Heat Content Agreement

On November 20, 2007, the Ohio Oil and Gas Association (OOGA) and Dominion East Ohio (East Ohio) announced a new agreement to enhance the value and improve the delivery of Ohio-produced natural gas flowing into the East Ohio system.

The new "Heat Content Agreement" (HCA) will have an eight year primary term that begins in 2008 and extends to April 30, 2016, with provisions that could stretch the agreement beyond 2016. The new HCA replaces a similar production enhancement agreement that has been in place since May 2003 and was set to expire in April 2009. If producers responsible for 90 percent of Ohio-produced natural gas throughput into the East Ohio system approve the agreement, the HCA will go into effect on January 2008 and the last year of the original 2003 agreement will replaced by the new agreement.

Under the new HCA, East Ohio commits to provide "first priority" access to Ohio-produced natural gas connected to the East Ohio system. East Ohio also agreed to implement two programs designed to increase access to the East Ohio system. The first is a new version of the original 2003 enhancement program that develops solutions fixing existing or expected constraints on the East Ohio low-pressure system – the traditional entry point for most Ohio production.

The second program looks down the road to anticipate the impact of new supplies arriving from the western United States that could impose severe constraints on Appalachian production. Over the next three years, East Ohio will implement the "Low to High" project by building the necessary infrastructure to provide for Ohio-produced natural gas first priority access to East Ohio’s high-pressure transmission system, where it can be delivered into East Ohio’s storage system or to large on and off-system markets.

Finally, the new HCA will create a new agreement that provides for adjustments to Ohio-produced natural gas to reflect the real heating value of the gas. As part of the HCA, Ohio producers and East Ohio agree to adjust the existing fee arrangements to reflect an equal sharing of the value of the heat content adjustment.

On November 20, East Ohio sent to producers operating on the East Ohio system a descriptive package along with the contracts necessary to participate in the new program. Also enclosed were explanations of the program and its fees. OOGA and East Ohio urge Ohio producers to expeditiously review the package and the associated contracts.

Background: In 2003, both OOGA and producers were growing increasingly concerned that East Ohio’s declining base-load burn would lead the company to place less value on managing its gathering system and encourage East Ohio to look elsewhere for revenues. East Ohio was leaving the merchant function and Ohio natural gas supplies were fading as a priority. Producers began looking for a new relationship with East Ohio – one that could break the mold of the traditional tension dividing producing and pipeline interests.

At the time, the Association was also worried about the growing national trend of predatory pipeline operators purchasing gathering assets. OOGA was looking for ways to avoid scenarios seen in other states where operators were purchasing pipeline gathering and transmission assets and imposing excessive fees and unreasonable terms, driving down the value of natural gas reserves. OOGA and East Ohio joined forces to focus on gathering operations, make needed system improvements and improve the flow of Ohio production. Value was found in the better than normal Btu content of Ohio-produced natural gas.

The 2003 Production Enhancement Agreement gave East Ohio new reasons to focus its energy on its gathering system. Producers and East Ohio teamed up to put into operation new projects relieving bottlenecks on the gathering system that previously were not addressed. Ohio-produced natural gas began to flow, much better than before. Throughput that had been steadily declining to a low of 50 Bcf per year in 2003 reversed itself and climbed to 56 Bcf per year in 2006. As part of the deal, Ohio-produced natural gas was able to be sold at market prices. The value of Ohio producers’ natural gas increased. OOGA and East Ohio created a win-win solution, producers and East Ohio mutually benefited, each enhancing their business goals. It was an agreement unlike any other in natural gas producing states.

Things change though. This time the change was driven by a boom in natural gas drilling that was causing migraine headaches for many producers, in many states, who were drilling into severely constrained pipelines. Ohio producers were looking across the borders to West Virginia and Kentucky where constraints, in some cases, made it nearly impossible to move new production, particularly in warm weather.

But, the mother of all problems looked like a T-Rex dinosaur; rushing eastward with its jaws wide open. Rocky Mountain producers with business acumen not often seen, had put together a $4.4 billion pipeline project and began construction of the 1,700 mile, 460,000 horsepower, "Rockies Express Pipeline" (REX). By 2009, REX will bring 1.8 billion cubic feet of gas per day from the Cheyenne Hub to eastern markets – actually to a hub at Clarington, Ohio in Monroe County, conveniently next to Dominion pipeline assets.

Rockies producers who this summer were experiencing ridiculous cash prices for their production – some for well under 50 cents per decatherm - appear elated at the prospect of accessing competitive markets. Conversely, Appalachian producers began steeling themselves for the opposite effect. Most analysts following REX are saying that the new pipeline will fundamentally change how natural gas flows across the nation. And, Appalachian producers could expect their here-to-now regionally advantaged access to local markets to be adversely impacted.

