It looked like pipeline companies would escape the turmoil roiling the rest of the oil patch. No longer. The bad times caught up with midstream companies and like producers, service firms and refineries, they, too, are now scrambling to keep growing.
Until last fall, when the bottom fell out of the oil market and prices sagged by 50 percent, it was good times all around in the energy industry. The domestic oil boom, sparked largely by advances in drilling technologies, had boosted earnings at companies up and down the production stream, prompted a building and hiring boom and made the United States truly energy independent. Midstream companies raced to lay down enough pipelines to carry andstore the higher and higher volumes of oil and natural gas to market and saw their earnings soar.
But now, with oil prices eking out new lows, midstream companies are finally showing the hurt and scrambling to keep their balance sheets strong. They’re selling pipelines, cutting earnings forecasts, lowering distribution outlooks, writing down inventories and selling stock to fund 2015 budgets and to pay debt. In February, Plains All American Pipeline trimmed its 2015 midpoint profit outlook to $2.35 billion from $2.5 billion and unveiled plans to sell stock to raise money.
“We are not immune to the adverse impacts of a major change in commodity prices that is accompanied by a similar change producers’ activity levels,” Greg Armstrong, chairman and CEO of Plains All American Pipeline, said in a conference call.
Falling crude prices have already pummeled the oil industry, forcing industry giants like BP and Halliburton to lay off thousands of employees in the last few months. Midstream companies haven’t escaped the pain even though they’re not as exposed to oil price fluctuations as drillers are. Thus far, Enterprise Products Partners, DCP Midstream, Enable Midstream and Enbridge have announced modest job cutbacks in the low hundreds.
“It’d be nice if prices were higher and the environment was such that money was falling from the sky,” Jim Teague, the chief operating officer of Enterprise Products Partners said in a conference call. “Those days are gone now.”
Energy firms are spinning off their midstream divisions as stand-alone public companies to raise money and to capitalize on investor interest. Scared off from exploration and oilfield service firms, stock investors have seized on pipeline companies for their stability. Last month,
Columbia Pipeline Partners went public, raising more than $1 billion in its debut, becoming the biggest initial public offering of the year. Antero Midstream Partners and Shell Midstream Partners each raised more than $1 billion in their respective IPOs last fall.
Uptick in Merger Activity
Mergers are another way to lower company’s risk because they expand their financial resources and geographic presence. They’re also a way to increase money for acquisitions and streamline their complicated businesses. Energy Transfer Partners bought Regency Energy Partners of Dallas in January for $11 billion. Williams Cos. purchased Access Midstream Partners in October for $6 billion and Kinder Morgan, in one of the biggest deals in the U.S. energy sector’s history last August, acquired three companies it owns for $44 billion to create one mega-company.
“In light of the current volatility in commodity prices and the changes in the capital markets, it became apparent over the last several months that Regency needed more scale and diversification, along with an investment grade balance sheet, to continue its growth,” Mike Bradley, Regency’s CEO said in a statement.
The midstream sector clocked its biggest deal flow in decades, hitting $144 billion in deals last year versus $62 billion in 2013, according to research firm IHS. This year looks like it will be as busy as oil and natural gas exploration and production companies, struggling to fund operations, sell their pipelines. Thus far, there have been $24 billion in sales and there likely will be more as smaller midstream companies with fewer assets and a limited geographic range sell their assets, according to Fitch Ratings.
Texas, with two of the country’s biggest energy plays, is at the center of many of the deals. This year, about $20 billion in deals, or most of the U.S. activity, has taken place in the Lone Star State. In February, Phillips 66 Partners bought stakes in three pipeline systems, two of them Texas-based, for $1 billion. Pioneer Natural Resources put up its Eagle Ford Shale pipeline network in Texas for sale. Press reports have listed its value at more than $3 billion.
Billionaire Harold Hamm sold his Bakken Shale pipeline system for about $3 billion in January and the previous month, Encana sold some of its natural gas and oil pipelines in Western Canada for $328 million. Smaller companies are also getting hit with the downturn in oil prices. RSP Permian, Diamondback Energy and Reliance Energy sold their Permian pipeline network for $600 million.
Contracts Insulate Midstream
Midstream companies have been largely insulated from tumbling oil prices because they have long-term, fixed-fee contracts with producers. In the last two to three years, pipeline companies have switched to fee-based contracts to protect themselves from price volatility. This year, Fitch expects the volume of crude transported on pipelines to climb in the mid-single digits. But if low prices persist into 2016, “Fitch would expect a pullback or delay in spending on new infrastructure projects.”
Most of the pipeline projects either announced or under construction this year and next likely won’t be affected by the oil price rout because their plans were inked when prices were higher. But if production eventually slows, as it’s expected to do, midstream companies would finally start to suffer and funding for future projects will be tough to secure. A pipeline usually takes 18 months to build and goes through a long process for permitting.
“For most of 2015 and some of 2016, there probably won’t be much change. There’s a huge shortage of capacity in trying to serve upstream as it is,” said Cynthia Pross, principal midstream analyst at IHS. “There’s still wiggle room.”
At least through 2014, U.S. crude production was still etching new records. In December, the most recent data available, the U.S. produced 9.2 million barrels per day, a level not seen since the early 1970s, according to the Energy Information Administration. And in Texas, drillers pulled 3.4 million barrels of Texas tea out of the ground per day, the highest level since at least 1981. But more drilling rigs have been taken out of service and Texas issued 38 percent fewer drilling permits in January than it did in 2014, according to the state Railroad Commission.
Lower crude and natural gas prices will eventually hammer the midstream industry when exploration companies slash production. It’s unclear, though, when the widespread carnage would begin. Some producers will slow or cease production at different prices depending on their location within a basin, their efficiency at pulling oil or natural gas out of the ground and the product they’re extracting. In Texas’ Eagle Ford Shale south of San Antonio, one of the most prolific drilling regions in the country, the break-even price can range from $49 to $102 per barrel of crude, according to Wood McKenzie.
The pain is still relatively minor for midstream operators but it’s clear stagnant oil prices will eventually wallop the sector. The only question is when.
Kristina Shevory is a contributor to North American Oil & Gas Pipelines and a freelance writer, based in Texas. Her writing has appeared in the New York Times, the Atlantic Monthly, Newsweek and more.