Chevron Overseas Petroleum, Inc. entered into a 1993 joint venture with the Republic of Kazakhstan, a former republic of the old Soviet Union, to develop the huge Tengiz oil field.4 Unfortunately, the climate in the region is harsh, making it difficult to keep oil flowing. The untreated oil comes out of the ground at 114°F. Even though the pipelines are insulated, as the oil gets further from the well on its way to be processed, hydrate salts begin to precipitate out of the liquid phase as the oil cools. These hydrate salts create a dangerous condition by forming plugs in the line.
The method for preventing this trap-pressure condition is to inject methanol (MeOH) into the oil stream. This keeps the oil flowing and prevents hydrate salts from precipitating out of the liquid phase. The present methanol loading and storage facility is a completely manual-controlled system with a rapidly deteriorating tank. The scope of repairs and upgrades is extensive. The storage tanks are rusting and are leaking at their riveted joints. The manual-control system causes frequent tank overfills. There is no fire protection system, as water is not available at the site. The present storage facility has been in service for five years. Permit requirements mandate upgrades to achieve minimum acceptable Kazakhstan standards. Upgrades in the amount of $104,000 will extend the life of the current facility to about 10 years. However, upgrades will not completely stop the leaks. The expected spill and leak losses will amount to $5,000 a year. The annual operating costs are expected to be $36,000.
As an alternative to the old facility, a new methanol storage facility can be designed on the basis of minimum acceptable international oil industry practices. The new facility, which would cost $325,000, would last about 12 years before a major upgrade would be required. However, it is believed that oil-transfer technology will be such that methanol will not be necessary in 10 years. The pipeline heating and insulation systems will make methanol storage and use systems obsolete. With a more closely monitored system and a lower risk of leakes, spills, and evaporation loss, the expected annual operating cost would be $12,000.
(a) Assume that the storage tanks (the new ones as well as the upgraded ones) will have no salvage value at the end of their useful lives (after considering the removal costs) and that the tanks will be depreciated by the straight-line method according to the Kazakhstan's tax law. If Chevron's interest rate is 20% for foreign projects, which option is a better choice? Assume a 40% tax rate.
(b) How would the decision change as you consider the risk of spills (resulting in clean-up costs) and the evaporation of the product having an environmental impact?