|November 26, 2012|
Previously published on November 2012
On November 14, 2012, the CFTC's Office of General Counsel (the "OGC") issued guidance on whether it would classify certain physical commercial agreements for the supply and consumption of energy as commodities options under the Swaps Rules jointly adopted by the CFTC and SEC. More specifically, the OGC clarified its view of the CFTC's interpretation of the three-part test in the Swaps Rules for determining when certain physical commercial agreements (e.g., tolls on power plants, transportation agreements on natural gas pipelines, and natural gas storage agreements) should not be classified as commodity options.
Under the Swaps Rules, the CFTC stated it would interpret an agreement not to be a commodity option if three elements are satisfied: (1) the subject of the agreement, contract or transaction is usage of a specified facility or part thereof rather than the purchase or sale of the commodity that is to be created, transported, processed or stored using the specified facility; (2) the agreement, contract or transaction grants the buyer the exclusive use of the specified facility or part thereof during its term, and provides for an unconditional obligation on the part of the seller to grant the buyer the exclusive use of the specified facility or part thereof; and (3) the payment for the use of the specified facility or part thereof represents a payment for its use rather than the option to use it. In the Swaps Rules, the CFTC also included an interpretation related to facility usage contracts in respect of this three-part test that entail separate payments for both fixed costs (e.g., a demand charge or reservation fee) and variable costs (e.g., storage fees, usage fees or rents).
In responding to questions to commentators about this interpretation, the OGC stated that agreements, contracts or transactions in which the buyer pays for a commodity in two parts, paying the seller's fixed/known costs upfront and the seller's variable costs associated with that commodity later once those costs are established or incurred, would not be considered a commodity option under the Swaps Rules. More specifically, in the OGC's view, if (1) a facility usage agreement, contract or transaction includes a two-part fee structure, (2) the right to use the specified portion of the facility for the term of the agreement, contract or transaction is legally established upon entering into the agreement, contract or transaction, (3) the party who has legally established the right to use the specified portion of the facility for the term of the agreement, contract or transaction pays any fixed price in the contract that typically track fixed costs in a commercially reasonable timeframe, (4) the use of the facility does not depend on the further exercise of an option and (5) the variable price in the contract that typically track variable/use-related costs is in the nature of a reimbursement for the variable costs incurred by the operator of the facility in rendering the service, such a facility usage agreement, contract or transaction is not an option and is not intended to be covered by the CFTC's interpretation about facility usage contract.
In short, the OGC stated that a facility usage agreement, contract or transaction with a two-part fee structure should meet the conditions above in order to be considered a forward rather than a commodity option subject to regulation by the CFTC. The OGC was also careful to remind market participants that even if an agreement, contract or transaction is a forward, not an option, it is not wholly excluded from the Commodity Exchange Act or the CFTC's regulations for all purposes, including with respect to the CFTC's residual anti-fraud, anti-manipulation and other authority over forwards.