New Credit Standards for Gas Pipeline Customers
By David Schumacher
Interstate natural gas pipelines will be required to adopt standardized procedures for determining the creditworthiness of their shippers, or customers, under new proposed rules that the Federal Energy Regulatory Commission published in late February. Comments were due at the beginning of April.
The new procedures are important because they set uniform limits on when pipelines can refuse to do business with companies that want to ship gas on grounds of poor credit.
FERC took action after a number of pipelines tried to toughen the credit standards in their filed tariffs. The pipelines sought these modifications in response to the deteriorating credit conditions in the energy industry.
Each interstate pipeline includes in its tariff a description of the information that potential and existing shippers must provide to the pipeline to demonstrate the shipper’s creditworthiness. The tariff also describes the type and amount of collateral that a potential or existing shipper that is not creditworthy can deliver to obtain or maintain service on the pipeline. The credit standards in these filed tariffs currently vary from pipeline to pipeline.
The new proposed rules would require the pipelines to adopt uniform credit standards. The rules address the following issues: the information that a potential or existing shipper can be required to provide to a pipeline to establish the shipper’s creditworthiness, the objective and transparent criteria that a pipeline must apply when judging a shipper’s creditworthiness, the collateral that a non-creditworthy shipper can be required to deliver to a pipeline to obtain or maintain service, remedies available to a pipeline if a customer defaults on its payment obligations or fails to deliver required collateral, and the credit standards that apply to capacity release transactions.
The proposed rules would allow a pipeline to request from each potential and existing customer certain information to enable the pipeline to judge the customer’s creditworthiness.
This information includes audited financial statements, annual reports, a list of the customer’s affiliates, parent companies and subsidiaries, publicly-available information from credit reports and rating agencies, bank and trade references, statements filed with the US Securities and Exchange Commission, interim financial statements, and such other information as mutually agreed by the pipeline and the customer. A pipeline does not have to ask for all of this information. The rules set a limit on the information it can demand.
FERC also would adopt certain creditworthiness standards developed by the North American Energy Standards Board, the standards organization for the energy industry. These standards establish additional procedural requirements that the pipelines must follow when communicating with potential and existing shippers regarding creditworthiness.
The proposed rules would require each pipeline to include in its tariff objective criteria that the pipeline would use in evaluating each potential and existing shipper’s creditworthiness. FERC did not propose a uniform set of criteria applicable to all pipelines, instead opting for a case-by-case review of potential criteria that each pipeline proposes. However, FERC asked interested parties to comment on whether FERC should adopt uniform creditworthiness criteria.
If a pipeline determines that a potential or existing shipper is not creditworthy, then the shipper could nevertheless obtain or maintain service by delivering collateral to the pipeline. The proposed rules describe the collateral that a pipeline can request from its non-creditworthy shippers.
A non-creditworthy customer can receive service on an existing pipeline by posting collateral in an amount equal to three months’ worth of the maximum fixed reservation, or demand, charges that the pipeline can charge the customer. According to FERC, three months of reservation charges is a pipeline’s maximum potential credit exposure before the pipeline can terminate service to a defaulting customer. In FERC’s view, the pipeline assumes the risk of remarketing the capacity available after a firm transportation contract is terminated. Customers would still be able to provide parent or third-party guarantees as credit support.
FERC requested comment on alternative approaches. For example, FERC asked for comment on whether pipelines should be permitted to allocate capacity based on a customer’s creditworthiness. If this were adopted in a final rule, then a pipeline could award capacity to a customer with a better credit profile than another customer requesting the same service or to a customer willing to post more collateral than another customer.
If the potential customer is seeking service using new facilities, then FERC would allow the pipeline and the potential customer to negotiate the amount of the required collateral. For service using new mainline facilities, the pipeline’s collateral requirement must reflect the reasonable risk of the mainline construction project, particularly the risk to the pipeline of remarketing the new capacity should the initial customer default. However, the amount of the collateral could not exceed the customer’s proportionate share of the project’s cost. The collateral requirement would have to be agreed upon prior to the initiation of construction. The collateral requirement imposed on the initial customer would continue to apply even after the new project goes into service.
