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Vol. 19, No. 10 Week of March 09, 2014
Providing coverage of Alaska and northern Canada's oil and gas industry

Some SR costs struck

FERC admin law judge finds upgrading initiative ‘imprudent’; requires refund

Eric Lidji

For Petroleum News

The Federal Energy Regulatory Commission is requiring the owners of the trans-Alaska oil pipeline to refund a portion of the interstate shipping rates collected in recent years because some of the costs associated with a major upgrading initiative were “imprudent.”

According to the evidence from a long hearing, “the project is not used and useful and does not provide any discernable benefits to shippers through personnel reductions, reduced major maintenance, enhanced reliability, additional throughput capability, or any other criteria. The project does not provide an enhanced level of service to ratepayers,” FERC Administrative Law Judge Carmen Ana Cintron wrote in a Feb. 27 ruling.

The initial ruling gives the owners of the pipeline 30 days to establish new rates and to refund most of the cost overruns collected through rates to date and going forward.

The beneficiaries of the refund include third parties like the independent producer Anadarko Petroleum Corp., the oil refiner Tesoro Alaska Corp. and the State of Alaska.

The state gets involved in rate cases because it collects royalties and production taxes after transportation costs have been paid. Higher costs mean less revenue to the state.

The federal case considered whether the costs of the ongoing Strategic Reconfiguration project were prudent, and whether the owners of the pipeline should be allowed to include those cost in their 2009 and 2010 shipping rates. Simply, the program is installing electric pumps at four pump stations along the pipeline and upgrading control systems.

The owners of the pipeline started the project in late 2001 and expected to be finished by 2005, but the work remains unfinished. The roughly $750 million spent to date is some three times the initial budget estimates for the project, according to the FERC ruling.

The Regulatory Commission of Alaska is considering the same facts for the purposes of establish intrastate shipping rates and is expected to release its ruling in the near future.

‘Serious doubts’

While giving the owners leeway to make management decision, Cintron wrote that the third parties raised “serious doubts” about the prudency of Strategic Reconfiguration.

Those doubts shifted the burden of proof to the owners — referred to as “carriers” in the decision. They were unable to convince Cintron their decisions were wise. “The evidence in this case proves the carriers sanctioned the project with insufficient engineering. Further, they started construction with insufficient engineering, fast tracked the schedule, hired inexperienced contractors and failed to properly manage them and failed to implement an effective management of change process, among others,” she wrote.

When the proceedings began, the owners included transportation subsidiaries of BP, ConocoPhillips, Exxon, Koch and Union Oil Company of California, although Koch recently transferred its interest to the three largest owners and Unocal is in the process of doing the same. The jointly owned Alyeska Pipeline Service Co. operates the pipeline.

Whether a decision is “prudent” in the eyes of the law involves precise legal definitions, but generally concerns what a utility should have known when it made spending decisions.

According to the state, the owners went into the project without enough engineering and ignored warnings along the way, which led to budget and schedule overruns. Anadarko Petroleum argued that the owners and Alyeska ran at cross-purposes during the project.

According to the owners, the project — considered the largest on the pipeline since its construction — was needed to reduce costs in response to reduced throughput.

The owners believe they obtained sufficient consulting and contracting work leading up to the project. They blame the delays and cost overruns on labor and material shortages, unexpected work related to operating in an industrial brownfield and contractor failures.

‘A discretionary project’

The case “shows an institutional mentality” to keep shipping rates high, according to Cintron, who quoted a 1977 industry memo advising the owners to “file a high tariff in order to minimize the combined government income from the field and the pipeline.”

“This was the mindset in 1977 and as this decision shows, continues to this day,” she concluded, calling the Strategic Reconfiguration effort “a discretionary project.”

It was discretionary, she said, because the existing equipment on the pipeline was “efficient and reliable and had adequate spare parts.” The project was also imprudent, according to the ruling, because the owners sanctioned and started the project without conducting sufficient engineering work, and also “failed to develop a realistic schedule.”

Given the complexity of the case, Cintron determined whether the owners should refund some of the Strategic Reconfiguration costs, but also which costs they should refund.

The parties to the case offered many proposals and Cintron ultimately chose a proposal from Anadarko. The proposal allows the owners to pass along some $229.2 million in early Strategic Reconfiguration costs while refunding most of the subsequent costs.

Nearing completion

The case involves the intersection of two complex matters.

While engineers designed the pipeline to have a dozen pump stations, the system came online with only eight. The owners added two more stations over the following years and later built a relief station. With throughput on the pipeline in decline since its peak of nearly 2 million barrels per day in 1988, Alyeska decommissioned all but four of those stations.

Strategic Reconfiguration is electrifying and automating the four remaining stations — Pump Stations 1, 3, 4 and 9. The owners completed Pump Station 9 and Pump Station 3 at the beginning and end of 2007, respectively, and completed Pump Station 4 in May 2009. Pump Station 1 is supposed to be done this year, according to the FERC ruling.

The owners of the pipeline are allowed to pass along certain costs to their customers and they have been incorporating the costs of Strategic Reconfiguration into their rates.

The rates have been a point of contention for decades. After considerable debate, the owners and the state settled on a ratemaking methodology in 1985. FERC accepted the settlement, but later overturned it. In a 2007 ruling, Cintron established a new system.

The owners used the new system for their 2009 rates, but FERC launched a hearing to resolve some additional matters and the case grew increasingly complicated. In early 2010, a FERC judge split the case to isolate questions over Strategic Reconfiguration.

As the proceedings continued, the owners filed rates for 2010, 2011, 2012 and 2013.

Given the overlap between the state and federal proceedings, FERC and RCA held joint hearings in Anchorage and Washington, D.C., in late 2011 and early 2012. The hearings focused on Strategic Reconfiguration issues. To resolve additional issues, the two bodies held supplementary hearings in Anchorage and Washington, D.C., in September 2012.

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