May 2010 Vol. 237 No. 5

Features

What Is The Value Of Your Pipeline?

Placing a value on a pipeline is a specialized process. The combination of methods used to determine the value or a pipeline or gathering system is unlike any other type of appraisal. Furthermore, no two pipelines are precisely the same. The unique methods described here are based on several years of observing the way a pipeline owner looks at a pipeline and the right-of-way in which it rests.

When placing a value on a proposed or existing pipeline system, several factors are considered by the author beyond the “across-the-fence” (ATF) method. The ATF method – used by many to assign a value to a pipeline right-of-way (ROW) – assumes that the ROW is worth whatever the surrounding land is worth. The ROW is the real estate where the pipeline lays. It is one of the factors in appraisal of the entire system.

The author saw the need to find or devise appraisal methods that are suited specifically to the pipeline industry when he was asked to put a value on pipeline salvage jobs. Among owners, the need for a fair pipeline appraisal methodology arose when it was discovered that pipelines were being overvalued by local taxing authorities and were being overvalued or undervalued during mergers, acquisitions and estate settlements. A valuation report concerning an active or inactive oil, gas, or product pipeline may be needed for one or more of the following reasons:

• Preparing for a sale or divestiture.
• Readjusting state, local, ad-valorem taxes/tax assessments.
• Estate settlement.
• Partnership termination.
• Preparing for a purchase or acquisition.
• Determining salvage value.
• Preparing for pipeline use conversion.
• Establishing value for accurate accounting.

Appraisal Methods
The author’s company uses a combination of methods to determine the value of a pipeline. We have found that value is a quantification of the interaction of demand for the property, utility of the property, the scarcity or supply of the property and the ease of transferability of ownership rights to the property.

Market Analysis. The method utilizes sales histories of comparable entities. This works well for valuing land and housing, but each pipeline is so different that a method of comparable sales is not so useful. Because land and housing are plentiful, making commodities of land or houses is much easier than making commodities of pipelines. However, this method is still useful to get an overview of pipeline value by looking at sales histories of comparable pipelines in varying circumstances and locales. One may make broad comparisons such as urban vs. rural, California vs. Mississippi, gas vs. crude, or regulated vs. non-regulated pipelines.

Highest and Best Use. This is mostly a real estate valuation term; however, on the occasion when a pipeline is being valued for usage change, this method can be useful to establish the value of the existing pipeline and the cost of converting it for another use. Pipelines can be converted from a crude product pipeline to fiber optic conduit or a conduit for electric power lines extending from a wind farm’s electric grid center. For the most part, pipelines are best used for the intent constructed. It is best to combine this highest-and-best valuation with some of the 40 pipeline valuation factors such as size of line, geography, terrain or ROW values. For example, the highest and best use for a 6-inch gas line might be to change it out for a 10-inch crude line using the same ROW, if the contract permits such replacement. Ultimately, the highest and best use is that which is most likely to bring the highest net return over time.

Seller Determined Need Or Book Value. This method is used if the seller wants to record financial gain or loss from a sale using book value. It is not much use to a purchaser since it has no relevance to current worth. The book value might be generated by the accounting of the seller/owner of the property, in whatever means the company accounting might use to determine the book value. It might be based on a valuation method such as construction cost-new and discounted, for example, but generally this book value designation by the seller has no relevance to the value of the pipeline as far as the purchaser is concerned.

Income Base Or Cash Flow. This method is a popular means of establishing value for pipelines if they are generating or will generate a predictable cash flow. This method takes into account forecast income based on throughput volumes and transportation rates of the commodity transported. Expenses based on the historical or projected income stream are discounted. Another variation of this method uses multiples of current cash flow where the average annual cash flow is multiplied by a factor of five to 12. This can be done on annual or monthly basis much like values of oil and gas royalties are determined. Many like to correlate pipeline values to oil and gas mineral interests regarding value. Both can have an indefinite life and both can be reborn as new drilling or new discoveries are made in an area served by the line. These additional income streams can be discounted to find a present day value or in some cases when using future multiples of income.

For example, the future income after operating expenses of a gas pipeline might be $200,000 per year. A reasonable value might be five times that amount or $1,000,000. A buyer might determine that the net present value in dollars paid today might be 20% less than the $1,000,000 or $800,000 in today’s dollars. Present value is the term used when discounting future income to a present value or the value of a future income to a present rate.

