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CFTC Commissioner O’Malia Resigns from the CFTC to join ISDA

Posted in CFTC

On Monday, July 21, CFTC Commissioner Scott D. O’Malia announced his resignation from the Commission as of August 8, 2014.  On July 23, the International Swaps and Derivatives Association (ISDA) announced that Mr. O’Malia was appointed chief executive officer and a director of ISDA.  See Scott O’Malia Appointed Chief Executive Officer of International Swaps and Derivatives Association.  Commissioner O’Malia was considered a strong advocate for end-user issues, specifically those impacting energy companies.  Therefore, energy companies should be sure to meet with the new Commissioners to discuss the impact of the new CFTC regulations on their businesses.

Commissioner O’Malia’s departure will, once again, leave vacant a Republican seat on the Commission.  Once Commissioner O’Malia departs, the sole Republican Commissioner will be Christopher Giancarlo, who was recently sworn in on June 16.  Commissioner O’Malia began his service on October 16, 2009, prior to the passage of the Dodd-Frank Act, and is currently the most senior Commissioner at the CFTC.  Upon his departure, Commissioner Mark Wetjen will be the longest serving Commissioner; his term began on October 25, 2011.

Commissioner O’Malia reconstituted the CFTC’s Technology Advisory Committee and served as its chairman.  The Committee was very active during O’Malia’s tenure and took a leading role in examining market issues such as the “flash crash,” and “high frequency trading,” as well as highlighting the importance of investments in technology by the CFTC.  It is as yet unknown who will be the next chairman of the Committee, but it is of particular importance as international regulatory scrutiny surrounding “high frequency trading” continues.

During his term, Commissioner O’Malia was an advocate for the impact of the CFTC’s Dodd-Frank regulations on end-users, including energy companies, and their ability to hedge commercial risk.  Earlier this month Commissioner O’Malia continued to express concerns for the increased costs of the CFTC regulatory reforms:

. . . CFTC regulations are negatively impacting liquidity for end-users and making hedging too costly.  These increased costs will ultimately trickle down to consumers through higher prices for commodities . . . The legitimate hedging and risk mitigation activities of commercial businesses like end-users were not supposed to be impacted by the OTC derivatives reforms in Dodd-Frank because they did not contribute to the financial crisis.

See Keynote Address by Commissioner Scott D. O’Malia at the Federal Reserve Bank of New York.  Commissioner O’Malia also voiced support in his speech for the CFTC reauthorization bill recently passed by the U.S. House of Representatives that provided, among other things, relief to end-users.  The bill would excluded end-users from the “financial entity” definition, which would potentially relieve entities such as energy companies from registration as a “swap dealer.”  CFTC reauthorization and the House bill still need to be considered by the U.S. Senate before any changes to the end-user provisions become law.  The specifics and timing of the ultimate outcome of the CFTC reauthorization remain unclear.

Mr. O’Malia’s statement in the press release announcing his CEO appointment notes the importance of hedging commercial risks through the use of derivatives: “The need by thousands of companies around the world to manage and hedge their business and financial risks via derivatives remains as important as ever.  ISDA’s role is to ensure derivatives markets help to fulfill this promise.”  According to ISDA, 42% of its members are end-users of derivatives and 8% are energy and commodity firms.  See ISDA: The Value of Derivatives. Therefore, it would appear that end-user issues will have a place on Mr. O’Malia’s agenda at ISDA.

The recent changes at the Commission continue to be of importance to energy companies.  The energy industry and market participants should follow developments at the CFTC, particularly as the agenda under new Chairman Timothy Massad takes shape over the next months.

Commerce Department Rulings Spur Oil Export Battle

Posted in Oil

As reported in our blog post of last week, the Commerce Department Bureau of Industry and Security (“BIS”) recently determined in two private classifications that lease condensate — a type of stabilized and distilled light crude oil — is not subject to the United States’ broad ban on crude oil exports.  BIS has for years defined “crude oil” in its regulations as “a mixture of hydrocarbons that existed in liquid phase in underground reservoirs and remains liquid at atmospheric pressure after passing through surface separating facilities and which has not been processed through a crude oil distillation tower.”   Although the regulations state that this definition includes lease condensate, BIS appears to have determined that lease condensate that has been distilled is a refined petroleum product that is not subject to the broad ban on crude oil exports from the United States.

