ECONOMIC PLANNING AND ANALYSIS OF COMMERCIAL PETROLEUM PIPELINE TRANSPORT

Wessel J. Pienaar

Department of Logistics Stellenbosch University Private Bag X1 Matieland 7602 South Africa

October 2009

Tel: 27 21 808 2251 Fax: 27 21 808 3406 e-mail: wpienaar@sun.ac.za

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ABSTRACT The paper represents an overview of an inquiry into and an investigation of economic aspects of commercial petroleum pipeline transport. The potential value of the research lies mainly (1) in the economic evaluation and planning framework, (2) the developed guidelines for the pricing of the carriage of petroleum commodities by pipeline, and (3) the comparative analysis of the most salient economic features of transport modes used for the carriage of petroleum commodities. The research approach combines a literature and internet survey as well as interviews conducted with specialists in the petroleum refining and pipeline transport industries. The following economic aspects of pipeline transport are discussed: (a) relative efficiency, (b) planning and evaluation, (c) market structure and ownership patterns, (d) cost structure, (e) management of costs, and (f) principles of efficient pricing.

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1. INTRODUCTION The commercial transportation of crude oil and petroleum products by pipeline and the envisaged new investment in this mode of transport are receiving increased attention in South Africa. Transnet Pipelines recently obtained permission from the National Energy Regulator of South Africa (Nersa) to construct and operate a new 60-cm petroleum products pipeline 704 kilometres in length from Durban to Gauteng. In addition, the newly-formed Petroline consortium recently obtained permission to construct and operate a 30 cm petroleum products pipeline 160 kilometres in length from Maputo to Nelspruit, with extension later to Kendal, where it can link with the present Transnet pipeline network. At an operating speed of 10 km/h the proposed 60-cm Transnet pipeline would be able to deliver 3.54 million litres of petroleum product per hour. This is equivalent to 89 deliveries per hour using road tank vehicles with an average carrying capacity of 40,000 litres of fuel per vehicle. This pipeline throughput is also equivalent to two trains departing per hour, each consisting of 42 petroleum tank cars with an average carrying capacity of 42,500 litres of fuel per car. Considering that such road trucks and rail cars return empty to the upstream refineries in Durban, it is clear that there is no tenable long-term alternative to pipeline transport. pipeline transport is substantially cheaper than road and rail transport; pipeline transport is much safer than rail and especially road transport; and pipeline transport frees up alternative road and rail transport capacity. 2. RELATIVE EFFICIENCY OF PIPELINE TRANSPORT Pipeline transport is unique among modes of transport in that the pipe, which facilitates freight movement, is both the way and the vehicle, and it is permanently connected to terminals, which facilitate freight storage. This feature makes it the only mode of transport that does not require any materials or goods handling. In view of the fact that pipeline transport infrastructure is extremely capital intensive and its unprecedented longevity, pipeline transport enjoys the highest level of economies of scale of all modes of transport. This economy is subject to steady and enduring high levels of demand (1). It is also the only mode of freight transport whose operations do not require a return journey, whereby joint cost due to empty running is avoided (2). Once constructed, the remaining operating costs incurred to supply service are relatively small. Consequently pipeline transport is very competitive with other forms of land transport, especially if full utilisation of the pipeline is possible at all times. Once in operation, continuous-flow pipeline transport replaces batch (i.e. separate vehicle loads) haulage by water, rail or road transport, with uninterrupted high-volume operation. For example, the comparative 2008 tariffs to deliver jet fuel from Durban to O.R. Tambo International Airport in Gauteng are (3): Pipeline: 12,55c/; Rail: 24,35c/; Road: 58,30c/. It is therefore clear that a Durban-based petroleum wholesaler that does not have access to pipeline or rail transport between Durban and Gauteng is subject to the likelihood of competitive foreclosure of marketing its product(s) in Gauteng (4). The economy of pipeline transport as an alternative to any other form of transport arises from the following (5, 2, 6): (a) Pipelines are able to move voluminous batches of fluids uninterrupted in a continuous stream over long distances at a low unit cost and low risk. Although the transit speed is low (between 5 and 15 km/h), commodity intake, carriage and discharge are combined in one process the commodity is immediately discharged into storage tanks upon arrival. This, coupled with the fact that the pumping process can take place continuously, without the need for a return journey or empty running or stoppages or transhipment delays, reduces the total transit time. For example, at a pump speed of 10 km/h through a pipe with a 40 cm diameter, the effective delivery rate equals 1.57 million litres per hour, which cannot be matched by any other mode of transport over land. (b) A commodity which is transported by pipeline to its destination requires no wrapping and packaging. Only the commodity itself moves, the pipeline provides the necessary containment and

