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Judge: Oil companies 'cavalierly' wasted hundreds of millions on pipeline work

Dermot Cole
A federal judge slapped the owners of the trans-Alaska pipeline in a major rate case, saying the companies wasted hundreds of millions of dollars and operated in a way that is "grossly in conflict with their duties as a regulated monopoly."
Stephen Nowers illustration

FAIRBANKS -- The owners of the Trans-Alaska Pipeline System, hoping to recover $750 million in construction costs for upgrading four pipeline pump stations and control systems, suffered a major setback Thursday in Washington, D.C.

A judge with the Federal Energy Regulatory Commission disallowed recovering more than half a billion dollars of the total through higher oil transportation costs. She said the companies spent hundreds of millions of dollars unnecessarily because of failures in planning, scheduling, supervision, engineering, execution and cost controls.

“No business in a competitive market would so cavalierly spend their own money as the carriers have done in this case,” Presiding Administrative Law Judge Carmen Ana Cintron said in a 542-page FERC ruling. She said the companies operated in a way that is “grossly in conflict with their duties as a regulated monopoly” and more than a half billion should be excluded from recovery through higher transportation costs.

She said the companies that own the Alyeska Pipeline Service Co. ignored their own employees, who offered more cost-effective alternatives for improving pipeline operations. The upgrade of the pump stations was considered the biggest pipeline project since the line was built in the 1970s.

“The sense is that execution was accomplished in a trial-and-error manner,” Cintron said.

For the state, this decision, if it stands, would mean a higher wellhead value for its oil and higher wellhead values for oil tax purposes. For companies like Tesoro and Anadarko, which took the lead in this case, argued by veteran Alaska attorney Robin Brena, the decision would mean lower costs for shipping oil to market.

Because the pipeline is a regulated monopoly, the owners are required by law to ship oil at the lowest price possible. This applies even though different branches of the same three companies ship most of the oil and pay themselves for doing so. For instance, one part of BP charges another part of BP for shipping oil to Valdez.

The principle of setting competitive rates is an important one, however, if new companies (that don’t own part of the pipeline and lack the ability to shift costs between subsidiaries) are ever going to emerge in Alaska.

The lower the shipping rates, the likelier it is that new companies can produce oil at a profit. The higher the rates, the more likely it is that the three companies that control the North Slope -- BP, ExxonMobil and ConocoPhillips -- will retain control.

Since the companies can collect the money back from themselves and don't have an arm's-length relationship, they don’t have an incentive to hold down transportation costs. Some argue they have an incentive to inflate costs because it reduces the chances that other companies will enter the North Slope.

When the three owners of the pipeline spend money on upgrading facilities, they do so with the expectation that they will get that money back by charging themselves -- and any potential future customers who don’t own part of the pipe -- higher transportation rates.

Starting in 2001, pipeline owners began a project to switch from gas-fired power at four pump stations to electric pumps. The “strategic reconfiguration” or “SR” project was scheduled for completion by 2005, but it remains unfinished, and the cost has more than tripled to about $750 million.

Anadarko and Tesoro, along with the state, all of which have an interest in keeping shipping charges down, challenged the expenses charged by the pipeline owners. The pipeline owners spent more than $520 million of that total “imprudently” and they cannot recover it through higher rates, the judge found.

“As a regulated monopoly, the service provider has a legal obligation to provide service at competitive rates, comparable to those found in a competitive market,” Cintron wrote.

She said the “preponderance of the evidence” showed the pipeline owners didn’t plan the pump station projects or execute them with prudence. They replaced equipment that didn’t need to be replaced and didn’t consider alternatives.

“They failed to take into account that the legacy equipment was efficient and reliable and had adequate spare parts,” she said. “The carriers ignored the in-depth studies performed by Alyeska regarding potential upgrades to the legacy pumps and controls systems. They ignored warnings of competent, subject matter expert employees. The carriers unreasonably dismissed studies indicating that an alternative to their chosen course of action was more cost effective (e.g., retaining and upgrading the legacy equipment.)”

Despite the added expense of the reconfiguration project, there has not been any savings in personnel, maintenance, reliability or capacity to ship oil, the judge found.

She said that a recurring theme of the oil companies in their FERC filings on the cost increases is the “implied blame of either Alyeska or the SR project team,” but she said they were agents of the owner companies. The judge found that reasonable utility managers would not have pursued the pump replacement and system upgrades the way the oil companies did.

The work has been finished on Pump Stations 3, 4 and 9, but not on Pump Station 1 on the North Slope, the largest and most complex pump station. Work is expected to be complete this year.

She said the state and Anadarko proved that the oil companies did not follow industry standards or Alyeska’s procedures and hired inexperienced people to run the project.

“What happened in this case borders on negligence,” the judge said, adding that the companies did not follow their own rules in approving a project when only preliminary engineering had taken place.

The companies argued that in deciding what was prudent, the standard should not be what the companies knew and should have known, but only what the companies knew.

The companies said they hoped to reduce costs with the electrification project by reducing the number of employees at pump stations, but the total number of Alyeska employees has been about 800 since 2005. The companies said they had eliminated 263 jobs as of 2010, but the judge said there was no evidence to back up that statement.

She said there was no need to replace equipment that was still in good condition.

“Therefore, it must be concluded that the replacement of well-functioning equipment that is near-fully depreciated with new equipment recapitalizes the rate base, thus artificially inflating rates,” she said.

The judge said the case reflects an “institutional mentality” that has not changed since 1977 when BP lawyers argued that all owners of the pipeline should want the highest possible tariffs because the higher the tariff is to begin with, the higher it will be after the regulatory agencies complete their reviews.

Contact Dermot Cole at dermot(at)alaskadispatch.com. Follow him on Twitter @dermotmcole