If the new facility is a lateral pipeline that is constructed to serve one or more customers, then the pipeline can require users of the lateral to post collateral in the aggregate equal to the full cost of the lateral.
FERC also requested comment on the collateral that pipelines could request to cover the risk of “loaned gas,” or gas that shippers borrow from a pipeline through imbalance mechanisms or park-and-loan services. Collateral for loaned gas would be in addition to the collateral that a pipeline could request for transportation service.
Cutting Off Service
The proposed rules also address suspension and termination of service to shippers that fail to pay or fail to provide adequate collateral when found not to be creditworthy.
If an existing shipper fails to deliver required collateral, then the pipeline can suspend service after giving the shipper five business days to provide an advance payment for one month’s service and 30 days to satisfy the collateral requirements. If an existing customer breaches its payment obligation and the pipeline’s tariff allows the shipper to continue service by delivering the required collateral, then the same timeline applies before the pipeline can suspend service.
A pipeline that suspends service cannot continue to bill the suspended shipper for transportation charges. In lieu of suspension, the pipeline could sue the shipper for consequential, unmitigated damages caused by the shipper’s breach.
Before a pipeline can terminate service to a shipper that either fails to pay or fails to provide the required collateral, the pipeline would have to provide the shipper and FERC with 30 days’ prior written notice. The proposed rules are not clear whether a shipper can cure a payment default or a failure to provide collateral during the 30-day notice period prior to termination or whether a pipeline can threaten to suspend and terminate service in the same notice. (For example, can the pipeline threaten to suspend service if a prepayment is not delivered within five business days and to terminate service if the payment or collateral default is not cured within 30 days?)
Capacity release is the mechanism for a firm transportation customer to assign, or “release,” its firm transportation capacity to a third party. Upon a capacity release, the new customer, or “replacement shipper,” enters into a new contract with the pipeline for the released capacity. The existing customer, or “releasing shipper,” remains liable for the reservation charges payable with respect to the released capacity, essentially acting as a guarantor of the replacement shipper’s obligation to pay reservation charges for the released capacity.
The proposed rules also address issues that arise from the contractual structure associated with a capacity release.
Creditworthiness of replacement shippers would be determined using the same standards that a pipeline applies to all other shippers. Releasing shippers would not be able to impose, as a condition to completing a capacity release, credit standards that are different from those in the relevant pipeline’s tariff.
The collateral required from a replacement shipper bidding for released capacity would have to be delivered to the pipeline before the released capacity is awarded through the capacity release bidding process, if the releasing shipper insists that potential replacement shippers must meet the pipeline’s credit requirements prior to an award of released capacity.
Following an award of capacity and the posting of collateral, if the replacement shipper defaults, then the pipeline would be required to credit to the releasing shipper any collateral that the replacement shipper delivered to the pipeline and that is not used to defray the replacement shipper’s obligation to the pipeline.
Because a releasing shipper remains liable to the pipeline under its contract even after a capacity release, the proposed rules address the rights of a replacement shipper if its releasing shipper is in default to the pipeline and the pipeline terminates its contract with the releasing shipper. In this circumstance, the terminating pipeline must allow the replacement shipper to continue receiving service using the released capacity if the replacement shipper agrees to pay, for the remaining term of the release, the lesser of three amounts. The amounts are 1) the releasing shipper’s contract rate, 2) the maximum tariff rate applicable to the releasing shipper’s capacity, or 3) some other rate that is acceptable to the pipeline. If the replacement shipper refuses to pay the lesser-of rate, the pipeline also may terminate the replacement shipper’s contract. Alternatively, the pipeline can continue to honor the replacement shipper’s original agreement following termination of the releasing shipper’s contract at the rate agreed in connection with the initial capacity release.
Under FERC’s current policy, if a releasing shipper executes a “permanent release” — that is, the releasing shipper releases its capacity at its contract rate for the remaining term of its agreement — then the pipeline cannot unreasonably refuse to relieve the releasing shipper of liability under its contract. In other words, if the pipeline is not in a worse credit position as a result of the permanent release, then the pipeline cannot require the releasing shipper to remain the guarantor of the replacement shipper’s reservation charge obligations. The proposed rules do not change this policy.