By Daniel R. Rogers

The US government moved at the end of 2002 to help prospective importers of liquefied natural gas, or “LNG,” by adopting a new regulatory policy that expressly authorizes development of closed-access, “proprietary” natural gas and LNG import terminals and allows the owners of such terminals to charge for services at market rates rather than rates that are tied to the cost of service.

The government took two actions.

First, the “Maritime Transportation Security Act of 2002” enacted by Congress in November provides a new statutory framework for federal regulation of offshore natural gas and LNG terminal facilities.  Second, the Federal Energy Regulatory Commission made a favorable preliminary decision in December to certify a proposed onshore LNG facility that Dynegy wants to build at Hackberry, Louisiana.

Both events reflect a US government response to the natural gas industry’s pleas to reduce or remove regulatory barriers to new gas and LNG import facility investment by establishing a more flexible regulatory policy.  Before these latest actions, developers interested in building LNG terminals were uncertain about some of the rules that would apply to them.  Some of the uncertainties stemmed from the need to comply with FERC’s open season/open access and cost-of-service tariff rate regulations in connection with shore-based terminals.  There was also no gas-specific regulatory framework under which offshore natural gas and LNG terminals could be developed.

Offshore Gas

The “Deepwater Ports Act of 1974” and its implementing regulations have been in existence for some time and govern the development and operation of offshore oil receiving and storage terminals.  However, it was not until November 2002 with the passage of the new Maritime Transportation Security Act, that a statutory framework existed for the development of offshore terminals to receive imported natural gas and LNG.

The new maritime statute amends the earlier Deepwater Ports Act to expand its reach to the siting, construction and operation of offshore natural gas and LNG import terminals (including any storage, sendout pipelines or other associated equipment) that are located seaward of the coastal high water mark.  It also provides that licensees of offshore gas terminals are not required to offer service to the public on an open-access or common-carrier basis.  In the event that third-party access is in fact provided, then the rates to be charged for such access may be privately negotiated, market-based rates as long as it can be shown that such rates are “reason-able” and such third-party use will not materially interfere with the licensee’s intended use of the terminal facility.

In developing this approach, proponents compared offshore gas and LNG reception facilities to existing offshore natural gas production and gathering facilities — which are not currently regulated by FERC — and argued that an offshore natural gas or LNG reception facility is simply another mechanism to introduce new gas into the US market.  Any gas imported would essentially be competing with other gas produced offshore.  Any pipeline, storage or associated equipment located onshore of the coastal high water mark will remain subject to FERC regulation, including any applicable open season/open access and cost-of-service tariff rate regulation. (Some companies may be able to avoid this regulation by claiming an “intrastate facility exception.”)

The new maritime statute makes the US Coast the “one-stop,” single point of contact for purposes of all necessary federal agency authorizations.  The Coast Guard must consult with all relevant federal agencies in connection with any offshore terminal license application.  The final decision with respect to approval or denial of a license application rests with the US Secretary of Transportation (who oversees the Coast Guard).

Although the new law consolidates all federal-level activity with respect to the siting, design, construction, operation and safety of an offshore gas or LNG terminal, it is important to note that it does not supersede existing regulations that require a gas or LNG commodity importer to obtain a gas or LNG import permit from the US Department of Energy.

Under the new statutory regime, applications for licenses to build an offshore gas or LNG terminal must be made to the Coast Guard.  The Coast Guard then has 21 days to review the application and determine whether the application is complete.  The next step is for the Secretary of Transportation to publish a notice of the application in the Federal Register.  This publication starts a 240-day time period during which any public hearings must be held.  The Secretary of Transportation then has another 90 days from when any hearings conclude to grant or deny the application.

The Department of Transportation must make a decision on the application based on a number of listed factors, most of which center on national interest and national security considerations.  The new maritime statute also requires the concurrence of the governors of all affected states before any terminal license can be issued.  Presumably, this will be obtained within the time periods laid out in the statute for a final decision on the application.  In practice, as long as a license applicant submits all necessary information in a timely manner, it appears that a final license determination should be in hand within 351 days from the date the application was filed.  This is a substantial improvement over the undefined 18-month to two-year period that it has typically taken to obtain final certification from FERC in connection with land-based LNG terminal facilities.

The Coast Guard is already at work on draft regulations to implement the new scheme.  These regulations are expected to resolve a number of questions that were not answered in the maritime statute.  At this stage it does not appear that any privately-negotiated terminal capacity agreement will be required to be filed with the government.  However, this will remain an open issue until the final regulations are published.  Of particular interest will be whether and how the statutory provisions relating to the reasonable rate requirement in connection with private third-party access arrangements will be handled, and how disputes over whether offered rates are reasonable will be resolved under a new citizen complaint procedure.

The new law raises a few interesting issues relating to marine transportation and delivery of natural gas or LNG into offshore facilities.  First, all vessels calling at the offshore gas or LNG terminal are liable for any penalties imposed for violations of regulations governing operation of the terminal (apparently including the terminal owner’s violations), unless it can be shown that the vessel owner or bareboat charterer was not a consenting party or otherwise involved in the prohibited conduct.  An example of a violation might be the discharge of cargo into a facility that does not possess a valid terminal license.

