More organic spending and fewer acquisitions are expected in the U.S. midstream energy sector next year, a Standard & Poor’s (S&P) analyst said Friday.

In an Industry Report Card, S&P analyst Plana Lee said the midstream sector in 2007 will continue to see organic spending, along with a variety of master limited partnerships (MLP), “evolving” pipeline regulations and “vigorous” financing activity. S&P’s report mirrors some of the comments by RBC Capital Markets last month (see Daily GPI, Nov. 17).

“Midstream energy companies (e.g., transportation, storage, gathering and processing) continue to look to organic spending — as opposed to their previous reliance on acquisitions — for their primary source of growth,” S&P’s Lee wrote.

As an example, Lee cited the $1 billion organic growth project by Oneok Partners LP, Boardwalk Pipeline Partners LP and Energy Transfer Partners LP to build an interstate pipeline from North Texas to Cohoma County, MS (see Daily GPI, June 12). In addition, Lee cited the projects by Kinder Morgan Energy Partners, Sempra Energy and ConocoPhillips to build the $4 billion Rockies Express (see Daily GPI, Sept. 22), and MarkWest Energy Partners LP’s announcement to build and operate a gathering system for Newfield Exploration Co.’s Woodford Shale play (see Daily GPI, Sept. 27).

Organic spending, said Lee, “enables companies to avoid recent high midstream acquisition multiples…” but “it also carries with it the risk of strained balance sheets and greater sensitivity to commodity price volatility given the lag between capital spending and cash flow generation.”

S&P’s eight-page report suggested that some companies “may tend to lean toward unregulated midstream segments, such as natural gas gathering and processing, as opposed to regulated interstate pipeline construction.” However, Lee noted that move also holds risks for credit quality.

Mergers and acquisitions may slow because of “robust” organic spending, but the midstream sector may see a “growing variety of MLP assets and a widening range of risk profiles,” Lee wrote.

“On the high end of the risk spectrum, there has been a lot of buzz about the return of [exploration and production] E&P MLPs,” Lee wrote. “At the same time, there are offerings of MLPs at the lower end of the risk scale. For example, Duncan Energy Partners LP has announced a planned spin-off from Enterprise Products Partners LP in early 2007” to hold mature, low growth assets that appeal to lower-risk investors (see Daily GPI, Nov. 3).

“Meanwhile, Targa Resources is taking a more traditional approach to the MLP structure and has announced plans for an MLP offering next year that will hold its North Texas midstream assets” (see Daily GPI, Nov. 17).

Changes in pipeline regulations that result in “lower-than-expected rates of return” also could cool spending in midstream infrastructure, the analyst said. Lee cited the October ruling by the Federal Energy Regulatory Commission, which adopted a median return on equity (ROE) of 11.2% for Kern River Gas Transmission Co. (see Daily GPI, Nov. 22). The new ROE excluded MLPs but also excluded El Paso Corp. and the Williams Cos. Inc., which were part of the original proxy group. Kern River has petitioned for a rehearing.

For more information on the S&P report, visit www.ratingsdirect.com .

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