The Office of the Chief Accountant (OCA) Associate Chief Accountant, Jonathan Duersch, recently addressed the application of the “normal purchases and normal sales” (NPNS) scope exception under derivative accounting rules for specific forward natural gas sales contracts. This discussion is particularly relevant given the evolving pricing structures in the liquified natural gas (LNG) market.
Key Takeaways from the SEC’s NPNS Analysis
Market Evolution
The expansion of the LNG market has led to new pricing terms in natural gas contracts. A notable example involves contracts for U.S.-produced and delivered natural gas which is priced using the Dutch Title Transfer Facility (TTF) index with a fixed percentage discount. Such pricing is uncommon in the U.S. market.
Accounting Criteria
Under ASC 815 (Derivatives and Hedging), for a contract to qualify for the NPNS scope exception, any price adjustments must be “clearly and closely related” to the asset being sold (see ASC 815-10-15-30 through 15-33).
SEC Staff Evaluation
The SEC staff considered whether:
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- Other market participants use similar pricing terms for natural gas sales in the same U.S. location.
- The pricing reflects the cost of delivering natural gas to Europe, including liquification, transport, and regasification costs.
- The fixed percentage adjustment to the TTF index reasonably approximates these delivery costs.
Judgment and Transparency
The assessment does not require sellers to consider the buyer’s ultimate use of the gas. Instead, it focuses on whether the pricing components known to the seller align with delivery into the relevant European market. The SEC staff concluded that, in this scenario, pricing based on the TTF index with a fixed percentage reduction is “clearly and closely related” to the natural gas being sold.
Conclusion
The SEC staff would not object to treating such contracts as qualifying for the NPNS scope exception. However, Mr. Duersch emphasized that significant judgment is required, especially for transactions in new or emerging markets with limited transparency.
Implications
This guidance provides clarity for entities entering into forward natural gas sales contracts with unconventional pricing terms, particularly those linked to international indices. It underscores the importance of evaluating the relationship between pricing mechanisms and the underlying asset, and the need for careful judgment in applying accounting exceptions in evolving markets.
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