OREANDA-NEWS. March 01, 2011. In 2010 the Caspian Pipeline Consortium (CPC) exceeded its capacity of 28 MTPA, shipping 35 million tons for the first time, thanks to the use of drag-reduction agents.

At the end of the year, the CPC's shareholders voted to expand the pipeline's capacity to 67 million tons per year. Dennis J. Fahy talks about technical solutions that were approved in order to achieve such a substantial increase in capacity, how tenders are being conducted among suppliers and contractors, and other aspects of the CPC's functioning and development, reported the press-centre of CPC.

- Mr. Fahy, how good or bad was the past year for the consortium in the context of the continuing crisis in the world economy and a decline in demand for energy resources in the global markets?

- 2010 was quite successful. I think you might be aware that we shipped 35 million tons of oil and it was our largest volume year ever since the start of CPC pipeline operation in 2001. This was achieved through application of drag reducing agents as the current design capacity is 28 MTPA.

In addition to that we had exceptional health, environment and safety performance. Between CPC employees and all of our contractors we worked about 6 mln manhours with only one recordable injury. Fortunately it was a very minor injury.

- Many companies saw their expenses going somewhat down during the crisis, including due to reduction in contractor prices. Was that the case in your sector?

- Our opex in 2010 was slightly higher than in 2009 but certainly less than what a background inflationary level would have predicted. Our operating expenses were quite manageable.
Our business was very stable in spite of the crisis. Our tariff was the same throughout the year. And our volumes were higher than they had ever been in the past and resulted in our highest revenue ever. We met or exceeded all of our financial objectives.

We ended up the year on a very positive note by receiving shareholder approval to perform an Expansion Project up to 67 MTPA.

- How confident are you than the expansion plan will be implemented on schedule?

- Maybe I should explain to you a little bit about our project execution plan and that will lead into the issue how confident are we in the execution.

We have numerous shareholders in CPC, many of whom have significant experience in the industry in Russia and Kazakhstan. So to gain confidence in our ability to execute the project on schedule and on budget we chose an execution model whereby we utilized the expertise available from our shareholders in executing similar projects.

In Kazakhstan, an affiliate of KazMunayGaz will be assisting CPC in execution of our construction work involving pump stations and the replacement of 88 km of pipeline.. In Russia an affiliate of Transneft will be assisting CPC in executing work at the pump stations. And at the Marine Terminal where we have a major addition of tankage and offshore facilities, Chevron with participation of Transneft will be helping CPC. All of the SCADA and telecommunications work throughout the pipeline will be performed with the assistance of Chevron.
This arrangement is the reason why we have confidence that the execution schedule will be met.

- What will be the tendering policy for contractor and equipment vendor selection for the portion of the work that will be done in Russia and Kazakhstan?

- We are well on the way of working through the tender process for contractor and vendor selection in Russia and Kazakhstan. The procurement process for major equipment is for the most part complete as we have signed contracts with vendors for long lead items, such as valves, pumps, etc.

For the major construction work we are tendering to major companies including those from Russia and Kazakhstan who demonstrated their capability to do such work.

- Who is responsible for conducting the tenders directly? Specifically, in Russia. Is it Transneft or CPC?

- Ultimately CPC is responsible for the tender process because it is CPC who ultimately enters into the contracts. Clearly, Transneft has a lot of experience in this type of construction of work in Russia and so they are providing a tremendous amount of support and input.

- Will the national content principle be applied in the host country in selecting contractors and vendors?

- We emphasis the national content; there is no question about that. For the equipment purchase orders that are already placed, it’s about 70% Russian suppliers and the other 30% is various international suppliers. For the construction work, we haven’t awarded the contracts yet but we expect that these will be overwhelmingly Russian and Kazakh contractors.

- It is known that the pipeline capacity expansion which will double the capacity will not affect the linepipe, except for a small section. What design solutions will allow to achieve such a significant capacity buildup?

