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By: Deonne Cunningham, Lead Counsel, North America Business (Wholesale), Direct Energy
This article outlines the various steps that are required for acquiring or constructing a new natural gas facility and/or pipeline infrastructure project.
YOU AND COUNSEL FOR THE OTHER PARTIES INVOLVED IN the project will need to clear several hurdles before the project is complete and the pipeline and/or facility is in service for the gathering, processing, shipping, or storing of natural gas. You will be required to file applications for construction permits and will also have to make a request to state and federal regulatory agencies for the right to provide service once the project is complete.
Along with these applications for certification, you will have to provide a worthwhile argument in the transmittal letter and accompanying documents showing a substantial need for the project, noting that the development will not substantially impact the environment. You may also be called upon to draft formal agreements with the agreed-upon terms and conditions being contingent on the requisite approvals by the appropriate governmental agencies.
There are several state and federal agencies that provide oversight of trading and marketing in the natural gas industry. Among them is the FERC, which regulates and oversees the transportation and storage of natural gas in interstate commerce as well as certain aspects of the interstate market itself. Since natural gas is transported through the interstate and intrastate pipeline network, it is federally regulated by the FERC under the Interstate Commerce Act (ICA) and state public service commissions (although state regulation varies). The Commodity Futures Trading Commission regulates the futures and options markets for commodities, including natural gas. Other federal agencies have more limited responsibility. However, in recent years, that responsibility has increased for certain types of activities in the natural gas industry.
The NGA gives the FERC the regulatory and legal authority to regulate natural gas companies, including interstate pipelines, facilities, and storage companies. The definition of natural gas companies is broad and encompasses any entity that engages in either the transportation and storage of natural gas in interstate commerce or the sale of natural gas for resale (i.e., related sales that are not to end users of the natural gas) in interstate commerce. To that end, natural gas companies are subject to the rule of the NGA and all regulations and orders that the FERC authorizes pursuant to the NGA.
The purpose of the NGA is to ensure that natural gas companies do not charge excessive rates or unfairly discriminate amongst their customers. All rates, charges, and terms of service by FERC jurisdictional natural gas companies must be just and reasonable. Undue preferences and unreasonable rates and charges are strictly prohibited. Under Section 4 of the NGA, natural gas companies are required to file rates and charges with the FERC as well as any amendments to rates, charges, or services. If the changes are for good cause, the FERC may allow the changes to take effect and waive the 30-day notice requirement to the FERC. Through its regulatory authority, the FERC reviews individual proposals to terms of service (either through a form of contract or a tariff) and issues general rulemaking orders to establish regulations. These agency rules are cited in the federal government’s Code of Federal Regulations.
Section 5 of the NGA provides a method for the FERC and the general public to seek changes to a natural gas company’s rates or terms of service once they have been approved by the FERC by filing a complaint. The section specifically requires the FERC to change any rate or term of service that no longer meets the substantive standards provided for in Section 4 of the NGA (i.e., a rate or term of service considered “unjust and unreasonable” or “unduly discriminatory”). Upon a hearing, the FERC may dictate changes to the rate or terms of service on its own volition or may do so in response to a complaint by another party. In either event, in cases of unjust and unreasonable or unduly discriminatory rates or terms of service by a natural gas pipeline or storage provider, relief is only available under Section 5 of the NGA in most proceedings.
Counsel for companies that fall under the jurisdiction of the FERC should be abreast of all recent and forthcoming rulemaking orders (e.g., Notice of Intent (NOI) and Notice of Proposed Rulemaking (NOPR)) issued by the FERC, as they may require amendments to pro forma tariffs and service agreements. Furthermore, attorneys are encouraged to provide insight into these rulemaking orders. After assessment with business units, attorneys are also encouraged to provide insight into the process with respect to matters of importance to the particular pipeline company or storage service provider (e.g., comments and/or interventions on behalf of the company in NOIs or NOPRs).
Each interstate company is required to file a tariff (Tariff or FERC Gas Tariff), which states the terms and conditions upon which it will provide stand-alone transportation and storage to its shippers (customers). The Tariff’s terms and conditions are then incorporated by reference in the actual contract known as a service agreement. The service agreement is used by a pipeline or storage company to provide a specific service and rates associated with that service to its shippers. Certain terms and conditions applicable to the service agreement will be addressed below.
Pre-filing, Environmental Review, Certificate Application, and Open Season
Pursuant to Section 7 (and 7(c) if a natural gas storage provider) of the NGA, the FERC has the authority to approve the location, construction, and operation of interstate pipelines, facilities, and storage facilities that transport natural gas through the interstate pipeline network. The term facilities under Section 7 includes all facilities used to provide interstate sale or transportation of natural gas, including the storage of gas in interstate commerce. Specifically, the FERC is authorized to issue certificates of “public convenience and necessity for the construction or extension of any facilities for the transportation in interstate commerce of natural gas.” This also includes any substantial expansions or upgrades to an existing pipeline or storage infrastructure. The FERC also approves the abandonment (cessation of activity) of these facilities. In preparing for the development, construction, and upgrade of interstate natural gas pipelines, facilities, and infrastructure, counsel for the pipeline must first obtain a certificate of public convenience and necessity from the FERC.
Prior to filing the application with the FERC, counsel for the pipeline (developer) must work with all business interests within an interstate natural gas pipeline project (e.g., business development, operations, land, and regulatory) to file a request with the FERC for permission to proceed. Counsel must use the FERC’s pre-filing procedures, which the FERC established to encourage the pipeline industry to engage in initial project development discussions with relevant public and governmental agencies. This provides an opportunity for all stakeholders (including all state, local, and other federal agencies and potentially affected property owners) to discuss any concerns with the developer and the FERC. A pre-filing can be beneficial to counsel drafting formal and service agreements in anticipation of the proposed project as it will assist in improving proposals and avoiding problems during the review of a subsequent FERC certificate application. Pipeline and storage providers under the FERC’s jurisdiction must also conduct a study of the potential project site, identify potential stakeholders, and potentially hold an open house for stakeholders to discuss the project. At the end of the pre-filing process, the developer (along with consultants) must conduct pipeline route studies and field surveys so that a final application can be drafted and presented to the FERC.
Pipeline companies that are seeking to modify and upgrade existing pipeline infrastructures must file an application for a blanket certificate. Pipeline companies that file an application for a blanket certificate and make prior-notice filings1 are not required to go through the pre-filing certification process. Accordingly, if the FERC determines that a proposed project falls within a category of activities that have been found to have no significant environmental impact, it may classify the project as a “categorical exclusion.” As such, projects that fall under these specific exclusions are also free of the requirement to file an environmental assessment (EA) or environmental impact statement (EIS).
Contemporaneous with the developer’s pre-filing activities, the FERC staff publishes a Notice of Intent for Preparation of an Environmental Assessment or an Environmental Impact Statement2 in the Federal Register and on the FERC website, after which there is a period for public comment. The FERC also consults with interested stakeholders, including various governmental agencies, and holds public scoping meetings and site visits to the proposed project development area. Pre-filing is part of the regulatory process for pipeline infrastructure development and requires a written request for authorization to proceed with construction and to acquire a new service (most likely drafted by the developer’s counsel) to the FERC’s Office of Energy Projects. Developers must begin the FERC pre-filing process at least seven to eight months prior to submitting their certificate applications. Once the application is approved, the FERC will issue a pre-filing docket number to be associated with the proposed pipeline project.
Counsel for the pipeline developer typically files the application for the certificate of public convenience and necessity on behalf of the developer and ensures that all application requirements have been met prior to the filing. The application must include a description of the proposed pipeline, route maps, construction plants, schedules, and a list of other statutory and regulatory requirements, such as essential permits from other agencies (state and federal). The application must also include environmental reports analyzing route alternatives and studies of potential environmental impacts (on water, plants, and wildlife); cultural resources; socioeconomics; soils; geology; aesthetic resources; and land use. Once the application has been received, the FERC will issue a public notice of application for authorization to construct and operate a new pipeline in both the Federal Register and on the FERC website and will initiate the application review process. The FERC will grant or deny a certificate based upon whether the pipeline project would be in the public’s best interest. The FERC assesses several factors, including a project’s potential impact on pipeline competition, environmental impacts, and the possible use of eminent domain, and other concerns.
The review of the certificate application requires examination of environmental impacts of the proposed project development in compliance with the National Environmental Policy Act3 (NEPA) and related regulations enacted by the Council of Environmental Quality.4 NEPA requires federal agencies to analyze potential environmental impacts of an action (such as granting a pipeline certificate) and inform the public of results and potential impacts before proceeding with that action. The Energy Policy Act of 2005 identifies the FERC as the leading agency responsible for coordinating NEPA compliance and “all applicable federal authorizations” in reviewing pipeline certificate applications.