While BIS claims that there has been “no change in policy on crude oil exports,” the recent determinations have spurred the debate over whether the U.S. should change its position on crude oil exports.  In particular, Senators Robert Menendez (D-NJ) and Edward Markey (D-Mass.) — who have been vocal opponents of lifting the ban on crude oil exports — wrote a letter to Commerce Secretary Priztker alleging that BIS may have impermissibly approved the exports of lease condensate and demanding copies of the two determinations and information on the legal rationale for approving such exports by July 14, 2014.  Senators Markey and Menendez argue that allowing exports of crude oil would increase reliance on foreign oil and cause domestic gas prices to rise.  However, with U.S. crude oil production surging as a result of the advancements in hydrofracking technology, Senators Lisa Murkowski and Mary Landrieu have championed the effort to reconsider the ban on crude oil exports, which has been in place since the Arab oil embargo and global energy supply shortages of the 1970s.  In particular, Senator Murkowski has issued a report calling for a “renovation” of U.S. energy export policy, which includes an April 2014 white paper in advocating for condensate exports.

While some view BIS’ approval of condensate exports as a step towards a greater liberalization in crude oil export policy, financial analysts such as Morgan Stanley are not bullish on any significant changes occurring before this years’ mid-term elections.  Moreover, recent reports indicate that the White House may not have been aware that BIS was planning to issue such determinations, and therefore this may not represent a conscious effort on the part of the Obama Administration to change crude oil export policy.  Indeed, Secretary Pritzker has confirmed publicly that the rulings were not a change in policy.  However, the Secretary also said that “it’s a mistake to think there isn’t serious conversation going on within the administration about what we should do,” and that the issue of energy exports overall should be “examined holistically from an economic, strategic, and diplomatic standpoint.”  These statements suggest that the Administration is not backing down from the condensate rulings, and is considering the broader policy issues involved in allowing exports of other oil products.

DOE Finalizes $4 Billion Clean Energy Technology Loan Guarantee Program

Posted in Biofuels, Government Contracts

On July 3, 2014, the U.S. Department of Energy (“DOE”) issued a final solicitation for the Renewable Energy and Energy Efficient Projects Loan Guarantee Program.  As we previously reported with respect to the draft solicitation issued on April 16, 2014, the Program is expected to make up to $4 billion in loan guarantees available for projects located in the United States that use innovative renewable or energy-efficient technologies that avoid, reduce, or sequester greenhouse gases.  The Program offers yet another opportunity to obtain financial assistance from DOE for innovative clean energy technology projects, as part of the Administration’s “all-of-the-above” energy strategy.

The final solicitation continues to identify five key areas of interest to DOE, including advanced grid integration and storage, drop-in biofuels, waste-to-energy, enhancement of existing facilities, and efficiency improvements.  Although a number of comments on the draft solicitation took issue with DOE’s intent to support waste-to-energy technology, as well as drop-in biofuels, which are chemically indistinguishable from petroleum-derived fuels and may be used in existing infrastructure, DOE highlighted in response that the statute authorizing the Program—the Energy Policy Act of 2005—defines both combustion and non-combustion technologies as eligible to receive loan guarantees.

DOE reiterated that projects will be evaluated on a case-by-case basis.  It further explained that the technologies identified in the final solicitation are for illustration purposes only; projects using an identified technology will not automatically be eligible to participate in the Program.  DOE will conduct a life-cycle assessment to determine the extent to which a proposed project avoids, reduces, or sequesters greenhouse gases.  DOE intends to issue guidance on the nature of the life-cycle assessment to ensure transparency in the evaluation process.

Although any project that meets the final solicitation’s requirements is eligible participate in the Program, DOE will look favorably on projects that have a catalytic effect on the commercial development of innovative technologies.  DOE will also look favorably on projects that make use of other sources of financing.

