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Will landmark case on LNG quality and interchangeability chill imports?

The Federal Energy Regulatory Commission (FERC) issued a potentially precedent-setting decision last April with important implications for the U.S. natural gas industry and the future of LNG imports. In the AES Decision, called "AES Ocean Express vs. Florida Gas Transmission Co." the FERC refused to accept requests to compensate customers of an interstate natural gas pipeline--Florida Gas Transmission (FGT) and other downstream entities for any mitigation costs such entities may incur as a result of the receipt of LNG on the FGT system.

Compensation had been sought, not for natural gas that failed to meet interstate pipeline gas compositional standards, but for costs incurred in using LNG-derived natural gas that meets applicable standards for gas quality and interchangeability. While the FERC refused to compensate users of-on-spec LNG, it did allow FGT to adopt interchangeability standards that are more stringent than those interim standards adopted by the Natural Gas Clearinghouse's NGC+ White Paper and recommended by LNG importers.

FERC found imposition of the higher standards to be just and reasonable because gas meeting such standards would permit electric generation turbines on FGT's system to operate safely and in compliance with environmental standards without the need to modify the turbines.

Interchangeability Decision

The AES decision--the first decision by the FERC under its Interchangeability Policy Statement issued in June 2006--is intended to clarify the Commission's gas quality and interchangeability policy. Unfortunately, the only certainty seems to be the dissatisfaction on both ends of the pipeline. Upstream, LNG suppliers--such as BP Energy Co., Chevron U.S.A. Inc., ConocoPhillips Co., ExxonMobil Gas & Power Marketing Co., and Shell NC LNG, LLC--are seeking rehearing of the AES decision, claiming that the restrictive standards placed on regasified LNG "will prevent the importation of LNG from over two-thirds of the world's LNG plants into the Florida market?' They seek broader standards to encourage a wider range of LNG imports.

Downstream, electric generators, LDCs and other users claim the Commission erred in failing to approve a cost-recovery mechanism to allow them to recover expenses associated with remediation and repair that may be necessary to allow their equipment to utilize the gas delivered by FGT.

If the LNG suppliers claim that interchangeability standards more restrictive than the NGC+ White Paper will shut out supplies while the natural gas users assert that even FGT's strict standards are too relaxed to be fully compatible with existing natural gas infrastructure, there is unlikely to be any result fully satisfactory to all the stakeholders. The AES decision may raise more questions than it answers and may have the potential to create unnecessary costs, as suggested by the numerous requests for reheating that have been filed.

Notwithstanding the controversy, a primary lesson learned from the AES case is that answers provided by regulators are likely to be less satisfactory than compromises reached by stakeholders. Thus, stakeholders should consider now where their flexibility lies and what costs and risks they can best absorb if compromises are to be successful.

Background

The AES Ocean Express vs. Florida Gas Transmission Co. case arose in 2004 when AES Ocean Express (AES) proposed building a gas pipeline from an LNG-receiving terminal in the Bahamas into the Florida market, thus necessitating an intercoinnect with the FGT system. AES and FGT were unable to agree on the gas quality and interchangeability terms and conditions of the Interconnection Agreement. Consequently, AES filed a complaint with the Commission alleging that FGT had refused to allow the tie-in based on gas quality concerns and that FGT's "onerous" conditions were frustrating its plans to build an offshore pipeline to the southern Florida market.

FGT first complied with the Commission's directive to revise the gas quality and interchangeability provisions in its tariff, proposing new standards based on (i) the ability of turbine equipment used by Florida power generators to handle increases in regasified LNG; and (ii) the historical maximum and minimum Btu content in FGT's market area.

After various parties challenged FGT's proposed standards, the complaint was set for a hearing before an Administrative Law Judge (ALJ). Following completion of the hearing and the submission of several rounds of legal briefs, the ALJ issued an Initial Decision on April 11, 2006. The AES Decision is the Commission's review of the Initial Decision.