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protection of the commodity. Therefore there is no dunnage dead weight, dunnage volume, vehicle or handling equipment moved. There also are no empty containers to be stored, handled or returned to the origin and no packing or unpacking problems at the start and completion of the haul. (c) Among all transport modes, pipelines require the least human resources expenditure and consume the least energy per unit of commodity moved. Fuel consumption by road tank trucks, for example, is several hundred times higher than pipeline to deliver the same quantity of commodity. (d) Pipelines are the safest mode of transport to carry petroleum commodities. There are an extraordinarily small number of deaths and injuries associated with pipeline operations. The high degree of automation throughout pipeline systems accounts to a large extent for their outstanding safety record, because human error is the principal cause of most transport accidents. High standards of design, construction, testing, preventive maintenance and monitoring techniques also contribute to the great safety of pipeline transport. (e) The goods security record of pipeline transport is outstanding. The risks of shrinkage or loss by theft, fire, damage, spillage and evaporation are insignificant. However, laying a pipeline in geographical unstable areas and locations where surface conditions are affected detrimentally by mining activities have to be avoided. Electronic monitoring of facilities as well as insignificant influence by the elements results in minimal loss and damage (through quick detection of leaks) and in highly reliable delivery schedules. The high accuracy and reliability of forecasted delivery times diminish the need for safety stock at the receiving end, while free storage is offered for as long as the order is on the way to delivery. (f) Large areas of land are not diverted to exclusive use. The area required is a narrow ribbon, and diversion of land from other uses is lessened if the pipes are buried beneath the surface of the ground (as they usually are). In addition to the productive use of internal pipe volume, pipeline transport is very economic in utilisation of external space. Once the pipeline is laid, the land above it can continue to be used for alternative purposes, except for activities that disrupt the ground surface seriously and the construction of permanent structures, subject only to the right of access for the pipeline operator to conduct inspections or when repairs and replacement become necessary. This lessens the opportunity cost of a pipeline right-of-way. Once locational and construction problems have been overcome pipeline transport causes the least external cost and ecological damage of all modes of transport (7). (g) Pipeline transport can offer international service. However, such services are confined to overland crude oil and natural gas supply, and in limited cases petroleum products carriage between neighbouring countries. Although pipelines can be built under the sea, such a process is both economically and technically highly challenging, so the majority of oil at sea is transported by tank ships. All international trade of crude oil and petroleum products that involves long-distance and trans-oceanic carriage is done by ship. Despite the fact that tank ships run empty during return trips, pipeline transport can only compete with sea transport between the same origin and destination if the pipeline route is considerably shorter than the sea route, or where sea transport is subject to exceptional charges, such as heavy canal dues (8). An example is the 254-km long Trans-Israel crude oil pipeline route between Eilat on the Red Sea and Ashkelon on the Mediterranean coast. This route is substantially shorter than the one around Africa, and cheaper than through the Suez Canal (9). 3. PLANNING AND EVALUATION Before initiating a pipeline as a commercial venture, it must be shown that for the economic life of the pipeline the users will ship sufficient volumes at the established tariff to enable the owners of the pipeline to repay their loan, meet the operating and maintenance costs, and return a profit to compensate for the risk element and warrant the investment (10). The disadvantages of pipeline transport lie mainly in its extreme functional specialisation and dependence upon sustained highvolume traffic. The initial cost of installation is high and justified only when both the demand and supply will continue for a long time. Exhaustion of wells brings the utility of the pipeline to an end and its salvage value may be low (i.e. the sunk cost proportion is high). For this reason (in oilproducing regions) gathering pipelines are mostly laid on the surface of the ground, because they may need to be moved from time to time as wells become depleted (11). When the opening of a new oil-producing area is considered geologists need to confirm the significance of the oil find, estimate the reserves and determine production capacity. This is the basis