The final solicitation provides for five rounds of evaluation.  In each round of evaluation, DOE will subject an application to a complete review only after making a preliminary determination that a proposed project meets the Program’s requirements.  Initial applications for the first round of evaluations are due on October 1, 2014, with complete applications due on January 14, 2015.  Initial applications for the fifth round of evaluations are due on December 2, 2015, with complete applications due on March 2, 2016.  Applications must be submitted via a web-based portal, which has yet to be established.

Commerce Department Clarifies Requirements for Exporting Condensate Oil

Posted in Oil

In a determination rendered last week, the Commerce Department provided guidance to two companies on the application of export controls to processed  condensate  that could mark a potential thaw in the long-standing ban on exports of crude oil. Condensate is an ultra-light oil that has seen increasing domestic development alongside the recent boom in shale oil production.  However, there is little domestic demand for the product, and the United States has substantially restricted the export of domestic crude oil since the 1970s.

Early reports on the decision, which was limited to the two companies and was not made public, suggested that the Department had partially lifted the ban on crude oil exports.  But as more details emerged, it became apparent that the Department had not officially altered these rules. Instead, its decision was based on a more expansive interpretation of what constitutes a “refined” petroleum product.  Unlike crude oil, refined petroleum products (such as a gasoline or diesel) are eligible for export with minimal restrictions.  The Department reportedly concluded that processing condensate through a stabilizer could suffice in certain circumstances to convert condensate into a refined product.  Since this is a relatively unobtrusive procedure, the decision should make it easier to convert unprocessed condensate into a product eligible for export.

As noted, the decision—which reportedly took the form of a classification determination under the export control regulations—is not public and limited to the two particular energy companies.  As a result, it is unclear how far it extends or the degree to which it marks a material change in oil export policy.  While Commerce Department officials denied that there had been any alteration to the ban on crude oil exports, the Department also indicated it was working on industry-wide guidelines that might further clarify any new opportunities that may exist for exporting oil products.  Pending such guidelines, a wave of similar classification requests involving processed condensate is likely. Two Senators have written to Commerce Secretary Pritzker questioning the decision.

Covington SEO Intern Kendra Mells provided integral research assistance on this blog post.

FERC Exploring RTO/ISO Market Pricing And Operational Practices

Posted in Electricity, FERC

At its recent public meeting, FERC opened a staff-led proceeding to address price formation and related issues in the RTO/ISO wholesale electricity energy markets.  Concerns with whether these organized markets are attracting appropriate levels and types of new generation capacity and the markets’ performance during last winter’s Polar Vortex have raised questions regarding their designs and operational practices.

The RTOs and ISOs run hourly energy auction markets to call forth, through price signals, the generators that will run, and the demand that is willing to be cut, to keep the grid in balance.  The operators also ensure that sufficient resources are committed over some future periods; some accomplish this through capacity auction markets.  There have been concerns recently that the capacity markets are attracting mostly low-cost gas generators and not taking into account the need for fuel diversity and for generators that can serve as workhorse “base load” resources.  During a FERC conference on the capacity markets, it was suggested that pricing rules in the energy markets also play a role in attracting investment and should be examined.  Subsequently, comments during FERC’s conference on market performance during the Polar Vortex suggested that energy market pricing rules and operational practices may have interfered with the markets’ response to the extreme conditions.

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A Quick Look at the Gazprom/Naftogaz Contract Dispute

Posted in Europe, Natural Gas

On Monday, June 16, 2014, Gazprom and Naftogaz each announced that they were commencing arbitration proceedings under the SCC Rules (seated in Stockholm, Sweden).

The arbitration arises under Contract No. KP dated January 19, 2009 (the “Contract”), a 10 year, long-term gas sales agreement between Gazprom and Naftogaz for volumes ranging from 40 to 52 billion cubic meters of gas per year. On the basis of the statements released by the parties, it appears that Gazprom will be alleging a debt claim. Naftogaz appears likely to invoke the price review provisions and seek a decrease in price. The value in dispute is in excess of US$4.5 billion.

