December 2013, Vol. 240 No. 12
Features
Pipelines As Real Estate: Midstream REIT Is Buying
A real estate investment trust (REIT) owns income-producing real estate and offers shares to investors — it allows people to buy an interest in many different individual properties in the same way a mutual fund sells shares composed of many different companies. Often REITs focus on familiar categories like shopping malls, hospitals or mortgaged homes. But pipelines also qualify as real estate for the purposes of a REIT, and one new trust is now interested in buying a selection of them as investments.
CorEnergy Infrastructure Trust has spent six years on the New York Stock Exchange, but after big changes in 2012, it is putting forth a simple strategy. It will purchase pipelines, storage facilities and a few other types of infrastructure from owner/operators, sell shares in the trust to the financial markets and lease the assets themselves back to their former owners. Operators will continue to behave as though they own the pipelines, taking care of maintenance and compliance and administering all their own management programs. Although CorEnergy has the right to inspect its property and operator records at any point, meaningful control remains with the operators.
CorEnergy’s management team has plenty of midstream experience. Dave Schulte, CorEnergy’s CEO, was on the board of Inergy L.P., the processing and storage company that recently merged with Crestwood Midstream. In 2002 he cofounded a financial firm listing energy securities, mainly pipelines. Rick Kreul, who handles asset evaluation at CorEnergy and is president of a subsidiary firm, was president of a natural gas pipeline bought by Aquila Energy in the early ’90s and vice president over West Coast midstream operations at Inergy. Kreul is a mechanical engineer with more than 30 years’ experience, and oversees a small local natural gas distribution company (LDC) in southern Missouri.
In fact, Schulte said, “Most of our team has energy operating experience rather than finance backgrounds — we think that enhances [energy companies’] comfort that we’ll be a good partner in the ownership of assets that are critical to their operations. We intentionally built our team with people with operating backgrounds for that reason.”
Although that relationship focus may help build trust, it also helps the company know what it’s getting when buying property.
Shopping For Pipelines
Kreul evaluates pipelines the trust is considering with an eye to both ease of ownership and longevity of partnership. “We exercise a disciplined investment approach when evaluating assets. They’ve got to be quality assets that offer steady and reliable revenue, and are long-lived.”
Asked what constituted an attractive opportunity, he said, “A natural gas pipeline that a producer owns; not only their gas but third-party gas flows on the system and it’s well maintained.” Opportunities are flexible, though; he said crude, natural gas liquids and gathering systems among other types could fit the bill.
To evaluate quality, Kreul relies on records and in-depth talks with the operators, as well as standard due diligence to ensure he’s comfortable entering a long-term partnership. “You can’t dig out the pipeline to make sure they’ve done their corrosion prevention work. But you can sure study all their records on how they operate their system. You can get a really good feeling very quickly on the integrity management and what it means for them.”
The trust’s largest REIT-qualifying acquisition is the Pinedale liquids gathering system in Wyoming, which came online in 2010. It consists of about 150 miles of underground gathering pipelines with 107 receipt points and four gathering facilities in the Pinedale Anticline, an estimated 25 Tcf gas field underlying mostly federal land. The trust paid around $230 million for it in 2012.
Large reserves are one of the most important qualifying criteria to the buyers, because they lead to long leases. The lease on the Pinedale system is 15 years, and Kreul said 10 to 20 years was the target range. Long leases mean income is stable for CorEnergy and expenses are stable for operators.
Schulte said they expected to hold purchased assets long term. While shares of the trust are publicly traded, “The money stays put where we invest it with companies. We’re well known in the energy sector as long-term patient capital, and those relationships are all working in our favor at CorEnergy,” Schulte said.
Selling To Build
So who is selling? “Our financing proposals are attractive to upstream energy producers that have dedicated pipeline or storage assets that they would rather not have to own,” said Schulte.
Producers aren’t the only target. “A lot of the people we’re talking to are midstream companies that are looking at different ways of monetizing their system, looking to do different things in different ways,” said Kreul.
Although the trust wants to diversify the type and location of its assets, sellers might be more motivated in some parts of the United States than others. The previous owner of the Pinedale system, Ultra Petroleum Corporation, wanted the cash on hand to pursue more development, and CorEnergy expects that to be a common situation with production companies that own their infrastructure.
“Obviously the hot spots are the Eagle Ford, Bakken and Permian areas — there’s more opportunity in those areas than elsewhere,” Kreul said.
“The increasing availability of natural gas creates need for takeaway transportation, and the eventual increase in natural gas as a percentage of industrial input, including power generation, will be beneficial as well. There’s need for additional infrastructure on both ends of the energy value chain, the production side and the transportation and distribution side,” Schulte said.
Though the need for more infrastructure is clear, that doesn’t mean the money is available to build it, and that’s where Schulte sees a role for CorEnergy. “As capital needs to be deployed in the energy sector in general, our type of financing can lower overall cost of capital and be an attractive solution for companies that have higher return opportunities they want to exploit.”
Operators’ control of the infrastructure is assured because of the nature of a REIT, Schulte explained. “We cannot be the operator of energy assets. We can only own them and rent them or lease them to an operator. So anybody who has the desire to retain control and operating control of their assets would be interested in leveraging their investment by building a financing relationship with us.”
Because the leases are long, operators maintain a predictable cost of ownership on the pipeline as well as the full use of the infrastructure. For those who see a lot of opportunity for expansion, production, infrastructure or acquisition on the horizon, the extra capital might prove tempting.
Of course, operators could also mortgage their pipelines, or sell to another buyer. But neither alternative offers precisely the same opportunity.
“Banks have a low cost of money,” Schulte explained. “We offer more total availability [of capital] than they can get from a bank. Whereas a bank might loan three times cash flow, we can buy the asset for seven to ten times cash flow and then lease it back to them. So we can provide more capital than a bank, and at a lower cost than issuing new equity.”
Kreul agreed, though he focused more on the outcome of the transaction. “It’s a better deal for [an owner] than going to a bank and selling the pipeline system or going to a pipeline operator and losing control of what they previously owned.”
If he were considering a purchase and lease-back like this from the selling side, Kreul said, “I’d want a team that has operational engineering experiences. You’re talking more than just financing; you’re talking operations with these people.”
Schulte knows of one other REIT working in the pipeline sector, and it’s a private trust. “I would expect the adoption rate of this financing vehicle would be slow, because nothing happens quickly in the energy sector, but there is potential” for more investors to compete for the business. CorEnergy is interested in plenty of options while the idea percolates — maybe even financing a small new-build project.
“We have total assets of approximately $284 million,” Schulte said. “So we are just getting started. Our target is to be much larger than that.”
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