June 2016, Vol. 243, No. 6
Features
Securing Pipeline Capacity in Today’s Turbulent Gas Markets
The combination of hydraulic fracking and horizontal drilling technology has revolutionized domestic gas markets. Pipelines have been scrambling to expand, reconfigure and modify their systems in response. Prospective shippers, faced with these changes, benefit from an often unprecedented multitude of expansion options.
The Federal Energy Regulatory Commission (FERC) has detailed rules governing what commercial terms pipelines can and cannot offer. An understanding of these rules, and how they typically come into play, helps shippers evaluate the risks and benefits of competing projects and develop strategies for bidding on capacity and negotiating on an equal footing with pipelines.
Before filing for construction authorization from FERC, pipelines must conduct an expansion open season to provide public notice of the proposed project and describe the terms under which they will agree to build.
Pipelines may initially solicit market interest via a “non-binding” open season followed by a “binding” open-season, or hold supplemental open seasons, depending on market demand. The time allowed to place a bid can be quite short if the pipeline has already negotiated precedent agreements (PAs) with anchor shippers.
Where there are anchor shippers, the notice will describe the amount of capacity committed, the rate and the term agreed to by such shippers. It will specify the minimum capacity, rate and term for any new qualifying bids and how the pipeline will evaluate such bids and allocate capacity if the bids exceed availability.
In evaluating bids, pipelines may need to take into account not just price but also operational factors such as constraints based on the volumes and receipt/delivery point combinations requested.
Precedent Agreements
After a successful bid, the next task is negotiating a PA that sets forth the terms under which the pipeline will build the project, and the terms under which the shipper will purchase the capacity. The following are selected issues typically encountered.
Shippers want a degree of certainty about when expansion capacity will be placed in service and what happens if the project is delayed. To manage the economic risk of delay, shippers may seek provisions that allow them to terminate if the project falls behind schedule or is not in-service by a specified date. PAs sometimes provide for interim service in the event the project is only partially completed on the proposed in-service date. Shippers may also choose to take service at a negotiated rate which, for example, may be a fixed formula or levelized rate. Alternatively, the shipper may always elect service at the pipeline’s recourse (cost-of-service) rate.
Recourse rates commonly, though not always, decline over time, as the pipeline’s rate base becomes more fully depreciated. Therefore, a shipper considering a fixed negotiated rate for a long-term contract that provides a small discount from the expected initial recourse rate may end up paying more than recourse rate shippers in later years.
The shipper should consider requesting that the negotiated rate apply not only to the shipper’s primary receipt and delivery points, but also to any secondary “in-path” receipt and delivery points. PAs will allow termination if assumed future events such as issuance of a FERC certificate by a specified date, do not occur.
Typical pipeline conditions precedent include:
- The shipper’s board of directors approves the PA by a specified date.
- The pipeline securing a threshold level of commitments through executed PAs. (This enables the pipeline to walk away if it fails to obtain sufficient commitments to make the project economic or financeable.)
- The shipper’s maintenance of creditworthiness/credit support. (This allows the pipeline to terminate the PA if the shipper fails to maintain creditworthiness or adequate credit support, a concern of increasing prominence today with low and declining gas prices.)
- The pipeline obtaining, by a specified date, a satisfactory FERC certificate.
- The pipeline obtaining necessary rights-of-way easements by a specified date. (If presented with such a proposed condition precedent, shippers may wish to object since FERC certificates accord pipelines the right of eminent domain.)
- The pipeline receiving board of directors authorization, by a specified date, to construct the project. (Depending on market conditions, shippers may wish to resist such a condition precedent, as it effectively allows the pipeline to pull the plug on the project for no reason.)
Typical shipper conditions precedent include:
- For local distribution companies, receipt of state commission authorization for pass-through of costs and other required authorizations.
- Issuance of the FERC certificate by a date certain. (This gives the shipper the ability to terminate if the certificate process proves significantly more protracted than anticipated. Expansion shippers have gas supply/demand risks to manage and need the ability to sign onto another project or procure other capacity, supply or delivery rights.)
- The FERC certificate contains no conditions that have a material adverse effect on shipper.
- Completion of associated upstream/downstream transportation facilities required to effectuate the service contemplated.
Pipelines are prohibited from engaging in undue discrimination, but not due discrimination. This means that pipelines can offer terms and conditions to anchor shippers that are not offered to later expansion shippers, as long as all shippers have an opportunity to qualify as an anchor shipper. FERC permits this because anchor shippers provide the market support needed to ensure the expansion actually gets built.
On this basis, FERC has allowed an array of anchor shipper benefits, including special rates, annual contract rollover rights, one-time, unilateral rights to extend the agreement’s term, ability to shift primary receipt/delivery points, ability to increase/decrease contract demand, and caps on fuel and lost-and-unaccounted-for (LUAF) gas charges.
New or expanded receipt or delivery points or interconnections, including the installation of associated taps, metering, regulation stations and compression, should be specifically addressed in the PA in a way that leaves no ambiguity about which party bears the costs.
