Thinking strategically on pipe build-out for the shale boom

Energy Alert


Recent developments in horizontal drilling techniques have propelled natural gas production from shale formations to the forefront of domestic oil and gas production today. This rapid expansion is presenting opportunities and challenges for producers and pipeline developers seeking to capitalize on the need to move this gas to market. These challenges include the ability of the current federal and state regulatory structures to keep pace with increased production and the resulting need for additional infrastructure development.

The Marcellus Shale covers 63 million acres over six states with 500,000 potential well sites. Already, an estimated $100 billion in projects has been committed to the gas field, and some reports indicate that in Pennsylvania alone shale exploration will require 10,000 to 25,000 miles of new natural gas pipelines.

To ensure their product reaches market on a timely basis, producers will wrestle with whether to become a shipper on an existing or to-be-developed pipeline or, alternatively, take a more proactive and direct stake by becoming an equity participant in a new infrastructure project to ship its gas.

A significant share of the current pipeline infrastructure used to transport Marcellus gas to market qualifies as “gathering lines,” which are pipelines that typically transport gas from interconnected well lines in producing regions to larger diameter pipelines downstream. FERC jurisdiction over interstate pipelines under the Natural Gas Act (NGA) does not extend to facilities used for the production or gathering and distribution of natural gas. As a result, gathering facilities in the shale regions are not subject to FERC jurisdiction.

FERC has developed the “primary function test” to determine whether specific facilities are gathering or transmission in nature. As articulated in 2010 in Laser Marcellus Gathering Co., FERC considers geographical and physical factors, including: (1) the length and diameter of the pipelines; (2) the extension of facilities beyond the central point in the field; (3) the facilities’ geographic configuration; (4) the location of compressors and processing plants; (5) the location of wells along or part of the facilities; and (6) the operating pressures of the pipelines.

In addition to these factors, “the commission also considers the purpose, location, and operation of the facilities; the general business activities of the owner of the facility; and whether the jurisdictional determination is consistent with the NGA.” The commission does not consider any one factor to be dispositive and recognizes that not all factors apply in all cases. The commission also weighs non-physical criteria.

If a gathering line owner’s facilities are FERC jurisdictional, FERC will grant the project a certificate that confers eminent domain authority to acquire the land necessary to construct those facilities. If a facility is classified as a non-FERC jurisdictional gathering facility, state public utility commissions may nevertheless elect to regulate the construction and operation of gathering facilities.

The Pennsylvania PUC (PPUC), which regulates all public utilities doing business in Pennsylvania, recently confronted a case of first impression regarding whether a gathering company, Laser Northeast Gathering Company LLC, is a public utility. The PPUC granted Laser’s application to become a public utility because it proposed to transport or convey “natural or artificial gas, crude oil, gasoline, or petroleum products…by pipeline or conduit, for the public for compensation.” The critical question was whether midstream services were “for the public.”

The PPUC relied on Laser’s testimony that it planned to offer nondiscriminatory service to “any and all potential customers needing to move gas through the pipeline system…include[ing] large capital, largely capitalized producers, small capitalized producers, individual landowners owning wells, marketers, or LDC companies, landowner groups who aggregate together.”

Having determined that Laser met the public utility definition, the PPUC remanded the case to the ALJ for the limited purpose of “determining whether the granting of a certificate of public convenience is ‘necessary or proper for the service, accommodation, convenience, or safety of the public’ under Section 1103(a) of the code.” Laser subsequently withdrew its application prior to the ALJ’s decision because it decided to change aspects of its service that it believed would disqualify it from being a public utility.

Pennsylvania grants eminent domain authority to public utilities operating in the commonwealth, including public utility corporations transporting artificial or natural gas under Title 15 of the Pennsylvania code. Pipeline developers that do not pursue public utility status will lack eminent domain power. As a result, private landowners will possess considerable negotiating leverage in discussions with those developers, knowing that the developers cannot commence condemnation proceedings should they refuse to sell their land at the developer’s offered price.

Under Laser Northeast, whether a midstream gathering pipeline will be regulated by the PPUC is based on the design of its facility and how it selects its customers. Therefore, a pipeline developer whose goal is to avoid regulation by the PPUC could limit its customers to only a defined and privileged group, perhaps by negotiating exclusive contractual agreements with only a select set of customers. Additionally, regulation could be avoided by stating that the pipeline will not expand capacity in the future to meet additional not-yet-identified customer needs, perhaps without prior PPUC approval.

An analysis of FERC’s primary function test and the PPUC’s decision in Laser Northeast demonstrates that developers can often design their facilities to ensure that the facilities will be either unregulated or regulated at the state or federal level. Therefore, it is critical that developers understand the benefits and drawbacks of the various regulatory structures. Additionally, investors considering the purchase of existing gathering line systems need to be aware of the regulatory implications of an asset purchase, because it could, when combined with existing assets or if expanded, alter the jurisdictional status of the facilities.

An earlier version of this Alert appeared in The Energy Daily on September 24, 2012.