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Competition Intensifying for Shale Gas Midstream Services

August 31, 2009
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With production from some of the more mature domestic natural gas basins declining, competition likely will intensify for gathering and processing (G&P) services to transport shale gas, according to industry players.

A review of 2Q2009 earnings reports issued by companies that are covered by Tudor, Pickering, Holt & Co. Securities Inc. (TPH) found G&P volumes slumped across a broad group of midstream companies. Like other sectors of the energy business, master limited partnerships (MLP) and other limited liability energy companies "were impacted by the decline in rig count and slowdown in drilling activity," wrote TPH's Anson Williams, Becca Followill and Jessica Chipman.

The onshore rig count appears to be leveling out in most areas, but "we still expect G&P volumes to decline" into the first half of 2010 "since it will take some time to stem the decline and return to growth," the TPH trio wrote.

Companies with "shale gas exposure should be able to offset some (not all) of their declines in more mature basins."

The review covered 11 companies, and eight of them showed quarter/quarter declines of 1-5%. Declines "were not isolated to one region/basin," but there were "significant" declines in South Texas and the Rockies, the TPH analysts said.

"We think volumes will continue to decline for the next few [quarters], but companies with shale gas exposure (Haynesville, Eagle Ford, Marcellus, etc.) will likely be able to offset some (not all) of their declines in more mature basins," said the TPH analysts.

Fractionation (frac) spreads currently are $5.45/MMBtu, which is "still well below $11/MMBtu in July '08, but significantly higher than the basically break-even fracs at the beginning of the year," noted analysts. Most of the G&P companies are heavily hedged through 2009, but an "improved processing margin environment [is] clearly a bright spot."

Because of falling gas prices and a drastic drop in the rig count, TPH's analysts were "cautious on volumes since the beginning of the year," and they generally forecast year/year declines. There are signs of recovery, however, and some operators are preparing for the day when gas production again is surging and G&P is needed. More liquid companies also are taking advantage of opportunities that have opened up in the cash-strapped marketplace.

Earlier this month Tenaska Capital Management LLC (TCM) and Energy Spectrum Partners V LP announced a joint venture (JV) partnership to operate Frontier Gas Services LLC, which would acquire, develop, own and operate gas infrastructure.

TCM, an affiliate of Tenaska Energy Inc., manages the $2.4 billion TPF II LP private equity fund, and with Energy Spectrum, the partners have pledged "at least" $250 million to fund Frontier. The JV's core focus will be to develop midstream infrastructure in the unconventional shale plays, TCM Senior Managing Director Daniel E. Lonergan told NGI.

"For some period of time we've been talking to variety of different parties, a number of midstream players and otherwise structured MLPs...some with challenged capital structures, and at the same time, we are facing a lot of new supply opportunities because of new drilling technology" in onshore gas basins, Lonergan said.

Once gas prices begin to climb, the need for G&P will be there, and it's an opportune time -- for those that are able -- to make investments, said Lonergan. Frontier Gas and Energy Spectrum plan to contribute from their existing midstream partnership the 36 MMcf/d Indian Creek natural gas processing facility in Roberts County, TX, with production from the Granite Wash formation in the Texas Panhandle.

The Frontier JV also will pursue established and greenfield opportunities in other gas basins, said Lonergan.

"It makes economic sense that higher finding cost areas or areas on the margin would be the first to see lower activities, but in the lower cost areas, there's a reduced rate of rigs being laid down," he said. "They're continuing to drill in the Granite Wash because of those characteristics. There's more wells coming online, which provides more opportunities for investments in gathering and processing..." (see related story). "The Indian Creek facility is a very competitive, economic processing plant, and we think we're as well positioned as anyone" to take advantage as production in the region grows.

The CEO of midstream operator Energy Transfer Partners also is optimistic about the future.

CEO Kelcy L. Warren told energy analysts earlier this month he thinks the industry could pull out of the bear market in 2010 (see NGI, Aug. 17). With gas volume declines overall, "this tends to suggest that we'll be recovering from this bear market hopefully in the not too distant future, maybe in 2010..."

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