To resolve the dispute, the tribunal will likely need to consider the price review provisions in the Contract. Pricing terms and price review provisions are confidential and rarely disclosed. However, Ukrainskaya Pravda — a Ukrainian news outlet — purported to publish the terms of the Contract when it was agreed. Assuming that the Contract published by Ukrainskaya Pravda contains the price review provisions that are relevant to the current arbitration between Naftogaz and Gazprom, the tribunal will be required to interpret some unusual terms.

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Pricing Complexity and Predictable Disputes – A primer on modern long-term gas supply contracts

Posted in Europe, Natural Gas

On Monday, June 16, 2014, Gazprom announced that it commenced arbitration proceedings against Naftogaz under the SCC Rules (seated in Stockholm, Sweden) alleging that Naftogaz has failed to pay US$4.5 billion for gas that Gazprom has already delivered to Naftogaz. Naftogaz also announced that it had commenced a claim under the SCC Rules, seeking the establishment of a fair price for gas and alleging that it has overpaid for the gas already supplied. Some reports suggest that another claim – valued at over US$18 billion – is just around the corner.

When disputes of this value arise, it is important to understand the issues underlying the dispute and how these disputes can be avoided or mitigated. We set out below some thoughts on the structure of pricing provisions in modern long-term gas supply agreements generally.

Complex pricing provisions are a common feature of long-term commodity contracts. In long-term gas sales agreements, a fixed price for the term of the agreement is usually unrealistic due to shifts in the competitiveness of the price over time. There is no single pricing term or indices that parties can universally reference. For this reason, parties typically agree on a bespoke price formula that includes a number of variables. The variables in the formula are agreed between the parties during the negotiation of the contract. Variables can represent substitute energy sources, hub prices, coefficients to counteract the impact of inflation or mitigate currency exchange risks or any other factor that the parties consider might impact the value of gas sold under the agreement.

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Senate Confirms New CFTC Commissioners

Posted in CFTC

On Tuesday, June 3, the Senate approved the nominations of Timothy Massad to be Chairman of the CFTC and Christopher Giancarlo and Sharon Bowen to be Commissioners of the CFTC.  Messrs. Massad’s and Giancarlo’s nominations were approved by voice vote.  Ms. Bowen’s nomination, however, was more controversial as demonstrated by its approval by a recorded vote of 48-46.  Senators David Vitter (R-LA) and Thad Cochran (R-MS) made public their reservations about Bowen’s nomination, which they attributed to her role as Chair of the Securities Investor Protection Corp. (“SIPC”) when the decision was made that SIPC would not compensate victims of Allen Stanford’s Ponzi scheme.

Two days after approval of the nominations by the Senate, on June 5, Mr. Massad was sworn in as Chairman.  Ms. Bowen was sworn in on Monday, June 9, and Mr. Giancarlo’s swearing in is soon to come.

The current Commission is Chairman Timothy Massad, Commissioner Sharon Bowen, and Commissioner Mark Wetjen, who are Democrats, and Commissioner Scott O’Malia, who is a Republican.  Upon the swearing in of Christopher Giancarlo, the Commission will be filled for the first time since the departure of Commissioner Jill Sommers in July 2013, whose seat will be filled by Mr. Giancarlo.

Former Chairman Gary Gensler placed strong emphasis on the importance of an aggressive Division of Enforcement and routinely referenced the negative impacts of what he viewed as inadequate funding on enforcement efforts, even stating that Enforcement had to “shelve cases” due to resource constraints.  Interestingly, one of the first actions Chairman Massad took upon being sworn in was appointing Aitan Goelman as Director of Enforcement.  Mr. Goelman is a former federal prosecutor and partner of Zuckerman Spaeder LLP.

