The Maui Gas Contract - A Brief History

March 1998

Part A

Introduction

When the Maui Field was originally discovered in 1969 the natural gas industry in New Zealand was still very much in its infancy. The Kapuni field had by then been discovered and contractual arrangements had been entered into which allowed for the development of Kapuni. However, at the time of the Maui discovery the only use of gas in New Zealand on any significant basis was by way of reticulation for predominantly domestic consumers.

The Maui field was originally thought to contain proved plus probable recoverable reserves of over 5400 PJ. It was immediately apparent that gas in these volumes could not be consumed by the then existing domestic or reticulated market.

Development of off-shore gas fields was, at that time, still relatively novel on a worldwide basis and completely unknown in New Zealand. However, the field had impressive deliverability capability of clean burning high quality gas that did not need a great deal of processing. The high gas/liquids ratio was also attractive. Accordingly the challenge was to ascertain if an industry could be established to use this potentially valuable resource. The government of the day, after much study, negotiation and consultation, concluded that the best use for this gas was as a fuel source for a series of thermal power stations which would be constructed to meet the then expected big increases in electricity demand.

Protracted negotiations followed between representatives of the Crown and the then Maui mining companies, Shell, BP and Todd Petroleum. By October 1973 a contractual arrangement was concluded. Part of the overall arrangement was the direct participation by the Crown by means of the acquisition through Offshore Mining Company Limited, of a 50% interest in the Maui field. The contract for the sale of Maui gas was signed on 1 October 1973 between the Maui mining companies which, at the time of signing, consisted of Shell, BP, Todd and Offshore Mining. Since that time, and as a result of a series of acquisitions Fletcher Challenge has acquired the interest of Offshore Mining and BP. The current participants in Maui are:

• Shell 18.75%
• Todd 12.5%
• Fletcher Challenge 68.75%

The principal intended use of Maui gas was as a fuel source for a series of thermal power stations that the Crown intended to construct first at Huntly (approximately 20 kilometres to the north of Hamilton) and two large new power stations in Auckland. The contractual arrangement called for the construction of a high pressure gas transmission network connecting the field to the power station in Huntly and envisaged an extension of that pipeline to Auckland.

The contract specified an initial term of 30 years from the date of first delivery. The Annual Quantities commenced at 40 PJ but with progressive increases through to a plateau period of approximately 169 PJ per annum from 1987 until 2000. The contract also established a regime whereby the buyer has great flexibility in its off-take entitlement in the form of a maximum daily quantity that is 150% of the specified daily quantities.

As was typical then, and still is, the developers of the field needed some assurance that they would be receiving adequate cashflows from the buyer sufficient to finance the very considerable development costs. The result was a significant take or pay commitment entered into by the Crown which, in the case of Maui, was a commitment to take in every year an amount equal to the contracted Annual Quantity.

The price of Maui gas was also vigorously debated but a regime was eventually settled involving an initial gas price of about 35 cents per GJ with an escalation regime of the greater of either 50% of the inflation rate on the inflation rate less 3%. The current price of Maui Gas (before allowing for the Energy Resources levy) is approximately $1.51 per GJ.

Within a few years of the contract being signed, problems arose.

The Maui Mining Companies' eventual cost in installing the platform and constructing the pipeline network proved to be much higher than was originally estimated.

It quickly became apparent that the Crown's forecasts for electricity demand had been overstated with the result that there would be no need to build two new power stations in Auckland. The contractual result was that the Crown found itself facing the likelihood of a very substantial take or pay deficit in each year of the contract.

As all this was happening the world experienced the dramatic oil shocks of the mid and late 1970s which very substantially increased the potential value of the condensate revenues from the field for the Maui Mining Companies. But from the moment deliveries of Maui gas first commenced in 1979 the Crown could not take gas at the contracted Annual Quantities and was therefore obligated to pay for substantial quantities of gas that it had not taken. Though this was financially painful for the Crown it also had significant adverse financial consequences for the Maui Mining Companies who, because gas was not taken, were not able to access the associated condensate and thus were deprived of a considerable source of revenue that they may otherwise have expected to receive.

Be that as it may, the Crown clearly did not wish to have on going take or pay obligations with little prospect of being able to gain access to pre-paid gas in subsequent years. Accordingly it set about investigating any possible usage of its Maui gas purchase commitments.