Furthermore, foreign flagged vessels are not authorized to call on US offshore gas and LNG terminals unless the relevant flag state government has either directly consented to or acknowledged the jurisdiction of the US government over the activities of the vessel while it is in US waters.  As a further condition to calling on US offshore gas and LNG terminals, foreign flag vessel owners and operators are also required to designate an agent for service of legal process in the US.  This heightened attention to foreign vessels means owners of such vessels will have to adopt new compliance practices in order to ensure uninterrupted transportation services.

Onshore LNG Facilities

The second important development for the LNG industry came on December 18, 2002 with the FERC Hackberry decision.  After initially failing to convince FERC that it would run a safe and economic LNG terminal, Dynegy was able to persuade the agency of the merits of its position.

The Dynegy application is important because it is the first time the agency has seemed willing to approve a closed-access, “proprietary” terminal that would charge for its services at market rates rather than rates that are tied to the cost of service.  FERC made a preliminary decision that the Dynegy application is in the public interest.  It was helpful that the proposed terminal is a new facility and thus there would be no adverse economic impact to existing users and also that Dynegy bears the entire investment risk of the terminal.  FERC also noted that this approach is consistent with the existing “first-sale” exemption for natural gas sales, as well as the new closed access terminal service regime that was authorized for offshore terminals in the Maritime Transportation Security Act in November.

Importantly, FERC recognized that in the case of the Hackberry terminal, which is located near the inlet of a fluid and dynamic natural gas market where a number of supply options appear to be readily available, it is unlikely that Hackberry’s closed-access import terminal would be in a position to exercise market power over the price of natural gas.  It will be interesting to see whether FERC makes similar market power findings in the future in cases where facilities are located closer to the end market.

FERC made it a condition to final approval that the project must file a copy of its private terminal service agreement with its Dynegy affiliate prior to commencing construction.  The Hackberry order is silent about whether subsequent amendments or modifications to the terminal service agreement must be filed.  It also offers no insight into what FERC would do in a case where the project structure does not involve a separate terminal service agreement.  For example, it is not clear what FERC would do with a project where the cost of terminal services is rolled into the price charged the consumer of the commodity.

While the Hackberry decision is notable in many respects for its lack of clarity as to future application, a few issues are fairly clear.  First, in issuing the Hackberry decision, FERC did not concede or otherwise modify its jurisdiction over the siting, design, construction and operation of LNG facilities from a safety standpoint.  The Hackberry decision only speaks to FERC’s economic (rather than safety) regulatory powers.  It does not supercede the open season/open access regulatory system or existing cost-of-service tariff rate regulation.  It merely offers an alternative means of obtaining FERC certification in the case where the terminal developer finds it preferable to operate closed-access facilities on market-based service pricing terms.  Nothing in the Hackberry decision appears to preclude a terminal developer from simply pursuing the more traditional FERC approval process, particularly where the eminent domain powers associated with authorization under section 7 of the Natural Gas Policy Act are key to developing the terminal.  Finally, the Hackberry decision does not divest FERC of its well-established authority to remedy complaints of discriminatory or anti-competitive behavior, nor does it preclude FERC from making any supplemental order or otherwise conditioning its final certification of any LNG terminal.

Some of the more significant open issues left unanswered after the Hackberry decision include the following:

• Will FERC certify projects where the terminal capacity holder is not an affiliate of the terminal owner (and thus the “entire economic risk” is spread among the participants instead of placed on the terminal owner)?
• Will the fact that FERC has authority to impose new conditions after certifying a project to redress complaints of discriminatory treatment or anticompetitive behavior create any significant issues for lenders in connection with project financing or to LNG suppliers, who may worry about changes that could affect the economic viability of the LNG buyer or terminal owner?
• Is FERC being consistent when it claimed jurisdiction in the Hackberry decision over the associated natural gas sendout line for the project with its earlier decision in the Cove Point project? There, it declined a customer request to unbundle the cost of terminal service at the Cove Point LNG facility from the cost of sendout pipeline service on the basis that the pipeline was integrated with the terminal and to decouple the two could have led to under-utilization of the LNG terminal.
• Can the owner or operator of an existing LNG facility now use the policy and rationale in the Hackberry decision to apply for authority to run a closed-access facility and charge market rates? What about for expansion capacity at an existing terminal?
• To what extent is it desirable to bring the approval processes with FERC and the Coast Guard into harmony?

The Hackberry decision might be seen as a sign by FERC that it does not plan any broad regulations in this area but rather prefers to address issues as they arise in individual applications.  If this is in fact the case, it is likely that there will be little concrete guidance for onshore LNG terminal developers until a consistent and reliable body of FERC precedent evolves.

Safety Plans

As should be expected, the good news from the government did come without at least one string attached.

The Maritime Transportation Safety Act requires LNG facility owners and operators to file a detailed LNG facility security plan within six months after regulations implementing the statute are issued by the US Department of Transportation.  This requirement to file a security plan applies equally to FERC-certificated shore-based LNG facilities and Coast Guard-licensed offshore natural gas and LNG receiving terminal facilities.  By law, the security plan must be approved by the US government within one year after interim regulations are issued or else the LNG facility will no longer be allowed to operate.  Each security plan is to be developed on a location-specific, user-specific basis.  Congress indicated that “boilerplate” security plans will not be viewed favorably.  The regulations that will start the clock on submitting security plans are in the works at this writing.