Hedging Your Bets -- Protection From Project Cost Increases
Most major projects are supported by negotiated rate contracts, under which the rate charged will not change if the project’s estimated cost proves to be wrong. However, along with death and taxes, another certainty is that an estimate will almost always be wrong. With a standard fixed rate contract, the project sponsor bears all the upside and downside from missing its proposed budget. However, some shippers and pipelines have begun to structure agreements that result in a sharing of the risk associated with coming in either under or over budget. Today, we look at how TransCanada’s Columbia Gas shared this risk with its customers.
Answers in Clicks Not Hours
With a couple of clicks in our platform, you can find that half of all projects that were estimated to cost over $500 million were over budget and the other half were under budget. From here, as we discussed last week in Project Costs -- Into the Twilight Zone, customers can dive into the specific cost line items, such as how labor and materials costs vary by region and over time, or evaluate different sized projects to calculate the cost spent per “inch-mile” of pipeline built.
Sharing the Upside and Downside
Columbia’s Mountaineer Xpress is a companion project to its sister company’s Gulf Xpress project, and the two projects shared a number of customers. Columbia Gas’s Mountaineer XPress project provided 2,660,000 Dth/day of firm transportation service on Columbia’s system from receipt points in West Virginia, Ohio, and Pennsylvania to delivery points at Columbia’s TCO Pool and Columbia’s Leach interconnect with Columbia Gulf. The Mountaineer Xpress project was supported by precedent agreements with Antero Resources, Kaiser Marketing Appalachian, Equinor Natural Gas, SWN Energy Services, Greylock Production, and THQ Marketing. Columbia Gulf’s Gulf XPress project was designed to provide 860,000 Dth/day of firm transportation service from Columbia Gulf’s Leach interconnect south to delivery points on Columbia Gulf’s system, including the Gulf Mainline Pool. Gulf Xpress was supported by precedent agreements with common shippers Antero Resources, Kaiser Marketing Appalachian, Equinor Natural Gas, and SWN Energy Services.
Both of these projects were estimated to cost more than $500 million, with Mountaineer Xpress being the most expensive with an estimated cost of $2,059,366,383 and Gulf Xpress’s estimated cost at $674,347,029. While neither of the projects has filed a final cost report, we know that Mountaineer Xpress has gone over budget, because, last July, it filed for an amendment to its FERC certificate. In that filing, Columbia stated that the estimated cost of construction had increased to approximately $3,033,100,059. Columbia stated that the primary reason for the increase in costs was related to contractor labor costs, inspection costs, and outside services costs that substantially exceeded the contingency established for such charges.
Exceeding a budget is to be avoided, because of negative financial impacts it has for pipeline returns. Coming in under budget can be a benefit, unless the estimate was so high that the company missed other investment opportunities by unnecessarily allocating capital to a project that ends up unused. Columbia structured its negotiated rate agreements with its shippers to provide for a sharing of the risk associated with both scenarios. In a filing made late last year seeking approval of its contracts with its shippers, Columbia provided a copy of the terms of its negotiated rate agreements with its shippers. While the base negotiated rate ranged from $0.375 to $0.615/dth/day, most of the contracts also contained a clause that adjusted this base rate if the final project costs were not the same as the original estimated cost. The basic structure of the rate adjuster called for the base rate to be multiplied by a number equal to 50% of the percentage by which the final costs were less than, or more than, the estimated costs.
Therefore, in the case of Mountaineer Xpress, if the final costs were 5% lower than the estimated costs, the shippers would see a 2.5% reduction in their base rate, but if the final costs were 5% higher than the estimated costs, then the shippers would be required to pay 2.5% more. However, all of the contracts also contained caps on both the percentage by which the rate could increase or decrease. All of the caps were less than 25%, which means that no shipper will be responsible for the full 25% increase that would have resulted from Columbia’s approximate 50% cost overrun, but Columbia is provided substantial protection when compared to a standard negotiated rate agreement without a sharing mechanism like the one in its contracts.
Interestingly, on the companion project, Gulf Xpress, the contracts with the same shippers did not have a risk-sharing provision and were traditional fixed negotiated rate contracts. While we don’t know whether that project will come in over or under budget, the risk and the benefit for the estimate being wrong appears to be borne entirely by Columbia Gulf.
Our customers who want to be aware of the filing of project amendments that reflect cost increases and the filing of contracts that support projects, can sign up for our daily or weekly alerts and check the boxes for Certificate Applications and Service Agreement Changes. It is always uncertain to assume that the pipeline bears all of the risk from a bad estimate and it is better to know how that risk has actually been shared.
Insights Coming Soon
- Open season to filing timelines
- Litigation Update on ACP/MVP