Manyright of way appraisers rely on the “across-the-fence” (ATF) method to assign value to a particular right of way. The ATF method suggests that the right of way is worth whatever the surrounding land is worth. This method is popular, but only accounts for the value of the land itself. It does not take into account the value of the entity that uses the right of way, especially when it comes to right of way segments that contain pipelines. Typically, an easement or right of way contributes 5% to 7% of the cost of a building a pipeline and is not a large factor in the value.
Pipeline Equities saw the need to find methods of appraisal that are suited specifically to the pipeline industry. The need for pipeline appraisals came about initially when a discovery was made of the overvaluation of pipelines by local taxing authorities as well as overvaluation (and undervaluation) of pipelines involved in mergers, acquisitions, or estate settlements.
A valuation report concerning active or inactive oil, gas, or product pipeline may be needed for 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
Methods of Appraisal
Pipeline Equities uses a combination of various methods to determine the value of a pipeline.
Market analysis utilizes comparable sales histories. 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 houses 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 by looking at sales histories of comparable pipelines in varying circumstances and locales in order to get some ideas in broader areas of comparison such as urban versus rural, California versus Mississippi, gas versus crude, and regulated versus non regulated pipelines. This factor is also called comparable analysis and is the primary tool for determining pipeline right of way values as opposed to the Across the Fence or ATF method used by real estate appraisers for valuing road and power line easements.
Highest and Best Use
Highest and Best Use is not best applied to pipeline evaluation; however, on occasion when pipelines are 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 crude product pipeline to fiber optic conduits or conduits for electric power line cables from wind farms electric grid centers. For the most part, pipelines are best used for the intent constructed. In the approach using highest and best use, it is better to combine the valuation with some of the forty factors such as size of line, geography, terrain or right of way values. An example might be that the highest and best use for a six-inch gas line might be to change it out for a ten-inch crude line using the same right of way if the contract permits the replacement.
Seller Determined Need
This method is used if the seller wants to record financial gain or loss from a sale use book value. It is not of much use to a purchaser since it has no relevance to current worth. Basically, the book value might be generated by the accounting of the seller or owner of the property, in whatever means the company accounting might use to determine the book value. It might be based on one or the other methods of determining value such as construction cost new and discounted, for example, but generally this book value designation by the seller has no relevance to the value 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 predicted cash flow. This method takes into account forecasted income based on throughput volumes and rates of the commodity transported. Expenses based on a 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 twelve. This can be done on annual or monthly basis much like values of oil and gas royalties are determined. Many like to compare 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 and area. These additional income streams can be discounted to find a present day value or Net Present Value (NPV) in some cases when using future multiples or 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 Net Present Value in today’s dollars.
Construction cost new
Construction cost new or replacement cost is the cost of rebuilding the same pipeline in the same size, same manner, and 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. An example would be in determining the value of a pipeline that has been operating for ten years after it was initially installed. The line might have an expected life of forty years. It could be discounted 2.5% per year of life or a total of 25% off the cost of new construction in today market.
Each of the above methods can be employed to determine value for a property if the occasion calls or a combination of all can be used. We have found that value occurs with the interaction of demand for the property, utility of the property, scarcity or supply of the property, and ready transferability of ownership rights.
In the area of local distribution, a per customer value is sometimes used to realize value for a system. This per customer value is assessed on an individual basis and vary depending on whether the system is in an urban or rural area, high or static growth and other demographic factors. Greater multiples are used for commercial and industrial customers than residential. Residential customers might be valued individually from as little as $400 in a low use slow growth area to as much as $2000 in a high use high growth area.
Factors for Determining Values
In addition to these methods, several factors must be considered when assigning value to a pipeline. Pipeline Equities uses as many as 40 different factors to make our value determinations regarding pipelines. These factors cover the more technical aspects of business, physical, property, and commodity value. Some of these regarding pipelines might include:
- Throughput value (transportation) This method can be used to value based on revenue and can be incorporate into a multiple approach, net revenue approach, or forms of discounted cash flow (income).
- Depth of coverage of pipe Depth of pipe or coverage is often associated with age. Often age and condition can be somewhat ascertained when depth is known and date of installation is not.
- Right of Way agreements Right of way agreements tell much about value. It is basically the legal instrument that determines the conditions by which a pipeline can be laid, width of right of way, maintenance conditions, repair conditions, term of contract, disposition of assets on termination of usage or term in contract, etc, etc.
- Replacement Value (asset) The replacement or cost basis is determined by the cost of replacing this same pipeline either on today’s cost basis or on a depreciated basis.
- Salvage Value Salvage is determined by what material can be sold as in another venue; taken out of the ground and sold for the steel tubes or scrap value. In this way the pipe is treated as a commodity or secondary tubular steel.
- Supply (other pipelines in area/scarcity) Supply is where the product comes from to feed the pipeline. Are there other pipelines to take the product? Are there other sources of supply? What is the life expectancy of the source for the supplier.
- Demand (potential buyers?) Is there sufficient demand to maintain or lay a pipeline? Is the demand stable and reliable? Is there room for future expansion with the demand group of buyers or transporters?
- Customer value In the area of local distributors, a per customer value is sometimes applied. This value can vary from one local to another depending on demographics and economics of the area: whether it is urban or rural, high or static growth, etc. A major factor can be number of industrial or commercial customers such as restaurants, schools, plants that consume gas in manufacturing, etc.
- Surface Inventory (including appurtenances) Generally pipelines are bought and sold including appurtenances which are all valves, risers, meters, and anything else connected to the pipeline that is part of it and contributes to its operation. This can include tanks storage facilities and terminals.