- When the pipeline system was originally designed back in the late 1990's, there was always the intention that the pipeline would be capable of handling up to 67 million tons. In order to achieve this volume it would require a 40 inch diameter pipeline and 15 pump stations. However in the early days of the pipeline the demand was not there to be able to transport that volume. So back in 2001 we only built and commissioned 5 pump stations.

So to take our capacity from where it is today up to 67 million tons per year requires adding additional pumping capacity at existing pump stations as well building new pump stations. As well as some additional handling facilities at the Marine Terminal such as additional tanks and a third SPM in addition to the two existing ones.

We currently have an 88 km section of pipe in Kazakhstan upstream of the Atyrau Pump Station that's only 28 inch diameter. We are planning to upgrade this pipe to 40 inch. We will then have in essence a 40 inch pipeline all the way through the system.

It should be noted that we are going to phase in the timing of bringing on line additional system capacity by commissioning additional pump stations in phases. It will be done in three tranches. One reason is to make this multi-billion project more manageable, as it will cost an estimated 5.4 billion dollars. But also the project execution in this phased manner will better match the throughput capability of the system to our shippers’ demand.

- Can you tell us about the Expansion project financing plan: sources, schemes and phasing.

- Our plan is to finance the expenditures for the expansion project out of our operational revenues. In anticipation of an expansion project sanctioning, for some time now we have been reserving our cash for that purpose.

The possibility is that at some point, well into the execution of the project, there may be a need for additional funding. And the plan is to go to the financial markets. Our modeling with respect to how much we would require is well within the borrowing capacity of CPC. So if there is a cash flow shortfall during the execution of the project, it will be a relatively small amount for a relatively short period of time and we can cover that through external borrowing.
The fortunate thing that CPC has, but many major construction projects don’t have, is that we have an ongoing business right now generating significant amount of cash.

- What portion may have to be borrowed out of the total project value?

- The project value is estimated at USD5.4 bn. So we are looking at the possibility that maybe at some point may have to borrow 10-15% of the total project value.

- Are the tariffs expected to be changed to cover the investment cost?

- The tariff is determined by the shareholders. And I’m not aware of any discussions that may be going on. But the expansion project was developed based on the current economics based on the current tariff.

- Is it already known today what shares will be allocated to CPC shareholders in the additional shipment volumes?

- The shareholders and in some cases their shippers have signed up for shipment volume commitments. So we know exactly what transportation volumes have commits for.

- And do we know?

- This is a question to our shareholders.

- CPC is operating a quality bank. How effective is it? How satisfied are the shippers with it?

- The quality bank we have, whereby shippers either pay to or receive from based on the quality of their oil vs. the common blend, was originally designed by our shareholders. They routinely audit it. We have external experts that also look at how the bank works to ensure that it is truly reflective of quality. Those expert reviews are made available to our shareholders. As of now we don’t have any requests from our shareholders for any significant modifications to the quality bank, so from that I would assume that our shareholders feel the quality bank is doing what it was always intended to do.

- You announced recently that the increase from the design capacity of 28 million tons per year to 35 million tons per year in 2010 YE results had been achieved due to use of drag reducing agents. The Expansion Project is expected to increase the CPC capacity up to 67 million tons per year. If the nominations are there, how much more can that capacity be increased using DRA?

- Currently, to move 35 million tons per year we require the use of DRA – we cannot do this without DRA. Now ultimately our shippers have a need to move 67 million tons per year. So we designed the system to be able to move that 67 million tons per year without any use of DRA. I don’t know exactly by how much it may be increased by using DRA. Our system is being built on shipment obligations that have been agreed to by our shareholders. And we can meet those obligations after the construction is completed, using the mechanical capacity of the system.

- Does the current use of DRA mean that the CPC pump stations are operating at the limit of their capacity?

- We are moving as much oil as we can but we are not exceeding the limits of a single piece of equipment.

- The region where CPC’s facilities are located is a seismic area. How is that factored in the design?

- Both in the initial construction phase and now we have taken the seismic zone conditions completely into consideration in all of the design.

