Legal Definitions - area-rate clause

An area-rate clause is a specific provision found in long-term contracts for the sale of natural gas, primarily within the oil and gas industry. Its purpose is to allow the contract price for gas to automatically increase if a government regulatory body sets or permits a higher price for gas sold in that particular geographic region. This mechanism ensures that sellers can adjust their prices to reflect new, higher market rates established or approved by regulators, even if their existing contract was signed at a lower price.

Here are some examples to illustrate how an area-rate clause works:

• Example 1: State Regulatory Price Adjustment

  Imagine a natural gas producer, "GasCo," has a 15-year contract to supply gas to a power utility, "PowerGen," from a specific field in Oklahoma. Their contract includes an area-rate clause. When the contract was signed, the Oklahoma Corporation Commission, the state's energy regulator, had set the maximum allowable price for gas in that production area at $2.50 per MMBtu (million British thermal units). Five years into the contract, due to rising production costs and increased demand, the Commission conducts a review and raises the maximum allowable price for gas in that specific Oklahoma region to $3.75 per MMBtu.

  How it illustrates the term: Because of the area-rate clause, the price GasCo charges PowerGen for natural gas would automatically increase from $2.50 to $3.75 per MMBtu. This adjustment occurs without the need for renegotiation, directly reflecting the new, higher price permitted by the state regulatory agency for that geographic area.

• Example 2: Federal Benchmark Price Change

  Consider "PipelineCorp," a company that transports natural gas across state lines, which has a long-term agreement to purchase gas from "Explorer Energy," a producer operating in a multi-state basin. Their contract contains an area-rate clause tied to federal regulatory decisions. Initially, the Federal Energy Regulatory Commission (FERC), the primary federal regulator for interstate natural gas, had established a benchmark price for gas in that particular interstate basin. Several years later, FERC completes a comprehensive market study and determines that the benchmark price for gas in that basin needs to be increased by 20% to reflect current market realities and encourage adequate supply.

  How it illustrates the term: The area-rate clause in their contract would automatically trigger a price adjustment. Explorer Energy would now be able to charge PipelineCorp the new, higher price approved by FERC for gas produced in that interstate area, ensuring the contract price aligns with the federally recognized market value.

• Example 3: Regional Price Review for Local Supply

  A small independent gas producer, "Local Gas Supply," has a 10-year contract to provide natural gas to a nearby industrial manufacturing plant, "FactoryWorks." Their agreement includes an area-rate clause. The state's public utility commission periodically reviews and adjusts the "just and reasonable" price for natural gas within specific local production zones to ensure fair compensation for producers and stable supply for consumers. During one such review, the commission determines that the prevailing costs and market conditions in Local Gas Supply's specific production zone warrant a 15% increase in the allowed price for gas.

  How it illustrates the term: Due to the area-rate clause, the price Local Gas Supply charges FactoryWorks for gas would automatically increase by 15% to match the new, higher price permitted by the public utility commission for that specific local production zone. This allows the contract price to adapt to the regulator's updated assessment of the regional gas market conditions.