Managing Complex Processing Agreements in CTRM by Commodity Point

A CommodityPoint Whitepaper

Managing Complex Processing Agreements in CTRM Complex Contract Management in Natural Gas Processing Operations

CommodityPoint, a division of UtiliPoint International, Inc. 19901 Southwest Freeway, Suite 121 Sugar Land, Texas 77479 www.commodity-point.com February 2012

Table of Contents

Introduction .................................................................................................................................... 3 Agreements Reflect Complex Physical and Business Processes ..................................................... 3 A Look at Typical Processing Agreements ...................................................................................... 5 Choosing a System for Managing Complex Processing Contracts.................................................. 7 About Enuit's Enstep ETRM Solution .............................................................................................. 9 State-Of-The-Art Technology................................................................................................... 9 Enterprise-Wide Solutions ....................................................................................................... 9 Bolt-On Applications .............................................................................................................. 10 About CommodityPoint ................................................................................................................ 11

Introduction Recent advances in exploration, drilling and completion technologies have led to a boom in natural gas production. Increasing prices for crude and natural gas liquids (NGLs) has focused development of new gas supplies in high BTU, liquid-rich basins, such as the Eagle Ford Shale in South Texas. This increased production of liquids-rich gas has spurred the construction of natural gas facilities for the treating and extraction of NGL's, with dozens of new facilities or expansions of existing facilities announced in 2011. Currently, there are about 500 operational natural gas processing plants in the US, processing up to 80 Bcf of gas daily. With the advances in shale gas development, new plants continue to be brought on line; while at the same time, older plants are retired as the conventional natural gas resources with which they were developed are depleted. As producers open up new fields and bring new wells on-line, those producers and the plant operators that service those fields are faced with negotiating new processing agreements that reflect not only mutually acceptable commercial terms, but are also reflective of the physical attributes of each of the individual facilities. Despite much standardization in many parts of the energy value chain, such as NASB contracts for wholesale interstate gas transmission and trading, natural gas processing has remained essentially untouched by regulatory or industry mandated standardization. Processing agreements reflect the reality of the business they encompass – these contracts are extremely complex; each is negotiated with terms that are bound only by the physical constraints of the processing facility. And just as there is no "standardized processing facility", there is no "standardized processing contract".

Agreements Reflect Complex Physical and Business Processes Some of the variables that are considered by either or both parties to the contract (the facility operator and the producer or owner of the gas stream) when negotiating commercial terms of a processing agreement include: •

Nature of the processing equipment – which hydrocarbons are being extracted and what is the efficiency of that process

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"Position" of the facility as either a straddle plant or a mainline processing plant

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Composition of the gas being processed, including Btu content and any contaminants which may be present such as H2S and CO2

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Installation and ownership of the connection between the plant and the source of the gas stream - If the plant provides the connection those costs will need to be recovered either explicitly or implicitly in the form of a discount to any reimbursement to the gas owner

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Ownership of the gas stream – is it a single well or multiple; will the operator sell for all owners and reimburse; can some owners opt out of processing?

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Pricing and payment terms for each extracted product, including any take-in-kind provisions

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Calculation of prices for the constituent products – basket pricing based on indexes or net backs

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Calculation and/or payment of taxes to the various jurisdictions involved in either the plant or the source of the natural gas

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Process/don't process decision authorities – is the decision to process solely under the control of the facility operator and what factors are to be considered when making that decision?

