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5.2 Physical natural gas storage
Publication date: 23 Feb 2024
us Utilities guide
In a basic physical natural gas storage arrangement, natural gas is injected into a storage facility and is withdrawn based on terms and at intervals agreed with the storage owner as depicted in Figure UP 5-1.
Figure UP 5-1
Basic physical natural gas storage arrangement
Basic physical natural gas storage arrangement
The owner of the natural gas storage (herein referred to as the “storage owner” or “transporter”) is not entitled to sell or loan the natural gas but is obligated to store the natural gas for the customer (shipper). The storage owner earns a service fee for the shipper’s injection, storage, and withdrawal of the natural gas. The storage agreement specifies the storage location, duration, limits on injections and withdrawals, maximum storage capacity, and other terms.
5.2.1 Accounting for natural gas storage arrangements
A physical natural gas storage arrangement should be evaluated using the commodity contract assessment framework (see UP 1). After identifying the contract deliverables, the parties should first determine whether the storage agreement contains a lease. If the contract does not contain a lease, the reporting entity should next assess whether it is a derivative in its entirety. Unless the contract is a derivative in its entirety, a reporting entity should consider whether the contract contains any embedded derivatives requiring separation from the host contract. If neither lease nor derivative accounting apply, the parties should account for the physical natural gas storage agreement as an executory contract (i.e., on an accrual basis). The accounting model applied impacts initial and subsequent recognition and measurement as discussed in the following sections.
5.2.1.1 Lease accounting
ASC 842 provides guidance for determining whether an arrangement is or contains a lease.
Excerpt from ASC 842-10-15-3
A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. A period of time may be described in terms of the amount of use of an identified asset (for example, the number of production units that an item of equipment will be used to produce).
Accordingly, an agreement should be accounted for as a lease only if it conveys the right to use an identified asset, which must be physically distinct and may be an entire asset or a portion of an asset, as discussed in ASC 842-10-15-16.
Excerpt from ASC 842-10-15-16
A capacity portion of an asset is an identified asset if it is physically distinct (for example, a floor of a building or a segment of a pipeline that connects a single customer to the larger pipeline). A capacity or other portion of an asset that is not physically distinct (for example, a capacity portion of a fiber optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset.
Once a reporting entity concludes that an arrangement involves an identified asset, it must evaluate whether the agreement conveys the right to control that asset. In accordance with ASC 842-10-15-4, an arrangement conveys control of an asset if the customer has both of the following:
- The right to obtain substantially all of the economic benefits from use of the identified asset
- The right to direct the use of the identified asset
Many contracts for physical natural gas storage specify a storage facility. An agreement that conveys the right to use the entire storage facility will likely contain a lease. In contrast, if an agreement conveys only a portion of the capacity of the storage facility, it will generally not contain a lease because it would not contain an identified asset. For example, a storage agreement that provides the shipper with all of the storage capacity of a particular facility for a period of time may be a lease (if the criteria in ASC 842-10-15-4 are met), whereas an agreement for only 25% of the capacity likely is not as the capacity is not considered physically distinct in the context of the overall facility.
See UP 2 for further information on determining whether an arrangement contains a lease.
If the contract does not contain a lease, the parties should then consider whether the contract is a derivative in its entirety or includes an embedded derivative.
5.2.1.2 Derivative accounting
A natural gas storage contract that specifies a storage facility provides the customer with temporary use of a portion of the storage facility (similar to renting space in a building). Derivative accounting typically does not apply to this type of contract because the net settlement criterion is not met. Nonetheless, the parties should evaluate whether a natural gas storage contract is a derivative in its entirety in accordance with the criteria in ASC 815-10-15-83. Figure UP 5-2 highlights the evaluation considerations for a typical natural gas storage agreement.
Figure UP 5-2
Does a typical physical natural gas storage agreement meet the definition of a derivative?
Does a typical physical natural gas storage agreement meet the definition of a derivative?