Construction Cost-New. This is the cost of rebuilding the same pipeline in the same size, same manner and in the same (or comparable) easement. This is an important factor in placing value on a pipeline to be considered by a purchaser. This approach also can be discounted. For example, a pipeline that has been operating for 10 years after it was initially installed might have an expected life of 40 years. It could be discounted 2.5% per year of life or a total of 25% off the cost of new construction in today’s market. This discussion is based on straight line depreciation which is common and prevalent in the industry.

Value Determination Factors
In addition to the appraisal methods, several factors must be considered when assigning value to a pipeline. The author’s firm uses as many as 40 factors to make value determinations regarding pipelines. These factors cover the more technical aspects of business, physical, property and commodity value. Some of these might include:

• Business Value – (1) throughput value transportation (income), (2) supply (other pipeline availability in area/scarcity), (3) demand (potential buyers and users), (4) potential for additional uses or more customers for product transported, (5) sales contracts or purchase guarantees (terms and length), and (6) management (front office and field).
• Physical Pipeline Attributes – (1) date of installation (vintage), (2) type of installation, (3) appearance of pipe, (4) method of construction, (5) salvage value after termination of usage, (6) type of system (oil, gas product, jet fuel), (7) size of pipe in pipeline (specifications), (8) interconnects (with other pipelines or supply sources), (9) amount of cover on pipeline, (10) pipe protection (coatings), (11) cathodic protection, (12) type of system (trunk, gathering), and (13) records availability (alignment sheets, maintenance records).
• Property Value – (1)right-of way-agreements (basic contracts), (2) geography/terrain, (3) maintenance records, (4) appearance, (5) surface inventory (including appurtenances), (6) condition of equipment (scrubbers, compressors), and (7) congestion (urban or rural locale).
• Commodity Value – (1) market price of commodity transported, (2) product source (well depths, reservoirs), (3) chemical content of product transported (gas liquids, corrosives), (4) proximity to markets, (5) diversity of suppliers, and (6) diversity of markets.

Other factors depend on whether product in the pipe is purchased at the wellhead and resold; whether and to what extent the product is compressed, enhanced, treated, cleaned, or processed; and by what procedures is it compressed, enhanced, treated, cleaned or processed.

Recent Appraisal Projects
The author’s firm has had several recent opportunities to appraise pipelines for a variety of purposes.

Pipeline Rehabilitation Appraisal. A vintage crude pipeline in a mature field on the West Coast recently was appraised. The line had been active in the past and later idled. The operator had intentions of rehabilitation and reactivation of the line and needed a fresh appraisal to help determine transport fees or tariffs as a common carrier. It was necessary to estimate the new construction price as well as depreciation and account for rehabilitation costs. We found the appreciation of the right-of-way costs in the heavily congested area more than made up for any deficiency in depreciated new construction costs.

Construction Financing Appraisal. A bank contacted Pipeline Equities to obtain an appraised value for a pipeline to be built that would transport jet fuel to an airport. The bank wanted to know the value of the proposed pipeline before financing the construction cost. In place were the contract (long term), a firm bid for construction (construction cost new), and competent experienced management.

Pipeline Divestiture Appraisal. A hedge fund decided to exit the pipeline business and sought Pipeline Equities for an appraisal of hundreds of miles of their active and inactive gathering and transmission pipelines. They needed to determine the value of the pipeline network in order to divide interests among investors. Pipeline Equities was able to use multiple methods including salvage to arrived at an equitable value to which all parties agreed. Many of the gathering lines had no discernable easement by which a ROW only method like the across-the-fence method could be used.

Appraisal For Taxing Authorities. The company has seen many instances where a pipeline or gathering system was built for a new field with flush production and the field now is nearing depletion. Nevertheless, the operators still must pay regular taxes where applicable according to earlier throughput or initial values which were generally not depreciated. Local and state taxing authorities want up-to-date appraisals if they are to lower rates. Many local tax appraisers use only construction cost-new method (the cost of replicating the pipeline today) with no regard for throughput generally via abbreviated Marshal and Swift formulas.

Ultimately, the appraiser can only offer an opinion based on data available and market conditions. When it is all completed, the value is based on what the seller will take and what the buyer will give for a property. For a complimentary copy of the Pipeline Recovery Manual, contact the author.

Author

David Howell is senior right-of-way agent and managing partner of Pipeline Equities, Houston. He has been in the pipeline salvage and recovery business for 26 years. He is a designated senior right-of-way agent through the International Right-of-Way Association with certificates in Environmental and Acquisition/Negotiation and a graduate of Texas A&M-Kingsville. He is the author of Pipeline Recovery Manual and Pipeline Appraisal Handbook. He can be contacted at: davidhowell @pipelineequities.com, www.pipelineequities.com.