For instance, at the Marine Terminal our tankage is constructed with thick walls, with strong reinforcement of all the connections to the tanks. (32 mm A537 steel of high specific density; 64 mm steel nozzles with connections reinforced with double thick steel thermally treated in a special way by the manufacturer).

We have control devices on our tanks and designed into our new tanks to be able to shut off and isolate to avoid an emergency. Each tank has a dike around it that will contain more than the volume of the tank, so if anything should happen,there will be no spill outside of the perimeter of the dike around the tank.

We have taken the seismic design to the extreme to make sure there is never an incident caused by seismic activity.

- Do you have contacts with environmental organizations?

- Absolutely. We have an ongoing engagement plan for environmental issues - not only with the authorities but, just as importantly, with all the communities that will be in and around our pipeline. There will be communication plans that will be in place during the construction. We’ll continue to engage as the project progresses.

- The expansion project has been in the works for a long time. It provides for an increase in offshore loading capacity. Over that time there has been the accident in the Gulf of Mexico. Technically speaking, these are different processes, and yet the disaster has affected all activity areas within the oil sector. Has the design undergone any changes as a result?

- Regarding our operations and the way we load ships, we fully take in consideration the most severe wind loading and wave heights – the most severe conditions one can experience in the Black Sea.

And we have numerous protective devices so that we don't have any type of uncontrolled release. The single point moorings (SPMs) and related equipment are equipped with load sensors, pressure sensors, temperature sensors with monitoring.

We have breakaway couplings that will immediately shut, to isolate the hoses should there be a problem. We have evacuation systems to evacuate the oil out of the system.
Let me give you an example just how safe and reliable our SPMs are. We have loaded in the vicinity of 2,300 vessels, over 247 million tons, since 2001 and have never had an incident.

Another example I'll give you… Your remember a couple of years ago we had a hundred year storm in the Black Sea (November 2007). It inflicted heavy damage up and down the Black sea coast. Our SPMs and subsea lines suffered no damage, not even any minor leaks.
Let me reiterate that the design was developed based on the most severe and difficult conditions one could encounter in the Black Sea.

- To what extent does the weather affect your activities? For instance, the Port of Novorossiysk close by occasionally has to close for days at a time. What can be said about the advantages of single point moorings and dependence on the weather?

- Weather conditions do at times impact our ability to load vessels. In a typical winter we have 10 or 15 instances where the seas are high enough that we suspend loading. Generally the duration of these interruptions lasts 24 hours or less. So in those cases we keep pumping the oil to the marine terminal tankage while the loading operations are suspended.

Our loading takes place 5-6 kilometers offshore, rather than in a harbor. The technology we use, including our storage facilities and two SPMs, and the way we manage the Marine Terminal operations, we can handle weather issues and ensure full safety of the operation.
So, we face weather, it does impact us, but without any incidents. We won't do anything unsafe in our operations but we will, if the conditions are not good, suspend our loading operations.

- Is there is a limit to the capacity of the port facility in Yuzhnaya Ozereevka? For example, what if Transneft wants to redirect a larger oil stream to the CPC terminal from outside of CPC proper?

- Our expansion design, with ten 100,000 cubic meter tanks and three single point moorings, is specifically matched to our pipeline system capacity at 67 mln tons per year. Could the facilities at the Marine Terminal some day be expanded to handle more – hypothetically, you could always add more facilities.

- Some time ago there was an idea floated around (by Transneft) to build a connecting line between the Russian oil pipeline going to Novorossiysk and CPC - from Tikhoretsk to Kropotkin. Is that discussion still ongoing?
- I have not been involved in any discussions around that.

- Have the CPC Shippers ever been affected by due to the narrowness of the Bosphorus straits? And was this factored in developing the CPC Expansion Project, same as any future potential new pipelines for crude oil exports from the Black Sea?

- We load an average of almost one vessel per day – about 320 vessels per year. Generally the vessels arrive and depart on time.

Given the fact that our shareholders are sponsoring the project to increase the CPC capacity to 67 million tons per year, I would expect that they have taken such concerns into consideration.