In reviewing environmental impacts associated with the certificate application, the FERC will prepare an EA, a public document which provides evidence and a concise analysis on whether the proposed project development will have a significant impact on the environment. In the course of reviewing the pipeline certificate application, the FERC may also determine that the pipeline developer needs to file an EIS. If that is the case, counsel for the developer will need to work with the appropriate business interests to draft an EIS for the FERC’s review and consideration. The EIS must include a statement of purpose, a description of the proposed project development, and the environment that would be affected by said development; a description of alternatives to meet the purpose of the project; a description of how those alternatives would affect the environment; and an analysis of direct and indirect effects of the alternatives (including cumulative impacts). Other agencies are allowed and required to provide insight, expertise, and comments to the FERC with respect to a pipeline developer’s EIS. The FERC takes into consideration all public comments and intervenors (those companies that intervene in the docket number) in its application review. Intervenors are allowed to file briefs, attend hearings, and appeal the FERC’s decision if it results in an unfavorable outcome. Counsel for the developer must take all of this into account as he or she will need to act on behalf of the developer and respond (in writing and possibly in face-to-face meetings) to intervenors, the FERC, and other agencies during the certificate review process.
Should the FERC grant a pipeline certificate, the FERC order will state the terms and conditions upon which the certificate has been granted, including the pipeline route that has been authorized, types of services, capacity levels, and any construction or environmental mitigation measures required for the project. Furthermore, a FERC certificate provides a pipeline developer with the authority to secure property rights and additional real estate to lay the pipeline and build infrastructure if the developer cannot secure the necessary right-of-ways from landowners through negotiation. The pipeline developer will need to provide the FERC with any outstanding information and take action to satisfy the terms and conditions as set out in the certificate order, including an implementation plan (IP). An IP is a timeline and guide as to when the pipeline developer will start and finish the project development. An IP must be filed with the FERC within a specified period of time subsequent to the certificate order. Once the pipeline developer has provided the FERC with the required information, the FERC will issue a Notice to Proceed with Construction Activities and construction for the project development can begin. Counsel for the pipeline developer will need to file weekly status reports with the FERC documenting the progress of the project development and certificate compliance until construction is complete. The pipeline developer must also obtain all other required state authorizations prior to construction and operation of the pipeline infrastructure.
Per FERC policy, once a project developer has received its Notice to Proceed with Construction Activities, it must conduct an “open season.” The open season policy applies to interstate pipelines and requires new construction to be preceded by a fair open season process through which potential shippers may seek and obtain firm natural gas capacity rights. With new construction, the pipeline developer (service provider) must solicit customers (new or current) for any capacity that is turned-back. The FERC has recently affirmed this policy in an effort to promote transparency and ensure that new capacity is allocated in a nondiscriminatory manner.
Investments in pipeline infrastructure are established by anchor customers contracting for long-term firm commitments in financial support of new project developments. To induce shippers to become anchor shippers to newly constructed facility, pipeline, and infrastructure development, interstate pipeline companies may permit certain contractual preferences to entice shippers in the interstate market. In Order 686-A, the FERC affirmed that project development sponsors may offer a rate incentive as an inducement to get potential customers to commit to a proposed project at the onset, while offering a less favorable rate to those customers who commit at a later date (see Revisions to the Blanket Certification Regulations and Clarification Regarding Rates5 (Order 686-A)). Furthermore, the FERC has confirmed that providing these rate incentives to anchor shippers is not discriminatory to potential customers of the project development. The FERC reviews various rate incentives for anchor shippers on a case-by-case basis. To minimize the risk of a project development sponsor being accused of undue discrimination against customers, the project sponsor should establish clear parameters in its open-season announcement with respect to bidding provisions and the available rate options. This will ensure that there is an even playing field for all potential customers to sign up for new service.
Drafting a Letter of Intent (LOI)
The LOI serves a key function at the beginning of negotiations between a company and a potential customer. Upon agreement by all parties, the initial draft of the LOI should include an in-depth description of the potential transaction and/or services contemplated upon commencement of service and completion of the midstream natural gas project. The LOI will include agreed upon and negotiated key deal terms. It is customary for the potential customer’s (or initiating party’s) counsel to assume the responsibility for providing the first draft. The drafting of the LOI (and key terms contained within the LOI) by the lessee could greatly impact the bargaining power and play a central role in further lease negotiations.
It is essential and part of the ordinary course of business for counsel for the respective parties to: opine on the necessary basic and key deal terms and conditions during legal negotiations, draft the LOI, and/or provide a cursory review of the LOI with suggestions and comments. This ensures that the interests of all parties involved are clearly distinct. Since the LOI is a nonbinding agreement, the use of legal counsel to prepare the LOI will protect the respective clients against any potential challenges as to the validity or binding nature of the agreement.
Texas courts have held that an LOI is a binding agreement and controls over a conflicting agreement.6 However, an LOI has only been deemed enforceable when the parties agreed that some terms were to remain open to negotiation and the LOI was used to determine the original intent of the parties.7 To ensure that the LOI is treated as a nonbinding agreement, counsel should include express, clear, and concise language stating, among other things, that it should not be construed as part of the lease agreement and that the parties do not intend for the LOI to be binding in nature. This language should be bold and conspicuous to the reader.
Drafting the Term Sheet
In lieu of or in conjunction with an LOI, parties should consider drafting a preliminary term sheet (the Term Sheet) during the initial negotiation phase. In most cases, a Term Sheet is a preliminary outline which contains a simple outline of potential key terms and conditions of the Precedent Agreement and subsequent definitive commercial agreements (e.g., purchase and sale agreement, service agreement, and accompanying assignment agreements that may be more fully developed upon completion of the proposed sale, midstream natural gas project, and facility). Upon the completion of the deal, the Term Sheet is intended to be for discussion purposes only. It should fully embody the most relevant definitive documents, if and when the respective parties come to a meeting of the minds in principle. It should be stated in either the beginning or ending statement of the Term Sheet that it is not a binding agreement and does not constitute a legitimate and final offer.
The Term Sheet should include a brief description of the respective parties to the Precedent Agreement and a factual background as to the proposed sale, project, facility, and services to be provided at the facility. Furthermore, it should include a complete legal description of the real property associated with the proposed project and facility, any additional contractual requirements, conditions precedent, and remedies if either party should default on the terms, conditions, and obligations noted in the Precedent Agreement or other definitive agreement. In regards to modifications or amendments to an existing midstream natural gas facility (e.g., modification, amendment, or replacement of current joint operators agreement upon transfer of percentage of ownership to existing or new party), counsel for both parties should provide a historical written account of any previous initial agreements and any subsequent amendments within the factual background section.
Counsel should document provisions concerning successors and assigns of the Precedent Agreement and/or purchase and sale agreement, any conditions precedent that must be satisfied prior to the execution of the lease agreement, and a working list of any definitive and future documents. As with the LOI, counsel should include express, clear, and concise language in the Term Sheet stating that it should not be interpreted as part of the Precedent Agreement (or a definitive agreement) and the parties involved do not intend for the Term Sheet to be binding in nature. The Term Sheet should state that the document is preliminary in nature and constitutes a “potential transaction” to show the express intent of all parties. It should further state that the Term Sheet does not obligate either party to enter into or finalize an agreement with respect to the prospective transaction. This language should be bold and conspicuous to the reader.
Drafting the Precedent Agreement
A Precedent Agreement is an agreement that lays out the conditions precedent, terms and conditions of service, and other key factors that will commence once a midstream facility is fully operational. A Precedent Agreement allows a company that is constructing a new facility or developing a new midstream natural gas project to seek early commitments from potential large customers before an open season can be held. Within the midstream segment, an open season is conducted when a new midstream natural gas facility offers current and new customers the option to transport, ship, and/or store natural gas or crude oil for a long-term, firm commitment. An open season gauges the market interest of current and potential customers and maintains compliance with federal and state regulations, in instances where there is more available capacity on a natural gas pipeline.
It may be helpful to include a Precedent Agreement as part of the definitive agreements in a midstream natural gas transaction as it sets out specific conditions precedent for operations and services that may commence upon the completion of the project and when the facility is operational. The parties should heavily negotiate the terms of service and define the conditions in which the facility will be in service and operational.
Typically, counsel for the company will draft the Precedent Agreement. However, the customer could greatly benefit from negotiations on certain provisions (e.g., governmental authorizations, acquisition of real property, corporate approvals, financing, etc.) that are necessary for the proposed project to commence. A Precedent Agreement should protect the potential customer from misrepresentation and provide remedies in case the company is unable to comply or meet the terms and conditions memorialized in the agreement.
Although the respective parties typically execute a nondisclosure agreement prior to the drafting and negotiations of a Precedent Agreement, counsel should still include a confidentiality clause which protects the information exchanged between the parties as it relates to the agreement. The confidentiality clause should mimic and not conflict with the nondisclosure agreement signed and agreed to by the respective parties. The Precedent Agreement (and any other principal agreement) should include a confidentiality provision that nullifies any previous versions of said agreement with respect to the exchange of confidential information.
