There is little doubt that natural gas and light oil from shale resources have changed the U.S. energy picture. The abundant supply has led to a 40% increase in natural gas production and a doubling of oil production since the beginning of the century. Equally important and perhaps outshining these tremendous production increases is the explosive growth of the energy midstream infrastructure.
The increased oil and gas production is possible because of the midstream facilities. Retrofitting the nation’s natural gas pipeline system and building new gathering, processing, treating, and storage facilities to handle the new sources of hydrocarbons has been a necessity. The large investments needed for these new midstream facilities have become a major income-maker for many companies.
The additional revenue has added greatly to the cash flows and distributions for many companies and operators. Many are now used to these good returns. But like anything good – they cannot go on forever – when will it change? That is the big question. Chicago investment analyst firm MORNINGSTAR issued a report in January in an attempt to answer this question.
According to their analysis, “we believe that the midstream has entered its midgame, where the easy wins of robust industry growth will be fewer and farther between, and operators will need to re-evaluate their longer business strategy. However, and perhaps contrary to conventional wisdom, we do not believe that a shrinking set of attractive organic growth opportunities will have a major impact on valuations; in fact, we believe that midstream firms are modestly undervalued today, even after taking into account the likely slowdown in out-year capex.” (The full report, ENERGY OBSERVER JANUARY 2014 is available from the firm’s office in Chicago.)
The midstream sector, which includes everything from the wellhead to the consumer, for a long time was a “stepchild” of the oil and gas industry. It has evolved into a critical element of growth and an important aspect of the capital infrastructure. Until the 1990s, the midstream was mainly a part of the producers’ and pipelines’ network. There are separate facilities for crude oil distribution and marketing mainly designed for getting oil from the well to the refinery. Natural gas has separate facilities which are for treating, processing and storing gas before shipment to local markets or “city gates”.
New federal regulations starting with the Natural Gas Policy Act in 1989 dictated that midstream activities would become a major operating segment of its own as the role of pipelines was changed. Interstate and intrastate pipelines to a lesser degree, changed from their multifaceted roles as companies that were handling storage, treating, processing and marketing of natural gas to transporters only!
Many natural gas pipelines spun off supplementary facilities such as gathering systems, treating and processing plants, storage centers and marketing operations. These became new independent companies, along with several entrepreneurs who began from scratch to fill the void created by the new regulations. The start of a formal midstream segment was underway. The midstream went from obscurity to the limelight in roughly a decade.
This was before the development of horizontal drilling and fracking – the first major steps to developing oil and gas from shale and tight deposits. But, it was the developing of oil and gas from shale that made an even bigger change on the midstream business. The new resources were not necessarily where the old oil and gas sources where located. The Bakken formation out in the Dakotas, the Marcellus along the mid-Atlantic, and even the Barnett in the Fort Worth area, to mention a few big examples of many, required new infrastructure to get the oil and gas to market. The boom was on in the midstream business!
As these businesses came alive and established the going trade, a new economic plan was becoming popular because it had some tax advantages for capital investment which fit the midstream business like a hand fits a glove. The new actions coming from the shale development need large quantities of capital to develop the midstream business.
This was unheard of in the oil and gas business. Prior to 2005, few institutional investors put money in midstream companies which, for the few around, were treated like utilities. The new game was called “master limited partnerships (MLPs). The big change in the MLP is that the investor’s money is returned directly to him from revenues and he is the only one burdened with the tax payment for profits. For a facility processing natural gas to remove the contained natural gas liquids (NGLs), this is an ideal way to handle financing.
The MORNINGSTAR report contains an interesting discussion on the size of the midstream shale caused boom. “A consequence of the shift to unconventional drilling was an escalation in midstream share of industry capital spending.”
Midstream investment was about 10% of E&P spending or $3 billion annually, according to a study by Deloitte’s energy practice. The share has increased to 16% of E&P capex since 2006 while total E&P spending also rose. “This amounts to a six-fold increase in capital intensity for midstream and a four-fold increase for upstream as a result of unconventional drilling.”
The report also covers future prospects and the outlook for extended nonconventional plays. One interesting area is a review of the INGAA (Interstate Natural Gas Association of America) study done in 2011 which calls for $250 billion in gas and liquids spending required by 2035.
Spending is summarized in the following table:
Required Oil & Gas Infrastructure Spending 2011-35, INGAA 2011
Natural Gas 2011-2020 2021-2035 2022-2035 Annual Average
Total Gas Capex 98.1 187.1 205.2 8.2
Oil Transmission 19.6 11.8 11.4 1.3
NGL Transmission 12.3 2.2 14.5 0.6
Total Liquids Capex 31.9 14.8 45.9 1.8
Total Midstream Capex 130.0 121.1 251.1 10.0
The report discusses that the change in midstream is dependent on future oil and gas production. The report clearly indicates how the midstream benefited from the shale boom. To show where future midstream energy is in its investment cycle, the authors believe investors need to see where future oil and gas production is forecast. To do this, the authors used the EIA (Energy Information Administration) Annual Energy Outlook to 2030. Using the report’s graph, it shows U.S. energy rising from 2014-2030 from16 to 20.5 mmboe/d.
The report lists 47 gas transmission projects to be put in service through 2016. Most of these are in the Marcellus region where the amount of shale gas is more than is needed for surrounding areas during the shoulder months and is causing transportation problems.
While the report is useful in its coverage of midstream values and in describing the relationship between midstream and oil and gas production, there is little information on continued shale development. It makes no mention of the potential problems arising from environmentalists over drilling and production techniques or the problems coming from environmentalists on the continued use of fossil fuels. Both of these could severely affect the shale development and the midstream. Nor did it mention the challenge some are seeing of potential shortfalls in shale projects that are not living up to production expectations.