Guidance |
Evaluation |
Comments |
|---|---|---|
Notional amount
and underlying |
Met
|
|
No initial net
investment |
Met
|
|
Net settlement
|
Generally not met
|
|
In general, we would not expect a contract for physical natural gas storage to be accounted for as a derivative in its entirety because it fails the net settlement criterion.
Net settlement. The contract can be settled net by any of the following means:
- Its terms implicitly or explicitly require or permit net settlement.
- It can readily be settled net by a means outside the contract.
- It provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement.
However, developing markets for physical natural gas storage in some parts of the United States and Canada could change that conclusion in certain locations. Because it is the storage agreement being assessed, the evaluation is based on whether storage itself has the characteristic of net settlement. The fact that the natural gas in storage may have the characteristic of net settlement (i.e., the natural gas may be readily convertible to cash) has no bearing on this evaluation.
Factors to consider in assessing whether physical storage contracts for a specified storage facility meet the net settlement criterion are discussed in the following paragraphs. See UP 3.2.3 for further information on the overall application of the net settlement criterion. See UP 5.3 for information about virtual storage.
Net settlement under contract terms
When evaluating whether the net settlement criterion is met, a reporting entity should first consider whether the contract terms explicitly or implicitly provide for net settlement of the entire contract. Natural gas storage contracts related to the use of a specified facility typically do not permit explicit net settlement. However, the type of contract and its terms should be reviewed for any implicit net settlement terms or liquidating damage provisions, which may imply that the contract could be net settled.
Net settlement through a market mechanism
In this form of net settlement, one of the parties is required to deliver an asset, but there is an established market mechanism that facilitates net settlement outside the contract. ASC 815-10-15-110 through 15-116 provide guidance on indicators to consider in assessing whether an established market mechanism exists. A key aspect of a market mechanism is that one of the parties to the agreement can be fully relieved of all of its rights and obligations under the contract. We are not aware of any markets that allow for net settlement of contracts for natural gas storage in the United States such that a provider has the ability to be relieved of its full rights and obligations under a previously executed contract.
Net settlement by delivery of an asset that is readily convertible to cash
Whether there is an active spot market for the particular asset being sold under the contract is the key factor in assessing whether an asset is readily convertible to cash. Current market conditions should always be considered in this analysis. To be deemed an active spot market, a market must have transactions with sufficient frequency and volume to provide pricing information on an ongoing basis. In addition, quoted prices from that market should be readily available on an ongoing basis. See UP 3.2.3.3 for further information on the determination of whether a market is active.
Overall conclusion
We are not aware of a market mechanism or active spot market for natural gas storage in the US, and thus we believe that derivative accounting is generally not applicable to these contracts. However, a reporting entity should evaluate all facts and circumstances in concluding on the appropriate accounting for a specific natural gas storage contract. In addition, a reporting entity should monitor its conclusion each reporting period because markets evolve, potentially rendering this type of contract a derivative. Reporting entities also should evaluate the contract to determine if there are any embedded derivatives that require separation from the host contract (assuming the contract does not meet the definition of a derivative in its entirety). See UP 3.4 for information on evaluating embedded derivatives.
Reporting entities may also consider conditionally designating physical natural gas storage agreements under the normal purchases and normal sales scope exception if physical delivery is probable throughout the life of the contract and the other criteria for application of this exception are met (ASC 815-10-15-22 through 15-51, as applicable). If a conditionally designated normal purchases and normal sales contract meets the definition of a derivative at a later date, it would be accounted for as a normal purchases and normal sales contract from the time the contract becomes a derivative. Absent such a designation, the reporting entity would be required to recognize the contract at fair value at the time the contract is determined to be a derivative. See UP 3.3.1 for further information on the normal purchases and normal sales scope exception.
5.2.1.3 Executory contract accounting
We would generally expect a physical natural gas storage agreement to be accounted for as an executory contract. In such cases, reporting entities should also evaluate whether there are any embedded derivatives (e.g., pricing mechanisms) that require separation from the host contract (see UP 3.4 for information on evaluating embedded derivatives).
