June 2024, Vol. 251, No. 6
Features
Mega-Deals Reshaping How Midstream Business Is Done
By Richard Nemec, Contributing Editor, North America
(P&GJ) – As a chartered financial analyst with significant capital markets and merger-and-acquisition (M&A) experience spread over 22 years of positions in energy investment banking in Houston and portfolio management and research in New York, Amol Joshi brings a broad perspective into most any business discussion.
He holds a mechanical engineering degree from the University of Bombay in his native India and a master’s in finance from Pittsburgh’s Carnegie Mellon University Tepper School. Since 2014, Joshi has provided his expertise to Moody’s Investors Service in the Big Apple.
The veteran analyst concentrating on exploration and production (E&P), midstream and oilfield services has been watching the oil and natural gas sector long enough to remember when the $80 billion Exxon-Mobil Oil merger was the peak of a rash of mega-mergers.
At the time of that 1998 combination it was considered the ultimate big bucks’ merger, but as one of Moody’s vice presidents and senior credit analysts today, Joshi is observing and commenting on M&A in the midstream oil and gas sector that could continue well into next year or longer. He can readily recite the litany of combinations in recent months and years. These corporate marriages are plentiful:
Dallas-based fuel distributor Sunoco buying NuStar Energy in a $7.3 billion acquisition to obtain the San Antonio-based last pipeline operator in a stock-swap transaction in February.
- Energy Transfer LP combining with Crestwood Equity Partners LP in the fall of 2023 in a $7.1 billion deal.
- Tulsa-based ONEOK Inc. acquiring Magellan Midstream Partners, L.P. in an $18.8 billion merger deal creating one of the largest oil and natural gas pipeline companies in September last year.
- The $1.5 billion deal completed by Tulsa-based Williams Cos. to expand the company’s infrastructure network in key markets in the Rocky Mountains region with the acquisition of MountainWest Pipelines Holding Co. from Las Vegas-based Southwest Gas Holdings Inc.
There were $12.5 billion of midstream deals announced through mid-March this year, compared with $21.9 billion for all of 2023, according to researchers at Enverus Intelligence Research (EIR). If the current pace holds, this year it will be the biggest for midstream mergers and acquisitions since 2019, the EIR researchers predict.
“Combining complementary assets through M&A should offer significant integration opportunities and increased connectivity, benefiting both producers and shippers,” Moody’s Joshi said. “Rising regulatory scrutiny and increasing difficulties in obtaining permits to build large projects such as interstate pipelines, have slowed the investment that underpins midstream EBITDA [earnings before interest, taxes, depreciation, and amortization] growth. M&A activity is becoming much more appealing to midstream operators as a way to provide growth, as traditional organic growth prospects slow.”
Joshi adds the thought that sector consolidation does not necessarily add to aggregate infrastructure, so he thinks it can be broadly beneficial to individual companies’ credit quality. During his interview with P&GJ, Joshi stressed that Moody’s considers the midstream M&A activity to be “accelerating” currently, while for both E&P and midstream, organic growth opportunities are limited now, driving more M&A.
Credit Ratings Steady
In adjusting credit ratings upward, Moody’s is looking for M&A deals that “create efficiencies through scale and market share, enhance competitive positioning by adding complementary assets, or improve access to export markets while still achieving sound leverage metrics of the companies involved in the transactions,” according to Joshi, adding that increased M&A in oil and gas has not caused Moody’s to change its basic credit rating criteria.
“The key factors we look at haven’t really changed, nor should they,” he said.
Organic growth remains elusive for both E&P and midstream companies, Joshi said, and it is largely equity investors preferring capital-disciplined companies, meaning you only spend what you need to and don’t grow for the sake of growth.
So, on the E&P side, that means capex has come down significantly, resulting in the volume production growth being very modest,” he explained.
Underscoring this fact, the U.S. Energy Information Administration (EIA) early in 2024 in a short-term outlook projected flat growth for 2024, or essentially no growth in ’24 and modest growth in ’25.
“There is little doubt midstream M&A is far from over if we recall recent history,” said Joel Moxley, CEO of the GPA Midstream Association. “It’s clear that scale is important – the ability to provide services across the midstream value chain from the wellhead to markets in multiple basins. Consolidation in upstream space [by producers] continues and is leading midstream M&A. As producers increase in size and are active in multiple basins, they naturally look to partner with midstream operators that can work with them in more locations – both sides leverage their interactions to make the best commercial arrangements.”
