Risks and burdens of joint-venture pipeline projects need to be managed and mitigated with fully termed project agreements addressing the potential problems involved in pursuing a project with partners. Reaching such agreements may require additional time on the front end, but this investment will pay off in greater internal efficiency as the project proceeds.
Background
JVs have emerged as the most recent trend for development of new pipeline projects. Companies pursue JVs because the benefits of shared risks and combined resources are attractive. These benefits often cannot be replicated by a company pursuing a pipeline project on its own.
JVs have submitted the majority of greenfield pipeline projects currently pending before the Federal Energy Regulatory Commission. Rockies Express Pipeline, for example, is a JV among Kinder Morgan Energy Partners LP, Sempra Pipelines & Storage, and ConocoPhillips to construct a project from the Rocky Mountains east. It is awaiting FERC approval for another phase (Fig. 1).
Southeast Supply Header LLC, a JV between subsidiaries of CenterPoint Energy Inc. and Spectra Energy, is awaiting approval of a 270 mile, 36-in. and 42-in. OD pipeline extending from the Perryville hub in northeastern Louisiana to the Gulfstream Natural Gas System LLC pipeline.
The JV of Kinder Morgan Energy Partners LP and Energy Transfer Partners LP, formed to construct and operate the Midcontinent Express Pipeline, a 500-mile natural gas pipeline from the southeast corner of Oklahoma, across northeast Texas, northern Louisiana, central Mississippi, and into Alabama, is another example of such an arrangement.
All indications point toward additional proposals from other JVs. On Aug. 6, 2007, for example, a newly formed JV between TransCanada Corp. and Northwest Natural Gas Co. announced a proposal to build and operate a natural gas pipeline of about 220 miles from northwestern Oregon to north-central Oregon.
The emergence of JVs pursuing pipeline construction projects is not limited to natural gas. ONEOK Partners LP and a subsidiary of Williams Companies Inc. have formed a JV to construct and operate a 750-mile NGL pipeline from Wyoming to Kansas.
Table 1 summarizes these projects.
JV and consortium projects have long been the norm in international cross-border pipeline projects, often following the consortium model from the upstream. In the past, however, major pipeline companies typically developed US pipelines on their own, and in many cases, in competition with alternative projects proposed by other major pipeline companies.
Examples of this traditional approach remain, with Spectra Energy, the Williams Cos. Inc., and El Paso Corp. each having announced individual projects extending from the terminus of the Rockies Express Pipeline into the northeastern US. Greenfield projects, however, are increasingly being sponsored by JVs. The tremendous costs and commercial risks associated with pipeline development make development through JVs increasingly attractive.
At the same time, however, prospective participants in JV pipeline projects must give special attention to the risks and unique issues associated with JVs. This is especially true for companies that traditionally have developed projects without partners. The success of a JV pipeline project depends on the participants being aware of, and allotting time to address, risks and issues created by capital intensive infrastructure development projects with partners.
Advantages, disadvantages
One of the primary advantages of a JV in any context lies in the participants’ ability to share costs and commercial risks, particularly appealing in the context of capital intensive pipeline projects. The costs associated with a major pipeline project can easily exceed $1 billion. Cost estimates for the Midcontinent Express Pipeline and the Rockies Express Pipeline projects total $1.25 billion and $4.4 billion, respectively.
The commercial risks are also significant, especially the possibility that there will not be adequate gas reserves or gas demand for the lifetime of the project (or even the lifetime of project debt). A JV can mitigate the commercial risks associated with a pipeline project by spreading the risks, both through shared capital contributions and partnering with entities that bring unique skill sets or market positions to the project.
A JV involving some combination of local gas distribution company, pipeline company, and producer, for example, may be able to address certain commercial risks that each entity, working alone, would be unable to mitigate. An LDC may lack the resources and specialized staff required to pursue a pipeline project, but an LDC with an ownership interest in a JV pipeline may be able to guarantee the pipeline adequate market support.