With a new Commission in place, over the coming days and months market participants will begin to see the priorities of the new Chairman.  He is expected to address two issues that have been the subject of much controversy – the position limits rule, which was proposed in December 2013, after the previously finalized rule was vacated by the District Court for D.C., and the CFTC’s cross-border guidance, which is the subject of a lawsuit filed in December 2013 by three large trade groups (Securities Industry and Financial Markets Association, International Swaps and Derivatives Association, Inc., and Institute of International Bankers).  In addition, it is expected that Mr. Massad will take steps to provide market participants certainty around regulation by making the multiple no-action letters issued by various CFTC Divisions into Commission rules.  Specifically, energy companies should follow developments related to the definition of swap, particularly volumetric options and trade options, as well as continued implementation of the End-User exception from clearing and trading.  Market participants should also be keen to observe the dynamic among the new Commission when they meet publicly.

DOE Proposes Changing Process for Non-FTA LNG Exports

Posted in FERC, Natural Gas

In a recent notice of proposed procedures issued by DOE, the agency proposes to act on applications to export LNG to countries without a free trade agreement with the U.S. only after any review required by the National Environmental Policy Act (NEPA) is completed.  DOE says that this change would mean that projects that are otherwise ready to proceed would not be held back from consideration by the current first-in-time order of precedence for applications pending at DOE.  In most cases, the NEPA review would be made by the FERC.

The Natural Gas Act (NGA) requires all natural gas exports to be approved by DOE. Exports to countries with which the United States has a free trade agreement (FTA) are deemed in the public interest by the NGA and must be authorized “without modification or delay.”   However, for exports to countries without an FTA (non-FTA countries), DOE must conduct an informal adjudication and authorize the proposed export unless it will not be consistent with the public interest.

Natural gas exports to non-FTA countries also require review under NEPA, as do LNG terminals located onshore or in state waters, which require FERC authorization.  Thus, LNG applications to both DOE and FERC must satisfy NEPA requirements, which typically result in an Environmental Impact Statement (EIS) or Environmental Assessment (EA).  Accordingly, DOE depends on FERC’s NEPA review.  FERC serves as the lead agency for preparing  environmental review documents and DOE serves as a cooperating agency.[1]

DOE’s current procedure is to consider all public interest factors other than environmental and to issue authorizations for non-FTA exports conditioned on the applicant completing the NEPA review.  For non-FTA export applications made after December 5, 2012, under existing procedures DOE prioritizes its order of review based on the order in which they were received.  According to DOE, one potential consequence of this current prioritization is that LNG terminal projects that satisfactorily complete FERC’s lengthy NEPA review, often taking two years or more, and are ready to proceed may need to wait for applicants ahead of them in the DOE authorization queue to complete the FERC review.

In the past three years, DOE has issued seven conditional authorizations and currently is reviewing 25 requests for non-FTA exports.  FERC has approved one LNG export terminal and  has received proposals for an additional fourteen projects.

Under the proposed procedures, DOE will suspend its practice of issuing conditional authorizations and no longer proceed according to the current priority scheme.  Instead, DOE will act on applications in the order in which they complete the NEPA review process and are ready for final action.[2]  DOE says the new procedures will:

  • Ensure that applications that are otherwise ready to proceed will not be held back by their position in the current priority order.
  • Inform decision making with better and more complete information: (1) economic issues will be considered with more current data; (2) the cumulative market impacts of authorizations will be better known because only applications that have completed the NEPA review and are more likely to proceed than those that have not will be considered; and (3) all public interest factors can be considered in a single order.
  • Better allocate agency resources because DOE can avoid reviewing applications that have little prospect of proceeding.

Comments on the proposed procedures must be filed with DOE by July 24, 2014.

DOE also announced plans to do an economic study on the impact of potential LNG exports between 12 and 20 billion cubic feet per day (Bcf/d).  DOE has already approved more than 9 Bcf/d of non-FTA exports.  EIA will update its 2012 LNG Export Study, which only looked at export cases of 6 and 12 Bcf/d.  DOE will then  contract for an  analysis of the economic and other impacts of this increased range of LNG exports.  DOE says it will continue to act on applications while the studies are conducted.

[1] Projects located offshore beyond state waters require approval from DOT’s Maritime Administration.  To date, only two of the 26 large-scale non-FTA export applications to DOE fall into this category.

[2] DOE says the new procedures, if adopted, will not affect the validity of already-issued conditional orders.