At this year’s CERAWeek energy conference in Houston, presented by S&P Global, various major financial news media, including Reuters News Service reported that oil and gas midstream was becoming the focus of a lot of consolidation, following all of the E&P action in 2022-23.
Reports from CERAWeek described the midstream sector as in short supply of big companies able to operate in multiple major basins, and thus, through consolidation, more of the suppliers will be able to provide a fuller array of processing, transport, storage and export services.
Importance of Scale
“Scale is definitely important,” Williams Companies’ COO Michael Dunn told Reuters at CERAWeek. “Continuing to expand is certainly one of our goals.”
In its annual report on oil and gas consolidation drivers, Colorado-based East Daley Analytics predicts the M&A activity will continue throughout 2024, noting that publicly held midstream companies have been “on a spree” since last year.
East Daley cited examples of Williams and Cureton Midstream/Rocky Mountain Midstream, along with Kinder Morgan, getting the NextEra Energy Partners’ south Texas gas pipeline assets.
“As the midstream sector transitions into a lower-growth environment with increasing regulations, we expect M&A to continue,” according to East Daley analysts. “Companies will use mergers to gain scale, better position themselves to take advantage of growing export markets and optimize their existing assets in the ground.”
Other well-regarded analysts, such as Housley Carr, at RBN Energy, and an online financial reporter Elle Caruso, at ETF Database offered similar breakdowns of the midstream space and the prospective M&A activity.
“It could be argued that conditions for large-scale midstream M&A have never been better,” Carr wrote toward the end of 2023, citing publicly held companies looking to gain more and more scale, and private equity firms seeking to cash out some well-planned developments.
In March, Caruso noted that midstream operators have a key role to play in the global energy transition, emphasizing that growth opportunities “remain constructive,” with the energy transition being a key long-term opportunity for the space.
“Both renewables and fossil fuels will be necessary to satisfy future energy demand,” she wrote in a Morgan Stanley Capital International, Inc. report. “The projected increases in both population and energy consumption can’t be supported by renewables alone. Importantly, increases in energy consumption enable quality-of-life improvements.”
From the prolific Permian Basin to the northeast Appalachian region’s natural gas gusher, officials told P&GJ that M&A is not negatively impacting U.S. energy production, and it only bids to help stabilize growth during some complex socio-political-economic times.
“Right now, the pause of LNG exports, I would think, has a much greater impact on production and thus midstream activity than the M&A market,” said Stephen Robertson, executive vice president at the Permian Basin Petroleum Association (PBPA).
Some Contradictions
Early in the second quarter of this year, Robertson saw some contractions for PBPA members until WhiteWater/I Squared and MLPX LP’s 580-mile Matterhorn Pipeline project was to come online later in 2024.
He noted in April that he believed the next significant capacity addition for the Permian Basin will be the Matterhorn, but pointed out that the project is not scheduled for completion until the third quarter, so operators in the Permian Basin will likely have to deal with discounts on natural gas production in the meantime, or longer.
“It is my understanding that several producers might be timing their development of new production facility additions to coincide with not just pipeline additions, but processing plant additions as well, so even with new [pipe] capacity coming online via the Matterhorn or other projects, that capacity is likely to get filled quickly.”
Shortly before Robertson made his comments to P&GJ, Austin, Texas-based WhiteWater (50.6%), MPLX (30.4%), and Enbridge (19%) jointly entered into a definitive agreement to “strategically combine” the Whistler Pipeline and Rio Bravo Pipeline projects in a joint venture. Enbridge retains its 25% interest in Rio Bravo.
At the time, industry commentators said the combined platform should provide significant benefits to the joint venture's customers by connecting Permian supply to incremental LNG export markets via Rio Bravo's connectivity with NextDecade's Rio Grande LNG facility.
Additionally, the creation of this platform is anticipated to support the development of incremental pipeline projects connecting Permian supply to export markets along the Gulf Coast.
The Matterhorn is an intrastate pipeline designed to transport up to 2.5Bcf/d of gas from the Permian Basin to the Katy area near Houston. It includes seven compressor and 21 meter stations. Ancillary facilities include mainline valve assemblies, launcher/receiver assemblies, riser assemblies and other appurtenances.
The 137-mile Rio Bravo project consists of 48- and 42-inch pipe to carry up to 4.5 Bcf/d of gas from the Agua Dulce supply area to Next Decade’s Rio Grande LNG export facility in Brownsville, Texas. It has an in-service target date for 2026, and the LNG facility would start later this decade.