The result of these investigations was the construction of three significant petrochemical plants - something which, when the Maui White Paper published in 1973, was not considered a viable proposition. The three plants were:

• A chemical grade methanol plant at Waitara Valley to be operated by Petralgas New Zealand - a Canadian company. Since then, and as a result of a series of acquisitions, this plant has been acquired by Methanex Corporation.
• An ammonia urea plant also in Taranaki. This plant is now owned by Bay of Plenty Fertiliser, a subsidiary of Fernz Corporation.
• The most ambitious programme - a large scale gas to gasoline plant to be built at Motunui. This plant is also now owned by Methanex Corporation.

The combined usage of gas for these plants, in conjunction with gas taken for domestic reticulation, industrial users and electricity production was still below the total take or pay obligation of the Crown but at least the take or pay obligation had become more manageable for the Crown. Nevertheless, by the time of the first deliveries of large quantities of Maui gas to the Synfuels plant at Motunui, the Crown had already accumulated a substantial pre-paid gas balance.

Some aspects of the original contractual arrangements for the supply of gas to the petrochemical plants were unusual.

Gas supplied to the ammonia urea plant was purchased from NGC (which at that time was part of the state owned company, Petrocorp) which sourced the gas partly from Maui and partly from Kapuni. Gas supplied to the chemical grade methanol plant at Waitara Valley was also purchased by Petralgas directly from the Crown pursuant to a lengthy gas contract arrangement signed in 1980.

However, the largest consumer of Maui gas, namely gas to gasoline plant did not purchase Maui gas. Instead the Crown became the 75% owner of a company which owned and operated the plant which in turn processed the gas into gasoline for the Crown on a tolling fee basis. The Crown in effect became a gasoline trader.

Throughout this period NGC gradually expanded the use of natural gas for domestic and industrial purposes throughout New Zealand and progressively extended the high pressure gas transmission network. However, as originally envisaged, gas use by NGC was never expected to be and has not become the major consumer of Maui gas. There has been extensive use of Maui gas as a fuel for the thermal power stations operated by the then New Zealand Electricity Department but, as noted above, the volumes taken for this purpose have never been at the levels originally envisaged.

By 1990 the contractual arrangements for Maui gas could be summarised as:

• The Maui gas contract between the Maui Mining Companies and the Crown dated 1 October 1973.
• A contract between the Crown and NGC for the supply of gas to NGC for NGC to sell at both the wholesale and retail levels of the gas market.
• A contract for the sale of Maui gas by the Crown to Petralgas for conversion to methanol.
• A tolling fee arrangement whereby New Zealand Synthetic Fuels Corporation processed the Crown's Maui gas into synthetic gasoline.

By 1990 approximately 40% of Maui gas was being burned at thermal power stations, initially owned directly by the Crown but from 1987 by a State owned enterprise, Electricity Corporation of New Zealand Limited ("ECNZ"). The contractual arrangements for the purchase of gas by ECNZ post 1987 were informal only - no formal agreement was signed in this period.

By 1990 it was apparent that with the collapse of the world price of oil, the gas to gasoline plant, while a technical success, was resulting in the Crown being the possessor of very expensive petrol. The Crown also had very substantial debt servicing costs associated with the construction of the plant. The Crown became determined to terminate the ongoing cash haemorrhage it was otherwise suffering. The end result of yet further months of negotiation and discussions were a series of contracts pursuant to which the Crown formalised its gas supply arrangements with ECNZ and otherwise onsold its entire entitlement to Maui gas.

However, and despite all this contractual activity on the part of the Crown, there is still only one contract for the sale of Maui gas and that is the 1973 gas contract between the Maui Mining Companies and the Crown. That contract has been amended in a number of relatively minor ways but is still almost the same document as originally tabled in Parliament in 1973. To this day it remains the most important gas contract in the New Zealand gas environment. Almost all gas users who have Maui gas ultimately depend upon the rights and obligations that arise under that original contract.

