Bad Quality Allocations Add Up on Joint-Use Crude Oil Pipelines

The Situation

Chevron Nigeria Limited (CNL) entered into a crude oil processing and handling agreement (CHA) with a predecessor of Addax Petroleum Development (Nigeria) Limited (“Addax”) in 1992 to process its crude oil production in the Jisike Field in Nigeria and to transport that oil to the Brass River Terminal on the Addax pipeline for export. Among other things, CHAs describe the duties of the parties with respect to the quality of crude to be transported and, particularly important in this case, the method by which to share losses arising from the commingling of oil produced by both companies and shipped on the pipeline. An “allocation formula” provides a method for sharing those losses (which inevitably arise in transport) based on the quality of measured volumes coming in against measured volumes of the commingled crude oil at the destination. In this case, Addax (the claimant) alleged that CNL’s crude did not meet the quality standards in the CHA and, therefore, caused excessive losses due to “gas entrainment.” CNL (the respondent) contended in a counterclaim that Addax was the problem, failing to remove and track large quantities of engrained water from its own crude oil supplies (which, for its part, CNL had removed from its own crude oil).

NERA's Role

NERA Managing Director Dr. Jeff D. Makholm and Associate Director Dr. Laura T.W. Olive were retained by CNL to provide expert testimony that described the role of contracts like the CHA in the oil pipeline industry and to calculate the value of the crude oil CNL lost during the period in which Addax unilaterally suspended the allocation formula.

Pipelines are by far the least expensive method of transporting crude oil overland any appreciable distance and, given the nature of the sunk cost, non-deployable capital involved in both crude oil production and transportation means that pipeline owners and shippers strive to make agreements to avoid “opportunism” on the part of either the pipeline company or its shippers that would harm the interests of the other party. Given the economic realities of uncertain oil markets and volatile fuel prices, there are many avenues for possible legitimate disputes in dealing with those who, either individually or in joint ventures, use or own oil pipelines that serve multiple independent shippers.

NERA calculated the dollar value of the barrels lost by CNL using a netback methodology that uses the relevant price of CNL’s Nigerian crude oil (as calculated monthly on a per-barrel basis by the Nigerian National Petroleum Company) minus the costs of transport to market from the production field. With help from an expert pipeline engineer (M. Doyle Sanders) to identify the number of barrels lost, NERA calculated a loss to CNL of $170,799,382.

The Result

The tribunal found that Addax owed approximately 1.5 million barrels to CNL for its water problem. Dr. Makholm traveled to Lagos, Nigeria, to provide expert testimony before the arbitral panel in July 2019 on the value of the oil denied to CNL. In their July 2020 decision, the panel found that “[a]lthough Dr Makholm was cross examined by Addax, there was no contradictory evidence adduced by Addax.” As such, the panel fully accepted Dr. Makholm’s calculation of CNL’s damages counterclaim.