Non-Price Provisions in Long-Term Natural Gas Contracts

Abstract

Current distortions natural gas markets have raised questions about the general efficiency of the contracting process the natural gas industry as it proceeds through phased-in wellhead deregulation under the Natural Gas Policy Act of 1978 (NGPA).1 Attention has increasingly focused on provisions wellhead contracts that tend to limit price adjustments an environment of market uncertainty, and on differences minimum purchase requirements across field contracts which have led pipelines to shut in suppliers with low-priced contracts because of higher take obligations for high-priced gas. Some observers have suggested that strong oversight and supervision of wellhead contracts, or even government-instituted changes the structure of such contracts, are necessary. In this article we argue that the principal nonprice provisions wellhead contracts provide vital functions allocating risks and reducing the costs of transactions between producers and pipelines such a way that some degree of rigidity gas markets is inevitable with or without price controls. However, we also argue that the incidence of these provisions existing contracts signed during the 1970s, and thus the magnitude of current market rigidities, are the direct result of pent-up excess gas demand stemming from the earlier era of field price regulation.2 This hypothesis has significant implications for the design of public policy by highlighting the importance of distinguishing that portion of current contractual rigidities which is endemic to field markets from rigidities rooted the legacy of field price regulation. The latter rigidities are diminishing over time as the upstream sector of the gas industry is increasingly deregulated and thus adjusts away from chronic excess demand toward market-clearing conditions.3 Thus, an important conclusion of our analysis is that while there may be a role for government promoting adjustments of existing field market contracts, wholesale regulatory intervention future contractual practices is unlikely to yield much benefit. However, a strong case can be made for regulatory reform aimed at promoting flexibility a d efficiency of market performance. The balance of the article is divided into five part . The next section analyzes the sources of transactions costs and risks inherent the