“The combination of Whistler Pipeline and Rio Bravo Pipeline assets confirms the importance of our Rio Grande LNG project as a major market for associated gas from the Permian Basin,” NextDecade CEO Matt Schatzman noted at the time of the joint venture’s creation.
For the future, the jury is still out on how regulation and investment in the midstream will unfold, but they are definitely intertwined as both Moody’s Joshi and GPA Midstream’s Moxley point out. Larger midstream companies should have access to capital to construct midstream infrastructure as long as permitting time is reasonable and there are sufficient customers for the projects, according to Moxley.
“Effectively, it means no new pipe is getting built, aside from some pockets in Texas and Louisiana; regulatory and siting issues are ongoing that affect the new pipe builds.” – Amol Joshi, analyst at Moody’s Investors Service
“There are few ‘build it and they will come’ investments in midstream – the customers have to commit for long enough terms to make capital projects work,” he said.
And as Joshi sees it, in addition to the volumetric slowdown, there is some heavy regulation bearing down on the midstream side.
“Effectively, it means no new pipe is getting built, aside from some pockets in Texas and Louisiana; regulatory, and siting issues are ongoing that affect the new pipe builds,” he said. “Given these two factors – volumes and regulations – M&A activity becomes that much more attractive,” Joshi said.
It all amounts to the current limited avenues to growth, as far as the Moody’s team is concerned. If the pie is not growing, you always want to gain market share or get a bigger slice of the pie.
Midstream is running a little behind E&Ps, according to Moody’s, but it has considerably more public companies.
“Midstream companies get the E&P companies’ product to market, so they continue to be impacted by consolidation of the E&Ps,” Joshi said. “As the E&Ps get larger and stronger, it means the counterparty or customer strength of the midstream companies gets better, benefitting the midstream as well.”
Moxley notes that the drivers for M&A are higher interest rates for debt and the reduction in private equity investment in midstream, estimating the interest rate hikes over the past year increased borrowing cost by 0.5%-1% as older debt matured.
“This increased cost goes directly to the bottom line as there are few ways to offset this added cost with higher revenues,” he said.
During CERAWeek, Jefferies Financial Group’s Peter Bowden noted that there now are few privately held midstream operations of any meaningful scale following the many sales in recent years. Hence, he thinks more public midstream consolidations are “inevitable.” And the coming consolidations will most likely skip the initial phase of private company deals that once was common for shale companies, diving directly into strategic combinations, according to industry observers like Bowden, the global head of Jefferies’ industrial, energy and infrastructure unit.
In the Williston Basin in North Dakota where the Bakken Shale continues to produce more than 1 million b/d of crude oil and 3.5 Bcf/d of natural gas, producers and midstream players are feeling the effects of the M&A trend, according to Lynn Helms, director of the state Department of Mineral Resources.
“Producers drilling budgets are definitely disrupted, especially if they are fully active Bakken companies,” Helms said in mid-April when he reported that the state had passed 6.9 billion barrels of oil production, with more than 5 billion coming from the Bakken.
“With consolidation, operators have a tendency to go back to the drawing board and reorganize their rig schedules and reprioritize, so you have an entirely new rig schedule trying to coordinate with the midstream folks to come up with gas capture plans,” Helms told news media on a monthly production webcast. “We tend to see the merger of two very different rig schedules and contracts, so everything gets reprioritized there, and typically we will see one or two rigs fall off the schedule short term, if not longer.”
GPA Midstream’s Moxley said there are “normal adjustment periods” after an acquisition when staff must be realigned to cover the new assets.
“Usually, fewer people cover the newly acquired assets than at the old one, so some time is lost as new people get up to speed,” he said.
New assets must be integrated into the company’s culture, records systems, safety programs, maintenance programs, etc. — all of which can take several months as integrating the new assets into the existing business takes time to study, evaluate, implement, and come online.
Moxley noted that an important factor driving midstream companies’ hunger for larger scale is the increasing costs of complying with new regulations, including methane fees and greenhouse gas emissions disclosure requirements. He said “massive amounts of data” are now required by the new rules.
“Complying with these new rules requires resources – staff and systems – that reinforce the importance of scale,” according to Moxley.
Generally, Moxley and other midstream officials view the continuing consolidation as not tipping the scales on capital spending up or down. If added service is needed and the financial numbers crunching adds up, they say multiple companies will usually bid for the work.
In this regard, midstream M&A is not just likely, they say, it is inevitable.
Richard Nemec is a Los Angeles-based writer and long-time contributor to P&GJ. He can be reached at rnemec@ca.rr.com.
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