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Midstream Reeling From Prices, Still Wheeling & Dealing

Midstream Reeling From Prices, Still Wheeling & Dealing

There's no doubt about it, times are tough in the midstream gas business. Depressed NGL prices and unfavorable margins have kept at least one player from selling its assets while the same factors caused another to seriously rethink the wisdom of a recent purchase. Executives and analysts predict a lot more horse trading of properties as companies look to rationalize assets and build positions for better times (hopefully) ahead.

The most recent midstream acquisition, American Electric Power's (AEP) purchase earlier this month of Louisiana Intrastate Gas (LIG) from Equitable Resources, is viewed as a strategic deal, another example of gas and power convergence (See NGI Sept. 21, 1998). "What [AEP] bought was a platform to trade BTUs," said one analyst focusing on the midstream who asked not to be named. He said the LIG assets give an adept trader something to trade around. Equitable was faced with a number of obstacles to capitalizing on LIG, exacerbated by a defection of traders following the announcement of LIG's sale. It remains to be seen, however, how AEP will make out with its new midstream properties. "All of these guys buy them with the intent of doing better than the old guy."

PG&ampE has decided, after much deliberation, not to sell the assets of Valero Energy, which it bought for $722 million last year, and Teco Pipeline Co., which it also acquired last year for $380 million. In April, PG&ampE CEO Robert Glynn Jr. told NGI some of the Texas assets were losing money (See NGI April 20, 1998). "And we are interested in having discussions with interested buyers on those particular pieces" that might be of more value to someone else.

Since then things have changed. "We, as you know, took a real hard look in late spring and through the summer at all of our business in Texas in particular, and we have a strong interest in power down there, and we have a strong interest in gas down there," said Joe Kearney, CEO of PG&ampE Gas Transmission. "We still have that interest, and we have no intention of selling any of the gas transmission assets we have down there. The gas transmission includes all our liquids assets."

Admitting Valero has suffered from low liquids prices, Kearney hastened to add the liquids downturn is purely cyclical. "Our view is that this is at or close to the bottom of the trough, and this trough may be a little longer than others. But we look at this business as a cyclical business that's going to turn around."

The $722 million price paid in an auction for Valero raised industry eyebrows. "PG&ampE paid well into a double-digit EBITDA multiple, and they paid for a company that has a lot of natural gas liquids exposure, and we were close to the peak in liquids markets," remarked the unnamed analyst. Liquids exposure, the dissipation of the price spread between East and West Texas, and expiration of above-market Valero citygate legacy contracts took the luster off Valero, the analyst said. PG&ampE "paid a high price, a strategic price, to enter the business, and the numbers have been difficult. We're dealing with trough numbers."

Kearney admitted the West-East Texas basis differential likely won't improve. "I think that the dynamics of the marketplace down there have changed fundamentally and that we are not anticipating a return to the large basis spreads that we saw in the 1996-97 timeframe. That's not to say that the business won't provide us opportunities beyond that because I think there are emerging markets down there that our gas transmission system is in an excellent position to serve."

Looking ahead, Kearney said there are opportunities in gas-power convergence in Texas. "We're going to be active on the power asset side there. There's going to be an opportunity on the pipeline as the electricity markets become more open to independent producers and wholesale electricity becomes more active and understood."

While it considered selling assets, PG&ampE did not go as far as UtiliCorp United did with Aquila Gas Pipeline - a sale attempt that was eventually aborted. When Aquila was put up for sale in March (see NGI March 16, 1998), Aquila CEO Joe Becraft said, "Clearly we are in a good M&ampA (mergers and acquisitions) market right now if you have assets to sell." His optimism followed the recent purchases of USX Delhi by Koch Industries, TPC Corp. by PacifiCorp and Valero by PG&ampE. Becraft touted Aquila's Oasis Pipeline and the Southeast Texas Pipeline System in the Austin Chalk as well as a pipeline and plant in western Oklahoma.

