Shipper Agreements – Realizing Hidden Risks

Natural Gas Rates

Delayed permitting commitments and financial credit requirements can pose real, and oftentimes misunderstood, threats to the viability of interstate natural gas pipeline projects. The financial well being of shippers, particularly those categorized as supply push, or E&P companies, may change dramatically in the years that follow the signing of a precedent agreement. In fact, depending on the shipper’s creditworthiness and governmental approval timeframes, shippers may not be obligated to transport gas on the pipeline at all. Some agreements also provide that shippers may abandon their commitments if regulatory approvals are not granted in a timely fashion as defined by circumstances detailed in the agreements. While the creditworthiness criteria is a more acute risk for supply push, rather than demand pull shippers, including the pipeline developers, governmental approvals and in-service date conditions apply to all. So which shippers and pipelines have the greatest exposure? And what commitments in the underlying contracts create this risk?

Signing up creditworthy shippers, and those that will remain creditworthy, is vital to mitigating a major risk to project viability. A key condition in precedent agreements requires the committed shipper to — at all times — satisfy creditworthiness standards. Well, how’s “creditworthiness” defined? Generally, the following language, excerpted  from the agreement for Energy Transfer Partner’s Rover Pipeline, is the norm for shippers: “its long-term unsecured debt securities . . . are rated at least BBB- by Standard & Poor’s Ratings Services or its successor and at least Baa3 by Moody’s Investor Services, Inc….” But, in other, more lenient, agreements, such as one used by Florida Gas Transmission, LLC, the agreement provides that when the shipper can’t satisfy the above standards, it may instead “provide an irrevocable letter of credit to cover the primary term of the service.”

Supply push shippers have not only been a source of risk for interstate pipeline developers, but may, themselves, be subject to risk associated with governmental approval delays. Natural gas E&P companies have been faced with a difficult market recently that has resulted in bankruptcy for some, such as Magnum Hunter, which led to an affiliated company, Triad Hunter, breaking a significant shipper agreement on a Boardwalk project. The ability to get gas to market and realize earnings is critical to the success of these shippers. Faced with in-service delays, these companies must also contend with mounting exploration costs and stalled production. Natural gas pipeline developers fear the failure of supply push shippers, but as we’ve discussed in other Insights, they may be contributing to their demise by establishing unrealistic permitting milestones.

Given the risks associated with supply push shippers, demand pull companies, or power generators, industrial facilities, and utilities, have recently come to represent a larger percentage of the shippers entering into precedent agreements. This can, in part, be attributed to the move away from coal-powered generation to natural gas-fired generation, a far cheaper and cleaner fuel source in a market facing increased monetary and regulatory constraints. Various natural gas projects, both major greenfield and minor laterals, across various regions are now aiming to serve these demand pull shippers.

In the South, the Sabal Trail, Florida Southeast Connection, and Dalton projects, all of which recently obtained FERC Orders to begin construction exemplify this trend. These projects are being built with the contract support of large, stable utilities, such as Florida Power and Light. In the Northeast and Mid Continent, new generation facilities are making specific deals with pipeline developers for new laterals or adding incremental capacity on existing mainlines. For example, Mattawoman Energy Center, Lackawanna Plant, Keys Energy Project, Panda Stonewall, and Hummel Station all have deals with big pipeline developers. But where does the risk come in for demand pull shippers?

The shift to a demand pull market has created additional local reliance on interstate infrastructure. This means that companies aiming to serve consumers are now dependent more than ever on expeditious federal and state permitting, as well as the timely review by other state and local jurisdictions. Each of these can create an element of both binary and temporal risk, as evidenced by New York’s refusal to grant a Section 401 Water Quality Certification to the Constitution Pipeline and, more recently, Georgia’s delay in granting the Section 401 certification to the Sabal Trail project. This is to say, demand pull shippers are faced with increased complexity as they try to keep the lights on. Relatedly, natural gas-fired power generators depending on this gas, such as various power generators in upstate New York, including Empire Generating Company, LLC, are also feeling the pressure.

It is important to consider the pressures faced by both parties entering into a precedent agreement. And LawIQ’s project-specific Profile pages, Alerts, and Reporting Analysis provide you with the relevant precedent agreement details you need to properly address the risk in any given regional market.

Regional Shipper Distribution