A nondisclosure agreement (NDA or confidentiality agreement) is an agreement which binds the recipients of another party’s sensitive or proprietary information from disclosing that information to third parties. An NDA also prevents the recipient from using that confidential information for any other purpose outside the purview of the agreement. The purpose of an NDA is to allow parties to freely exchange sensitive information with one another while also protecting their own interests and making an informed decision about conducting business together.
Parties typically enter into an NDA prior to the drafting of a formal agreement for service, project development, or potential business transaction so that confidential information can be shared during the negotiation and due diligence process. There are two types of NDAs: a unilateral agreement when one party (disclosing party) discloses information to the other party (receiving party), and a bilateral agreement when both parties are exchanging confidential information.
The term confidential information should be clearly defined within the NDA. Most NDAs define confidential information as information including trade secrets, confidential, or proprietary information and note the importance of maintaining the confidence of such disclosed information between the parties. Some NDAs may list specific information to be excluded from the term confidential information, such as information that was publicly available at the time of disclosure or information that become publicly available through other means.
A receiving party will be bound throughout the term of the confidentiality agreement and typically for a period thereafter as specified by the agreement. During the term of the NDA, the receiving party is prohibited from using or disclosing information to a third party outside the scope of the agreement and relationship with the disclosing party. Furthermore, the receiving party has a legal duty and obligation to use a certain level of care in handling the confidential information. Most NDAs require the receiving party to use a commercially reasonable amount of care to protect and keep the sensitive information received confidential. A typical NDA will contain a provision allowing the receiving party to disclose the confidential information in certain instances, such as when required by a court order or other judicial proceeding. In such cases, a disclosing party will want to include a provision within the NDA requiring written notice from the receiving party within a reasonable amount of time prior to the disclosure of such information.
NDAs should also provide for the return or destruction of confidential information upon the termination of the agreement. Most recent confidentiality agreements provide for the destruction of digital information by providing that once such information has been destroyed, certification should be sent to the disclosing party to confirm that the destruction has been completed. Parties should also consider the extent to which confidential information should be destroyed (i.e., whether the destruction applies to cloud backups on computers and other digital devices).
Counsel for the disclosing party will want to ensure that a clause within the NDA prohibits either party from assigning the agreement to any other party, whether expressly or by operation of law. However, the disclosing party may permit the receiving party to assign the NDA to a successor if prior written consent is obtained.
Most NDAs include a remedies provision to provide remedies or damages at law to the disclosing party should the receiving party disclose or misappropriate confidential information. The disclosing party will want language in the NDA reserving its right to reject proposals, decline to send confidential information to the receiving party, and terminate discussion concerning the proposed business transaction without any liability. The disclosing party will also want language stating that if negotiations end and no deal is reached, the receiving party will still have a duty to keep the information confidential.
Conducting Due Diligence
Due diligence is a process, typically conducted by counsel of potential customers of the midstream natural gas facility, to assess the creditworthiness, business or financial condition, real property holdings, and other essential details of the company’s business and financial standing. The legal due diligence required will vary according to the type of proposed project and facility. In most instances, due diligence will be conducted prior to or during the drafting and negotiation stage of the formal agreements to a midstream natural gas transaction or proposed project development.
Midstream companies that are considering joint ventures or operations with other similarly situated companies in the natural gas market will likely want their counsel to perform legal diligence on the following issues.
Counsel for the receiving party should review the disclosing party’s creditworthiness within a specific time period of the request. The amount of the guaranty of credit may be dependent upon the analysis of creditworthiness. Furthermore, if noted within the formal agreements to the proposed transaction, creditworthiness analysis may be required to conduct business with the receiving party. At the receiving party’s request, the disclosing party or its credit support provider should provide, at a minimum, the following items: audited and unaudited financial statements (including balance sheets); a list of affiliates (if any); credit bureau reports; Form 10-K (if applicable); credit and trade references; and information as to pending litigation, collections actions, or judgments that could be expected to cause a substantial deterioration in the financial condition of the disclosing party. Counsel for the disclosing party will probably reject some of the financial information being requested due to confidentiality concerns. However, as it can assist in identifying issues early on so that they can be resolved in a timely manner prior to the proposed transaction or project development, it is customary for the receiving party to review and analyze such information.
It is prudent for the receiving party’s counsel to review the organizational documents, certificates of good standing, board resolutions, etc., of the disclosing party. While the disclosing party’s counsel may only provide a simple legal opinion or comment with respect to the organizational status and due authorization at the closing of the proposed transaction, it is helpful for all parties involved to identify and resolve any potential issues as quickly as possible.
As is typical in the midstream natural gas segment, particularly in the pipeline and storage sector, a company may claim a lien on the gas delivered to the facility for charges related to such matters as storage and/or transportation, insurance, labor, and inventory. As such, counsel for the receiving party should conduct lien searches for both secured and unsecured loans early in the proposed transaction process.
The receiving party’s counsel should conduct an exploratory search on whether there are any known, unknown, or contingent liabilities related to pending or contemplated litigation. To accomplish this in a cost-effective manner, counsel should conduct public record searches (judgment searches) to determine if such litigation or potential litigation is problematic for the proposed business transaction. Counsel should also review any board minutes, resolutions, and audit records that may exist in connection with litigation or pending litigation.
The receiving party should inquire as to whether the disclosing party owns or leases real property, especially if those interests are used as collateral. Counsel should coordinate such diligence efforts with its in-house land department or an independent title company.
Environmental and Regulatory Issues
Environmental and regulatory issues are a substantial concern for midstream natural gas companies. The disclosing party’s ability to conduct business and financially participate in a proposed transaction could be considerably impacted if it is found liable for damages, remediation costs, fines, and/or penalties. Additionally, the receiving party could be exposed to liability by association if the real property is the subject of the proposed transaction. Counsel for the receiving party should include this issue as an area of inquiry in the due diligence process.
At the conclusion of conducting due diligence, counsel for both parties can begin to draft, negotiate, and review the formal agreements as they relate to the proposed midstream natural gas facility and/or project. With respect to acquisitions and construction of new or existing facilities, some midstream companies may deem it prudent to form a joint venture or jointly operate a facility for the purpose of collaborating on a specific project.
With a joint venture (JV), two or more businesses pool their assets, efforts, and/or skills in order to succeed in a midstream natural gas undertaking. A typical JV is formed for a certain activity. It may have a limited lifespan dependent upon a variety of factors or may be created for long-term or even permanent partnerships. A JV is formed by an expressly written agreement between the parties or by the creation of a new and separate legal entity (e.g., a limited liability corporation, partnership, or corporation). Midstream companies may want to create a JV for a variety of reasons: (1) to carefully outline the shared costs, risks, and responsibilities as they relate to the proposed project, venture, or business transaction; (2) to pool and increase profits; and (3) to gain access to or share particular midstream natural gas segments.
A JV is not usually a separate legal entity and in some instances, a formal contractual agreement may be unnecessary as the conduct and course of dealings between the parties shows the intent of a joint venture (i.e., a noncontractual JV). However, a noncontractual JV may give way to unintended and potentially unlimited liability for the other party’s actions and/or conduct. There are also inherent risks associated with complex business transactions that involve many technical components, such as a midstream natural gas project. Without a written agreement clarifying each party’s rights and obligations associated with the proposed business transaction, the parties involved could be opening themselves up to costly litigation and undue costs.
A contractual JV is most appropriate for projects such as a midstream natural gas project due to various components related to constructing a facility (e.g., land, engineering and design, environmental, and regulatory). A contractual JV does not change the structure of the parties’ existing business entities. Counsel for the respective parties can draft indemnity provisions in the JV agreement substantially similar to those used for independent contractors in which a party seeks to shield itself from liability due to the act or omission of another party. The parties should ease liability concerns by carefully constructing indemnification provisions in the JV agreement and having each party maintain its existing legal entity for tax and regulatory filing purposes.
Midstream natural gas companies may also form a JV by creating a separate entity and operation that operates independently from the other co-venturers’ respective businesses and entities (corporate joint venture). The new corporation or company (Newco) will be a new legal and business entity and will serve as a vehicle to both parties to further the project’s growth and development. Corporate joint venture is a viable resource and is often used by foreign-owned entities to invest in certain countries where foreign-ownership is not permitted. Counsel for Newco will need to ensure that the corporate governance is in line with state and federal laws and regulations to ensure that each owner has a suitable voice in the JV management as intended and agreed to by the parties involved.
