Long-Term Natural Gas Contracts: Dead, Dying, or Merely Resting?

Article excerpt

I. INTRODUCTION

The last several years have been marked by considerable discourse within the natural gas industry about the decrease-over the course of the last two decades-in the length of natural gas contracts and the claimed adverse consequences associated with that decrease.1 While there has certainly been discussion on the subject, the literature appears to be sparse; most of the literature in fact antedates the movement toward shorter contract terms. Nor does there seem to have been any examination of why contract terms appear to have shortened, the advantages and disadvantages of shortened terms, and whether action can or should be taken to alter the status quo. It is also fair to say that the current conversation has only focused on portions of the issue and has failed to make a comprehensive review of the subject.

This article addresses: (1) the apparent trend over the last twenty years from relatively long-term contracts for natural gas supply and natural gas transportation to relatively short-term contracts and examines the apparent causes of that change; (2) whether the trend has proven to be desirable or undesirable; (3) whether missteps of public policy have caused or accelerated the trend; and (4) if so, what can or should be done to chart a proper course. It discusses both natural gas supply contracts and natural gas transportation contracts, and the different considerations involved with each. The discussion focuses principally on the impact of the trend on natural gas consumers.

The article also addresses the implications of the trend toward shorter contract terms for the two largest potential sources of new natural gas for the United States in this era of constrained supply-an Alaska natural gas transportation system and additional liquefied natural gas import terminals. Much of the current discussion concerning long-term contracts has focused upon whether today's trend toward short-term contracts will impede the construction of infrastructure to bring Alaska natural gas to market and to bring liquefied natural gas to North American markets.

The trend toward shorter contract terms appears to have a number of causes. They can be grouped as either market-related or regulatory-related, although the relative magnitude of each is impossible to discern. Plainly, the market changes of the last twenty years (which were, as will be discussed below, largely caused by federal regulatory initiatives) have had a major impact on contract terms. The creation of competitive markets in natural gas and somewhat competitive markets in transportation has inexorably led to shorter contract terms.

From the purchaser's perspective, there is today, in the simplest terms, increased confidence that natural gas supply and transportation capacity can be obtained in the relatively near term, thus undercutting the perceived need for, and benefits of, long-term contracts and the certainty they provide. From the broader economic perspective, the market forces that have been unleashed in the last two decades have caused significant changes in industry structure. In the formative years of the American natural gas industry, the assets of gas producers and of pipeline operators-each involving enormous levels of investment-were essentially committed to particular customers and particular geographic markets. These assets would diminish greatly in value if not linked in some fashion to particular customers and markets. For many years, long-term contracts provided the assurance of revenue streams that were necessary to finance this infrastructure.

With the growth of competitive gas markets, creating multiple purchasers and multiple sellers and a variety of natural gas products, sellers of natural gas and of transmission service have been confronted with vastly expanded geographic markets. This change has dramatically reduced the risk of being captive to particular customers. Similarly, from the customer perspective, a whole array of new sellers of gas and transmission has become available, diminishing the risk of a "recalcitrant" or monopoly seller. …