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for estimating expected throughput. Petroleum industry specialists study potential markets and the value of future production. They forecast conditions that might affect the pipeline, directly or indirectly, over the next 15 to 20 years, such as the state of the economy; shifts in population; product demand growth; refinery construction; expansions and shutdowns; domestic and foreign crude oil production; prospects for competitive pipelines; industry changes; and government actions. These aspects are considered in detailed technical, financial and economic appraisals (12). Technical appraisal is concerned with, among other aspects, physical, design and environmental matters as they relate to the construction process and the operation of the project after it is completed. The financial evaluation process focuses on the business and financial details, primarily the expected costs and revenues of the enterprise responsible for the project. Financial appraisal is used to determine the quantum of funds that will be required and whether the venture is likely to be financially viable that is, whether it can meet its financial obligations, produce a reasonable return on the capital invested, and make a contribution from earnings toward the cost of future investments. If the pipeline is a joint venture, those involved form a company, secure throughput agreements and arrange for financing. The economic assessment of a pipeline necessitates the investigation of several alternatives in order to determine whether the project is justified in terms of the economic resources its commercial existence will require (12). Firstly, alternative locations of the pipeline may have to be compared. The shortest and most direct alignment between origin and destination might initially be preferred (for example, in the case of a crude oil pipeline that delivers all its payload at one destination). However, deviations may be necessary because of topographic obstructions and other environmental considerations, present land uses, difficulty in obtaining rights-of-way, and the need to pass near some supply or delivery point or to skirt heavily populated areas (for example, in the case of a products pipeline that has delivery points along the route). Bearing in mind that the largest delivery point (or customer) is usually the one at the end of the line, the route alignment should not be located so circuitously that it unnecessarily puts the customer(s) at the end of the line at a distance and tariff disadvantage in favour of intermediately located delivery points/customers. In this case the economic trade-off is between a circuitously located pipeline and one with a direct alignment, but with small lateral branch delivery lines along the way. A second consideration may be the size of the pipeline, since one with a larger diameter, able to handle a greater traffic volume, involves higher initial investment cost but lower costs for pumps and energy to propel the pumps. Large-diameter trunk pipelines are an important factor in making it viable to extract crude oil in remote regions and convey it to refineries or exporting seaports. This is because the unit cost of transporting commodities by pipeline decreases as the diameter of the pipe increases. This economy requires that the total quantity handled be sufficient to keep the pipeline full. A prerequisite for successful pipeline transport is proper sizing for the quantity of oil that will be carried. A third decision concerns the choice of pump technology. Most pumps are driven by electric motors, although diesel engines or gas turbines can also be used. The benefit of electric propulsion is its low cost and the economy of remote-controlled operation. However, with the likelihood of high electricity price increases in South Africa in the future, coupled with the prospect that the present diesel fuel price may be close to a peak, and that service reliability can be jeopardized by electric power failures, diesel propulsion may become an economic contender for electric propulsion in South Africa (3). A fourth important consideration is whether the refinery should be located at the beginning of the line (upstream, close to the oil field or the port of entry) or at the end of the line (downstream, close to the market). The need for the latter investigation arises from the fact that the cost of carriage varies between commodities. The greater the viscosity and the density (i.e. mass in relation to volume) of the commodity to be carried, the more difficult it is to pump and therefore the higher the cost. For example, crude oil is substantially more expensive to carry over long distances than the lighter and more fluid petroleum products that are refined from it. The greater the volumes to be carried and the longer the distance concerned, the more economical it may become to locate the refinery at the lines origin. Upstream refinery location also enables the provision of downstream delivery points along the line, which can improve the efficiency of product distribution.