Prompted by the number of gas quality and interchangeability issues being raised on an ad hoe basis in complaint, certificate and tariff proceedings, in June 2006, the Commission issued its Policy Statement on Gas Quality and Interchangeability. The Policy Statement elaborates five principles by which FERC will address quality and interchangeability issues in the future:

First, only natural gas quality and interchangeability specifications contained in Commission-approved gas tariffs may be enforced.

Second, pipeline tariff provisions on gas quality and interchangeability need to be flexible to allow pipelines to balance safety and reliability concerns with the importance of maximizing supply as well as recognizing the evolving nature of the science of underlying gas quality and interchangeability specifications.

Third, pipelines and their customers should work together to develop gas quality and interchangeability specifications based on technical, engineering and scientific considerations.

Fourth, pipelines and their customers are strongly encouraged to use the Natural Gas Council Plus (NGC+) Interim Guidelines on file with the Commission.

Fifth, to the extent pipelines and their customers cannot resolve disputes over gas quality and interchangeability, those disputes can be brought before the Commission on a case-by-case basis to be resolved based on a record of fact and technical review. (Authors' note: The NGC+ proposes two alternate methods for controlling gas quality--the "CHDP Method," which establishes hydrocarbon dew point limits, and the "C6+ GPM Method", which regulates the number of hexanes and heavier hydrocarbons per unit. Its Guidelines for gas interchangeability also involve a maximum Wobbe Index Level of 1,400, a maximum heating value of 1,100 Btu/scf, maximum butane or heavier hydrocarbons of 1.5 molecular percent and maximum total inert gases of 4 molecular percent. The onus will be on parties seeking to vary from these guidelines to articulate reasons based on their particular operational circumstances in the context of the broader market.)

LNG Supply

At the forefront of the debate over the ramifications of the AES Decision is concern that the more restrictive standards will make it harder for the U.S. to compete for Atlantic Basin imports. The LNG Suppliers argued that approval of a maximum Wobbe Index of 1,396 will interfere with importing LNG. (The Wobbe Index is a widely accepted measure of interchangeability which is based on energy input and specific gravity.)

The LNG Suppliers encouraged wholesale adoption of the standards in the NGC+ White Paper, including a maximum Wobbe limit of 1,400. On the other hand, the Florida Generators maintained that FGT should have proposed an even greater departure from NGC+ White Paper. They pressed for narrower standards consistent with FGT's historic gas stream over the last five years with a Wobbe range of 1,346 to 1,371, with an average of 1,356. The Florida Generators worried that broader standards would cause their turbines to malfunction and that the dry low NOx combustion system in many of their turbines required a narrower Wobbe range.

Ultimately, the Commission upheld the ALJ's analysis in the Initial Decision, which focused on the potential impact of introducing regasified LNG into the FGT system on gas turbines owned by the Florida Generators. FERC found that the ALJ had accurately interpreted the manufacturers' warranty specs for the turbines, which would require that, for a maximum Wobbe index variation beyond plus or minus 2%, active tuning and/or nozzle changes would be required.

Simple economics tells us that a surcharge on LNG may render it a significantly less attractive fuel source in the U.S., depending on its price elasticity. However, the LNG suppliers failed to establish that using an upper Wobbe Index of 1,400 instead of 1,396 would boost LNG supplies in the U.S. Thus, from the Commission's perspective "adopting an upper Wobbe Index limit of 1,400 would result in greater risks with no offsetting benefits."

Given that all liquefaction plants except those in Trinidad and Egypt and those planned in Qatar and Norway ship gas with a Wobbe number over 1,400, according to Lukens Energy data, an upper Wobbe Index limit of 1,400 may not have significantly increased the odds of U.S. markets receiving more of the world's supplies of LNG.

The Costs

The AES Decision also has raised concerns from downstream entities, mostly LDCs and power generators, that the Commission's failure to adopt more stringent interchangeability standards will result in higher costs for transportation and distribution of regasified LNG and maintenance of the relevant facilities.

