Hey Crude - Estimating Rates for New Crude Oil Pipelines

Many factors are weighed before a midstream company commits to building, or a shipper commits to shipping on, a major crude oil pipeline. Where is incremental pipeline capacity needed? What would be the logical origin and terminus for the pipeline? What should the project’s capacity be, and what would be the capital cost of building the project? Where the economic rubber really meets the road is the question of what unit cost––or rate per barrel––would the pipeline developer need to charge to recover its costs and earn a reasonable rate of return on its investment. Today we continue our review of crude oil pipeline economics with a look at the rules-of-thumb for determining what pipeline transportation rates would be.

In Part 1 of this series we discussed the fact that new pipeline development is driven by either need or opportunity, and more often than not, a combination of the two. The key question that pipeline developers and their customers (the shippers) have to consider before committing to build new capacity, we said, is whether it will “pay” to flow crude on the pipeline once it’s built––not just the first year or the first three, but for years if not decades to come. To answer this question, pipeline developers and shippers have to consider both current and future economics. There are three fundamental factors that drive pipeline economics: 1) future supply dynamics (and the resulting price impact) at the origination point (Point A); 2) future demand (and price) at the destination point (Point B); and 3) the transportation cost to flow crude from Point A to Point B. In Part 2, we focused on estimating capital costs. We went through a geometry exercise to confirm an already-popular industry rule-of-thumb for estimating the diameter of the pipe to reach a certain capacity. We also explained and used a “cost per inch-mile” approximation to figure out what the pipe itself would probably cost, then included standard rough estimates of the cost for everything else: the pumps, storage, and meters necessary for the pipeline to work.  We confirmed those numbers by reviewing some pending new projects, and ultimately got to the example of a 200-Mb/d crude oil pipeline 500 miles long costing $990 million to build.   

Today, we get to the heart of the matter: What per-barrel rate needs to be charged for a pipeline project to be worthwhile to the developer? And––just as important––would the rate be low enough to attract sufficient commitments from crude oil shippers? One preliminary warning: We noted that this series on oil pipeline economics is similar in a lot of ways to our But I Would Pipe 500 Miles series on the economics of natural gas pipelines. As in that effort, our aim is to present simple, rule-of-thumb approaches to determining whether an oil pipeline project might be worth pursuing, not to undertake the detailed engineering analysis that would be needed to really develop one. So ours is the calculation that tells you whether to think more about a prospective project, not the calculation that would get someone to give you $990 million to build a 200-Mb/d, 500-mile pipeline—that takes a bunch of engineers and estimators.

Now to the task of estimating our per-barrel rate. In addition to knowing the capacity and capital cost of the pipeline, we need to know a couple of other important things to be able to establish what the pipeline’s rate would be. First, we need to know the operating costs––the annual out-of-pocket cost of actually running the pipeline (sometimes including having to heat the pipeline––or add diluent or lubricant––to keep heavy oil flowing). Second, we need to recognize that the pipeline won’t always run at full capacity.  If it will charge by the barrel that actually flows, we need to estimate the pipeline’s “load factor,” or the average flow divided by the capacity.