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The fifth step in the economic evaluation is to compare the pipeline cost with the cost of the next best transport alternative, which is usually rail transport. If the above-mentioned investigations indicate that a pipeline promises to be technically feasible, financially viable and economically justified, detailed design of the pipeline may commence. The major feature in the system's design is the pipe, even though it is usually almost entirely buried. Selecting the specific pipe for a given project is affected by economic factors as well as by the nature of the commodity, expected throughput, terrain and construction conditions. 4. MARKET STRUCTURE AND OWNERSHIP PATTERNS Pipeline transport is usually provided by private users for their own (ancillary) purposes, or by a common carrier acting on behalf of all the shippers linked to the pipeline. The supply of pipeline transport is in terms of the number of market participants the most highly concentrated of all transport modes. The absolute number of firms is low, but the significant measure of concentration is the number of participants in a specific transport market segment or transport corridor. With a few exceptions, there is but one crude oil, one products and one natural gas pipeline connecting producing areas or refineries and areas of consumption. This high degree of monopoly power results from declining unit costs with increases in capacity, so that the lowest costs are achieved by a concentration of output in a single pipeline. A high degree of concentration is efficient, and changes toward a more competitive market structure through economic regulation would entail high losses in efficiency. Therefore, pipeline operations that can fulfil entire market demand are pure natural monopolies (13). Where the distance between supply points (such as geographically separated oil fields or ports of entry) is high in relation to the delivery distance to the market area, such an areas fuel demand can often be most efficiently fulfilled by two or more different pipeline operations. For example, from 2010 onwards the Province of Mpumalanga in South Africa will receive petroleum products via the Transnet products pipeline from refineries close to the Port of Durban and the Petroline products pipeline from the Port of Maputo in Mozambique. In the latter case a pipeline transport oligopoly (in this case more specifically a duopoly) will exist. Because of the high capital costs of a pipeline, the financial barrier to entering the market is high. Owing to the inflexible capacity limits of a pipeline once installed and the maximum flow rate at which pumping can take place, a new method of moving the product (such as by road or rail) needs to be found once the flow rate reaches pipeline capacity and replacement with a pipe of larger diameter or a second pipe is not feasible (2). In view of the above-mentioned considerations financial stakeholders in pipeline operations tend to consolidate and start with a large initial investment, which tends to yield higher returns, partly because of economies of scale and partly because of inherent performance characteristics (for example, a 30-cm pipe operating at capacity transports three times the quantity carried by a 20-cm pipe) (6). The gains from scale are substantial. Cookenboo (14), for example, showed that the lowest cost for a throughput of 100,000 barrels of crude oil per day in a 45-cm pipeline would be approximately double the cost per barrel when compared to carrying 400,000 barrels per day in an 80 cm pipeline over the same distance. The implications for the industry are important. It would be extremely wasteful, for example, for four competing refineries in a consuming area in which each used crude oil from the same area of origin to build four pipelines. If, for example, each required 100,000 barrels per day, then building four parallel 45-cm pipelines instead of a single 80-cm pipeline would double the cost per barrel for transport. Efficiency dictates a common system for use of the same pipeline in such circumstances. It also follows that costs for carrying petroleum on a route that has a large pipeline will be much lower than on other routes not thus provided. There will be external economies in locating large refining capacity in the same area (15). 5. COST STRUCTURE Pipelines provide their own right-of-way. Once the investment is made, the remaining operating costs are low. Since the pipe component, the pumps, and the tank and plant facilities are highly specialised

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and durable, fixed cost constitutes a high portion of the total cost the highest proportion of all modes. Pipeline transport is highly efficient when utilisation of capacity remains consistently high. For example, continuous pumping may take place with no need for any return flow, which eliminates unutilised joint costs. Therefore a high level of economies of scale does prevail in pipeline transport. The fixed costs of pipeline transport can be classified in a sequence from almost permanently fixed through to items that are fixed for a one-month period (2): pipeline right-of-way; pipes; storage facilities; operations-related terminal buildings; pumps; management and administration overheads; routine maintenance of facilities, pipes and pumps; and monthly charge for a continuous minimum availability of electricity supply. In the construction of the long-run cost function, the three principal fixed cost components are as follows: (a) those that change with pipe diameter; (b) those that change with pumping power; and (c) those that change with length of pipeline. Fixed costs that change with pipe diameter include the interest and the depreciation on the pipeline itself, the costs of constructing/laying the pipeline, the costs of steel, pipe coating, valves and corrosion protection, and scheduled maintenance costs of the pipeline. Although these costs rise as pipe diameter increases, the rise in costs is less than proportional to the increase in diameter. For example: the width of the pipeline right-of-way (i.e. the cost of the servitude) remains the same regardless of pipeline diameter; in most cases the width of the trench in which the pipe is laid remains the same (or increases very little); whenever wall thickness remains the same or it increases to a lesser extent than the increase in the diameter, proportionally less steel is needed as the inside diameter of pipes increases; unavoidable routine inspection, monitoring and general management costs for a large pipeline are only fractionally more than for a small pipeline of the same length. Fixed costs that change with pumping power include the interest and depreciation on the investment in pumping stations and the outlays for electric power, plus the unavoidable labor used in the routine maintenance and the operation of pumping stations. Fixed costs that change with length of pipeline rise in direct relation with increases in distance. These costs include the initial costs of surveying and obtaining right-of-way and of the pipe, additional pumps, tankage, trenching and laying the pipe, backfilling the trench and restoring the surface, damages to terrain crossed, and scheduled (preventive) maintenance and operation of a communications system. Hence longer pipelines do not give rise to significant economies of distance, as directly proportional longer or more of each of these items is required for longer haulage distances. Furthermore, the terminal costs are relatively small. Thus the cost per ton-kilometre is sensitive to the regularity of flow but not to the length of the pipe. Consequently there is no distinct taper in the tariffs charged per ton-kilometre as the length of haul increases (16). The only discernible variable costs (where variable costs refer to cost items with a commitment period of less than one month) in pipeline transport is the electricity (or other energy) consumed during pumping over and above the volume that is paid under the fixed availability charge, overtime wages paid to maintenance staff to repair faulty components, and the actual repair costs over and above routine or preventive maintenance. On the principle of economies of density, an increase in pipe diameter can result in a lower unit cost. An uninterrupted and prolonged throughput of a large volume of homogeneous commodity increases economies of density. Should such continuous pumping with a specific commodity not be sustainable, common production can make petroleum products pipelines more efficient, since a variety of petroleum products can be pumped consecutively, thereby enhancing the achievement of economies of scale through economies of scope. The fundamental relationships involved depend upon the principles of geometry concerning the relation between the surface of a cylinder and its volume. Consider a circular cross-section of a pipe: because the area of a circle is r2, the area of the circle will increase with the square of the radius. The circumference will increase only in proportion to the radius, since the circumference is

