Plains All American Pipeline (PAA) has made national news in 2015 for all the wrong reasons. The firm has had two pipeline leaks or bursts since May, one in Southwest Illinois and one near Santa Barbara, California, which have resulted in thousands of gallons of crude oil being spilt.
Worsening the company’s reputation is the recent Los Angeles Times report that Plains All American has had 175 safety and maintenance infractions since 2006, according to federal records. The California pipeline in question was reported to the US Department of Transportation by its Pipelines and Hazardous Materials Safety Administration (PHMSA) to have been corroded by 54%-74% of its original thickness at its weakest points, leaving significantly less than half its original thickness. PAA reported that the area of the pipe that failed corroded 45% of its original thickness away, but PHMSA investigators insisted that the actual corrosion was higher than that.
However, the same investigators later concluded that the protection system used to repair the affected pipeline from external corrosion following a 2012 report was in accordance with regulations. This leads us to believe that the problem may not lie within Plains All American, but that the regulations themselves are insufficient to ensure the proper maintenance of the infrastructure. Though there has not been an official report on the spill in Southwest Illinois, it stands to reason that the leak was caused by a similar effect as the spill in California.
As is the case for every MLP and some midstream corporates, maintenance or sustaining capital expenditures have not been sufficient in accounting for the depreciation of the corresponding assets, and while it cannot be conclusively stated, the mismatch could be the primary reason why pipelines have been failing. A common counter-argument is that pipelines will generally outlast their GAAP depreciation lifetime, thus requiring less maintenance spending than non-cash depreciation expenses in any given year, but this does not appear to be the case in the California incident. This long-held counter-argument may no longer hold water.
Pipeline experts have said that corrosion alone has not been the cause of the recent bursts, but if corrosion reaches the levels that it had in the California incident, a rigorous inspection and monitoring program must be in place. PAA has insisted prior to the spill that “the pipeline and its operations are state of the art.” In 2014, the firm devised a spill response plan, in which it acknowledged the possibility of spills, but added that they were “extremely unlikely.” Federal regulators supported the plan, giving more reason to question the relevance and effectiveness of existing regulations. It appears that Plains All American’s operations were in accordance with federal regulations, and regulators supported the plan the firm had in place as recent as last year.
This leads us to believe that this kind of spill could happen to any industry participant, even those whose pipelines may be in accordance with minimum requirements. Such a view then raises the question of whether or not the regulations governing pipeline maintenance are just too lax in allowing operators to theoretically “underinvest” capital, as evidenced by the relationship between sustaining capital spending and GAAP depreciation. Could the regulations, not the companies themselves, actually be facilitating many MLPs to ignore prudent maintenance spending because it simply is not mandated by regulations? From our perspective, stricter regulations are coming and may soon put an effective end to that argument, tying maintenance capital spending closer to GAAP depreciation—thereby putting the pinch on the pace of distribution expansion.
The PHMSA has already proposed massive changes to pipeline safety rules. If its current proposal comes to fruition, approximately 95% of all pipelines in the US, or 182,000 miles, will be subject to the new rules and will undergo extensive testing to ensure they comply. According to the PHMSA, ~50% of all US pipelines were installed before 1970, and the amount of crude oil pumped in the US has increased by nearly two thirds in the last five years, creating maintenance issues for pipeline operators across North America.
One of the largest alterations in the new proposal is how pipeline operators determine a pipeline’s maximum operating pressure, or how much oil or natural gas it can transport. The proposed adjustments will require a much more expensive and thorough upgrade to the current processes used. The image below shows the age of pipelines throughout the US, further illustrating the need for massive improvements to the aging infrastructure of the industry.
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