Indications that Dominion, in light of REX, would be taking a new look at how best to use its East Ohio and wider transmission assets were a warning sign that Ohio producers and East Ohio must look at the 2003 production enhancement agreement with fresh eyes. In early 2006, OOGA and East Ohio began an intense series of discussions to establish long term security and market access for Ohio-produced natural gas.

By May 2007, OOGA and East Ohio entered into a Letter of Intent stating principles of the new HCA. On November 20, the OOGA Board of Trustees unanimously approved executed contracts between East Ohio and OOGA memorializing the entire agreement and authorizing release of the agreement to Ohio producers for their approval.

The Heat Content Agreement

The HCA establishes a new "Low to High" project. This is in addition to expanding the existing improvement program commonly known as the "Project Review". East Ohio commits to provide "first priority" access to the receipt of Ohio-produced natural gas throughout its systems. And, East Ohio will provide to OOGA Services, LLC 1.0 Bcf per year of natural gas storage that will be used, in a plan not yet established, for the benefit of producers paying fees on the East Ohio system.

The HCA primary term begins in 2008 and extends to 2016, providing eight years of security with the possibility for extension under certain provisions.

There will be a new two-part fee structure – one permanent, and one temporary. The heat content fee replaces the existing production enhancement fee and it will equally split between producers and East Ohio the value of the heat content adjustment to Ohio-produced natural gas. East Ohio will also recover the Low to High investment through an additional $0.06 per Mcf surcharge that will expire once recovery of investment occurs. The two fees combined will not exceed $0.50 per Mcf. In other words, the maximum charge is capped at $0.50 per Mcf. Actually, absent unusually good market conditions, the combined fees will be lower than $0.50 per Mcf.

Finally, in the event a bona fide third party offer to purchase East Ohio’s gathering system (or a significant portion of the gathering system), East Ohio grants to OOGA Services, LLC the right of last refusal to purchase from East Ohio the gathering asset under consideration at a price discounted to account for Ohio producers’ investment through fees to upgrade the East Ohio system.

The Heat Content Agreement’s essential terms are:

1. Priority Access for Ohio-Produced Natural Gas

● Low to High Project: Over the next three years, Dominion East Ohio (East Ohio) will spend $15 million on projects to improve and/or augment its current infrastructure to accommodate the movement of Ohio-produced natural gas from East Ohio’s low-pressure systems to its high-pressure transmission systems. From there Ohio-produced natural gas can be delivered into East Ohio’s storage system, off-system markets, and/or to on-system customers. As part of this commitment, East Ohio will engage in the necessary construction projects for East Ohio to meet a minimum deliverability of at least 30 Mmcf per day into the high-pressure system. These projects will include, but may not be limited to, the installation of significant compression stations. The Low to High Project is separate from, and in addition to, system upgrade commitments made by East Ohio that are contemplated under existing agreements and are reviewed by the Project Review Committee.

● Project Review Funds – Original Agreement, Remaining Funds: By December 31, 2007, East Ohio commits to spend the $2 million per year on system upgrades called for in the original agreement for a total of $10.1 million in capital that has been managed by the Project Review Committee

● Heat Content Agreement – Project Review Going Forward: Beginning in 2008 and for each year of the new Heat Content Agreement (HCA), East Ohio will spend $2.5 million annually for system improvements to further enhance the receipt of Ohio-produced natural gas into the East Ohio system. This is an additional $500,000 per year in capital commitment for the term of the Heat Content Agreement. As in the prior agreement, the Project Review Committee will control the funds and select the enhancement projects that will take place.

2. Commitments to Ohio-Produced Natural Gas:

● East Ohio will use all commercially reasonable efforts to provide Ohio-produced natural gas first priority access into East Ohio’s high-pressure transmission system, where it can be delivered into East Ohio’s storage system, to off-system markets, and/or to on-system customers.

● East Ohio will use all commercially reasonable efforts to provide first priority access to the receipt of Ohio-produced natural gas into its systems, including its gathering, transmission and distribution systems, over other sources of supply consistent with East Ohio’s obligation to operate an open access system in accordance with state and federal regulatory requirements.

● For the term of the new HCA, East Ohio will annually provide OOGA Services, LLC, with the option to use up to 1.0 Bcf per year of its on-system natural gas storage at the prevailing maximum tariff rate applicable to comparable service.

3. Term of the Heat Content Agreement

● The primary term of the new Heat Content Agreement will be from January 1, 2008 through April 30, 2016. One-year evergreen periods will follow, with a 6-month written prior notice to terminate. The new program will become effective once producers responsible for 90% of existing Ohio throughput into the East Ohio system have agreed to the contract(s) implementing the HCA. An additional year may be added to the agreement should East Ohio, with OOGA’s support, achieve certain regulatory provisions as part of rate case proceedings now underway at the Public Utilities Commission.