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2r. The friction that must be overcome to move a liquid commodity through a pipe is the friction between the liquid and the wall of the pipe. Therefore, increasing the diameter of a pipe will increase the quantity of liquid in the pipe faster than it will increase the area of the wall of the pipe in contact with the liquid. Consequently, there are gains in economies in the propulsion power required to pump the same quantity of commodity from increasing the diameter of the pipe. There are also economies in the cost of the pipe itself: For larger pipes the number of tons of steel for casings per unit of pipeline capacity is less than for smaller pipes. The only effective limit on the diameter of a new pipeline comes from the demand-side of the market. There is no sense in building pipelines of larger capacity than will be used in the future. The economic problem in planning and pricing pipeline services is determining the lowest possible unit cost per ton-kilometre for the level of expected throughput. This, in turn, requires determining the optimum combinations of pipe diameter and pumping power required for each level of throughput. The size of the pipeline is important, since a larger one, able to handle a greater traffic volume, involves higher capital costs but lower costs for pumps and operations, and less electricity or other energy costs to run the pumps (10). Although the capacity of a pipeline is dependent on the diameter of the pipe and the maximum speed at which the commodity can flow, the flow rate can be adapted by applying more or less pumping power. An increase in pumping rate of the installed pumps will invariably lead to an increase in energy consumption, and therefore higher variable cost. However, as flow increases, the proportional increase in variable costs will be higher than the increase in the commodity flow rate. As a result of the geometric increase in friction resistance of the wall of the pipe on commodity flow as flow speed rises, a quadratic increase in pumping power is needed to overcome the friction resistance that impedes commodity movement. As Figure 1 shows, the long-run average cost curve is continuously decreasing. Theoretically, for a pipe with an infinitely small diameter, total unit cost will be infinitely high. As pipeline diameter increases, and for as long as throughput volumes can keep up, the total unit cost of commodity carried will decline (it will approach zero total unit cost, but never reach zero.) (17, 13, 10).

FIGURE 1 Total cost per unit for various crude oil pipeline sizes and annual throughput.

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Table 1 provides a comparative summary of the most salient economic features of the four modes of transport used for carrying petroleum commodities. Table 1: Comparison of salient economic features of transport modes used for the carriage of petroleum commodities Economic characteristics Cost per unit Cost structure (fixed cost to total cost ratio) Predominant intramodal market type Predominant intermodal competition Market coverage Road High/moderate Lowest Rail Moderate High Pipeline Low Highest Sea Lowest Balanced

Open to oligopoly

Rail: tank wagons

Natural monopoly; duopoly when access is open Road: tank trucks and trailers

Natural monopoly

Open (charters)