Joint Ownership and Asset Transfer Agreements
A joint ownership agreement (JOA) is an agreement that memorializes the contributions and ownership interests of the parties in a new entity. The formation and structure of a JOA is similar to that of a JV. Each party to the JOA contributes assets to and owns shares of the new or existing entity. Such contributions, shares, and ownership interests are properly memorialized within the agreement. A JOA is different from a JV as it describes the specific ownership of the real and physical property and the parties’ duties and responsibilities as it relates to their specific ownership interest. For example, two companies own a midstream natural gas gathering facility. However, one party has exclusive ownership of the physical asset that is the facility, while the other party has exclusive ownership of all equipment, personal property, and fixtures of the facility. With JOAs, ownership interest is usually described as a percentage, and in the case of midstream natural gas, may also be described as the amount of working gas (usually in dekatherms) that is gathered, processed, or stored at the facility.
In the case where a certain percentage interest of ownership in the physical asset is being transferred to another party, but joint ownership will still remain as originally contemplated, an asset transfer agreement should be properly memorialized between the parties. An asset transfer agreement provides a historical and factual background of the owners; the physical and legal description of the asset being sold, granted, and conveyed to the other party; consideration; and any other payments (e.g., closing payments) to be paid once the conveyance has been completed. With a JOA and an asset transfer agreement, counsel for both parties should ensure that each party is solely responsible for their own costs, expenses, and taxes associated with the physical asset.
Purchase and Sale Agreement
Purchase and Sale Agreements (PSAs) are commonly used in acquisitions and divestitures of producing natural gas infrastructures. A PSA is a type of agreement drafted to evidence the transfer of rights, title, and interest of certain assets (e.g., a pipeline) within a gathering system or pipeline infrastructure. Most PSAs start with a preamble to the agreement identifying the parties (Seller or Buyer or Purchaser), type of entity, state of organization, and address. PSAs also usually contain a recitals provision which gives a historical account of the two parties, the particular asset to be sold and purchased, and the general purpose of the PSA. The recitals provision usually appears right after the preamble. Some PSAs contain a separate article for definitions of terms to be used throughout the agreement. If a definition article is included within the PSA, it is common for it to precede the recitals or be a separate exhibit to the PSA. It is strongly suggested that the definitions be included within the body of the PSA for drafting and negotiating purposes.
The first substantive article to appear within the PSA will contain specific, legal descriptions of the asset(s) being conveyed and granted to the purchaser. This section may also include any equipment, appurtenant facilities, easements, right-of-ways, surface leases, permits, licenses, and other real property that are to be conveyed and granted along with the initial asset for purchase and sale. Counsel for seller should be aware that if easements, right-of-ways, surface leases, etc. are being conveyed and granted in connection with the asset, separate agreements (e.g., easement and right-of-way) will need to be drafted, negotiated, and included separately as an exhibit to the PSA. The PSA will often specify certain assets that are to be excluded and clarifies who will remain responsible for such assets (e.g., corporate, financial, tax, and legal records). Excluded items are a heavily negotiated provision for both seller and purchaser.
PSAs must also state the consideration or purchase price for the conveyed asset. This article typically begins with a contractual provision such as: “Subject to the other provisions hereof, in consideration of the sale of the Assets by Seller to Buyer, Buyer shall pay to Seller in cash, the amount of [dollar amount] (the Purchase Price).” The seller and buyer may also negotiate the amount of the purchase price and if it will include or exclude certain taxes, costs, and fees associated with the conveyance. A closing article may or may not be separate from the Purchase Price article as it provides a mechanism for the parties to agree on any estimated adjustments in anticipation of the closing. The closing article will also note or define the effective date of the PSA.
Most PSAs cover the representations and warranties of the seller. These are representations which, if materially breached, may give rise to termination of the PSA by the buyer and a possible cause of action for damages against the seller. Counsel for the seller should craft the language in this article to assure the buyer that it is getting that for which it paid, but also to protect both parties from any underlying issues, should they develop. Counsel for seller will often thoroughly negotiate this article—including exclusions and limitations, notice, length of duration, etc., in an effort to minimize risks associated with the representations and warranties. It is also helpful to include an indemnities section which will protect both parties against any fines, actions, claims, suits, or liabilities in connection with the conveyed asset. The seller and buyer will typically make general representations focused on assuring the respective parties that the PSA and other associated proposed transactions will be fully enforceable against the other party. The common representations made in a PSA are organization and existence, power and authority, valid and binding agreement, non-contravention, and pending litigation.
Each party should agree to the following mutual covenants as preclosing actions: (1) use commercially reasonable efforts to take (or cause to be taken) such actions as may be necessary to consummate the transaction, such as obtaining waivers and consents, filing any required governmental notifications, and responding to government inquiries; (2) notify the other party of any relevant new or pending litigation commenced or threatened or the discovery of any fact or condition that would cause a representation of either party to be inaccurate; (3) cause the other party’s conditions to closing to be fully satisfied; and (4) not take any actions that would result in a breach of any representations or make such representations inaccurate.
The buyer should negotiate to include a right to audit article within the PSA as a mutual covenant. The right to audit article should be for the term and the seller should make all relevant files and records available for inspection and review by the buyer. The seller may counter that article by including language limiting the time available for the buyer to inspect records and requiring a representative be on site during the review and inspection.
After closing of the PSA, it is typical for the seller to deliver the executed documents, associated agreements, and any other records to the buyer. However, the closing, execution, and recording of the documents is a negotiated point to be ultimately agreed upon by both parties.
The North American midstream natural gas infrastructure consists of pipelines, processing facilities, compressor stations, interconnects, hubs, and related infrastructures for transporting natural gas from underground well sites and preparing the gas for consumer consumption. Issues related to the midstream sector such as increased public and media notice of pipeline infrastructure development and construction, levels of financial activity in the midstream sector, and increased applications for approval of pipeline permits and infrastructure development with the FERC are of growing importance to midstream natural gas companies and the attorneys who represent them. Due to the intricate nature of the midstream natural gas infrastructure, a brief factual background and description of the formal agreements and regulations are warranted.
Gas Gathering and Processing System
Midstream gathering and processing of natural gas and crude oil involves processing oil and natural gas liquids (NGLs) into marketable products. Midstream companies operate vast networks of low-pressure gathering pipeline systems that transport natural gas from a large number of wellheads into pipeline webs that bring gas through takeaway pipelines. Gathering pipelines are smaller in diameter and calibrated for flows of lower pressure than distribution pipelines. These products continue into the refining processing portion of the downstream segment of the business by being shipped through a web of pipelines, stored, and then transported.
Different production areas throughout the United States and Canada dictate different gathering systems. Although gas gathering is exempt from federal regulations, midstream counsel should be aware of the states that do regulate gathering (or intrastate) facilities and pipelines. The weight of the regulations vary from state to state, but the following are a few requirements intrastate facilities and pipelines must meet: (1) facilities and pipelines must abide by the state common access requirements, (2) facilities and pipelines must perform under state common carrier obligations which require gas to be transported without discrimination, and (3) facilities and pipelines must recognize anchor or fundamental shippers. Firm shippers that financially commit to long-term contracts for pipeline capacity utilization are known as anchor shippers. Anchor shippers are typically committed through Precedent Agreements in the beginning stages of midstream natural gas project development, pipeline, and facility construction. Some gathering systems may need one or more compressors to move the gas to the pipeline or to the processing plant/facility.
Gas processing is the industrial process of separating NGLs from methanes. Natural gas must be processed to produce natural gas within specifications imposed by major transportation pipelines. The extraction process for the NGLs is dependent upon the capacity available at processing plants. While some field processing of raw streams of natural gas can be accomplished at the wellhead, the complete processing of natural gas occurs at processing plants and facilities.
Natural gas processing capacity in the United States has climbed significantly in recent years and is set to further increase. As NGLs are extremely valuable byproducts of gas processing, current NGL pricing makes NGL extraction a key value driver in negotiations of gathering and processing agreements. Gas containing a significant amount of NGL is known as “wet gas,” while gas that flows through pipelines to consumers is known as “dry gas.” Fractionation plants receive the wet gas to further separate NGLs through a method called fractionation. To further the goal of processing wet gas into dry gas of pipeline quality within set specification levels, plants must then remove oil condensate and water, separate the NGLs, and remove sulfur and carbon dioxide.
Traditionally, processing is not a federally regulated segment. However, it may be regulated if the natural gas is processed by a gas processing company which owns interstate pipelines and other midstream infrastructure. State public service commissions regulate processing facilities, but do not normally assess fines and penalties for failure to comply with such rules and regulations. Due to the intricate nature of processing gas and NGLs, the largest regulatory issue present with processing plants is environmental compliance. Currently, more than half of the current natural gas processing plant capacity in the United States is located offshore, in Texas, and in Louisiana. However, this is shifting with recent shale gas resource development in several U.S. regions. Counsel should consider that state regulation varies with respect to gas processing. However, there are key rules and regulations that should be addressed when drafting formal agreements: (1) similar common carrier or common access regulations as for gas gathering; (2) some states may require prorationing of processing capacity; (3) while states may require the acknowledgement of anchor shippers, states may not require the same for gas processing; (4) states maintain broad nondiscrimination principles which can affect and govern the rates and access for NGL transportation.
