Insight: Oil pipeline crunch shifts U.S. shale race from drillbits to valves

HOUSTON Mon Jul 30, 2012 4:44am EDT

The Keystone Oil Pipeline is pictured under construction in North Dakota in this undated photograph released on January 18, 2012. REUTERS/TransCanada Corporation/Handout

The Keystone Oil Pipeline is pictured under construction in North Dakota in this undated photograph released on January 18, 2012.

Credit: Reuters/TransCanada Corporation/Handout

HOUSTON (Reuters) - The U.S. shale oil revolution can't be stopped, but it could be delayed by a potential shortfall of 10-ton valves and giant pipeline pumps essential for rebalancing markets upended by the surge in production.

Amid an unanticipated boom in inland oil output that turned the domestic market upside down last year, firms from Enterprise Products Partners to Shell Pipeline and Plains All American have launched a $20 billion bonanza to build, expand or reverse two dozen pipelines in the past year.

But as they help effectively to switch the flow of oil from the north to southern refineries and relieve the glut of cut-price, landlocked crude, concerns are growing that the firms that make key pipeline components may be straining to keep pace.

"The supply chain hasn't quite caught up," said Terry McGill, president of Enbridge Energy Co Inc, the U.S. division of Canadian pipeline giant Enbridge Inc, which has some $4 billion worth of U.S. projects on the books.

Thus far, there are no signs of project delays or cost overruns in what is the biggest build-out of oil and liquid pipelines since World War II.

Executives say they are building in plenty of lead time to produce dozens of multi-ton valves and massive pumps essential for maintaining pipeline flow. Underutilized steel mills, meanwhile, can rev up furnaces to forge the pipes -- which have a diameter of up to 42 inches.

But the task is enormous. After decades of moving U.S. offshore or Middle East crude from the Gulf Coast to inland refineries, pipelines must flow in the opposite direction to accommodate surging output from Canada and shale oilfields such as North Dakota's Bakken.

It all makes for a historic boom, said Larry Schwartz, senior analyst for natural gas liquids at consultancy Wood Mackenzie: "Midstream, which was the redheaded stepchild, is now in vogue."

RAMPING UP FAST

Spending has already accelerated far faster than many expected. A year ago, the Interstate Natural Gas Association of America (INGAA) estimated North America would add 19,000 miles of oil pipelines at a cost of $31.4 billion by 2035 as production surged 50 percent to 12.7 million barrels per day.

But industry monitor IIR Energy now estimates that $10 billion a year will be spent on crude oil pipeline projects in 2012 and 2013, four times the average of the previous seven years.

"You're not just connecting in to existing grids," Enbridge's McGill said. "The grid is being built."

The biggest projects, those pumping 1 million barrels daily or more, face the greatest risk of delay, experts say. Each of the dozens of valves required on something like TransCanada Corp's proposed $7.6 billion Keystone XL pipeline -- which has a 36-inch diameter -- usually must be custom-made.

"We definitely consider ours an ‘engineered to spec' product," said John Starck, vice president of sales for M&J Valve, a division of multi-industry manufacturer SPX Corp that operators say is a leading valvemaker for liquids pipelines.

"We do not actually build the product and keep it on the shelf because each customer has their own unique set of specs."

Meanwhile, the market is consolidating as bigger companies snap up industry-favored manufacturers. That shrinks the already small field of venders in the brand- and manufacturer-loyal industry, threatening higher prices as demand swells.

Operators saw prices for parts shoot up sharply in 2007 and 2008, the apex of the last huge pipeline build-out that brought on thousands of miles of new natural gas pipelines.

"The price just goes up the more projects are out there," said Leon Zupan, president of gas pipelines for Enbridge's U.S. division. "Whenever you need big castings for pumps or valves, there's only so many people who can do it."

At SPX, valves and pumps make up part of its fast-growing global flow technology business that the company has said it expects overall to contribute $1 billion to sales this year.

SPX has given no specific sales data on parts involved in the U.S. liquids pipeline boom.

CANADA TO BAKKEN TO OHIO...

The first huge build-out in the United States came during World War II when the federal government ordered a two-pipeline system, the Big Inch and Little Big Inch, to carry oil and refined products to the Northeast from the Gulf Coast.

The network, created largely to thwart German submarines that had repeatedly torpedoed tankers along the Atlantic Coast, later had its lines converted to carry natural gas.

Postwar prosperity generated industrial demand for natural gas, and pipeline construction flourished for another 20 years. Big one-off oil projects included the Colonial refined product pipelines linking Gulf Coast refiners to the Northeast market and the 48-inch, 800-mile Trans-Alaska Pipeline System (TAPS) to bring newfound Alaskan crude to that state's coast.

After that, pipeline construction slowed dramatically as refinery construction stopped and steady oil production necessitated only incremental improvements in the network.

Then came the natural-gas shale frenzy that spurred a huge wave of pipeline construction from 2006 until 2008, when the financial crisis and a collapse in prices halted investment, leaving some parts distributors nursing heavy losses.

MRC Global Inc, the largest global distributor of pipe, valve and fittings to the energy industry, recorded a $46.5 million writedown in 2009 on an overhang of unused inventory as customers dried up. The company declined to comment on its business.