Rail when pipeline operates close to capacity Terminal-toterminal

Road and rail: inter-port services Terminal-toterminal

Point-to-point

Economies of fleet size Economies of vehicle size Economies of distance

Moderate

Terminal-toterminal; with private sidings: yard-to-yard Moderate

Moderate

Moderate

Low

Highest

Lowest (referring to number of pipes) Highest (referring to pipe diameter) Lowest (almost non-existent)

Low

High

High

Source: Pienaar and Vogt 2009:353

6. MANAGING COSTS Initiatives that can contribute to reduce operating cost per unit of commodity carried by existing pipelines include cost-effectively increasing capacity, reducing energy consumption and finding more economical ways to maintain facilities (7). Systematically eliminating bottlenecks, boosting operating pressure by adapting, adding and improving pumps and by looping some line sections are examples of enhancing capacity. When demand for crude oil pipeline transport falls substantially below the installed capacity, certain options are available to adjust operations to the situation, for example, by 'moth-balling' individual pumps or entire pump stations and/or closing down loop lines or sections of them. Since lower throughput means lower flow speed and consequently lower friction loss, the above-mentioned measures are aimed at reducing energy cost (10). A large breakthrough was achieved in the 1970s when the controlled addition of a small amount of a long-chained molecule was found to reduce the friction in a pipe, thus increasing pipeline capacity in most cases. Since then a drag-reducing agent (DRA) has been employed in many crude oil

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and products pipelines. Ongoing research is aimed at finding even more effective DRA compounds, requiring less additive and producing more benefit (7). Energy consumption represents a large operating cost item in pipeline transport, and it is a focus area for cost reduction. One tactic has been to employ equipment that uses less energy, such as more efficient pump motors with no moving parts, variable-speed motors and other equipment that requires less power, or to supplement electric power supply with solar and wind power generation near pump stations. Another tactic is aimed at managing the consumption of electric energy by using advanced computerised monitoring and control systems to reduce peak demands and to better utilise valley demand periods, by decelerating the pumping rate during electricity high-tariff periods and vice versa during electricity low-tariff periods. Opportunities to reduce costs by enhancing maintenance activities cover a wide range of examples, from sophisticated to relatively simple. At one end of the spectrum there are complex computer-based maintenance management systems that track equipment performance and maintenance history, and enable the application of preventive maintenance, thereby largely eliminating the expensive repairs necessitated by breakdowns and also avoiding costly down-time. For example, suitable pipeline pigs can be used (a) to help separate consecutive batches (thereby reducing commodity intermixing and dilution); (b) to clean a pipes wall (thereby keeping the entire inside volume of the pipe available to accommodate payload and keeping the wall smooth, which enhances the flow of commodity); and (c) to detect at an early stage the formation of flaws and wear (thereby obviating future costly repairs and loss of income through down-time) (18). An example at the other end of the spectrum relates to the need to maintain pipeline rights-of-way through use of improved herbicides to control the growth of vegetation and the use of helicopter mounted sidecutting tools to trim trees along the edges of rights-of-way. 7. THE EFFICIENT PRICING OF PIPELINE SERVICES Efficient pipeline transport service pricing requires that price be set equal to marginal cost. Unlike most other transport services, pipeline transport supply is relatively homogeneous and there is not a particularly severe peak demand problem (19). In Figure 2, the demand for pipeline transport service is portrayed by D, the average variable cost curve by AVC, and short-run marginal cost by SRMC. Efficient resource allocation occurs at price PA, where the demand curve intersects the SRMC curve.

FIGURE 2 Pricing of pipeline services in the short run.

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It is unlikely, however, that an unregulated monopoly pipeline transport supplier would produce at, or near, this short-run optimum. Overland pipelines enjoy a large cost advantage over other transport modes. Without regulatory restraint, the monopoly supplier would maximize profits at throughput level QB and price PB. From the viewpoint of society, this output is inefficient, since the price exceeds marginal costs. Therefore the prevalence of monopoly power leads to a divergence between the private and social optima. The efficient pricing of pipeline services in the long run is more complex than the short-run situation. In Figure 3 the demand curve intersects the long-run average and long-run marginal cost curves (i.e. LRAC and LRMC respectively) in the region where substantial spare capacity exists. Without regulation a profit-maximizing monopolist would opt to carry output QB and charge a price of PB. In this situation the socially efficient level of output occurs where the demand curve intersects LRMC, corresponding to an output of QA. In this situation the efficient price PA will not result in all production costs being recovered. In this case the appropriate remedy is to apply a two-part tariff strategy, where the unit price is set at LRMC, and the resulting deficit is met by charging its users a fixed charge (20).