In accounting for a natural gas storage contract following an executory contract model, the shipper should expense the cost of storage as a period cost when incurred. The storage owner should recognize revenue from storage fees over the period of the contract in accordance with the revenue guidance. See UP 5.2.2 for a discussion of the impairment considerations associated with natural gas in storage and other natural gas inventory.
Application examples — natural gas storage agreements
The following examples provide guidance on how reporting entities should account for natural gas storage.
EXAMPLE UP 5-1
Shipper’s accounting for a physical gas storage agreement
Shipper’s accounting for a physical gas storage agreement
Effective April 1, 20X1, Ivy Power Producers (IPP) enters into a natural gas storage agreement with Guava Gas Company (GGC). The storage location and other key terms are specified in the agreement. On May 1, 20X1, IPP purchases 10,000 MMBtus of natural gas for $4.00/MMBtu on the spot market and injects the natural gas into the GGC storage facility. IPP is required to withdraw the natural gas on December 1, 20X1. The storage facility’s total capacity is 100,000 MMBtus of natural gas. IPP pays a storage fee of $2,000 per month, regardless of the amount stored.
For purposes of this example, the spot and forward prices (forward price for delivery in December 20X1) of natural gas are as follows ($/MMBtu):
Date |
Spot |
Forward |
|---|---|---|
May 1, 20X1
|
$4.00
|
$5.00
|
June 1, 20X1
|
4.00
|
4.75
|
June 30, 20X1
|
3.00
|
4.50
|
September 30, 20X1
|
3.50
|
5.50
|
December 1, 20X1
|
6.00
|
—
|
IPP’s cost of the natural gas injected is $4.00/MMBtu. On December 1, 20X1, IPP withdraws the natural gas and sells it on the spot market.
How should IPP account for the natural gas held in storage, as well as the expenses associated with this agreement?
Analysis
IPP would conclude that the natural gas storage agreement does not contain a lease because the contract is for use of only a portion of the facility, meaning it is not physically distinct and therefore, there is not an identified asset under ASC 842-10-15-4.
Further, IPP would conclude that the arrangement does not contain a derivative because there is no active spot market for natural gas storage and the contract does not contain any other net settlement provisions. The storage agreement would be accounted for as an executory contract and the stored natural gas would be included in IPP’s inventory.
IPP would record the following journal entries to account for the storage of natural gas in inventory and the expenses associated with this agreement (amounts in $000s).
Date |
Journal entries |
Cash |
Fuel inventory |
Fuel revenue |
Fuel expense |
|---|---|---|---|---|---|
04/01
|
Record initial storage fee at contract inception
|
($2)
|
$2
|
||
05/01
|
Initial purchase of inventory (10,000 × $4.00/MMBtu)
|
($40)
|
$40
|
||
Monthly
|
To record storage fees
($2,000 per month x 7months) |
($14)
|
$14
|
||
12/01
|
To record the sale of natural gas inventory (10,000 × $6.00 spot)
|
$60
|
($40)
|
($60)
|
$40
|
Total
|
$4 |
$- |
($60) |
56 |
It is assumed that no lower of cost and net realizable value adjustment to inventory was necessary. However, IPP would need to assess the carrying value in periods of declining prices. Refer to UP 5.2.2.2.
In addition, this example assumes that the natural gas was sold in the spot market at the time it was withdrawn from storage and revenue is therefore presented at the gross selling price. However, IPP would assess whether in the context of their business whether the sale would be considered part of their trading activities (see UP 3) or an exchange of inventory to facilitate sales to a customer (see UP 11).
No journal entries would be recorded by IPP when it first enters into the agreement (April 1, 20X1), other than payment of storage fees which should not be added into the cost of inventory, because the natural gas storage agreement is an executory contract and there is no activity at that date. In addition, no journal entries are needed to reflect the injection into storage; natural gas in storage is reflected as part of a reporting entity’s fuel inventory.