Given the many variables that go into the negotiation and construction of processing agreements, it's perhaps not surprising that the end result of those negotiations generally yields an agreement that does not lend itself to being captured and tracked in most of the energy/commodity trading and risk management (E/CTRM or CTRM) systems that are currently available. In fact, it is not an uncommon practice in this industry to find processing agreements being managed outside of the producer's CTRM system, usually in a spreadsheet. The reality is that many times these agreements are either too complex or they may contain optionalities that cannot be modeled using the standardized forms of contract management found most commonly in CTRM systems. In these cases, the spreadsheet is used to model the agreement, track changes to prices and/or other terms, and calculate revenues or volumes (for take in kind), with the results committed, usually by manual entry, into the CTRM system. For some plant operators, legacy bespoke systems have proven difficult to update and adapt to changing business conditions, limiting their ability to create new contract types and terms, and ultimately hurting their ability to compete for new gas hook-ups in competitive market areas. Additionally, for those facility operators that rely on spreadsheets or other unstructured systems for management of commercial agreements, contract administration and plant accounting is a highly manual process that induces significant overhead and potential for error. For producers, accurate modeling of multiple agreements with several or more plant operators is a daunting task. Given the inability to systematically manage the complex terms of processing contacts in a timely fashion, producers may turn to managing the gas and/or liquids positions that are related to

those processing agreements in spreadsheets. Managing agreements in this way is essentially a guessing game, in which the volumes (positions) related to those agreements are simple rolling estimates that are prone to error and potentially reflect outdated price or operating assumptions. In times of highly volatile prices, these errors can produce significant financial exposures that may go unseen until invoices and/or plant operating statements are exchanged at the end of the month.

A Look at Typical Processing Agreements The "standard" agreement in processing is anything but "standardized". Again, these agreements are constructed to account for a number of variables that not only impact the commercial aspects, but are also reflective of the operational parameters of the facility and the nature of the agreement – such as whether the plant is purchasing most or all of the products and/or gas stream; whether the plant is returning most or all of the equivalent BTU value and is charging a fee for processing or treating the gas stream; or whether there is an agreement that provides for a hybrid or some degree of a combination of either of the two extremes. Processing can be on fee basis, in which the plant returns all or part of the liquids associated with the raw gas stream to the owner or producer of that gas, and charges that producer a fee for treating/processing the gas stream in order to make the gas salable or to recover high value liquids. Following is an example of a common construction of terms for a gas processing agreement in which the plant operator retains a portion of NGL value and purchases all residue gas, with the value of each calculated as follows: •

Value of residue gas:

GDD-Tetco ELA * 0.995 - 0.125 less, if applicable, pipeline

transportation charges and any other fees for conditioning, low pressure, lost gas, meter fees, other similar fees or charges, and pipeline fuel adjustment (based on published tariffs where applicable). •

Value of Natural Gas Liquids: 87% of the total net value of the Natural Gas Liquids as determined by the Plant, less applicable costs, including processing fees, conditioning fees, or other similar fees, taxes, and less Transporter(s) transportation charges and fuel adjustment (based on published tariffs where applicable) on the PTR volume, plus or minus the value of the PTR Imbalance, if applicable.

Processing agreements may also contain volumetric tiers as in this example:

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Value of residue gas: (Inside FERC Tetco ELA less $.17) multiplied by the applicable percentage: 88% if the volume is 15,001 Mcf/day or greater; 84% if the volume is 10,000 15,000 Mcf/day; 83% if the volume is less than 10,000 Mcf/day, less, if applicable, Transporter(s) transportation charges and any other fees for conditioning, low pressure, lost gas, other similar fees or charges, and Transporter(s) fuel adjustment (based on published tariffs where applicable).

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Value of Natural Gas Liquids: 90% of the total net value of the Natural Gas Liquids as determined by the Plant, less applicable costs, including processing fees, conditioning fees, or other similar fees, taxes, and less Transporter(s) transportation charges and fuel adjustment (based on published tariffs where applicable) on the PTR volume, plus or minus the value of the PTR Imbalance, if applicable.

Further complications can include the use of complex pricing terms such as tiered averages: •

Value of residue gas: StepAvgMcf {0 to 69: [IF-Waha]*0.75, 70 to 250: [IF-Waha]*0.76, 251 to : [IF-Waha]*0.77} less, if applicable, Transporter(s) transportation charges and any other fees for conditioning, low pressure, lost gas, meter fees, other similar fees or charges, and Transporter(s) fuel adjustment (based on published tariffs where applicable), Transporter(s) fuel adjustment.