FIGURE 3 Pricing of pipeline services in the long run. Commercial petroleum pipeline operators supply a common service to wholesale petroleum suppliers. The aim of a commercial enterprise is to recover full costs plus a return on investment. Because the clients of commercial pipelines are direct competitors in the wholesale fuel market, they should bear full cost responsibility for the service rendered by the pipeline. Service below total cost to a client implies that it is subsidized by its competitors. The only instance when delivery can take place below total cost is when (21):

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the necessary spare capacity exists to accommodate the consignment (i.e. that the opportunity for another consignment to be delivered at full cost is not jeopardized);1 all the avoidable (i.e. short-run) cost is covered and some contribution to unavoidable (i.e. fixed or long-run) cost is made; and the consignment delivery would not have taken place at a price covering full costs. Although commercial natural monopoly pipeline transport operators are not common carriers with social obligations, they should strive to operate in a way that is beneficial to the public interest. A beneficial pipeline transport monopoly is one that succeeds in achieving economies of scale in an industry where the minimum efficiency scale is at a level of production that would mean having to achieve a large share of the total market supply, and whose price is lower than the second cheapest mode of transport. 8. CONCLUSIONS Pipeline transport is very competitive with other forms of land transport, especially if full utilisation of the pipeline is possible at all times. For example, between Durban and Gauteng pipeline tariffs per litre of fuel are approximately one-half of rail tariffs and one-fifth of road transport tariffs. It is, therefore, clear that a Durban-based petroleum wholesaler who does not have access to pipeline or rail transport between Durban and Gauteng is subject to the likelihood of competitive foreclosure in Gauteng. The disadvantages of pipeline transport lie mainly in its extreme functional specialisation and dependence upon sustained high-volume traffic. The initial cost of installation is high and justified only when both the demand and supply will continue for a long time. Despite the fact that tank ships run empty during return trips, pipeline transport can only compete with sea transport between the same origin and destination if the pipeline route is considerably shorter than the sea route, or where sea transport is subject to exceptional charges, such as heavy canal dues. The economic assessment of a pipeline necessitates the investigation of several alternatives in order to determine whether the project is justified in terms of the economic resources its commercial existence will require. Firstly, alternative locations of the pipeline may have to be compared. A second consideration is the size of the pipeline, since one with a larger diameter, able to handle a greater traffic volume, involves higher initial investment cost but lower costs for pumps and energy to propel the pumps. A third decision concerns the choice of pump technology. Most pumps are driven by electric motors, although diesel engines or gas turbines can also be used. A fourth important consideration is whether the refinery should be located at the beginning of the line (upstream, close to the oil field or the port of entry) or at the end of the line (downstream, close to the market). The fifth step in the economic evaluation is to compare the pipeline cost with the cost of the next best transport alternative, which is usually rail transport. If these investigations indicate that a pipeline promises to be technically feasible, financially viable and economically justified, detailed design of the pipeline may commence. The supply of pipeline transport is in terms of market participants the most highly concentrated of all freight transport modes. With a few exceptions, there is but one crude oil, one products and one natural gas pipeline connecting producing areas or refineries and areas of consumption. This high degree of monopoly power results from declining unit costs with increases in capacity, so that the lowest costs are achieved by a concentration of output in a single pipeline. Therefore, pipeline operations that can fulfil entire market demand are pure natural monopolies. Where the distance between supply points (such as geographically separated oil fields or ports of entry) is high in relation to the delivery distance to the market area, such an areas fuel demand can often be most efficiently fulfilled by two or more different pipeline operations. The clients of a common carrier are direct competitors in the wholesale fuel market, therefore they should bear full cost responsibility for the service rendered by the pipeline. Service below total cost to a client implies that it is subsidized by its competitors. The only instance when delivery can take place below total cost is when: the necessary spare capacity exists to accommodate the consignment (i.e. that the opportunity for
1

This situation could possibly arise when Transnets proposed new 60-cm pipeline is in operation, comparing its cost situation to the one illustrated in Figure 3.

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another consignment to be delivered at full cost is not jeopardized); all the avoidable (i.e. short-run) cost is covered and some contribution to unavoidable (i.e. fixed or long-run) cost is made; and the consignment delivery would not have taken place at a price covering full costs.

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