The 1990 Gas Contracts

As noted earlier, by 1990 there was a need for the Crown to rationalise its position as the purchaser of all Maui gas. The central problem for the Crown was disposing of its involvement, in the gas to gasoline plant but, in addition, the Crown wished to cease its involvement, so far as it practicably could, with respect to all ongoing purchases of Maui gas. The result of considerable negotiations between affected parties was a series of contracts entered into in 1990. While a number of contracts were concluded the key contractual arrangements can be summarised as follows:

• The Crown and New Zealand Liquid Fuels Investments Ltd entered into a new gas purchase arrangement whereby NZLFI acquired part of the Crown's share of Maui gas for the purpose of having that gas processed at the Motunui gas to gasoline plant. NZLFI had previously been the Crown's corporate vehicle for investing in New Zealand Synthetic Fuels Corporation but, as part of the overall 1990 arrangements, Fletcher Challenge Limited also acquired the Crown's interest in NZLFI and therefore became the purchaser of gas for processing at Motunui. NZLFI has since assigned its gas purchase rights to Methanex Motunui Limited and the plant itself has been sold to Methanex.
• A formal agreement was concluded between the Crown and ECNZ allocating to ECNZ a further part of the Crown's right to purchase Maui gas. ECNZ's entitlements have since been assigned to Contact Energy Limited ("Contact").
• An agreement amending the purchase entitlements of NGC of Maui gas from the Crown which included a separate (but related) arrangement whereby NGC purchased in the form of one lump sum advance payment much of the Crown's accumulated Maui prepaid gas entitlement.
• An amendment to the contract purchase entitlements of Petralgas into a contract substantially similar to the purchase entitlements of NZLFI, NGC and ECNZ. Petralgas has since assigned its gas purchase rights to Methanex Waitara Valley Limited. Methanex now owns and operates both the methanol plant at Waitara Valley and the methanol/synfuel plant at Motunui.

The main contractual terms for the above arrangements were intended, as far as was possible, to be compatible. Elaborate mechanisms were established in the contracts whereby the Crown's rights under its Maui contract were allocated to each of the purchasers from the Crown. The Crown had a clear commercial objective in endeavouring to "mirror" any obligation it would have to the Maui Mining Companies to a similar obligation to be owed to the Crown under its 1990 downstream sale arrangements. The Crown considered that its arrangements were, in all material respects, "back to back" (whatever that means) to the Crown's Maui purchase obligations.

The Crown allocated between each of the 1990 downstream purchasers the remaining reserves in the field as assessed from a 1989 perspective (with commensurate take or pay obligations), as follows:

• Contact 2.7905%
• NZLFI 0.5062%
• NGC 7.4725%
• Petralgas .2308%

For the sake of clarity it should be noted that NZLFI and Petralgas are now both Methanex subsidiaries with the result that the aggregate Methanex entitlement is fixed at 29.737%.

The end result of these arrangements is that the Crown has distributed to each of the downstream purchasers all of its take or pay obligations, all of its prepaid gas entitlements and has distributed its total quantity entitlements to each of the downstream purchasers.

The manner in which the Crown has done so is not entirely consistent as between each of the downstream purchasers so that, for example, NZLFI and Contact have different MDQ entitlements and the take or pay commitments of each downstream purchaser are different. Similarly, the mechanisms for gaining access to prepaid gas entitlements which the Crown has as against the Maui Mining Companies are not dealt with in the same way for each of the Crown's customers.

Annual Quantity entitlements are also different. Thus the collective Annual Quantity entitlements of the Methanex purchase arrangements commenced at a high level (about 67 PJ per annum) but slowly decline and cease in 2003. NGC's entitlement remains relatively constant (about 35 PJ per annum) until 2000 and then slowly declines until 2009 to coincide with the decline and termination of the Maui contract. Contact has high Annual Quantity entitlements initially (65 PJ in 1996) and also then slowly declines until termination in 2009. The overall effect is to match the individual Annual Quantity entitlements of the 1990 downstream purchasers to the Annual Quantity delivery profile in the Maui contract.

Accordingly, the Crown now considers that it has neatly exited from its Maui gas purchase obligations. But, this is not entirely the case. The only contract that relates directly to the sale of Maui gas remains the 1973 contract between the Crown and the Maui Mining Companies. No amendment was made to that contract to accommodate any of the provisions included in the 1990 downstream arrangements. If there is any default in gas uplift by any of the 1990 downstream purchasers only the Crown has a take or pay liability under the Maui contract - that liability has not been assigned to any other party - rather the Crown has secured obligations from other parties that in aggregate account for all its take or pay liability.

Equally clear is that all of the Crown's gas purchase entitlements and obligations are now accounted for. The Crown has no more Maui gas to sell. Thus, unless Maui reserves are substantially upgraded all Maui gas is contractually committed.

Go to Part B