- Sales Contracts / Length If the pipeline depends on a certain customer, or group, then it is important to know the term of the sales contract.
- Potential for replacement volume (new wells, tie ins) The potential for new customers is worth noting. It there is room for growth and the potential or possibility of new growth then it could affect the premium or discount values.
- Type of System, oil & gas, product, etc. The type of system is significant for various reasons whether it be gathering, trunk, transmission, liquid, product, gas, or whatever.
- Size of pipe Size of pipe helps determine salvage as well as whether or not the pipe must be removed on termination of usage, etc. Mainly, size determines volume that can be transported and thus revenue potential.
- Specification of pipe specifications are important when determining value regarding salvage as well as dictates type of product and pressures that can be operating while the line is in service.
- Management (front and field office) Management can make or break any business, pipelines included.
- Date of Installation dates are key as they determine and reveal vintage of the pipe, coating, type of construction, and environmental considerations as of date of installation.
- Maintenance of property Care and maintenance reveal the type and attitudes of management and the company as well as general conditions. Most pipelines are buried and the appurtenances above ground reveal much of the overall care to a property.
- Interconnects The interconnects are different as they are considered a separate asset and not an attachment or appurtenance to the pipeline even though it is or has become part of the system. We consider it separately and value accordingly varying from one to another.
- Cathodic protection This corrosion protection of last resort is significant and the degree to which it is maintained is important. Conditions change and can affect the efficiency of any system especially in rapid growing and transitional areas.
- Pipe coatings (vintage) Pipe coatings reveal age and sometimes the type of construction and vintage of pipe. Knowledge of pipe coatings is important because this is the first line of defense against corrosion. Often older pipelines present environmental concerns as they have asbestos fiber embedded.
- Environmental concerns This becomes a maintenance issue as much as anything as concerns center mostly around releases (spill, leaks) and what the oil, or any other kind of product might be transported.
- Demographics- urban or rural? Pipelines in and out of cities and in the path of rapidly expanding areas of the country pose different sets of problems and generally require more maintenance than pure rural and thus can add significantly to overhead and upkeep as well as create higher tax rates by some appraisers.
- Appurtenances other than surface inventory Often there is forgotten the fee land that is acquired with a pipeline. In many situations real estate of value is part of a system but not recognized for its value as an entity by itself. Others might include loading docks at terminal especially docks on important water transportation corridor (Intracoastal Canal, Mississippi River).
- Appearance Curb appeal is importance in buying or selling a pipeline as it is in buying and selling any kind of property. The appeal of any property is always enhanced by well maintained and clean, well kept appearances.
- Reservoir studies Reservoir studies are important when any system is dependent of a particular field or reservoir that feeds the pipeline system. It is important to know the life of the pool that is being depleted.
- Market price of commodity The price of the commodity determines the activity. Current high prices encourage much activity. When prices were lower, pipelines did not change hand very often for lack of motivated buyers.
- Type of system: trunk, gathering, distribution, etc. The type of pipeline system is significant because each has its own set of peculiarities. Gas distribution companies deal with retail customers; Oil pipelines generally require more operations personnel than gas transmission, etc.
- Chemical content of transported product (H2S, CO2) Aside from the obvious such as H2S and CO2 there are the myriad other chemicals, residues, and contaminants that are part of the process of eliminating cleaning and disposing of to some degree or another for safety as well as environmental reasons.
- Market diversity Does the transporter have any diversity or opportunity to sell to more than one designated buyer?
- Proximity to markets How far is the distance from the source to the market? Is there room for competition? Could another line be built economically to compete?
- Geography Geographical considerations can determine construction costs and when factoring in terrain, drainage, rivers, streams, and elevations.
- River crossings One or more river crossings on right of way can add asset base and value to a pipeline.
- Diversity of suppliers Is there another supplier on the horizon in case the current source changes in any way. What is the stability of the current supply?
- Regulatory oversight or governmental factors What kind of oversight. Is this a state regulated pipeline, FERC. To what agency does management report?
- Social factors These can relate broadly to demographic characteristics of the area of the pipelines: age and gender composition, population, and social attitudes.
- Economic factors This can relate to employment cost of money, inflation, rent levels, possible new development, and construction costs in an area.
- Transportation Is area accessible for new construction, maintenance, and repair?
Other factors depend on whether product 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.
Pipeline Equities has had several recent opportunities to appraise pipelines for a variety of purposes.
Appraisal for Pipeline Rehabilitation
Pipeline Equities recently appraised a vintage crude pipeline in a mature field on the West Coast. 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.
Appraisal for Construction Financing
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.
Appraisal for Pipeline Divestiture
A hedge fund made a decision 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 come to an equitable value to which all parties agreed. Many of the gathering lines had no discernible easement by which a right of way only method like the ATF method could be used.
Appraisal for Tax Authorities
We have had many instances where a pipeline or gathering system was built for a new field with flush production and the field now is nearing depletion. 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 methods with no regard for throughput generally via abbreviated Marshal and Swift formulas (Marshall and Swift is a commercial database of information, which is like a supermarket for almost any kind of asset valuation. The data is offered on a subscription basis.)
The appraisal of pipelines is a specialized and niche industry. The methods for determining value are different from any other type of appraisal practice due to the uniqueness of the product being appraised. No two pipelines are the same. Our methods are based on the way a pipeline owner looks at a pipeline and the right of way in which it rests.
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.
Each of the factors, examples, methods and definitions could be greatly expanded on. For additional information on this subject email a request for a complimentary copy of the Pipeline Recovery Manual to email@example.com