EXAMPLE UP 5-2
Storage owner’s accounting for a physical natural gas storage agreement
Storage owner’s accounting for a physical natural gas storage agreement
Effective April 1, 20X1, Ivy Power Producers (IPP) enters into a natural gas storage agreement with Guava Gas Company (GGC). The storage location and other key terms are specified in the agreement. On May 1, 20X1, IPP purchases 10,000 MMBtus of natural gas for $4.00/MMBtu on the spot market and injects the natural gas into the GGC storage facility. IPP is required to withdraw the natural gas on December 1, 20X1. The storage facility’s total capacity is 100,000 MMBtus of natural gas. IPP pays a storage fee to GGC of $2,000 per month, regardless of the amount stored.
For purposes of this example, the spot and forward prices (forward price for delivery in December 20X1) of natural gas are as follows ($/MMBtu):
Date |
Spot |
Forward |
|---|---|---|
May 1, 20X1
|
$4.00
|
$5.00
|
June 1, 20X1
|
4.00
|
4.75
|
June 30, 20X1
|
3.00
|
4.50
|
September 30, 20X1
|
3.50
|
5.50
|
December 1, 20X1
|
6.00
|
—
|
IPP’s cost of the natural gas injected is $4.00/MMBtu. On December 1, 20X1, IPP withdraws the natural gas and sells it on the spot market.
How should GGC, the storage owner, account for the natural gas held in storage, as well as the revenue from this arrangement?
Analysis
GGC would not record any journal entries when the natural gas inventory is physically received or when it is physically withdrawn from storage because it does not own the natural gas. Title to the natural gas remains with the shipper (IPP in this case) during the storage period, so GGC would not recognize an asset on its balance sheet for natural gas held for a third party. GGC should record revenue as it satisfies its performance obligation to store the gas over the contract period (i.e., monthly) in accordance with the provisions of ASC 606. Refer to RR 6.3.
If GGC had the right to use and then replace the gas at a later date, the accounting for a “physical park-and-loan” transaction would apply (see UP 5.4.1).
5.2.2 Accounting for natural gas held in storage
Reporting entities may hold natural gas in inventory (“working gas”), as well as gas held in storage fields that is not intended for sale, but is required for efficient and reliable operation of the facility (“base” or “cushion” gas). The nature and intended use of natural gas held by a reporting entity will impact its balance sheet classification, as well as the impairment model used in subsequent accounting.
5.2.2.1 Balance sheet classification
Figure UP 5-3 highlights considerations in determining the balance sheet classification of natural gas held in storage.
Figure UP 5-3
Balance sheet classification of natural gas
Balance sheet classification of natural gas
Category |
Description |
Classification |
|---|---|---|
Working gas
|
|
Inventory
|
Base or cushion gas
|
|
Generally classified as part of property, plant, and equipment; represents a permanent investment necessary to use a storage facility and maintain reliability
|
Any volumes held in excess of amounts required for system deliverability or system balancing are considered natural gas for resale and should be classified as inventory.
5.2.2.2 Impairment considerations
Natural gas held in storage is subject to potential impairment. The impairment model applied will vary depending on whether the natural gas is classified as part of inventory or as property, plant, and equipment.
Natural gas classified as inventory
Natural gas classified as inventory is subject to the inventory accounting guidance in ASC 330, Inventory. Natural gas prices are volatile and a reporting entity that owns natural gas inventory may need to assess whether a lower of cost and net realizable value (NRV) adjustment to its carrying value is necessary as of the reporting date. See INV 1.3.2 for information on evaluating lower of cost and NRV adjustments for inventory. See also UP 11.6 for information on additional inventory considerations for regulated utilities.
Natural gas classified as part of property, plant, and equipment
Natural gas classified as property, plant, and equipment (such as base or cushion gas necessary for a facility to operate) should be accounted for and evaluated for impairment in accordance with the general guidance for plant. See UP 12 for further information.
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