With the quick pace of shale resource development in certain parts of the country, midstream infrastructure and project development continue to exceed current expectations. With the rise of a robust midstream segment due to significant increase in the natural gas development, midstream companies are focusing on revamping the gathering and pipeline infrastructure. This includes construction and installation of new pipelines, increased maintenance work at wellheads, investments in liquid fractionation facilities, liquefied natural gas export facilities, oil gathering lines, and compression and pumps for gathering systems. Counsel for midstream companies are inundated with gathering and processing agreements in an effort to keep up with the increased infrastructure development to support the increase in supply and demand.
Gas Purchase Agreement
A natural gas purchase agreement is a contract whereby gas is purchased in anticipation of the construction or operation of a natural gas gathering system. A typical gas purchase agreement involves a seller that owns a number of oil and gas, mining leases, or rights associated with those leases and wants to deliver or sell the gas associated with the producing wells attached to those respective leases. The agreement provides the terms and conditions surrounding the delivery and receipt points of the gas from the seller to the buyer. Furthermore, the agreement details the associated costs and responsibilities with the construction of facilities necessary for the delivery and receipt of gas to respective gas gathering systems.
Counsel for sellers will want to reserve certain leasehold rights related to the gas produced. Counsel for both parties will want to clearly outline the ownership and responsibilities associated with the delivery points for the gas and spell out when the buyer will hold title to the seller’s gas. As the gas being delivered must be of a certain quality and temperature to flow through respective gas gathering systems, counsel for buyer should strongly negotiate terms concerning gas quality specifications and the various methods in which the seller can treat the gas before it is delivered to a respective receipt point. A heavily negotiated term between both parties will be the consideration associated with delivering gas to the buyer and the method by which that consideration is calculated. Most gas purchase agreements calculate the delivery price by the value of plant products and the surplus residue attributed to the seller’s gas. Additionally, counsel for both parties will want to provide certain provisions concerning the gas volume, the operation and maintenance of meters, and warranties related to the flow of gas by the seller. A typical gas purchase agreement will also provide remedies and notice requirements for both the seller and the buyer, in the event that gas is unable to be received and/or delivered to its respective points. With this agreement, indemnity provisions should also be drafted and negotiated in an effort to protect the various interests. Most gas purchase agreements will also include a definition and extensive provision for force majeure and notice requirements associated with claiming a force majeure.
Gas Gathering Agreements
A gas gathering agreement is an agreement which memorializes the ownership and operations of natural gas gathering systems between the gatherer and the producer. There are varying forms of gas gathering agreements. Some midstream natural gas companies will draft gas gathering agreements in which the company dedicates all of the natural gas owned or controlled by them and produced from or attributable to existing and future wells within acreage(s) dedicated in a specific region (e.g., Barnett Shale, Eagle Ford Shale, Mid-Continent, Marcellus Shale regions). A dedicated acreage contract is a contractual provision which declares that all gas produced from the dedicated acreage is dedicated by a gatherer to a company (often a producer). Acreage dedication contracts are longer term gathering agreements and are typically in regions with rich natural gas development. In acreage dedication contracts, producer customers are generally required to deliver all of their production within the dedicated area to the respective gathering system over the duration of the agreement. Counsel for gatherers and facilities prefer to have a long-term fixed-fee based agreement, particularly if a gathering plant is slated to be newly constructed or upgraded to increase natural gas processing capacity.
Depending on the gatherer, the contemplated long-term agreement and partnership with the producer, the proposed transaction, and the business model contemplated by the gatherer, some midstream natural gas companies prefer to propose volume commitments instead of dedicating acreage for a long period of time. With volume commitments, gatherers and producers agree on an annual minimum volume commitment of natural gas on the gatherers’ respective system or, in lieu of shipping such volumes, producers pay gatherers a periodic fee, as if that minimum amount has been shipped. In negotiating this provision, counsel for both parties should specify the exact percentage each party is responsible to attribute to the annual volume commitment. Gatherers may prefer gathering agreements containing the volume commitment provision as it provides the plant/facility with stable cash flows.
Rate structures used in gas gathering agreements are largely structured and similar to those used by interstate pipelines and storage facilities. The rate structures normally used in gas gathering agreements are: (1) fixed fee, (2) sharing/inkind, (3) variable, and (4) cost-of-service. The agreements also typically contain provisions related to the producer’s (or shipper’s) title to the gas and clauses related to maintaining sufficient delivery pressure. Counsel should heavily negotiate the gas quality and specifications provisions of the gas and provide for remedies should non-specification (or non-spec) gas be delivered to a particular receipt or delivery point.
Gas Processing Agreements
Under FERC Order 636, interstate pipeline companies were required to change from buying and selling natural gas they transported to selling the transportation service only. This required the natural gas industry to restructure ownership of natural gas processing plants across the country. Today, midstream companies or operating divisions own and operate most processing plants. Consequently, as the natural gas pipeline network has become more efficient and regulated in specific regions, there is more of a need for increased and better natural gas processing, both in the number and operational efficiencies of natural gas processing plants.
The primary role of a natural gas processing plant in the current midstream marketplace is to produce pipeline quality natural gas. Gatherers and producers consider the production of NGLs and other byproducts from the natural gas stream to be a welcome benefit of processing. The quantity and quality of the production of byproducts is in direct correlation to current market prices.
In the past, counsel for processing companies would draft keep whole agreements. Under this type of agreement, NGLs recovered at a processing facility are retained by the processing company as payment, while the other party’s delivery of gas is kept whole by returning the residual natural gas at the tailgate of the processing plant. With the robust natural gas market in recent years, some processing companies have moved away from keep whole agreements, as these types of agreements can create income uncertainty. However, the keep whole agreement is still frequently used by processing companies in an effort to lock in gas supply. From a practical standpoint, keep whole agreements are only profitable when the value of NGLs is greater than the value of the separated liquid as a portion of the residue natural gas stream. Nevertheless, counsel for processors should consider that exposure to commodity prices in the NGL market changes the risk profile.
Processors that have moved away from keep whole agreements have replaced them with alternative and more complex natural gas processing agreements: (1) percent-of-liquids or percent-of-proceeds, (2) percent-of-index, (3) margin-band, (4) fee-based, and (5) hybrid agreements.
A percent-of-liquids (POL) or percent-of proceeds (POP) agreement is a certain type of agreement in which the processor takes title of an agreed upon percentage of the NGL mix extracted from the producers’ natural gas stream.
The producer either retains title to or receives the market value of the remaining NGL mix. As a result, producers reimburse the processor for costs associated with the liquids extraction process. In a POL agreement, the processor takes a percentage interest of the extracted NGL as payment for services rendered and markets the NGL independently from the producer. Counsel should be aware that with POL and POP agreements, the processor is completely and fully exposed to the commodity risk. Therefore, a processing company will need to have an active marketing and business development group to ensure the best NGL returns. It is also helpful if a processing company has an industrial and/or chemical load nearby so that costs are minimized with respect to NGL mix extraction.
With a percent-of-index agreement, the processor agrees to purchase its natural gas at (1) a percentage discount relative to a certain index price, (2) a certain index price less a fixed amount, or (3) a percentage discount relative to a certain index price minus an additional fixed amount. The processor can then resell the natural gas at the index price or at a different percentage discount to the index price.
Under a margin-band agreement, the processor takes title to the NGLs extracted from the natural gas stream delivered by the producer. In return, the producer is paid based on the energy value of the NGL mix less the fuel consumed in the extraction process. Counsel for both parties will negotiate the acceptable specified floor and ceiling return levels with the intent of presenting an acceptable rate of return to each party. This agreement is typically used when natural gas processing economics have leaned towards negative returns or economic gains become disproportionate.
A fee-based agreement is an agreement in which the processor and producer negotiate the fee based on the anticipated volume of processed gas. The producer can either retain title to or receive the value associated with the extracted NGLs, but remains responsible for all energy costs associated with the natural gas and NGL processing. In determining which agreement to use as a processing agreement, counsel should note that fixed fees limit the upside of earning potential for a processing plant. To that end, a fee-based agreement may be more profitable for the producer. However, with a fee-based agreement, the processor has no direct commodity exposure as returns are fixed by rate and vary dependent upon the anticipated volume of processed gas. In negotiations, counsel for a processor should consider the current demand for processing as it is also linked to current NGL prices.
Typical hybrid agreements provide for the producer to receive processing services under a monthly POL arrangement. After a specified period of time, the producer will have the option to switch to either a fee-based or keep whole arrangement. As it provides an incentive for both producer and processor to maintain operations during a volatile period in the natural gas market, parties typically use this type of processing agreement when there are increased periods of natural gas market fluctuations.
