Tax, environment, safety issues loom for US gas processors

Issues with major economic implications currently facing the U.S. gas-processing industry include federal tax treatment of gas gathering lines as defined by the US Internal Revenue Service (IRS), the initiative by the Department of Transportation's Office of Pipeline Safety (DOT-OPS) to propose a rule defining gas-gathering lines, and pipeline safety legislation and initiatives at the federal and state levels.

Each issue can significantly affect future development of the industry.

Tax treatment

Proper treatment of natural gas gathering lines for purposes of depreciation has vast economic consequences.

At issue is whether such lines are assets used in the exploration for and production of natural gas and therefore subject to a 7-year recovery period or whether they are assets used in pipeline transportation and subject to a longer 15-year recovery period.

Given the substantial investment of many companies in gathering assets, the difference for tax purposes between these two recovery periods can be significant.

Despite several taxpayer victories on this issue in the courts, in particular the Tenth Circuit's decision in Duke Energy Natural Gas Corp. v. Commissioner of Internal Revenue, 172 F.3d 1255 (10th Cir. 1999), the IRS has indicated that it intends to continue litigating this issue in other jurisdictions.

The Gas Processors Association (GPA), therefore, has sought legislative clarification of the proper treatment of these assets and will continue its efforts.

Last year, Rep. Sam Johnson (R-Texas) and Sen. Don Nickles (R-Oklahoma) introduced legislation to clarify that natural gas gathering lines are subject to the shorter 7-year recovery period.

Sen. Nickles secured passage of an amendment in the Senate Finance Committee to include this provision in tax legislation under consideration. Unfortunately, this provision was not ultimately signed into law.

GPA is at work enlisting support in Congress' tax writing committees for the Johnson-Nickles legislation.

Recently, US House of Representatives' leadership held "listening sessions" seeking input from members of the business community on its priorities for tax legislation. GPA, along with several member companies, submitted letters to the leadership urging support for legislation to resolve this issue.

While the prospects for enacting a significant tax bill are clouded by election year politics, GPA plans to continue to press Congress to ensure the 7-year clarification is made through legislation.

Gathering-line definition

Federal pipeline safety standards generally apply to natural gas transmission, distribution, and non-rural gathering facilities under the Pipeline Safety Act of 1968. These federal pipeline safety standards can be found in 49 CFR Part 492, which simply defines a gas-gathering line as a pipeline that delivers gas from a production facility to another pipeline that is not a gathering line.

During the past 20 years, the industry and DOT, as well as state regulatory agencies, have made several efforts to establish a workable definition for gas-gathering lines.

The need for such a definition is recognized by many field inspectors and gas-processing companies because the ambiguity in the existing definition causes inconsistent application of DOT regulations: The definition makes it difficult to determine when a gas-gathering line falls under DOT regulation.

Federal and state regulators often have differing opinions, as do gas-processing companies themselves, as to what is and what is not a gas gathering line, and thus within federal or state jurisdiction.

Inconsistent application of the current definition on a state-by-state basis and by the DOT results in operational problems by, and the imposition of, unnecessary regulations on many gas-gathering operations. The result for many companies is unnecessary compliance costs.

As an example, the ambiguity within the existing definition has caused many gathering lines to be inappropriately "labeled" as transmission lines and thus subject to DOT rather than state regulation.

While previously proposed definitions were largely based on physical characteristics, thus making the proposed definition controversial within the industry and difficult to implement, the current focus is on the definition of function of the gathering line itself.

A group of associations within the natural gas industry has established a coalition to work with the DOT's OPS and state regulatory agencies in developing a definition for gas gathering lines. The coalition consists primarily of API, GPA, and several Appalachian associations.

To date, the coalition has developed a proposed definition for gas gathering lines upon which any DOT Notice of Proposed Rulemaking could be based. The proposed definition relies primarily on function for determining what is a gas gathering line and where gas gathering ends and transmission begins.

Simultaneously, the coalition is working on a guidance document that discusses the practical aspects of the definition and how it applies in the field to gas-gathering lines and related operations. API and GPA expect that the guidance document will be published this spring as an API Recommended Practice to be used by the industry and regulatory agencies.

Safety legislation

Pipeline safety is an important issue for gas processors regardless of whether such issues relate to state or federal programs, or both. Although many federal and state pipeline safety regulations may not directly affect gas processing, integrated gas processors (owning and operating gas-processing facilities and transmission lines) could be affected by such regulations that address operating standards for pipeline operators.

Currently, members of Congress from the state of Washington have introduced federal legislation concerning new pipeline safety standards. In the Senate, Sen. Patty Murray (D-Wash.) introduced the Pipeline Safety Act of 2000 (S2004), while in the House, Rep. Jack Metcalfe (R-Wash.) has introduced the Safe Pipelines Act of 2000 (HR3558).

S2004 proposes to expand state authority in matters involving pipeline safety, establish new federal requirements for the improvement and enhancement of pipeline safety operations, create a public "Right to Know" program, and authorize funding for implementation of any new regulatory standards.

HR3558 also proposes to broaden state authority to regulate interstate pipelines and includes provisions concerning federal safety certification of pipeline employees, hydrostatic and corrosion testing, availability of pipeline maps on the Internet, and other issues.

Leadership of the House Transportation and Infrastructure Committee will likely introduce an alternative to the Metcalfe and Murray bills.