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Value of Natural Gas Liquids: 78% of the total net value of the Natural Gas Liquids as determined by the Plant, less applicable costs, including processing fees, conditioning fees, or other similar fees, taxes, and less Transporter(s) transportation charges and fuel adjustment (based on published tariffs where applicable) on the PTR volume, plus or minus the value of the PTR Imbalance, if applicable.

Further complicating the capture and maintenance of these types of agreements, the processor may also have the right (and generally does) within any agreement (such as those reflected by the above terms) to make the decision to discontinue processing should prices move in such a way that it becomes uneconomical for them (though not necessarily the producer) to continue processing. This "go/no go" decision is generally not an instantaneous right – it will require some notice period or it may be limited to a predetermined number of days within a given period (i.e. 10 days out of every 90 contiguous days). Nonetheless, this right to discontinue processing is an additional complication that must be reflected when capturing/administering the agreement. In addition to a binary "process/don't process" decision, the plant operator can adjust operating parameters, changing product yields in order to maximize the value of one or more of the constituent products in reaction to changing market prices. For example, maximum recovery of all potential NGL ®

products requires the highest fuel burn by the plant. If natural gas prices rise without an equal corresponding increase in prices for NGLs, the plant operator may make the decision to reduce the product yields well below plant capacity. Though this is will reduce the amount of NGLs available for sale, it will also reduce fuel costs and by extension increase the quantity and value of the processed gas at the tailgate of the plant. These variables of market prices, plant yields and operational decisionmaking are all either explicitly or implicitly reflected in the commercial arrangements that a producer will make with a plant operator; and are further complexities that must be accounted for when attempting to capture and manage such agreements within a natural gas producer's CTRM system.

Choosing a System for Managing Complex Processing Contracts Though vendor supplied ETRM/CTRM systems have been around for more than a decade, and while many were originally designed to fit the majority of the needs of oil and gas producers, experience with these systems has shown that in the area of managing complex contracts such as those found in natural gas processing, this capability has not necessarily been top priority for many technology suppliers. Indeed, such complex agreements are one of the principle reasons that both producers and plant operators continue to utilize spreadsheets in their operations. The inability to capture such agreements in their ETRM/CTRM system and then to manage and report on their processing agreements has left many producers and plant operators/producer services companies in the dark in terms of their volumetric and financial positions associated with those contracts. Enuit, a Houston-based company founded a few years ago by a group of gas industry veterans with combined decades of experience in information technology and energy trading software, has designed a system to address the explicit requirements of this complex industry function. Their product, called Enstep, has been designed with the unique functional capabilities necessary to model complex processing agreements. These capabilities are broadly outlined below: Basic Enstep Natural Gas Processing functions â&#x20AC;˘

Captures contract terms including: o Language elements o Complex financial terms o Evergreen dates o Physical location o Baseload and swing volumes ÂŽ

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o Wellhead balancing terms o Pipeline cash-out terms Forecasts profit margin Schedules pipeline transportation of: o PTR o Residue o Raw gas Displays pipeline, zone, and point balances and imbalance volumes Tracks relevant scheduling volumes o Nominated o Confirmed o Allocated o Actual Generates pipeline charge reconciliation Captures actual deal fees and volumes Generates invoices and remittance advice statements

The system was designed from the ground up to address the daily and monthly needs of a producer services company or plant operator (in addition to providing mirrored capabilities to producers), and can manage all aspects of the processing business cycle including all pre-trading month activities such as: • • • • • •

Record next month forecasted wellhead volumes, GPM values, and PTR percentages Adjust forecasts based on actual data from prior periods Record physical and financial sales deals Monitor storage balances and value Path first-of-month volumes from wellhead locations to pipeline pools and/or interconnects Schedule first-of-month volumes in pipeline EBBs

Additionally, the system is capable of forecasting next month anticipated revenues and profitability via its ability to calculate complex pricing scenarios using forecasted data. The system can also manage all day-to-day pipeline scheduling and nominations activities, including calculation, management and valuation of pipeline imbalances throughout the trading month. Enstep will also accurately and completely calculate and reconcile all pipeline charges, including demand charges and cash outs. Enstep can also manage the post-trading month reconciliation and accounting activities, including capture of all actualized volumes and charges from pipeline and plant statements, preparation of any

and all pipeline, producer and plant invoices and/or remittance statements, and generation of prior period adjustments.