The EU’s New Energy Efficiency Directive Becomes Applicable Across Europe

Posted in Energy Efficiency, Europe, Government Contracts

On June 5, 2014, the European Union’s Energy Efficiency Directive (“EED”) will become applicable in all EU Member States. This Directive establishes an EU-wide framework aimed at promoting energy efficiency and will provide important challenges and opportunities for companies doing business in Europe.

What is the purpose of the Directive?

The EED is one of the main instruments of the EU to achieve its target of a 20% cut in Europe’s energy consumption by 2020.  To help achieve this objective, the Directive imposes binding EU-wide energy efficiency targets for 2020 that are expressed in maximum values of primary and final energy consumption:  1474 Mtoe (Million Tonnes of Oil Equivalent) primary energy, and 1086 Mtoe final energy.

The Directive requires EU Member States to translate the EU wide targets into national indicative targets, which vary per Member State and may become mandatory in the future.  For example, the United Kingdom envisages a maximum of 157.8 Mtoe final energy consumption by 2020 (i.e., a 18% energy saving by 20%).

What does this mean in practice?

In order to reach the targets it sets, the EED requires Member States to take specific energy saving measures that will have a significant impact on public authorities, energy companies, energy retailers and distributors, and industry as a whole.  These measures include:

  1. Annual Energy Saving of 1.5% on Energy Distributors and Retailers: Energy distributors and retailers are required to achieve an annual saving of 1.5% on their volumes of energy sales to final consumers (compared to the period 2009-2011).  Member States may adopt different mechanisms to ensure that energy distributors and retailers achieve this ambitious target.  They may set up so-called “energy efficiency obligation schemes”, i.e., schemes that impose targets on companies, failing which they will be subject to penalties.  They may also impose a combination of other measures, such as energy or CO2 taxes, fiscal incentives for energy efficient technologies, or energy labelling schemes.
  2. Promotion of the Energy Services Market: Member States must promote energy services (i.e., energy solutions that demonstrably lead to energy efficiency improvements or energy savings) delivered by so-called energy services providers (“ESPs”).  These services include the supply and installation of energy-efficient equipment, building refurbishment, maintenance and operation, or facility management.  Among other measures to promote energy services, Member States may develop certification schemes, adopt model contracts for energy performance in the public sector, encourage the development of quality labels, and provide final consumers with accurate information on energy services.
  3.  Compulsory Energy Audits for Large Companies:  Large companies (other than SMEs) are also required to perform energy audits every four years starting on December 2015.  Member States have an obligation to encourage SMEs to perform energy audits, through for example, tax incentives, financial aid, and advisory services.
  4. Renovation of 3% of Public Buildings Per Year: The Directive also requires the public sector to play an “exemplary role” in the saving of energy.  It requires central governments (i.e., excluding regional and local authorities) to renovate 3% of the buildings that they own and occupy per year.  These renovations must meet the national minimum energy performance requirements of the Energy Performance of Buildings Directive.
  5. Public Procurement of Energy Efficiency Products: Central governments are also required to purchase high performing energy-efficiency products, services and buildings, for which the Directive identifies the applicable energy efficiency standards.  It also encourages Member States to apply these public purchase requirements to other public bodies, including regional and local authorities.
  6. Access to Individual Meters and Accurate Billing Information:  Member States must also improve consumer access to energy consumption data by means of more accurate metering.  As far as technically possible, Member States must ensure that final consumers of electricity, natural gas, district heating, district cooling and domestic hot water are provided with “competitively priced individual meters.”  Where technically possible and economically justified, Member States must also take measures to ensure that energy distributors, distribution system operators, and retail companies provide consumers with accurate billing information based on actual consumption.
  7. National Efficiency Action Plans:  Member States are also required to prepare and submit to the Commission National Energy Efficiency Action Plans outlining their national measures to remove barriers to facilitate energy savings.

Importantly, the new European Commission that will come into office in the Autumn of 2014 is expected to propose an increase of the energy efficiency targets for 2030.  This is likely to result in stricter energy efficiency requirements for both public authorities and companies in the near future.