Now the focus is on crude as drillers apply the same hydraulic fracturing technology that upended the natural gas market five years ago to neglected onshore oilfields, unleashing a burst in production unimagined a few years ago.

Output in the Bakken alone has surged from nothing to more than 600,000 barrels per day in five years, and may double by 2015.

Texas is on pace to issue the most drilling permits since 1985 as output from Eagle Ford, the Permian Basin and the Granite Wash surges. More liquids may emerge from the gas-heavy Marcellus shale in the Northeast or Ohio's nascent Utica shale.

Much of that increased production is in remote areas far from refining hubs or in the Midwest and Northern Tier, turning the traditional south-to-north flow pattern on its head. Producers were forced to turn to costly rail, barge and even truck tankers to move oil from the wellhead to refineries.

"New infrastructure is going to be critical to push these commodities around the country where they need to be," said David Seaton, chairman and CEO of engineering company Fluor Corp. "It's going to be the lifeblood of economic growth for my lifetime."

The aim is to eliminate the bottlenecks and reduce transportation costs, shrinking the discount of benchmark inland U.S. crude in Cushing, Oklahoma to global prices. At $15 a barrel last week, the gap remains historically wide.

The first such project, Phase I of the reversal of the Seaway Pipeline to move crude from Cushing to the Texas coast, began pumping on time in mid-May. It will require a host of additional pumps and valves -- but no major pipeline sections -- to reach 450,000 bpd by the first quarter of 2013.

It's not just oil pipes. Some $6.5 billion is being spent on natural gas liquids pipelines needed to accommodate output growth in propane, butane, hexane and other NGLs that emerge from shale plays and feed hungry petrochemical complexes, according to IIR.

Operators are optimistic, but on guard.

"By carefully managing those rare instances when we've had an issue with a valve or a pump, we have been able to complete the vast majority of our projects on time or even ahead of schedule," said Leonard Mallett, senior vice president of engineering for Enterprise Products Partners. His company is one of the largest U.S. operators with planned projects totaling some $7 billion across pipelines, terminals and storage.

10-TON VALVES

As manufacturers see orders for critical inputs increase, some are hiring more workers, from welders to salespeople. Others are soaking up current capacity to produce more by adding shifts and some seem to be expanding, cautiously.

A valve for a 20-inch pipeline can weigh 3,000 pounds (1,360 kg) to 4,100 pounds, while one for a 36-inch line can weigh 15,500 to 19,000 pounds, depending on whether flanges are included. The biggest valves for the largest pipes are heftier, plus they cost about $120,000 each.

It can take 20 to 22 weeks of lead time to build a 42-inch valve, said M&J Valve's Starck. Enbridge's McGill said for big pressure pumps, "it would be a year."

John Lenander, vice president of oil and gas valves for another major valve and pump supplier, Dallas-based Flowserve, said timing depends on the level of specialization, the amount of valves needed, and pipe size.

For example, 10 valves for 200 miles of 42-inch pipe could be supplied in six to eight months. But 60 valves for 1,200 miles of 42-inch pipe would more likely be quoted with partial deliveries starting in six months, with everything completed in about a year, he said.

"We've been putting a lot of additional resources into supply-chain management, project management and engineering," he said. Flowserve, which reports second-quarter results on Tuesday, is also expanding plant capacity, he said, but declined to provide details.

Flowserve has said U.S. and Canadian unconventional resources -- such as shale and tight oil and gas production -- have led to "significant project activity" in its North American oil and gas, chemical and power markets. The company does not break out valves and pumps for U.S. liquids pipelines.

Starck said M&J, whose parent SPX reports earnings on August 1, has bulked up its manufacturing workforce slightly, but so far has mostly worked to optimize existing plant capacity.

ClydeUnion Pumps, a leading pumpmaker that SPX bought last year for $1.25 billion, has no plans to expand manufacturing capacity, confident its five factories in North America and Europe can meet demand.

"We can see ahead just how our capacity is, and do what we need to do whether it be one shift or two shifts," said Dick McAdam, vice president of sales in the Americas for ClydeUnion.

SOME COMPLAINTS

Some competitors to the top firms say builders have begun to complain about long lead times, even at manufacturers with which they regularly work.

"You need to diversify your supplier base. That's being done right now, and it should have been done a long time ago," said Elis Zhonga, a senior U.S. sales representatives for Valvitalia, which distributes Italian- and Chinese-made valves. He said the company is hiring more sales and distribution staff at its U.S. operations in response to increased demand.

But Zhonga said that despite the complaints, pipeline companies are loyal to tried-and-true suppliers, and he doesn't expect that to change even if manufacturing times lengthen.

The most basic raw material for pipelines and a majority of mainline valves -- steel -- remains plentiful, operators say.

U.S. steel production is at about 75 percent capacity, according to the American Iron and Steel Institute. About 7.2 percent of steel production went to the energy industry in 2011, and that share is expected to grow this year.

Capacity is rising as well. Industrial Info is tracking more than $1.7 billion in projects to build mills designed to produce pipe in North America, much of it by foreign companies including China's Tianjin Pipe and India's Welspun Gujarat Stahl Rohren.

(Additional reporting by Steve James and Matt Daily in New York; Editing by Dale Hudson)