting and re-selling gas: the prime target for regulation in the eyes of producers and consumers. Independent producers were left largely alone and the local distribution companies and intrastate transactions were left to local regulation, if any.5
The relative tranquility experienced by independent producers during the early years was shattered in 1954 when the Supreme Court ruled in Phillips Petroleum Co. v. Wisconsin6 that producers selling gas to interstate pipelines were subject to FPC regulation under the NGA.7 This meant that producers intending to make
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sales for re-sale in interstate commerce had to obtain a certificate from the FPC that their transactions were in the public convenience and necessity. As with pipelines, the producer's obligation to continue selling under its certificate could not be terminated without first having received abandonment authority by the FPC.8 Also like the pipelines, producer rates were regulated and subject to a finding by the FPC that prices charged were "just and reasonable."
Reaction from producers to Phillips was swift and predictably fierce. Despite the Court's certainty that Congress had intended to regulate producer matters under the NGA, the decision was received with utter disbelief and surprise by many in the industry. So great was the negative reaction that Congress passed a bill in late 1955 that would have legislatively overruled the Phillips case. However, the bill was vetoed by President Eisenhower due to evidence that fraudulent means had been used to obtain its passage.9
The industry soon found out that regulation of producer rates was no simple chore. The FPC's experiments went through various phases. From 1954 to 1960, the Commission struggled in vain to establish individual rates for each producer. However, after completing only ten producer rate cases in six years, the
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Commission gave up the process as hopeless in 1960.10 For the period 1960-1973, the FPC switched to a so-called area rate approach.11 All producer sales in interstate commerce made from a given geographic area were subject to prescribed rates for that specified area. While this process was manageable from a regulatory standpoint, inherent weakness in the methodology led the Commission to abandon the area rate process and to undertake establishing national rates for producers in 1974.12
1.3 Market Distortions and Regulatory Disillusionment
As with other New Deal experiments (e.g., trucking, airlines, agriculture) the comprehensive regulatory framework enacted by Congress in the 1930s and interpreted by the Supreme Court in the early 1950s as extending to producers' interstate sales began experiencing severe market distortions by the late 1960s and early 1970s. No matter what rate methodology FPC employed to regulate producers' sales of interstate gas, it simply was not keeping pace with those of unregulated markets. Some attribute the problem to the FPC using a historical costs methodology in its rate-making, which though consistent with traditional utility-type practice simply did not keep pace with actual replacement or opportunity costs established by the market. Perhaps a better reason is that the underlying regulatory approach is as much influenced by politics as it is by...
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