Rise of the midstream
Oil and gas changes are providing a golden opportunity for companies sitting between producers and refiners
Oil and gas infrastructure companies are experiencing a financial renaissance analysts haven’t seen in decades, as North America races to accommodate growing production and demand.
Billions of dollars are flowing to the Canadian midstream sector to build up pipelines and processing plants, key operations to get energy resources to market. The assets boast long-term contracts backed by a multitude of customers and are harbingers of more to come, say analysts.
Canada and the United States will need to spend an average of almost US$30billion a year on infrastructure for oil and gas, a total of US$641-billion over the next 22 years, according to a recent study by ICF International for U.S.-based INGAA Foundation, which represents North American natural gas pipeline companies.
Almost half, about US$14.2billion per year will flow toward midstream natural gas investment between now and 2015. Oil will command US$12.4-billion on gathering and main line pipeline systems, equipment and storage tanks, the report said. Natural gas liquids infrastructure, such as pipelines, pumping, fractionation and NGL export facilities will demand another US$2.5-billion per year.
Midstream companies process and transport oil and gas resources, sandwiched between producers upstream and refiners downstream. The sector has fallen in and out of favour as producers swing between wanting total control over their barrels and shedding non-core assets to focus on getting the resource out of the ground.
The rise of midstream companies is part of that evolution, say analysts.
“The renewed interest in midstream companies, and why you’ve seen the significant growth — and them accessing a lot of capital — is really a reflection of the fundamental restructuring that is underway in North America,” Barry Munro, Canadian oil and gas leader with Ernst & Young LLP, said.
The growth is caused by the dramatic ramp-up of oil production in Canada and the United States, as well as the structural shift in natural gas production on both sides of the border, he said.
“Infrastructure kind of woke up one day and didn’t really match very well with where all of the oil and gas was being produced in North America,” primarily due to shale, Mr. Munro said.
Canadian crude output is expected to rise to 4.9 million barrels per day by 2020 from 3.2 million bpd in 2012, largely from the Alberta oilsands. Natural gas production, which dropped 15% between 2008 and 2013, is expected to jump to 18 billion cubic feet per day by 2035, from about 13.9 bcfd.
Drilling and completion technologies have untapped vast quantities of natural gas and oil reserves previously too complex and expensive to produce. Horizontal drilling and multi-staged fracturing have unleashed an unprecedented surge in oil and gas production in new basins, or taxed processing and transportation assets in traditional exploitation regions.
In addition to the lack of take-away infrastructure, regions of production have changed. New shale gas volumes in the eastern U.S. are pushing back Canadian exports, and western Canadian oil moving east is replacing offshore barrels used by refiners such as Irving Oil and Suncor Inc.
The shift in flow has prompted a re-evaluation of existing assets resulting in projects such as TransCanada Corp.’s Energy East line converting parts of its natural gas main line to oil, or Enbridge Inc.’s Line 9 reversal, bringing Western crude to refiners in Quebec and the Atlantic.
The surge in activity translates into a significant growth opportunity for midstream companies to fill the gap in infrastructure, including field processing plants, fractionation plants, storage facilities, loading and shipping terminals. It’s a second golden age for the sector, after the heady build out of the 1960s in Western Canada, said Steven Paget, analyst with investment brokerage FirstEnergy Capital Corp.
As well, the nature of their cash flow streams, earning fee-based returns in a deregulated transportation, storage or handling market, make midstream companies the current in- vestor darlings, he said.
“Midstream companies are popular because of very strong yields,” Mr. Paget said. “People want income and they want secure assets.”
Predictable, long-term cash-flow-generating assets such as pipelines and midstream companies have proven attractive to riskaverse investors following plummeting interest rates. Investors refocused on yield, bid up midstream and infrastructure stocks, thereby reducing the cost of capital for the company.
For example, when Calgary-based Pembina Pipeline Corp. agreed to build a $2-billion system expansion in northwestern Alberta and northeastern British Columbia, it did so with various producers, allowing a secured return on capital. Only a midstream company can bring competitive companies together to build a huge project, Mr. Paget said.
They are building bold projects, l ong term, with secured contracts, he said, adding competition for those producer contracts is fierce. And there is more in store as exports of natural gas liquids and liquefied petroleum gas gain steam.
“We think these assets can earn for many years to come,” Mr. Paget said. “And there are still many opportunities for growth.”
Pembina Pipeline, Veresen Inc., Keyera Corp., AltaGas Ltd. and Gibson Energy Inc. are only a few of those midstream companies announcing new projects and expansions to accommodate producer and market demand. And they’re financing them through bond issues, tapping into private debt markets and other equity.
A lower regulator risk also attracts investors to midstream companies with operations located within one provincial boundary, i.e., ones, which don’t cross any borders, says Pat Kenny, with National Financial Bank.
The staying power of contracts locked in over many years and a diverse client base — such as Pembina Pipeline’s 10-year-contracts with 30 customers — will provide a healthy return on capital over the next decade, he said.
The added bonus is such projects likely will result in further expansion downstream of that value chain as processing and fractionation facilities are underpinned by the expansions, he predicted.