If the PA requires the shipper to support pipeline efforts to obtain a FERC certificate, the shipper may want to condition this obligation on the pipeline’s actions being consistent with the PA and seek reciprocal language from the pipeline regarding shipper’s efforts to obtain approvals for any shipper-constructed facilities.
PAs typically require the shipper to execute a contract within a specified number of days after execution of the PA or another triggering event. PAs typically require the pipeline to proceed with due diligence to obtain authorizations needed for the project and complete construction in a timely manner so that it can achieve the targeted in-service date. This protects the shipper from the pipeline suspending work while it pursues other market opportunities.
Pipelines frequently propose language reserving a right not to proceed if in its best interest. Where market conditions permit, a shipper may seek language providing it liquidated damages in the event of an in-service delay of a specified length not caused by an event of force majeure.
The shipper may want to specify cost responsibility for interconnections/taps and construction responsibility, along with who will own metering/regulation facilities. Where new or expanded interconnections are needed, it may be desirable to include language requiring the pipeline to enter into any necessary interconnection agreements by a specified date.
Pipelines commonly require language providing that, if at any time a shipper, or its guarantor, ceases to be creditworthy, the pipeline can require financial security in the form of cash prepayment, an irrevocable standby letter of credit or a guarantee from a creditworthy party. Although FERC policy prohibits pipelines from requiring more than three months of financial security when selling existing capacity, pipelines constructing new capacity can require the posting of multiple years of financial security by shippers who do not meet creditworthiness requirements.
Pipelines may require a shipper to bear its proportionate share of incurred project costs if the PA is terminated due to shipper actions/inactions, as specified in the PA. In response, the shipper may wish to limit its exposure by requiring the pipeline to mitigate any early termination damages in a commercially reasonable manner and specifying that its pre-service cost exposure is limited to a proportionate share of the overall project as of the termination date.
PAs are largely treated by FERC as non-jurisdictional, commercial agreements that the parties are free to negotiate as they see fit. There are no pro forma PAs in a pipeline’s tariff and no generic set of required or prohibited terms. Yet where asked to interpret ambiguous contract language, FERC may rely on PA language to interpret the parties’ intent. Where a PA sets forth creditworthiness requirements that vary from those in the pipeline’s tariff, those PA provisions typically remain in effect even after the balance of the PA is terminated and service commences.
Although PAs must be filed with FERC, pipelines usually file them under seal and request privileged treatment as “commercially sensitive information.” When challenged, FERC may deny requests for privileged treatment of PAs and require public disclosure. Alternatively, FERC may require the pipeline to produce the PAs, subject to the terms of a protective order. FERC certificates typically are conditioned on the pipeline executing firm contracts for capacity under the PAs.
Expansion Contracts
FERC generally prohibits pipelines from individually negotiating terms and conditions of service because of the risk of undue discrimination. Expansion contracts that contain material deviations from the pipeline’s tariff are “non-conforming” agreements subject to FERC review.
Non-conforming provisions FERC has allowed on a case-by-case basis include:
- Most Favored Nations (MFN) clauses, which theoretically ensure no one will get a better deal than the shipper. The value of MFN clauses has proven to be fairly limited because pipelines often design subsequent expansions to avoid triggering such rights.
- An option to extend the primary term at a negotiated rate.
- The right to have a negotiated rate apply to segmented quantities.
- The right to future delivery/receipt point amendments.
- Requirements that shippers maintain a minimum credit rating.
- A pipeline right to amend initial negotiated rates if final construction costs exceed a defined limit.
- A requirement that the shipper pay for service on a fixed date, even if it is not yet taking service.
Non-conforming provisions found to create a risk of undue discrimination are prohibited unless the pipeline modifies its tariff to offer the same terms to all, or demonstrates why it is not unduly discriminatory to offer this provision to a single shipper. Disallowed provisions include giving a “first priority right” in future contract reduction situations or an early contract termination right, giving a preferential right to acquire future expansion capacity, and allowing variable contract demands.
Pipelines must file contracts containing non-conforming provisions 30 days before service is expected to begin. As PAs are generally confidential, it is only when contracts are filed that shippers can determine whether the pipeline has offered the same non-conforming provisions to all similarly situated expansion shippers. If a shipper feels it has been inequitably treated, it can raise an undue discrimination claim with FERC.
Conclusion
With the surge of pipeline expansions in the wake of the fracking revolution, companies looking to secure new capacity may be faced with a variety of options. Understanding FERC’s rules and how they affect negotiations will allow them to maximize the value and utility of the capacity they select.
Authors: Glenn S. Benson is a partner in Davis Wright Tremaine’s Washington, D.C. office, with over two decades of experience representing companies across the energy industry, including gas producers, local distribution companies, pipelines, and gas marketers, in litigation before the courts, FERC and other federal and state agencies.
Barbara S. Jost is a partner in Davis Wright Tremaine’s Washington, D.C. office, with over 30 years of experience representing gas industry participants before FERC and the courts in both gas pipeline and certificate proceedings.
Comments