December 2016, Vol. 243, No. 12
Features
Pipeline Infrastructure: LDCs, the Little Engines that Could
Matt Sheehy, president of the Rockies Express Pipeline (REX), and David Lavoie, the vice president of business development at NG Advantage LLC, are engaged in different parts of the natural gas infrastructure sector, but they both see a new paradigm for what will be driving the future projects that get built. They both seem to realize intuitively that the old producer-driven model is fast being replaced.
Sheehy, a former Connecticut-based venture capitalist, joined the operating side of the energy business in 2012 as part of Tallgrass Energy Partners LP when it acquired an initial interest in REX, which he now heads. He has watched the midstream pipeline business shift from being west-to-east and producer-driven to something entirely different that he thinks will change even more in the next three years. Sheehy and Lavoie are both in a position to see the local distribution companies (LDCs), the forgotten “little engines,” begin to assert themselves in the marketplace, and by definition in the future infrastructure decisions that became more complicated and less clear in 2016.
Sustained low commodity prices, a worldwide oversupply of oil and gas, overleveraged exploration and production (E&P) companies and a myriad of balance sheet and marketplace challenges have become a perfect storm for the LDCs.
Under the theme of “Back to the Future,” Sheehy offered his thoughts at an LDC Gas Forum Rockies & West meeting in Denver in the fall. He foresees a new phase of growth in the LDC world that will help direct much of the future midstream infrastructure additions.
“We’re headed into a new phase of growth in the LDC world and many of the companies in the West are going to play a major role,” Sheehy told Forum attendees, stressing the “westward trend” in infrastructure and market growth will continue and his own REX organization will remain a catalyst for a lot of change as it leads the east-to-west reversal of pipeline flows from the northeast Marcellus and Utica shale plays.
As a “virtual pipeline” alternative, Lavoie’s Vermont-based company sees this paradigm shift from the perspective of an enabler in New England and other areas seeking natural gas when pipelines are problematic. NG Advantage can be a bridge for LDCs when they can’t reach new customers because of infrastructure constraints that continue to plague the Northeast, even with all the recent buildout of energy infrastructure in response to the Marcellus, the single-most productive U.S. basin for gas and likely to stay that way for another decade or longer.
Lavoie said his company’s “gas island” concept involves NG Advantage trucks delivering supplies of compressed natural gas (CNG) to serve customers off the pipeline grid until an LDC can extend its system to those customers. NG is not in competition with various pipeline proposals. While Vermont Gas Systems, the LDC, struggles to expand its distribution system to several large customers in the Middlebury, VT area, the LDC asked Lavoie’s company to serve them through the virtual pipeline, and they have done that for over two years.
In this case, the utility owns the gas; NG Advantage just has a tolling arrangement to be the carrier of the supplies in the form of CNG to each customer. Vermont Gas handles all billing and servicing arrangements. Lavoie notes his company is now majority-owned by publicly held California-based Clean Energy Fuels Corp. and is not subject to any of the regulations that a normal gas LDC would face.
The niche for firms like NG Advantage becomes clear when considering the pipeline infrastructure permitting pitfalls evident throughout the Northeast and Upper Midwest. This fall, Vermont Gas was still struggling to undertake its 41-mile natural gas pipeline extension that would cover a western portion of the state, ending in Middlebury, site of NG’s CNG service. It didn’t help in getting the project back on track when the estimated pipeline costs nearly doubled from $86 million to $165 million in mid-2016.
In these cases, state regulators often will attribute the higher costs to poor management by the utility, while the LDCs attribute the increases to unanticipated circumstances, such as rock ledges, more expensive than expected horizontal drilling, and added costs associated with acquiring pipeline rights-of-way.
Timelines seem to slip on many of the proposed pipeline projects in the continuing low commodity price environment. In October, FERC speculated about delays in the Williams Partners’ Transcontinental Gas Pipe Line Co. LLC’s Atlantic Sunrise expansion out of the Marcellus. The anchor shipper for that project is a producer, Cabot Oil & Gas Corp., but that’s one of the facets of the future that is changing, according to Sheehy and others.
While the producers and pipelines have played the lead role in promoting these infrastructure expansions with a mixture of success, the LDCs are going to play the dominant role in coming years, Sheehy expects. He particularly likes the prospects for western LDCs and for resurgence in the Rockies supply basins, noting that the Mancos Shale could be a “game-changer,” and he sees new investment opportunities for E&P companies that in 2016 were more focused on the Permian and Eagle Ford plays in Texas.