Terms for gas processing agreements vary and range from month-to-month to the life of the producing facility. Some parties may prefer limiting the terms of the agreement from one to 10 years dependent upon the type of agreement and any market constraints.
Gas Balancing Agreement
Most gas balancing agreements are used by operating personnel to remedy issues related to imbalances or disproportionate production of natural gas, NGLs, and other related hydrocarbon liquids. The agreement defines the term gas and sets out the terms and conditions related to the gas produced from wells under certain oil and gas leases and/or oil and gas interests and delivered by the operator to gas purchasers. A gas balancing agreement may also be used in conjunction with a JOA. The agreement outlines the responsibility of the operator in balancing the gas and hydrocarbons and the production accounts between the respective parties. Provisions concerning nonmarketable gas production are provided for within the agreement. Counsel should be mindful of remedies associated with both overproduction and underproduction of natural gas.
From the gathering and processing system, the natural gas flows into the transmission system. Midstream natural gas transmission lines are wider in diameter and navigate the often long distances between the gathering systems, processing plants, and ultimately, distribution network. The current transmission pipeline infrastructure is designed as a trunk line system, with a large number of lateral pipelines branching off the main line system to form interconnections that receive the processed gas and deliver it to end users for further marketing and distribution. As noted above, natural gas that is transported through the interstate and intrastate pipeline network is federally regulated by the FERC under the Interstate Commerce Act (ICA) and state public service commissions (although state regulation varies).
Under the NGA, the FERC requires that interstate pipelines and storage companies provide open access and information with respect to the transportation and storage of natural gas on a nondiscriminatory and non-preferential basis. This means undue discrimination or preferences in the duration or quality of services, in the categories, prices, or volumes of gas to be transported or stored, or in customer classification is strictly prohibited. Furthermore, transportation and storage services of natural gas must be provided “on a basis that is equal in quality for all gas supplies transported under that service, whether purchased from the pipeline or another seller.” A pipeline or storage provider is required to enact commercially reasonable operational conditions within its respective FERC Gas Tariff.
The Natural Gas Policy Act of 1978 (NGPA) provided even more oversight to the FERC as it relates to the interstate transportation and storage services from the sale of natural gas. As previously mentioned, pursuant to Section 5 of the NGA and NGPA, the FERC began a process which opened up interstate natural gas companies to other pipeline companies that wanted to transport their own natural gas on interstate systems. The main objective with the NGPA was to eliminate duality of the interstate and intrastate pipeline market that existed at the time of promulgation. After the enactment of the NGPA, the FERC enacted open access rules for interstate pipeline companies’ unbundled transportation and storage services, and also ordered each interstate pipeline company (and storage provider) to file a FERC Gas Tariff to state the terms and conditions upon which the company would provide its stand-alone transportation and storage services and the rates in which those service would be provided to shippers.
In an effort to facilitate this open access process, Section 311 of the NGPA allowed intrastate pipelines, subject to certain conditions, the ability to transport natural gas in the interstate natural gas market, on behalf of interstate pipelines and local distribution companies served by the interstate pipelines. The FERC has defined an intrastate pipeline as any person or company engaged in natural gas transportation (not including gathering) that is not subject to the FERC’s oversight under the NGA. More importantly, the NGPA stipulated that intrastate pipeline companies could provide those services without being subject to the FERC’s regulations. Intrastate services are met with FERC oversight under the NGPA, which established different standards for approvals of rates and terms of services, while maintaining that intrastate pipelines and accompanying services are exempt from FERC regulation.
Section 311 of the NGPA is not applicable to non-FERC jurisdictional companies, also known as “Hinshaw companies” (e.g., local distribution companies with high-pressure facilities and independent natural gas storage providers in the intrastate market). Hinshaw companies are exempt from FERC regulation, but have the same benefits as Section 311 intrastate pipelines. The FERC has imposed regulations that authorize Hinshaw companies to apply for authority to transport natural gas in interstate commerce in the same manner as those Section 311 intrastate pipelines. Intrastate and Hinshaw companies are required to have FERC-approved rates on file with the FERC; terms of service must be filed in a Statement of Operating Conditions. A Statement of Operating Conditions is similar to that of a FERC Gas Tariff, but has a more condensed version of terms and conditions of service. The FERC has limited regulation of Hinshaw companies and these companies continue to provide intrastate services that are outside of the FERC’s oversight and jurisdiction. However, under the Energy Policy Act of 2005 (EPAct 2005), the FERC has the authority to penalize intrastate and Hinshaw companies up to $1 million per day for any violation of the NPA. EPAct 2005 provides the FERC with broad authority to define and prohibit manipulative, fraudulent, and deceptive activities in interstate natural gas markets.
Blanket Certificate Authorization
As noted above, under Section 7(c) of the NGA, interstate pipelines and storage providers may construct, modify, acquire, operate, and abandon a limited set of natural gas facilities and offer a restricted number of services, provided that each activity complies with constraints on costs and environmental impacts as set forth in various FERC regulations.8 There are two types of blanket certificate projects: those that qualify for selfimplementation or automatic authorization from the FERC, and those that require prior notice to the public. For automatic authorization, the construction for the specific project development must have a value of less than $11 million.
In 1985, the FERC revised its transportation service authorization regulations. Under Order No. 436, the FERC agreed to provide blanket authorization for unbundled transportation services by interstate pipeline companies, conditioned upon the pipeline companies providing those services on an open-access and nondiscriminatory basis (see Regulation of Natural Gas Pipelines After Partial Wellhead Decontrol, FERC Stats & Regs. ¶ 30.665 (1985) (Order No. 436)). Furthermore, pursuant to Order No. 436, the FERC determined that any pipeline company with blanket authorization would be required to allocate capacity to shippers on a first-come, firstserve basis. This presented issues with existing shippers selling or assigning portions of their capacity rights to other interested parties and on a preferential basis (i.e., capacity brokering).
Accordingly, the FERC established the shipper-must-havetitle rule (SMHT), which requires that a shipper have title (i.e., ownership) of the natural gas at the time of delivery to the FERC-jurisdictional pipeline or storage company and throughout the period that such gas is transported and stored. Interstate pipeline and storage companies are also required to incorporate the SMHT requirement within its respective FERC Gas Tariff. The FERC implemented the policy in an effort to prevent shippers from capacity brokering and to assist in nondiscriminatory access to transportation capacity. Furthermore, in its capacity release program, the FERC requires interstate pipeline and storage companies to adopt tariff provisions that require shippers to warrant good title to the natural gas tendered to them under their respective service agreements. The FERC requires the shipper to hold title throughout the entire course of transportation of the gas. Specific Tariff language may vary depending on the interstate pipeline and storage company. Limited waivers are available to interstate pipeline and storage providers, but only under limited circumstances.
As noted above, the NGA provides that rates charged for interstate pipeline services must be just and reasonable. Under cost-of-service ratemaking, rates are established based on an interstate pipeline’s cost of providing service with a further financial incentive for the pipeline to earn a reasonable return on the investment. The FERC uses five steps to determine cost-of-service ratemaking: (1) establishing a revenue requirement, or cost-of-service; (2) functionalizing the cost-of-service; (3) cost classification; (4) cost allocation; and (5) rate design.
The FERC sets the rates for interstate pipelines in a number of proceedings. If an interstate pipeline company seeks to increase the rates that it charges for service to its current and prospective customers, the company must make a filing to the FERC under Section 4 of the NGA (also known as a “general Section 4 rate case”). The FERC will then review all of the pipeline’s rates and services. The burden falls to the pipeline to demonstrate that the new proposed rates are just and reasonable. Section 4 rate increase application filings are often suspended and set for hearing by FERC order. Once the application is set and posted for hearing, it is processed by the FERC’s litigation staff in the Office of Administrative Litigation. In some instances, counsel for the pipeline may have to negotiate with customers regarding the increase in rates for service. If the issue cannot be resolved between the parties, a hearing is held before an administrative law judge. Ultimately, the FERC will act upon either the settlement between the parties or the record in the hearing. There are also “limited Section 4 rate case” filings which are used when a pipeline wants to add a new service and establish new rates for said service. These must also be addressed and reviewed by the FERC.
Under Section 5 of the NGA, the FERC may require pipelines to change rates charged by a pipeline when it can be demonstrated that those rates are no longer just and reasonable. The FERC can initiate this proceeding on its own accord or through a complaint by an interested party. In this type of proceeding, the FERC ultimately has the burden to prove that the pipeline’s current rates are no longer just and reasonable.