The thrill is gone, for the time being at least. Aquila was taken off the market in August (See NGI Aug. 10, 1998). "It's difficult right now, largely because of the low prices in natural gas liquids, and we see that improving modestly but not really significantly over the next few months. We do think it will return to some strength over the next year," Becraft told NGI last week. He said August probably was Aquila's second best month in terms of volumes gathered - a little more than 500 MMcf/d - from the Austin Chalk. "We're operating pretty much at capacity there and are wrestling with the fun questions of how do we expand our assets." He also pointed to "decent drilling" in southwestern Oklahoma where Aquila's Elk City system gathers 70 to 75 MMcf/d. "That's holding up quite nicely, growing a bit."

Still, Becraft conceded the timing of the sale attempt "wasn't the most auspicious." Again, the story was low liquids prices and erosion of basis differentials on the Oasis pipeline, which "spooked a lot of folks."

Petrie Parkman principal Stu Wagner said potential Aquila buyers likely fretted over high decline rates in Aquila's home turf, the Austin Chalk. "The seller saw one environment. The potential buyers were concerned about the opposite happening. In Aquila's defense, this has always been a concern about this system. I think buyers have a hard time stepping up when there are these kinds of long-term concerns in a weak price environment." Becraft said he has a bullish outlook on gas demand, and plans to sell Aquila have been scrapped. "I won't say that subject will never pop up again."

Still in the offing is the sale of Union Pacific Resources' midstream assets as part of the company's extensive and ongoing de-leveraging program. "We are in discussions with prospective buyers and we're at a very sensitive stage in all of this," said UPR spokesman Dan Sullivan.

UPR's midstream business has attracted the interest of at least one of the midstream's 400-pound gorillas, El Paso Field Services. "We're still involved with UPR. They have to raise capital," said Field Services President Bob Phillips. Besides El Paso Field Services, the big boys of the midstream include Duke, Williams, Shell-Tejas, Dynegy, GPM, as well as Conoco and Amoco among the producers, Phillips said. Giving credence to the argument for consolidation of the midstream among the largest companies, big pipeline company El Paso enjoys synergy opportunities that smaller midstream players typically don't have.

"We view gathering and processing both as a very solid, long-term, non-regulated complement to our regulated transmission business, but it also creates significant synergies with those transmission systems because we aggregate supplies." Phillips said about 45% of Field Services' throughput ultimately flows to El Paso's regulated pipelines. He said the company has not been as exposed to liquids prices as some others as about 75% of its overall gathering and processing portfolio is fixed-fee with only about 25% of fees fluctuating with commodity prices.

El Paso Field Services has positions in the San Juan Basin, Permian Basin, North Louisiana, South Texas and the Gulf Coast. Expect more asset trading as companies like Field Services seek to build geographically diverse and balanced portfolios. Phillips pointed to asset swaps between Duke Energy Field Services and Koch Midstream Gathering and Processing (See NGI Aug. 3, 1998), and Field Services' own recent sale of Anadarko Basin assets to Midcoast Energy (See NGI Aug. 3, 1998). "We'll concentrate our capital and resources on geographic areas where we can be very successful."

For its part, Becraft said Aquila is "looking at a number of not major but nonetheless acquisition opportunities. grassroots gathering in our general area of operation [Central Texas, southwestern Oklahoma]. We're looking elsewhere also, but we're seeing some opportunities in those particular areas."

Predictions call for big oil companies to become more involved in the gas midstream. Chevron is in with Dynegy; Mobil has Duke. And Shell has built itself into a significant midstream player along with Tejas. In the early 1990s, deregulation made the midstream attractive to Shell. Through a series of steps, the company created its midstream business unit in 1996. "In 1998, we looked around and said that our philosophy was that we had to bring our trading activity and the marketplace and the intelligence that came with that data. we had to bring those much closer together, both with the Shell midstream assets and the Tejas assets," said Curtis R. Frasier, Tejas Energy executive vice president. That led to the Shell-Tejas combination.

As trading of midstream assets continues on the road to consolidation and the convergence of gas and power, Phillips wonders what view Wall Street will take of the midstream. If the Street looks past the short-term decline in earnings from depressed liquids prices and focuses on the quality of companies' midstream assets it will "see this segment as a segment that has significant earnings power, and they'll see a segment that has significant growth capability. And that's really what all these companies want. They want a business that has reasonably stable earnings power, and they want a business that has significant investment opportunity."

Joe Fisher, Houston

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