“In my mind, it is the LDCs turn to step up and seize opportunities, particularly in the East where we are going to see power generation, LNG exports and other industrial loads filling out the marketplace,” Sheehy told his Denver audience of mostly LDC and marketer representatives.
He finds the rationale for this view emerges from the crippled balance sheets of producers in 2016, exacerbated by the continuation of over two years of depressed commodity prices. What he called the “producer push model” for new infrastructure no longer applies. “It was a great model in a $100 a barrel world, but not now,” he said.
In the mid-2014 or earlier higher-priced commodity market, producers and pipelines were doing the right things, but global economic forces were pushing against them, Sheehy said, with statistics from banks and elsewhere that debt was getting out of hand.
“There is a lot of debt that wasn’t there before,” he said, noting that as a result, producers for the past two years have been slashing drilling costs by an average of 25%, and cutting general operating costs another 10-15%. “The guys in the Bakken and in the West have done a spectacular job of knocking down costs – everything from well completion to water costs.”
For LDCs which should be stepping into the fray deciding future infrastructure and backing new reserves, these continuing efficiencies and advances in cost-reduction eventually need to help break the ice with state regulators who are reluctant to turn them loose in the gas patch to leverage new cost savings on future fuel supplies for captive local retail utility customers.
LDCs and new power plants are the prime targets for REX’s most recent shift of over 4 Bcf of capacity moving east-to-west out of the Marcellus to serve new loads in Ohio and Indiana, said Crystal Heter, vice president of commercial operations at REX and Tallgrass Energy Partners LP.
At the other end of REX, the Rockies were somewhat quiet in 2016, but longer term there is the potential for a ramp-up, and there will be much more gas moved from there in REX, said Heter, echoing her boss, Matt Sheehy’s outlook.
Heter describes an evolving REX that is ever-changing, and that is looking for the market, particularly LDCs, to chart the new directions. “We have the ability to flow in both directions, so you [LDCs] tell us what you want,” she told the industry audience in Denver in October.
“East-to-west is the new natural gas paradigm,” said Kevin Petak, vice president with the energy consultants ICF International, noting that the Marcellus is North America’s largest supply basin and he expects it to stay that way for years to come. “Basically, the Marcellus is displacing gas molecules across the continent.”
For both pipelines and LDCs, diversification of supply sources, hedging and changing footprints are important elements for future success. Implicit in this is the need for new infrastructure and receipt points, said Petak, who labels himself as “bullish” on natural gas pricing generally, seeing prices trending upward through 2015, reflecting current future market prices in the $3-3.50/Mcf range.
The importance of global pricing and supply demand-balances for not just natural gas, but the entire fossil fuel spectrum from crude oil to natural gas liquids (NGL), is part of a broader backdrop of interconnectedness that increasingly is characterizing the North American energy sector, according to Dawn Constantin, vice president for marking and fundamentals at BP Energy Co.
Keynoting at the same Denver conference with Sheehy and the others, Constantin thinks industry is in the midst of relearning receipt points and flows on the nation’s gas pipeline grid, and that trend “changes the game in terms of operations and regulations,” along with commercial and marketing relationships. She sees very dynamic but challenging times ahead in the energy industry through 2019, during which the need for infrastructure to keep up with supply/demand shifts and price volatility will be only part of the conundrum.
Constantin argues that it is getting increasingly difficult to predict what future supply and infrastructure needs there will be, based on Henry Hub future gas prices.
“All of the commodities are more interconnected than ever before,” she said. Based on current reduced production in response to over two years of depressed global oil/gas prices, it is difficult to reconcile the signals for higher futures prices and stepped-up demand that Constantin sees “right around the corner.”
Ultimately, the difference between $50/bbl and $70/bbl oil is huge, regarding having the incentives to build the infrastructure and produce the added gas supplies that eventually will be needed to meet that stronger demand.
“There are more and more pieces of this puzzle that can move on any given day, making it much more difficult to figure where these [Henry Hub and WTI crude] prices are going to go,” Constantin said. “That North American puzzle is way bigger than it used to be because of how North America has changed the rules.”
As a result, she warned her mainly LDC audience at the Denver LDC Gas Forum to create new ways to protect themselves and thrive, leading back to Sheehy’s message for the distributors to seize the current moment in time more aggressively.
“What is the new paradigm contracting for new pipeline projects?” Sheehy asked rhetorically. First, he answered himself: “It is not just new pipelines, but capacity in general.”
“LDCs and end-use customers [power plants and large industrials] are going to have to step up and say what they want, and the producers would love nothing more than to sign long-term agreements with an LDC or an end-use customer.