The FERC may also set rates for a pipeline under Section 7 of the NGA. As previously noted, under Section 7(c) of the NGA, a pipeline must file a request for a Certificate of Public Convenience and Necessity to construct a new pipeline or expand existing facilities in an effort to offer new or additional services. The rates provided for in the application and subsequently established by the FERC under Section 7 for these services are referred to as initial rates and generally remain in effect until a pipeline files a Section 4 general rate case filing. The FERC also sets rates for intrastate pipelines under Section 311 of the NGPA. As referenced above, intrastate pipelines are allowed to transport gas for interstate pipelines and LDCs in interstate commerce without being subjected to the FERC’s regulation under the NGA. The rates established under Section 311 must meet a fair and equitable standard, as opposed to the interstate pipeline standard of just and reasonable. The FERC sets the rates for Section 311 facilities by using the same cost-of-service methodology under the NGA. However, since intrastate pipelines are regulated by their respective state agencies, the pipeline may choose to use an approved costbased rate on file with that particular state agency.
An interstate pipeline company or storage service provider seeking to charge market-based rates must file an application to charge market-based rates with the FERC for authorization. In its review of the application, the FERC must find that the applicant (i.e., pipeline company or storage service provider) has little to no market power. In other words, it must find that the market is sufficiently competitive to preclude the pipeline from profitably maintaining prices above competitive levels for a prolonged period of time. An application to charge market-based rates must: (1) include a description of the proposed service; (2) define relevant product and geographic areas and markets; (3) provide details concerning the pipeline or storage service provider’s ownership; (4) list affiliated energy companies, services provided at those affiliates, and their location; (5) detail good and reasonable alternatives to the proposed service (i.e., which parties provide similar services within the same geographic market); (6) include market share and Herfindahl-Hirschman Index (HHI) calculations to measure market concentration; (7) discuss any other relevant competitive factors (e.g., ease of entry and excess capacity held by competitors); and (8) describe how the applicant’s proposed rates compare to that of its competitors. The HHI is used as an initial screen to determine market concentration between an applicant and similar competitors/suppliers. It is not to be viewed as a definitive statement as to whether the applicant can exercise market power.
Tariffs and Service Agreements
In order to conduct business in the midstream natural gas market, all interstate pipeline and storage companies under the FERC’s jurisdiction must have a tariff or FERC Gas Tariff. A FERC Gas Tariff is part of a contractual agreement between the midstream natural gas company and its customers. The actual contract is known as a service agreement and incorporates by reference the provisions in the FERC Gas Tariff that are applicable to a specific service. A shipper and customer do not negotiate the terms and conditions of a FERC Gas Tariff prior to it being filed with the FERC. Therefore, it is the responsibility of the customer (and respective counsel) to read the rights and obligations associated with a company’s FERC Gas Tariff so that they understand the applicable pipeline or storage company’s terms and conditions of service and type of service(s) being provided prior to entering into a binding service agreement. Violations of FERC-approved Tariffs have been treated as violations of not only the FERC’s regulations, but also as violations of the NGA, which may levy strict penalties and fines. The FERC mandates that the FERC-approved Tariffs must be posted on the interstate pipeline or storage company’s website(s). A typical FERC Gas Tariff contains a description of the pipeline or facility, types of service and rates and charges applicable to that particular service, general terms and conditions of service, North American Energy Standard Board (NAESB) business practice standards (some incorporated by reference within the Tariff itself), and pro forma service agreements.
Every Tariff filing is required to have a transmittal letter, attachments (including supporting documentation and worksheets), and the proposed amended tariff records (which are required to be in tariff text in eTariff required format). The transmittal letter is typically drafted and submitted by the company’s counsel and identifies the company and its contacts, the applicable section of the FERC’s regulations, the action it is requesting of the FERC, the documents and tariff records it is submitting in support of its request and any other statements or opinions deemed necessary to complete its Tariff filing,9 and any certifications or attestations that are relevant to the action requested.
A pro forma service agreement is a form agreement that sets forth the standard terms and conditions that will enforce the service at an interstate pipeline and storage company, usually leaving blanks for information such as (1) the rate schedule relevant to the particular type of service(s) provided; (2) the quantity or volume of the natural gas that the customer will be entitled to transport or store; (3) the primary term of the service agreement and extension rights (as necessary); and (4) any special terms and conditions with respect to the rates, charges, etc. A service agreement will be considered a materially nonconforming agreement only if it contains a provision that goes beyond the blank spaces with the appropriate information allowed by the FERC Gas Tariff and applicable FERC orders, and affects the substantive rights of the parties. A service agreement that is considered a nonconforming agreement to the applicable pro forma service agreement must be filed with the FERC for approval. If an interstate pipeline company and customer agree to the terms of a nonconforming agreement, counsel for the company will be responsible for filing the nonconforming agreement with the FERC as well as providing an argument to the FERC as to why such an agreement should be approved. The FERC will only approve those nonconforming agreements that are considered just, reasonable, and not unduly discriminatory.
A materially nonconforming term is called a material deviation from a pro forma service agreement. The FERC has ruled that material deviations from a pro forma service agreement fall into two general categories: those that are prohibited due to the potential for undue discrimination among customers and those that can be permitted without a significant risk for undue discrimination.
A prohibited material deviation is one in which a provision is related to an operational condition of service (see Regulation of Short-Term Natural Gas Transportation, Services, and Regulation of Interstate Natural Gas Transportation Services, FERC Stats & Regs. ¶ 31,091 at P 31,344 (2002) (Order 637), citing “scheduling imbalances, or operations obligations like Operational Flow Orders”). The FERC will only approve material deviations if the applicable FERC Gas Tariff would make the requested material deviation applicable to other similarly situated customers.
An example of a permissible material deviation to a pro forma service agreement would be one that contains a negotiated, discounted rate for service (i.e., a rate that is between the minimum and maximum rates approved by the FERC for that particular service). Typically, a FERC Gas Tariff will provide a rate ceiling and floor for each service provided. The pipeline or storage company is free to charge a rate anywhere within the prescribed range, on a nondiscriminatory basis, in order to meet competition. This is particularly true of those pipeline or storage companies that are authorized by the FERC to charge market-based rates. Examples of negotiated rates of services include seasonal rates, term rates, and index-based rates. The FERC has also been known to approve material deviations that do not relate to operational matters (see, e.g., FERC Order 637, at P31,344), such as those relating to “the price, the term of service, the receipt and delivery points, and the quantity or volume of natural gas.”
In negotiations of permissible material deviations, counsel for both parties should review relevant FERC orders in an effort to make sure that the particular pro forma service agreement is in compliance with the FERC’s policy concerning nonconforming service agreements. Both parties (customer and company) should note that the FERC has the authority to levy heavy fines against the parties. Should the FERC find the proposed nonconforming term to be an impermissible material deviation, the parties will need to renegotiate the service agreement. As such, parties should include remedies or other benefits in nonconforming agreements to compensate for the potential loss of revenue if a nonconforming term is rejected by the FERC.
Changes to a pipeline or storage company’s FERC Gas Tariff, either pursuant to Section 4 or 5 of the NGA, can have a tremendous impact on a customer’s rights. Standard service agreements include a Memphis clause, which allows a pipeline or storage company to seek authorization from the FERC to amend its customers’ rate and terms of service under its respective FERC Gas Tariff. Customers are able to intervene and comment on the proposed changes and may argue that the proposed changes do not satisfy the standards under Section 4 of the NGA. However, it is ultimately up to the FERC to decide whether to approve changes to the FERC Gas Tariff. It is imperative for customers to monitor the FERC filings of the pipelines and storage companies that provide them service. Under Section 4, the pipeline or storage company has the burden of providing support for its proposed changes. The shipper may provide compelling evidence as to why the FERC should outright reject or seek further inquiry into the proposed changes to the FERC Gas Tariff.
Pipeline and infrastructure development, interstate, and pipeline companies may permit certain contractual preferences to shippers at newly constructed facilities to entice them to become anchor shippers in the interstate market.
Natural gas that is received and transported by major interstate and intrastate pipelines and mainline transmission systems must meet quality standards as specified by pipeline and storage companies in their general terms and conditions in their respective pro forma FERC Tariffs. The gas quality standards imposed by these companies vary from pipeline to pipeline and are typically a function of the pipeline system’s design, its interconnecting pipelines and appurtenant facilities, customer base, and storage facility.
Statement of Operating Conditions
Under Section 311 of the NGPA, an intrastate pipeline or storage facility that is transporting natural gas on behalf of other intrastate pipelines and LDCs served by an interstate pipeline must file (1) rates and charges and (2) a Statement of Operating Conditions (SOC) or Tariff with the FERC. An SOC describes the operating conditions under which an intrastate pipeline or storage facility provides various services (e.g., natural gas transportation, storage, or other related services) at the pipeline or facility. An SOC also outlines the transportation or storage service transaction rendered pursuant to a master service agreement (Master Service Agreement) and subject to the requirements of Section 284.123 of the FERC’s regulations. Negotiations of service rates, charges, scheduling of receipts, and deliveries of gas between a pipeline or storage facility typically take place within the Master Storage Agreement (MSA) and the associated standard confirmation form. Like the FERC Gas Tariff, the SOC is a nonnegotiable operating statement that provides the terms and conditions of services provided by the pipeline or storage company and offered to interstate and intrastate customers.