A pipeline company, meanwhile, may be unable to guarantee market support for a project but could well have access to the diverse resources, staff, experience, and technology needed for a pipeline project to move forward. A producer may have access to gas reserves but lack the experience and specialized knowledge needed to build the infrastructure required to bring the gas to market. By combining unique skill sets, participants in a JV can achieve project elements not within the control of a single entity.
At the same time, the JV model does have problems. Unique skill sets often bring with them unique corporate cultures with varied commercial and regulatory objectives and philosophies. An LDC with expenditures and commitments routinely scrutinized by a state regulatory commission, for example, will likely have a commercial and regulatory philosophy that differs greatly from the commercial and regulatory philosophy of a producer that operates in a part of the industry subject to less regulatory oversight.
Although the differences may not be as pronounced, even a JV between entities in the same segment of an industry, such as a JV between two pipeline companies, will likely involve the meshing of different corporate cultures. The JV requirement that distinct companies act as one creates complexities that would be absent if the distinct companies acted alone.
Participants in a JV have less flexibility and control over a project than they would if they acted alone. The decision-making process in a JV often takes more time and may require a degree of consensus building. This reality follows from the fact that each JV participant essentially serves two or more masters.
Although any potential participant in a JV pipeline project should be aware of the risks and issues associated with the JV model, participants should also be aware that many of the risks and issues can be addressed with careful planning begun at the earliest conception phases of the pipeline project.
JV issues
The first task of any JV is to define clearly its objectives and participants. This may seem obvious and self-explanatory but is often neglected. Just as a pipeline company, LDC, and producer each bring value to a JV, each may also bring a different commercial objective.
A pipeline company’s objective may center on providing service to an underserved market or accessing a market to optimize the value of what might be an underutilized part of its existing system. An LDC, on the other hand, may focus on introducing a competitive supply alternative, while a producer may seek sufficient capacity to vacate production from a field and increase the price at the wellhead.
Each entity may be seeking to relieve a bottleneck, but the ultimate commercial objective of the producer or LDC may be to affect commodity price-cost while the pipeline company’s objective may be to maximize return on its pipeline investment.
Such circumstances do not present insurmountable problems. The key lies in communicating objectives and adopting a JV structure that satisfies the objectives of each participant. If the objectives of the respective participants are at fundamental odds, the likelihood of a successful venture is low.
In the late 1990s, Portland Natural Gas Transmission System and Maritimes and Northeast Pipeline were pressured to create a JV to construct and operate a shared segment of what was first proposed to be two distinct, competing pipelines. Development of what came to be referred to as the joint facilities occurred despite the competing commercial objectives of PNGTS and Maritimes. This has resulted in a steady stream of disputes and litigation, not surprising when entities pursue a JV without understanding and accepting each other’s objectives.
Structuring a JV requires addressing numerous governance issues. The decision-making process of the JV must receive immediate and ongoing attention. If each of two participants owns 24% of a JV and another participant owns 52%, the participants with the minority interests in the JV likely will want to ensure they have a role in decision making and management, while the 52% interest owner may want to structure the JV so that a simple majority carries decision-making power.
Participants should also consider the merits of crafting a voting structure that protects against a tyranny of the minority, where one small interest owner can hold a project hostage. The governing structure of the JV will have to address issues that will require unanimity, issues that will require only two of three interest owners, and issues that can be resolved by a simple majority.
Participants also may want to consider whether there should be limits on the transferability of ownership interests and management responsibilities. Some participants may be uncomfortable with the idea that they could end up managing a JV with another participant’s undetermined assignee. Rights of first refusal limit transferability or at least provide existing owners with the ability to keep a project among themselves rather than be forced into business with an undesirable or unknown successor-in-interest. At the same time, however, parties should take care to structure the right of first refusal to minimize its negative impact on interest value in the marketplace.
In addition to establishing protocols for JV governance, participants in a JV must have a clear understanding of the role they will have in the JV. Issues that must be resolved include determining which company will manage the development and construction of the project and which will operate the pipeline. Planning must also address how each party will be compensated.