“They don’t know where the gas is needed. Producers literally want to meet more people who want to do deals, and the LDCs can be matchmakers for this. New infrastructure is not necessarily going to be interstate, but necessarily much will be within a given LDC’s service territory. Utilities and other end-users can support development, and LDCs can spot all of these opportunities; utilities can and do spot development.”
In a sense, Sheehy sees the LDCs as the radar and reconnaissance for the midstream and producers, given the local distributors’ boots-on-the-ground perspective is ever-more important in determining future infrastructure growth.
Sheehy cites REX’s attempt in 2016 to do a project with Illinois-based Nicor Gas, an AGL Resources utility, aimed at bringing a new transmission pipeline into the Chicago area and connect with producers in the Joliet, IL area south of the city, but from the LDC’s standpoint, the project was solely related to the northern part of its service territory, which the utility saw changing in major ways.
Similarly, Kansas City has a service territory growing and changing, but interstate pipelines, such as REX, do not know the important details of these changes. “This is where there is a value proposition for LDCs,” he said.
What Sheehy sees squarely in the industry’s immediate future is what he dubs “the re-plumbing of America,” as growth centers on the existing major pipelines, especially in the Rockies. “[Gas flows] are going to continue to come back toward the Rockies, and I don’t see the Marcellus [supplies] kicking the Rockies in the teeth; this is just another example of how things are going to change.”
The future in the Mid-Continent and the West has already happened in the Northeast with Tennessee [Gas Pipeline/Kinder Morgan], TETCO [Texas Eastern/Spectra], Transco [Transcontinental Gas Pipe Line/Williams], Dominion [Transmission Inc.], and REX, where the flows on those pipelines have changed. Sheehy sees that repeating in the West. “The [Tallgrass] Pony Express pipeline is an example of re-purposed infrastructure [690-mile oil pipeline from Wyoming to Oklahoma in which 430 miles is a converted, existing gas pipeline], and I think we will see more of that.”
Sheehy described a “wave” of LDCs stepping up to identify the need for re-plumbing will be heading West in the months and years ahead. He offers the example of the St. Louis LDC Spire Energy’s (formerly Laclede) proposal to build the 60-mile Spire STL Pipeline to connect with REX in Scott County, IL, offering the potential for St. Louis getting some supply from the Marcellus.
“Stepping back from the details, this is a really big change with the existing LDC that for decades was served by the same pipelines from the same supply basins; all that is now changing,” he said. “St. Louis is a great example; no one could get in there for 25 years, and now they’re building up to REX to get access to different basins [Marcellus, Utica and possibly the Rockies].”
In a similar vein, Chicago and Kansas City metropolitan areas are going to change. The prospect is for more infrastructure between the LDCs and the interstate pipelines. “Denver or Salt Lake City also come into play as you continue this march westward,” said Sheehy, recognizing that California “is a little bit of a different beast because its LDCs have been standing up and supporting bigger projects for a while.”
The reality of state regulatory commissions still looms large as Rapid City, SD-based Black Hills Corp. found out in 2016 when it withdrew its carefully crafted proposal to six state regulatory commissions seeking approvals for the first phase of a proposed two-step move to ratepayer-funded cost-of-service gas supply programs tapping future supplies from the Mancos Shale and elsewhere in the West. Its executive leadership has indicated it still wants to pursue the program.
“The program proposes to reduce our customers’ exposure to long-term gas price increases and volatility with reasonable expectations of lower long-term gas costs for customers,” Black Hills officials then noted. “Both are worthy objectives, considering the historical volatility of gas prices, particularly during critical winter heating months.”
Noting the barrier the state regulators can present, Sheehy said, “We’re in a paradigm where we have a lot of gas, lots of producers looking for a friend, and the LDCs have growing needs with coal conversions, sprawling service territories, and the need for new sources of supplies.” Now is the time to think outside the box, beyond REX or another established interstate pipeline, he urged.
While the producers’ balance sheets have been hit hard by the low commodity prices, Sheehy said the LDCs’ balance sheets are relatively “pristine” because they operate in a methodical, thoughtful way for the most part.
“I don’t want my LDC rolling the dice on projects as an end-use customer in Kansas City where I live,” Sheehy said. He is looking for a leveling of the scales in the immediate year ahead with the LDCs on par with the producer/customers. Now is the time for large industrial customers of LDCs to recognize the benefits that the local distributors can bring, Sheehy said.
He is expecting some loud and clear market signals coming from the local areas around the West. Not just the industry, but customers and regulators need to listen to and be sensitive to those signals. How they respond could speak volumes for future gas infrastructure projects.
Richard Nemec is a P&GJ contributing editor based in Los Angeles. He can be reached at: rnemec@ca.rr.com.
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