About Enuit's Enstep ETRM Solution Enstep Enstep is a comprehensive, state-of-the-art enterprise application for the Energy Commodity Trading and Risk Management business. It is a fully functional enterprise-wide application with all of the bells and whistles. And, at the same time, it can extend the capabilities of any existing transaction management system with Enstep's bolt-on technology. No ETRM need is too big or too small for Enstep. It can do it all; and it can do only what each situation requires, making Enstep extremely versatile and economical. It can focus in on a specific transaction processing need, or spread its wide-ranging application across a customer's broader need.

State-Of-The-Art Technology Enstep was created using Microsoft's latest set of .NET application framework tools. All program code is written in the C-sharp programming language, organized into a state-less n-tier application: Client application tier, business processing tier, and data access tier, as shown in the adjoining diagram. The Client is a SmartClient application, and can be deployed using ClickOnce. Enstep can be configured to access data from either Oracle or SQLServer data sources. The highlyscalable, business processing tier is made up of many web service applications, which can be hosted on one or many application servers.

Enterprise-Wide Solutions Enstep is a fully functional, enterprise-wide solution for companies managing portfolios of energy commodity-related transactions, such as electricity, natural gas, natural gas liquids, crude oil, and coal. Its functional capability covers the spectrum from production marketing to retail; and includes distinctive features to support natural gas processing and inventory management.

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However, its most unique and distinguishing feature is its deal type factory, which enables application users to create, using application forms and metadata, new types of transactions without programming one single line of programming code. Each new transaction type automatically decomposes risk, values profitability, and aggregates credit exposure, along with every other business process, without any need for programming support. Application users will therefore no longer need to handle certain difficult transactions off-system, usually in some off-line spreadsheet. Each transaction type takes only a few hours to setup. Enstep's transaction set is dynamic, and evolves as business evolves. Enstep users can easily create complicated transaction types to represent any structured transaction using drag-n-drop mouse operations. Structured transactions can then be sent to Enstep's simulator to determine a probability of profitability using Monte Carlo simulation analysis. Such capability can save weeks of time and effort valuing structured transactions.

Bolt-On Applications In addition to being deployable as an enterprise-wide application, Enstep can also be deployed to address specific needs and gaps in a company's application architecture. A company can use Enstep to enhance the value of legacy systems. For instance, Enstep can be "bolted" onto a company's existing application infrastructure to provide physical scheduling, credit management, hedge accounting, production marketing, or any other Enstep feature. In this way, Enstep can reduce a company's information technology costs by extending the life of existing ETRM software and associated applications.

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About CommodityPoint CommodityPoint is a division of leading energy and utilities analyst and consulting firm, UtiliPoint International, Inc. CommodityPoint provides Commodity Trading & Risk Management (CTRM) research, analysis and consulting services. Our services bring insight into business issues, trends, processes and technology, to energy companies, utilities, banks, brokers, funds, investors and vendors, enhancing their competitive position and supporting critical business decisions. CommodityPoint brings focus and clarity to the broad array of issues surrounding the wholesale trading of commodities. Our team provides expert analysis of market trends and, in particular, the technologies and applications supporting those that participate in regional or global commodity markets. Our principal analyst, Patrick Reames, brings years of practical experience to his roles. With offices in Europe and the US, and backed by an experienced research team, our organization provides an unparalleled view of the marketplace. UtiliPoint, a company with75 year history, is a leader in providing analysis and consulting services to the energy and utility industry, having serviced to over 500 clients. Our staff is comprised of leading utility and energy experts with diverse backgrounds in utility generation, transmission & distribution, retail markets, mergers and acquisitions, new technologies, investment capital, information technology, outsourcing, renewable energy, regulatory affairs, and international issues. www.commodityâ&#x20AC;?point.com www.utilipoint.com

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