In making these determinations, JV participants should consider not only which of them has the most experience and expertise in operating a pipeline, but also the overall operating philosophy of the pipeline. They must, further, determine the restrictions and guidelines that will guide transactions between the operator and its affiliates.
The issue of affiliate transactions between energy industry participants has received increased scrutiny from both federal and state regulators, and accordingly any JV pipeline project must take steps to ensure the pipeline’s eventual operator will comply with relevant federal and state restrictions on affiliate transactions, both with respect to arrangements with affiliates as shippers and with respect to shared services and support relationships with affiliates.
Failure to comply with affiliate standards can be costly. In 2003, FERC approved a settlement between its Division of Enforcement and Transcontinental Gas Pipe Line Corp. under which Transco agreed to pay a $20 million civil penalty to resolve a range of affiliate abuses.1
Since 2003, FERC has acquired even greater authority to impose civil penalties for affiliate violations (or any other violations of FERC’s natural gas rules and regulations). Under the Energy Policy Act of 2005, FERC has the authority to impose civil penalties of up to $1 million/day/violation.2
Although many companies are aware of the restrictions on affiliate transactions, some companies interpret the restrictions in a more permissive manner than others. Participants in a JV must be comfortable with how the pipeline’s operator will handle affiliate transactions.
The likelihood that any pipeline project may be subject to regulatory oversight of local, state, and often federal agencies, requires that participants share a common regulatory strategy and philosophy. Participants should also consider how the JV will communicate and work with landowners who may be directly affected by the construction of pipeline.
Participants should likewise consider how the JV will interact with regulators. For instance, FERC has a prefiling process in which applicants seeking approval of an interstate gas pipeline construction project may work with FERC staff and other interested parties to identify and address issues related to the project before it is formally submitted for FERC approval. Some JV participants may see the FERC prefiling process as an opportunity to increase the likelihood of a project obtaining FERC approval, while others may see it as creating an opportunity for a regulator or other interested party to insist on certain conditions that might not be mandated in a less collaborative process.
The prevailing view, shared by the authors, holds that project developers are well-advised to participate in the prefiling process and to engage early, often, and candidly with all affected parties.
Just as participants in a JV pipeline must agree on an approach to regulatory issues, so must they agree on an approach to commercial issues. One common issue that requires resolution is whether anchor shippers (shippers with large capacity commitments at the project’s outset that have financially supported its initial stages) will be treated more favorably than shippers not committed at the outset to take capacity on a new project to support its development.
Although regulatory agencies such as FERC have some restrictions on the advantages that a pipeline company may give to its anchor shippers, participants in a JV pipeline project should consider whether to provide their anchor shippers with rates or other benefits commensurate with their commitments. Each participant must be comfortable with how commercial issues such as the treatment of anchor shippers will be handled.
References
- Transcontinental Gas Pipe Line Corp., Enforcement Settlement 102 FERC, Par. 61,302, 2003.
- Natural Gas Act, Sec. 22(a), 15 U.S.C., Sec. 717t-1(a), 2005.
The authors
Mark K. Lewis ([email protected]) is a partner at the international law firm Paul, Hastings, Janofsky and Walker, resident in the firm’s Washington office. Lewis regularly represents project companies and sponsors in the development of oil and gas pipelines and related transactions. He holds a JD (1990, magna cum laude) from Georgetown University Law Center, Washington, and a BS (1987, magna cum laude) from the University of Maryland, College Park. He is a member of the Association of International Petroleum Negotiators and the Energy Bar Association.
D. Kirk Morgan II ([email protected]) is an associate at Paul, Hastings, Janofsky and Walker, also resident in the firm’s Washington office. Morgan regularly advises clients on energy-related projects, transactions, and regulatory issues. He holds a JD (2001, magna cum laude) from the Catholic University of America School of Law, Washington, and a BA (1998, summa cum laude) from the Catholic University of America. He is a member of the Energy Bar Association.