An SOC should include (1) a title record that identifies the company and company contact information; (2) a rate summary record that lists all applicable charges, rates, and fees for each service provided under the SOC;10 (3) a statement of all terms and conditions of service for all offered interstate services;11 and (4) if required by the FERC, a section on the company’s standards of conduct.12 Additionally, an SOC filing should include a transmittal letter and SOC record in the eTariff required format. The SOC documents should state the terms and conditions of service for any service not offered to interstate shippers. Any supporting documentation for the filing (e.g., transmittal letters, court or FERC orders, and rate deviations) should also be included.
Master Storage Agreement and Confirmation
An MSA and Confirmation is an agreement construed in accordance with the SOC. Operating terms and conditions are typically incorporated by reference. The agreement of service provided by the Section 311 pipeline or facility is formed based on the provisions of service in the MSA and transaction-specific terms that are memorialized in the pipeline or storage service provider’s standard confirmation form (Confirmation). The MSA and Confirmation, which constitute the transaction between the pipeline and storage service provider, are made in accordance with the SOC. Unlike the SOC, the MSA states the terms and conditions in which the customer may transport or store gas, for receipt or redelivery, to intrastate and/or interstate pipelines.
Furthermore, an MSA outlines the terms of the agreement and procedures in which a customer may request service from a Section 311 pipeline or storage service provider (e.g., a customer must execute a confirmation and submit a nomination for service in accordance with the SOC). Most MSAs contain provisions related to security interests and creditworthiness. Depending on the location of the intrastate pipeline or storage service facility, counsel for intrastate pipeline or storage service providers may also want to include language related to security interests and appropriate statutory citations.
Counsel for Section 311 pipelines and storage service providers typically draft the SOC and MSA with the assistance of various in-house business groups (e.g., regulatory, credit, business development, etc). While an SOC is nonnegotiable, the terms and conditions of an MSA and Confirmation are negotiable between the parties. As the MSA is a form agreement drafted by counsel for their Section 311 intrastate pipeline and storage service provider clients, most MSA provisions are constructed in a way to protect the interests of the intrastate pipeline or storage service provider.
A typical MSA will note that all transactions are entered into with reliance on the fact that the MSA, the SOC, and all related transactions (whether oral or in writing by a confirmation) collectively form a single agreement between the parties. It is essential for a potential customer to read the operating conditions of an SOC along with the MSA prior to executing an MSA and respective confirmation for service. Once the parties agree to the terms of the transactions, the intrastate pipeline or storage service provider should promptly memorialize the terms of each transaction in the confirmation. Terms of a transaction are specific to the agreed-upon service, but should always include service fees, the fee structure, and the term of the transaction period. For example, a confirmation for a firm storage service should also include terms for capacity demand, maximum daily injection quantity, and maximum daily withdrawal quantity.
Interconnect and Operational Balancing Agreements
An interconnect agreement is an agreement between an interstate or intrastate pipeline and an interstate or intrastate storage service provider that provides specific terms and conditions as they relate to the interconnecting and natural gas metering facilities that connect the storage facility to the pipeline system. The agreement is typically drafted by the storage facility. The purpose of an interconnect agreement is to clearly outline the ownership and responsibilities concerning operation, maintenance, and repair at the interconnect lateral pipeline and associated facilities (e.g., metering site, compression facilities, and other appurtenant facilities). The term of an interconnect agreement can be for the duration of the interconnect or until an effective abandonment process has been approved by the FERC. Parties may choose to negotiate an actual date for the termination of an interconnect agreement. Counsel for both parties should review respective FERC Gas Tariffs and SOCs as they relate to the gas quality specifications and method of measurement associated with the gas flowing in and out of the interconnect.
Operational Balancing Agreement
An operational balancing agreement (OBA) is drafted contemporaneously with an interconnect agreement and assists with facilitating the interconnection between the pipeline system and storage service facility. The purpose of an OBA is to provide terms and conditions to minimize gas imbalances at the meter. Any imbalance that is created when actual quantities of gas received or delivered at the meter are different than the total aggregated confirmed nomination quantities for the meter is considered an operational imbalance. As such, the agreement puts provisions in place that allow the parties to use their commercially best efforts to expeditiously adjust any operational imbalance toward zero within a specific period (e.g., a calendar month).
Ms. Deonne Cunningham currently serves as Lead Counsel, NAB Legal Wholesale team, responsible for trading services related to natural gas, electricity, and renewable energy at Direct Energy. She has over 10 years of energy law, marketing, and trading experience and has represented several companies as counsel such as Noble Energy, Inc., Repsol and Iberdrola Energy Holdings, LLC in Houston, Texas. Deonne’s practice includes legal issues related to energy matters, including but not specifically limited to, commercial transactions related to marketing, physical and financial derivatives trading for petroleum products, regulatory and compliance, project development and facility operations, real estate, land, and corporate governance. Deonne has significant experience in drafting and negotiating of commercial agreements related to natural gas and/ or crude oil gathering and processing, project development and facility operations confidentiality agreements, vendor service agreements, commercial agreements, interconnection and metering agreements, precedent agreements, term sheets, memoranda of understanding, natural gas storage agreements, and interpretation, drafting, and revisions of Gas Tariffs; analyzing of federal and state regulations and orders related to the interstate and intrastate storage and transportation of natural gas and electricity; drafting of applications and other documents related to the authorization of new or expanded service to the Federal Energy Regulatory Commission (FERC), developing processes and procedures for facility and company operations; experience with corporate governance matters, commodities trading transactions involving industry standard agreements (NAESB, EEI, and ISDA), origination transactions and other complex energy transactions, and long-term power purchase and sale transactions; substantive knowledge of natural gas gathering, processing, and transportation agreements; and FERC matters and regulations relating to cost-base and marketbase authorization for natural gas pipeline infrastructures. In her current role at Direct, Deonne also provides assistance to Direct’s compliance and training programs for NAB personnel related to regulatory compliance matters with the FERC, U.S. Commodity Futures Trading Commission, Department of Energy, other state regulatory agencies, and public utilities.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Energy & Utilities > Midstream Oil & Gas > Midstream Oil and Gas Construction & Project Development > Practice Notes
For comprehensive coverage of joint operating agreements in the oil and gas industry, see
> JOINT OPERATING AGREEMENTS
RESEARCH PATH: Energy & Utilities > Upstream Oil & Gas > Exploration & Production (E&P) > Practice Notes
For a sample confidentiality agreement for use in an oil and gas transaction, see
> CONFIDENTIALITY AGREEMENT (GAS)
RESEARCH PATH: Energy & Utilities > Upstream Oil & Gas > Leasing > Forms
For a letter of intent for a contemplated transaction involving the purchase and development of a natural gas storage facility project, see
> LETTER OF INTENT (NATURAL GAS STORAGE)
RESEARCH PATH: Energy & Utilities > Midstream Oil & Gas > Gathering, Processing, Transportation & Storage > Forms
For an agreement for a proposed joint venture and acquisition of a midstream natural gas gathering or processing facility, or the purchase of an interstate or intrastate natural gas storage facility, see
> ASSET PURCHASE JOINT VENTURE (OIL & GAS ASSETS)
For an operational balancing agreement with practical guidance, drafting notes, alternate clauses, and optional clauses, see
> OPERATIONAL BALANCING AGREEMENT (PIPELINE AND STORAGE OPERATORS)
For a detailed review of the application of the National Environmental Policy Act (NEPA) to the energy industry, see
> 1 REGULATION OF THE GAS INDUSTRY § 9.02
RESEARCH PATH: Energy & Utilities > Midstream Oil & Gas > Midstream Oil and Gas Construction & Project Development > Secondary Materials
For information on the key ratemaking standards that are pertinent to transportation, see
> 1 REGULATION OF THE GAS INDUSTRY § 8.05
1. 18 C.F.R. § 380.4a(21). 2. 40 C.F.R. § 1508.22. 3. 42 U.S.C.S. § 4321 et seq. 4. 40 C.F.R. §§ 1500–08. 5. 117 FERC 61,074 (2006). 6. See Foreca, S.A. v. GRD Dev. Co., 758 S.W.2d 744 (Tex. 1988). 7. See Gen. Metal Fabricating Corp. v. Stergiou, 2013 Tex. App. LEXIS 11700 (Tex. App. Sept. 17, 2013). 8. See 18 C.F.R. 157.201–157.218. 9. See 18 C.F.R. § 385.203. 10. 18 C.F.R. § 284.123(e). 11. Id. 12. 18 C.F.R. 358.2.