(Authors' note: There are potential costs associated with the introduction of regasified LNG into U.S. markets. These include upstream costs related to processing, i.e., stripping the regasified LNG of natural gas liquids, and/or blending the regasified LNG with "cooler" domestic gas or by subjecting it to nitrogen injection to meet the tariff enumerated gas quality and interchangeability standards before its introduction into the market; and midstream and downstream incremental capital operational and maintenance costs resulting from the transportation and distribution of regasified LNG.)

Given that the Commission "will not accept requests from interstate natural gas pipelines to compensate customers or other downstream entities for any costs they may incur in using gas supplies that include revaporized LNG that meets approved standards for gas quality and interchangeability," downstream entities will have to find an alternative cost-recovery plan. But before they embark on their new mitigation cost recovery journey, they would be well served identifying and quantifying the costs which are attributable to the actual importation of LNG. Given the speculative nature of these costs until such time when significant supplies of regasified LNG are introduced into U.S. markets, it might be a while before the industry reaches resolution of this matter.

Most of the parties to the AES case, other than LNG Suppliers, asked the Commission to establish a method for downstream gas users to recover the costs of testing, remediation, and making repairs necessary to accommodate the new standards. With respect to downstream users, the Commission found that costs were "prospective" and "highly speculative with regard to their need, amount, or cause" and held there should be no recovery mechanism established to enable downstream users to recover costs due to the introduction of LNG.

Significantly, the failure by LDCs to provide set procedures or a timeline that other parties to the proceeding or the Commission could evaluate was detrimental to their position. The Commission interpreted the LDCs' failure to provide such information as "a proposal for indefinite delay."

In addition to the holding that mitigation costs were too speculative to be compensable, the Commission held that it lacked the jurisdiction to mitigate the costs of downstream users. "The Commission's only rate jurisdiction in this situation is over the rates [FGT] charges its shippers for transporting their gas."

In order for the Commission to have jurisdiction to establish a mechanism for the recovery of customers' costs of testing and modifying their own equipment, the Commission would have to find some basis to find that whatever mechanism it were to approve is necessary to ensure that the jurisdictional pipeline would recover "its costs of providing jurisdictional transportation service from its customers in a just and reasonable manner." Downstream entities failed to show a nexus between their mitigation costs and FGT's cost of providing jurisdictional transportation service. Therefore, the Commission indicated that no recovery mechanisms should be established now or ever in FGT's tariff with respect to such costs.

The Impact

While the AES Decision may have longterm implications for the U.S. natural gas industry and the future of LNG in this country, we do not expect a drastic or even noticeable change to the overall health of the industry in the immediate future. We expect continued bifurcation of supplies, with imports to the U.S. coming from countries with "leaner" composition LNG; and imports to the European and Asia-Pacific markets with far broader standards coming from countries with "richer" composition LNG. There are long-term LNG supply agreements and other related contractual commitments in place in the U.S. that pre-date the current focus on gas interchangeability issues.

In certain instances, these agreements may not line up perfectly with the Commission's gas interchangeability policies as applied in the AES Decision. These issues will need to be addressed on a case by case basis, As a general matter, we expect that gas composition and interchangeability issues will be addressed on a regional or pipeline-by-pipeline basis. The blending of LNG imports with domestic gas supplies in the interstate natural gas pipeline grid should serve to resolve some of the concerns associated with LNG imports.

Authors: Erik Swenson is a partner on King & Spalding's Global Projects and Transactions Team. His practice centers on the nationwide representation of energy project participants, including developers, equity investors and lenders.

Lisa Tonery is a partner in King & Spalding's Global Projects Practice Group. Her work focuses on gas, electric, oil and transactional matters on behalf of natural gas and LNG companies, natural gas marketers and end-users, oil pipelines and shippers, as well as independent power producers and power marketers.

Tania S. Perez is an associate in the Global Transactions Group in the New York office of King & Spalding. Her practice focuses on federal and state regulatory law and transactions involving the energy industry.
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Author:Swenson, Erik J.A.; Tonery, Lisa M.; Perez, Tania S.
Publication:Pipeline & Gas Journal
Date:Sep 1, 2007
Words:2245
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