Environmental issues

Compliance with environmental regulation continues to consume significant resources of gas processors. Not only have the laws and rules grown in complexity, but aggressive enforcement of the law has also galvanized the attention of industry.

Environmental regulation has grown more sophisticated and more costly over the last decades. Over the next year and a half, gas processors face the following environment issues:

• High production volume testing. As part of the Chemical Right to Know Initiative, the US Environmental Protection Agency (EPA) developed a program to increase the public awareness of the toxicity of 2,800 "high production volume" chemicals.

The program encourages companies voluntarily to test their product streams and make toxicity data available to the public. Of the 2,800 chemicals, approximately 400 are manufactured by the petroleum industry, which has volunteered to test its product streams.

As the voluntary program continues to unfold in the coming months, several elements could increase the cost to gas processors for testing product streams.

The first of these is EPA approval of test protocols that industry will use to develop toxicity data. EPA is allowing for public comment on test protocols in response to comments.

Should the agency amend protocols to require individual rather than representative sampling or testing of chemicals, estimated test costs could rise significantly.

A second matter is the related Children's Test Rule program. Under that program, EPA will publish a list of chemicals of concern to children's health and that will be subject to a more extensive battery of testing.

Petroleum substances may be included on the list, and industry could be required to expand its testing of those substances, which would increase the cost of industry's completing its voluntary and mandatory commitments to test product streams.

• Toxic-release inventory. A recent EPA proposed rulemaking under the Toxic Substances Control Act (TSCA) could increase and decrease burdens of gas processors at the same time.

Under TSCA, facilities that produce or import 10,000 lb/year of chemicals on the TSCA inventory must report volumes, facility, and other data to EPA every 4 years. This "inventory update report" (IUR) is intended to identify potential harm to human health and the environment from the inventory chemicals.

EPA recently proposed several changes to the IUR regulations. One change would exempt several natural gas streams from the IUR, diminishing the reporting burden on gas processors. The exemption is based on the fact that the IUR data duplicate data provided to the Department of Energy, Energy Information Administration.

Another proposed change to the IUR, however, could offset the reduced burdens from the exemption.

EPA has proposed that upstream producers estimate and report the level of potential exposure to the inventory chemicals by downstream workers and end-users including consumers. This would increase the existing reporting burden on producers who would be required to provide details about the handling and consumption of products after they leave the facility.

A final rule is due out in the next few months.

• Clean Air Act reform, compliance. The effort to overhaul the nation's complicated clean air law could have far-reaching consequences for gas processors, which are subject to a large share of its provisions.

Reform efforts will continue to sputter along in Congress through the election year, but committee hearings now will lay the foundation for the serious drafting that will get under way in the 107th Congress.

The natural gas industry could benefit from statutory clarification of some areas of the law that have been inconsistently interpreted through regulation and enforcement. An example is the permitting program for new construction or major modifications of facilities that significantly increase air-pollutant emissions.

EPA has not consistently interpreted the terms "major modification" and "significant increase," resulting in uncertainty in the industry as to when a permit should be obtained.

On the state side, tighter federal clean-air standards translate into tougher decisions for states in deciding what sources to regulate to meet statewide emission reductions.

With a finite number of emitters to choose from, states must determine which types of sources can decrease emissions and at what cost to those sources and to society can those emission reductions be achieved.

States must balance multiple constituencies in deciding what sources to regulate more.

• Climate change. For some time, several programs to encourage reduction of greenhouse gas emissions have been under way. These include the DOE's 1605(b) voluntary greenhouse-gas-emission reporting program and EPA's Natural Gas STAR program.

Support for each of these continues to build and several bills are pending in Congress that would further institutionalize efforts to reward companies for voluntary reduction of greenhouse-gas emissions. Under any one of these "early action" proposals, companies would earn marketable credits for reducing their baseline greenhouse-gas emissions.

If the government were legally to guarantee the future value of credits earned, thereby increasing the interest in emissions reductions, many industrial energy consumers would switch from carbon-based fuels to natural gas and other cleaner burning fuels.

Although the prospect of such a program being established is long-term, that or smaller interim steps toward that goal of greenhouse-gas-emissions reductions could indirectly benefit gas processors.

• Research, development. The ever-growing federal budget surplus is tantalizing Congressional members with the chance to boost funding for pet projects. Research and development is a perennial favorite.

Last year, R&D funding of environment and energy projects was increased. This year, the President has proposed additional increases and Congress appears amenable to a significant increase.

Gas producers could benefit greatly from this boost in research spending. Gas consumption will reportedly increase from 22 to 32 tcf over the period 1997-2010, a 40% increase.

With increased demand goes a need to develop the technologies to deliver the product. Research that focuses on finding new ways to meet increasing energy needs and protect the environment at the same time will continue to be supported by gas processors and all levels of government.

The Authors

Marc C. Hebert is an associate in Bracewell & Patterson's government relations and strategy section. Before joining the firm in 1996, he worked with the majority staff on the House Government Reform and Oversight Committee, subcommittee on National Economic Growth, Natural Resources and Regulatory Affairs. Hebert holds a BA (1991) from Tulane University and JD (1994) from Loyola University School of Law, both in New Orleans, and an LLM (1996) in environmental law from George Washington University, Washington. He is admitted to the bars of the District of Columbia, Virginia, and Louisiana, and to practice before the 4th US Circuit Court of Appeals.