Book 2: Chapter 2 Economic Planning for New Pipelines

Objectives After reading the chapter and reviewing the materials presented the students will be able to: Understand economic justification Identify pipeline ownership Describe technological considerations Explain factors affecting cost Classify measures of profitability Examine use of computers in economic planning

Introduction Before orderly production practices were common, the shortest practical route between the oil field and the nearest suitable pipeline, refinery, sea, or river port was chosen. Pipe in one of the few standard sizes available was ordered and the pipeline hurriedly built. About 1930, stronger pipe became available, and field welding of pipe joints was perfected. Pipelines could then be built in larger sizes and operated at higher pressures. Some of the systems built prior to 1930 are still in use.

Economic Justification A group of oilfields in an area may be capable of producing more oil than existing facilities can transport. An existing or proposed refinery may need a more dependable or greater supply of crude oil. New pipeline systems are needed to supply new markets or replace one or more existing systems. Some of the older systems cannot be modernized to meet the economics, safety, and control that can be built in new systems.

Pipeline Sizes Once the need for a pipeline system is recognized, it is important to determine the maximum size of pipeline that can be justified. The lower unit shipping cost resulting from increased pipe size and carrying capacity, make it desirable to obtain commitments for transport of the maximum available quantity of oil. The lower construction, operating, and maintenance cost per unit, reduces transportation costs to shippers.

Pipeline Ownership Shippers of crude oil are usually companies that buy or buy oil to supply their own refineries. An undivided interest system can be described as one pipeline system wherein each participant owns a percentage of the capacity of the pipeline and is responsible for a corresponding percentage of the capital cost and the fixed operating cost. When a separate corporation is formed to own and operate a multiple interest system, the various parent companies have stock ownership in approximate proportions to their expected use of the pipeline. A third form of organization is each company building its own system. The upper limit of current pipelines is 48 inches in diameter which can ship two million barrels a day.

Technological Considerations Economic studies are expensive and time consuming and should include only those factors pertinent to the situation under study. Management may have technologists analyzing alternative modes of transportation such as tanker or barge shipment. Various alternative plans are developed and compared so that specific proposals can be submitted to management for approval. The quantities and types of oil are determined from the best forecasts available.

Route Selection as a Cost Factor Route selection for the main trunk pipeline is a major item in planning. The desire to route the pipeline to or near intermediate supply or delivery locations and various other factors affect route selection. Ecological considerations are an ever increasing influence on the design of and rights of way selection for pipelines.

Other Factors Affecting Cost As pipe diameter increases, cost increases approximately linearly. As pipe diameter increases, capacity increases exponentially. Right of way costs and labor costs for various pipeline projects are apt to vary widely from one job to another. Weather conditions also affect construction costs. For a given route, the cost of construction will increase linearly with pipe diameter.

Measures of Profitability When construction costs have been estimated and capital requirements determined, the income required to make the venture profitable can be calculated. Income is derived from charging for movement of oil through the pipeline system. Additional income is sometimes obtained for performing services such as storing or blending oil. The payback period of a project is the length of time required for the investment to generate an amount of cash equal to its original cost. It does not take into account the time value of money. Rate of return and present value profit method will give adequate long range views of profit.

Use of Computers in Economic Planning Computers make possible fast solutions to many complex problems associated with economic analysis. Economic studies of a proposed project provide company management the best available basis for deciding whether the supply and demand conditions justify the project. Capital requirements, available revenues, tariffs, and profitability are included. Proof of profitability are often needed to obtain outside financing, to explain company action to stockholders, and to obtain required permits from governmental regulatory agencies.

Summary Before orderly production practices were common, the shortest practical route between the oil field and the nearest suitable pipeline, refinery, sea, or river port was chosen. New pipeline systems are needed to supply new markets or replace one or more existing systems. The lower unit shipping cost resulting from increased pipe size and carrying capacity, make it desirable to obtain commitments for transport of the maximum available quantity of oil. An undivided interest system can be described as one pipeline system wherein each participant owns a percentage of the capacity of the pipeline and is responsible for a corresponding percentage of the capital cost and the fixed operating cost. When a separate corporation is formed to own and operate a multiple interest system, the various parent companies have stock ownership in approximate proportions to their expected use of the pipeline. A third form of organization is each company building its own system. The upper limit of current pipelines is 48 inches in diameter which can ship two million barrels a day. Route selection for the main trunk pipeline is a major item in planning. As pipe diameter increases, cost increases approximately linearly. As pipe diameter increases, capacity increases exponentially. The payback period of a project is the length of time required for the investment to generate an amount of cash equal to its original cost. Proof of profitability are often needed to obtain outside financing, to explain company action to stockholders, and to obtain required permits from governmental regulatory agencies.

Home Work 1. Why do we want to build the maximum size of pipeline that can be justified? 2. What is the upper limit of current pipelines and how much can we ship in a day? 3. What is the relationship between diameter of pipe and cost and capacity? 4. Why do we need proof of profitability?