OT05435 - PRT: valuation of non-arm's length disposals and appropriations - gas - take or pay arrangements

Certain payments commonly allowed for in gas contracts are not actually payments for oil within the terms of OTA 1975. FA84\S114 sets out the methods by which these are included within the computation of gross profit under OTA75\S2(5). See also OT05440, Capacity Charges.

Contracts are often drawn up to allow the buyer substantial flexibility in the amount of gas taken at any time. To compensate for this, one way of giving the producer security for the development is for the sale contract to oblige the buyer to pay for a certain quantity of gas each ‘period’ whether or not that amount is actually taken. The arrangements will usually give the buyer the opportunity to make up the quantity paid for but not taken. The make-up may be taken either:

• in priority over that period’s contract amount; or
• only when the minimum for that period has been taken.

There may also be a limit on the time in which make-up gas can be recovered.

Where a payment in a period exceeds the charge for the amount of gas actually taken, the arrangements may treat the excess as an advance payment for the make-up gas to be taken in the future, or they may simply give the buyer a right to take volumes free of charge in the future. The former arrangement would give rise to a normal PRT gross profit contribution equal to the advance payment, when the gas is subsequently delivered. In the latter arrangement the payment is treated as if it was an advance payment, and the subsequent recovery of ‘free’ gas leads again to a PRT gross profit contribution when the gas is delivered.

Where the arrangement is for the recovery of ‘free’ gas, a corresponding part of the original payment is attributed to the amount of gas when delivered - FA84\S114(2) and FA84\S114(3). If make-up gas from one period at one price is being delivered, the corresponding payment is a simple proportion of the total. Where, however, make-up gas is derived from more than one previous period, the calculation of the PRT gross profit contribution requires attribution of payments received in a number of previous periods to gas delivered in each subsequent period. In order to arrive at an appropriate proportion, the averaging method has generally been used, which takes the total value and total volume of ‘free’ gas and then applies the average price derived from this to all quantities delivered subsequently. LB Oil & Gas will however consider other methods of computation, such as FIFO, if requested. Any method adopted must be used consistently from the time the ‘free’ gas is first taken.

If there comes a time when an entitlement to take gas free of charge can no longer be exercised (e.g. because of a contractual time limit) then the corresponding part of the payment which remains shall give rise to a PRT contribution at that time. This is achieved by deeming one tonne of oil to have been delivered and the balance of the payment not attributed to oil actually delivered under FA84\S114(3) is attributed to that one tonne.