4. Fees

The fee structure that is part of the original agreement will change. There are two fees to consider in the new Heat Content Agreement:

1. The Heat Content Fee – Designed to commence as of the April 2008 production period.

2. The Low to High Project Surcharge - a fee collected by East Ohio to recover capital investment related to boosting Ohio-produced gas into the high-pressure system. The $0.06 per Mcf surcharge will commence as of the January 2008 production period. This fee will continue until East Ohio recovers their investment and will terminate at some point in the future.

● Heat Content Fee: Essentially, the producer and East Ohio will equally share the benefit derived from the heat content adjustment applied to Ohio-produced natural gas.

● The producer’s share of the Btu adjustment monetary benefit is designed to be no less than 50% of the total Btu adjusted monetary benefit. That is very similar to the sharing arrangement at the start of the prior agreement. In order to ensure that benefit level, the production enhancement will be adjusted annually, effective with the April production period, in the following manner:

Heat Content Fee (HCF) = 0.5 x (BTUOhio/BTUInterstate – 1) x P (Generally, P is the sum of the NYMEX 12-month strip price for the period during which the adjusted rate will be in effect plus a basis adjustment)

● Events may occur as part of future rate proceedings that could change the value of the benefit East Ohio receives from the HCF. If that happens, the formula used to determine the heat content fee will be revised and the producer’s share of the heat content adjustment will be 55 percent and East Ohio’s share will be 45 percent. The parties expect to evaluate this situation on or about October 2011.

● Low to High Surcharge: As stated above, East Ohio commits to spend an additional $15 million for the Low to High Project. East Ohio will recover that $15 million, plus 15 percent (for a total of $17.25 million), through a $0.06 per Mcf surcharge. The surcharge will begin in January 2008. Upon cumulative payment of the $15 million plus 15%, the surcharge shall terminate. There is a credit applied to the surcharge of 25% of any increased collections by East Ohio prior to April 2009.

● The Combined Fee Limitation: This is important. The combined effect of the Heat Content Fee and the Low to High Surcharge shall not exceed $0.50 per Mcf.

5. Right of Last Refusal on Sale of the Gathering System:

● During the term of the Heat Content Agreement and for a period of time after it expires, East Ohio will grant to OOGA Services, LLC or its assignee the right of last refusal to purchase East Ohio’s gathering system in the event East Ohio agrees, in an otherwise binding agreement with a bona fide third party purchaser, to sell all or a significant part of its gathering system as part of a transaction that does not involve the sale of East Ohio in its entirety. As part of the right of last refusal, OOGA Services, LLC or its assignee will have the right to acquire that part of the East Ohio gathering system included in the transaction for a price equal to the price agreed to be paid by the bona fide third party purchaser less all gathering system capital expenditures that relate to the part of the gathering system involved in the transaction, net of depreciation, made by East Ohio pursuant to the HCA and the original agreement since its inception in May 1, 2003. If East Ohio in its entirety is sold to another company during the term of the agreement, this agreement and the terms of this paragraph will transfer with the sale.

What Needs to Happen Now?

On November 20, East Ohio sent Ohio producers operating on East Ohio a package detailing the program. Enclosed in the package is a Heat Content Agreement (Attachment D) and a Supplement to Gas Purchase Contract (Attachment E).

• The Heat Content Agreement must be signed and returned to East Ohio.
• The Supplement to Gas Purchase Contract must be signed and returned to the Producer’s respective gas marketer(s).

After commencement of the primary term of this agreement all agreements previously entered into by and between East Ohio and Producer addressing a heat content adjustment shall terminate.

If a producer delays execution of the Heat Content Agreement, but does execute the Agreement at a later date, the Producer will be required to pay "catch-up" fees to obtain the benefits of the Heat Content Agreement.

East Ohio directs producers to return the executed Heat Content Agreement to East Ohio at the address below.

Brent Breon
Dominion East Ohio
7015 Freedom Ave., NW
North Canton, OH 44720

To assist you in directing any questions you may have to the appropriate East Ohio or OOGA personnel, please use the following information as a guideline:

For general questions, please contact:
Brent Breon, East Ohio: 330-266-2130
Tom Stewart, OOGA: 740-587-0444

For transportation contract questions, please contact:
Dina Gallaway, East Ohio 216-736-6559
Kim Manning, East Ohio 216-736-6385

Additional Resources

Documents from Dominion East Ohio:

Letter to Producers
Attachment A: Essential Terms
Attachment B: New HCA Fee Calculations
Attachment C: Btu Conversion Value Illustration
Attachment D: Heat Content Agreement
Attachment E: Supplement to Gas Purchase Contracts

Additional Documents:

Chart Explaining How the BTU Conversion Works
Dominion East Ohio's Approved Marketers List